Introduction to Financial Intermediaries and Risk

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Chapter 11

• Introduction to Financial Intermediaries and Risk

Presume not that I am the thing I was. - William
Shakespeare
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Financial Innovation

• Creation of new
• Financial instruments
• Markets
• Institutions
• Key to growth in financial services sector

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Common characteristics

• Insurance company and commercial bank?
• Both channel funds from SSUs to DSUs
• Reduce risks/costs associated with borrowing,
  lending, etc.
• Fulfill demand for financial assets/services/
  protection against financial losses

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Types of Risks Facing FIs

• Credit or default risk
• Interest rate risk
• Liquidity risk
• Exchange rate risk

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Financial Assets and Liabilities of Commercial
Banks, June 30, 2001 (in Billions of Dollars)
Totala Percent of Total Assetsa
Financial assets 6,592.2 100.0 Reserves
56.2 .09 Vault cash
37.2 .06 Deposits at the Fed
17.6 .03 Loans 3,899.2 59.0
Business loans 1,462.9 22.2
Mortgages 1,723.1 26.1 Consumer
credit 540.2 8.2 Security
credit 173.0 2.6 U.S. Government
securities 875.5 13.3 Treasury
securities 178.1 2.7
Government agency securities 697.5
10.6 Municipal securities 116.2
1.8 Corporate and foreign bonds 326.1
4.9 Miscellaneous 1,319.4
20 Liabilities 6,503.1 98.8 Checkable
deposits 503.4 7.6 Small time and
savings deposits 2,342.1 35.5 (including
money market and deposit accounts) Large time
deposits 904.8 13.7 Fed funds and
repurchase agreements (net) 823.6 12.5
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Deposit-type Financial Institutions

• Commercial banks
• Savings associations
• Credit unions

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Financial Assets and Liabilities of Commercial
Banks, June 30, 2001 (in Billions of Dollars)
(continued)
aDetials may not sum to totals because of
rounding. bThis item is not proposed as a measure
of capital for use in capital adequacy
analysis. SOURCE Flow of Funds Accounts, Z1,
Second Quarter 2001. Board of Governors of the
Federal Reserve System (September 18, 2001) 69.
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Financial Assets and Liabilities of Savings
Associations, June 30, 2001 (in Billions of
Dollars)
Totala Percent of Total Assetsa
Financial assets 1,273.9 100 Reserves at
the Fed 1.0 lt.1 Checkable
deposits and currency 21.7 1.7 Time
and savings deposits 2.4
.2 Fed funds and repurchase agreements
22.0 1.7 U.S. government securities
158.2 12.4 Municipal securities
4.0 .3 Corporate and foreign bonds
93.1 7.3 Mortgages 751.7
59 Consumer credit 65.3
5.1 Corporate equities 25.6
2.0 Loans and advances 43.8
3.4 Miscellaneous 85.1
6.7 Liabilities 1,241.3 97.4 Deposits
755.5 59.3 Checkable 291.9
22.9 Small time and savings 307.2
24.1 Large time 156.4
12.3 Repurchase agreements 69.5
5.5 Corporate bonds 6.4
.5 Loans and advances 288.1
22.6 Miscellaneous 121.7 9.5 Net
worth (capital) 32.6b 2.6b
aDetials may not sum to totals because of
rounding. bThis item is not proposed as a measure
of capital for use in capital adequacy
analysis. SOURCE Flow of Funds Accounts, Z1,
Second Quarter 2001. Board of Governors of the
Federal Reserve System (September 18, 2001) 73.
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Financial Assets and Liabilities of Credit, June
30, 2001 (in Billions of Dollars)
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Contractual-type Financial Institutions

• Life insurance companies
• Pension funds
• Property and casualty insurance companies

