Summary Financial Markets and Institutions A European Perspective

ISBN-10 110702594X ISBN-13 9781107025943
211 Flashcards & Notes
8 Students
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This is the summary of the book "Financial Markets and Institutions A European Perspective". The author(s) of the book is/are Jakob de Haan Sander Oosterloo Dirk Schoenmaker. The ISBN of the book is 9781107025943 or 110702594X. This summary is written by students who study efficient with the Study Tool of Study Smart With Chris.

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Summary - Financial Markets and Institutions A European Perspective

  • 1 Functions of Financial System

  • What are the main functions of the financial sector?
    1. Reducing information and transaction costs
    2. Facilitating the trading, diversification and management of risk
  • What is the main task of the financial system?
    It is to channel funds form sectors that have a surplus to sectors that have a shortage of funds
  • What does the financial system consist of?
    All financial intermediaries and financial markets, and their relationship to the flow of funds to- and from households, governments, business firms, and foreigners, as well as the financial infrastructure.
  • What is a financial infrastructure?
    It is a set of institutions that enables effective operation of financial intermediars and finanacial markets, including such elements as payment, credit information bureaus, and collateral registries
  • What is the main task of the financial system?
    To channel funds from sectors that have a surplus to sectors that have shortage of funds
  • Explain what direct finance is?
    sectors who are in need of funds borrow from an another sector via a financial market
  • What is a financial market?
    It is a market where participants issue and trade securities
  • What is indirect finance?
    A financial intermediary obtains funds from savers and uses these savings to make loans to a sector in need of finance
  • What is a financial intermediaries?
    These are coalitions of agents that combine to provide financial services, such  as banks, insurances companies, financial companies, mutual funds, pension funds
  • Name a few coalitions of agents of a financial intermediaries?
    banks - insurances - financial companies - mutl funds - pensioen funds
  • Name two financial systems?
    1. Market-based
    2. financial based
  • What is vitally linked to economic growth?
    The functioning of financial systems
  • What are the two main functions of the financial system?
    1. Reducing information- and transactioncosts
    2. Facilitating the trading diversification, and management risk, to explain why the financial sector may stimulate capital formation and/or technological innovation, two of the driving forces of economic growth
  • In what does a financial system help?
    By overcoming an information asymmetry between borrowers and lenders
  • Explain how asymmetry information arises in a ex-ante fase? 
    It arises in a ex-ante because borrowers generally know more about their investment project than lenders. Borrowers most eager to engage in a transaction are the most likely ones to produce an undesirable outcome for lender (adverse selection
  • What are the causes of high informations costs?
    They keep the funds from flowing to their  highest productive use.
  • When does asymmetry problem occures in the ex-post?
    When borrowers, not investors, can observe actual behaviour. 
  • What kind of risk is there once a loan has been granted?
    There is a risk that barrowers will engage in activities that are undesirable from perspetive of the lender (moral hazards)
  • What is the difference between the roles of financial markets and financial intermediaries?
    Intermediaries are necessary for the successful functioning of the markets.
  • In the EU were do they rely on.. which market? 
    These countries have bank-based system and rely on banks
  • What do all countries have incommon  with all financial systems regarding investment by firms?
    Most investments by firms in the industrial countries are financed through retained earnings (ingehouden winsten) regardless financial market and intermediaries.
  • Characterise a disruption  in the financial system?
    Sharp declines in asset prices & failure of financial intermediaries -> economic downturns
  • Explain why financial development may stimulate economic growth?
    A well-functionig financial system that direct funds to their most productive use is crucial for economic development (als er obstakels zijn om geld naar behoevende te krijgen dan staakt de economie). A well-functioning system is a vitally linked to economic growth.
  • How do financial intermediaries improve resource allocation?
    By reducing the cost of acquiring and processing information.
  • What are the pro's regarding intermediaries with an investment?
    Without intermediaries, each investor would face the large fixed cost associated with  evaluating investment projects. Plus identifying new technological innovation and new entrepreneurs

  • Why does the financial sector stimulate capital formation?
    Financial intermediaries can reduce transaction cost  by pooling the funds of small savers. Also by overcoming information asymmetries by lowering information costs
  • Why does the financial sector stimulate technological innovation?
    1) Progress in information tech. has facilitated the development of advanced risk management models 2) without innovation fs would be locked into illiquid long-term investments (poss to hold liquid assets and transform into long term capital investment) 3) Securitisation is possible illiquid assets -> liquid assets
  • What is the role of government?
    1) protect property 2) transparency 3) regulation & supervision 4) competition policy
  • How can foreign participants have an effect on liberalisation?
    1) opening up to foreign markets 2) foreign intermediaries

