Introduction to Finance: Understanding Financial Systems, Institutions, and Markets, Appunti di Finanza

Scarica Introduction to Finance: Understanding Financial Systems, Institutions, and Markets e più Appunti in PDF di Finanza solo su Docsity! Prof. Mavie Cardi Introduction to Finance MBA Applied Economic Science BASIC KNOWLEDGE Content •  Introduction and fundamentals of financial systems •  Financial institutions •  Financial markets •  Regulation •  Central banking and supervision The role of financial institutions within the system is primarily to intermediate between those that provide funds and those that need funds, and typically involves transforming and managing risk. Financial markets provide a forum within which financial claims can be traded under established rules of conduct and can facilitate the management and transformation of risk. FINANCIAL SYSTEM Within a financial system, the role of banks is central. They often provide a convenient location for the placement and borrowing of funds and, as such, are a source of liquid assets and funds to the rest of the economy. They also provide payments services that are relied upon by all other entities for the conduct of their business. FINANCIAL SYSTEM Failures of banks can have a significant impact on the activities of all other financial and nonfinancial entities and on the confidence in, and the functioning of, the financial system as a whole. This makes the analysis of the health and soundness of banks crucial to any assessment of financial system stability. CRUCIAL ROLE OF BANKS FINANCIAL SYSTEM Regulators and Authorities Households Banks and Financial Intermediaries Government Business firms Financial Markets deposits bonds shares loans securities bonds bonds shares Technological facili-es IIS Financial Institutions  Function of Financial Intermediaries: Indirect Finance A financial intermediary (such as a bank) plays as the middleman, instead of savers lending/investing directly with borrowers: "  the intermediary obtains funds from savers; "  the intermediary then makes loans to borrowers. This process, called financial intermediation, is actually the primary means of moving funds from lenders to borrowers. Needed because of transactions costs, risk sharing, and asymmetric information. F inanc ia l ins t i tu t ions (banks, o ther f inanc ia l intermediaries, Insurance Companies, Pension Funds) play a crucial role in improving the efficiency of the economy. Without them, financial markets would not work properly. Financial institutions - at least in US and UK - are among the largest employers. FINANCIAL INSTITUTIONS THE ROLE OF FINANCIAL INSTITUTIONS The role of financial institutions within the system is primarily to intermediate between those that provide funds and those that need funds ! typically involves transforming and managing risk. Particularly for a bank, this risk arises from its role in maturity transformation: •  where liabilities are typically short term (for ex., demand deposits), •  while its assets have a longer maturity and are often illiquid (for example, loans). Due to transaction costs, small investors with a small amount of money at disposal might find difficult to invest in equity or bond market. Transactions costs influence financial structure. Financial intermediaries are able to reduce transactions costs. ! Reduce transactions costs by developing (technological) expertise and taking advantage of economies of scale. TRANSACTIONS COSTS MORAL HAZARD Moral Hazard: After transaction Occurs when one party has an incentive to behave differently once an agreement is made between parties Hazard that borrower has incentives to engage in undesirable activities making it more likely that won’t pay loan back. (Again, with insurance, people may engage in risky activities only after being insured) gue ipo Financial markets  A financial market can be defined as a market in which entities can trade financial claims under some established rules of conduct. There are various types of financial markets, depending on the nature of the claims being traded. They include bond markets, equity markets, derivatives markets, commodity markets, and the foreign exchange market. Financial markets are critical for producing an efficient allocation of capital, allowing funds to move from people who lack (even temporarily) productive investment opportunities to people who have them. FINANCIAL MARKETS In this market, borrowers issue a security (bond) that promises the timely payment of interest and principal over some specific time horizon. The interest rate is the cost of borrowing. An active bond market also allows credit risks to be spread over a wide range of investors, reducing the potential for concentration of credit risk to develop and providing borrowers with up-to-date information on the market views of their credit worthiness. BOND MARKETS The stock market is the market where stock - representing ownership in a company (equity securities) - are traded. Initially, companies sell stock (in the primary market) to raise money. But after that, the stock is traded among investors (secondary market). An active stock market can be an important source of capital à to the issuer for use in business and allows the investor to benefit from the future growth of the business through ! dividend payments and/or an increase in the value of the equity claim. STOCK MARKET The foreign exchange market is where