1. Monetary financial institutions
Credit institutions
Money market funds
Specialized credit institutions
Bank liquidity
Banking performance
Banking risks

2. Monetary financial institutions (MFIs)
Monetary financial institutions (MFIs) are central banks, credit institutions, and other financial institutions whose business is:
to receive deposits and/or close substitutes for deposits from entities other than MFIs and, for their own account
to grant credits
and/or make investments in securities.
Money market funds are also classified as MFIs.
MFIs comprises: CB
credit institutions
other financial institutions which fulfill the MFI definition.
money market funds

3. Evolution of MFI sector in EU
Source:

4. Credit institutions
Credit institution is an undertaking whose business is to receive deposits or other repayable funds from the public and to grant credits for its own account.
To increase transparency within the European Single market, the European Banking Authority (EBA) publishes a list of credit institutions to which authorisation has been granted to operate within the EU and European Economic Area countries.
Credit institutions comprises:
Banks
Savings banks for housing
Mortgage loan bank
Credit cooperatives/ credit unions/cooperative banks

5. Banking system
It represents the totality of the institutions authorized to perform banking operations.
In the majority of the countries, it is organized on two levels:
the banks
the CB
In some countries (German, Japan) banks are the primary owners of industrial corporations and in other countries (United States) banks are prohibited from owning non-financial companies.
The first modern bank was founded in Italy in Genoa in 1406, its name was Banco di San Giorgio (Bank of St. George).
Banks:
one of the most important intermediaries in the relation savings – investments (significant for economic growth).
monetary intermediaries, which have the ability to create money through lending funds from excess reserves made available from the deposits.

6. Bank’s functions Generally, a bank fulfills three important functions:
to act as payment agents by conducting checking and current accounts for customers and making the payments ordered by the customers;
to borrow money by accepting funds deposited on current account, accepting term deposits and by issuing debt securities such as banknotes and bonds;
to lend money by making advances to customers on current account, by making installment loans, and by investing in marketable debt securities and other forms of lending.
Banks provide almost all payment services within the economy, and a bank account is indispensable by most businesses, individuals and governments.
Banks borrow most funds borrowed from households and non-financial businesses, and lend most funds lent to households and non-financial businesses.

7. Commercial banks vs. specialized banks
A basic distinguish is made between the commercial bank and specialized bank:
a commercial bank performs all the operations allowed by the banking law (generally they are universal banks).
a specialized bank develops operations especially in some sectors.
The dominant financial institutions in the economies of most countries are the commercial banks:
raise funds by collecting deposits from businesses and consumers via checkable deposits, saving deposits and time deposits.
make loans to businesses and consumers.
buy corporate bonds and government bonds.
The name commercial implies that banks devote most of their resources to meeting the financial needs of business firms.
In recent years, commercial banks have significantly expended their offerings of financial services to costumers and governments around the world.

8. Commercial banks primary liabilities = deposits primary assets = loans
Banks also provide many services to their costumers, earning commissions/fees:
funds transfer;
portfolio management and advice;
safekeeping and administration of securities and other financial instruments;
intermediation on the interbank market;
guarantees and commitments;
investment advice;
security underwriting;
financial planning.
Most of the services provided to their customers are registered outside of the balance sheet – are off balance sheet items.

9. Bank’s assets and liabilities
Cash and other payment means
Deposits held in CB and other banks
Loans (working capital, transactions, term loans, consumer loans, mortgages)
Marketable securities held
Shares and other equities held
Fixed assets
Liabilities:
Equity
Clients’ deposits: overnight, time deposits, redeemable at notice
Other institutions’ deposits
Marketable securities issued
Shares issued
Loans from CB and other credit institutions

10. Specialized credit institutions
Saving banks: accept deposits and extend loans and other services, primarily to household costumers.
Usually, the costumers’ deposits held at these institutions benefit of the total deposit insurance.
Investment banks: are specialized in large and complex financial operations (underwriting, acting as an intermediary between a security issuer and the investors, facilitating mergers, acquisitions, and corporate reorganizations, and acting as a broker and/or financial adviser for institutions and private investors).
Foreign banks: hold many branches in other countries.
International banks: have stockholders coming from several countries.
Banks for Agriculture: offer financial support to agriculture companies.
Banks for Foreign Trade: offer financial support to companies which perform foreign trade operations.

