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1、Lecture 1Dr Asma MobarekPart one: Globalization of banking Introduction to Banking5/2/2022Cardiff University Business school, International bankingREADINGBasicBarbara Casu, et al., Introduction to Banking, CH 1-3.More AdvancedColin Mayer, The assessment: Money and banking: Theory and evidence, Oxfor

2、d Review of Economic Policy, vol. 10, no. 4, 1994,1-13.Franklin Allen & Anthony M Santomero, What do financial intermediaries do?, Journal of Banking & Finance, 25, 2001, 271-94.5/2/2022Cardiff University Business school, International bankingLearning objectivesTo analyse the theories of financial m

3、arkets and financial intermediation/banksThe analyse the speciality of banks. To understand the basic types of banking.5/2/2022Cardiff University Business school, International bankingBank based and market based systemFinancial systemDirect (Money market, capital market)Indirect/ intermediaryDeposit

4、ory (banks) vs. Nondepository institutions (Insurance company)5/2/2022Cardiff University Business school, International bankingChart of Direct Financing or DisintermediationDirect financing5/2/2022Cardiff University Business school, International bankingTheoretical view on whether we need intermedia

5、tion or notStandard market based theory : Intermediary has no role to improve welfare ArrowDebreu model,1954; Pareto efficiency, Fama, 1980.Extreme view is denied by Money and capital for economic development Mckinnon, 1973 Intermediation theory assumes frictions in market like transaction cost and

6、information asymmetry and justify the role of intermediary acting as delegated monitoring added value Diamond, 1984.5/2/2022Cardiff University Business school, International bankingProblems without Intermediation assuming market frictions in the real worldTwo types of barriers to the direct financin

7、g process:1) Difficulties and costs (transaction cost) in matching the borrowers and lenders.2) Preference mismatch of the financial needs of borrowers and lenders (i.e. savers require liquidity; borrowers want longer maturity loans; plete contracts).5/2/2022Cardiff University Business school, Inter

8、national bankingTransactions Costs involved in borrowing and lending5/2/2022Cardiff University Business school, International bankingPreference mismatch between borrower and lender1. Size 2. Maturity3. Risk 5/2/2022Cardiff University Business school, International bankingAsymmetry of Information is

9、the evilBasis borrower knows more about the project risk than the lenderHence it is necessary for the lender to collect and process information5/2/2022Cardiff University Business school, International bankingNecessities of Intermediaries/Banks as an exampleThe benefits to ultimate lendersThe benefit

10、s to ultimate borrowersThe benefits to society5/2/2022Cardiff University Business school, International bankingExample of a simple banking model 5/2/2022Cardiff University Business school, International bankingModern financial intermediationChart of Indirect Financing or Financial Intermediation5/2/

11、2022Cardiff University Business school, International bankingBanks as transformers that capital market can not Size transformation (exploiting the economies of scale associated with their functions).Maturity transformation ( ing opposing time preferences of savers and borrowers).Risk transformation

12、(minimising the risk of individual loans through diversification)5/2/2022Cardiff University Business school, International bankingQuiz: Size transformation by Banks refers to which of the following statements A) ing opposing size preferences of savers and borrowers B) Exploiting the economies of sca

13、le associated with their functions C) Minimising the risk of individual loans through diversification5/2/2022Cardiff University Business school, International bankingStandard market based theory-Loanbale fund theory5/2/2022Cardiff University Business school, International bankingWould the Loanable F

14、unds theory as a mechanism of financial intermediation? Answer is No. What is needed for the LF theory is the existence of a perfect capital market. But there is a preference mismatch and information asymmetry between investors and savers. The development of financial intermediaries can solve this.

