Chapter 15: The Financial Sector
Explainer, notes, worksheet and data.
What you'll learn in this chapter
- analyse demand and supply of cash/credit in the money market
- explain how commercial banks create credit (fractional reserve banking) and the consequences
- explain what influences interest rates and how rate changes affect economic activity
- evaluate the role of financial institutions and regulators
Core ideas
This chapter explains how the financial system supports spending and investment — and why instability can spill into the real economy. You’ll connect bank lending, money creation and interest rates to borrowing, saving, house prices, investment, growth and unemployment.
Exam focus
- step-by-step explanation: how deposits can multiply into new credit in a banking system
- rate-change impacts: list and explain effects of rising vs falling interest rates
- evaluation: why regulation exists (consumer protection, stability) and possible downsides
Interactive: Compound Interest Visualiser
See how compound interest (interest on interest) grows wealth dramatically over time compared to simple interest. Adjust the principal, rate, and time horizon below.
Interactive: Credit Creation Model
Adjust the sliders to see how banks create credit through the money multiplier process. Live ECB policy rate shown.
The money/credit multiplier illustrates how banks expand the money supply. Note: ECB reserve requirement is 1% since Jan 2024 (was 0% from 2019–2024). Capital requirements (Basel III: 8% CET1) also limit lending. This model is illustrative — real credit creation depends on demand, risk appetite, and monetary policy.