Finance 129

Financial Institutions Management

Syllabus

TextbooksFinancial Institutions Management

PrerequisitesFinance 101, Econ 105, Junior Standing

Rules of the GameOffice Hours /Contact Information GradesWebsite

AssignmentsExaminations DisabilitiesAcademic Misconduct Evaluations

Academic Misconduct

Examples (include but not limited to:)Copying from another student’s paper, laboratory report or other report, or computer files and listings;Using, during a test material and/or devices not authorized by the person in charge of the test;Without the instructors permission, collaborating with another, knowingly assisting another or knowingly receiving the assistance of another in writing an examination or in satisfying any other course requirement;

Misconduct Continued

Incorporating into written assignments materials written by others without giving them credit, or otherwise improperly using information written by others (including that which may be stored on computer disks or other technological devises), or buying and submitting commercially prepared papers as one’s own work;Submission of multiple copies of the same or similar papers without prior approval of the instructors involved;Claiming as one’s own work that which was done by tutors or others with no mention of credit to or the assistance of those persons.

Grades

Individual Assignments 200 points (20%)Sept 15th 50 points Oct 13th 50 points Nov 3rd 50 pointsNov 22nd 50 points

Group Assignments (10%) 100 points

Tests (70%)Sept 29th and Nov 10th 200 points each Final 300 points December 13th

Course Description

Bank Vs. Financial Institutions ManagementYears of deregulationFinancial Services Modernization Act 1999 (Gramm-Leach Bliley Act)

The “New” Financial Industry Shadow Banking

Fall out from the credit crisisThe current economic environment

The Modern Bank

Services Provided:Credit (loan) servicesThrift (savings) servicesPayment (transaction) servicesInvestment and financial planning servicesInvestment Banking (security underwriting)Brokerage (trading) servicesInsurance ServicesOther

Course Topics

Depository Institutions and the Financial System.Introduction, financial intermediation

Intro to ManagementUBPR, Dupont Analysis, Financial Analysis

Measuring Risk in FI’sGAP analysis (Rate sensitive assets and liabilities)Market, Liquidity, Credit, Operational and other Risks

Managing RiskLiability and Liquidity Risk, Capital Adequacy

International AspectsForeign Exchange and Sovereign Risk

Background

Financial Institutions (FI) – Channel funds from individuals and institutions with a surplus of funds to (suppliers) to those with a shortage or funds (users of capital).

Banks, Credit UnionsInsurance CompaniesMutual FundsPension Funds

**www.financialsectorfacts.org

Distribution of Assets

US Financial Sector

Accounts for over 7.6 million jobs (approximately 5% of workforce)*Activities in the industry account for approximately 20% of GDP**

http://www.bls.gov/iag/tgs/iag50.htm ** average reported from 200-2007 by financialsectorfacts.org ** average reported from 200-2007 by financialsectorfacts.org

Categories of FI’s

Depository InstitutionsBanks, Savings and loans, Thrifts, Credit Unions

Nondepository InstitutionsInsurance Co’s, Investment Banks, securities firms, mutual funds and finance companies

Similar Risks and Rewards

All Financial Institutions:Hold Assets that are subject to default (or credit) riskAre exposed to interest rate risk based on maturity of assets and liabilitiesExposed to liquidity (withdraw) risksFace operational costs and risks

Without FIs

Corporations

(net borrowers))

Households

(net savers)

Cash

Equity & Debt

©2003 McGraw-Hill Companies Inc. All rights reserved

Problems w/o FI’s

Monitoring is costlyExposes households to increased risk

Lack of LiquidityHouseholds may not be able to easily convert claims to cash

Price RisksPrices fluctuate

With FIs as Intermediaries

Cash

Households Corporations

Equity & Debt

FI

(Brokers)

FI

(Asset Transformers)

Deposits/Insurance Policies

Cash

©2003 McGraw-Hill Companies Inc. All rights reserved

Special Roles played by FI’s

Economy - Wide ServicesInformation, Liquidity, Price risk reduction, Transaction cost and Maturity intermediation services

Institution Specific ServicesMonetary policy transmission (depository Institutions), Credit allocation (thrifts, farm banks), Intergenerational Transfers (Insurance and pensions, payments services (depository institutions) and Denomination intermediation

Roles played by FI’s

Brokerage FunctionResearch and information provider (reduces information costs such as agency costs)Economies of Scale (decreases transaction costs and information costs)

Asset – Transformation FunctionPurchase primary claims and issue secondary claims (reducing contracting costs)Allows for risk sharing via diversification (reduces price and liquidity risk)

Other Functions

Maturity IntermediationProvides households with desirable maturitiesIntermediaries are willing to accept longer term risks and finance them with short term deposits.

Denomination IntermediationCommercial paper is issued in $250,000 units, too large for most households

Payment MechanismFacilitate the payment of claims w/o cash.

Special Roles played by FI’s

Transmission of Monetary PolicyThe liquid nature of depository institutions make them the main way monetary policy is transmitted to the public

Credit AllocationPrimary suppliers of capital to special sectors of the economy (Residential lending for example)

Intergenerational Transfer of WealthInsurance and pension funds

The Impact of FI’s on Economic Growth

Traditional Economic Theories of GrowthLabor Usage and Capital AccumulationLimited by decreasing marginal returns to capital -- sustained growth requires productivity growth

New Growth TheoryTechnological change increases productivity that offsets diminishing marginal returnsFinancial Sector Development promotes productivity growthTermed “Endogenous Growth”

The Impact of FI’s on Economic Growth

Financial Development’s ImpactPromotes Capital Accumulation & Productivity GrowthRajan and Zingales (1998)

Young firms in higher productivity sectors depend upon external financing and benefit from low cost financing associated with financial development

Galindo, Schiantarelli, and Weiss (2002)Financial liberalization in developing economies improves capital allocation

Both Studies stress the importance of the quality of regulation, supervision and enforcement.

Regulation

Given their vital role in the economy FI’s are highly regulated. The goal of this regulation is to protect against a disruption in the services they offer (provide confidence in the system).Some segments of the population could be discriminated against without regulation (race, gender etc)The difference the private benefits and private costs of regulation are the net regulatory burden.

Safety and Soundness Regulation

Protects borrowers and depositors against failure of the FIDiversification requirementsMinimum capital to asset ratiosGuaranty funds provisionsMonitoring and surveillance

Monetary Policy Regulation

Since Financial Intermediaries serve as a conduit for monetary policy they merit special regulation.Reserve requirements, for example.Might make control of monetary policy more predictable.

Credit Allocation Regulation

Supports lending to portions of the economy deemed socially important (housing and farming are two examples).

Requiring a % of assets in a particular sector of the economy for example. Also interest rate restrictions.

Consumer Protection Regulation

Home Mortgage Disclosure ActPrevents discrimination in lending based upon gender, race, age, or income. Requires standardized form on why credit is granted or deniedMay provide a heavy net regulatory burden without an offsetting social benefit.

Investor Protection Regulation

Protection of investors that use investment banks directly. Insider trading restrictions, lack of disclosure and breach of fiduciary responsibility are examples.

Entry Regulation

Barriers to entry can promote safety and soundness.Also impose costs on current market participants.