Guy Hargreaves
ACF-104
Course goals
 To gain a fundamental understanding of the banking
system
 To understand the different forms of banks,
particularly commercial banking
 To understand the financial logic and concepts behind
the banking system
2
Course Coverage
 Overview of banking systems and their structure in
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developed economies
Understand how management of banks and commercial
banks affects the economic system and the whole financial
system in an economy
Understand the roles played by banks and how asset
management of banks can affect financial structure
Understand liability and risk management in banks with
understanding of risk and Basel concepts
Understand how savings, loans in short and long term
affect the roles and profitability of financial institutions
Acquire knowledge of how international banking systems
and global banks work and operate
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About.me
 25-years of experience in Investment and Corporate
Banking in Asia Pacific region
 Kiwi living in Hong Kong with wife and three children
 My goal: deliver academic based introduction to
banking from the perspective of a highly experienced
practitioner
=> please feel free to ask questions at any time
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Structure and assessment
 Text:
Financial Markets and Institutions;
Frederic Mishkin, Stanley Eakins
 3 x 50 min lectures Mon-Fri 8.30-11.30am
Rm 4239
 1 x 50 min tutorial Mon-Thurs 2.30-3.30pm Rm 4410
 Exam: 2 hours on Friday, 20th November
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multiple choice questions + short questions + short essay
100% of final mark
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Today’s goals
 Understand the fundamental principles of financial
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intermediation
Explain “financial claims” and distinguish between
marketable and non-marketable financial claims
Identify various financial markets, and banking and nonbanking financial intermediaries
Distinguish between deposit-taking and non-deposittaking financial intermediaries
Understand banking versus shadow banking markets
Explain the functions and characteristics of money and
monetary bases
Explain the importance of market liquidity to the operation
of the global economy
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Financial Assets
 An asset is any “property” of value held or owned by an
individual or company
 A Financial Asset can be thought of as financial
property eg:
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Cash (money) in your wallet
Deposit with a bank
Corporate bond
Common share of a company
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Financial System
 The typical components of any financial system:
1.
2.
3.
4.
Financial Assets
Borrowers and Savers of financial assets
Financial Intermediaries
Central Bank regulators (set and manage the rules of the
financial system)
 Financial systems exist within individual countries
which have their own currency
 Currency blocks (eg Euro) can have common
components (eg European Central Bank)
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Financial Intermediation
 Two fundamental parties to any financial system:
1. Borrowers (deficit units)
2. Savers (surplus units)
 Financial Intermediation is conducted by third
parties who take deposits from Savers and make
loans with those deposits to Borrowers
 Financial intermediation increases economic
efficiency by offering valuable transformative
services to both Borrowers and Savers
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Intermediation…
Savers
Financial
Intermediaries
Borrowers
…versus Direct Finance
Savers
Financial
(Capital)
Markets
Borrowers
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Financial Claims
 Financial Claims are contractual obligations created
when a Borrower accepts money from a Saver (or
Lender)
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Obligation to pay that money back at some time in the future
Obligation to pay interest or a return on that money
Can be Secured or Unsecured by other assets
 Holder of financial claim has a Financial Asset
 Grantor of financial claim has a Financial Liability
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Marketability
 Financial Claims are said to be marketable if a holder can
efficiently sell (transfer) the claim to a third party eg:
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Commercial Paper (CP)
Bonds
Shares
Asset Backed Securities (ABS)
 Financial Claims are said to be non-marketable if a holder
can not efficiently sell (transfer) the claim to a third party
eg:
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Structured Project Finance Loan
Insurance Policy
Bank deposit
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Major world financial systems
Country
Currency Central Bank
Major Banks (sample)
China
RMB
PBOC
BOC, ABC, ICBC, CCB
USA
USD
Federal Reserve
Citi, JP Morgan, BAML
EU
EUR
ECB
Deutsche, SG, BNP
UK
GBP
BOE
Barclays, RBS, Lloyds
Australia
AUD
RBA
ANZ, CBA, Westpac, NAB
Canada
CAD
BOC
RBC, CIBC, TD, BNS, BMO
Hong Kong
HKD
HKMA
HSBC, Stan Chart
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Types of financial intermediaries
 Intermediaries are usually either:
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Regulated licensed banks or building societies etc
Non bank financial institutions (NBFIs)
 Regulated banks are typically:
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Retail Commercial Banks
Wholesale Commercial Banks
Universal Banks
 “Deposit-Taking Institutions” – eg banks
 “Non-Deposit-Taking Institutions – eg insurance
companies
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Types of financial intermediaries
 Non Bank Financial Institutions are typically:
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Investment Banks
Insurance Companies
Pension / Mutual Funds
Private Equity Funds
Hedge Funds
Venture Capital Funds
Securitised Lenders
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Building Societies
 Member based mutual (cooperative) organisations
 Operate at “retail level”
 Mortgage and savings product focused
 Mostly unlisted
 Smaller balance sheets, regional
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Nationwide Building Society (UK)
Yorkshire Building Society (UK)
IMB (Australia)
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Retail Commercial Banks
 Limited liability corporate organisations
 Primary focus at “retail level”
 Mortgage and savings products
 Mostly listed
 Medium sized balance sheets
 Large number of smaller customers
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Wholesale Commercial Banks
 Limited liability corporate organisations
 Primary focus at “wholesale or corporate level”
 Corporate loans
 All listed
 Large sized balance sheets
 Smaller number of larger customers
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Universal Banks
 Limited liability corporate organisations
 Focus at “retail and wholesale / corporate level”
 Retail banking, corporate and Capital Markets
products
 All listed
 Large sized balance sheets
 Large number of large and small customers
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Investment Banks
 Partnerships or limited liability corporate
