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Banking and Financial InstitutionsGuy HargreavesACF-1041Course goalsTo gain a fundamental understanding of the banking systemTo understand the different forms of banks, particularly commercial bankingTo understand the financial logic and concepts behind the banking system2Course CoverageOverview of banking systems and their structure in developed economiesUnderstand how management of banks and commercial banks affects the economic system and the whole financial system in an economyUnderstand the roles played by banks and how asset management of banks can affect financial structureUnderstand liability and risk management in banks with understanding of risk and Basel conceptsUnderstand how savings, loans in short and long term affect the roles and profitability of financial institutionsAcquire knowledge of how international banking systems and global banks work and operate3About.me25-years of experience in Investment and Corporate Banking in Asia Pacific regionKiwi living in Hong Kong with wife and three childrenMy goal: deliver academic based introduction to banking from the perspective of a highly experienced practitioner=> please feel free to ask questions at any time

4Structure and assessmentText: Financial Markets and Institutions; Frederic Mishkin, Stanley Eakins

3 x 50 min lectures Mon-Fri 8.30-11.30am Rm 42391 x 50 min tutorial Mon-Thurs 2.30-3.30pmRm 4410

Exam: 2 hours on Friday, 20th Novembermultiple choice questions + short questions + short essay100% of final mark 5Overview of financial intermediation and the global financial systemTodays goalsUnderstand the fundamental principles of financial intermediationExplain financial claims and distinguish between marketable and non-marketable financial claimsIdentify various financial markets, and banking and non-banking financial intermediaries Distinguish between deposit-taking and non-deposit-taking financial intermediariesUnderstand banking versus shadow banking markets Explain the functions and characteristics of money and monetary basesExplain the importance of market liquidity to the operation of the global economy7Financial AssetsAn asset is any property of value held or owned by an individual or companyA Financial Asset can be thought of as financial property eg:Cash (money) in your walletDeposit with a bankCorporate bondCommon share of a company8Financial SystemThe typical components of any financial system: Financial AssetsBorrowers and Savers of financial assetsFinancial IntermediariesCentral Bank regulators (set and manage the rules of the financial system)Financial systems exist within individual countries which have their own currencyCurrency blocks (eg Euro) can have common components (eg European Central Bank)

9Financial IntermediationTwo fundamental parties to any financial system:Borrowers (deficit units)Savers (surplus units)Financial Intermediation is conducted by third parties who take deposits from Savers and make loans with those deposits to BorrowersFinancial intermediation increases economic efficiency by offering valuable transformative services to both Borrowers and Savers 10Intermediationversus Direct Finance11Financial ClaimsFinancial Claims are contractual obligations created when a Borrower accepts money from a Saver (or Lender)Obligation to pay that money back at some time in the futureObligation to pay interest or a return on that moneyCan be Secured or Unsecured by other assetsHolder of financial claim has a Financial Asset Grantor of financial claim has a Financial Liability12MarketabilityFinancial Claims are said to be marketable if a holder can efficiently sell (transfer) the claim to a third party eg:Commercial Paper (CP)BondsSharesAsset Backed Securities (ABS)Financial Claims are said to be non-marketable if a holder can not efficiently sell (transfer) the claim to a third party eg:Structured Project Finance LoanInsurance PolicyBank deposit13Major world financial systemsCountryCurrencyCentral BankMajor Banks (sample)ChinaRMBPBOCBOC, ABC, ICBC, CCBUSAUSDFederal ReserveCiti, JP Morgan, BAMLEUEURECBDeutsche, SG, BNPUKGBPBOEBarclays, RBS, LloydsAustraliaAUDRBAANZ, CBA, Westpac, NABCanadaCADBOCRBC, CIBC, TD, BNS, BMOHong KongHKDHKMAHSBC, Stan Chart14Types of financial intermediariesIntermediaries are usually either:Regulated licensed banks or building societies etcNon bank financial institutions (NBFIs)Regulated banks are typically:Retail Commercial BanksWholesale Commercial BanksUniversal BanksDeposit-Taking Institutions eg banksNon-Deposit-Taking Institutions eg insurance companies15Types of financial intermediariesNon Bank Financial Institutions are typically:Investment BanksInsurance CompaniesPension / Mutual FundsPrivate Equity FundsHedge FundsVenture Capital FundsSecuritised Lenders

16Building Societies Member based mutual (cooperative) organisationsOperate at retail levelMortgage and savings product focusedMostly unlistedSmaller balance sheets, regionalNationwide Building Society (UK)Yorkshire Building Society (UK)IMB (Australia)

