What is the role of the financial markets? 

1. To facilitate saving. The financial markets allow economic agents to save in the form of stocks, shares and many other assets.
2. To lend to businesses and individuals. The financial markets allow economic agents to borrow money. Households, firms and governments all need to borrow money. Firms and governments typically borrow from the bond market.
3. To facilitate the exchange of goods and services. This is achieved through a payment system. For example, financial institutions process transactions and transfers and the bureau de changes’ buy and sell foreign currencies.
4. To provide forward markets in currencies and commodities. Forward markets lead to improved stability of the costs of production for producers. This is because forward markets allow firms to guarantee a price for a good or service in the future, which gives firms knowledge of their future costs.
5. To provide a market for equities. Stock markets allow economic agents to buy and sell shares. This helps to improve the liquidity of shares as an asset. 

What are examples of market failure in the financial sector? 

1. Asymmetric information. This occurs when financial markets have more information than their customers. A good example is the PPI (Payment Protection Insurance) scandal. PPI was designed to help protect the customer if they failed to make repayments, but PPI was found to be oversold, and many customers were sold PPI even though they didn't need it.
2. Externalities. These are costs which economic agents have to pay that the financial markets don't pay for even though the financial markets created them. For example, the government had to bail out the banks following the Global Financial Crisis, which also affected taxpayers whose tax was used to bail out these banks. 
3. Moral hazard. This is where an economic agent will make a decision in their own best interest even though there may be large potential risks, of which the cost is likely to be suffered by other economic agents. For example, bankers may take very large risks to generate large profits for the firm as they seek a large bonus.
4. Speculation and market bubbles. Lots of trading in the financial markets is speculative which leads to market bubbles where prices rise so high that the market eventually collapses. A good example is the Dot-com bubble where herding behaviour caused the price of the shares of Internet-based companies such as Yahoo to rise extremely high above their intrinsic value, with the bubble eventually 'bursting' leading to a subsequent plummet in the price of the shares.  
5. Market rigging. This is where a group of economic agents will collude to set prices or exchange information that is likely to benefit them at the cost of others. A good example in the financial sector is insider trading where an individual has knowledge about what will happen in the future, but others don't as this individual does not share this knowledge with other market participants.

What are the roles of the central bank?

1. Implementation of monetary policy. The central bank controls monetary policy which involves managing the money supply through the manipulation of interest rates and quantitative easing. This is in order to achieve macroeconomic objectives such as price stability.
2. Banker to the government. The central bank manages the financial accounts of the government. It helps the government manage its debt and operations by overseeing the issuance and redemption of government bonds. 
3. Banker to the banks. The central bank is known as the lender of last resort. This means that if a bank is seriously struggling for liquidity, for example during a financial crisis, they can usually borrow from the central bank.
4. Regulation of the banking industry. Central banks play a crucial role in the oversight and regulation of the financial markets. The central bank has the power to force all banks to deposit money with them. They can also implement risk management standards.