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organisations
Focus at “wholesale / corporate level”
Capital Markets products
Listed and unlisted
Volatile balance sheets
Smaller number of large customers
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Insurance Companies
 Mutuals or limited liability corporate organisations
 Focus at “retail and wholesale / corporate level”
 Premium based risk management products
 Listed typically
 Large off-balance sheet exposures
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Pension / Mutual Funds
 Trust based corporate organisations
 Focus at “retail and wholesale / corporate level”
 Investment management products
 Listed and unlisted
 Limited to no leverage
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Hedge / Private Equity Funds
 Trust based corporate organisations
 Focus at “wholesale / corporate level”
 Investment management products
 Target absolute returns
 High potential leverage
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Venture Capital Funds
 Trust based corporate organisations
 Focus at “wholesale / corporate level”
 Investing in startup or early stage companies
 Target absolute returns
 Zero leverage
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Securitised Lenders
 Trust based corporate organisations
 Focus at “retail and wholesale / corporate level”
 Originating and funding portfolios of financial assets
 Highly structured Special Purpose Companies
 High leverage
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Shadow banking
 The term Shadow Banking has been used in the past 5-
10 years to describe a banking-like system of financial
intermediation conducted by NBFIs
 As a result it is largely unregulated and is considered to
have contributed significantly to the 2007-9 GFC
 Post 2007-9 GFC shadow banking closed down but in
recent years it is re-emerging in the form of P2P
lending, crowdfunding and private equity
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Financial markets
 “Places or platforms” where financial assets are bought
and sold
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Electronic or “over-the-counter” (OTC)
Open outcry exchanges are almost things of the past (eg
futures pits)
 Most significant financial markets conduct trade in:
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Securities (shares and bonds eg NYSE, Nasdaq)
Futures and derivatives (eg Chicago Mercantile Exchange /
Chicago Board of Trade)
Foreign exchange (largest cash market of them all)
Commodities (much of the physical trade is OTC)
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Financial market regulation
 Everywhere there is a financial market there is usually
a regulator establishing and monitoring the rules
governing that market
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China – CSRC oversees securities markets
US – SEC oversees US security markets
UK – FSA
Australia – ASIC
 Regulators aim to ensure markets are fair and orderly
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Information Asymmetry
 Financial market participants often have varying levels
of information –> Information Asymmetry
1.
2.
3.
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Some players have differing information
Some players have Inside Information
All players have imperfect information
Inside Information is usually gained from private
sources and is usually illegal to trade from (insider
trading)
A key regulatory task is to prevent insider trading
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Global financial markets
 In 2015 most financial markets attract participants
from all over the world ie they are global in nature eg:
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Gold derivatives traded in USD by most global players
AUD corporate bonds can be held by most global investors
but more interest generally shown by Australian investors
Shares traded on NYSE by investors on all continents
 Some markets have restrictions such that many global
players can not access them -> localised pricing and
trading
 Many markets are highly correlated with each other
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Financial market liquidity
 Market liquidity impacts a participant’s ability to:
1. Transact in a market at their time of choosing
2. Transact volume of choosing
3. Minimise transaction costs
 Increasing market liquidity grows volumes while
lowering per unit transactions costs
=> Increased economic efficiency
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The history of money
 Before “money”, market participants used the Barter
System:
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Participants exchange goods and services directly for other goods
and services
Very inefficient because of high transactions costs, lack of price
transparency, minimal standardisation and costly/difficult to store
wealth
 “Commodity Money”, a fixed weight of grain, was used by
the Mesopotamians some 3,000 BC
 Commodity money was replaced by gold and silver, and
eventually by banknotes (first used in China during the
Song Dynasty circa 1,000 AD)
 Today we may be standing at the dawn of Cryptocurrency
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The uses of money
 Medium of exchange – widely accepted as payment for
goods and services
 Medium of valuation – widely accepted as method of
“relative” valuation of goods and services
 Store of value – confidence that participants can hold
money into the future to pay for goods and services in
a predictable way
 Standard of Deferred Payment - goods and services
consumed now can be paid for in the future with
money
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The properties of money
 To be a viable medium of exchange a monetary asset
needs various qualities:
1.
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5.
Acceptable to participants
Standardized quality
Durable
Valuable relative to its weight ie efficient to use
Divisible to accommodate various prices of goods and
services
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Money of today
 Governments around the globe today issue banknotes
and coins which derive value by government order or
“Fiat”
 Governments decree by law that all public and private
financial liabilities can be repaid by this “Fiat” money
– designating it as “legal tender”
 The right to issue (or print) money comes with
responsibility. Printing excessive banknotes or
expanding the Money Supply can cause inflation and
lead to collapse in trust in that money
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Yes, Zimbabwe?
 Zimbabwean dollar was the official currency from 1980 to
2009, when it was abandoned
 Following a period of hyperinflation the currency was
redenominated on three occasions from 2006
 When abandoned the $Z had been redenominated by
10^25!
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Money Supply
 Monetary aggregates are measures of the quantity of
money in circulation – typically broader than simply
banknotes and coins:
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M1 is defined as banknotes, coins and on-call deposits
M2 is defined as M1 + most term deposits
 M1 and M2 is carefully watched by many markets to
monitor government trustworthiness!
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