15、5/2/2022Cardiff University Business school, International bankingTheories: Bank as a financial intermediaryFinancial intermediation and delegated monitoringInformation productionLiquidity transformationConsumption smoothingCommitment mechanism5/2/2022Cardiff University Business school, International

16、 bankingDelegated Monitoring3 aspects Screening Creditworthiness of borrower Adherence to contractBank has private information from bank borrowers bank account5/2/2022Cardiff University Business school, International bankingInformation production and liquidity transformationBanks contribute to minim

17、ise the costs of information production1. Gain economies of scale. e.g., Depositors information at first place2 Expertise. e.g., Bankers acting as board members of corporate firms. 3. Liquidity. Diversifying balance sheet assets 5/2/2022Cardiff University Business school, International bankingConsum

18、ption smoothing and commitment mechanismConsumption smoothing: e.g., Bank Overdraft Commitment mechanisms: e.g., Relationship banking5/2/2022Cardiff University Business school, International bankingWhy Banks are so special?5/2/2022Cardiff University Business school, International bankingRelevant eco

19、nomic theories of bank specialty1.Transaction cost theory (Williamson, 1975) and asymmetry of information - Stiglitz (2000)2. Agency Theory (Jensen and Meckling 1976, Arrow 1985, Eisenhardt 1989)opportunistic behaviourmoral hazard & adverse selection3.Intermediation theory (Fama ; 1985; Diamond 1984

20、; Corrigan 2000)5/2/2022Cardiff University Business school, International bankingRelevant economic theories of bank specialty-Transaction cost theory:#Williamson (1975) Transaction cost theory (TCT) assumes that human are bounded rational, prone to opportunism, self interest. TCT does not assume tha

21、t all are opportunism but suggest that it is costly to distinguish those who are prone to opportunism. This assumes asymmetric information problem (Stiglitz, 2000) in the market.5/2/2022Cardiff University Business school, International bankingRelevant economic theories of bank specialty-Agency Theor

22、y: Agency theory- Risk attitudes of principals and agents Eisehardt 1989. Agency relationship? Whenever one partner in a transaction (the principal) delegates authority to another (the agent), and the welfare of the principal is affected by the choices of the agent Arrow, 19855/2/2022Cardiff Univers

23、ity Business school, International banking5/2/2022Cardiff University Business school, International bankingPrincipal Agent Problem ?Agent lacks incentive to put the principals interests first. Arrow, 1985Example 1: Adverse selection: asymmetric information between borrower and bank may explain the p

24、resence of adverse selection Example 2: Moral Hazard: incentives of at least one the 2 parties change after they enter into a contract. E.G. Depositors may not monitor bank activities closely enough because: - depositor knows bank has a diversified loan portfolio - deposit insurance schemes Outcome:

25、 the bank (agent) takes on riskier activities than it otherwise would. 5/2/2022Cardiff University Business school, International bankingAGENCY PROBLEMS IN BANKINGThe interest of principal and agent might typically diverge.The principal can not perfectly and costlessly monitor the agents action .Poss

26、ibility of opportunism behaviour by the agent Example of Adverse selection in loan pricingMoral hazard effect.5/2/2022Cardiff University Business school, International bankingHow bank addresses agency problems? Transaction Banking - short-term loans, high liquidity, frequent review of loans, high co

27、llateral requirements - e.g. UK. Relationship (or Commitment) Banking - information sharing, close bank-client relationship, heavy investment by bank in information gathering, commitment, governance responsibilities e.g., Japan. Strictly related to the type of financial system. Regulation: Informati

28、on, Prudential, Economic5/2/2022Cardiff University Business school, International bankingRelevant economic theories of bank specialty-Intermediation theoryBank manage to collect deposit at lower rate and lend at higher rate and maintain the intermediation cost.i* is the interest rate observed in cap

29、ital market on nonbank securities Interest margin: (iL) (iD): determined by: iL =interest on loans as banks asset and iD is the cost of a deposit as bank liabilitiesMarket structure- Greater the competition for loans and deposits Interest margin decrease5/2/2022Cardiff University Business school, In

30、ternational banking5/2/2022Cardiff University Business school, International bankingSLiiLiDSDDLi*0TBVolume of loans/depositsiL- iD: bank interest differential between the loan rate (iL) and the depositrate (iD) which covers the cost of the banks intermediation.Banks as intermediary Empirical evidenc

31、e-Mayer 1994The role of banks in corporate financing Banks have informational advantage over external investors The influence of financial factors on corporate investment Firms with greater ties with Bank have strong influence on corporate investmentThe role of credit in transmission mechanisms Smal

