H2 b en v samenvatting.docx

# The role and operations of financial intermediaries Financial intermediaries are central to the economy, facilitating the flow of funds between savers and borrowers through a range of core operations and transformations, while also managing inherent risks. ### 1.1 Core activities of financial intermediaries Financial intermediaries (KI) primarily engage in intermediation, using collected deposits and their own borrowed funds to provide credit and invest in the capital market. Their fundamental commodity is money. A key operational requirement is the constant ability to repay deposits. #### 1.1.1 Deposit collection Clients deposit their money with a financial intermediary, yet they remain the legal owners. This allows the intermediary to utilize these funds for its operations. #### 1.1.2 Lending Financial intermediaries utilize deposited funds to extend credit to other clients. #### 1.1.3 Profit generation through interest margin Profit is generated by the difference between the interest charged to borrowers on loans (debit interest) and the interest paid to depositors on their accounts (credit interest). This difference is known as the interest margin. This margin is crucial for covering operational costs such as personnel, taxes, and capital expenses. The interest margin can be expressed as: $$ \text{Interest Margin} = \text{Debit Interest Rate} - \text{Credit Interest Rate} $$ #### 1.1.4 Transformation of deposits Financial intermediaries transform deposits to make them suitable for lending. ##### 1.1.4.1 Scale transformation By pooling numerous small deposits, financial intermediaries can finance larger loans. ##### 1.1.4.2 Maturity transformation This involves financing medium- to long-term loans using short-term deposits. This is a primary source of interest rate risk for financial intermediaries. ##### 1.1.4.3 Currency transformation Deposits in one currency are converted into loans denominated in another currency. > **Tip:** Maturity transformation is a core function of financial intermediaries but also a significant source of risk due to potential mismatches in interest rate movements. ### 1.2 Risks faced by financial intermediaries Financial intermediaries are exposed to several types of risks in their operations. #### 1.2.1 Credit risk This is the risk that a borrower will default on their obligations. Financial intermediaries mitigate this by requiring collateral or guarantees. #### 1.2.2 Interest rate risk This risk arises from changes in interest rates, which can reduce or even negate the interest margin. It is particularly relevant due to maturity transformation. #### 1.2.3 Exchange rate risk This risk is associated with currency transformation, where fluctuations in exchange rates can negatively impact the value of assets or liabilities denominated in foreign currencies. #### 1.2.4 Liquidity risk This is the risk that a large number of depositors may demand their funds simultaneously, leading to a "run on the bank." #### 1.2.5 Market risk This risk pertains to the possibility of a decrease in the value of the investments held by the financial intermediary. ### 1.3 Added value of financial intermediaries Financial intermediaries provide significant value to the economy. * **Economies of scale:** Services can be produced at a lower average cost. * **Cost savings:** They reduce transaction costs and the search costs for individuals and businesses. * **Risk reduction for savers and investors:** Through intermediation, they offer a more diversified and less risky investment avenue compared to direct lending or borrowing. * **Creation of scriptural money:** By accepting client deposits, financial intermediaries contribute to the money supply through the process of fractional reserve banking. #### 1.3.1 Scriptural money creation The extent of scriptural money creation is influenced by the (cash) reserve ratio. Central banks use this ratio to manage the lending capacity of financial intermediaries. A higher reserve ratio leads to less money creation. > **Example:** If a financial intermediary has a reserve ratio of 10 percent, one dollar of initial deposit can lead to the creation of up to 10 dollars in the broader money supply through successive lending. $$ \text{Money Multiplier} = \frac{1}{\text{Reserve Ratio}} $$ ### 1.4 The balance sheet of a bank The balance sheet of a bank illustrates its assets and liabilities. * **Assets (left side):** These represent what the bank owns. * **Liabilities (right side):** These represent what the bank owes to others. * The sum of all assets equals the sum of all liabilities, representing the total balance sheet size. #### 1.4.1 Liabilities Liabilities typically include: * **Equity:** Own capital and reserves. * **Debt capital:** Subordinated debt, bonds, and treasury bills. * **Client deposits:** Funds held on behalf of customers. * **Other sources of funding:** Borrowings from the European Central Bank (ECB), National Bank of Belgium (NBB), or other banks. #### 1.4.2 Assets Assets typically include: * **Fixed assets:** Long-term holdings, potentially including intangible assets like reputation or growth potential. * **Investment portfolio:** Securities purchased with collected funds. This can be further divided into: * **Trading portfolio:** Assets held for short-term sale. * **Available-for-sale:** Assets that can be held until maturity or sold intermediately. * **Loans and advances:** Credit extended to clients. * **Other assets:** Cash, excess cash held at the ECB, and interbank claims. #### 1.4.3 Accessing funds for liquidity deficits Banks facing a liquidity shortage can borrow funds from various sources: * **ECB:** Requires