17Retail Commercial BanksLimited liability corporate organisationsPrimary focus at retail levelMortgage and savings productsMostly listedMedium sized balance sheetsLarge number of smaller customers18Wholesale Commercial BanksLimited liability corporate organisationsPrimary focus at wholesale or corporate levelCorporate loansAll listedLarge sized balance sheetsSmaller number of larger customers19Universal Banks Limited liability corporate organisationsFocus at retail and wholesale / corporate levelRetail banking, corporate and Capital Markets productsAll listedLarge sized balance sheetsLarge number of large and small customers20Investment Banks Partnerships or limited liability corporate organisationsFocus at wholesale / corporate levelCapital Markets productsListed and unlistedVolatile balance sheetsSmaller number of large customers21Insurance CompaniesMutuals or limited liability corporate organisationsFocus at retail and wholesale / corporate levelPremium based risk management productsListed typicallyLarge off-balance sheet exposures22Pension / Mutual FundsTrust based corporate organisationsFocus at retail and wholesale / corporate levelInvestment management productsListed and unlistedLimited to no leverage23Hedge / Private Equity FundsTrust based corporate organisationsFocus at wholesale / corporate levelInvestment management productsTarget absolute returnsHigh potential leverage24Venture Capital FundsTrust based corporate organisationsFocus at wholesale / corporate levelInvesting in startup or early stage companiesTarget absolute returnsZero leverage25Securitised LendersTrust based corporate organisationsFocus at retail and wholesale / corporate levelOriginating and funding portfolios of financial assetsHighly structured Special Purpose Companies High leverage26Shadow bankingThe term Shadow Banking has been used in the past 5-10 years to describe a banking-like system of financial intermediation conducted by NBFIsAs a result it is largely unregulated and is considered to have contributed significantly to the 2007-9 GFCPost 2007-9 GFC shadow banking closed down but in recent years it is re-emerging in the form of P2P lending, crowdfunding and private equity 27Financial marketsPlaces or platforms where financial assets are bought and soldElectronic or over-the-counter (OTC)Open outcry exchanges are almost things of the past (eg futures pits)Most significant financial markets conduct trade in:Securities (shares and bonds eg NYSE, Nasdaq)Futures and derivatives (eg Chicago Mercantile Exchange / Chicago Board of Trade)Foreign exchange (largest cash market of them all)Commodities (much of the physical trade is OTC)

28Financial market regulationEverywhere there is a financial market there is usually a regulator establishing and monitoring the rules governing that marketChina CSRC oversees securities marketsUS SEC oversees US security marketsUK FSAAustralia ASICRegulators aim to ensure markets are fair and orderly

29Information AsymmetryFinancial market participants often have varying levels of information > Information AsymmetrySome players have differing informationSome players have Inside InformationAll players have imperfect informationInside Information is usually gained from private sources and is usually illegal to trade from (insider trading)A key regulatory task is to prevent insider trading 30Global financial marketsIn 2015 most financial markets attract participants from all over the world ie they are global in nature eg:Gold derivatives traded in USD by most global playersAUD corporate bonds can be held by most global investors but more interest generally shown by Australian investorsShares traded on NYSE by investors on all continentsSome markets have restrictions such that many global players can not access them -> localised pricing and tradingMany markets are highly correlated with each other

31Financial market liquidityMarket liquidity impacts a participants ability to:Transact in a market at their time of choosingTransact volume of choosingMinimise transaction costsIncreasing market liquidity grows volumes while lowering per unit transactions costs=> Increased economic efficiency 32The history of moneyBefore money, market participants used the Barter System:Participants exchange goods and services directly for other goods and servicesVery inefficient because of high transactions costs, lack of price transparency, minimal standardisation and costly/difficult to store wealth Commodity Money, a fixed weight of grain, was used by the Mesopotamians some 3,000 BCCommodity money was replaced by gold and silver, and eventually by banknotes (first used in China during the Song Dynasty circa 1,000 AD)Today we may be standing at the dawn of Cryptocurrency33The uses of moneyMedium of exchange widely accepted as payment for goods and servicesMedium of valuation widely accepted as method of relative valuation of goods and servicesStore of value confidence that participants can hold money into the future to pay for goods and services in a predictable wayStandard of Deferred Payment - goods and services consumed now can be paid for in the future with money34The properties of moneyTo be a viable medium of exchange a monetary asset needs various qualities:Acceptable to participantsStandardized qualityDurable Valuable relative to its weight ie efficient to useDivisible to accommodate various prices of goods and services

35Money of todayGovernments around the globe today issue banknotes and coins which derive value by government order or FiatGovernments decree by law that all public and private financial liabilities can be repaid by this Fiat money designating it as legal tender The right to issue (or print) money comes with responsibility. Printing excessive banknotes or expanding the Money Supply can cause inflation and lead to collapse in trust in that money

36Yes, Zimbabwe? Zimbabwean dollar was the official currency from 1980 to 2009, when it was abandonedFollowing a period of hyperinflation the currency was redenominated on three occasions from 2006When abandoned the $Z had been redenominated by 10^25!

37Money SupplyMonetary aggregates are measures of the quantity of money in circulation typically broader than simply banknotes and coins:M1 is defined as banknotes, coins and on-call depositsM2 is defined as M1 + most term deposits M1 and M2 is carefully watched by many markets to monitor government trustworthiness!38