L5 Theories of financial intermediation

Question 1

Developed markets: EU financial integration

Answer 1

Your summary of the developments in the European Union (EU) financial integration process is comprehensive and accurate. Here’s a breakdown:

1. Pre-1980s Era: Prior to the late 1980s, many European financial systems were characterized by high levels of controls, which inhibited competition and limited market integration.
2. Changes in Market Conditions: Since the late 1980s, several factors have contributed to significant changes in the European financial landscape, including:
   
   • Evolving customer preferences towards more sophisticated and price-conscious financial services.
   • Globalization of financial markets, leading to increased competition.
   • Deregulation of financial markets, fostering greater market openness and efficiency.
   • Financial innovation and automation, driving technological advancements and product diversification.
3. Impact on Market Structure: The European financial market has witnessed a decline in the number of banks and branches due to mergers and acquisitions (M&As). National consolidation has been the preferred approach, leading to the emergence of larger financial groups and conglomerates.
4. Diversification in M&As: Mergers and acquisitions have resulted in the diversification of financial institutions, with virtually all major European banks becoming part of larger financial groups. This consolidation has contributed to the strengthening of the European financial sector.
5. Retail Financial Services: The retail financial services industry has gained increasing importance, with banks offering a wide range of services such as deposits, consumer loans, credit cards, and advanced phone and internet-based banking services.
6. Private Banking: Private banking has emerged as a significant segment, catering to the needs of high net worth individuals by offering personalized financial services and wealth management solutions.
7. Corporate and Investment Banking: Corporate and investment banking remains a mainstay of the European financial sector, providing a range of services including advisory, capital raising, and risk management solutions.
8. Technological Advancements: Progress in information technology has played a crucial role in transforming the European financial sector, enabling the establishment of new delivery channels and innovative financial products to meet evolving customer needs.

Overall, the process of financial integration in the EU has led to significant changes in the structure, competitiveness, and offerings of the European financial market, ultimately contributing to its growth and development.

Question 2

The European Central Bank

Answer 2

Your summary of the European Central Bank (ECB) is accurate. Here’s a breakdown of the key points:

1. Formation: The European Central Bank (ECB) was established as part of the process of creating a single currency, the euro, within the European Union (EU). It was officially inaugurated on June 1, 1998, and began operating fully on January 1, 1999, when the euro currency was introduced.
2. Principal Function: The primary mandate of the ECB is to achieve price stability within the euro area. This objective is enshrined in the Treaty on the Functioning of the European Union (TFEU). Additionally, the ECB is responsible for prudential supervision of financial institutions within the euro area to ensure the stability of the financial system.
3. Monetary Policy: The ECB, together with the national central banks of the eurozone countries, forms the European System of Central Banks (ESCB), which is responsible for conducting monetary policy for the euro area. The primary tool for implementing monetary policy is through setting interest rates, specifically the main refinancing rate.
4. Composition: The European System of Central Banks (ESCB) comprises the ECB and the national central banks of all EU member states that have adopted the euro currency. Each national central bank operates under the guidance and framework set by the ECB.
5. Independence: The ECB is designed to be independent in its decision-making processes and operations. This independence is intended to shield the ECB from political influence and ensure that it can pursue its mandate of maintaining price stability effectively. As such, the ECB operates above and beyond the reach of any single national government or institution.

Overall, the ECB plays a crucial role in shaping monetary policy and maintaining financial stability within the euro area, with a primary focus on achieving price stability while operating independently from national governments.

Question 3

US Banking System: Structure

Answer 3

Your summary of the structure of the US banking system is informative. Here’s a breakdown of the key points:

1. Unique Characteristics: By the late 20th century, the US banking and financial structure differed notably from other Western countries. Regulators have often sought statutory remedies for perceived issues, sometimes resulting in what’s seen as ‘over’ legislation.
2. Historical Context: Since the 1930s, there has been a focus on protecting small depositors, a concern that has shaped regulatory efforts.
3. Number of Banks: One of the most striking features of the US banking system is the large number of banks, which contributes to its lack of high concentration. In 2000, there were 7,770 commercial banks, a significant drop from 14,500 in 1984.
4. Asset Distribution: Despite the large number of banks, commercial banks still hold over 80% of total US banking assets. However, approximately 80% of these assets are controlled by just 373 banks, indicating a degree of concentration at the top.
5. Types of Institutions:
   • Commercial Banks: These are the most prominent institutions in the US banking system, offering a range of financial services to individuals and businesses.
   • Savings Banks: Also known as thrifts, these institutions were originally established to provide long-term residential mortgages funded by short-term savings deposits.
   • Credit Unions: Owned by their members and operated as non-profit entities, credit unions offer attractive deposit and loan rates to their members.
   • Investment Banks and Securities Firms: There are approximately 4,000 of these institutions in the US, specializing in underwriting securities and providing investment services.
   • Other Financial Firms: This category includes insurance firms and finance companies, which play important roles in the broader financial services sector.

Overall, the US banking system is characterized by its diversity and the significant role played by commercial banks, while also featuring a range of other financial institutions serving various segments of the market.

Question 4

US Banking System: Reforms

Answer 4

1. Riegle-Neal Act (1994): Enabled nationwide branching in the US banking system, allowing banks to operate across state lines, boosting competition and accessibility.
2. Gramm-Leach-Bliley Act (1999): Repealed Glass-Steagall Act provisions, permitting financial holding companies to engage in diverse financial activities, leading to the rise of large conglomerates but also raising concerns about conflicts of interest and systemic risk.

Both reforms had significant implications for the structure and operation of the US banking system:

Nationwide branching allowed banks to expand their geographic footprint, increasing competition and access to financial services for consumers.

