Financial Companies

Week 1

1. Types of Financial Companies

Commercial Banks- highly regulated, accept deposits and make loans.

Investment Banks- help to issue securities in Primary Market. Large Investment Banks facilitate mergers and acquisition.

Insurance companies- accept premiums and underwrite insurance policies.

1. Regulatory Arbitrage

As commercial banks are the most regulated, it is better to open the business under the least regulated regime. This process is called Regulatory Arbitrage. Banks can choose between the home-state regulator and the federal government.  

1. Securitization

https://www.investopedia.com/terms/s/securitization.asp

It is the process of pooling similar financial assets in order to sell them to the investors in the secondary market. During the Global Financial Crisis, mortgages were pooled and sold to the investors by banks in order to create a liquidity.

1. With recourse- the original issuer of the security bears the loss
2. Without recourse- the investor who bought the security bars the loss

1. Subprime loan

Riskier loans, that are given to borrowers with lower credit rating

1. Asset write-downs

https://www.investopedia.com/terms/w/writedown.asp

It is the reduction in the book value of an asset when the fair market value has fallen below the value in the book.

1. Negative amortization

It is an increase in the principal balance of the loan. For example, if the interest payment on a loan is $500, and the borrower only pays $400, then the $100 difference would be added to the loan's principal balance.

1.  Ted-Spread

The difference between the interest rate on short-term U.S. government debt and the interest rate on interbank loans. It is calculated by the formula

TED= Interbank Rate – T-Bill rate

TED measures the risk. Lower TED means lower risk of banks default

1. Geographic classification of banks

Global bank- the largest. Combines Commercial Banking, Investment Banking and Insurance. Provide services for governments, businesses and individuals.

Super-regional bank- smaller than global banks. Limited global operations and fewer non-traditional products.

Regional banks- operate within the country

Community banks- operate within the country and focus on lending to small businesses and individuals.

1. Transactional and Relationship banking

Transactional Banking- products that are highly standardized and require little human input.

Relationship Banking- a strategy used by banks to strengthen customer loyalty by offering range of products to increase the revenue. The credit granted procedure here requires additional expertise, if the credit score is not standardized.

1. Originate-to-Distribute business model

It is a model, when bank sells loans to the third parties (SPV). This model was used during the Global Financial Crisis, but failed because of the huge amount of subprime loans.

1. Universal Banking

Originally created in Western Europe. Combines traditional commercial and investment banking.

1. SIFI and TBTF

SIFI (Systemically Important Financial Institutions)- banks that would pose a serious risk to the economy if it were to collapse. This label imposes extra regulation, higher minimum capital requirement and stress testing. This regulation was created after the GFC.

TBTF (too big to fail)- a business or sector whose collapse would cause catastrophic damage to the economy. Therefore, the government will consider bailing out the business or even an entire sector to prevent economic disaster.

The critique was that TBTF firms get unfair help from the government. In response, the Dodd-Frank Act was imposed. The Act helps to avoid the need for future bailouts by imposing new regulations.

1. Hierarchy of claims

The order of getting paid by a company. Debtholders(1)- hybrid securities(2)- equity and common shareholders(3)

Week 2

1. Differences in roles played by CB and IB

1. The number of contracts involved: CB is an intermediary, so it has two contracts (depositor-bank and bank-borrower). IB just arranges deals, so there is only one contract (company-investor).
2. Timing difference: in CB the dime difference between taking deposits and making credits is bigger than in IB
3. Risk: CB carries credit risk that borrower will default. IB caries market risk, but only if it provides underwriting facility. Underwriting means that the IB guarantees that the company will be able to sell a certain amount of securities. In investors fail to buy them, the IB must buy.

1. Cross-selling

Selling multiple related products to one customer.

1. Similarities in roles played

They both connect those with fund surplus (depositors) with those with fund deficit (borrowers). This action is called the mobilization of surpluses.

1. Core divisions of CB

1. Corporate Banking

Funded facilities, that require spending money by the bank: overdrafts (credit cards), direct loans, bill discounting (selling unpaid invoice to the bank).

Non-funded facility: issuance of letter of credit, issuance of guarantees, foreign currency transaction. Non-funded facilities earn money by taking fees for issuance.

1. Retail banking- banking for individuals
2. Treasury

1. Core teams

1. Relationship Manager- sales team. Main goal- to work with clients
2. Credit Analysist – recommends credit limits for borrowers
3. Trade finance- operates with non-funded facilities  

Week 3

1. Deposit Insurance

It is a measure to protect depositors in case of banks default. It promotes the financial stability and the insurer is usually the company runed by the government. This measure reduces the probability of bank runs (situation, when high percentage of depositors decides to withdraw money from the bank and the bank doesn’t have enough cash).

1. Goals of regulations

Safety and soundness of financial institutions

Efficient financial system

Monetary stability

Consumer protection

Integration of payment systems

1. Drawbacks of regulations

1. Hybrid financial companies can find loopholes to provide the same products as banks
2. US-based firms are more restricted than foreign-based firms. For example, underwriting is not allowed for US-based.
3. Reduced consumer choice of products- this is called “nanny state”

1. Fractional Reserve System

In this regime banks cant lend 100% of their reserves. Central Banks states the reserve requirement for the bank. The bank should keep this requirement, but now the US requirement is 0%. The central bank can control the money supply by increasing/decreasing reserve requirement. Increased reserve- decreased supply