Inhoud
International Financial markets .............................................................................................................. 3
Lecture 1: Introduction ....................................................................................................................... 3
The Financial System ...................................................................................................................... 3
Allen & Gale (1999) ........................................................................................................................ 7
Lecture 2: European financial markets ............................................................................................... 9
Introduction ................................................................................................................................... 9
European financial integration within EMU ................................................................................. 10
Macroeconomic imbalances and EMU crisis ................................................................................ 12
Policy reactions and shift to market-based finance ...................................................................... 15
Post-EMU crisis: persisting macroeconomic imbalances .............................................................. 16
Lecture 3: Financial Structure and Economic Performance .............................................................. 17
Dolar Meh (2002) - Financial systems generate economic growth............................................... 17
De Haas & Popov Paper - Case Study: Green Abilities .................................................................. 20
Lecture 4: Financial Innovation ........................................................................................................ 24
Application 1: ABS, CDO, and securitization (products) ................................................................ 24
Application 2: Coco’s (Contingent convertible bonds) ................................................................. 28
Application 3: CCP’s (Infrastructure) ............................................................................................ 29
Application 4: Modern Monetary Theory (paradigm .................................................................... 29
Lecture 5: Financial Innovation II...................................................................................................... 31
Blockchains ................................................................................................................................... 31
Cryptoassets ................................................................................................................................. 31
Smart Contracts ............................................................................................................................ 34
Lecture 6: Macro- and micro-economic causes of the financial crisis (2008) ................................... 37
Macroeconomic causes ................................................................................................................ 38
Microeconomic causes ................................................................................................................. 42
Lecture 7: Policy reactions in Europe after the global financial crisis: monetary policy ................... 44
Immediate reaction following onset of credit crisis ..................................................................... 46
Changes in monetary policy ......................................................................................................... 47
ECB’s response to the coronavirus pandemic............................................................................... 52
Lecture 8: The Role of Collateral ...................................................................................................... 54
Lecture 9: Policy reactions in Europe after the global financial crisis: micro- and Rationale for
government intervention ................................................................................................................. 60
Macroeconomic causes ................................................................................................................ 60
Microprudential regulation & supervision ................................................................................... 62
, Financial stability and macroprudential supervision .................................................................... 67
Crisis management and resolution ............................................................................................... 70
Lecture 10: ESG and Climate Finance ............................................................................................... 72
Busch et al. (2021) ........................................................................................................................ 73
Giglio et al. (2021) ........................................................................................................................ 76
,International Financial markets
Lecture 1: Introduction
The Financial System
Financial system = financial infrastructure & intermediaries & markets and their relationship to the
flow of funds to and from households, governments, business firms and foreigners.
Financial infrastructure = set of institutions that enables effective operation of financial
intermediaries and markets (incl. elements such as payment systems).
Two main aims of the financial system:
Bring money from savers (lenders) to
borrowers (spenders), via:
➢ Intermediaries (e.g. banks/ insurance
companies/ mutual funds) indirectly,
profit = interest margin
➢ Financial markets directly (e.g. bonds/
equity/ derivatives), derivatives
intermediaries are deal makers and
profit = fees.
To select profitable projects (economic growth)
• Channelling funds from surplus (left) to shortage (right)
• Direct finance: borrowing via a financial market (market in which participants issue and trade
securities)
• Indirect finance: financial intermediaries obtain funds from savers and uses these savings to
issue loans to sector in need of finance.
• Bank-based system: indirect finance main route for moving funds from lenders to borrowers.
Market-based system: rely more on financial markets
Main Functions
• Information Asymmetry
• Ex ante: borrowers know more about investment project than lenders
➔ Adverse selection: most eager (gretig) borrowers most likely ones to
produce undesirable outcome for lenders.
• Ex post: borrowers, but not investors, can observe actual behaviour
➔ Moral hazard: once loan has been granted, risk that borrower will engage
in activities that are undesirable from perspective of the lender.
, • Inefficiencies
• Reducing transaction costs (e.g. by pooling, i.e. due to size & transparency)
• Reducing information cost (search costs)
• Idiosyncratic Risk -> From idiosyncratic- to systematic risk (Idiosyncratic Risk type of
investment risk that is endemic to an individual asset)
Historical perspective
• Overcoming Information Asymmetry -> Building Trust
• Trust is the reduction of complexity by means of positive expectations of other (Luhmann,
1979)
• In the world of securities, success is information. Know the horse and the race before betting.
(Chrichton, Rising Sun)
“.. societies need effective, impersonal contract enforcement, because personal ties, voluntaristic
constraints, and ostracism are no longer effective as more complex and impersonal forms of exchange
emerge” (North, 1991).
