1. Financial Institutions
Globex at Peking University
Financial Institutions

2. GDP of domestic economy is highlighted…
GDP = Consumption + Gross Investment + Government Spending + (Exports – Imports)
GDI = Private Consumption + Investment + Government Spending + (Net Exports)
GNI = Consumption + Gross Capital Formation + Government Spending + (Net Exports)
Note: Greens terms are both “Consumption”:
we split private consumption (also called “consumer consumption”) and
government spending (also called “government consumption”)

3. Savings and investment are equal for the whole economy
GDP = Consumption + Gross Investment + Government Spending + (Exports – Imports)
GDP = Consumption + Gross Investment
GDP = “Spend” ”Save”
S = I for the whole economy, but not individual firms or people.
High savings economies (e.g., J & C) are high investing economies, which grows the GDP.
What is “saved” by one person is then borrowed or “invested” by another.
Financial institutions bring together savers and investors.

4. What are the mechanisms to balance savings and investment?
GDP: simplified equation for a closed economy (no net exports). Let’s relate GDP to financial system, savings, & investment…
GDP: Each unit of output sold in the economy is consumed, invested, or bought by the gov.
GDP = Consumption + Investment + GovSpending
GDP – Consumption – Government Spending = Investment
GDP – Consumption – Government Spending = income remaining after paying for consumption and government spending
GDP – Consumption – Government Spending = national savings (or just “savings”)
So “Investment” is “Savings”
I and S are equal for whole economy, but not individual firms or people
What are the mechanisms to balance savings and investment?
Financial institutions, e.g., stock/bond markets, banks, mutual funds, other…

5. (borrowers; they take loans)
In an economy, savings = investment, and financial institutions mediate savers and investors
Savers Investors
(borrowers; they take loans)
FAMILIES
FAMILIES
FINANCIAL INSTITUTIONS AND CAPITAL MARKETS
BUSINESSES
BUSINESSES (including SOEs)
OTHER ORGS
OTHER ORGS (including infrastructure)
Gov websites now have chat rooms, contacts, “mayor’s mailbox”, etc.
Legislation can be posted for public commentary.
Do challenges threaten the regime or strengthen it? (ngo’s on aids, envir; legal aid for migrants, petititons for back wages, journalists embarrassing local official corruption….etc.)
Expanding the role of CPPCC and 8 other parties
Creating prov, muni, county e-gov websites: info and feedback
Letter and vists office where public can report state abuses
Many officila info sources document problems: party controlled newspaper, officially-spon scholarly journals, state planning commission reports, state statistical yearbooks, opinion surverys by institutes, xinhua news agency, …
Jiang zemin (conservative) followed by hu jintao
Party feels weakened as discontent mounts in 1990s, so increases participation to legitimize party/gov
In 1980s, prior to 6/4, Zhao Ziyang was reformer advocationg….
Harmonious society harmonizes various interests and defuses complicated contradictions thru fair distribution of the benefits of econ growth, but politics remain authoritarian.
Village level elections, but local party controls nomination and screening of candidates, elected committee has no independ political or fiscal authority because subordinate to township gov.
Before Nat labor Contract Law, 30 days for public to comment on it on-line
In 94, 15k labor disputes. In 2008, 700k labor disputes, Mary Gallagher.
Media advertises law
Trade unions weak in the enterprises but stronger at national level
(Xu Zhiyong arrested in 2009 sought rule of law, incremental reform, guarantees already in constitution, supported disadvantaged. Not against CCP nor one party.)
OGI includes budget info, formerly a state secret, but now “taxpayers right to know”. Gov orgs must pulbishin libraries, office and on web. Polluters,
Protests:
only allowed after getting permission from the Public Security Bureau, the government department that handles policing, public security, and social order, as well as residence registration, immigration and travel visas for foreigners.
But in reality, protesting is a right that is rarely practiced.
During the 2008 Summer Olympics, in order to give the world an impression of open mindedness, the Beijing police opened three parks in the capital as "protest zones." But when two 70-year-old women tried to apply for a permission to protest against the illegal demolition of their houses, they were informed that they would be sent to labor camp for charges of "disturbing social order."
According to media reports, China received a total of 77 applications to stage protests during the Olympic Games, but none were approved.
According to the Ministry of Public Security, there were 10,000 across China in By 2005, that had risen to 87,000.
FI&CM…
pay interest to savers, so savers earn interest, e.g. 2%
charge interest to borrowers (investors), so investors pay interest on their loans, e.g., 5%
make profit on difference between interest rates, E.g., 5% - 2% = 3%