collateral with high creditworthiness. ECB lending policies significantly impact short-term interest rates. The interday credit facility provides short-term loans within the Eurozone. * **NBB (Lender of last resort):** Offers funds at a high debit interest rate through mechanisms like Emergency Liquidity Assistance (ELA), which may be less stringent in its collateral requirements than the ECB. * **Other banks (Interbank market):** Banks lend to and borrow from each other daily. Interbank rates like LIBOR and EURIBOR are key benchmarks. ### 1.5 Intermediation under pressure The traditional role of financial intermediaries is facing challenges from several trends. #### 1.5.1 Industry blurring and de-specialization Various financial players are diversifying their offerings, leading to increased competition. This occurs between: * **Intermediaries themselves:** Driven by economic growth and increased demand for credit and scriptural money. * **Intermediaries and insurance companies:** Through "bancassurance," where intermediaries sell insurance products, act as brokers, or develop their own insurance subsidiaries. Conversely, "assurfinance" sees insurance companies offering banking products. * **Intermediaries and brokerage firms:** Banks offer investment funds and operate in financial markets. #### 1.5.2 Market model shifts The intermediating role is diminishing as savers and businesses increasingly connect directly. For instance, savers might invest directly in stocks rather than depositing funds. This results in fewer deposits for intermediaries and reduced direct lending, although this is often compensated by other business activities. #### 1.5.3 Banking crises Bank failures are closely linked to customer confidence. A mass withdrawal of deposits can force banks to sell assets, potentially leading to liquidity crises and collapse if insufficient. Market crashes and sovereign debt issues can also trigger banking crises. #### 1.5.4 Digitalization Technological innovations have transformed payment systems, securities transactions, insurance claims processing, and financial advice. This has led to job losses as clients increasingly manage their banking needs independently. Challenges for intermediaries include educating clients on technological risks, safeguarding privacy, and managing the costs associated with maintaining digital platforms and a reduced branch network. #### 1.5.5 Branch closures Large banks are closing branches at a faster rate than smaller ones. #### 1.5.6 Corporate Social Responsibility (CSR) The banking sector is expected to prioritize sustainability and social responsibility, focusing on stability, service quality, and healthy profitability. This includes engagement in climate-related investments. #### 1.5.7 Blockchain technology Blockchain is a control system that facilitates transactions between parties without a central intermediary. Based on software and digital tokens, it has the potential to make traditional intermediaries redundant. It offers benefits such as lower costs for cross-border payments and more streamlined securities trading. Cryptocurrencies are a prominent application. #### 1.5.8 Fintech Large technology platforms (e.g., Google, Amazon, Apple) pose a threat by offering payment processing and other banking and insurance services. Collaboration between banks and fintech companies could create a win-win situation, enabling banks to offer new services and fintechs to reach a larger market through bank data. --- # The balance sheet of a bank and sources of liquidity This section details the structure of a bank's balance sheet, distinguishing between assets and liabilities, and explains how banks manage liquidity shortages through various borrowing avenues. ### 2.1 Bank balance sheet structure A bank's balance sheet is divided into two main sides: assets (left side) and liabilities (right side). The sum of all assets and liabilities equals the total balance sheet size. #### 2.1.1 Liabilities Liabilities represent what the bank owes to others and are typically categorized as follows: * **Equity (Eigen vermogen):** This includes the bank's capital and reserves. * **Debt (Vreemd vermogen):** This comprises: * Subordinated debts. * Bonds and treasury bills. * Deposits from clients. * **Other credit sources:** These are funds borrowed by the bank from various institutions when it experiences a liquidity deficit. #### 2.1.2 Assets Assets represent what the bank owns or is owed, including: * **Fixed assets (Vaste activa):** These are assets intended to remain with the bank for the long term. Their value might be an estimation based on factors like reputation, growth potential, or brand value. * **Investment portfolio (Effectenportefeuille):** This includes securities purchased by the bank with funds collected from various sources. It can be further divided into: * **Trading portfolio:** Assets held for quick sale. * **Available-for-sale:** Assets that the bank may hold until maturity but can also sell intermediately. * **Loans (Kredieten):** These are the credits extended by the bank to its clients. * **Other assets:** This category encompasses: * **Cash and cash equivalents (Kasgelden):** Highly liquid investments that can be quickly converted to cash or are readily available. * **Cash surpluses parked with the ECB:** Funds temporarily placed with the European Central Bank. * **Claims on other banks (Interbank claims):** Funds that banks lend to and borrow from each other on the interbank market for their daily operations. > **Tip:** Understanding the composition of both assets and liabilities is crucial for analyzing a bank's financial health and its ability to manage