J. K. Dietrich - FBE 525 - Fall, 2006 Portfolios, Risks, and Regulation of Financial Firms Week 10...
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Transcript of J. K. Dietrich - FBE 525 - Fall, 2006 Portfolios, Risks, and Regulation of Financial Firms Week 10...
J. K. Dietrich - FBE 525 - Fall, 2006
Portfolios, Risks, and Regulation of Financial Firms
Week 10 – October 26, 2006
J. K. Dietrich - FBE 525 - Fall, 2006
Correlation and Efficiency
Most financial institutions have levered portfolios– Deposits and loans– Insurance reserves and investments
Correlation between cash flows can be positive, zero, or negative– Short-term vs. long-term rate movements– Deposit costs and lending activity– Policy loans and cancellations, benefits
J. K. Dietrich - FBE 525 - Fall, 2006
Efficient Portfolios
< 1
= 1
Asset 1 Risk
Asset 2
Asset 2 Risk
Ass
et 2
Ret
urn
Ass
et 1
Ret
urn
0
Asset 1= Liability
J. K. Dietrich - FBE 525 - Fall, 2006
Portfolio Constraints
Asset regulation/activity regulation Capital requirements Restrictions on portfolio can
– Lower returns
– Raise risks
– Increase desired leverage
J. K. Dietrich - FBE 525 - Fall, 2006
Constrained Portfolios
r
0
Unconstrained and Efficient
Constrained (inefficient)
J. K. Dietrich - FBE 525 - Fall, 2006
Equilibrium and Risks
Equilibrium – Short-run and long-run– Outcomes in equilibrium– Risk and equilibrium
Shocks to equilibrium– Real shocks– Monetary shocks
Strategy, equilibrium, and risk
J. K. Dietrich - FBE 525 - Fall, 2006
Macroeconomic Risks
Current events in financial markets– Stock market– Interest rates– Causes?– Short-run and long-run implications?
Policy and demographics– California industries– Prospects and opportunities?
J. K. Dietrich - FBE 525 - Fall, 2006
Types of Portfolio Risk
Holding-period yield risk– Capital gains risk– Reinvestment risk– Market risk
Credit risk– Non-payment of principal– Delayed or reduced payments– Effect of change is creditworthiness on value
Operating and liquidity risks
J. K. Dietrich - FBE 525 - Fall, 2006
U.S. Stock Market 1970-2004
Source: Haver Data Base
0
200
400
600
800
1000
1200
1400
1600
60 65 70 75 80 85 90 95 00
SP500
S&P 500 Index
J. K. Dietrich - FBE 525 - Fall, 2006
Monetary Shocks and Rates
-40
-30
-20
-10
0
10
20
30
40
50
1960 1965 1970 1975 1980 1985 1990 1995 2000
CHGINBASE FFED
Change in Moneary Base and Fed Funds Rate
J. K. Dietrich - FBE 525 - Fall, 2006
Components of Discount Rates
-3
-2
-1
0
1
2
3
4
5
1960 1965 1970 1975 1980 1985 1990 1995 2000
RISKPREMIUM TERMPREMIUM
Term and Risk Premia in BAA Bond Rate
J. K. Dietrich - FBE 525 - Fall, 2006
Risky Rate: Components
0
4
8
12
16
20
1960 1965 1970 1975 1980 1985 1990 1995 2000
FBAAFAAA
FTBS3FCM10
Baa Aaa 10YrTreasury 3-Month Treasury Yields
J. K. Dietrich - FBE 525 - Fall, 2006
Microeconomic Risks
Specific market changes in area of specialization
Technology changes Approach management of microeconomic
risks– Diversification– Barriers to micro-economic risk management:
geography, authorities
J. K. Dietrich - FBE 525 - Fall, 2006
Rationales for Regulation of Financial Services
Economic activity– Monetary policy (money creation)– Credit allocation (‘disadvantaged’ sectors)– Government financing
Competition (equal opportunity and fairness)
Asymmetry between providers and users Uninsurable (system-wide) risks
– Safety and promoting public confidence
J. K. Dietrich - FBE 525 - Fall, 2006
Types of Financial Firm Regulation
Chartering, branching, and registration Ownership, mergers, acquisitions Pricing and product review Activity and asset restrictions Capital requirements Disclosure and examination
J. K. Dietrich - FBE 525 - Fall, 2006
Recent Legislative History - U.S.
