of Management Financial Institutions
Instructor: Dr. QU Baozhi TA: Miss CHEN Jiao Phone: [phone] Email: [e-mail] Office: ACAD-P7407 Office Hours: Monday 9:30-11:20 AM Wednesday 9:30-11:20 AM 1-1
Syllabus
x
Posted on the Blackboard (under the link Course Information)
1-2
Assessment
x x
Final examination (two hour) Coursework
60% 40%
Case Study (10%) Written assignments & quiz (20%) Contribution to in-class discussion and attendance (10%)
1-3
An Introduction to the Financial Services Industry
x
Why Are Financial Intermediaries Special?
1-4
Without FIs
Equity & Debt
Households (net savers)
Cash
Corporations (net borrowers)
1-5
FIs Specialness
x
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
1-6
With FIs
FI (Brokers)
Households
Cash Deposits/Insurance Policies
Corporations
Equity & Debt Cash
FI (Asset Transformers)
1-7
Functions of FIs
x
Brokerage function
Acting as an agent for investors:
e.g. Merrill Lynch, Charles Schwab Reduce costs through economies of scale Encourages higher rate of savings
Asset transformer:
Purchase primary securities by selling financial claims to households
These secondary securities often more marketable
1-8
Difference between Commercial Firms and FIs
Commercial Firms Assets Liabilities Real Assets Primary Securities Financial Institutions Primary Securities Secondary Securities
1-9
Role of FIs in Cost Reduction
x
Information costs:
Investors exposed to Agency Costs
Role of FI as Delegated Monitor (Diamond, 1984)
Shorter term debt contracts easier to monitor than bonds FI likely to have informational advantage
1-10
Specialness of FIs
x
Liquidity and Price Risk
Secondary claims issued by FIs have less price risk FIs have advantage in diversifying risks
x
Reduced transaction & information costs
economies of scale
1-11
Other Special Services
x x x
x
x x
Maturity intermediation. Transmission of monetary policy. Credit allocation (Areas of special need such as home mortgages). Intergenerational transfers or time intermediation. Payment services (FedWire and CHIPS). Denomination intermediation.
1-12
Specialness and Regulation
x
FIs receive special regulatory attention.
Reasons: Special services provided by FIs in general. Institution-specific functions such as money supply transmission (banks), credit allocation (thrifts, farm banks), payment services (banks, thrifts), etc. Negative externalities arise if these services are not provided.
1-13
Regulation of FIs
x
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 system as a whole.
x
Regulation is not costless
Net regulatory burden.
1-14
Regulation
x
Safety and soundness regulation:
Regulations to increase diversification
No more than 10 percent of equity to single borrower
Minimum capital requirements Guaranty funds:
FDIC: Bank Insurance Fund (BIF), Savings Association Insurance Fund (SAIF) Securities Investors Protection Fund (SIPC)
Monitoring and surveillance.
1-15
Regulation
x
Monetary policy regulation
Federal Reserve directly controls outside money. Bulk of money supply is inside money (deposits). Reserve requirements facilitate transmission of monetary policy.
1-16
Regulation
x
Credit allocation regulation
Supports socially important sectors such as housing and farming.
x x
Consumer protection regulation Potential extensions of regulations to other FIs such as insurance companies
1-17
Regulation
x
Investor protection regulation
Protections against abuses such as insider trading, lack of disclosure, malfeasance, breach of fiduciary responsibility.
1-18
Regulation
x
Entry regulation
Level of entry impediments affects profitability and value of charter. Regulations define scope of permitted activities.
Financial Services Modernization Act of 1999.
Affects charter value and size of net regulatory burden.