The GLB Act facilitated the consolidation of financial services under one roof, leading to the creation of large financial conglomerates offering a wide range of products and services. However, it also raised concerns about the concentration of economic power and the potential for conflicts of interest within these conglomerates.

Overall, these reforms aimed to modernize and promote efficiency in the US banking system, but they also posed challenges and sparked debates about the appropriate balance between competition, innovation, and regulatory oversight in the financial sector.

Question 5

Banking in developing/emerging/transition economies

Answer 5

In developing, emerging, and transition economies, banking systems are shaped by political and economic histories, leading to common characteristics:

1. Traditional Banking Dominance: Traditional banking plays a central role in the financial system of these countries.
2. Financial Repression: Governments often seek to control financial markets through measures such as:
   
   • Setting government control over interest rates, especially deposit rates.
   • Imposing high reserve requirements on banks.
   • Directing bank credit to specific sectors, often state-owned enterprises.
   • Interfering with the day-to-day management of bank activities, including nationalization.
   • Restricting the entry of new banks, particularly foreign ones.
   • Imposing controls on borrowing and lending abroad.
3. Heterogeneity and Financial Stability: Emerging countries vary widely in their economic development and financial stability. They are not homogeneous like developed economies, with differences in factors such as institutional quality, economic structure, and policy frameworks.

Overall, banking systems in these economies are heavily influenced by government intervention and control, which can have implications for financial development, stability, and efficiency.

Question 6

The banking system in BRIC countries: Brazil

Answer 6

Summary:
Brazil’s banking system has distinct features shaped by its historical context:

1. Hyperinflation Legacy: Brazil experienced severe hyperinflation in the 1980s and 1990s, reaching over three digits in the 1980s and over 1000% in the 1990s.
2. “Float” Gains: Banks benefitted from “float” during hyperinflation, earning profits from low-cost liabilities and short-term investments at significantly higher returns.
3. Real Plan Impact: The implementation of the Real Plan in 1994 aimed to stabilize the economy, but it led to losses for banks due to the elimination of inflationary income. Some major banks went bankrupt as a result.
4. State Banks’ Role: State-owned banks played a critical role in Brazil’s banking system. They underwent significant restructuring, privatization, or liquidation to adapt to changing economic conditions.
5. Interest Margin: Brazil’s banking sector has historically had one of the highest interest margins, reflecting the challenges and opportunities in the market.

Overall, Brazil’s banking system has undergone significant transformations due to its economic history, with both challenges and opportunities shaping its development.

Question 7

The banking system in BRIC countries: Russia

Answer 7

Summary:
Russia’s banking system has undergone significant transformations since its emergence in the early 1990s:

1. Post-Soviet Transition: The banking system emerged in the early 1990s following the collapse of the centrally-controlled system. Initially, it was small, highly fragmented, and dominated by state banks.
2. Economic Challenges: Russia faced severe economic challenges during this period, including a dramatic decline in GDP and hyperinflation, with inflation reaching 2510%.
3. Banking Crises: The 1990s and 2004 saw a series of systemic mini banking crises, highlighting the fragility of the banking sector.
4. Privatization and Reform: Russia underwent massive and uncontrolled bank privatization, leading to significant changes in ownership structures. Following the 1998 crisis, banking reform efforts began, aimed at modernizing and stabilizing the sector.
5. Financial Liberalization: Russia’s banking system has become largely free of financial repression, allowing it to participate more actively in international financial markets. This has involved positioning the banking system to meet international standards and regulations.

Overall, Russia’s banking system has experienced a tumultuous journey marked by economic instability, banking crises, privatization, and reform efforts aimed at modernization and integration with global financial markets.

Question 8

The banking system in BRIC countries: India

Answer 8

Summary:
India’s banking system has undergone significant changes since independence in 1947:

1. Pre-1960s: Initially, India’s financial system was relatively unrestricted, but in the 1960s, the state took control, leading to a highly regulated banking sector.
2. BoP Crisis and Liberalization: In response to the Balance of Payments (BoP) crisis in 1991, India initiated financial deregulation and liberalization, although the process was slow to unfold.
3. Partial Privatization: Since 1996, there have been efforts to partially privatize state-owned banks, with the government maintaining a majority stake of 60-80%.
4. Dominance of State Ownership: Unlike centrally-planned economies, India’s banking sector is dominated by state ownership. However, this dominance has led to challenges such as poor asset quality, excessive supervision, weak financial institutions, and rigid lending requirements.

Overall, India’s banking system has evolved from a highly regulated structure to one undergoing gradual liberalization and partial privatization, although state ownership remains dominant, posing both opportunities and challenges for the sector’s development.

Question 9

The banking system in BRIC countries: China

Answer 9

Summary:
China’s banking system has undergone significant changes over the years:

1. 1949-1979: China operated under a mono-banking system, with one central bank controlling all banking activities.
2. 1979-Present: Since 1979, China has pursued reform and rehabilitation approaches, leading to a series of reforms focused on institutional restructuring, deregulation, and commercialization of the banking sector.
3. NPL Crisis: China faced a Non-Performing Loan (NPL) crisis in the late 1990s, highlighting weaknesses in the banking system.
4. Radical Reforms: From 2003 onwards, China embarked on more radical reforms aimed at modernizing and strengthening its banking system.
5. Global Presence: China is home to four of the world’s largest banks by capitalization, reflecting the significant growth and internationalization of its banking sector.

Overall, China’s banking system has transitioned from a mono-banking system to a more diversified and competitive landscape through a series of reforms, although challenges such as NPLs and ongoing reform efforts persist.