Pre 1980 DIDAMCA (1980) Garn-St Germain Act (1982) Competitive Equality Banking Act (1987) FIRREA (1989) FDICIA (1991) Riegle-Neal Banking Act (1994) Gramm-Leach-Bliley Act (1999)
J. K. Dietrich - FBE 525 - Fall, 2006
Deposit-Taking Regulation
Reserve requirements Investments
» Prohibited investments (e.g. corporate equity}
» Prohibited activities (e.g. real estate development)
» Restrictions on allowable investments (25% equity to one borrower)
Examination and reporting Capital requirements Closure rules (since FDICIA)
J. K. Dietrich - FBE 525 - Fall, 2006
Capital Adequacy
Capital bufferBuffer = Assets - Liabilities =>Liabilities = Assets - Capital =>
Liabilities = Assets - Capital Assessing capital adequacy over time (U.S.)
– ABC– Leverage– Risk-based capital
J. K. Dietrich - FBE 525 - Fall, 2006
Overview of Capital Regulation
Risk adjusted assets– Basel Agreements – we have case (Nov. 20)– Banks, thrifts, and insurance companies– Risk weights, on- and off- balance sheet– Tier 1 and Tier 2
Value-at-risk (VAR) capital requirements– Internal models, trading assets 10% or $1
billion, after January, 1998– 3 x 10-day 99th percentile risk and benchmarks
J. K. Dietrich - FBE 525 - Fall, 2006
Changes and Risks
“Legal Developments” in Federal Reserve Bulletin– Issues raised– Strategic importance
Rationale for regulation– “Systemic risk”– Important discussion
J. K. Dietrich - FBE 525 - Fall, 2006
Holding Company Regulation
Bank holding companies– Bank Holding Company Act of 1956– 1970 amendments– FIRREA changes
Non-bank holding companies– Thrifts– Insurance companies– Securities firms
J. K. Dietrich - FBE 525 - Fall, 2006
Holding Companies andGlass-Steagall Act (to 1999)
Securities FirmInsurance Company
Non-Bank HoldingCompany
Bank HoldingCompany
Commercial Bank
Securities Subsidiary(Section 20)
SEC, ExchangesSROs
State InsuranceAgencies
Federal ReserveBoard
OCC, FDIC, orFRB
J. K. Dietrich - FBE 525 - Fall, 2006
Securities Markets Regulation
Issuers and investors– Registration and disclosure
Investor behavior– Insider trading– Market manipulation– Speculation and margin requirements
Investors and brokers– NASD and exchanges
J. K. Dietrich - FBE 525 - Fall, 2006
Securities Firm Regulation Registration Reporting (FOCUS) Capital requirements
– Haircuts Self-regulatory organizations
– NYSE– NASD– Futures Merchants Association
Government
J. K. Dietrich - FBE 525 - Fall, 2006
Legal Liabilities
Securities Regulation
MutualFunds
Exchanges and SROs
Brokers,Dealers, IBs
Investor Issuer
Investor
Investor
Issuer
Issuer
Disclosure and Reporting
Man
ipu
lati
on, I
nsi
der
Tra
din
g
SEC ReviewLegal Liabilities
J. K. Dietrich - FBE 525 - Fall, 2006
Insurance Regulation
United States vs. Rest of the World– States and McCarran-Ferguson Act– National Association of Insurance
Commissioners (NAIC)– Ministries of Finance, etc., elsewhere
Domestic, foreign, alien insurance companies in United States
EEC and 1992 China, Korea, etc.
J. K. Dietrich - FBE 525 - Fall, 2006
Finale: Gramm-Leach- Bliley Act
Established Financial holding companies– Insurance– Securities activities– Maintained separate of banking and commerce in
general Federal Reserve in umbrella regulator, but
regulation relies mainly on function regulators, state insurance commissioners, SEC, CFTC,
J. K. Dietrich - FBE 525 - Fall, 2006
Banks with Glass-Steagall
Finance CompanyCommercial Bank
Bank HoldingCompany
Discount Broker
Securities Subsidiary(Section 20)
J. K. Dietrich - FBE 525 - Fall, 2006
Financial Holding Company
Investment BankCommercial Bank
Financial HoldingCompany
Insurance Company
Thrift InstitutionAsset Management
Company
J. K. Dietrich - FBE 525 - Fall, 2006
Taxation and Financial Services
Taxation of primary sectors– Housing– Corporate tax treatment– Inside build-up– Retirement products
Taxation of financial service firms– Deposit-taking firms– Insurance firms
J. K. Dietrich - FBE 525 - Fall, 2006
Taxation and charters
Banks and thrifts– pre 1986– Currently– “Grandfathering” of municipals
Credit unions Mutual and stock insurance companies
– participation Investment companies
J. K. Dietrich - FBE 525 - Fall, 2006
Taxation and Financial Products
IRA accounts in the 1980’s Roth accounts in the 1990’s Education savings: 529 and ESAs Leasing and the investment tax credit Limited partnerships Taxation and transaction processing Tax treatment of major banks in the 1980’s
– Political implications