11. Mortgage loan banks
They are specialized credit institutions, which have as core business:
the granting with professional title of mortgage loans for real estate investments and
the raising of repayable funds from the public by issuing mortgage bonds.
Mortgage loan is a loan granted for real estate investment pledge with the real estate which is financing through the loan or for the reimbursement of a mortgage loan received before by the client.
With the exception of deposit collection activities, mortgage loan banks may, within the boundaries of the granted authorization, carry on the activities permitted to the credit institutions, provided these activities support the granting of mortgage loans and the issuing of mortgage bonds.

12. Savings banks for housing/Housing saving banks (I)
Housing saving banks are called “Bausparkasse" in Austria and Germany.
They are credit institutions specialized in long-term financing for housing.
To benefit of a loan, customers have to conclude with this institution a saving-lending contract, according which:
the client is bound to save an amount representing the minimum saved amount;
the savings bank for housing is bound to grant a fixed-rate loan to cover the difference between the total amount stipulated by the contract and the amount saved, including interest and premiums granted.
Every client shall benefit from a government-granted premium for the annual savings made on the basis of a saving-lending contract.
For example, in Romania the government-granted premium is established at 15% of the saved amount in the year concerned, which may not exceed the RON equivalent of EUR 120.

13. Savings banks for housing (II)
Savings banks for housing may, to the limit of the powers assigned following the authorization granted, carry out the following activities:
collective saving and lending for housing;
anticipated financing based on saving-lending contracts:
the credit at market interest rate granted to the client who did not yet save the minimum amount established by the bank in the saving-lending contract;
this credit, for which only the interest is paid, turns into a fixed-rate credit at the date all stipulated terms and conditions for granting the credit are met;
intermediary financing based on saving-lending contracts:
the credit at market interest rate granted to the client who saved the minimum amount established by the saving-lending contract but who does not fulfill the other stipulated terms;
this credit, for which only the interest is paid, turns into a fixed-interest rate credit at the date all stipulated terms and conditions are met;

14. Savings banks for housing (III)
granting of credits for housing;
management of third parties’ credit portfolios and intermediation of credits to third parties, if the credits are intended to financing of some housing activities;
issuance of guarantees for those types of credits granted to third parties that the savings banks may grant;
low risk investments, according to the regulations;
granting of credits to commercial companies in which the savings banks for housing hold equity stakes;
issuance and management of payment and credit instruments;
funds transfers;
financial and banking consulting services;
financial-banking mandate operations;
other operations, according to the provisions of the law.

15. Credit unions (I)
A credit union is a member-owned financial cooperative, controlled by its members, in which individuals pool their money to provide loans and services to other members.
Credit unions’ core business consists of savings and loans, but in a number of member states credit unions also offer a variety of services to their members:
Many credit unions provide services intended to support community development  or sustainable international development on a local level.
Worldwide, credit union systems vary significantly in terms of total system assets and average institution asset size.
They are typically (still not exclusively) the smaller form of cooperative banking institution.
In some countries they are restricted to providing only unsecured personal loans, whereas in others, they can provide business loans to farmers, and mortgages.

16. Credit unions (II)
They differ substantially from commercial providers in as the following ways:
Credit unions are democratic, member-owned financial cooperatives. They are locally owned community institutions controlled by their members on the basis of a one-member, one-vote system. Services are provided to members only.
Membership is based on the existence of a common bond among members (geographical, associational or based on another common interest).
Credit unions are not-for-profit institutions. Excess earnings are used to offer members more affordable loan rates, a higher return on savings, or lower fees for products. Thus, profits are re-distributed to the credit unions’ members.
Governance responsibilities are overseen by a board of directors serving the credit union on a voluntary basis. The board is elected from within the membership. Each credit union member, regardless of account size in the credit union, has one vote and may run for the board.

