Lecture 1

• On-balance-sheet items are directly recorded on a bank's financial statements: assets (loans), liabilities (deposits), and equity, reflecting the bank's core activities of borrowing, lending, what it owns, and owes.
• Off-balance-sheet items do not represent actual assets or liabilities at the time of reporting, like loan commitments, derivatives, letters of credit, and securitizations, which can expose a bank to risk.
• Interest income is considered on-balance-sheet banking, as it represents money earned rather than what a bank owns or owes, and is recorded in the income statement.
• Lender-savers have excess funds, while borrower-spenders need funding.
• Indirect funding occurs when funding flows through financial intermediaries, such as banks, mutual funds, or insurance companies.
• Banks liabilities are deposits.
• Banks assets are loans.
• Direct funding happens when funding flows directly through financial markets, such as businesses issuing bonds or stocks for investors to purchase, which banks may facilitate without holding the loan or security on their balance sheet.

Financial Intermediaries

• Depository institutions (banks) accept deposits and use these to provide loans, including commercial banks, credit unions, and savings and loan associations, with primary liabilities as deposits and primary assets as loans, mortgages, and securities.
• Contractual saving institutions collect funds through contracts like insurance policies or retirement contributions, such as pension funds and life insurance companies, with primary liabilities of premiums and assets invested in bonds, stocks, and mortgages.
• Investment intermediaries pool funds from investors and allocate them across various investments, including hedge funds, mutual funds, and finance companies, with primary liabilities as money through shares and commercial paper and primary assets as loans, stocks, bonds, and money market instruments.
• Banks are dominant institutions holding about 40% of global financial assets.
• Non-banking financial institutions (NBFIs) make up about half of the global financial assets, complementing banking by offering alternative forms of financing and risk management.
• Banks collect funds from deposits, asset management, and issued bonds, then use these funds for loans, investments, and other assets.
• Retail and corporate banking mainly use on-balance-sheet banking for deposits and liabilities, while investment and asset management mainly use off-balance-sheet banking, resulting in contingent liabilities or fee income.

Finnish Financial Markets

• In Finland, households hold a significant portion of their income in banks, making bank deposits the primary financial assets.
• Money is most often held in banks, and then invested in listed companies.
• This trend reflects a saving-oriented culture, where stability and safety are prioritized over risk.
• The Finnish market has seen a steady increase in mutual funds.
• Finland has a mandatory pension system, with constant growth.
• Public pension institutions emphasize fixed-income investments, such as bonds, to maintain stability.

Role of Financial Institutions

• Private pension funds invest in equity of listed company shares.
• They are the largest owners in Finnish companies.
• Financial markets and intermediaries exist to facilitate consumption timing and smoothing, allocate, manage, and pool risk, separate ownership and control, provide liquidity, and process information.

Role of Banks

• Size transformation involves banks pooling money from small depositors to provide larger loans to borrowers.
• Maturity transformation involves banks using short-term deposits to fund long-term loans.
• Risk transformation involves banks managing and reducing risks associated with lending by diversifying across different industries and locations.
• Banks must manage credit, liquidity and interest rate risks.
• Deposit guarantee systems help to mitigate risk

Banks Incentives

• Banks benefit from deposits as these are a stable source of funding.
• "Too large to fail" refers to financial institutions that cannot be allowed to fail due to the severe consequences on the economy; there can be issues of moral hazard because of this.