Banking Activities

Question 1

Two types of financial intermediaries

Answer 1

Depository FIs (DF Is)
Non-Depository FIs (NDF Is)

Question 2

List depository FIs

Answer 2

Commercial Banks
Building Societies
Savings Banks
. Credit Unions:

Question 3

List nondepository FIs

Answer 3

Venture Capitalists
Finance Companies
Insurance Companies
Pension Funds
Mutual Funds
Hedge Funds
Investment Banks:

Question 4

difference between hedge and mutual funds

Answer 4

-hedge is private
-hedge is higher risk
-hedge requires greater initial capital
-mutual funds diversification for low risk (across economies) and buy the average

Question 5

investment bank roles

Answer 5

◦ Advisory services on Mergers & Acquisitions
◦ Underwriting of securities issues
◦ Trading and investing on behalf of their clients or with their own
capital (proprietary trading)
◦ Asset management

Question 6

core difference between dfi and ndfis

Answer 6

dfi discretionary and ndfis contractual

Question 7

ownership differences of DFIs

Answer 7

◃ DF Is ownership forms affect their operational efficiency: stocks
(e.g. commercial banks) and mutuals (e.g. building societies)
* A stock DF Is can ↑ capital by selling stock, whereas a mutual
cannot
* A stock DF Is is owned by shareholders who have: a claim to
residual profits; voting rights; right to dissolve the organisation
* A mutual DF Is is owned by its depositors but ownership rights
are weaker
◦ Depositors cannot force the mutual to pay more than the
promised interest
◦ Limited voting rights
◦ Little incentive to liquidate the fund as it is protected by Deposit
Insurance

◃ Principal-agent problem is more severe for mutual DF Is
◦ Managers in mutuals operate less efficiently due to less efficient
control
◦ Operate at inefficient output levels (diseconomies of scale)
◦ Expand product offerings (diseconomies of scope)
* In the past, simplicity of mutual DF Is’ operations ⇒
principal-agent problem and moral hazard were limited
* Overtime, shareholder ownership became the preferred ownership
structure:
◦ Increased complexity of operations → worsen principal-agent
problem
◦ Deposit Insurance → removed moral hazard advantage of
mutuals
◦ Deregulation → ↑ competition
◦ ↑ probability of bankruptcy → managers’ benefits of mutuality ↓
* Benefits of conversion > benefits of mutuality ⇒ ↑ number of
conversions to stockholder-ownership structure

Question 8

insurance company roles and negatives

Answer 8

3. Insurance Companies: raise funds from policies’ premiums and
   invest mainly in capital markets
   ◦ Life Insurance: contract against the expiration of life (Permanent
   and Term Life Insurance Policies) and hold illiquid assets
   ◦ Property and Casualty Insurance: contract against damage or
   loss of physical property and hold liquid assets (reinsurance,
   policies by several insurers)
   * Insurance companies’ liabilities are ‘contingent’ of longer
   duration that those of Banks
   * Insurance companies perform Asset Transformation as assets
   such bonds, stocks and loans are transformed into insurance
   policies

◃ Adverse Selection and Moral Hazard problems in Insurance
* Adverse Selection: people most likely to receive large insurance
payoffs are the ones who will want to purchase the insurance the
most
◦ Screening: information collection
◦ Risk-Based Premiums
* Moral Hazard: existence of insurance encourages the insured
party to take risks that increase the likelihood of an insurance
payoff
◦ Restrictive provisions
◦ Prevent fraud: conduct investigations
◦ Cancelation of insurance
◦ Deductible: a fixed amount deducted from the insured’s loss
when coverage is paid, no costs in handling small claims
◦ Coinsurance: policyholder shares a % of losses along with the
insurer
◦ Limits on the amount of coverage