Managing Financial Institutions

Markets and Sustainable Finance

Elizabeth S. Cooperman

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317480136
• Edition: 1
• Topic: Commerce
• Subtopic: Finances d'entreprise

This book goes beyond traditional financial institutions textbooks, which tend to focus on mathematical models for risk management and the technical aspects of measuring and managing risk.It focuses on the role of financial institutions in promoting social and economic goals for the communities in which they operate for the greater good, while also meeting financial and competitive challenges, and managing risks.

Cooperman divides the text into seven easily teachable modules that examine the real issues and challenges that managers of financial institutions face. These include the transformative changes presented by social unrest, climate change and resource challenges, as well as the changes in how financial institutions operate in light of the opportunities that rapid innovations and disruptive technologies offer. The book features:

• Up-to-date coverage of new regulations affecting financial institutions, such as Dodd Frank and new SEC regulations.
• Material on project financing and new forms of financing, including crowd funding and new methods of payment for financial institutions.
• New sustainable finance models and strategies that incorporate environmental, social, and corporate governance considerations.
• A new chapter on sustainable financial institutions, social activism, the greening of finance, and socially responsible investing.

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Practical cases focusing on sustainability give readers insight into the socioeconomic risks associated with climate change. Streamlined and accessible, Managing Financial Institutions will appeal to students of financial institutions and markets, risk management, and banking. A companion website, featuring PowerPoint slides, an Instructor's Manual, and additional cases, is also available.

Part One
Overview

Financial Services Industry and Its Environment

Module I The Financial Services Industry: Today and the Future

Chapter 1 Financial Institutions as Social Value Creators and Financial Risk Takers

Module II Financial Markets, Interest Rates, and Their Regulatory Environment

Chapter 2 Interest Rates: Theories and Duration as an Overall Risk Measure

Chapter 3 The New Regulatory Environment and the Regulatory Dialectic

Chapter 1
Financial Institutions as Social Value Creators and Financial Risk Takers

At its most basic definition, finance is the act of allocating capital to individuals and businesses that want to make productive use of it. In short finance creates social value.

(University of California, Haas School of Business Center for Responsible Business website)

Sustainable finance refers to any form of financial service integrating environmental, social and governance (ESG) criteria into the business or investment decisions for the lasting benefit of both clients and society at large.

(Swiss Sustainable Finance website)

WHEN financial markets and institutions are working well, they create social value by providing funds to businesses and individuals that these borrowers in turn can use for productive purposes. Financial institutions, for instance, often provide guidance and financing for small as well as medium-sized, and large businesses. Individuals can borrow from banks and savings associations to purchase homes they would otherwise never be able to afford. Consumers can also invest with mutual funds to save for dream retirements, their children’s future college tuition, and other future goals. Without financial institutions, these dreams likely would not be possible. Similarly, businesses are able to engage in capital expenditures through financing by financial institutions, leading to greater hiring, that in turn increases employment in communities. Many banks are chartered to serve their communities and provide community outreach services as well. Venture capital and private equity firms provide financing for new innovations, such as the development of disruptive technologies to help solve environmental challenges. Hence, financial institutions stimulate growth and job creation and assist in financing technological innovations to help solve social and environmental problems in an economy.

However, if financial institution managers engage in practices only for their own benefit at the expense of their customers and stakeholders, or if they fail to understand the implications of risky business practices, great harm can be done that can lead to home foreclosures, business bankruptcies, job loss, and economic recessions, such as the U.S. subprime loan crisis and the great global recession.

Well-functioning financial institutions (FIs) are essential for economic growth, while poorly functioning FIs can contribute to economic losses, leading to poverty in developing countries. Central banks also depend on financial markets and institutions for their monetary policy operations to stimulate or cool down economies and to help control inflation or prevent deflation.

This chapter provides an overview of the different types of financial institutions, how they differ from nonfinancial firms, and the special types of risks they face. The chapter also discusses how FIs make profits, and the challenges of financial institutions to balance differing goals for different stakeholders including stockholders, customers, and regulators, as well as meeting environmental, social, and corporate governance (ESG) goals.

What Do Financial Institutions Do?

In the 21st century, we often take for granted the services provided by financial services firms, including checking accounts, online banking, debit and credit cards, home mortgages, car loans, business loans, life, health, auto, insurance, and investment and mutual funds. Financial institutions also provide financial planning, wealth management, and business working capital management and payment services. Likely you have relationships with at least three or more financial institutions or with a single large financial holding company that offers a variety of different types of financial services.

Financial institutions, as financial intermediaries, provide indirect financing, where they create indirect securities that have more desirable characteristics for borrowers and lenders (savers) than direct securities or loans exchanged directly between savers and borrowers. They also provide economic functions making an economy more efficient, such as liquidity, maturity, denomination, search, monitoring, and information financial intermediation benefits.

For example, banks, savings institutions, and credit unions (depository institutions) take in deposits from small savers (providing liquidity with checking, debit, credit card accounts) and pool deposits to make consumer, business, real estate, and agriculture loans to borrowers that desire longer maturities.

Such indirect financing provides advantages over direct finance (transactions directly between savers and borrowers) by reducing information, search, and monitoring costs, as well as providing lower costs and more efficient operations through economies of scale (cost advantages with a greater output and scale of operations) and a greater variety of financial services and products through economies of scope (with interrelationships and functional expertise allowing cross-selling of products). Financial institutions also provide convenience benefits with neighborhood branches, online banking services, branches, and debit and credit cards, mobile payments for transactions, and expertise, and working capital management and other special payment and certification and credit services.

Other types of financial institutions, such as mutual funds and wealth management firms allow savers advantages in terms of diversification, portfolio selection, investment screening, and risk management services. Mutual funds allow small savers to invest in diversified portfolios, managed by experienced portfolio managers at low costs. Socially responsible investment (SRI) funds in addition supply screening services for investors with portfolio selection on desired environmental or social or governance criteria. Investors can select different types of mutual funds based on their particular investment goals, maturity preference, and risk tolerance.

Investment and securities firms provide expertise and risk management as portfolio and wealth managers. By doing so, these firms reduce risk management costs. Large banks and investment banks also provide risk management services. This includes providing letters of credit that guarantee payment by other parties, facilitating trade transactions between different parties, such as importers and exporters, to reduce or eliminate the default risk between the parties. Other services include helping companies to hedge risks using derivatives (swaps, forward contracts, caps and floors based on future price movements of underlying instruments) against credit, interest rate, and foreign exchange risk, as well as assisting new businesses to raise capital, through initial public offerings, and later through secondary offerings and small business loans.

Contractual financial institutions (such as insurance companies and pension funds that involve long-term contracts) take on specialized investment, maturity intermediation, and risk management services. Insurance companies pool premiums from thousands of individuals and businesses as secondary securities (policyholder reserves) that they invest in intermediate-term and long-term securities providing income and capital gains to fund contingent future payouts to these policyholders in the event of property damage, theft, or loss of life. With the pooling of premiums of a large number of customers, insurance companies are able to provide risk management services at a much lower cost than if consumers or businesses had to save funds on their own to meet these contingencies.

Pension funds, as well as mutual fun...