GLOBAL FINANCIAL ENVIRONMENT

Catherine DOMALAIN-FAUSSEY

Money appeared with the increase of the

exchange of merchandise
and has changed in different ways in order
to follow evolution of exchanges.

Definition of currency:
currency is any object or record that is
generally accepted as payment for goods
and services and repayment of debts in a
given socio-economic context or country.

I- DIFFERENT FORMS OF CURRENCY

Three main stages for this evolution (history of
money)
A. Barter : exchange of products
B. Metalic money
C. Fiducial and scriptural money

A- barter or exchanging of goods Beginning : direct exchange of goods

without money

Without

exchange on the market

B- METALIC MONEY
Metals quickly as sustainable necessary, divisible and rare
Three Steps
1- Money weighing
To avoid fraud
- China: weighers
- Rome holders of balance, control the quality of payments
2- counted currency
Appearance of bullion because the possibility of fraud
(balls or discs non-precious metals inside)
3- Coinage currency 18me 19me
Shaped piece the seal of prince
To avoid fraud that will statements
that may coinage

C- Fiducial and scriptural money

fiduciary money and scriptural early 16th century
with merchants of Amsterdam
was too difficult to manage
banks and trust management
Central banks have a monopoly
on the issuance of
creation of issuing house
last step: make it legal tender (cannot be
refused in settlement of debt) - France 1870
(Napoleonic France)
Forced currency : can not be converted into
coinage
France decreed in 1936 = establishes the role of
currency in circulation

II. Various functions of money

There are three functions of money
A- Intermediate currency in the exchanges
In primitive society, exchange is barter
But quickly exceeded because
Buyer and seller must be interested in their
respective goods (and be simultaneously a
seller and a buyer)

The goods cannot be divided (difficulty of

the exchange ie. Equal value of the goods)

Comparison between goods is difficult

Money is an instrument which allows to exchange

two goods, by avoiding the constraints of the
barter

Thus the one who detains

the good or the service and wishes to sell is going to
be able to sell this good
against a certain quantity of
money
and so can acquire other
goods with the obtained
money.

B- money - UNIT OF
ACCOUNT
Goods and services are
expressed in moneytheir value can be
compared, which allows to
save information with
economic theory.

Money is thus a valuable

standard

C MONEY store of value

Money can be stored
Possibility of transferring the
purchasing power from period A
to period B Immovable property, jewels, works of
art also have this possibility.
Another aspect of money is its
"liquidity", that is its availability
without any cost of transformation.
Money can loose its value during
inflation: loss of value under the
influence of the rise of prices.

III- Money
A- QUALITIES EXPECTED FROM A GOOD MONEY1) Internal stability of money Depends on trust
In a broad sense = safety of the "investment or
"placement

Necessary conditions:
lack of inflation:
Trust of the stakeholders
Opposite situation = lack of trust
Mechanism:
High inflation would decrease the
purchasing power of the households
Shift

of capital towards safest-havens

(sector of property, gold) safer
than money..

The Households are covered against risk

To be able to remove money from bank accounts
(solidity of banks):
Ex : Financial crisis: the level of 50 000 euros of the
money present in the accounts is officially guaranteed by
the EU

USA, is the role of the FDIC (Federal Deposit Insurance

Corporation) to assure the deposits in case the bank fails
they are able to sell their assets

2) ) External stability of money

Necessary conditions = Capacity to preserve buying
power abroad (exchange rate).-

in case of Strong depreciation

loss of purchasing power on the market of goods and
services payed in foreign currencies
In extreme cases the currency may become
inconvertible.

Synthesis:
Quality currency is primordial for a good statement of
economy:
It is the base of the social contract between
stakehoders.
Tacit contract based on trust

B- ROLE OF THE MONETARY AUTHORITIES 1) impact of the variation of the money stock on the
prices
Relation between global money stock and level of prices
If Growth of Money stock is superior to the growth of
the production
inflationary pressures

If Growth rate of monetary mass > Growth rate of the

GDP(GROSS DOMESTIC PRODUCT)

increase of Inflation Rate and Increase of the general

level of the prices(prizes).
Currently, the growth of the money stock is no longer
connected to the production of bank notes and coins

2) Oversight of the monetary

authorities
The
monetary
authorities
supervise the evolution of
money, conscious of its impact
on the general level of the
prices.
The ECB (EUROPEAN CENTRAL
BANK) uses the monetary mass has a
tool for this monitoring

Remark : Is the wealth effect responsible for

inflationary tensions?
To consider yourself richer than reality can
encourage consumption and so create
inflationary pressures
This effect is qualified as wealth effect by
the economists.

