Financial Markets Final

• Financial transactions can occur indirectly through financial intermediaries or directly through financial markets.
• Transformations in financial markets can lead to mismatches, resulting in risk.

Lecture 2

• High debt levels are especially prevalent in mature markets.

Lecture 3

• SSM and AQR took place in 2014.
• A clear deviation from the norm was observed in 2016, leading to a Nordic top.
• Europe faces challenges: slow growth, Non-Performing Loans (NPLs), and a profitability gap compared to the US.
• Net Interest Income (NII) gains primarily stem from wide margins banks charge for loans versus payouts on deposits.
• Trading continues at a steep discount.
• In 2012 a spillover led to a banking union.
• There were Single Supervisory Mechanism (SSM).
• As well as Single Resolution Mechanism (SRM).
• European Deposit Insurance Scheme (EDIS).
• Germans feared moral hazard, while Southern countries like France supported the scheme.
• The final stage of the Capital Markets Union (CMU) involves debt and Initial Public Offerings (IPOs).

Lecture 4

• Central banks use lending/deposit facilities, open market operations, and reserve requirements as tools.
• Central banks emerged to address bank failures and protect depositors.
• Independence in central banking stimulates the economy by relaxing credit policy instead of printing money.
• The European Central Bank (ECB) operates with a hierarchical mandate, prioritizing price stability. Reserve requirements are rarely used due to immediate liquidity problems for banks. Uncertainty can make illiquidity management difficult.
• Conventional monetary policy involves short-term interest rates.
• Unconventional monetary policy includes forward guidance, Asset Purchase Programmes (APP), term funding facilities, and negative interest rates.
• Low interest rates can create a false sense of security.

Lecture 5

• Liabilities, including core deposits and managed liabilities, are sources of funds.
• Managed liabilities are more volatile and rate-sensitive.
• Equity, including regulatory components, serves as a cushion.
• Interest-earning assets (loans, leases, and investment securities) are uses of funds.
• As well as fee-generating assets and nonearning assets.
• Basel I: Risk-Adjusted Ratio (RaR) = (CET1 + CET2) / Risk-Weighted Assets (RWA), adjusted by risk class.
• Basel II incorporates credit ratings and the Internal Ratings-Based (IRB) approach.
• Basel III includes a leverage ratio (CET1 / average total consolidated risks) and simple non-risk-based backstop measures like Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR).
• Basel IV removed the worrying of variability so the very large is no longer used.
• Market assessments are difficult due to information asymmetries.

Lecture 6

• Regulation involves governing structure, activities, liquidity, transparency, and capital adequacy.
• The 2nd directive allowed offering a full range of financial services, leading to universal banking.
• The Gramm-Leach-Bliley Act in the US allowed financial institutions to undertake securities and insurance activities.
• Unforeseen demand government safety nets include EDIS and lender of last resort facilities.
• Regulators must monitor liquidity and show statistical findings.

Lecture 7

• Aggregate risk in the system is higher than the sum of individual risks.
• G-SIBs: allocated buckets corresponding to higher capital buffers that they are required to hold by national authorities in accordance to international standards.
• O-SIIs require additional loss absorption capacity.
• Three main issues affect how strict these rules are:
  • Moral hazard - Forbearance can lead to continuation of operating when capital is fully depleted
  • Compliance costs
  • Barriers to entry
• Shadow banking includes Money Market Funds (MF), Exchange Traded Fund (ETF); Hedge Funds (HF); Venture Capital (VC); Private Equity (PE), FinTech, insurance, and pension funds.
• Mutual funds offer liquidity intermediation, denomination intermediation, diversification, cost advantages, managerial expertise, and indirect fees.
• Investment funds: both Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Funds (AIFs), pool savings of investors with similar investment goals.
• Discretionary Management (DM): asset managers can buy/sell assets and execute transactions on an investor's behalf, in their private account.
• ETFs are listed on stock exchanges and are highly liquid.
• They are growing in popularity but fees are under pressure.
• Active ETFs generate more fees than passive ones from new flows.

Lecture 8

• Asset-Backed Securities (ABS) are bonds issued on the back of a package of assets.
• Collateralized Debt Obligations (CDOs) are securitizations of packages of corporate bonds/loans.
• Credit risk is difficult for end-investors to assess.
• Banks maintain credit risk on their balance sheets.
• Peer-to-peer (P2P) lending doesn't maintain own credit risk, thus incurring less stringent capital requirements.
• Sustainability of shadow banks depend on:
  • More regulation as size increases
  • Hard to expand to asset classes like volatile mortgages with more stringent regulatory scruitny
  • Competitive response from incumbent banks.

Lecture 9

• Capital market supervision involves information and addressing market abuses.
• Banking supervision involves capital adequacy, governance, risk management, and reporting.
• Digitalization and analysis include policy, payment, and reporting.
• Insurance supervision protects insured benefits, solvency, and manages risk.
• Legal units handle administrative sanctions, guidelines, regulations, and legal support.
• The European Banking System (EBS) works with the European Supervisory Authority (ESA).
• Fund managers must be authorized and registered.
• There is harmonized fund regulation and collective portfolio management.
• UCITS are open-ended funds marketed to retail investors.
  • They must be managed by authorized UCITS fund managers, authorized before marketing, hold assets separate from their own in a depositary, and must have limited liability.
  • Regulations for the funds are not harmonized.
• AIFMD does not require authorization.
• An Alternative Investment Fund Manager (AIFM) is the legal entity in charge of managing an AIF.
  • AIFMs raise capital, undertake collective investments, manage based on investor numbers, and invest according to the definitions within policy.
  • FIN-FSA can decide whether funds need a license.
• Authorization is not fulfilled if investors haven't delegated decision-making to third parties.
• AIFs are only for professionals.

Lecture 11

• Insurance companies are risk-neutral, while buyers tend to be risk-averse.
• Sources of income:
  • Initial underwriting income from insurance premiums
  • Investment incomes from holding premiums occurs from collecting now and paying later.
• Adverse selection solutions involve screening and risk-based premiums.
• Moral hazard is limited with restrictive provisions, prevention of fraud cancellation of insurance, deductibles, and coinsurance.
• Solvency II reduces the probability of insurers failing.
  • Valuation techniques, capital requirements plus governance, and reporting standards
  • In addition to risk based capital regime
• Unit-linked products do not insure your assets they are investment through an insurance company.
• Defined Benefit (DB) plans: constant accrual rate for service years, placing the burden on employers to fund benefits.
• Defined Contribution (DC) plans: flow into an individual account, accumulating contributions with investment returns (converted into a pension-income stream at retirement).
• 401k plans have a target date, may postpone, and include employer matching.
• Finland has partial funding incorporating both earnings related pension expenditures and previously collected funds.