faculty of economics
and business
finance
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Economics of Banking
Welcome to the
course!
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faculty of economics
and business
finance
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Economics of Banking
Lectures: Daniel te Kaat (2,4,6), Kasper Roszbach (1,3,5,7)
Tutorials: Fred Giesenow, Carolina Laureti, David Peng
Administration: Ellie Jelsema
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PRACTICALITIES
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How to contact us
› All relevant information is listed in the course
manual on Brightspace.
› For organizational and administrative matters,
contact Ellie Jelsema at e.t.jelsema@rug.nl
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Classes, tutorials, Q&A, exam
› 7 lectures of 2 hours

Overview of core material (course manual on Brightspace)
- Chapters in Mishkin’s book
- A few articles
- Online videos
› 6 Tutorials
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Questions posted on Brightspace
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Prepare exercises in advance, tutorials to discuss & understand better
› Assessment:
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Group assignment (20%): sign up by 20/4, hand in before 16/5
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Exam (80%): some exercises to get a feel, in lectures
› Questions
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Discussion board for general questions

Lectures and tutorials
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How much time do you need?
› Remember: 15 ECTS implies a 42h workweek
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This course is 5 ECTS, meaning a 14h
workweek
Minus contact hours, this leaves 10-11h for
self-study to read, summarize, make
exercises, prepare exam, etc.
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Exam
› Training questions at end of lectures, discuss in
“next” class
› Open & multiple choice Q´s (numerical & essay)
› Stands for 80% of final course grade
› What can you do to be well-prepared?
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Attend the lectures
Follow the reading schedule week-by-week
Prepare the tutorials before you attend them
Sign up for and make the group assignment
Be active, ask questions, discuss with fellow students
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What can you do to learn from the course?
https://www.youtube.com/embed/k9X0ogs0Ihc?
si=kWb7ekQbJiIi6ZEE
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COURSE SETUP
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Topics of lectures
1. Why do we have “banks”?
2. An overview of the financial system
3. Interest rates
4. What banks do, their structure
5. Regulation of banks
6. Monetary policy
7. Financial crises
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Week 1: Overview
› Why do we have banks?

Doug Diamond [Nobel symposium, 0:37-6:17]
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Week 2: Interest rates
› Banks “live” off the yield curve
Lend long
Interest margin
(return)
Maturity mismatch
(risk)
Borrow short
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Week 2: Interest rates
› Important to understand the yield curve
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Discuss theories, why it moves
What does slope of YC tell about economic activity and
risks for banks
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Week 3: Why do banks exist?
› Risk-sharing, transaction costs, agency problems
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Adverse selection (screening)
Moral hazard (monitoring)
› Empirical evidence
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Week 4: What banks do
› Delve into the balance sheet of banks
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How balance sheets work

How to assess bank performance
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What risks banks run and how to manage this
- Interest rate risk
- Credit risk
- Market risk
- Etc.
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Week 5: Regulation and competition
› What is the structure of the banking markets
› The role of regulation?

