The Role of Central Banks in Shaping Global Share Markets
Central banks take an interest in maintaining healthy financial institutions and markets, serving as lender-of-last resort as part of their mission.
Further, they are responsible for several other areas such as payments systems, currency and economic analysis and statistics – tasks which require extensive operational transformation to successfully carry out.
1. Interest Rates
Interest rates refer to the percentage of money paid monthly as interest on any sum that has been loaned or borrowed, typically over one year but also sometimes shorter terms.
Rising interest rates can have an immediate effect on corporate profits. Debt-laden companies tend to experience decreased earnings as higher borrowing costs cut into their profit margins, particularly small cap firms which tend to borrow more frequently than larger counterparts.
Rising interest rates can reduce the present value of future cash flows when discounting them with a higher discount rate, placing additional strain on assets like stocks that may be riskier investments.
2. Liquidity
Liquidity refers to the ability to quickly convert assets to cash without experiencing significant price changes, making the transaction of funds between savers and borrowers simpler and easing funding flows more smoothly.
Market observers typically use liquidity in its broadest sense to encompass concepts such as credit availability, fund flows and asset prices. Investors tend to place greater faith in risk measures when liquidity conditions are conducive.
Central banks manage the flow of money in circulation by purchasing or selling assets like Treasury bills, repurchase agreements or repos, private company bonds and foreign currencies in order to increase or decrease circulation and market liquidity. Liquidity also plays a crucial role for businesses, as having access to funds allows them to cover unexpected expenses or invest in growth-focused projects.
3. Financial Stability
Financial stability means constructing an adaptive system capable of withstanding all of the unpredictable changes occurring within an economy at any one time, but also making sure individual institutions don’t suddenly collapse, stopping real economy activity altogether and hurting people who couldn’t have expected this disaster to strike so suddenly.
To do this effectively requires taking a systemic perspective that considers all links within and between parts of the financial system and between it and real economy. Furthermore, judgments regarding financial stability must also take into account risk-taking by individual institutions along with interconnection and vulnerability of each system; and recognize how effective self-corrective market-disciplining mechanisms may create resilience that endogenously prevent problems from becoming systemwide risks.
4. Payment Systems
Payment systems we take for granted represent a vast network that took decades to construct. Central banks oversee this financial infrastructure that keeps money moving smoothly throughout our economy.
They are responsible for issuing and regulating how much money is in circulation to ensure families, businesses, and States have access to enough currency exchange. Furthermore, they supervise the system that transfers funds between bank accounts either domestically or internationally.
Central banks also lend to banks to cover temporary liquidity shortfalls or increase cash reserves, using discount operations. Their rates may be set by central banks so as to encourage or dissuade specific types of lending activity.
5. Financial Stability
Financial stability can be defined in various ways, but most agree it means the absence of system-wide episodes in which finance fails (crises) and that systems are resilient against shocks. Achieve financial stability involves identifying, monitoring, and assessing vulnerabilities across all parts of the financial system – markets, institutions and infrastructure alike – while simultaneously considering risks that build up over time and imbalances that form as they develop over time. It is also vital that public policy instruments do not circumvent market forces as this can cause moral hazard or adverse selection issues.
Financial stability should be seen as an evolving state that can fluctuate over time; its fuller definition reflects this reality by occurring along an infinite continuum rather than as a static condition or state. Financial instability rarely results from one event alone.