risk. ### 2.2 Managing liquidity deficits and sources of funds Banks must always be prepared to repay customer deposits. When a bank faces a liquidity deficit, meaning it doesn't have enough readily available cash to meet its short-term obligations, it can borrow from several sources: #### 2.2.1 Borrowing from the European Central Bank (ECB) * **Requirements:** Borrowing from the ECB typically requires collateral with high creditworthiness. * **Impact:** The ECB's credit policy significantly influences short-term interest rates. * **Intraday credit facility:** This facility provides credit for a single day within the eurozone, though it has limited facilities. #### 2.2.2 Borrowing from the National Bank of Belgium (NBB) * **Role:** The NBB acts as a "lender of last resort." * **Interest rates:** Borrowing from the NBB often involves a high debit interest rate. * **Emergency Liquidity Assistance (ELA):** The ELA is a facility provided by national central banks to banks facing severe liquidity problems. The NBB is less selective regarding collateral compared to the ECB for ELA. #### 2.2.3 Borrowing from other banks (Interbank market) * **Mechanism:** Banks can lend to and borrow from each other on the interbank market to manage their daily liquidity needs. * **Key rates:** Important interbank rates include LIBOR (London Interbank Offered Rate) and Euribor (Euro Interbank Offered Rate). > **Example:** A bank might experience a temporary liquidity shortfall because a large number of customers decide to withdraw their savings simultaneously. To meet these withdrawal demands, the bank could borrow funds from another bank on the interbank market or use its facilities with the ECB. #### 2.2.4 Liquidity transformation Banks engage in liquidity transformation by financing medium- to long-term loans with short-term deposits. This inherent transformation creates a potential liquidity risk if too many depositors withdraw their funds concurrently. > **Tip:** The "run on the bank" scenario is a direct consequence of liquidity risk, where a loss of confidence leads to mass withdrawals and can quickly deplete a bank's liquid assets. --- # Challenges and evolution in the financial intermediary sector The financial intermediary sector faces significant pressures due to industry blurring, the rise of direct market models, digitalization, and fintech, leading to profound changes in its operational landscape and business strategies. ### 3.1 Industry blurring and despecialization Financial intermediaries (FIs) are increasingly shedding their traditional specializations to pursue income from diverse activities, resulting in heightened competition across different levels of the financial ecosystem. #### 3.1.1 Competition among financial intermediaries Historically, economic growth fostered a greater demand for credit and liquid assets, benefiting FIs. However, as the sector evolves, the lines between different types of FIs blur. #### 3.1.2 Blurring lines between FIs and insurance companies This trend manifests in several ways: * **Bancassurance:** FIs increasingly focus on selling insurance products, either by acting as brokers or through exclusive partnerships with insurers. * **Direct Insurance Operations:** Banks may establish their own insurance subsidiaries to offer insurance products directly. * **Assurfinance:** Insurance companies expand their offerings by including banking products, blurring the distinction from traditional intermediaries. #### 3.1.3 Blurring lines between FIs and stockbroking firms Banks are expanding their operations into financial markets by offering investment funds and other market-related services. ### 3.2 Rise of market models and direct intermediation The traditional role of financial intermediaries is diminishing as savers and businesses increasingly connect directly, bypassing FIs. * **Direct Investment:** Many savers opt to invest their funds directly in stocks rather than depositing them with FIs. * **Consequences:** This shift leads to fewer deposits held by FIs, reduced direct lending to businesses, and a potential decline in the traditional net interest margin. However, FIs often compensate for this through diversification into other revenue streams. ### 3.3 Impact of digitalization and technological innovation Technological advancements have opened up a vast array of new possibilities in financial services, including payment processing, stock transactions, insurance claims handling, and financial advisory services. * **Job displacement:** Digitalization has led to job losses as clients increasingly manage their banking activities independently through digital channels. * **Challenges for FIs:** Banks face significant challenges in adapting to these changes. They must: * Warn clients about the risks associated with new technologies. * Ensure client privacy and protect geographical data without explicit consent. * Streamline their branch networks. * Develop and maintain robust online platforms (apps, websites) for remote banking, acknowledging that each communication channel incurs costs. #### 3.3.1 Branch network rationalization Larger banks are often more aggressive in reducing their physical branch networks compared to smaller institutions. ### 3.4 Blockchain and the potential end of intermediaries Blockchain technology offers a decentralized system for managing transactions between parties without the need for a central intermediary. * **Decentralized nature:** Transactions are managed by software, and a digital token (code) is required. This structure potentially makes traditional FIs redundant. * **Participant involvement:** All connected participants are kept informed and