Introduction to Banking

and Finance
Guy Hargreaves
ACE-102
Course goals
Understand the role of financial markets and financial
intermediaries
Develop a sound understanding of the banking
business
Understand the importance of regulation in the
financial sector
Understand the crucial role of central banks in the
financial sector

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Course Coverage
Motivation for the existence of financial markets and financial
intermediaries
Main types of financial instruments, financial markets and
financial intermediaries
Financial market pricing and efficiency
Unique characteristics of banks and recent developments in the
banking sector
Financial crises and contagion risk for the real economy
Regulation in the financial sector: motivation and recent
developments
Theory of central banking: monetary policy, supervision and
lender of last resort
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About.me
25 year of experience Investment and Corporate
Banking in Asia Pacific region
Kiwi living in Hong Kong with wife and three children
My goal: deliver academic based introduction to
banking and finance from the perspective of a highly
experienced practitioner
=> please feel free to ask questions at any time

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Structure and assessment
Text: Introduction to Banking; Casu, Girardone
& Molyneux

3 x 50 min lectures Mon-Fri 8.30-11.30am

1 x 50 min tutorial Mon-Fri 2.30-3.30pm

Exam: 2 hours on Friday, 22nd May

 multiple choice questions + short questions + short essay
 100% of final mark

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Overview of financial intermediation
and the global financial system
Today’s goals
Understand the fundamental principles of financial intermediation
Explain “financial claims” and distinguish between marketable and
non-marketable financial claims
Identify various financial markets, and banking and non-banking
financial intermediaries
Distinguish between deposit-taking and non-deposit-taking
financial intermediaries
Understand banking versus shadow banking markets
Explain the functions and characteristics of money and monetary
bases
Explain the importance of market liquidity to the operation of the
global economy

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Financial Assets
An asset is any “property” of value held or owned by
an individual or company
A Financial Asset can be thought of as financial
property eg:
 Cash (money) in your wallet
 Deposit with a bank
 Corporate bond
 Common share of a company

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Financial System
The typical components of any financial system:
1. Financial Assets
2. Borrowers and Savers of financial assets
3. Financial Intermediaries
4. Central Bank regulators (set and manage the rules of the
financial system)
Financial systems exist within individual countries
which have their own currency
Currency blocks (eg Euro) can have common
components (eg European Central Bank)

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Financial Intermediation
Two fundamental parties to any financial system:
1. Borrowers (deficit units)
2. Savers (surplus units)
 Financial Intermediation is conducted by third
parties who take deposits from Savers and make
loans with those deposits to Borrowers
 Financial intermediation increases economic
efficiency by offering valuable transformative
services to both Borrowers and Savers

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Intermediation…

…versus Direct Finance

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Financial Claims
Financial Claims are contractual obligations created
when a Borrower accepts money from a Saver (or
Lender)
 Obligation to pay that money back at some time in the future
 Obligation to pay interest or a return on that money
 Can be Secured or Unsecured by other assets

Holder of financial claim has a Financial Asset

Grantor of financial claim has a Financial Liability

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Marketability
Financial Claims are said to be marketable if a holder can
efficiently sell (transfer) the claim to a third party eg:
 Commercial Paper (CP)
 Bonds

 Shares

 Asset Backed Securities (ABS)

Financial Claims are said to be non-marketable if a holder

can not efficiently sell (transfer) the claim to a third party
eg:
 Structured Project Finance Loan
 Insurance Policy

 Bank deposit

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Major world financial systems
Country Currency Central Bank Major Banks (sample)
China RMB PBOC BOC, ABC, ICBC, CCB
USA USD Federal Reserve Citi, JP Morgan, BAML
EU EUR ECB Deutsche, SG, BNP
UK GBP BOE Barclays, RBS, Lloyds
Australia AUD RBA ANZ, CBA, Westpac, NAB
Canada CAD BOC RBC, CIBC, TD, BNS, BMO
Hong Kong HKD HKMA HSBC, Stan Chart

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Types of financial intermediaries
Intermediaries are either:
 Regulated licensed banks or building societies etc
 Non bank financial institutions (NBFIs)

Regulated banks are typically:

 Retail Commercial Banks
 Wholesale Commercial Banks
 Universal Banks

“Deposit-Taking Institutions” – eg banks

“Non-Deposit-Taking Institutions – eg insurance
companies

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Types of financial intermediaries
Non Bank Financial Institutions are typically:
 Investment Banks
 Insurance Companies
 Pension / Mutual Funds
 Private Equity Funds
 Hedge Funds
 Venture Capital Funds
 Securitised Lenders

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Building Societies
Member based mutual (cooperative) organisations
Operate at “retail level”
Mortgage and savings product focused
Mostly unlisted
Smaller balance sheets, regional
 Nationwide Building Society (UK)
 Yorkshire Building Society (UK)
 IMB (Australia)

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Retail Commercial Banks
Limited liability corporate organisations
Primary focus at “retail level”
Mortgage and savings products
Mostly listed
Medium sized balance sheets
Large number of smaller customers

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Wholesale Commercial Banks
Limited liability corporate organisations
Primary focus at “wholesale or corporate level”
Corporate loans
All listed
Large sized balance sheets
Smaller number of larger customers

