What makes something money, and what do banks and the rest of the financial sector actually do?
Explain the functions and characteristics of money and the role of the financial sector, including commercial banks, the central bank, building societies, insurance and the stock market.
A CCEA GCSE Economics answer on money and the financial sector, covering the functions and characteristics of money, the role of commercial banks and building societies, what the central bank does, and the parts played by insurance companies and the stock market in the economy.
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What this dot point is asking
Before you can manage money or understand monetary policy, you need to know what money is and what the financial sector does. CCEA expects you to explain the functions and characteristics of money, and the roles of the main parts of the financial sector: commercial banks, the central bank, building societies, insurance companies and the stock market. This is the first part of Section 3, Money, banking and personal finance, and it sets up both personal finance and the national economy.
What money is and what it does
Money is anything that is widely accepted as payment for goods and services and in settlement of debts. Before money, people relied on barter: swapping goods directly. Barter needs a double coincidence of wants (each person must want what the other offers), which is slow and clumsy. Money solves this by being accepted by everyone.
Money performs four functions, and CCEA expects you to know them.
- A medium of exchange. Money is accepted in return for goods and services, so trade does not depend on barter.
- A store of value. Money holds its value reasonably well, so people can save now and spend later.
- A unit of account. Money measures and compares the value of different goods, so prices can be set and compared.
- A standard for deferred payment. Money lets debts and future payments be agreed and settled, which makes borrowing and lending possible.
The characteristics of good money
For something to work as money it needs certain qualities. It must be acceptable (people trust and take it), durable (it lasts and does not wear out quickly), portable (easy to carry), divisible (can be split into small units for small purchases), scarce (limited in supply so it keeps its value) and hard to forge. Modern notes, coins and electronic balances are designed to meet these tests; this is why a perishable or easily copied item would make poor money.
Commercial banks and building societies
Commercial banks are the high-street banks used by households and firms. They have three core roles. They accept deposits, keeping money safe and paying interest, which encourages saving. They lend through loans, overdrafts and mortgages, charging interest, which funds spending by households and investment by firms. And they run the payments system of current accounts, debit cards and transfers. Banks make a profit from the gap between the interest they charge borrowers and the interest they pay savers.
Building societies are owned by their members and focus on savings accounts and mortgages, helping people save and buy homes. They behave much like banks for everyday customers.
The central bank, insurance and the stock market
The central bank (the Bank of England in the UK) is the bank for the whole system. It is the government's bank, issues notes, sets the official interest rate to control inflation, acts as lender of last resort to commercial banks in trouble, and helps to regulate the financial system to keep it stable. Its decisions drive monetary policy in the national economy.
Insurance companies let households and firms spread risk. By paying a regular premium, the policyholder is protected against large losses (fire, theft, accident, illness), with the insurer pooling the premiums of many people to pay the few who suffer a loss. This gives people the confidence to take everyday risks, such as driving or running a business.
The stock market is where shares in public companies are bought and sold. It lets firms raise capital by selling shares to investors, and lets savers own a stake in companies and earn dividends. It channels savings into business investment, though share prices can rise and fall.
Why this matters
Money and the financial sector are the plumbing of the whole economy: they let people trade, save, borrow, insure and invest. This topic underpins personal finance, where individuals use these services, and the national economy, where the central bank's interest-rate decisions are the main tool of monetary policy. Examiners reward candidates who can explain the functions of money clearly and match each part of the financial sector to what it does.
Exam-style practice questions
Practice questions written in the style of CCEA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
CCEA-style4 marksState and explain two functions of money.Show worked answer →
Money performs several functions, and any two clearly explained earn the marks.
A medium of exchange: money is widely accepted in return for goods and services, so it removes the need for barter and the need for a double coincidence of wants. Award two marks for this explained.
A store of value: money keeps its value reasonably well over time, so people can save now and spend later. Award two marks for this explained. (Other acceptable functions are a unit of account, which lets us measure and compare prices, and a standard for deferred payment, which lets borrowing and lending be agreed in money terms.)
The strongest answers explain why each function is useful, not just name it.
CCEA-style6 marksExplain the role of commercial banks in the economy.Show worked answer →
Commercial banks are the high-street banks that serve households and firms.
They accept deposits, keeping customers' money safe and paying interest on savings, which encourages saving. Award marks for the deposit-taking role.
They lend money through loans, overdrafts and mortgages, charging interest; this lending lets households buy homes and firms invest, supporting spending and growth. Award marks for the lending role.
They also provide a payments system (current accounts, debit cards, transfers) that lets people and firms pay each other easily. The best answers link these roles to the wider economy, for example noting that bank lending helps fund investment and that the gap between interest charged and interest paid is how banks make a profit.
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Sources & how we know this
- CCEA GCSE Economics specification (7510) — CCEA (2017)
- CCEA GCSE Economics specification (Standard PDF) — CCEA (2017)