have a say in the transaction process. * **Benefits:** Blockchain can lead to lower costs for cross-border payments, more efficient and streamlined securities trading. * **Application:** Cryptocurrencies are a prominent example of blockchain technology in action. ### 3.5 Fintech and competition from tech giants Large technology platforms such as Google, Amazon, and Apple pose a significant threat to traditional financial intermediaries. * **Expanded services:** Beyond payment processing, these platforms are increasingly offering banking and insurance services. * **Potential for collaboration:** A win-win situation could arise from collaboration, where banks can offer new services to their clients, and fintech companies can leverage bank databases to reach a much larger market. ### 3.6 Corporate social responsibility (CSR) and sustainability The banking sector is increasingly expected to embrace sustainability and social responsibility. This includes a focus on: * **Stability:** Maintaining a stable financial system. * **Service delivery:** Providing reliable and accessible services to clients. * **Healthy profitability:** Ensuring long-term viability through sound financial management. * **Environmental considerations:** FIs are increasingly involved in initiatives such as climate investments. > **Tip:** Understanding the interplay between these forces—industry blurring, market models, digitalization, and fintech—is crucial for grasping the future strategic direction of the financial intermediary sector. > **Example:** A traditional bank that has historically focused solely on lending and deposit-taking might now offer investment advice, insurance products through a subsidiary, and facilitate peer-to-peer lending via a blockchain-based platform to remain competitive. --- # Bank crises and the emergence of blockchain technology Bank crises, rooted in the erosion of customer trust and subsequent liquidity problems, highlight vulnerabilities in traditional financial systems, paving the way for disruptive technologies like blockchain that can potentially disintermediate traditional financial institutions. ### 4.1 The nature of bank crises Bank crises are fundamentally linked to the trust customers place in financial institutions. When this trust erodes, particularly during periods of economic distress, such as a stock market crash or broader economic downturn, customers may initiate a mass withdrawal of their deposits. * **Loss of customer trust:** The primary catalyst for a bank crisis is a widespread loss of confidence in the bank's stability and its ability to safeguard customer funds. * **Liquidity problems:** A "run on the bank" occurs when a significant number of depositors simultaneously attempt to withdraw their funds. This sudden demand for liquidity can overwhelm a bank's reserves, forcing it to sell assets rapidly. * **Asset sales and insolvency:** The forced sale of assets under pressure can lead to substantial losses, especially in a declining market. If the proceeds from asset sales are insufficient to meet withdrawal demands, the bank faces severe liquidity shortages and may ultimately become insolvent. * **Economic downturns:** Bank crises are often exacerbated by or occur during broader economic downturns, such as stock market crashes or recessions, which can trigger a cascade of financial difficulties across the economy. ### 4.2 Blockchain technology as a disruptive force Blockchain technology presents a paradigm shift by offering a decentralized system for managing transactions, potentially rendering traditional financial intermediaries, such as banks, obsolete. * **Decentralized transaction management:** Blockchain acts as a control system that facilitates transactions between multiple parties without the need for a central authority or intermediary. * **Underlying technology:** It is built upon software and relies on digital tokens, which are essentially code, to record and verify transactions. * **Disintermediation of banks:** The inherent nature of blockchain technology allows for direct peer-to-peer transactions, bypassing traditional gatekeepers like banks. * **Transparency and participation:** All participants connected to the blockchain network are kept informed about transactions and have a role in the decision-making process, enhancing transparency and collective oversight. * **Potential benefits:** * **Reduced costs:** Blockchain can significantly lower the costs associated with cross-border payments. * **Increased efficiency:** It can streamline and expedite processes in areas like securities trading. * **Application:** Cryptocurrencies are a prominent application of blockchain technology. > **Tip:** Understanding the fundamental principles of decentralization and immutability in blockchain is crucial for grasping its potential impact on traditional financial services. > **Example:** Imagine sending money to a friend overseas. Traditionally, this involves multiple banks and intermediaries, each adding fees and time delays. With blockchain, a direct, secure transfer could occur with significantly lower costs and faster settlement. --- ## Common mistakes to avoid - Review all topics thoroughly before exams - Pay attention to formulas and key definitions - Practice with examples provided in each section - Don't memorize without understanding the underlying concepts

| Term | Definition | |------|------------| | Financial Intermediary (KI) | An institution that acts as a middleman between savers and borrowers, facilitating the flow of funds in the economy by collecting deposits and providing loans. | | Deposit | Money entrusted to a financial institution by a client, who remains