17. Cooperative banks/credit co-operative
Larger credit unions are often called cooperative banks and some are tightly integrated federations of credit unions:
Like credit unions, cooperative banks are owned by their customers and follow the cooperative principle of one person, one vote.
Unlike credit unions, cooperative banks are often regulated under both banking and cooperative legislation.
They provide savings and loans to non-members (individuals, legal entities or from other entities without legal personality) as well as to members, and some participate in the wholesale markets for bonds, money and even equities.
A credit co-operative is a credit institution established as an independent association of individuals fulfilling, out of their own free will, their common economic, social and cultural needs and aspirations, whose activity is based mainly on the principle of mutual benefit of the co-operative members.
Credit co-operatives may, to the limit of their authorization, carry out the majority of banking activities allowed to the banks.

18. Credit institutions in Romania
In Romania credit institutions include:
banks
credit co-operative organizations
savings banks for housing
mortgage loan banks
The credit institutions are authorized by the National Bank of Romania.
The initial capital required for the establishment of a bank is the equivalent in RON of EUR 5 million (37 million of RON).
Banks :
Banks are credit institutions with universal activity, which may perform any of the activities mentioned by the law.
Banks are legally constituted as joint-stock companies in accordance with the commercial legislation and with the provisions of the Emergency Ordinance no. 99/2006.

19. Activities of credit institutions in Romania (I)
acceptance of deposits and other repayable funds;
lending including: consumer credit, mortgage credit, factoring with or without recourse, financing of commercial transactions, including forfeiting;
financial leasing;
money transmission services;
issuing and administering means of payment;
guarantees and commitments;
trading for own account and/or for account of clients, according to the law, in:
money market instruments, such as: cheques, bills, promissory notes,
certificates of deposit;
foreign exchange;
financial futures and options;
exchange and interest-rate instruments;
transferable securities and other financial instrument

20. Activities of credit institutions in Romania (II)
participation in securities issues by underwriting and selling them or by selling them and the provision of services related to such issues;
advice on capital structure, business strategy and other related issues, advice and other services relating to mergers and purchase of undertakings, other advice services;
portfolio management and advice;
safekeeping and administration of securities and other financial instruments;
intermediation on the interbank market;
credit reference services related to provision of data and other credit references;
safe custody services;
operations in precious metals, gems and objects thereof;
acquiring of participations in the capital of other entities;
any other activities or services that are included in the financial field.

21. Money market funds
A mutual fund is a company that pools money from many investors and invests the money in stocks, bonds, short-term money market instruments or other securities.
A money market fund is a type of mutual fund that is required by law to invest in low risk securities:
government securities,
certificates of deposit,
commercial paper of companies,
other highly liquid and low-risk securities.
Money market funds have relatively low risks compared to other mutual funds an pay dividends that generally reflect short-term interest rates.
Money market funds issue redeemable units (shares) to investor, which represent form the liquidity point of view close substitutes for deposits.
Money market funds are widely (though not necessarily exactly) regarded as being as safe as bank deposits yet providing a higher yield.

22. Non-bank financial institutions
They are financial institution that provide banking services without meeting the legal definition of bank (does not have a full banking license).
These institutions typically are restricted from taking deposits from the public.
Their financing sources arise from own resources or resources borrowed from credit institutions, from other financial institutions from other sources.
They may perform the following lending activities:
granting of loans: consumer credits, mortgage credits, real-estate credits, micro-credits, financing of commercial transactions, factoring, discount, etc. ;
financial leasing;
issuing of guarantees and assuming commitments, including credit guarantee;
granting of loans in exchange of goods for safekeeping (pawnshops);
granting of credits to members of non-profit-making associations based on free will of employees (mutual benefit societies);
issuing and managing credit cards, advisory services, mandate operations etc.

23. Bank liquidity (I)
Liquidity for a bank means the ability to meet its financial short-term obligations. 
Bank lending finances investments in relatively illiquid assets, but it fund its loans with mostly short term liabilities. 
one of the main challenges to a bank is ensuring its own liquidity. 
Commercial banks differ widely in how they manage liquidity. 
There are two methods to manage the liquidity:
Asset Management Banking  - is appropriate to a small bank:
gets its funds primarily from customer deposits = a reasonably stable source. 
its assets are mostly loans to small firms and households
usually has more deposits than it can find creditworthy borrowers for. 
excess funds are invested in liquid assets (government securities). 
The holding of assets that can readily be turned into cash when needed, is known as asset management banking.  