international currencies trade and exchange rates are set. Financial derivatives markets are different from money, bond, and equity markets in that the instruments - such as swaps and options - are used to trade financial risks, such as those arising from foreign exchange and interest rates, to those more able or willing to bear them. OTHER FINANCIAL MARKET Market failures require public intervention: regulation is one of the possible tools. Main goals of banking and financial regulation: •  financial stability •  transparency •  competition/efficiency MAIN GOALS OF BANKING AND FINANCIAL REGULATION The traditional approach to financial regulation was largely based on the special nature of banks, which: •  perform a crucial function of intermediation between surplus and deficit entities; •  create liquidity, transforming (funding) typically illiquid, long-term assets into (with) liquid and on demand liabilities, i.e. bank deposits; the latter are a component of money, a means of payment and store of value; •  due to the particular structure of their balance sheet, are exposed to the risk of bank runs, if depositors decide, suddenly and simultaneously, to withdraw their deposits bank runs may trigger panic and contagion REGULATION AND SPECIAL NATURE OF BANKS Banks are also key players in the payments system. All these features distinguish banks from non-bank financial institutions (e.g. insurance companies, securities firms) in terms of implications for financial stability, both at micro and macro level. REGULATION AND SPECIAL NATURE OF BANKS FINANCIAL CRISIS The exceptional boom in credit growth was fed by: -  A long period of benign economic and financial conditions, including historically low real interest rates and abundant liquidity, which increased the amount of risk and leverage that borrowers, investors and intermediaries were willing to take on; -  By a wave of financial innovation, which expanded the system’s capacity to generate credit assets and leverage but outpaced its capacity to manage the associated risks. THE RESPONSE TO FINANCIAL CRISIS During the crisis it became evident that the regulatory and supervisory nets should extend, in a proportional manner, to all intermediaries, market, operations, instruments and derivatives, that may have a systemic impact, even if they have no immediate links with the retail investors. The Basel II framework needed fundamental review ! It underestimated some important risks and over-estimated bank’s ability to handle them. Bank capital rules are a fundamental pillar of banking regulation. Capital performs a number of key functions: •  cushion to absorb losses and protect depositors and other creditors •  direct investment by shareholders •  protection of stability of individual banks •  protection of systemic stability At the international level, in 1988, the Basel Committee on Banking Supervision adopted the so-called Basel I rules ! imposing a minimum bank capital requirement. BANK CAPITAL RULES BASEL II Pillar 1! Minimum capital requirements: Minimum solvency ratio remains 8%. Numerator of solvency ratio (regulatory capital) not radically changed; important changes in the calculation of denominator (risk-weighted assets) with the goal of refining risk weights. Pillar 2! Supervisory review: supervisors must evaluate effectiveness of risk management systems and internal control processes of banks, and intervene if not satisfied. Pillar 3! Market discipline: transparency requirements aimed at strengthening market discipline. BASEL III After the financial crisis the Basel Committee has integrated Basel II. !  Basel III introduced: •  Strengthening the global capital framework •  Capital conservation buffer •  Countercyclical buffer •  Leverage ratio •  Global liquidity standard •  Risk Coverage. STRENGTHENING THE GLOBAL CAPITAL FRAMEWORK Total regulatory capital consist of the sum of the following elements: •  Tier 1 Capital (going-concern capital) Common Equity Tier 1 Additional Tier 1 •  Tier 2 Capital (gone-concern capital) Subject to the following restrictions: Total Capital = Tier 1 Capital + Tier 2 Capital ! must be at least 8.0% of risk-weighted assets at all times. LEVERAGE One of the underlying features of the crisis was the build- up of excessive leverage in the banking system. The leverage ratio is intended to achieve the following objectives: •  constrain the build-up of leverage in the banking sector and •  reinforce the risk based requirements with a simple, non-risk based “backstop” measure. During the early phase of the financial crisis that began in 2007, many banks – despite adequate capital levels – still experienced difficulties because they did not manage their liquidity in a prudent manner. The Committee has developed two standards that have separate but complementary objectives for supervisors to use in liquidity risk supervision: Liquidity Coverage Ratio; Net Stable Funding Ratio. GLOBAL LIQUIDITY STANDARDS Liquidity Coverage Ratio: aims to ensure that a bank maintains an adequate level of high-quality liquid assets that can be converted into cash to meet its liquidity needs for a 30 calendar day time horizon under a significantly severe liquidity stress scenario specified by supervisors. Net Stable Funding Ratio: this metric establishes a minimum acceptable amount of stable funding based on the liquidity characteristics of an institution’s assets and activities over a one year horizon. In