The impact of macro economic factors on the stock market
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ModernBankingandRegulation WolfWagner Lecture 1
ModernBankingandRegulation 2 1 Overview empty space Topicofthiscourse: understand thebusiness of banksand their rolefor theeconomy empty space We willanalyze banksbothfrom theperspective of bank management as well as society empty space Questionsasked: empty space ²Whatrisksare bankssubject to andhowcan they bemanaged? ²Why are banks fragile? ²Whatactionscan beundertakentomake a bankssafer? Is this always desirable? ²Howdoes thecompetitive environment affecttheoperation of banks? ²Howdo changes in the ﬁnancial system impactthe operation of banks?e mpty space empty space During the course we will learn about the leading theories in banking and apply them to current problems.
ModernBankingandRegulation 3 2 Courselogistics empty space empty space ²Final grade: 75% exam grade plus 25% assignment (practioner lecture not included in exammaterial) ²Coursematerial: lecture notes (availableon DSO) – ForadvancedstudyofmaterialIrecommendthebookFreixas/Rochet"MicroeconomicsofBanking" ²Courseassignment – available on DSO – puttheoryintopractice: analysebalancesheetofbanksusingvariousconceptscoveredincourse – form groups of three andsend your choice to Ingrid van Beek (by 5th ofFebruary) – deadline for handing in assignment is25thofFebruary empty space ²Contact: after class or by email(email@example.com)
ModernBankingandRegulation 4 3 Whyisunderstandingbanksimportant? empty space empty space empty space ²banks have essentialrole in channelingfunds fromsavers to borrowers ()ﬁgure) ²banks overcome informational assymmetries (through monitoring and screening of borrowers) and hence cannotbe easily besubstituted by markets ²ﬁnancialdevelopment is importantfor growth (eg,Beck, Levine, Loyaza,JFE2000) ²banking crisis are common and costly (seeﬁgure)
Figure: TheRole of Banks (Intermediaries) in the Economy
Figure: The Costs of Banking Crises
ModernBankingandRegulation 7 3.1 BanksareinherentlydifferentfromotherFirms empty space empty space empty space ²Failuresinnon­ﬁnancial companiesare less common and do nottendto spread ²Non­ﬁnancialﬁrms typically only failifthey areinsolvent,while banks canfail evenifproﬁtable ²Banks failures impose large costson the economye mpty space empty space Whatisitthatmakesbanksfragileandtheirfailurecostly?
ModernBankingandRegulation 8 3.2 Implicationsofthestandardmodelforbanking empty space empty space empty space ²The standard model of the ﬁnancial sector in macroeconomics: – demand for funds (ﬁrms, government) – supply of funds(households) – in equilibrium interest rate adjusts suchthat demand and supply are equal ²Thus, funds of savers are seamlessly channelled to ﬁrms, all ﬁrms with worthwhile projects obtain ﬁnancing ²Implications: – Suppose a bank goes bankrupt)the ﬁrms it has ﬁnanced should be able to obtain credit from otherbanks(orthemarketbydirectlytappingthefundsofsavers)atno(orsmall)aggregateloss – In addition, smallshocks should only have smallimplications for quantities
ModernBankingandRegulation 9 3.3 Contrastthiswiththecrisisof2007­2009... empty space Thesubprimecrisisanditsaftermathinanutshell ²banks madelosses becauseofrisky investments ²underminedtheirability to makenewloans (toﬁrms) ²credit volumedeclines,economy entered in recession ²governments had to bail­out banks, resultinginsovereign debt crisese mpty space Questionsthatarise ²Whyshouldproﬁtableﬁrms nolongerbeﬁnanced? Firms cantapmarketﬁnancingorlessaffected banks step in and make proﬁts (more prudent banks should be able to completely substitute for other banks). Banks withlossesmay also simply recapitalize. ²Total initial losses from subprime investments itself small compared to total economy. Why should this cause very large problems inthe ﬁnancial systemand howcanitcause an overall recession? ²Whyaregovernments(onadviceofeconomists)regularlybailingoutbanks? Thesameeconomists would typically advice againsthelping ﬁrms
ModernBankingandRegulation 10 4 Thebalancesheetofthebankandbankrisks (ﬁgure: aggregatebalance sheetofcommercial banks) empty space empty space ²The assetsideis dominated by loans – ordering byliquidity: cash,securities, loans,physicalcapital ²The liabilityside is dominated by deposits and other short­term ﬁnancinge mpty space )there is amismatchbetweenassetsandliabilitywhich exposes banks to runs
ModernBankingandRegulation 12 5 Keyrisksfacedbybanks empty space empty space empty space empty space ²liquidity risk (asset and liability side) ²credit risk (assetside) ²interestraterisk (asset andliability side)
ModernBankingandRegulation 13 6 Liquidityriskinaction: The"classic"bankrun empty space empty space ²suppose depositorswithdrawfrom initiallysolventbank ²bank hastoliquidate assets ²itwillstart with themore liquid assets, buteventuallyithas to liquidate loans ²loans cannot be sold atfair­value (ﬁre­sale prices) ²this can eventually cause insolvency ofthe bank