Financial Markets and Institutions 28C Vesa Puttonen Fall 2016

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1 Financial Markets and Institutions 28C00800 Vesa Puttonen Fall

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3 Course objectives Understanding the workings of financial markets and institutions Commercial banks, central banks, investment banks Funds, insurance companies Which economic phenomena create the observed structure and design of markets, institutions and products Understanding various facets of this and previous crises Crises in developed and emerging markets Regulation Linking together arguments, understanding current debates and challenges; almost no math / equations We will have in-class discussions 3

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5 What is the course about? Date Topic Mishkin& Eakins Nov 1 Introduction to the course and the financial system Ch 1, 2, 7 Nov 3 The global financial crisis Nov 8 CEO Jussi Laitinen / Aktia Inside job * Nov 10 Fixing the financial system European Capital Markets Union Nov 15 Fundamentals of financial institutions and commercial banking 7, 17 Nov 17 Central banks 9 * Before the lecture watch Inside job (2010) movie (e.g. 5

6 What is the course about? Date Topic Mishkin& Eakins Nov 22 Financial regulation 10, 18 Nov 24 Shadow banking 19, 20, 22 Nov 29 Financial innovations 19 Dec 1 Insurance companies 21 Dec 8 Wrap-up, feedback and exam prep. Deadline for the Term paper: Nov 21 at 16:00 Deadline for the Case: Dec 2 at 16:00 6

7 Course materials On MyCourses web page Lecture slides Guest lecture slides Reading list (compulsory reading) Term paper and Case Course book not required in the exam but you may use it as supplementary material Mishkin, F.S. and S.G. Eakins (2016/2012): Financial Markets and Institutions, Pearson (global edition) Chapters as indicated in the course overview 7

8 Reading list Aktia Bank, Interim Report January-June 2016 Financial Crisis and Central Banks G30 (2015). Fundamentals of Central Banking. Lessons from the Crisis. EU-wide stress tests European Banking Authority EU-wide stress test. 29 July, European Capital Markets Union Goldman Sachs (2015). Unlocking Europe s economic potential through financial markets. Issue No: 15/07, February 21, The best case Stress testing European banks report 8

9 Grade Exam: 50%, Case: 30%, Term paper: 20% Extra points possible for case and term paper To pass the course, there are 3 requirements To take part in the exam (do not forget to register for the exam) To get at least half of the points from the exam (25/50) To get at least 50 points from the course overall For example, either one below would make you pass Exam: 25, Case: 22, Term paper: 3 Exam: 50, Case: 0, Term paper: 0 9

10 Workload Lectures, 24 h Class preparation, 12 h Case and term paper preparation, 70 h Exam preparation, 50 h Exam, 3 h 10

11 Case (group work) Topic: Stress testing European banks Max. 20 ppt slides Groups with 2-4 students Quality of content is more important than quantity Deadline: Friday, 2 December at 16:00 The best case will earn 5 extra points and the report will be part of the course material 11

12 Case (group work) Why ppt slides? Facilitates structuring and presentation of results Encourages you to focus on main aspects and think more systematically about connections between various arguments / facts and how to present them Encourages you to use various sources of information because you can use pictures / graphs / cartoons besides text Facilitates grading 12

13 Term paper (individual/small group work) Topic: Deutsche vs Monte dei Paschi 1-2 students in a group Deadline: Monday, 21 November at 16:00 Best 4 papers on will earn 5 extra points 13

14 Term paper (individual/small group work) Some guidelines Use font size 12, spacing 1,5 No explicit requirements on margins (content is more important than length!) Max. length for answering the questions is 5 A4 pages; references can be listed on an additional 6 th page Cite properly 14

15 Case and term paper Case and term paper topics are based on current topics that are broadly discussed in the media and among politicians, policy makers and economists You need to combine various aspects You need to read new information and combine it with the lecture materials Aim is to acquaint you with some of the current discussions and to allow for a digging-deeper Also: boosting presentation and argumentation skills (filtering out the relevant points and forming conclusions) 15

16 Submission and grading policy Late submissions not accepted The only exception is: if you are sick, a report from your doctor is needed I have a strict grading policy Once the term paper/case results are posted on the course webpage, there is no room for change unless the grader has made an obvious mistake in calculating the grades So: you need to write ALL YOUR ARGUMENTS clearly in your answers 16

17 Scholastic honesty and academic integrity I expect adherence to highest standards of scholastic honesty Examples of scholastic dishonesty are Presenting answers as own work without proper citation to the sources (plagiarism) Sharing answers during the final exam All class work (Case & Term paper) is to be done by the students that return the work Co-operation in preparing answers to the exercises between groups (or individuals not belonging to the same group) is strictly prohibited 17

18 Contact information Professor Vesa Puttonen Office hours: Mondays 14:00-15:00, Chydenia, Room G

19 Course Messengers Financial Markets and Institutions Christian Danford Minttu Bergendahl Phone number: Phone number: Feel free to contact us by phone, , Facebook or in person!