C) IMPACT OF THE VARIATION OF THE

MONEY STOCK ON THE ECONOMIC

ACTIVITY
our economic market is based mainly on
money
financial crisis 2008 and crisis sovereign
debt are perfects illustrations.
Crisis of the finance Pass of an excess of
world liquidity in a lack of liquidity.
The volume of money circulating can thus
be responsible
Of
overheating (inflation, speculative
bubble),
Of lack of money (credit current crunch),
Of a good balance between economic
growth and realization of productive
projects.

1) An excess of liquidity favors

the economical activityIf there is a low interest rate
companies and households will
invest
Low rate for consumer credit
will help to answer to household
needs.
An excess of liquidity supports
the economy.

2) An excess of liquidity can lead to a crisisGenerally it leads but to inflation but also to full
employment..
Currently, the excess of world liquidity
(money from petrol and trade surplus)
are
not
necessarily
inflationary
pressures but they are concentrated on a few assets
and feed speculative bubbles which
move from assets to assets
Ie Asian markets, Internet, petrol,
American real estate, raw materials

Example:
The american Housing bubble has led the
world economy toward a crunch credit.
lack of liquidity.

Healthy companies can be brought to close

just for financials gaps
Productive investments cannot find funding
to complete.
In front of this reality, States have understood
the absolute necessity to promote a financial
system which works and re-injects liquid
assets into the economy.

IV-BANK AND STOCK EXCHANGE

GB (STOCK MARKET USA), TWO
WAYS OF FINANCING Three ways to finance
1) Personal savings (selffinancing)
2) Monetized bank credit: nobody
saves (banking
intermediation);
3) Financial markets, which bring
together savers and borrowers:
transfer of savings, and not
new currency (financial or
market intermediation)

A- Internal and external

Economic activities financed:

Internally,
financing

through

self-

And/or
externally,
by
resorting to the monetary
and financial system.

1) Needs and resources for

financing economic agents
a)
Various
needs
and
resourcesEconomic agents (companies,
households, States) have
needs to finance
Must find the necessary
means
Significant and diverse needs..
Household:
food, clothing,
and accommodations.
Companies: raw materials,
work,
and
making
investments (such as buying
new equipment)

Satisfying
these
needs
requires purchasing goods
and services, which must
be paid.
Investments
=
mobilization
of
significant
financial
resources
in
an
occasional manner Everyday
needs
=
mobilization of resources
in
more
modest
amounts,
but
in
a
recurring manner.

b) Needs for financing Needs generally classified according to their

duration.
Short-term:
Household consumptionOngoing enterprise operation (to ensure
production, companies must buy raw materials,
services from other companies - electricity,
transport, pay their employees, etc.)
States (pay State employees, ensure operation
of schools) -

Long term Investments: increase the stock of production

means, in anticipation of future production.
We distinguish:
Immaterial investments (intangible): purchase
of software and patents, spending on professional
training,
in
research
and
development,
advertising;

Physical investments (tangible): acquisition of

long-lasting production assets by companies
(machines, buildings),

also, investment by the State to develop public

infrastructure (roads, airports, schools), as well
the acquisition of housing by households

c) Resources for financing Economic agents receive revenue that allows them
to finance needs. If insufficient = appeal to
external financing. .
Internal resources:
Households have
income from their work and capital (revenue from
their primary distribution),
but
also transfer payments (revenue from
redistribution),
Companies receive the fruit of their production
The State collects tax and social security
contributions (levies, taxes, and national insurance
contributions collected by the central government,
regional government, and Social Security bodies).

External resourcesSeek the resources

economic agents;

of

other

Individual = borrows from a

person in his/her family or from
the bank,

Company = emits bonds, just like

the State, for example.

Savings = portion of income not consumed,

enables financing future needs and thus to
be self-financed
Depreciation = company makes a profit and
puts aside sums to be able to make future
investments = cash flow.
Cash flow = Profit + Depreciation
And
distributes a portion of profits to its owners
as dividends..
Self-financing = cash flow Dividends.