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Financial Assets and Liabilities of Life
Insurance Companies, June 30, 2001 (in Billions
of Dollars)
Totala Percent of Total Assetsa
Financial assets 3,223.6 100 Checkable
deposits and currency and money market fund
shares 216.9 6.7 Corporate and foreign
bonds 1,280.3 39.7 Corporate equities
955.1 29.6 U.S. government
securities 297.7
9.2 Mortgages 236.1 7.3 Policy
loans 103.1 3.2 Mutual fund
shares 46.1 1.4 Open market
paper 53.5 1.7 Miscellaneous
29.6
.9 Liabilities 3,006.2 93.3 Life
insurance reserves 807.5 25.0 Pension
fund reserves 1,405.1 43.6 Miscellaneous
791.7 24.6 Net worth (capital)
217.4 6.7b
aDetials may not sum to totals because of
rounding. bThis item is not proposed as a measure
of capital for use in capital adequacy
analysis. SOURCE Flow of Funds Accounts, Z1,
Second Quarter 2001. Board of Governors of the
Federal Reserve System (September 18, 2001) 75.
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Financial Assets and Liabilities of Public and
Private Funds, June 30, 2001 (in Billions of
Dollars)
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Financial Assets and Liabilities of Property and
Casualty Companies, June 30, 2001 (in Billions of
Dollars)
Totala Percent of Total Assetsa
Financial assets 866.1 100 Checkable
deposits and currency, and repurchase
agreements 4.5 Corporate
equities 38.6 21.3 Municipal
securities 184.7 21.5 U.S. government
securities 186.1 15.2 Corporate and foreign
bonds 191.2 22 Trade receivables
68.6 7.9 Miscellaneous 63.7
7.4 Liabilities 572.3 66.1b Net
worth 293.7 33.9b
aDetials may not sum to totals because of
rounding. bThis item is not proposed as a measure
of capital for use in capital adequacy
analysis. SOURCE Flow of Funds Accounts, Z1,
Second Quarter 2001. Board of Governors of the
Federal Reserve System (September 18, 2001) 75.
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Investment-type Financial Institutions

• Mutual funds
• Money market mutual funds

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Financial Assets and Liabilities of Mutual Funds
and Money Market Mutual Funds, June 30, 2001 (in
Billions of Dollars)
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Financial Assets and Liabilities of Money Market
Mutual Funds, June 30, 2001 (in Billions of
Dollars) (continued)
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Finance Company-type Financial Institutions

• Finance Companies
• Consumer
• Business-related

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Financial Assets and Liabilities of Finance
Companies, June 30, 2001 (in Billions of Dollars)
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Total Financial Assets of Principal FIs (in
Billions of Dollars)
1970 1984 1991 1998
2001 Deposit-type Commercial
banks 505 1,951 3,414.4 5,635.5 6,592.2
Savings associations 252 1,180 1,144.9
1,088.1 1,273.9 Credit unions 18
116 240.0 394.5 476.2 Contractual-t
ype Life insurance companies 201 697
1,499.5 2,819.5 3,233.6 Property and
casualty companies 50 251 575.8
884.0 866.1 Pension funds 170 1,211
1,892.1 6,675.3 6,651.8 Investment-type
Mutual funds 47 368 840.7 3,626.1
4,269.9 Money market mutual fund
535.0 1,334.2 2,014.8
Figures for 2001 are as of June 30,
2001. SOURCE Figures for 1970 are from the
Annual Statistical Digest, Federal Reserve Board,
1991, various pages. Figures for 1984 and 1990
are from the Flow of Funds Accounts, Z1, Fourth
Quarters, 1984, 1990,. 1998. Figures for 2001 are
from the Flow of Funds Accounts, Z1, Second
Quarter, 2001, various pages.
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Differentiation among Financial Institutions

• Financial services provided
• Composition of balance sheets
• Examples
• SLs specialize in mortgage lending due to tax
  and competitive advantages
• Tax-exempt FIs do not hold tax-exempt securities
• Life insurance companies hold more long-term/
  less liquid securities since able to predict
  outflows
• Banks prohibited from holding corporate equities

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Gramm-Leach-Bliley Act, 1999

• Repealed Glass Steagall Act of 1933
• Removed barriers between banks and other
  financial services