Financial Institutions and Financial Markets

An introduction
 Financial Institution

• What is a financial institution?

– An organization that conducts/performs financial transactions

• Examples?
– Central banks (of a country) FED, HKMA, etc..
– Banks (commercial, retail)
– Investment banks
– Credit unions (Only in US)
– Insurance companies
– Fund management companies （Vanguard, Fidelity）
– Security firms
– Credit card companies (VISA, UnionPay, PayPal)
– …
S. M. Ng, HKUST 2
 Financial Institutions

• Banks: Accept deposits from public (individuals or

corporations) and make loans to the public, including
local and central governments
– Retail banks:
• serving individual customers or households – accept deposits, make
loans, facilitate payments,
– Commercial banks (also merchant banks):
• Serving corporations and governments, accept deposits, provide
loans (buy goods, expand business operations, paying off debts,
facilitate payments), currency exchange,
– Wholesale banks:
• Serving between merchant banks and other financial institutions;
deal with large institutions, and large amounts per transactions

S. M. Ng, HKUST 3
 Financial Institutions
– Investment banks:
• Do not accept deposit from public; conduct services for corporations
and government, like underwriting of debts and equity offerings
(IPO), large public and private share offerings, mergers and
acquisitions (M&A)…
• The separation of this banking operations/sector from a commercial
bank (in USA) was the result of the Glass-Steagall Act of 1933, after
the stock market crash of 1929 and the resulting Great Depression.)
• Investment banks operate under less regulations than commercial
and retail banks. (e.g., less restrictions on capital ratios, or
introducing new products)

– Thrift (Savings and Loan Associations, or S&L):

• Serving individuals and small business in an area or a community;
offering competitive deposit rates (it has access to low-cost funding
from Federal Home Loan Banks), focus on mortgages for the
individuals in the area
S. M. Ng, HKUST 4
 Financial Institutions

• Credit unions:
– Operate like a retail bank, however, it’s a member-owned. Once
you have a credit union account, you are a partial owner of this FI
and will share its profitability. Usually it serves the employees or
members of a community (like a large corporation, a university)

• Insurance companies:
– Insurance is the transfer of the possible loss from one party to
another in exchange for payment. (hedging against the loss)
– An Insurance Company is a company selling the insurance; the
insured, or policy holder is the person or party buying the
insurance policy.

S. M. Ng, HKUST 5
 Financial Institutions

• Mutual Fund Management Companies: Fidelity

• Private Equity (PE): Blackrock
• Venture Capital (VC): Sequoia
• Payment Companies: Visa, MasterCard, American
Express, Ant Financial, Lufax, ApplePay, Google Pay,
AliPay, WeChatPay (TenPay?), PayPal, …
• ….

S. M. Ng, HKUST 6
 Updated list (2018)

• Largest banks in the United States, China and the world:

www.relbanks.com

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 USA Bank deposits by type

Banks in USA (2013)

Domestic Deposits by Type Amount Percentage

Individuals, Partnerships & Corp. 9,361,652,301,000 93.07

U.S. Government 3,483,529,000 0.03

U.S. States & Political Subdivisions 478,983,567,000 4.76

Commercial Banks 90,922,090,000 0.9

Banks in Foreign Countries 96,801,565,000 0.96

Foreign Governments 26,874,078,000 0.27

Total 10,058,717,130,000 100

S. M. Ng, HKUST 8
 New developments

• New Financial Institutions developing, are they?

• Peer-to-Peer lending:
http://www.bloomberg.com/video/how-peer-to-peer-
lending-can-rattle-banking-industry-
Ws792ZLPQ4adOe2Qweq6ww.html
• Internet payment-lending: Alipay(支付宝,余额宝)-
https://www.youtube.com/watch?v=0KGGwJIIlvM
• Apple Pay:
https://www.youtube.com/watch?v=5ExcCyS1ZH8
• Ant Financial:
• Lufax:

S. M. Ng, HKUST 9
 Financial Markets

• What is a financial market?

– It is a market place where buyers and sellers of financial products
perform trading or transactions. In general, it is regulated by
government, and assumed to be price transparent and low cost.

S. M. Ng, HKUST 10
 Financial Markets

• Examples:
– Interbank (lending) market (There is no physical location of the
market)
– The Foreign exchange market
– The Stock Market
– The Bond market
– The Insurance Market
– The Commodities Market
– The Futures market
– The Money Market
– ….