particular, the NSFR standard is structured to ensure that long term assets are funded with at least a minimum amount of stable liabilities in relation to their liquidity risk profiles. GLOBAL LIQUIDITY STANDARDS The Single Rulebook includes: - Capital Requirement Regulation (CRR); - Directive CRD IV; - Bank Recovery and Resolution Directive; - Reg. on Single Resolution Mechanism; - Directive European Deposit Insurance Scheme. CRR (575/2013) and CRD IV (2013/36/EU) transposed into European law the international framework (Basel III) developed by the Basel Committee on Banking Supervision (BCBS) THE SINGLE RULEBOOK Schemes of governance In the years following the crisis, one of the primary objectives of the revision of European rules had been to enhance the way how banks govern themselves and how supervisors oversee this critical area. This was due to the acquired awareness of negative and potentially systemic externalities of ineffective schemes of governance. ! controlling excessive risk taking also requires regulation of corporate governance Centrality of governance profiles ! ! not only in the framework of regulation, but also of supervision. The recent financial and economic crises exposed many corporate governance weaknesses - most clearly in the financial services industry - as causal factors, or at least aggravating factors. ! momentum for change. A large number of stakeholders - including governments, regulators, standard setters, and professional bodies, as well as international agencies and organizations, such as the International Organization of Securities Commissions, Organisat ion for Economic Co-operat ion and Development - are debating governance challenges and solutions. Global Perspectives on Governance CG is subject to various guidelines and constraints Guidelines and constraints include behaving in an ethical way and in compliance with laws and regulations. From a shareholder’s perspective, corporate governance can be defined as a process for monitoring and control to ensure that management runs the company in the interests of the shareholders. Corporate Governance Why are Risk Management and Internal Control Important? The financial crises demonstrated quite clearly that, with increasingly globalized economies and markets, a crisis in one nation or region can affect far more than those living and working in the immediate area. National economic, social, and environmental issues need to be considered in a global context, especially issues related to risk. In addition, risk management and internal control need to embrace a wider perspective, since organizations are affected by many variables, often outside their direct control. Corporate governance of banks The crucial role of general economic interest assigned to banks in the economy, by intermediating funds from savers and depositors to activities that help drive economic growth, underlies the reasons of the specificity of corporate governance regulation (compared to the regulatory principles of governance of non financial firms). Banks’ safety and soundness are key factors for financial stability. A weak corporate governance - if related to Global Systemically Important Banks - plays a negative role in the financial system as a whole, having impact on the banking sector and the general economy. Corporate governance of banks: the presence of weaknesses The need to strengthen the corporate governance of banks emerged more vigorously after the financial crisis, which highlighted the presence of weaknesses. Although, corporate governance in financial institutions was not the main cause of the financial crisis, however, in many instances, boards and senior management of financial firms "  failed to understand the characteristics of the new, highly complex financial products they were dealing with, "  were often unaware of the aggregate exposure of their companies, "  and consequently largely underestimated the risk they were running Corporate governance principles The strengthening of the governance approach was already previously a topic of interest of the international institutions, even though limited to setting out non-binding principles through the issuing of best practices, updated at various times: !  OECD, 1999; OECD, 2004; OECD 2015 OECD Corporate governance principles Originally developed by the OECD in 1999, then updated in 2004, the 2015 revision of the Principles of Corporate Governance addresses emerging issues that are increasingly relevant. Building on the expertise and experience of policy makers, regulators, business and other stakeholders from around the world, the Principles provide an indispensable and globally recognised benchmark for assessing and improving corporate governance. •  Capital Requirements Regulation - CRR (575/2013) and Capital Requirements Directive - CRD IV (2013/36/EU) transposed into European law the international framework (Basel III) developed by the Basel Committee on Banking Supervision (BCBS). •  The objective of the CRD IV Directive in the field of corporate governance is to: - impose principles aimed at guaranteeing the effective supervision by the “management body” and together the control by Competent Authorities on the adequacy of the internal governance arrangements; - contain the excessive risk appetite of the management. •  A new framework is being developed, at a national and international level, centered on better managing risks and