24. Bank liquidity (II)
Liability Management Banking  - is appropriate to large banks:
lack sufficient deposits to fund their main business
deal with large companies, governments, other financial institutions, and wealthy individuals. 
most borrow the funds they need from other major lenders in the form of short term liabilities which must be continually rolled over. 
it is a much riskier method than asset management. 
A small bank will lose potential income if gets its asset management wrong. 
A large bank that gets its liability management wrong may fail. 
Key to Liability Management  = always being able to borrow. 
A bank's most vital asset is its creditworthiness: 
if there is any doubt about its creditworthiness, lenders can easily switch to another bank. 

25. Bank liquidity (III)
the rate a bank must pay to borrow will go up rapidly with the smallest suspicion of trouble. 
if there is serious doubt, it will be unable to borrow at any rate, and may fail. 
Recently, large banks have been making increasing use of asset management in order to enhance liquidity, holding a larger part of their assets as securities. 
There are 3 issues regarding the liability management:
Diversification to reduce liquidity risk (CDs, Eurodollars, repos, subordinated and interbank debt, time and demand deposits)
Liability mix – choice of:
traditional deposits – relatively stable source
and risk-sensitive investment instruments – more volatile
Maturity structure – duration matching affects the degree of liquidity risk, but may also reduce flexibility.

26. Bank liquidity (IV)
Protecting against bank liquidity risk is possible applying the following measures:
holding liquid assets;
dissipating withdrawal risk by diversifying funding sources (liability management);
seek low volatility ratio: VL-LA/TA-LA where VL volatile liabilities, LA liquid assets, TA total assets; prudent banks have ratio < 0;
backup: capital adequacy to ensure creditworthiness maintained in face of shocks;
important role of supervision and minimum reserve requirements and money market infrastructure ensuring liquidity maintained.

27. Indicators to measure bank liquidity
Liquidity index
Weights = the serial numbers of maturity bands
Liquidity ratio/Global liquidity
Stable funds allocation

28. Bank run. Deposit insurance
A bank run is a great demand for cash by a bank's depositors:
a very harmful phenomenon affecting the banks’ activity.
A rumor about a bank, even though unfounded, can generate bank run that may cause a solvent bank to fail. 
To protect bank against the bank run, deposit insurance was introduce.
Insurance is limited to:
$100,000 per deposit in USA
€100,000 in Europe (and in Romania)
cover a large part of smaller deposit.
The role of the deposit insurance system consists in securing the protection of:
deposit holders against the risk of losing their financial savings;
banks against the negative effect of runs on their liabilities caused by the public’s weakened confidence in the banking system.

29. Deposit insurance can cause the failure of the bank.
!!! depositors doubts regarding the safety of their bank deposits withdrawals:
can cause the failure of the bank.
can be interpreted by the public as a signal of weak financial situation of other banks may cause liquidity problems even to solvent banks.
bank run contagion = the situation in which liquidity or insolvency risk is transmitted from one financial institution to another:
unsound financial markets and financial crises
increased systemic risk – risk of collapse of an entire financial system
harmful consequences for financial system expansion and economic growth.
The purpose of deposit insurance is:
to diminish the risk of strong banks being affected by the bad reputation of weak banks.
to increase the confidence of the public in banks because the deposits are guaranteed if the bank could not respect its payment obligations.
may have a positive contribution to the safety of the financial system.

