Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
The role of banks in the economy Semaine de la finance quantitative Loïc BRIN
École Nationale des Ponts et Chaussées Département Ingénieurie Mathématique et Informatique (IMI) – Master II
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Loïc BRIN The role of banks in the economy
1/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
1 Introduction 2 Banks are financial intermediaries which fill the gap between supply and demand on
money market and the risk market 3 Banking regulation: As concentration points of risks, banks are increasingly more
regulated 4 Conclusion: what future for banks and regulation?
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Loïc BRIN The role of banks in the economy
2/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Some puzzling figures
Some puzzling figures
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Loïc BRIN The role of banks in the economy
3/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Brief history of the financing of the economy through time
Brief history of the financing of the economy through time
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Loïc BRIN The role of banks in the economy
4/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
1 Introduction
▶ Some puzzling figures ▶ Brief history of the financing of the economy through time
2 Banks are financial intermediaries which fill the gap between supply and demand on money market and the risk market ▶ Supply and demand on the money market and the role of banks ▶ Supply and demand of risks and the role of banks
3 Banking regulation: As concentration points of risks, banks are increasingly more regulated ▶ Why regulating banks? ▶ Focus on the prudential regulation and its impact on the structure of the economy
4 Conclusion: what future for banks and regulation? ▶ What future for banks? ▶ What future for regulation? ▶ References
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Loïc BRIN The role of banks in the economy
5/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Supply and demand on the money market and the role of banks
Supply and demand on the money market
Non Financial Agents Households
Supply
Public Adm.
Firms
Time mismatch Risk Mismatch
Demand
Banks & Markets
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Loïc BRIN The role of banks in the economy
6/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Supply and demand on the money market and the role of banks
Who finances the economy? (in TUSD) Corporate bonds
Equity
Loans
Public debt securities
86 TUSD
76 TUSD
69 TUSD
58 TUSD
Source: Aspects of Global Asset Allocation, IMF. and personal cross-checkings.
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Loïc BRIN The role of banks in the economy
7/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Supply and demand on the money market and the role of banks
Who borrows? (in TUSD) Banks 130 TUSD
Private Wealth
Mutual funds and Insurrance companies
37 TUSD
58 TUSD
Foreign Exchange Reserve
Pension funds 34 TUSD
11.7 TUSD
Sovereign Wealth Funds 7.3 TUSD
Hedge Funds 2.8 TUSD
Private Equity Funds 2.2 TUSD
Source: The Random Walk, Mapping the world financial markets, 2014, DB research.
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Loïc BRIN The role of banks in the economy
8/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Supply and demand on the money market and the role of banks
The two financing of the economy – Markets and intermediation Financial Agents Other financial intermediaries
Non Financial Agents
Financial Markets
Non Financial Agents
Desintermediation
Banks
Intermediation
Lends
Borrows .
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Loïc BRIN The role of banks in the economy
9/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Supply and demand on the money market and the role of banks
An heterogenous structure of financing of the economy through the world The difference between the US and the EU
Banking loans 100% 90%
22%
Private debt securities (securitization)
Quoted shares
16% 33% 17%
80% 17% 70% 60%
40%
50% 40%
61%
67%
30% 20%
27%
10% 0%
Total financing / GPD
Economy based on intermediation
France 153 %
Euro Zone 158 %
Disintermediated economy
United States 241 %
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Loïc BRIN The role of banks in the economy
10/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Supply and demand on the money market and the role of banks
An heterogenous structure of financing of the economy through the world Why is it different in the US?
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Loïc BRIN The role of banks in the economy
11/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Supply and demand on the money market and the role of banks
The benefit of banking intermediation – An expertise in maturity transformation
Households
Firms
Public Adm.
Banks
Insur. Cie
Other FI
100% 50% 0% -50% -100% -150%
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Loïc BRIN The role of banks in the economy
12/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Supply and demand of risks and the role of banks
Introduction to bank businesses and customers Households Corporate Firms
Households Large Corporate Firms Financial Institutions
Wealthy households
Sovereigns Public Administration
Universal Bank Domestic Retail Banking
Proprietary Trading International Retail Banking
Investment Banking
Specialized Banking services
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Loïc BRIN The role of banks in the economy
13/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Supply and demand of risks and the role of banks
Example of contracts designed by banks
Economic purpose of banks’ products Transfering the risks
Financing the economy
Loans
Bonds Equity
ABS
Derivatives
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Loïc BRIN The role of banks in the economy
14/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Supply and demand of risks and the role of banks
Other advantages of banks
▶ ▶ ▶ ▶
Information theory (wider scope of vision); Economy of scale; Diversification of risks; Proximity with more non-financial agents (small firms, households, etc.).
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Loïc BRIN The role of banks in the economy
15/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
1 Introduction
▶ Some puzzling figures ▶ Brief history of the financing of the economy through time
2 Banks are financial intermediaries which fill the gap between supply and demand on money market and the risk market ▶ Supply and demand on the money market and the role of banks ▶ Supply and demand of risks and the role of banks
3 Banking regulation: As concentration points of risks, banks are increasingly more regulated ▶ Why regulating banks? ▶ Focus on the prudential regulation and its impact on the structure of the economy
4 Conclusion: what future for banks and regulation? ▶ What future for banks? ▶ What future for regulation? ▶ References
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Loïc BRIN The role of banks in the economy
16/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Why regulating banks?
The risky business of banks Banks concentrate risks
Market Risk Credit Risk
Operational Risk Structural Risks
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Loïc BRIN The role of banks in the economy
17/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Why regulating banks?
The risky business of banks Banks balance sheet and the necessity for capital
Loss distribution
Assets Loans and other Financial Assets
Liabilities Debts
Capital Provisions
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Loïc BRIN The role of banks in the economy
18/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Why regulating banks?