At the national level, this

corresponds
to
gross
corporate savings.
Companies make the most
investment
in
a
given
economy
However,
the amount of
investment depends on the
level of economic activity and
employment.
Ensuring
conditions
for
financing these investments
has proven to be important
for the economy.

2) NEEDS AND FUNDING RESOURCES IN THE

NATIONAL ECONOMY
a) Definitions of capacity and need financingFinancing capacity: economic agent does
not spend all of its income Savings = part of unconsumed income Production = Production of consumer goods
and financial instruments
In an economy, Savings = Investment

Besoin de financement

3) SITUATION OF ECONOMIC AGENTS IN A COUNTRY

Each individual agent has a funding need or funding
a) Economic agents generate funding capacity Households generate savings, which is the main means
to cover the financing needs of other economic agents.
This is occasionally the case for other institutional sectors
thus, companies generated funding capacity in France in
the 1990s
o At that time, they reduced their investment, notably because
real interest rates were highs
o At the same time, they reestablished their margins thanks to
distribution of value-added that was more favorable to them.

b) Economic agents generating funding

needs
Two economic agents:
1) Companies
2) State: since 1975, France has shown a
need for funding, which has increased
dramatically in recent years.

3) Situation of countries
If economic agents residing in a country
have expenses > income
, Investment > Savings
Country generates a need for funding
Conversely
Expenses < income
, Savings > Investment
Country shows a need for funding
(capacity).
.
Funding needs or capacity can be
seen in the balance of current
transactions
Which summarizes all the countrys
foreign purchases and sales of goods
and services..

Two cases may arise: :

Studying current account balances reveals

two groups of countries:
1) Countries regularly having a surplus balance
of current accounts
Oil-exporting countries (including Russia)
Countries whose products are highly competitive in
the market (notably Japan, China, and Germany);

Countries regularly
having a deficit
balance of current
accounts:
France since 2005,
but the United
States in particular.

2)

Economic agents can finance their needs

With their own savings
Or that of other economic agents.

Insufficient cashflow requires economic

agents to seek additional means outside.
The question is:
how to ensure that economic agents that
have the capacity to lend, actually lend
their savings to those with funding needs ?

B- FUNDING

External funding
Direct when performed on short-term
capital markets (money market) or long
term capital markets (financial market).
Indirect when resulting from credit
transactions by financial institutions.

The financial system connects

agents who have funding capacity
with
agents who have needs to be funded.

Nationally as well as internationally

transferring funds from economic agents who save,
to economic agents who wish to spend at a level
higher than their revenue.

1) Distinction between direct and indirect

funding
a) Direct funding
Borrowers obtain funds directly from
lenders by selling securities to them in
the financial market.
= Debt claims on the borrowers future
income or assets..

Overview of direct funding mechanisms /

b) Indirect funding
Borrowers obtain funds from financial
intermediaries allocating credit.
Lenders deposit their funds with financial
intermediaries Indirect funding,
Indirect finance, or even intermediated
finance because both lenders and
borrowers operate via intermediaries..

These two financing modes coexist.

For example, a company can both issue bonds and borrow from a bank.

2) Direct funding circuit

Based on the security maturity periods, we
may distinguish:
Financial market for long-term securities;

Money market for short-term securities.

a) The financial market

Two types of securities are exchanged
on the financial market in order to
fund long-term needs, that is,
investment:
Bonds
A bond is /
A security representing a certificate
of debt.
Yields fixed revenue (interest) and is
reimbursed when term is reached.
Businesses, local communities, and
the State can issue bonds..
In France, the bonds issued by the
State are treasury bonds (OAT).

Stocks and shares

Certificates representing a companys capital
shares.
Shareholders are associated.
Unlike stocks
Shares are not freely transferable because the
person (associate) himself is as important as the
capital he brings (the intuitu personae present in
partnerships and LLCs).
They are issued at the time of incorporation or
during subsequent capital increases.