6. Financial institutions bring together savings (savers) and investment (borrowers)
The financial system is important because:
The financial system in each country greatly influences that economy; also money flow is the “blood” of the economy
Financial institutions have global clients, so they connect different national economies by being the conduit for money flows
Individuals from the financial sector are often business & government leaders
4) Young professionals should know how to access financial markets in order to make investments and grow their business
The following terms are used somewhat interchangeably:
Financial sector
Financial system
Financial institutions
Financial markets*
Capital markets*
*but these 2 often refer to stocks/bonds/commodity exchanges

7. Financial institutions bring together savings (savers) and investment (borrowers)
What are financial institutions?
Financial Markets (also called Capital Markets), savers directly supply money to investors. 2 most important…
Bond market
Stock market
Financial Intermediaries, stand between savers and investors, 2 most important…
Banks
Mutual funds
Key discussion: Do our financial institutions allow money to flow to “good” investments? That is, are they making wise loans? Will borrowers use loans effectively to increase the productivity of their assets? Or will they use money inefficiently or even wastefully? If wasted, then the borrower can not repay its loan, and the saver loses her savings (or “her investment.”)

8. 1. Financial markets: savers directly supply money to borrowers
Bond market:
X buys a bond from Y, so X essentially loans money to Y.
Large corporations and governments sell (“issue”) bonds w/ periodic interest payments and promise to repay the principal.
Ys issue bonds to “raise money”; that is, bonds help Ys to “borrow” money.
Issuing bonds is called “debt financing” because Y is getting “financing” (that is, getting money, getting loans) by being in “debt” to the purchasers of their bonds.
Maturity: the “term”…a longer term bond pays higher interest
Credit risk: refers to the likelihood that borrower will default on his promised interest and principal payments
gov bonds considered safer, so they pay relatively low interest; unreliable corps pay higher interest
Credit risk assessed by ratings agencies like S&P

9. 1. Financial markets: savers directly supply money to borrowers
Stock market: Stocks represent ownership in a company, and they entitle the owner of stock to a claim on the company’s profits. If a company sells 1m shares of stock, then each share is 1/1,000,000 ownership of the company.
Companies sell their stock to raise money (capital) in order to invest in, that is, try to grow, their business.
Selling stock is called “equity financing” because a company is getting financing (getting money) by giving equity (that is, ownership) to the purchasers of their stock.
Buyers of stock can later sell the stock (hopefully at higher price), but there is no guarantee that the stock price will go up. So unlike buying a bond, there’s no guarantee of pay back.
If you buy a company’s stock, then you have invested in the co, and you hope to get a positive return on your investment. You convert your savings into an investment in this co.
Risk: Stocks are higher risk but potentially higher return than bonds. If business goes poorly, then bond holders will get paid before stockholders get anything
Trading: After a company issues shares of stock to buyers, then the stocks are traded on stock exchanges (e.g., NYSE and NASDAQ)
Price: On exchanges, stock prices determined by supply & demand. If people are optimistic about a company, then demand for the stock increases & thus the price of the stock increases
Indices: Stock indices monitor the overall level of stock prices in the market, e.g., the Dow Jones Industrial Average (30 companies) and the S&P 500 Index (500 companies) indicate whether overall stock market is up/down and whether economy (GDP) might be growing/shrinking

10. Financial institutions bring together savings (savers) and investment (borrowers)
What are financial institutions?
Financial markets, savers directly supply money to investors, 2 most important…
Bond market
Stock market
Financial intermediaries, stand between savers and investors, 2 most important…
Banks
Mutual funds

11. 2. Financial intermediaries: stand between savers and borrowers
Banks: Unlike large corporations or governments, small businesses & individuals don’t sell bonds/stocks to raise money. Thus, they often go to a bank for a loan when they need to borrow money. Banks mediate money from savers (depositors) to borrows (people who take loans.)
Mutual Funds: An institution wherein an individual can invest her savings (say, $10,000), and the mutual fund invests her money in a “portfolio” of stocks and/or bonds in various companies. The saver then owns $10,000 worth of the portfolio stock, which may go up (or down) in value.
Buying stocks in individual companies is risky because the stock’s value is dependent on the company’s business. Thus, savers prefer to diversify their risk by having their savings invested in a portfolio (or basket) of companies
In developed financial systems, mutual funds enable even those with small savings to put their savings in the stock and bond markets (via mutual funds)
Examples of mutual fund providers: Fidelity, Vanguard, BlackRock, Janus, Oppenheimer

12. We’ve looked at these four major types of financial institutions, but now let’s look at others…
What are financial institutions?
Financial markets, savers directly supply money to investors, 2 most important…
Bond market
Stock market
Financial intermediaries, stand between savers and investors, 2 most important…
Banks
Mutual funds