Basel framework
› Important institutions
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Week 6: Monetary policy
› Role of monetary policy
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
Central banks
(Un)conventional policies
- Effect on yield curve
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Real effects
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Week 7: Financial crises
› Causes of the 2008/9 financial crisis
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Low interest rates
Securitization
Interconnectedness
› Policy responses
› Economic fallout
› SVB failure
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TODAY’S LECTURE
AN OVERVIEW OF THE
FINANCIAL SYSTEM
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Agenda
› Introduction to the financial system and money
› Discuss key institutions and concepts
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Banks, NBFI
› Why are they important?
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Why is the financial system important?
› Why do many people put their (liquid) savings in a bank?
› Efficient allocation of resources across people & time
› How do maturity/price of credit affect real econ. outcomes?
› How do P2P lending, FinTech, BigTech affect credit market
efficiency?
› Why spend public resources on supervising fin institutions?
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Function of financial markets
› Financial markets (FM):
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Channel “funds” (i.e., money)
- from those with surpluses (savings) ...
- to those with a current need (early consumption or
investment)
› Channeling funds can be done [graph]
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Directly
- via markets, by means of more or less tradable securities
Indirectly
- via financial intermediaries (FI), e.g., banks etc
- can be specialized, diversifying risk, exploit scale economies
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Efficiency and welfare improvement
› How can financial system increase efficiency?
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Enable intertemporal substitution of consumption
Exploit differences in productivity/productive opportunities
Allow for risk-sharing
› Whether it improves welfare will depend on
market’s structure/features
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Information frictions
Transaction costs
Financial structure and financial development
Market power
Heterogeneous effects on households
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What is the current focus of banking research?
› The role of heterogeneity in consumers/firms
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Differential effects of policy/regulation on households/firms
How does capital mobility between countries affects e.g.,
effectiveness of regulation through bank behavior
› Climate change
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How will variation in the exposure to climate change and
transition risks affect banks, firms, households, nations?
› Do new financial institutions raise efficiency or risk?
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Do FinTech firms create more information that improves
credit allocation or do they fragment information access
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Question #1
Generally, many depositors (savers) like demandable
deposits (that can be withdrawn at any time) while
borrowers prefer longer term credit.
What can banks do to mitigate the risk of short-term term
funding?
What can banks do to reduce the riskiness of long-terms
loans?
Discuss 2 minutes and summarize
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Direct vs indirect finance
› Is funding allocated through markets or
financial intermediaries
› No sharp line
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E.g., VC funds can combine market funding with
intermediary role
Banks can be a market-maker (syndicates)
Banks provide credit for equity purchases, against
collateral pledge
P2P platform can link lenders and borrowers but also
grant credit itself
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There’s not “one” FM!
Various markets meet different needs, and (agents)
face different regulations (capital, liquidity, etc)
› Debt vs equity markets
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Variation in risk: equity holder is residual claimant
› Primary vs secondary markets
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Underwriters, syndicates, dealer/brokers
Market liquidity important for proper valuation of assets
[example of the 113 mn $ diner] and efficient markets
› Exchanges/CCP’s, OTC markets
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Variation in counterparty: standardization, insurance,
supervision
› Money vs capital markets (duration)
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Short vs long lived assets
› Money market instruments
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Treasury bills (T-bills)
CD’s, CP, interbank deposits, repos
› Capital market instruments
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Stocks, mortgages etc, corporate bonds, government
bonds
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FM or FI, why and when?
› If FM were complete and absent frictions, markets
are efficient allocation mechanism
› What breaks FM’s efficiency and creates a role for FI?
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Transaction costs
-
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Information asymmetries
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Time and money needed for/spent on a financial transaction
Scope for economies of scale
Adverse selection and moral hazard
FI have scale advantage and develop monitoring and screening expertise
Need for risk-sharing
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Both savers and borrowers have specific preferences for a risk-return
combination. FI can transform (increase or reduce) assets’ riskiness (risk
concentration or diversification)
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When FM, when FI?
› Some assets are characterized by higher
transaction costs or information asymmetries;
some savers/investors have greater need for risk
sharing.
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This creates a scope for FI
Mortgages: carry little aggregate risk, benefit from
diversified portfolios
Small business lending: small investors lack knowledge
about single firms
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Question #2
How do these financial institutions increase
efficiency? [transaction costs, opportunity for risk-sharing,
asymmetric information]
 Index fund
 Loan syndicate
 Centralized counterparty
 Rating agency
 Commercial bank
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Why are FM and FI regulated?
› Intermediaries differ by source/maturity of funding,
level of insurance/risk, regulation
› Retail savers\investors face similar frictions in
relationship \w FI as \w FM, lack resources to monitor
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Creates potential role for the government, i.e., regulation
› Purpose of regulation - and supervision
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Increase and improve information for retail investors/savers
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Maintain a sound financial system
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Disclosure requirements
Entry requirements, standards, inspection
Avoid panics, preserve trust in financial system
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deposit insurance
› Trade-off efficiency vs stability
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SPECIAL ROLE OF BANKS
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Why are banks special?
› Create and provide liquidity for
households and firms (dep/loans)
[The Narrow Bank][Icesave]
› Run the payment system [Fintech]
› Can diversify risk and reduce costs for retail savers
› Specialized in collecting information (screen, monitor)
› Main tool for transmission of monetary policy
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EU bank-based, US market-based
Source: BIS Quarterly Review, 2014
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EU bank-based, but less so over time
Source: Financial Integration and Structure in the Euro Area, ECB 2020
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Debt securities play larger role in US
Source: Financial Integration and Structure in the Euro Area, ECB 2020
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Question #3 Bank vs market based
What are reasons why small economies tend to be more bankbased than market-based?
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Fintechs & markets drivers of change
Source: Financial Integration and Structure in the Euro Area, ECB 2020
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Banks are adjusting to tech change
Source: Financial Integration and Structure in the Euro Area, ECB 2020
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MONEY:
WHAT FUNCTIONS?
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Money has three main functions
› Money = anything generally accepted in payment
for goods, services, debts
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Changes over time as certain assets become easier to
convert into currency or cheque account deposits
Greatly reduced interest in steering or even monitoring M
› Three functions
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Medium of exchange
Store of value
Unit of account
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Measures of money
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Question #4:
› Which properties (medium of exchange, unit of
account, store of value) do the following assets
lack to be classified as money?
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Amazon cash
Boxes of detergent during a hyperinflation
Bitcoin
Central bank digital currency (wallets capped at 500€)
Banknotes in a country where shops only accept cards
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Upcoming
› SIGN up for group
› Next week
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The role of interest rates (lecture)
Tutorial
Training questions for week 3
1. Explain why regulators sometimes rescue non-banks
despite them not having guaranteed deposits
2. Fintech lending platforms can lower transaction costs for
small ”investors”. Explain how they potentially can
increase information asymmetries and what
consequences this may have.
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Thanks for your
attention
Enjoy the course!
kasper.roszbach@norges-bank.no
RETURN
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Flow of funds in the financial system
Lending platforms
Insurance companies,
pension funds, mutual
funds, hedge funds
(Commercial and
investment) banks,
venture capitalists
Lending platforms
Bonds
Stocks
Return
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Are deposits insured?
Return
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Return
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Fintech conversion
Return
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Finance and growth
From Alex Popov, Evidence on finance and
economic growth, ECB working paper (2017)
Return
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Full reserve bank
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What do banks do?
› Take deposits
› Make loans
Commercial banks
› Insurance
› Investment banking
 Raising debt and equity;
M&A advice, etc
Universal banks
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Balance sheet
Assets
Cash + liq. assets
Securities (incl. govt)
Interbank loans
Liabilities
Deposits (short/long term)
Interbank deposits
Bonds
Loans (short/long term)
Fixed assets
Equity capital
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Income statement
Interest income
Interest expense
-
Retail
+
-
Investment,
private banking,
fees
Net interest income
Non-interest income
Non-interest expenses
Provision for loan losses
Income before taxes
Taxes
Net income
-
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Aggregated balance sheet of Euro
area banks (x1000 bn EUR, 2021-12-31)
Assets
Liabilities
Loans to residents
13,5
Deposits by
residents
Securities issued by
residents
7,0
Currency
1,5
Fixed assets
0,2
Other
liabilities
11,4
Other assets
11,1
Equity
3,0
Total
31,8
Total
31,8
15,9