LECTURER: (Elikplimi Komla Agbloyor, PhD ) DEPARTMENT: (Department of Finance, UGBS) (Contact Information:

Transcription

1 THE ECONOMICS OF FINANCIAL INTERMEDIATION AND INNOVATIONS ) LECTURER: (Elikplimi Komla Agbloyor, PhD ) DEPARTMENT: (Department of Finance, UGBS) (Contact Information: ekagbloyor@ug.edu.gh) College of Education School of Continuing and Distance Education 2017/ /2019 ACADEMIC YEAR

2 Course Information Provide the following information: Course Code: Course Title: Course Credit Session Number & Session Title: Semester/Year: Teaching Assistant 3 Credit(s) 2 THE ECONOMICS OF FINANCIAL INTERMEDIATION AND INNOVATIONS 2 nd Semester /18Year Francis K. A. Baidoo fbaidoo@live.com Slide 2

3 Session Overview The purpose for existence of financial intermediaries in the financial market is enshrined in this session. Also, various transformations in the nature of products and operational procedures (financial innovations) within the financial markets over the years are also discussed. Asset Securitization, a key example of financial innovations is also discussed. Slide 3

4 Session Learning Outcomes At the end of the session, the student will 1. Understand the role of financial intermediaries in the financial system 2. Understand financial innovation 3. Understand asset securitization Slide 4

5 THE ECONOMICS OF FINANCIAL INTERMEDIATION AND INNOVATIONS

6 Financial Intermediaries Financial intermediaries obtain funds by issuing financial claims against themselves to market participants, then investing those funds. They may fall into three categories: Depository institutions Contractual savings institutions Investment intermediaries

7 Depository Institutions They are financial intermediaries that accept deposits from individuals and institutions and make loans. They include: Commercial banks Savings and Loans Associations Mutual Savings/Savings Banks Credits Unions

8 Contractual Savings Institutions They are financial intermediaries that acquire funds at periodic intervals on a contractual basis. Can predict the benefits to be paid over a period. They include: Life Insurance companies Fire & Casualty Insurance companies Pension & Govt. Retirement Funds

9 Investment Intermediaries These financial intermediaries include: Finance companies Mutual Funds

10 Asset/Liability Management for FIs Spread and Non-Spread Businesses Mensah, S., & Abor, J. Y. (2014). Agency conflict and bank interest spreads in Ghana. African Development Review, 26(4), Spread businesses Banks and Insurance companies Non-Spread businesses Pension funds Mutual funds excluding open-ended funds Nature of Liabilities Amount of cash outlay Timing of cash outlay Liquidity Concerns Profitable but illiquid FIs can easily collapse Regulations and Taxation

11 Nature of Liabilities of FIs Type Amount Timing Example Type I Known Known Fixed deposits, GICs Type II Known Uncertain Life Insurance Type III Uncertain Known Floating rate instruments Type IV Uncertain Uncertain Automobile, home insurance

12 Financial Innovation n Is the development of new products and delivery systems, and the emergence of new kinds of financial providers. n Usually occurs in response to changing needs for financial services and the availability of new technology to support it. n Offers a means by which market participants may avoid govt. regulation that they find restrictive. n Innovation changes the financial structure and diminishes the effectiveness of current forms of financial regulation.

13 Motivation for Financial Innovation Two extreme views why there are financial innovations To endeavor to circumvent regulation and find loopholes in tax rules To introduce financial instruments that are more efficient for redistributing risks among market participants

14 Causes of Financial Innovation Increased volatility of interest rates, inflation, equity prices, and exchange rates Advances in computer and telecommunications technology Greater sophistication of market participants Financial intermediary competition Incentives to circumvent regulations and tax laws Changing global patterns of financial wealth

15 Categories of Financial Innovation by Economic Council of Canada Market-broadening instruments Increases the liquidity of markets and the availability of funds by attracting new investors & offering new opportunities for borrowers Risk-management instruments Makes it possible to reallocate financial risks to those who are less averse to them, or who have offsetting exposure and thus are presumably better able to shoulder them Arbitraging instruments and processes Allow investors to take advantage of differences in costs and returns between markets

16 Categories of Financial Innovation by BIS Price-risk-transferring innovations Provide market participants with more efficient ways of dealing with price or exchange rate risk Credit-risk-transferring instruments They make it possible to reallocate the risk of default Liquidity-generating innovations They increase the liquidity of the market, they allow borrowers to draw upon new sources of funds, and allow market participants to circumvent capital constraints imposed by regulators Credit-generating instruments Instruments to increase the amount of debt available to borrowers. Equity-generating instruments Instruments to increase the capital base of financial and non-financial institutions

17 Asset Securitization as a Financial Innovation Meaning of Securitization Involves the collection or pooling of loans and the sale of securities backed by those loans Basic Structure of Asset Securitization May involve more than one institution Lending bank, insurance company, institution servicing the loan, a securities firm, investors

18 Benefits to Issuers Diversification and reduced cost of financing Management of regulatory capital Generation of servicing fee income Management of interest rate volatility

19 Other Benefits To Investors Greater liquidity Reduced credit risk To Borrowers Lower lending rate spreads Social Benefits

20 References Abor, Joshua Y. (2016), Financial Markets and Institutions: A Frontier Market Perspective, Digibooks. Madura, Jeff, Financial Markets and Institutions, South-Western College Publishing. Fabozzi, Frank J., Modigliani Franco and Michael G. Ferri, Foundations of Financial Markets and Institutions. Thygerson, Kenneth J., Financial Markets and Institutions: A Managerial Approach, Harper Collins College Publishers Mishkin, Frederic S., and Stanley G. Eakins, Financial Markets and Institutions, published by Addison-Wesley. Cecchetti, Stephen G. Money, Banking, and Financial Markets, McGraw-Hill, Irwin Mensah, Sam, Securities Markets and Investments: A Ghanaian Primer, Smartline. Ghana Fixed Income Market Manual Ghana Stock Exchange (GSE) 25th Anniversary Lecture Prospectus for Edendale Bond Issue Greenwood, R., & Scharfstein, D. S. (2012). How to Make Finance Work (Digest Summary). Harvard Business Review, 90(3), Merton, R. (2009). Making the Financial Markets Safe. Harvard Business Review. Campbell, J. Y., Jackson, H. E., Madrian, B. C., & Tufano, P. (2011). Making Financial Markets Work for Consumers (Digest Summary). Harvard Business Review, 89(7/8), Slide 20