30. Banking performance Sources of Income Sources of Expenses
Interest on granted loans
Interest paid for clients’ deposits
Interest paid for other banks’ deposits
Interest on deposits held in other banks
Interest paid for received loans
Interest on held securities:
Treasury bills
Government bonds
Other securities
Interest paid for issued securities:
Bonds
Certificates of deposits
Loan fees (noninterest income)
Operating expenses
Other income (fees)
Other expenses (taxes)

31. Banking performance indicators (I)
Net margin (profit ratio)
Interest margin
Earning assets = granted loans + T-bills + government bonds + deposits held
Asses utilization:

32. Banking performance indicators (II)
Return on assets
Return on equity:
Leverage multiplier:

33. Banking performance indicators (III)
Yield on earning assets:
Cost rate on interest bearing funds:
Net interest rate spread = Yield on earning assets – Cost rate on interest bearing funds
Return on equity model:
 ROA = Net margin * Assets utilization
ROE = ROA* Leverage multiplier

34. Bank risks
Credit risk – the risk of loss due to the fact that counterparties may be unwilling or unable to fulfill their contractual obligations:
it involves the risk of default on the asset (a loan, bond, security or a contract).
Market risk – the risk of loss due to movements in financial market variables. (interest rates, foreign exchange rates, equities, and commodities).
For traded assets, there is no clear-cut demarcation of market and credit risk:
market risk also reflects credit risk; for example, a corporate bond:
some of the price movement may be due to movements in risk-free interest rates, which is pure market risk.
the remainder will reflect the market’s changing perception of the likelihood of default, which is credit risk.
Operational risk – the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events (including legal risk).
Liquidity risk – the risk a bank be unable to meet its short-term obligations, as they come due.

35. Efficient market and asymmetric information
In the fields of finance and economics there exist a great debate concerning the availability and cost of information.
Efficient market hypothesis (EMH) argues that information relevant to the pricing of loans, securities, and other financial assets is readily available to all borrowers and lenders at insignificant cost.
Asymmetric information concept argues that the financial market contains pockets of inefficiency in the availability and use of information regarding the customers:
Some market players (e.g. professional lenders of funds, auditors, managers of corporations etc.) may posses special information that enables them to get more accurate picture of the value and risk of certain assets.
These “insiders” can earn excess returns by selectively trading financial and other assets based on the special information they have been able to acquire – information that would be costly for others to obtain.
Research studies have especially confirmed the weak and semistrong of EMH.

36. Adverse selection (I)
The asymmetrical distribution of information can alter the nature of contracts and can generate adverse selection and moral hazard problems.
Adverse selection means that, due to asymmetric information, bank can choose to work with the wrong clients.
For example, banks face an adverse selection problem with checking accounts. There are two principal categories of checking account customers:
1) those who hold high deposit balances and make few payments, giving the bank more money to lent while the low level of account activity keeps bank costs down;
2) those who keep low balances in their account but make lots of payments, giving the bank few funds to invest while heavy activity runs up bank costs.
When a customer wants to open a new account, the bank does not know what kind of checking account customer he will be.
If the bank sets one price for all checking accounts, the bank runs the risk of being adversely selected against by its potentially most profitable customers.

37. Adverse selection (II)
The preferred high-balance, low activity costumers will leave, because the one price set by the bank is likely to be too high for them, but that price may be too low to cover the bank’s operating costs in serving the less preferred low-balance, high-activity checking accounts customers.
Another bank could simply enter the market with a cheaper checking account services and attract the most profitable accounts.
The first bank would be adversely selected against by those customers it most wanted to attract.
The most common technique used to mitigate the adverse selection problem is to set up a price schedule in which the prices charged vary based on how much money each customer keeps on deposit each month and how many payments are made and to let the customer pick which checking account plan to sign up for.

38. Moral hazard (III)
Moral hazard implies that one party to a contract may change its behavior after contract is concluded and decide to peruse their own self-interest at the expense of other parties to the agreement.
Moral hazard often arises because of poorly drafted contracts or ineffective and inefficient monitoring activity by the principal parties involved in a contract.
One party may not always find it in his or her best interest to behave honestly and may strive to achieve personal benefits that result in losses or lower returns for others involved in the agreement.
For example, moral hazard problem centers around deposit insurance provided to bank depositors by many governments around the world.
Because the deposit insurance protects most depositors, many of them no longer pay much attention to the condition or management policies of their bank, since in the case of bank’s failure the government will simply pay them off anyway.
This allows some careless bank managers to take on additional risk with the public’s funds.