The Financial System and its Institutions Prof. Concetta Brescia Morra

INDEX The role of Finance in an Economic System Overview of types of financial activities: Banking Capital markets Institutional investors (investment funds, pension funds, insurance companies) Different models of capitalism Anglo-American system German-Japanese system

Defining finance The term finance in this lesson: Finance is “that part of the economy which includes all the institutions involved in moving funds from savers (household and firms) to borrowers, and in transferring, sharing and insuring risks, notably banks, insurance markets and stock markets” (J. E. Siglitz) The financial system is the set of the institutional structures, the economic agents and the legal instruments through which liquidity and credit flow through the economy.

Capital markets FINANCIAL SYSTEMS Banks Savers (housholds) Institutional investors - Investment funds - Pension funds - Insurance companies Banks Firms (corporations) States and Public entities Housholds Capital markets Savers (housholds) Loans Bonds Shares - Deposits - bonds - Hybrid securities Banks and Investment firms trading  for own account (dealer) execution of orders for clients (broker) Portfolio management Investment consultancy Banks and Investment firms underwriting and/or placement based on an irrevocable commitment towards the issue Investments in Shares Bonds Other securities Selling Shares Bonds Other securities

The role of Finance in an Economic System Finance performs five functions: Mobilizing capital from savers who have more financial resources than uses for them Selecting projects from amongst those seeking investment to capital and monitoring the performance of those seeking for investment to capital Provide secure mechanism for payments at a distance: the creation of bank money and other form of liquid assets in substitution of gold and metallic money

The role of Finance in an Economic System Transfer and management of risk: financial intermediation is management and distribution of risk among economic agents. Provision of information: financial intermediaries supply information on the level of risk of financial activities

Different models of capitalism The German- Japanese financial system is a bank-oriented systems: banks play a leading role in mobilizing savings, allocating capital, overseeing the investment decisions of corporate managers, and providing risk management vehicles. The Anglo-American financial system is a market-oriented system: markets share center stage with banks in getting society's savings to firms, exerting corporate control, and easing risk management. Financial markets play a more important role relative to banks.

Liabilities of the firms: loans are more important in SP e IT (percentage composition of liabilities, excluding pension funds and derivatives)

3. The leverage of firms is still higher than 15 years ago (ratio between bonds + loans and total financial liabilities; percentages)

Leverage Leverage is higher in Spain and Italy, because companies rely more on loans and financial markets are less developed Share capital of firms is higher in the UK and in France than in Italy and Spain German companies had the highest leverage at the beginning of the 2000s, due to bank-loan growth following the German unification in 1989 10

4. Bonds issued by firms are of great importance in UK and France (ratio of bonds to bonds + loans)

Bonds: issuance trends Because of the credit crunch, companies increased securities issues in all countries, except Spain The German and Italian firms have doubled the weight of the securities issued on their total financial debt, but the difference with FR and UK remains wide For large industrial groups in Italy securities issues more than offset the contraction in bank lending, while issues of small business firms declined 12

Different models of capitalism The Anglo-American shareholder system Share ownership is dispersed among many institutional and small investors The German- Japanese cross-shareholdings system The ownership structure is influenced by relatively small group of large banks The State-led financial market system prevailing in the past in France and Italy The State controls directly or indirectly all the major industrial and banking companies

Different models of capitalism Recent changes State-owned companies diminished Privatization has been an important phenomenon in Latin America, Western Europe, Asia and (obviously) the former Soviet bloc, but not in the USA where State ownership of enterprises has always been very small The Italian case: a much smaller role of the State, an increased role of foreign companies a reduction in the importance and complexity of pyramidal groups In OECD countries : the growth in defined contribution pension plans has channeled an increasing fraction of household savings through mutual and pension funds and has created a constituency of investors that is large and powerful enough to be able to influence corporate governance