Why a macroprudential regulation? Banks positive and negative externalities
Banks are at the center of our economies
Banks face numerous and complex risks
- Finance the economy; - Provide way to transfer risks; - At the basis of money creation.
- Credit Risk (~80 %*); - Market Risk (~10 %*); - Liquidity Risk; - Operational Risk (~10 %*). * Computed as a percentage of Risk Weighted Assets (RWA, see Lecture 5).
It is thus a highly regulated sector Banks must set capital apart to face an likely rise of these risks.
Incentives to reduce balance sheet size
Moving toward an originate to distribute model ? (vs originate to hold)
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Loïc BRIN The role of banks in the economy
19/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Why regulating banks?
Why regulation must be macroprudential? The historical concentration of banks failures
600
500
400
300
200
100
19 34 19 36 19 38 19 40 19 42 19 44 19 46 19 48 19 50 19 52 19 54 19 56 19 58 19 60 19 62 19 64 19 66 19 68 19 70 19 72 19 74 19 76 19 78 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08 20 10 20 12 20 14 20 16
0
Source: Federal Deposit Insurance Corporation (FDIC).
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Loïc BRIN The role of banks in the economy
20/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Why regulating banks?
Why regulation must be macroprudential? The pro-cyclical behaviour of the banking sector Cycles de crédit et cycles de l'activité économique aux Etats-Unis 220%
4
200%
2
180%
0
160%
-2
140%
-4
120%
-6
100%
-8
Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4 1980 1981 1983 1985 1987 1988 1990 1992 1994 1995 1997 1999 2001 2002 2004 2006 2008 2009 Sources : Datastream, FMI, OCDE
Crédit sur PIB
cycles
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Loïc BRIN The role of banks in the economy
21/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Why regulating banks?
Why regulation must be macroprudential? Because they are too big to fail?
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Loïc BRIN The role of banks in the economy
22/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Focus on the prudential regulation and its impact on the structure of the economy
The prudential regulation Brief history of banking regulation history – Basel Accords
Basel I 1988
Basel II 2004
Basel III 2010
Cook ratio Credit Risk Simple weights for assets Market Risk by 1995 Operational Risk Stress Tests Internal models 3 pillars Liquidity Risk Contracyclical buffer SIFI Macroprudential approach
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Loïc BRIN The role of banks in the economy
23/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Focus on the prudential regulation and its impact on the structure of the economy
The prudential regulation Purpose of banking regulations
Limit the number of banking failures Reduce the cost of banking failures Better governance
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Loïc BRIN The role of banks in the economy
24/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Focus on the prudential regulation and its impact on the structure of the economy
The consequences and limits of regulation A negative short term impact
IIF assessment of regulatory changes on banks Change in Real GDP Level % point , difference between real GDP paths in "regulatory reform" scenario versus "base" scenario 0
-1
-2
-3
-4
-5
Countries included in the simulation: US, Eurozone countries, Japan, UK, Switzerland 2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
Source : IIF (septembre 2011) .
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Loïc BRIN The role of banks in the economy
25/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Focus on the prudential regulation and its impact on the structure of the economy
The consequences and limits of regulation A new structure of the financing and its drawbacks
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Loïc BRIN The role of banks in the economy
26/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Focus on the prudential regulation and its impact on the structure of the economy
The consequences and limits of regulation What are the benefits?
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Loïc BRIN The role of banks in the economy
27/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
Focus on the prudential regulation and its impact on the structure of the economy
Are our economies getting disintermediated? It still depends on the studied countries
8,99,1)+. /+:4;)9;?/3;6 ;9*. /+4@;,. /$&A$&A
%$50
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0 25
-50 -100
0 -150 -25
-200 2009
2010
2011
2012
2013
8,99,1)+. /+:4;)9;?/3;6 ;9*. /+4@;,. /#$A#$A#&
2009
2010
2010
2012
2013
500
200
400 150
300 200
100
100 0
50
-100 -200
0
-300 -50 2009
2009 2010
2011
2012
2010
2011
2012
2013
2013
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Loïc BRIN The role of banks in the economy
28/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
1 Introduction
▶ Some puzzling figures ▶ Brief history of the financing of the economy through time
2 Banks are financial intermediaries which fill the gap between supply and demand on money market and the risk market ▶ Supply and demand on the money market and the role of banks ▶ Supply and demand of risks and the role of banks
3 Banking regulation: As concentration points of risks, banks are increasingly more regulated ▶ Why regulating banks? ▶ Focus on the prudential regulation and its impact on the structure of the economy
4 Conclusion: what future for banks and regulation? ▶ What future for banks? ▶ What future for regulation? ▶ References
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Loïc BRIN The role of banks in the economy
29/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
What future for banks?
Challenges faced by banks Challenges they are facing and the ones to come
Fintechs Low rates Regulation
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Loïc BRIN The role of banks in the economy
30/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
What future for regulation?
Challenges faced by the regulation Challenges they are facing and the ones to come
Securitization Shadow banking Tax havens
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Loïc BRIN The role of banks in the economy
31/31
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Introduction
Banks are financial intermediaries
Banking regulation: why and how?
Conclusion
References
Bank of International Settlements (2016). Seminannual otc derivatives statistics. Link. Basel Committe (2000). Principles for the Management of Credit Risk – Final Document. BIS. Link. Brunel, V. and Roger, B. (2015). Le Risque de Credit, Des modeles au pilotage de la banque. Economica. Link. Fergusson, N. (2008). The Ascent of Money: A Financial History of the World. Penguin Books. Link. Scialom, L. (2013). Economie bancaire. Link.
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Loïc BRIN The role of banks in the economy
31/31
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