13. Financial institutions bring together savers and investors
Big Asset Managers (BAM)
Mutual Funds (e.g., Vanguard, Fidelity)
Institutional Investors (big pension funds, teachers’ retirement funds, etc.)
Large Hedge Funds
Public Markets
Exchanges: stocks, bonds, commodities (e.g., NYSE)
Issued by government & large corps (WS banks do DD, underwrite, and issue, and conduct sales & trading)
Liquid and sell-able
SEC regulated, public disclosures required, large banks conduct “due diligence”
Savers
(People & Businesses)
Borrowers (Investors: People & Businesses)
Private Markets
Commercial Banks (P, $P, B)
Angel Investors ($P)
Venture Capital (BAM, $P…e.g., Kleiner Perkins; many on Sand Hill Road in SV)
Private Equity (BAM, $P….e.g., Blackstone)
Hedge Funds ($P…e.g., Bridgewater)
Funds (various)
(Gov-Business Loans)
(Gov Grants)
VC = invest in smaller companies in ~$50mm range, minority stake, co may seek funding from “friends and family” first
PE = invest in larger companies, take a majority position
P = People
$P = Wealthy people
B = Businesses

14. What is Wall Street? Essentially large banks and other financial institutions
Trends in finance in terms of sought-after jobs:
Investment banking (then and now!)
Venture capital (hot in the late 1990s tech boom, still key…)
Private equity (post 2000, after the tech bust)
Hedge funds (since ~2005, as income inequality increases and top ^^)
What is “investment banking”? 2 sides:
Corporate finance: investment banking (e.g., M&A, capital raises)
Capital markets: research; sales and trading
Does Wall Street lack ethics? WS does much good, but banks will “ride a vein until it bursts.” Banks compete against one another, so if one bank is making large profits on an unsustainable vein (sector, say, real estate), then other banks will also mine this vein to match the profits and expansions. Some examples of unsustainable veins: mergers in the 1980s, tech late 1990s, sub-prime mortgages in 2000s…what’s next?

15. China’s financial institutions

16. China’s financial institutions have a few unique or less-developed characteristics
Chinese banks are mostly state-owned, dominated by Big Four. They:
ICBC, Bank of China, China Agricultural Bank, China Construction Bank
Loan to SOEs and for infrastructure; currently may hold (too?) many bad loans
Give few loans to individuals and smaller/medium sized private businesses
Provide low interest to savers
China’s has fewer private markets, such as mutual funds, private equity, venture capital, hedge funds, etc., though these are developing

17. China’s financial institutions have a few unique or less-developed characteristics
Chinese banks are mostly state-owned, dominated by Big Four. They:
China’s has fewer private markets, such as mutual funds, private equity, venture capital, hedge funds, etc., though these are developing
Owing to #1 and #2 above, “shadow banking” is prevalent, which is essentially unregulated or informal financial organizations and transactions, e.g.,
Online lending, P-to-P financing, crowd funding, etc (13th FYP somewhat strengthened regulations on these financing channels)
“Wealth management” vehicles
Off-the-books loans organized by banks (maybe between 2 companies)
Financial orgs established to connect savers-with-investors (LGFV)
Person A loans to person B or person A loans to 50 people or businesses…generally, this personal lending was very helpful as China’s reformed

18. Continued: China’s financial institutions have a few unique or less-developed characteristics
China’s financial sector has been largely closed to foreign investment, though this is slowly changing.
China’s public markets are dominated by SOEs and trading is limited
China controls international capital flows in/out of China
China’s exchange policy is controversial to it’s trading partners

19. #5: China’s public markets (that is, stock exchanges) are dominated by SOEs and trading is limited
Three main stock exchanges: SH, SZ, and HK. Some considerations:
Most Chinese companies listed on these exchanges are state-invested
Chinese exchanges do have “listing requirements,” e.g., report timely financial statements, audits, requirements for size, etc.
However, the rules (accounting, etc….as well as practices) for publicly listed Chinese companies different from those in developed economies
“Insider trading” is too common and not totally dis-allowed
How might a foreigner invest in China? Invest in:
Foreign brands doing well in China
Foreign managed mutual funds that have a Chinese portfolio
Chinese companies listed abroad (mostly private…do you trust their financials?)
SH and SZ listed companies typically have:
A-shares – quoted/traded in RMB and only available to “qualified” foreign investors
B-shares – quoted/traded in foreign currencies and generally open to foreign investment
HK listed companies also have -- H-shares quoted/traded in HK dollars, these are shares of mainland companies listed on HKSE

20. #6: China controls/limits capital flows in and out of China, but Shanghai FTZ will have increased RMB “convertibility”
“Currency convertibility” is the ease with which a country's currency can be converted into another currency
“Full capital account convertibility” allows local currency (in our case, RMB) to be exchanged for foreign currency without any restriction on the amount.
Similarly, RMB “convertability” on the “capital account” means the ability to convert RMB into foreign currency freely or at the going exchange rate. This is generally called capital asset liberation (CAC)
A nation’s “capital account” includes: portfolio and other investments, FDI, and changes in the reserve account
“Convertibility” is important for international trade and finance. When a currency is not convertible, it poses a risk and barrier to trade with foreigners because foreigners do not want to forever keep RMB; they want to be able to convert RMB to their home currency. That is, foreigners want to be able to convert any revenues or profits earned in China. They want to convert to their own currency and bring it home.