S. M. Ng, HKUST 11
 Financial Markets
• Interbank (lending) Market
– It is an exclusive market place where banks or large financial
institutions borrow or sell short-term funds, currencies. No
individuals or small parties are allowed to participate
– Minimum deal USD 5 million, mostly deals are 100m to 1 bn
USD.
– Most loans have maturities of a week or less. The majority are
overnight loans. The rate of these loans is the interbank rate.
(overnight rate; e.g. LIBOR, HIBOR, SHIBOR, etc.) It plays a key
role in setting the interest rate in the financial market of an
economy.
– Low transaction volume was considered the key factor of the
financial crisis of 2007 (Credit crunch)

S. M. Ng, HKUST 12
 Financial Markets

• Stock market (also known as equity market)

– A market place where the shares of companies (public held) can
be issued and traded. Individuals or organization can purchase or
trade shares in the company through brokers. These shares are
called securities.
• One of the most vital components of a free-market economy. It
provides capital access for companies to grow their business. On the
other hand, it also provides investors to invest in these companies
and become owner of them without actually running the business.

S. M. Ng, HKUST 13
 Major stock markets in the world

Global top 10 stock markets (Bloomber, end of 2013)

Market cap. (T.
Stock Market Regions USD)
1 New York Stock Exchange USA 17.95
2 Nasdaq OMX Operates in 24 mark 6.085
3 Japan Exchange Group Japan 4.543

4 London Stock Exchange Group United Kingdom 4.429

5 NYSE Euronext Europe 3.584
6 Hong Kong Stock Exchange China 3.101
7 Shanghai Stock Exchange China 2.497
8 Toronto Stock Exchange Canada 2.114
9 Deutsche Borse Germany 1.936
10 SWX Swiss Stock Exchange Switzerland 1.54

Top 10 total Market cap 47.779

World total (WFE Total, Jan 2014) 57.52

S. M. Ng, HKUST 14
Global stock market ranking

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 Top World stock markets by 31 Dec 2017

• Table: World stock market by end of June 2018 (new

data)

S. M. Ng, HKUST 16
Global stock market ranking

S. M. Ng, HKUST 17
 Bond Markets

• Bond market (also known as debt market, capital

market):
– The market place where debts or debt securities issuance and
trading occur. (It is not necessary a physical market location, but
a connection of computer networks where trading occurs.)
– There are three key players in this market:
• Issuers: Organizations that sell bonds to raise funds for their operations
(banks, corporations, municipal and central governments)
• Underwriters: Mainly investment banks and leading FI in the investing
business. They perform the key role of middlemen and perform the critical
activities like preparing legal documents, prospectus, and other collaterals to
simplify transactions. (Packaging the bond.) They are also responsible for the
validity of the information related directly to the bond.
• Purchasers: Corporations and governments that buy the bonds, fund
management companies (like mutual fund management companies, trusts,
etc. where individual investors can invest in their products: including unit-
investment trusts, bond funds, ..)

S. M. Ng, HKUST 18
 Bond Markets
• US Bond Market: 20180405 cm-us-bond-market-trading-
volume-sifma 2018.xls
• Asian bond markets transaction:
https://asianbondsonline.adb.org/regional/data/bondmark
et.php?code=trading_volume

S. M. Ng, HKUST 19
 Bond markets by 30 June 2016
Market Govt bonds (US$ billion) Corp bonds (US$ billion) Total (US$ billion)
Sep-16 CN 3238.94 353.02 3591.96
Sep-16 HK 92.19 12.32 104.51
Sep-16 ID 67.94 4.57 72.51
Sep-16 JP 11737.67 22.78 11760.45
Sep-16 KR 401.7 104.61 506.31
Sep-16 MY 61.87 11.24 73.11
Sep-16 SG 43.38- 43.38
Sep-16 TH 152.31 8.53 160.84
Dec-16 CN 2631.09 312.22 2943.31
Dec-16 HK 83.32 13.88 97.2
Dec-16 ID 72.41 4.5 76.91
Dec-16 JP 9803.93 18.29 9822.22
Dec-16 MY 43.5 7.39 50.89
Dec-16 SG 39.85- 39.85
Dec-16 TH 135.91 7 142.91
S. M. Ng, HKUST 20
 Foreign Exchange Market