These securities entitle the holder to a

portion of profits (dividends);
They are only reimbursed upon dissolution
of the company and after repayment of
all creditors.
More risky than bonds.
In return, the associate benefits from
increasing profits or valuation of company
assets
Only incorporated businesses may issue
stocks or shares.

b) Money market
Money market securities shortterm debt.
to fund cash needs.
Two compartments:
1) Interbank
market (central
bank and commercial banks)
Refinancing banks that need
liquidity.
The central bank implements
monetary policy on the
interbank market.

1)
o

Market for debt securities:

Companies (financial and
non-financial)
and the State.

Several securities are traded in

this market
each security refers to a specific
issuer.
o Firms issue treasury bills,
o Credit institutions issue deposit
certificates
o Firms and credit institutions
negotiable medium-term notes
o The State issues treasury bills.

Only large companies have access to this

market to finance their cash reserves
The market for negotiable debt securities
was created in France in 1985.
Until then, the only way to finance cash
requirements was to apply for a shortterm loan from a financial intermediary
Only the State could issue treasury bills.

3) The indirect funding circuit

Various financial intermediaries
We may distinguish three categories
financial intermediaries.

of

1- Depository institutions
Banks and savings banks.
Receive deposits from their customers and
extend credit.

2- Contractual savings institutions

Their funds are regularly paid by their
customers on the basis of long-term
contracts.

Insurance companies (life and non-life

insurance) collect premiums from their
customers
Pension
funds
receive
pension
contributions
from
employees
and
employers..

They invest received funds in securities

that they buy on financial markets.

These include:
Financial corporations : leasing companies
and consumer credit companies.
In France, these entities are often subsidiaries
of banks or companies, and benefit from
funding from their parent company
Collective investment funds :
for Collective Investment in
Securities (UCITS) ....
Sell shares to the public and
savings which they invest
markets.

Undertakings
Transferable
collect their
in financial

The most common UCITS are SICAV and FCP.

SICAV (Investment Companies with Variable
Capital)
o Legal personality
o Issue shares
FCP (investment funds)
o Jointly-owned transferable securities
o No legal personality.

Also
o

CIPF (Mutual Fund Business)

dedicated
to
managing
employee savings

Venture capital funds (high-risk

mutual fund investment)

FCIC (Innovation-focused mutual

funds)
Partly invested in companies not
listed on the stock exchange.

Collection of savings
In an economy, most available savings is
provided by households.
Knowing how this savings is collected is
therefore essential.

Household savings includes

Called
non-financial
savings,
for
acquiring property,
Financial savings that can be used to
finance investments in other economic
agents.
Saving can be held in the form of liquid
investments (such as deposits), or
placed in financial assets.

distinction
betweeen:

is

generally

made

Liquid savings (deposits, savings

accounts
and
sustainable
development accounts, money market
funds ...).
These accounts can be used to pay for
purchases directly or after a simple
transfer by the investor

Contractual savings (home

plans,
bank
popular
plans);

savings
savings

Non-monetary
securities
(bonds,
equities, non-money market funds);

Investments in life insurance (as well

as pension fund rights).

Financial savings are placed in one type of

account or another
according to the
investors interests and preferences.
Selection criteria
Compensation, which affects tax levels;
Investment security;
Liquidity, that is, the ability to quickly
transform savings into payment means;;
Economic and social context.
Economic
crisis
situation,
fear
of
unemployment,
and
difficulties
of
financing pensions justify todays strong
growth of savings through life insurance;

Granting credit
Households and businesses
=
credit
to
finance:

Cash requirements:
Bank overdrafts
Specific credit, such as to fund
purchases of durable goods for
a household (notably a car);

Investment:
Such as new equipment for a
company
Accommodations
for
a
household

Which induces financialization of

companies /

IV- INSTITUTIONS CENTRAL TO INTERMEDIATED

FUNDING
A- Credit institutions grant credit
Types of credit institutions
Common feature of credit institutions = grant credit.
But the resources enabling them to grant loans
differ from one type of institution to another;
Distinguish banks from other credit institutions.

1) Banks
Banks = The only financial institutions that
have the right to receive deposits from their
customers.
We typically
Private
banks: capital held by private
shareholders (such as BNP Paribas and
Socit Gnrale); are publicly traded;

Mutual banks: capital owned

by their members, who are
often their clients (such as
Crdit Agricole, Banques
Populaires
(cooperative
banks), Caisses d'Epargne).
Cannot be listed on the stock
Can create specific structures
==>Enabling them to open a
portion of their capital to private
shareholders and thus to be
listed
==>Or consolidate with banks
not belonging to the mutual
sector (which is what Crdit
Mutuel did with CIC).