• From trust in the player to trust in the game = Formation of national institutions
• Property rights
• Transparency
• Supervision
• Competition policy
Modern Financial system: Banks (indirectly) and Markets (directly)
Recent Trends
,Bank-based vs. Market-based
View Instrumental Institutional
Purpose Maximize profits and Embedded in social/ political
shareholder value context
Ownership Firm as investment instrument Aligns with firm mission/identity
Internal relations Contracts and hierarchy Informal norms and values
Firm-Owner Link Separate goals Closely aligned goals
External Forces Economic focus Social/political/cultural/influences
Motivations Return on investment Stability, legitimacy, prestige
Investment smoothing: bank-based is more trust & relationship based. So the banks have more
control on the firm, investments have longer horizons; can have influence so that irrational decisions
are not made during recession. That’s why they’re more willing to rent, rather than market-based;
more reliant on numbers.
Consumption smoothing: in market-based
system: lack of volatility in consumption so
smoothing is easier. So consumers are
capable of finding funding even in a
recession.
Corporate governance
= the set of mechanisms regulating the relationship between a firm’s stakeholders & management.
➢ How do banks and markets constrain companies from adverse selection & moral hazard
(principal-agent theory)? Principal-agent theory: managers (i.e. agents) may not always act in
the best interest of the owners (i.e. principal).
• Bank-based: close relationship, collateral
• Market-based: transparency, equal treatment of all investors, law against the use of insider
information, collateral;
Bank-based Market-based
Conservative Innovative
Risk Aversion – long term relationship Short-term Focus – Profitability ratio more
important
Schumpeter creative destruction
Creatieve destructie of creatieve vernietiging is een
proces van voortdurende innovatie, waarbij
succesvolle toepassingen van nieuwe technieken de
oude vernietigen.
Debt Equity
Conservatism Relationship Model
,Long term Employments contracts Short term Employments contracts
Training Incentive
Firms in bank-based systems invest more in employee
training and development
Repeated Game
Start firm – run – failing, and start from scratch
Unions Hiring and Firing
Specialized education Generic education
Incremental innovation Radical innovation
Civil law Common law
Relatively low inequality Relatively high inequality
Labor power
Taxation
Competition policy Competition policy
Banks limit economic rents and monopoly power via Markets → winner-takes-all
regulation
Executive pay Executive pay
Moderate in banks Astronomical in market-based systems
Inheritance
Monetary policy banks Monetary policy markets
Inflation aversion
- Fiscal conservatism; run like a household
- Bank systems need tighter money supply
- If inflation is high, banks’ long-horizon lending loses
value
Credit controls
- Direct controls to regulate lending vs. indirect
interest rate effects
Banks don’t like rapid rate cuts (it damages their Lobbying, Markets prefer lower rates
margins)
Bubble prevention
Exchange rates volatility prevention
,Allen & Gale (1999)
Intermediaries
Delegation → manager makes decision (do you agree with his/her assessment?)
Advantage: Economizing on information
Disadvantage: Disagreement → One size fits all
Market finance:
Advantage: Individuals can make heterogeneous decisions → agree to disagree
Disadvantage: Costly information
The first steps of the model
• Final decision: Do I want to invest or not?
• Intermediate decision: Do I want to get informed?
➢ (INFORMATION ASYMMETRY)
• This is what we call market/intermediate finance
• You study the accounting books/do your research
• Time structure:
• Ex ante (t=0): Everybody assigns same
Probability (alpha)
• Choice (t=1):
Either: Buy C and discover what type you are (H or L)
Or: Stay uninformed
You invest or not (t=2)
This gives us three options:
We introduce banks
• You are not investings; your banker is!
• What is the probability that you agree with your banker?
• Bèta (𝛽): The probability that you (investor 2) are an optimist given that your banker is
(investor 1).
• (1- 𝛽): Diversity of opnion! Probability that you disagree with your banker
, • Bèta has two “ingredients”:
• Ingredient one: How many people do have Corona? (are optimist?)
• Ingredient two: What is the probability that the test gives a false positive (what is the
probability that your banker invests but you disagree?)
• Banking finance only profitable if Bèta is higher than Alpha (Covariance/correlation is
positive)
Now the model is complete:
I= number of bankers or clients
➢ Beta and C matter the most
➢ What if alpha changes?
o A decrease – entrepreneur will (probably) finance largely with inside equity
o A increase – more optimistic outside investors agree to dept financing at favorable
rates
o A = 1 – almost all outside financing can come from dept rather than equity
➢ What could be an economic variable that
indicates alpha?
o Higher aggregate demand
o Lower competition
o Barriers to entry the market
o Technological innovation
o Etc.
➢ What happens if H or L changes?
o Increase H – project more attractive to optimistic investors
Market finance through equity > intermediate bank finance or no finance
o Increase L – Greater downside risk
Project less appealing to risk-averse intermediaries like banks
Intermediate bank < market finance or no external finance
