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FNCE 4000 Financial Institutions Management Chapter 1

FNCE 4000 Financial Institutions Management Chapter 1. Why are Financial Institutions Special?. Equity & Debt. Households (net savers). Cash. Without FIs. Primary difference is direct transacting versus transformation Example of direct below:. Corporations (net borrowers).

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FNCE 4000 Financial Institutions Management Chapter 1

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  1. FNCE 4000Financial Institutions ManagementChapter 1 Why are Financial Institutions Special?

  2. Equity & Debt Households (net savers) Cash Without FIs • Primary difference is direct transacting versus transformation • Example of direct below: Corporations (net borrowers)

  3. FIs’ Specialness • Without FIs: Low level of fund flows. • Information costs • Economies of scale reduce costs for FIs to screen and monitor borrowers • Less liquidity • Substantial price risk

  4. FI (Brokers) FI (Asset Transformers) Households Corporations Equity & Debt Deposits/Insurance Policies Cash With FIs Cash

  5. FIs are Middlemen! • Why should they exist? • Reduce information costs • Spread of risk • Economies of scale • Maturity intermediation • Payment services • <transfer monetary policy>

  6. Specialness and Regulation • FIs receive special regulatory attention. Reasons: • Negative externalities of FI failure • Special services provided by FIs • Institution-specific functions such as money supply transmission (banks), credit allocation (thrifts, farm banks), payment services (banks, thrifts), etc.

  7. Regulation of FIs • Important features of regulatory policy: • Protect ultimate sources and users of savings • Including prevention of unfair practices such as redlining and other discriminatory actions • Primary role: Ensure soundness of the overall system

  8. Regulation of FIs • Safety + soundness • Monetary policy • Credit allocation • Consumer protection • Investor protection • Entry • Consumer protection • Regulation is not costless

  9. Regulation • Safety and soundness regulation: • Regulations to increase diversification • No more than 10 percent of equity to single borrower • Minimum capital requirements • Guaranty funds: • Deposit insurance fund (DIF): • Securities Investors Protection Fund (SIPC) • Monitoring and surveillance. • FDIC monitors and regulates DIF participants.

  10. Regulation • Consumer protection regulation • Community Reinvestment Act (CRA) • Home Mortgage Disclosure Act (HMDA) • Effect on net regulatory burden • FFIEC processed info on as many as 17 million mortgage transactions in 2009 • Analysts questioning the net benefit

  11. Consumer Protection Regulation • Potential extensions of regulations • CRA to other FIs such as insurance companies in light of consolidation and trend toward universal banking • New additions: • Consumer Financial Protection Agency (2009) • Credit card reform bill effective 2010

  12. Additional Terms • Redlining • Negative externality • Disintermediation • Liquidity • Solvency • Information costs • Payment Services

  13. Global Trends • US FIs facing increased competition from foreign FIs • Securitization of assets (30 year trend) • Only 2 of the top ten banks are US banks • Foreign bank assets in the US typically more than 10 percent • As high as 21.9 percent

  14. Largest Banks

  15. Financial Crisis • DJIA fell 53.8 percent in less than 1 ½ years as if mid-March 2009 • Record home foreclosures • 1 in 45 in default in late 2008 • Goldman Sachs and Morgan Stanley • Only survivors of the major firms

  16. Risk and the Financial Crisis • Reactions to FSM Act and other factors: • Shift from “originate and hold” to “originate and distribute” • Affects incentives to monitor and control risk. • Shift to off balance sheet risks • Degraded quality and increased risk • Housing market bubble • Encouraged subprime market and more exotic mortgages

  17. Financial Crisis • AIG bailout • Citigroup needed government support • Chrysler and GM declared bankruptcy in 2009 • Unemployment in excess of 10 percent

  18. Beginning of the Collapse • Home prices plummeted in 2006-07 • Mortgage delinquencies rose • Forelosure filings increased 93 percent from July 2006 to July 2007 • Securitized mortgages led to large financial losses • Subprime mortgages • Countrywide Financial bailed out and eventually taken over by Bank of America

  19. Significant failures and events • Bear Stearns funds filed for bankruptcy • Acquired by J.P. Morgan Chase • Fed moved beyond lending only to Depository Institutions • Government seizure of Fannie Mae and Freddie Mac • Lehman Brothers failure • Crisis spread worldwide

  20. Rescue Plan • Federal Reserve and other central banks infused $180 billion • $700 billion Troubled Asset Relief Program (TARP) • Still struggling in 2009 • $827 billion stimulus program • American Recovery and Reinvestment Act of 2009

  21. Types of FIs • Depository institutions • Insurance Companies • Pension Funds • Investment Banks • Mutual Funds • Finance Companies

  22. Trends in Assets Held by FIs

  23. The Banker Federal Reserve FDIC FFIEC Investment Co. Institute OCC SEC SIPC Wall Street Journal www.thebanker.com www.federalreserve.gov www.fdic.gov www.ffiec.gov www.ici.com www.occ.treas.gov www.sec.gov www.sipc.org www.wsj.com Pertinent Websites

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