  • Why is a government regulation needed to protect property rights?
    If it's not clear who is entitled to perform a transaction, exchange will be unlikely.
  • Why is government regulation needed for transparency?
    So that providers of funds can take better decisions on how to allocate their money
  • Why is government regulation and supervision needed for soundness?
    Intermediaries have  an incentive to take too many risk -> more revenues. government may provide depositors with deposit-security (this will to help intermediaries and will take more risk) Investors may fail because of risk and contagion)

  • Why is government regulation needed for competition policy?
    Price fixing - support from the banks (state aid)  
  • What are the benefits if it becomes possible to lend or borrow in foreign financial markets?
    opening up the domestic financial market and competition from financial intermediaries in foreign companies = financial liberalisation
  • What are the pro's of bank-based system?
    Investment smoothing, keeping info to themselves, corporate governance, inexpensive/ basic risk model, greater asses to capital, low risk products.
  • Explain the various corporate governance mechanisme?
    1) banks appointment of the board of directors (to monitor company) 2) manager's compensation depend nonperformance firm 3) hostile takeover
  • Why may a take over threat not work?
    1) information asymmetry, ill informed outsider 2) free rider problem 3)firms can take action to weaker position of the firm
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What is the SRM?
Single Resolution Mechanism of the Banking Union. The second pillar, and introduces centralized decision making and a centralized resolution fund. Rather than the decentralized approach based on the BRRD. 

> ensuring the availability of temporary funding to support the restructuring of a failing bank
Resolution tools can be used in case of a bank failure. Describe three.
1. private sector acquisition the resolution authority acts as broker to effect the acquisition, whereby parts of the bank can be sold without the consent of the shareholders. If acquisition is not immediately at hand, the resolution authority can transfer part of the bank to a temporary structure, to keep essential functions working.

2. separation good & bad assets: via a partial transfer of assets & liabilities. Result: the original bank is split in a good bank with performing assets and a bad bank with toxic assets. The latter are liquidated or restructured.

3. latter process, bail-in: aim: stabilize a failing bank in order for it to continue its critical functions
Name a main reactive instrument that can be used in crisis situations
Bank Recovery and Resolution Directive (BRRD) provides comprehensive & effective arrangements to deal with failing banks at the national level. Cooperation arrangements to tackle cross-border banking failures for banks in EU. 
target: rescue a bank's critical functions
What is the CCR/CRD IV package?
new EU prudential rules, provides for the use of:
countercyclical buffer: to counteract the effects of the economic cycle on banks' lending activity

use of pillar II: ability to impose additional requirements on a specific bank

national flexibility measures: allowing national authorities to impose stricter prudential requirements (adressing systemic risk)

real estate related instruments
member states retain the possibility to set higher risk weights for real estate lending, thereby being able to address real estate bubbles

leverage ratio: to limit the growth of the total balance sheet as compared to available own funds
Describe the key macro prudential instryments under the structural pillar
1. exposure concentrations.
large exposures restrictions

2. misaligned incentives.
a. SIFI capital surcharges
b. systemic risk buffer
Describe the key macro prudential instruments under the cyclical pillar
1. excessive credit growth & leverage 
a. counter cyclical capital buffer
b. capital instruments (e.g. leverage ratio)  
c. LTV/LTI caps

2. excessive maturity mismatch and market illiquidity
a. stable funding restrictions
b. liquidity charges
Explain the difference between macro and micro prudential instruments
The macroprudential instruments under the cyclical pillar can damper both the upswing and the downswing of the financial cycle. A  micro one tends to tighten capital requirements when it is bad time.
4 problems. 1. Excessive credit growth & leverage 2. Exposure concentration, 3. Excessive maturity mismatch & market illiquidity 4. Misaligned incentivesState for every problem under which pillar it stands and what indicators are used to analyze them.
1. Cyclical pillar:      Credit to GDP; housing prices
2. Structural pillar:   Interconnectedness, price contagion
3. Cyclical pillar:      Structural funding ratio, Short term liquidity stress indicators
4. Structural pillar:    Size, complexity, substitutability
What is the policy and ultimate objective for macro- and micro prudential supervision, respectively?
macropolicy: limit financial system wide distress
ultimate: avoid GDP costs

micropolicy:limit distress of individual firms
utlimate: consumer protection
How is risk characterized for macro- and microprudential supervision?
macro (endogenous)dependent on collective behaviour, interactions between financial institutions & their environment
 > risk of aa shock is generated & amplified within the system

micro (exogenous)independent of individual agents' behaviour
> risks emanating from agents' environment