FINCANCIAL SYSTEMS, FUNCTIONS AND SYSTEMIC RISKS
Lecture 14
GENERAL SYSTEMS OF CORPORATE GOVERNANCEModel 1. Shareholder value
Model 2. Stakeholder value
Equity Market
Board
BusinessEmployees Creditors
CustomersState
Suppliers
Salary
Labour
Credit
Interest rate
Tax, fees
Laws, directives, enforcement
Payment
InputsGoods, services
Payment
Monitoring
Other shareholders Annual reports
Long-term active shareholders, consultation, board representation
Institutional passive s.h.
Voting power
Dividens
Model for shareholder value
Model for stakeholder value
Priority Profit before responsibility
Responsibility, then profit
View on organisation
Instrumental Cooperation, a set of contracts
Objective of organisation
To serve the interest of the shareholders
To serve the interests of all partners involved in the business activity
Measure of success
Stock price and dividends
Content among all interest groups
Largest issue Getting management to act in the interest of the shareholders
To balance between various interest groups
Execution of corporate control
Independent external actors with shares
Representation of various interest groups
Acting of interest groups
Instrument (means) Target and instrument
Utility in society
To achieve economic efficiency by focusing on self-interest
To achieve economic gains by focusing on cooperation
Social respons-ibility
Individual matter, not an organisational (firm) issue
Both an individual and organisational issue
FINANCIAL SYSTEMS
Market-based systemControl-oriented system
FINANCIAL SYSTEMSMarket-based (US, UK)
Control-oriented (Europa, Asia)
Ownership and control
Dispersed ownership Controlling
blocks
Protection for minority shareholders
Strong Weak
Board Potentially independent
Close to controlling owner
Management Strong independence
Close to contr. owner
Bank relationships
Arm-lengths distance, no ownership
Close, possibly ownership
Management incentives
Central, strong Less central, somet. weak
Capital structure
Low debt/equity High debt/equity
Market for control
Hostile takeovers
Less hostile takeovers
SIX FUNCTIONS OF A FINANCIAL SYSTEMA. Providing ways of clearing and setting
payments to facilitate the exchange of goods, services and assets.
B. Providing a mechanism for the pooling of funds to undertake large-scale enterprise or for the subdividing of shares in enterprises to facilitate diversification.
C. Providing ways to transfer economic resources through time, across geographic regions, and among industries.
MORE FUNCTIONS…
A. Providing ways to manage uncertainty and control risk.
B. Providing price information that helps coordinate decentralized decision-making in various sectors of the economy.
C. Providing ways to deal with the incentive problems when one party to a financial transaction has information that the other party does not have, or when one party is an agent for another.
2004199819951978
2007 19641992 19581987 1994 19511979 1991 19491974 1976 19461973 1972 1941 20061962 1969 1940 19971961 1967 1935 19891957 1965 1933 19851956 1960 1928 1980
1990 1955 1953 1927 19751970 2001 1948 1945 1926 1971 20051966 2000 1947 1944 1925 1963 20031939 1984 1937 1943 1924 1950 19961932 1977 1923 1942 1918 1934 1982 1959 1993
2002 1921 1952 1922 1938 1910 1916 1968 1936 1988 19991931 1920 1930 1913 1929 1907 1915 1954 1911 1986 1983
2008 1914 1919 1908 1903 1912 1904 1906 1917 1909 1981 1905-51-40% -31-40% -21-30% -11-20% -0-10% +0-10% +11-20% +21-30% +31-40% +41-50% +51-60% +61%-
65 % positive yearsBest decades:
40-, 80- and 90th
35 % negative yearsWorst decades:
30-, 70- and 00th
2008 worst year ever: -42 %
SYSTEMIC RISK, FOCUS ON NEGATIVE EXTERNALITIES
Systemic risk is something that is built up before a crash. It signifies the danger of the system-wide contagion of the crisis.
Systemic risk is the very spread of financial fragility and financial distress within the system of finance.
System risk can be defined as negative externalities occurring when one actor takes a risk that causes a further risk for others in the financial system.
FOCUS ON LIQUIDITY RISK
A demand for central bank money and other liquid and safe investments exceeding supply.
A rapid reduction in the loan volume built up during the boom.
A situation where a borrower has previously been able to borrow without difficulty, now can not borrow at all, regardless of condition.
CONTINUING…
A forced sale of assets when liquidity is tight, which in turn further lowers the price of assets - the bubble burst.
A rapid decrease in the value of bank assets, leading to uncertainty about the value of the bank, bank runs and ultimately to the insolvency and bankruptcy of many banks.
EX POST EXPLANATION TO SYSTEMIC RISK
A systemic risk is the risk or probability of a collapse of the entire financial system as opposed to problems in its parts.
The systemic risk is indicated by the different elements in the system moving together, and that the correlation between different assets increases.
FOCUS ON FINANCIAL INSTABILITY (MINSKY)
The financial institutions and the functioning of the market change both as a result of market forces and because of practices and legislation. For this reason, the development of various financial variables will differ over a long phase of expansion in relation to the experience of the average business cycle.
The changes in the financial structure over a long period of growth allows the financial panic which then erupts.
CONTINUING…
An element in the development of a financially unstable financial system is a marked increase in total assets relative to income and capital.
Disturbances in the financial system are caused both by the system's own characteristics and the errors that people make. Once a strong reaction set in on the financial markets, after a long expansion, the shortcomings of its institutions quickly become apparent.
Bubble burst
Debt crisis and new structure
Increasing
demand
Financial muscles
Institu-tional clash
Idle capital
Debt accumula-
tion
Banking Crisis Cycle
WHAT HAVE WE LEARN TODAY?