Changes in the global financial system
5 important questions on Changes in the global financial system
The financial evolution occurs in two stages. Explain stage 1.
- Stage 1: Heightened competition (70s-80s) between banks and other intermediaries involves new instruments & processes.
- Until 1970s: traditional banking earns oligopoly rents due to barrios to entry and restrictions on pricing
- Oligopoly rents eventually attract competitors that put pressure on the traditional role of banks
- Heightend competition in the financial sector reflects trend toward reducing government interference
- New roles for traditional intermediaries (blurring lines between depository institutions, brokers, dealers etc)
- New instruments ( money market mutual funds, interest rate and stock index futures, options, securitisation of mortgages, swaps, junk bonds)
- New processes ( electronic trading, pc financial transactions, automatic teller machines)
What is a Money Market Mutual Fund
- Invest in short term debt obligations
- Preservation of the principal
- Deposits are not insured (unlike bank accounts)
What do we refer to as the process of disintermediation of banks during the heightened competition of the 70s and 80s
The role of traditional banks changed during that period
- Innovation erodes traditional bank charter values
- Statistics indicate decline sector (fall bank market share)
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What changed when entering the second stage of financial evolution (symbiosis) (90s and 00s)
- new intermediaries, instruments and processes no longer compete against one another but enter a period of codependence
- Move from originate to hold modelto originate to distribute model
- Rapid rise in securitisation and structured finance
- Use of repurchase agreements REPOs for short term funding
- Derivatives trading to support risk transfer (CDS, interest rate swap)
What is structured finance? The most characteristic feature of the process of securitisation and structured finance is an SPV. Explain an examples an SPV
Example 1: Special purpose vehicles (spvs): They are created to use assets originated by/obtained from a sponsoring firm to support the sale of securities to investors.
SPV purchases mortgages originated by a bank and use the cash flows generated by the mortgages to create a "pass-through security" purchase by investors that seek an exposure to real estate.
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