1-19
Trends in the Financial Services Industry
x x x
x
x
Decline in share of depository institutions. Increases in pension funds and investment companies. May be attributable to net regulatory burden imposed on depository FIs. Technological changes affect delivery of financial services and regulatory issues Potential for regulations to be extended to hedge funds
Result of Long Term Capital Management disaster 1-20
Trends in the Financial Services Industry
x
x
Weakening of public trust and confidence in FIs may encourage disintermediation Increased merger activity within and across sectors
Citicorp and Travelers, UBS and Paine Webber More large scale mergers such as J.P. Morgan and Chase, and Bank One and First Chicago
x
Growth in Online Trading
1-21
Equity Trading on the Internet
1-22
Global Issues
x
x x
Increased competition from foreign FIs at home and abroad Mergers involving worlds largest banks Mergers blending together previously separate financial services sectors
1-23
Top 10 Banking Groups in the World Ranked by Assets (billion US$ as 2004)
1 UBS (Switzerland) 2 Citigroup (U.S.) 3 Mizuho Fin. Group (Japan) 4 HSBC (U.K.) 5 Credit Agricole Group (France) 1,533 1,484 1,296 1,277 1,243 6 BNP Paribas (France) 7 J.P. Morgan Chase (U.S.) 8 Deutsche (Germany) 9 Royal Bank of Scotland 10 (U.K.)of Bank America (U.S.) 1,234 1,157 1,144 1,119 1,110
Source: http://en.wikipedia.org/wiki/Bank
Top 10 Banks in the World Ranked by Market Capitalization (billion US$ as July 2006)
1 Citigroup (U.S.) 2 ICBC (China) 3 Bank of America (U.S.) 4 HSBC (U.K.) 5 J.P. Morgan Chase (U.S.) 275 250 230 200 150 6 7 8 9 Mitsubishi UFJ (Japan) 145
Wells Fargo (U.S.) 120 UBS (Switzerland) 110 Royal Bank of Scotland (U.K.) 100
10 China 100 Construction Bank
Source: http://en.wikipedia.org/wiki/Bank
Overview of Depository Institutions
x x x
Size, structure and composition Balance sheets and recent trends Regulation of depository institutions
1-26
Specialness of Depository FIs
x
Products on both sides of the balance sheet
Loans
Business and Commercial
Deposits
1-27
Size of Depository FIs
x x
Consolidation has created some very large FIs Combined effects of disintermediation, global competition, regulatory changes, technological developments, competition across different types of FIs
1-28
Depository Institutions
Commercial Banks
Largest depository institutions are commercial banks. Differences in operating characteristics and profitability across size classes.
Notable differences in ROE and ROA as well as the spread
Thrifts
S&Ls Savings Banks Credit Unions
Mix of very large banks with very small banks
1-29
The Three-Tier Banking System in Hong Kong
Authorized Institution (AI): An institution authorized under the Banking Ordinance to carry on the business of taking deposits.
1-30
Trends of the AIs in HK
Year 1999 2002 2005 2008 (as of June) Number 285 224 199 202 Total Assets (HK$ million) 6,783,377 5,999,078 7,246,969 10,396,199
1-31
Authorized Institutions
x
Licensed Banks (Banks): In Kong, Hong only licensed banks may carry on banking business:
receiving from the general public money on current, deposit, savings or other similar account repayable on demand or within less than three months; paying or collecting cheques drawn by or paid in by customers.
1-32
Authorized Institutions
x
Restricted Licence Banks (RLBs): A restricted licence bank may take time, call or notice deposits from members of the public in amounts of HK$500,000 and above without restriction on maturity. Restricted licence banks generally engage in activities such as merchant banking and capital market operations
1-33
Authorized Institutions
x
Deposit-Taking Companies (DTCs): Deposittaking companies are restricted to taking deposits of HK$100,000 or more with an original term to maturity of at least three months. These companies are mostly owned by, or otherwise associated with, banks. They engage in a range of specialised activities, including consumer finance, trade finance and securities business
1-34
Examples
x
The 3-tier banking system in Hong Kong CITI Bank (Licensed Bank)
CITI Hong Kong, Ltd. (Restricted License Bank)
1-35
Structure of AIs in Hong Kong (as of June 2008)
Licensed Banks Incorporated in HK Incorporated outside HK Total 23 121 144 Restricted Deposit-taking Licence Banks Companies 16 13 29 29 0 29 202
1-36
Functions & Structural Differences
x
Functions of depository institutions
Regulatory sources of differences across types of depository institutions.
x
Structural changes generally resulted from changes in regulatory policy
1-37
Commercial Banks, December 2006
x
Primary assets:
Real Estate Loans: $3,207.1 billion C&I loans: $1,117.2 billion Loans to individuals: $846.9billion Investment security portfolio: $1,632.9 billion
Of which, Treasury securities: $1,070.6 billion
x
Inference: Importance of Credit Risk
1-38
Small Banks, U.S.
C&I 15% Credit Card 1% Consumer 6% Other 5%
Real Estate 73%
1-39
Large Banks, U.S.