the legal owner of the funds while the institution can use them for lending and investment. | | Credit | A loan of money provided by a financial institution to a borrower, with the expectation of repayment with interest. | | Interest Margin | The profit a financial intermediary makes from the difference between the interest rate charged on loans (debit interest) and the interest rate paid on deposits (credit interest). | | Transformation (Transformatie) | The process by which financial intermediaries convert deposits into forms suitable for lending and investment, encompassing scale, maturity, and currency transformations. | | Scale Transformation (Schaaltransformatie) | The aggregation of many small deposits to enable the provision of larger loans, creating economies of scale for financial intermediaries. | | Maturity Transformation (Looptijdtransformatie/Termijnomzetting) | The practice of financing long-term loans or investments using short-term deposits, a core function that also introduces liquidity risk. | | Currency Transformation (Valutaomzetting/Deviezentransformatie) | The conversion of deposits held in one currency into loans or assets denominated in another currency, essential for international financial operations. | | Credit Risk (Kredietrisico) | The risk that a borrower will default on their loan obligations, leading to financial loss for the lender. Financial intermediaries often mitigate this by requiring collateral. | | Interest Rate Risk (Renterisico) | The risk that changes in interest rates will negatively impact a financial intermediary's profitability, particularly affecting the interest margin due to maturity transformation. | | Exchange Rate Risk (Wisselrisico) | The risk of financial loss due to fluctuations in the exchange rates between different currencies, relevant in currency transformation activities. | | Liquidity Risk (Liquiditeitsrisico) | The risk that a financial institution may not have sufficient liquid assets to meet its immediate obligations, such as a sudden surge in deposit withdrawals (a "run on the bank"). | | Market Risk (Marktrisico) | The risk of losses in the value of a financial institution's investments due to adverse movements in market factors like stock prices or bond yields. | | Added Value of Financial Intermediaries | The benefits financial intermediaries provide to the economy, including economies of scale, cost savings, risk reduction for individuals, and the creation of scriptural money. | | Scriptural Money Creation (Girale geldcreatie) | The process by which financial intermediaries expand the money supply through lending, based on the fractional reserve system and influenced by reserve requirements set by central banks. | | Reserve Ratio (Kasreserve coëfficiënt) | The proportion of a bank's deposits that must be held in reserve and cannot be lent out, a tool used by central banks to control money creation and credit. | | Assets (Activa) | The resources owned by a financial institution, including cash, investments, loans, and fixed assets, listed on the left side of the balance sheet. | | Liabilities (Passiva) | The obligations of a financial institution to external parties, including deposits, debt, and equity, listed on the right side of the balance sheet. | | Equity (Eigen vermogen) | The net worth of a financial institution, representing the owners' stake, comprising capital and reserves. | | Debt (Vreemd vermogen) | Funds borrowed by a financial institution from external sources, such as subordinated debt, bonds, client deposits, and loans from central banks. | | Central Bank (ECB, NBB) | The monetary authority of a region or country responsible for managing currency, money supply, and interest rates. The ECB is the European Central Bank, and the NBB is the National Bank of Belgium. | | Interbank Market (Interbankenmarkt) | The market where financial institutions lend and borrow funds from each other, typically for short-term needs to manage liquidity. | | LIBOR (London Interbank Offered Rate) | A benchmark interest rate that indicates the average rate at which major global banks lend to one another in the international interbank market for short-term loans. | | EURIBOR (Euro Interbank Offered Rate) | An interest rate at which euro interbank term deposits are made between banks in the euro zone. | | Securities Portfolio (Effectenportefeuille) | A collection of financial investments, such as stocks and bonds, held by a financial institution. | | Trading Portfolio | Assets held by a financial institution with the intention of selling them in the short term to profit from price fluctuations. | | Available-for-Sale Securities | Investments that a financial institution may hold until maturity but can also sell before maturity if needed, subject to market conditions. | | Digitalization | The adoption of digital technologies to transform business processes, operations, and customer interactions, significantly impacting the financial sector. | | Blockchain | A distributed, immutable ledger technology that records transactions across many computers, enabling secure and transparent transactions without a central authority. | | Fintech | Financial technology companies that leverage technology to offer financial services, often disrupting traditional banking models with innovative solutions. | | Corporate Social Responsibility (MVO) | A business approach that emphasizes ethical and sustainable practices, aiming to contribute positively to society and the environment. | | Bancassurance | A business model where a bank and an insurance company collaborate, allowing the bank to sell insurance products to its customers, or vice versa (assurfinance). |