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Non-Banking Financial Intermediaries

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  • Hello.AM john and in Kenya.Am still in college and have done lots of research and found out all the tactics of starting a NBFIs here in the country. After evaluation its much workable, yet i don't have the fund. How can you help please.
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  • 1. NBFI and Securities Market Institutions
    • Nonbank Financial Intermediaries (NBFI) -- Financial Intermediaries other than banks.
    • Experiences same fundamental “nightmares” as banks.
    • Also covers Securities Market Institutions (e.g. investment banks)
    • Less regulated than banks
      • better able to handle problems?
      • disadvantages of not being banks (investment banks)
  • 2. Securities Market Institutions
    • Investment Banks -- buy and sell securities on the primary market
    • Profits come from underwriting -- buying the entire issue then selling it in the market when they choose
  • 3.
    • Securities Brokers and Dealers -- conduct trading in the secondary market
    • Brokers -- arrange sales between buyers and sellers
    • Dealers -- “play the market” with bonds as well as stock
  • 4.
    • Brokerage Firms -- engage in investment banking, brokering, and dealing
  • 5. The Securities Industry Versus the Banking Industry
    • The Glass-Steagall Act (1933) -- separation of banking industry from the securities industry
  • 6. Arguments to Repeal Glass-Steagall
    • Brokerage firms have invaded banking industry with “bank-type” accounts (MMMFs, Cash Management Accounts).
    • Benefits from increased competition.
    • Financial markets are more sophisticated and liquid today.
  • 7. Arguments to Keep Glass-Steagall
    • Banks would have unfair advantage -- FDIC.
    • Securities market activity is risky, could mean significant losses for banks.
    • Potential conflicts of interest between banking department and securities department
  • 8. Financial Services in the Post Glass-Steagall Era
    • 2000 -- Repeal of the Glass-Steagall Act.
    • Some large banks merging with securities market institutions to increase economies of scale (e.g. Chase and J.P. Morgan).
    • In general much more overlap between banks and securities market institutions.
  • 9. Nonbank Financial Intermediaries
    • Structured as a financial intermediary – pooling small savers’ funds (liabilities) to make large loans to borrowers (assets).
    • Makes profits off the difference in liquidity and default risk between their assets and liabilities.
    • Can experience the “bank nightmares” of disintermeidation and loan default.
  • 10. Insurance Companies
    • Life Insurance Companies
    • -- Assets : Corporate Bonds,
    • Commercial Mortgages, Stock
    • -- Liabilities : promised payouts
    • upon death
  • 11.
    • Property and Casualty Insurance Companies
    • -- Assets : Municipal Bonds,
    • Treasury Bonds, Corporate
    • Bonds, Stock
    • -- Liabilities : promised payouts
    • upon fire, accidents, etc.
  • 12. Pension Funds
    • Assets : different types of Bonds or Stocks
    • Liabilities : promised payouts upon retirement
  • 13. Defined Contribution Pensions
    • Defined Contribution Pensions -- Employee contributes amounts over his/her working years to an identified fund, with possibly employer contributions as well. Upon retirement or leaving the firm, employee receives the fund. Taxes are typically deferred until the fund is withdrawn from.
  • 14. Examples of Defined Contribution Pensions
    • Individual Retirement Accounts (IRAs) -- Classic IRAs and Roth IRAs
    • Keough Plans -- Self-Employed individuals
    • 401(k) Plans (and 403(b) Plans) -- increasing in frequency
  • 15. Defined Benefit Pensions
    • Defined Benefit Pensions -- Employee does not contribute over his/her working years, is promised a fixed monthly payment upon retirement.
  • 16. Characteristics of Defined Benefit Plans
    • Vesting -- How long the employee has to work at the firm to be eligible for pension.
  • 17.
    • Fully Funded Versus Underfunded
    • -- Fully Funded : employer
    • contributions plus returns fully
    • cover promised benefits
    • -- Underfunded : employer
    • contributions plus returns do not
    • cover promised benefits
  • 18. Employee Retirement Income Security Act (ERISA)
    • Regulates Pensions
    • -- degree of underfunding
    • -- how pension is invested
    • -- reporting and examination
    • Creation of Pension Benefit Guarantee Corporation -- pension insurance
  • 19. Examples of Defined Benefit Pensions
    • Some Corporate, Federal and State and Local Government Pension Plans
    • Social Security -- “pay as you go” plan
  • 20. The Trend Toward Defined Contribution Pensions
    • Employers moving away from defined benefit to defined contribution plans, largely for convenience.
    • To the employee – potential losses and (big) wins.
    • Will it affect the retirement decision of individuals?
  • 21. Finance Companies
    • Assets -- Consumer loans
    • Liabilities -- (their own) Commercial Paper, Stock, and Corporate Bonds
    • Not subject to bank regulation
    • Not eligible for Discount Window
  • 22. Mutual Funds
    • Assets -- bonds, stocks, as advertised in prospectus
    • Liabilities -- mutual fund shares
    • Regulated by Securities Exchange Commission (SEC)
    • Some have insurance against dishonest practices (SIPC), most are not insured.
  • 23. Mutual Funds
    • Can offer unique features based upon characteristics of asset portfolio
    • Tax-exempt mutual funds
    • Checkability and money market mutual funds (MMMF)
  • 24. Subprime Mortgages, NBFI, and Investment Banks
    • Large amount of high default risk mortgage-backed securities (MBS) held by investment banks and other NBFI.
    • Defaults in MBS adversely affects entire industry
    • 2008 – collapse of Bear Stearns, Lehman Brothers (investment banks), and AIG (insurance company).
  • 25. The Federal Reserve, Financial Firms,and the Credit Crunch
    • 2008 – established a lending service between the Fed, investment banks, and some other nonbanks -- analogous to the Discount Window.
    • Arrangement of mergers with some investment banks with banks (e.g. Bear Stearns and Chase-JP Morgan)
    • Bailout of AIG, Fannie Mae, and Freddie Mac.
    • Granted bank holding company status to some NBFI (GMAC) and investment banks (Goldman Sachs, Morgan Stanley)
  • 26. Underlying Issues: The Credit Crunch
    • Bailouts -- necessary or increasing Moral Hazard/Adverse Selection?
    • Consistency in response – Bear Stearns versus Lehman Brothers.
    • The end of stand-alone investment banks?
    • Where is the SEC?
    • Harsher regulations after the crisis passes for banks and others (like FIRREA)?
    • Possibly other players entering banking?
    • Time for a totally revamped regulatory structure for banking, NBFI, and securities market institutions?

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