C&I 20%
Real Estate 53%
Credit Card 7% Consumer 9% Other 11%
1-40
Commercial Banks
x
Primary liabilities:
Deposits: $6,426.5 billion Borrowings: $2,020.7 billion Other liabilities: $306.2 billion
x
Inference:
Highly leveraged
1-41
Balance Sheet and Trends
x x x
x
Business loans have declined in importance Offsetting increase in securities and mortgages Increased importance of funding via commercial paper market Securitization of mortgage loans
1-42
Off-balance Sheet Activities
x
Heightened importance of off-balance sheet items
Large increase in derivatives positions is a major issue Standby letters of credit Loan commitments When-issued securities Loans sold
1-43
Other Fee-generating Activities
x x
Trust services Correspondent banking
Check clearing Foreign exchange trading Hedging Participation in large loan and security issuances
Payment usually in terms of noninterest bearing deposits
1-44
1999 Financial Services Modernization Act (U.S.)
x
Financial Services Modernization Act
Allowed banks, insurance companies, and securities firms to enter each others business areas Provided for state regulation of insurance Streamlined regulation of BHCs Prohibited FDIC assistance to affiliates and subsidiaries of banks and savings institutions Provided for national treatment of foreign banks
1-45
Balance Sheet of AIs in HK (HK$ million, as of June 2008)
x
Total Assets: 10,396,199
Total loans to customers: 3,348,612
Hong Kong dollar: 2,354,384 Foreign currencies: 994,228
Amount due from banks abroad: 3,673,321
Hong Kong dollar: 373,321 Foreign currencies: 3,300,000
1-46
Balance Sheet of AIs in HK (HK$ million, as of June 2008)
x
Liabilities:
Total deposits: 5,705,110
Hong Kong dollar: 2,872,430 Foreign currencies: 2,832,680
Amount due to banks abroad: 2,452,020
Hong Kong dollar: 171,676 Foreign currencies: 2,280,345
1-47
Key Regulatory Agency in HK
x
Hong Kong Monetary Authority (HKMA): established on 1 April 1993 by merging the Office of the Exchange Fund with the Office of the Commissioner of Banking. Its main functions and responsibilities are governed by the Exchange Fund Ordinance and the Banking Ordinance and it reports to the Financial Secretary.
1-48
Policy Objectives of HKMA
x
x
x
To maintain currency stability, within the framework of the linked exchange rate system, through sound management of the Exchange Fund, monetary policy operations and other means deemed necessary; To promote the safety and stability of the banking system through the regulation of banking business and the business of taking deposits, and the supervision of authorised institutions; and To enhance the efficiency, integrity and development of the financial system, particularly payment and settlement arrangements.
1-49
Web Resource
For more detailed information on the regulators, visit: http://www.info.gov.hk/hkma
x
Web Surf
1-50
Overview of Insurance Companies
x
Two major groups:
Life, Property & Casualty
x x x
Size, structure and composition Balance sheets and recent trends Global competition and trends
1-51
Insurance Companies
x
Differences in services provided by:
Life Insurance Companies Property and Casualty Insurance
1-52
Life Insurance Companies
x
Size, Structure and Composition of the Industry (U.S.):
In 1988: 2,300 life insurance companies with aggregate assets of $1.12 trillion Mid 2000s: 1,300 companies In early 2006: $4.5 trillion in assets
3 largest wrote 20% of new premium business in 2005
Increasing involvement of commercial banks in insurance policy sales
1-53
Life Insurance: Issues
x x
Demutualization Adverse selection
Insured have higher risk than general population Alleviated by grouping of policyholders into risk pools
1-54
Life Insurance Companies
x
Life Insurance Products:
Ordinary life
Term life, Whole life, Endowment life. Variable life, Universal life, Variable universal life.
Group life Industrial life Credit life
1-55
Distribution of Premiums
1-56
Balance Sheet
Long-term liabilities
Net policy reserves to meet policyholders claims
Long-term assets
Need to generate competitive returns on savings components of life insurance policies Bonds, equities, government securities Policy loans
1-57
Property and Casualty Insurance
x
Size and Structure
Currently about 2,700 companies. Highly concentrated. Top 10 firms have 48% of market in terms of premiums written.
Top 100 frims: over 87% M&A increasing concentration
1-58
Global Issues
x x
x
Insurance industry becoming more global Regulatory and tax effects in Cayman Islands and Bahamas Introduction and acceleration of insurance market reforms
cross-country mergers (insurance companies as well as universal banks)
1-59
Worlds Largest Life Insurers
Revenues ING Group AXA Group Assicurazioni Generali Aviva Prudential Nippon Life ($millions) 138,235 129,839 101,404 92,579 74,745 61,158 Country Netherlands France Italy UK UK Japan
1-60
Worlds Largest P & C Insurers
Revenues ($millions) Allianz 121,406 American Intl Group 108,905 Berkshire Hathaway 81,663 Zurich Financial Svc. 67,186 Munich Re Group 60,256 State Farm Insurance 59,224 Country Germany US US Switzerland Germany US
1-61