medium term performances. The post-crisis process of regulatory revision CRD IV Directive At the regulation level, CRD IV Directive provides a first explicit and systematic placement of governance in the context of primary regulation. Rules that the Directive dedicates to the themes of corporate governance and remunerations ! defining the governance arrangements ensuring an effective and prudent management, through reduction in excessive risk taking. Two main key points of CRD IV regulation: 1)  reinforcing of the collective oversight and risk governance responsibilities of the board; 2) emphasizing key components of risk governance such as risk culture, risk appetite and their relationship to a bank’s risk capacity. CRD IV Directive Banks shall have: - strong governance arrangements, which include a clear organisational structure with well defined, transparent and consistent lines of responsibility, and effective processes to •  identify, •  manage, •  monitor •  and report the risks they are or might be exposed to; -  adequate internal control mechanisms, including sound administration and accounting procedures; -  remuneration policies and practices that are consistent with and promote sound and effective risk management. The central bank is the national financial institution that exercises control over key aspects of the financial system and carries out such activities as issuing currency, managing international reserves, and providing credit to banks. Central banks are the government authorities in charge of monetary policy. In Europe, CB is the European Central Bank. CENTRAL BANKS ECB – MONETARY POLICY The European Central Bank (ECB) is the central bank of the 19 European Union countries which have adopted the euro. It was given independence in the Maastricht Treaty ! The ECB's independence is laid down in the institutional framework for the single monetary policy (in the Treaty and in the Statute). The treaty set the ECB’s main goal as price stability in the euro area (and so preserve the purchasing power of the single currency). Price stability is essential for economic growth and job creation ! two of the European Union’s objectives. ECB – MONETARY POLICY “The primary objective of the European System of Central Banks [...] shall be to maintain price stability” (Article 127 of the Treaty on the Functioning of the European Union). The Governing Council of the European Central Bank aims to keep inflation below, but close to, 2% over the medium term. In order to achieve its primary objective, the Governing Council bases its decisions on a two-pillar monetary policy strategy and implements them using its operational framework. SINGLE SUPERVISORY MECHANISM e(t1 — Banking Union — I. Single VI 1015 3. Harmonised IMITA tad1ie07 ENTI ITTSTA) IST CIRIE, (Sdi talktati Guarantee (SSM) (SRM) Schemes (DGS) Common rules (EBA Single Rulebook) Common supervisory practices (SSM Supervisory Manual)  Single Supervisory Mechanism The Single Supervisory Mechanism (SSM) is the new system of financial supervision comprising the European Central Bank (ECB) and the National Competent Authorities (NCAs) of euro area countries. The SSM, which officially entered into operation in November 2014, is itself a step towards greater European harmonization: !  it promotes the single rulebook approach to the prudential supervision of credit institutions in order to enhance the robustness of the euro area banking system; !  Established as a response to the lessons learnt in the financial crisis, the SSM is based on commonly agreed principles and standards. ECB Supervision Supervision is performed by the ECB together with the national supervisory authorities of participating Member States. The SSM works in cooperation with the European Banking Authority (EBA), the European Parliament, the European Commission, and the European Systemic Risk Board (ESRB), within their respective mandates, and is mindful of cooperation with all stakeholders and other international bodies and standard-setters. •  The ECB has adopted three high-level priorities to guide its supervision. •  The aim of Single Supervisory Mechanism (SSM) is to ensure that supervised banks address key risks effectively: to enable banks to address these key risks effectively, European banking supervision has streamlined its supervisory priorities. •  3 priority areas in banking supervision: 1.  business models and profitability drivers; 2. credit risk, with a focus on NPLs; 3. risk management. The institutional control is periodical and pervasive and envisage instruments of reaction if any possible weaknesses arise. Supervision: priorities Corporate governance and Supervision As regards governance, SSM’s assessment is qualitative, and embraces different aspects: I)  the assessment concerns the functioning and effectiveness of the board and the decision-making process, particularly on key issues such as strategy, risk awareness and management, transparency towards shareholders, availability of adequate information, and so on. II)  It concerns the banks’ risk appetite frameworks and the extent to which an appropriate risk culture is effectively ensured throughout the organization, starting from the board and working down the hierarchical ladder. III)  It concerns the remuneration policies, looking specifically at the different components of remuneration and dividend distributions. IV)  Finally, it concerns the internal control functions