21. #6: China controls/limits capital flows in and out of China; cross borders flows still small
What are the benefits of more cross-border capital flows?
Increase efficiency of investments (don’t get ur investment “stuck” in China)
Prevent over investment in particular domestic assets (due to lack of other investment options)
accelerate reform of the financial sector (due to more international competition and exposure)
Make visible the cross-border flows which are currently hidden in trade and FDI accounts; bringing these flows to light would give policy makers a complete picture
Capital account opening will progress, but controls on large-scale, short-term “portfolio” flows will remain in place (don’t allow a repeat of Asia in 1997!)
See chart: Relative to China’s capital markets, cross-border investment allowed is very small at ~ RMB 2t/69t

22. #6: China controls/limits capital flows in and out; the new limited cross border flows allow “qualified” foreign investors
China has been gradually relaxing regulations on foreign investment in China’s capital markets for investment, competition, integration, etc.
This also boosts demand for the RMB by global investors and promotes the RMB as an international reserve currency
2017 focuses on opening the stock and bond markets to foreign investors, mainly “institutional investors,” especially long-term investors such as pension funds (but not to individual jump in-jump out investors)
The goal of RMB convertibility is to attract foreign investors into China’s financial markets. However, with convertibility, China also has concerns about too many RMB flowing out overseas
China has taken measures to curb capital (RMB) flight, including increasing scrutiny of Chinese firms' overseas investments and Chinese people’s purchases of foreign currency

23. ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
#7: China’s RMB exchange rate policy is controversial to its trading partners; China’s uses a “managed float”
Developed economies (with so-called free markets) prefer floating exchange rates.
The exchange rate is the “price” of a currency, e.g., RMB1 “costs” US$0.12
With a floating exchange rate, the price of a currency fluctuates with supply and demand on the global market
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Less developed economies have used “fixed” exchange rates
They fix the price of their currency (their exchange rate) to another currency, perhaps the US$, or perhaps to a “basket” of other currencies
China’s RMB was fixed to the US$ from to ~2004 at US$1 = RMB8.28
Now the RMB has a “managed float” against a basket of currencies, which is believed to be dominated by US$, but the make-up of the basket is confidential

24. #7: China’s RMB exchange rate policy is controversial; the RMB is likely undervalued to maintain China’s export power
The RMB is likely significantly undervalued (~30%?)
China’s maintains this undervaluation by buying US$ and selling RMB (…so the market has more supply of RMB, so therefore the price of RMB is lower.) This leads China to hold a high a level of US$ in reserves. If China decided to sell off its US$ reserves, then the value (exchange rate) of the US$ would fall, owing to a flood (over supply) of US$ on the market. This is a slight risk for the US
China keeps the RMB somewhat undervalued so that its exports are inexpensive to foreign buyers
Example: a factory in China sells shoes for RMB100/pair.
If the exchange rate is US$1=10RMB, then the shoes coat US$10.
If the exchange rate is US$1=5RMB, then the shoes cost US$20.
So, Americans will buy more shoes made in China if the RMB has a lower exchange rate to the US$

25. Financial Institutions
Globex at Peking University
Financial Institutions

26. Slide not used…. The 2008 Financial Crisis (the “sub-prime mortgage” crisis)
What happened? Bad mortgages (low interest, little down payment, unqualified buyers, unclear/inaccurate documentation, “adjustable mortgage rates”); mortgages sold from bank to bank; mortgages “rolled up” into securities called CDOs which ultimately were not valuable because they were based on bad debt.
Results:
Banks failed: Major banks like Lehman, Merrill, Fanny Mae and Freddie Mac, Bear Stearns, AIG; banks failed from
Optional: see this short explanation on AIG and its role its role in the 2008 crisis and bailout; recall AIG provided insurance on mortgage backed securities…
Individuals lost savings, homes, retirement funds
Few to no bankers penalized
Actions:
1. The US gov “bailed out” banks with $700 billion thru TARP (reduced later to $475b.) The treasury purchased “distressed assets” (mortgage-backed securities) and essentially infused cash to banks.
2. Dodd Frank Act of 2010 for WS reform aimed to promote financial system stability, accountability and transparency by…
Creating a number of new agencies (merging and closing others) to streamline the regulatory process and increase oversight of institutions with systemic risks
Amending the Federal Reserve Act
Creating new rules on executive compensation and corporate governance
Eliminating certain loopholes that led to the 2008 crisis
Thereby ending "too big to fail” and taxpayer bailouts and protecting consumers from abusive financial services practices