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Universal Banks
Limited liability corporate organisations
Focus at “retail and wholesale / corporate level”
Retail banking, corporate and Capital Markets
products
All listed
Large sized balance sheets
Large number of large and small customers

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Investment Banks
Partnerships or limited liability corporate
organisations
Focus at “wholesale / corporate level”
Capital Markets products
Listed and unlisted
Volatile balance sheets
Smaller number of large customers

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Insurance Companies
Mutuals or limited liability corporate organisations
Focus at “retail and wholesale / corporate level”
Premium based risk management products
Listed typically
Large off-balance sheet exposures

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Pension / Mutual Funds
Trust based corporate organisations
Focus at “retail and wholesale / corporate level”
Investment management products
Listed and unlisted
Limited to no leverage

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Hedge / Private Equity Funds
Trust based corporate organisations
Focus at “wholesale / corporate level”
Investment management products
Target absolute returns
High potential leverage

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Venture Capital Funds
Trust based corporate organisations
Focus at “wholesale / corporate level”
Investing in startup or early stage companies
Target absolute returns
Zero leverage

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Securitised Lenders
Trust based corporate organisations
Focus at “retail and wholesale / corporate level”
Originating and funding portfolios of financial assets
Highly structured Special Purpose Companies
High leverage

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Shadow banking
The term Shadow Banking has been used in the past
5-10 years to describe a banking-like system of
financial intermediation conducted by NBFIs
As a result it is largely unregulated and is considered
to have contributed significantly to the 2007-9 GFC
Post 2007-9 GFC shadow banking closed down but in
recent years it is re-emerging in the form of P2P
lending, crowdfunding and private equity

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Financial markets
“Places or platforms” where financial assets are bought
and sold
 Electronic or “over-the-counter” (OTC)
 Open outcry exchanges are almost things of the past (eg

futures pits)
Most significant financial markets conduct trade in:
 Securities (shares and bonds eg NYSE, Nasdaq)
 Futures and derivatives (eg Chicago Mercantile Exchange /

Chicago Board of Trade)

 Foreign exchange (largest cash market of them all)
 Commodities (much of the physical trade is OTC)

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Financial market regulation
Everywhere there is a financial market there is usually
a regulator establishing and monitoring the rules
governing that market
 China – CSRC oversees securities markets
 US – SEC oversees US security markets
 UK – FSA
 Australia – ASIC

Regulators aim to ensure markets are fair and orderly

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Information Asymmetry
Financial market participants often have varying levels
of information –> Information Asymmetry
1. Some players have differing information
2. Some players have Inside Information
3. All players have imperfect information
 Inside Information is usually gained from private
sources and is usually illegal to trade from (insider
trading)
 A key regulatory task is to prevent insider trading

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Global financial markets
In 2015 most financial markets attract participants
from all over the world ie they are global in nature eg:
 Gold derivatives traded in USD by most global players
 AUD corporate bonds can be held by most global investors

but more interest generally shown by Australian investors

 Shares traded on NYSE by investors on all continents

Some markets have restrictions such that many global

players can not access them -> localised pricing and
trading
Many markets are highly correlated with each other

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Financial market liquidity
Market liquidity impacts a participant’s ability to:
1. Transact in a market at their time of choosing
2. Transact volume of choosing
3. Minimise transaction costs
Increasing market liquidity grows volumes while
lowering per unit transactions costs
=> Increased economic efficiency

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The history of money
Before “money”, market participants used the Barter System:
 Participants exchange goods and services directly for other goods and
services
 Very inefficient because of high transactions costs, lack of price

transparency, minimal standardisation and costly/difficult to store

wealth
“Commodity Money”, a fixed weight of grain, was used by the
Mesopotamians some 3,000 BC
Commodity money was replaced by gold and silver, and
eventually by banknotes (first used in China during the Song
Dynasty circa 1,000 AD)
Today we may be standing at the dawn of Cryptocurrency

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The uses of money
Medium of exchange – widely accepted as payment for
goods and services
Medium of valuation – widely accepted as method of
“relative” valuation of goods and services
Store of value – confidence that participants can hold
money into the future to pay for goods and services in
a predictable way
Standard of Deferred Payment - goods and services
consumed now can be paid for in the future with
money
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The properties of money
To be a viable medium of exchange a monetary asset
needs various qualities:
1. Acceptable to participants
2. Standardized quality
3. Durable
4. Valuable relative to its weight ie efficient to use
5. Divisible to accommodate various prices of goods and
services

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Money of today
Governments around the globe today issue banknotes
and coins which derive value by government order or
“Fiat”
Governments decree by law that all public and private
financial liabilities can be repaid by this “Fiat” money
– designating it as “legal tender”
The right to issue (or print) money comes with
responsibility. Printing excessive banknotes or
expanding the Money Supply can cause inflation and
lead to collapse in trust in that money

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Yes, Zimbabwe?
Zimbabwean dollar was the official currency from 1980 to
2009, when it was abandoned
Following a period of hyperinflation the currency was
redenominated on three occasions from 2006
When abandoned the $Z had been redenominated by 10^25!

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Money Supply
Monetary aggregates are measures of the quantity of
money in circulation – typically broader than simply
banknotes and coins:
 M1 is defined as banknotes, coins and on-call deposits
 M2 is defined as M1 + most term deposits

M1 and M2 is carefully watched by many markets to

monitor government trustworthiness!

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