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FiMa Lecture II

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17 views23 pages

FiMa Lecture II

Uploaded by

pasanentoomas
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Lectures II

1
Introduction to the financial system

• Why study financial markets and institutions?


• The Finnish financial markets
• Why do financial intermediaries exist?
• The big questions in bank regulation

2
Q’s
Questions at the end of the lecture

• How large is the market for banks and other financial


intermediaries?
• Why banks are so important?
• Why banks are bailed out by the government?

3
Why study financial markets &
institutions?

In 2000, in his presidential address to the American


Finance Association, Franklin Allen, of the University of
Pennsylvania’s Wharton School, asked: “Do financial
institutions matter?” Lay people, he said, “might be
surprised to learn that institutions play little role in
financial theory.” Indeed they might. Mr. Allen’s
explanation was partly that the dominant theories had
been shaped at a time when America, especially, was
spared financial crises.

4
The Economist, July 16, 2009
Flow of funds through the financial system

5
Mishkin & Eakins
Primary assets and liabilities of financial intermediaries

6
Mishkin & Eakins
Principal financial intermediaries and
value of their assets (US)

7
Mishkin & Eakins
NBFI = Non-banking financial intermediate
OFI = Other financial institution

Note: Global GDP in 2021 approx. 90 trillion 8


9
Global financial intermediation is a complex system that generated about
$5.5 trillion in annual revenue in 2019 (Source: McKinsey)

Note: Global GDP in 2021 approx. 90 trillion 10


The Finnish financial markets

11
Sources: Statistics Finland, Bank of Finland, Investment
Research Finland

12
<- See the next slide

13
Note: Finland’s GDP in 2018 was 234 billion EUR
14
Breakdown of gross premiums written by
Finnish insurers 2013–2022

15
Breakdown of the largest Finnish
pension institutions

TELA (The Finnish Pension Alliance)


Why do financial markets and
intermediaries exist?
• Consumption timing and transfer of financial resources over time
– The financial system provides a way to shift purchasing power from
high-earnings periods to low-earnings periods of life
• Allocation, management, and pooling of risk
– Financial markets provide means for investors with the highest taste for
risk to bear that risk
• Separation of ownership and management
– Most corporations and too large to owned by one individual
– Mitigation of agency problems
• Providing and producing information
• Providing liquidity

17
Financial intermediaries: The role of
banks
• In general: banks channel funds from entities in surplus
of funds to entities in deficit of funds
• They are able to do
– Size transformation
– Maturity transformation
– Risk transformation
→ Transformations imply mismatches on banks’ balance
sheets, i.e. acceptance of risks
→ Risk is integral part of banks’ business and needs to be
managed
18
Basic concepts

Information asymmetries
• Common problem at the heart of all (financial)
transactions
• Make transactions difficult because not everyone has
the same information or one party has “private”
information
• Can explain many of the features observed in banking,
e.g. screening and monitoring (credit analysis),
collateral, credit rationing, regulation, relationship
lending, credit bureaus…

19
Bank’s incentives
• Example: Bank deposits
– Customers may think that:
• They have to hold deposits because they need access to the
payments system
• Deposits are simple, risk-free instruments
– Banks may think that they have a source of funds which are:
• Almost guaranteed
• Subject to little supervision by their owners
– This creates incentive for banks to invest in risky assets to make profit
– Some banks may even invest in projects which are much riskier than
depositors would agree to if they understood what was happening
– If the bank takes on too much risk and suffers large asset losses, then
their perfectly innocent (and naïve) depositors face the prospect of loss
– Banks are bailed out to limit the substantial damage a deep banking
crisis can inflict on the economy.

20
2008

21
22
The big questions in bank regulation*

• Should banks be regulated? If yes, how?


• Who should regulate and supervise banks?
• How to set optimal capital requirements?
• Other requirements (e.g. liquidity requirements)?
• What is the optimal level (and price) of deposit guarantee?
• How large is ”too large to fail”?
• Should the bank structure and operations be regulated?
• Who should pay for the regulatory costs?

23
* We will return on these questions at the end of the course

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