20 Introduction to the financial system Why study financial markets and institutions? Finnish financial markets Need for a fix 20

21 Why study financial markets? Source: tures.com/2011/09/size-offinancial-markets.html 21

22 Why study financial institutions? Do they matter? The Economist, July 16, 2009 In 2000, in his presidential address to the American Finance Association, Franklin Allen, of the University of Pennsylvania s Wharton School, asked: Do financial institutions matter? Lay people, he said, might be surprised to learn that institutions play little role in financial theory. Indeed they might. Mr. Allen s explanation was partly that the dominant theories had been shaped at a time when America, especially, was spared financial crises. 22

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24 Function of Financial Markets 24

25 Types of Financial Intermediaries Mishkin & Eakins Financial Markets and Institutions (Pearson) 25

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27 Selected Countries: Relative Size of Financial Intermediaries (Percent of GDP) 27

28 Finnish financial markets 28

29 Finland - Banks 29

30 Finland 30

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32 Development of insurance classes Statutory pension insurance Life insurance and other pension insurance Foreign reinsurance Motor liability insurance Workers' compensation insurance Voluntary non-life insurance Premium income as a percentage of GDP

33 Finnish pension assets Source: Tela

34 Investments of largest pension institutions as of June 30, 2016 Basic allocation by market value Elo Etera Ilmarinen Varma Pension- Veritas Pension insurance companies average and total Local Gov PF (KEVA) State PF (VER) Fixed-income 43,7 45,8 44,7 38,0 45,4 42,0 47,2 47,3 Loans 2,5 4,5 3,3 3,3 1,3 3,2 0,9 Public sector Bonds 37,0 32,6 40,6 27,1 36,5 34,1 36,4 39,8 Government bonds 20,0 4,3 12,6 11,8 10,8 13,2 15,0 12,6 Other bonds 17,0 28,3 28,0 15,3 25,7 20,9 21,4 27,2 Other fixed income instruments and deposits 4,2 8,8 0,8 7,6 7,5 4,7 9,9 7,5 Equity 30,8 27,1 38,6 36,9 34,7 35,7 40,2 46,0 Listed 23,9 17,6 30,0 28,7 28,7 27,6 33,9 41,2 Private equity 5,5 8,8 5,8 6,3 4,2 6,1 5,3 4,3 Unlisted 1,4 0,7 2,8 2,0 1,7 2,1 1,0 0,5 Real estate 12,9 18,2 11,3 9,3 10,2 11,2 6,6 2,8 Direct 9,6 13,4 10,0 7,6 7,6 9,1 5,0 Indirect 3,3 4,8 1,4 1,7 2,6 2,1 1,6 2,8 Other investments 12,6 8,9 5,3 15,7 9,7 11,1 6,1 3,9 Hedge funds 12,6 5,2 2,3 15,8 4,9 9,7 6,1 3,3 Commodities 0,0 0,2 0,0 0,0 0,0 Other 0,0 3,6 3,0 0,0 4,8 1,3 0,5 Total investements, % Investment allocation at fair value, million eur Pension insurance companies As of

35 Breakdown of life business in 2014 million Personal life insurance, unit linked Capital redemption policies (Guaranteed-return) Personal pension insurance Other life insurance Voluntary group pension Employees group life insurance Total 5,942 million

36 Life insurers' market shares in 2014 Nordea Life 31.3% 42.4% OP Financial Group Mandatum Life + Kaleva 22.8% 24.7% 19.0% 23.3% By premium income By assets under management Others 15.9% 20.7%

37 Finnish finance companies: Outstanding credits* ,0% 2009 m ,0% +1,2% +4,6% ,6% Q1 0 Hire purchases Leasing Car leasing Investment financing Factoring Source: Federation of Finnish Financial Services, *only member finance houses

38 Total net assets of mutual funds domiciled in Finland (billion eur) ,1 92, , ,9 66,0 54,3 61,5 55,4 66, ,1 44,7 41, ,1 15,7 13,5 14,5 10,2 4,9 0,1 0,6 1,0 0,9 1,9 3, /2015

39 Function of financial markets Allow transfer of funds from persons without to persons with investment opportunity Result: economic efficiency Allow interactions of buyers and sellers to determine price of the traded asset, i.e. price discovery process Result: allocation of capital and guidance to managers Provide a mechanism for an investor to sell a financial asset, i.e. liquidity Result: possibility for corporations to raise capital in the primary market Reduce transaction (search and information) costs Allow the transfer of risk, e.g. in the derivatives market 39

40 Need for a fix 40

41 Christine Lagarde, IMF Jackson Hole, August 27, 2011 As we all know, a major cause of the crisis was too much debt and leverage in key advanced economies. Financial institutions engaged in practices that magnified, disguised and fragmented risk, while households borrowed too much. Experience tells us that these excesses (combining both housing and financial crises) take a long time to work off and require decisive action.[...] The crisis has shown/reminded us that financial institutions matter! 41

42 Financial institutions and financial crisis First, financial institutions and other investors were excessively optimistic about asset prices and risk, lulled by a low interest rate environment and changes in the financial landscape that masked the extent of leverage and made these risks more opaque and interconnected. Second, neither market oversight nor prudential supervision were able to stem excessive risk-taking or take into account the interconnectedness of the activities of regulated and non-regulated institutions and markets. This was due in part to fragmented regulatory structures and legal constraints on information sharing. 42

43 Financial institutions and financial crisis Third, once the crisis hit, weaknesses and differences in national and international approaches to dealing with crossborder bank resolution and bankruptcy came to a head. And finally, the crisis drove home the limitations of existing mechanisms for central bank liquidity support and the need for significant changes in practice on this front. Lessons of the Financial Crisis for Future Regulation of Financial Institutions and Markets and for Liquidity Management International Monetary Fund,