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Chapter 3: Learning Objectives

Chapter 3: Learning Objectives. What Do Financial Institutions Do? Functions of Intermediaries Financial Institutions and Market Types The “four pillars” The role of technology & government regulation How Important is the Financial System?. Financial Institution.

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Chapter 3: Learning Objectives

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  1. Chapter 3:Learning Objectives • What Do Financial Institutions Do? • Functions of Intermediaries • Financial Institutions and Market Types • The “four pillars” • The role of technology & government regulation • How Important is the Financial System?

  2. Financial Institution • An institution that provides financial services for its clients or members • The most important financial service provided by financial institutions is acting as financial intermediaries • Most financial institutions are highly regulated by government

  3. The Function of Financial Institutions • Intermediation  transforming assets • Brokerage an “agency” function: bringing would-be buyers and sellers together

  4. Financial Intermediary • A financial institution that connects surplus and deficit agent • Bank, trusts, credit union • Channel funds, resources from people who have extra money (savers) to those who do not have enough money to carry out a desired activity (borrowers)

  5. Financial Intermediaries Provide 3 Major Functions • Maturity transformation • Converting short-term liabilities to long term assets (banks deal with large number of lenders and borrowers, and reconcile their conflicting needs) • Risk transformation • Converting risky investments into relatively risk-free ones (lending to multiple borrowers to spread the risk) • Convenience denomination • Matching small deposits with large loans and large deposits with small loans

  6. The Functions of Intermediaries • Facilitate the acquisition/payment of goods & services • via lower transactions costs • Facilitate the creation of a “portfolio” • economies of scale & scope • Ease liquidity constraints • Reallocate consumption/savings patterns • Provide security • Reduce asymmetric information problem

  7. A Legacy from the Past: The “Four-Pillars” Chartered banks personal, commercial loans, and deposits Trusts company and credit unions fiduciary responsibilities and personal loans and deposits Insurance company underwriting insurance contracts Investment dealers underwriting and brokering securities

  8. Conflict in Regulation • Regulation prevented banks to sell insurance • Currently, much blending between all “Pillars” due to ease of legislation and financial innovations • Protect the public if the institutions go bankruptcy

  9. Types of Financial Institutions 1. Deposit-taking institutions – accept deposits and make loans • chartered banks, trusts, credit unions 2. Insurance Companies and Pension Funds • RRSPs (individual); RPPs (employer); CPP (Public) 3. Investment Dealers and Investment Funds • Mutual funds, underwrite corporate and government securities 4. Government financial institutions • Alberta Treasury Branch (ATB), Business Development Bank, CDIC

  10. Types of Financial Markets:A Selection of Types • Primary vs Secondary • newly-issued vs previously issued • Term to maturity • short vs long term, money vs capital • Direct vs Indirect • brokerage vs intermediation functions • Size • Retail vs Wholesale • Organization • open auction, private, public • Sectoral classification • Households and unincorporated businesses • Nonfinancial corporations • The financial • The government or public • The Rest of the world • Complexity

  11. Assets as a Percent of total assets Non-Financial Assets 42.2% 57.8% Financial Assets

  12. Most important Financial Instruments, 2004

  13. The Relative Importance of the Financial Sector Non-Financial Sector Financial Sector 40.98% 59.02%

  14. Key Financial Sector Institutions in Canada

  15. What Future for Banking? • Non-bank firms are increasingly offering financial services • Are banks better at spreading risks? • The threat & opportunities from technology • Banks: One-stop shopping for all financial services

  16. Summary • Intermediation is a central concept • Financial institutions can be classified by type, size, function • Financial markets can be classified by size, term, organization, type of assets issued • Banks are the most adept at the intermediation function • Financial systems should strive for efficiency

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