• Foreign Exchange Market

– The largest financial market in the world. Participants are banks,
commercial companies, central banks, investment management
firms, hedge funds, retail forex brokers and investors. This
market determines the relative values of different currencies.
– BIS’s triennial survey showed the following daily volume:
• April 2016: 5.1 Trillion a day
• April 2013: 5.3 Trillion a day
• April 2010: 4.0 Trillion a day
• April 2007: 3.3 Trillion a day
• BIS file: 20170402 Global foreign exchange daily volume.xls
– Estimating the fees generated in a Forex Market
• Example: Earning estimations in Forex market: Forex
transaction earnings estimation.xls

S. M. Ng, HKUST 21
 Exchange market

Market share by currency

2013 2016

Rank Share Rank Share Rank

USD 87.0 1 87.6 1
EUR 33.4 2 31.4 2
JPY 23.0 3 21.6 3
GBP 11.8 4 12.8 4
AUD 8.6 5 6.9 5
CAD 4.6 7 5.1 6
CHF 5.2 6 4.8 7
CNY³ 2.2 9 4.0 8
SEK 1.8 11 2.2 9
NZD³ 2.0 10 2.1 10
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 Financial Markets

• Insurance Market
– Refer to the market of buying and selling of insurance for
individuals, groups (organizations), properties and specific
events.
– Through paying the seller a premium, the buyer transfer the risk
of potential loss to the seller, and the payment that the seller will
pay in case the loss occurs.
– Some of the common insurance products in the markets are: auto
insurance, home insurance, health insurance, Life Insurance …
– Data: http://stats.oecd.org/Index.aspx?DatasetCode=INSIND
– Global market places: https://www.iii.org/publications/insurance-
handbook/economic-and-financial-data/world-insurance-
marketplace

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 Insurance companies

• Contribution to the economy (USA):

https://www.iii.org/publications/insurance-
handbook/economic-and-financial-data/contribution-to-
the-economy
• Largest insurance companies by market capitalization:
https://www.relbanks.com/top-insurance-
companies/market-cap
• Largest global insurance companies by assets:
https://www.statista.com/statistics/270998/worlds-largest-
insurance-companies-by-total-assets/
• Largest insurance companies by revenue:
https://www.worldatlas.com/articles/largest-insurance-
companies-in-the-world-by-revenue.html
S. M. Ng, HKUST 24
 Money Market

• Money market
– A financial market where buyers and sellers buy or
issue/sell short term loans (less than a year). These
bonds/securities are also known as financial instruments
(called papers).
– Functions of the market: Finance trades, industry operations,
smooth the functioning and increase the efficiency of the central
bank, …
– Participants: Banks, retail money market funds, trading
companies, central banks, trading companies, cash management
funds

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 Money Market

• Some common products:

– Commercial paper: Short term (less than 270 days) loan issued by
corporations with no collateral, usually at discount from face value and
pay back face value plus interest at maturity.
– Treasury bills (T-bills): Short-term (1-,3-,6-months) debt issued by the
US government and bid at discount from face value. No interest paid,
but pay back at face value.
– Banker’s acceptance: Similar to T-Bill (Letter of Credit. Guaranteed by a
commercial bank. The bank and the borrower are liable to the amount.
Frequently used in international trading. )
– Repurchase agreements (repos): A short-term (usually overnight)
borrowing in the money market.
• A seller (borrower) sells the collaterals (securities) to a buyer and agrees to buy
back the following day at a certain rate (overnight rate)
– ….

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 Commodity market

• Commodity Market:
– A physical or virtual market place where buyers and sellers
trade raw or primary products or the future contracts of
these products.
• Hard commodities: gold, oil, copper, …
• Soft commodities: agricultural products like wheat, rice, sugar,
cocoa, coffee, pork, …
• There are over 50 commodity markets over the world
• China alone has over 1000 of these markets all over the country

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 Derivative and futures market

• Derivative markets
– A derivative is a contract between two or more parties agreeing on selling/buying
certain assets. It is a security with a price derived (or dependent upon) from a set of
underlying assets. These assets include stocks, bonds, currencies, interest rates,
commodities, market indexes, …
– The derivative market is the market trading these derivatives. It includes the futures
market (standardized and regulated) and over the counter (OTC) market. (non-
standardized and not regulated)
– The notional value of the market is estimated to be 1.2 quadrillion (1200 trillion, more
than 10 times the world GDP), however, the actual market value is much smaller.
• Futures market (futures exchange)
– A market place where participants trade standardized futures contracts – to buy a
specific quantities of a commodity or securities at a specified price with delivery at a
specific time in the future.

S. M. Ng, HKUST 28