Financing in the Banking Sector: The Role of Financial Intermediaries and Markets - Prof. , Papers of Banking and Finance

Download Financing in the Banking Sector: The Role of Financial Intermediaries and Markets - Prof. and more Papers Banking and Finance in PDF only on Docsity! Introduction to the Banking Sector Kevin Salyer Economics, UC Davis Spring 2009 K D Salyer (Institute) Markets Spring 2009 1 / 2 Putting the Recession in Perspective In terms of economic output and jobs lost, this recession pales in comparison with the Great Depression. The charts show the course of the recession that started in December 2007 and of the Great Depression of August 1929 throwgh March 1933. The lines show how much higher or lower each indicator was in the months before or after the recession started, measured a5 a percentage of the level of that indicator at the start of the recession. Gross. domestic product Employment Consumer prices Start of each recession Or t Current recession “10k Ponder =20 Seseasesccsssued) sas saseads cea reereerererereerieocssrerprrererereny BY ey tee fe Great Depression 00 eee fee Great Depression Great Depression SN ere yop yey _ vps pecepeseqeeadesng se spe “2-8-4 0 4 8 12 16 20 24 060K 24 #0 24 48 quarters before quarters after months before months after months before months after Notes: GDP is measured at 4 seaconally adjusted anrual rate in constant (1929 and 2000); employment levels are for nonagrigullunal jobs; 19205-2306 figures are annual and exchude the military: price data are consumer price indemes. Sources: National Bureau of Economic Research Macrohistory Database (Depression-era GOP and employment}: Commerce Department (current GDP); Labor Department (ourrent employment and all price data) Figure 2: Sources of External Funds for Non-Financial Businesses Bonds 30% Stock 2% Loans 62% Other 6% Bonds Loans Stock Other Direct and Indirect Finance • Indirect external finance (that is, loans) is more important than direct finance (stocks and bonds) •Generally, loans are the most important source of financing in most developed (and developing) economies. Reasons for Financial Intermediaries •Transaction Costs •A direct saver-to-borrower venue may be too costly, if the saver is to be guaranteed a full return in the investment •Financial intermediaries have the advantage of economies of scale and know how/expertise 2. Adverse Selection •The lemons problem in a used-car market •Same principle, holds in bond and equity markets Conclusion: For these market to work, we typically need to have a dealer/broker or intermediary Ways to Alleviate Adverse Selection •Generate information –Free-rider problems •Regulation •In the U.S. the SEC (Securities and Exchange Commission) requires firms to: –Release company information –Follow accounting rules •Rely on financial intermediaries –Create private information •Require collateral/equity capital Moral Hazard / Principal-Agent Problem Managers=Agents Stockholders=Principals •Different incentives –Managers may prefer higher pay/benefits –Stock owners: higher stock prices Table 1: Major Financial Intermediaries Type of Intermediary Primary Liabilities Primary Assets Contractual savings institutions Life Insurance Cos. Fire and casualty insurance Pension Funds, government retirement funds Premiums from policies Premiums from policies Employee or employer contributions Corporate bonds and mortgages Municipal bonds, corporate bonds, stocks, government securities Bonds and equity Table 1: Major Financial Intermediaries Type of Intermediary Primary Liabilities Primary Assets Investment intermediaries Mutual funds Money market mutual funds Finance companies Shares Shares Commercial paper, equity and bonds Equity and bonds Money market instruments Loans (consumers and business) 1980Q4 1990Q4 2003Q3 Commercial Banks 1481.72 3337.48 7624.10 Savings Institutions 792.38 1323.03 1437.12 Credit Unions 67.62 217.24 609.37 Bank Personal Trusts andEstates 244.80 522.14 824.27 Life InsuranceCompanies 464.18 1351.44 3579.25 Other InsuranceCompanies 182.10 533.47 976.31 PrivatePensionFunds 513.03 1626.75 3802.32 StateandLocal Govt. Retirement Funds 196.56 800.58 2104.88 Table 2. Assets of Financial Intermediaries ($ billions) Figure 4: Assets of Financial Intermediaries 38% 14% 2% 6% 24% 8% 8% Banks Insurance Investment Funds Financing Thrifts & Credit Unions Pensions Asset-Backed & GSEs 23% 12% 13% 6% 8% 6% 32% 1980Q4 2003Q2 Table 4: Regulatory Agencies of the U.S. Financial System Financial Institution Regulatory Agency Nature of Regulation Depositories  Commercial Banks  Credit Unions  Savings and Loan National Banks: Office of the Comptroller of the Currency Bank Holding Companies: Federal Reserve State-Chartered Banks: State banking commissions All insured banks: Federal Deposit Insurance Corporation (FDIC) National Credit Union Administration (NCUA) Office of Thrift Supervision (OTS) Charter requirements, bank examination, capital requirements, restrictions on asset holdings, etc. Table 4: Regulatory Agencies of the U.S. Financial System Financial Institution Regulatory Agency Nature of Regulation Contractual Savings Institutions  Insurance Companies  Pension Funds Investment Intermediaries  Mutual Funds and MMMFs  Finance Companies State insurance commissions. Indirectly the government through the Internal Revenue Service (IRS) Employ Retirement Security Act, 1974 (ERISA). Pension Benefit Guarantee Corporation. Securities and Exchange Commission Usually subject to state regulation. Licensing, examination, capital requirements, restrictions on asset holdings, branching restrictions. Funding rules, transfer of benefits, minimum vesting requirements, disclosure. Disclosure requirements, restrictions on soliciting business. Bankruptcy laws, usury laws, transparency rules