32、l firms do not have access to corporate finance depends on bank finance5/2/2022Cardiff University Business school, International banking5/2/2022Cardiff University Business school, International banking BANKS is Special- summary Banks are part of the financial sector - their core activities distingui

33、sh them from other financial firms. These are: An Intermediary service, A Liquidity service, Payments: a by-product of the above servicesAdditional Points Related to Core Functions:Transaction cost: Scale economies: in transactions costsEconomies of scale and economies of scope pooling a portfolio o

34、f assets: lowers default risk - same expected returnAsymmetric information: i) Adverse selection and moral hazard(ii)Principal agent problem(iii)The free-rider problem(iv)Relationship and transaction bankingBanks act as special compare to other industry 1. 21st century- Too big to fail (moral hazard

35、); crisis and bail out#Economic growth and systemic risk (contagion) spillover over other sectors of the economy2. Highly regulated vs. deregulation crisis and lesson to reform5/2/2022Cardiff University Business school, International bankingCritical analysis of theories-Is bank dead? Credit Rating A

36、gency to evaluate the market based security. Mutual fund for portfolio of investment Deregulation, Financial innovation are the new trend of global financial system. Reduction of market imperfection does not reduce the demand for intermediary. 5/2/2022Cardiff University Business school, Internationa

37、l bankingBank Typology: Traditional and Modern BankingBanking TypologyTraditionalRetailCommercial, corporate, personalModernUniversal, Investment, wholesale, Euro dollar, Multinational, International, Islamic, Shadow banking5/2/2022Cardiff University Business school, International bankingTraditional

38、 versus modern banking5/2/2022Cardiff University Business school, International bankingQuiz:One of the differences between traditional and modern banking is in respect of customer focus. Which one is relevant for the traditional banking viewpoint from the alternatives given below? Supply led Demand

39、led Creating value for the customers5/2/2022Cardiff University Business school, International bankingRetail Banking Traditional business of banking Main risks: liquidity and asset risk Large volume low value end of the business Both risks mainly managed by having large numbers of depositors and borr

40、owers5/2/2022Cardiff University Business school, International bankingInvestment Banking: basic features No high street branch network. Services for corporate clients e.g., new capital issues, underwriting, advising and handling mergers & acquisitions for client firms. Asset management businessportf

41、olios management of clients such as pension funds. Trading. Private client business = High Net Worth Clients.5/2/2022Cardiff University Business school, International banking415/2/2022Cardiff University Business school, International bankingUniversal Banking (UB)Combine functions of both Commercial

42、and Investment Banks.Accepted in Europe since early 1990s. Later adopted also in the US and in Japan. Traditionally German banks cited as best examples.Recent years: movement across functional boundaries as banks, whatever the location, e more universal in type, and are transformed into financial co

43、nglomerates.UBS, Barclay examples of UB.Conventional strategic move: from Commercial Banking to Universal Banking.Increasing issues with the financial crisis: Volcker rules, Ring-Fencing etc (See Lecture on Regulation). Universal Banking Keeps customers in one stop shop. Economies of scale exhausted

44、 quickly and constant returns to scale. Economies of scope. Size allows for risks to be spread and internally diversified Size also creates danger of Too Big to Fail5/2/2022Cardiff University Business school, International bankingWholesale BankingLarge value, low volume part of banking businessMix o

45、f domestic and foreign currency business, Size of deposits and loans. Deposits of 50k but 500k is normalTailor made loansDependence on inter-bank marketGreater importance of OBS facilitiesSmall proportion of sight or demand deposits5/2/2022Cardiff University Business school, International bankingIsl

46、amic Banking: General PrinciplesRisk sharing each participant must share in the same risk-return distribution (removes asymmetric information problem)Materiality all financial transactions must be backed by a tangible asset (no options).Non-exploitation neither party can be exploitedNo sinful activi

47、ty alcohol, gambling, etcThe distinguishing feature of Islamic banks is that interest payments are prohibited.5/2/2022Cardiff University Business school, International bankingGlobal Islamic banking assets, 20092013Source: Ernst and Young (2014).5/2/2022Cardiff University Business school, International bankingMicrofinance Microfinance is more general than microcr