2) Other credit institutions

May grant credit even if they do not have the
right to receive deposits from their
customers.
From their own funds or loans they have
contracted themselves..
Specialized in certain types of loans.

These other credit institutions may be:

Such as regional development companies that
can provide credit to companies or local
authorities under the conditions established by
the Ministry of the Economy;
Specialized financial companies:
Consumer credit (such as Sofinco and Cofidis)
Credit
for businesses (such as leasing or
factoring companies)
Mortgage
And thus address individuals, businesses and
public institutions (such as Crdit Foncier)..

B- THE BENEFITS OF BANKING INTERMEDIATION

For some entities, it is not possible to turn to the market for
funding;
Households and small businesses =
Single option : a loan borrowing from credit institution if
they want to fund a long-term project or an occasional cash
need..
... May also prefer to go through an intermediary, rather than
address the market directly

This overcomes the shortcomings

failures
of
financial
markets
promoting:
1) Lower transaction costs;
2)

3)

and
by

Management of risks associated with

loan transactions;
Limited the consequences of
asymmetric information.

B- The benefits of banking intermediation

1)

Banking
intermediation
transaction costs

enables

reduced

Reminder: CPP model, all necessary information is

available to all, free of charge. .

In financial markets... This requires:

Identifying contracting party(ies)...
Establishing several
Tracking the implementation of these contracts
Many fees
Significant time.
These are referred to as transaction costs =
market imperfection.

Bank
Avoids transaction costs
Allows investing or borrowing under better
conditions.
Banks role is to channel savings and grant
loans;
Numerous operations
Banks achieve economies of scale

2) Banks bear the risks associated

with loan operations
Lending = risk =

Non-repayment of loan by defaulting

debtor = losses for the lender
(credit risk or counterparty risk);

illiquidity;

Loss of earnings = loan made at

interest rates lower than it would be
possible to obtain today by investing
those same funds (interest rate risk)

Risks to be assumed by the individual lender

Unless the lender assigns risks to a lending
banking establishment.

Therefore, banks allow:

Transforming short-term savings into longterm financing;

Transforming low-risk investments into riskier

funding.

3) Banking intermediation limits the impact

of asymmetric information
Assumption
An individual lender lends funds only if he is
certain to be repaid.
Most often, lender does not have complete
knowledge about borrower
Whether he/she is honest,
Whether
the borrower can meet
his/her obligations
Borrower has more information than lender
Asymmetry of information because, in
the contract, one party has more
information than the other.
Two consequences:
1.
Anti-selection (or adverse selection):
2.
Moral hazard

a) Anti-selection (or adverse selection): :

Assumption: How can a business be able to obtain
the necessary funding to achieve its investment,
for which it has no guarantee of success?
If borrowing only from individual lenders no
funding = for fear of not being reimbursed, unless
a very attractive rate of compensation is offered.
Two cases may arise:
1.
Only very risky projects are funded because of
high rates of return, to the detriment of safer
projects;
2.
No projects would obtain funding.

3 Moral hazard:
Assumption:
There is no proof, for example, that the obtained loan
will indeed be used as intended, and riskier uses
could be chosen.
Fearing this possibility, investors may decide not to
lend their funds.
In either case, information asymmetry prevents the
conclusion of transactions that could be beneficial for
both the lender and the borrower.

Banks have
know-how
and expertise
that enable them to properly
assess the viability of a project;
to be able to select projects
funding projects they deem
profitable,
while
rejecting
projects that seem too risky.
Banking
intermediation
transforms available funds from
savings into funds that finance
borrowers
The presence of banks facilitates
financing the economy and
promotes economic growth

IV- FINANCIAL INSTITUTIONS ARE

ENTITIES INVOLVED WITH THE

FUNCTIONING OF FINANCIAL MARKETS
A- The role of institutional investors
1) Presentation of institutional investors
Institutional investors
Investors other than individuals
Whose role is to place the savings they
receive into financial markets.
Different from banks by their use of the
savings they collect.

Activity of banks and institutional investors

Institutional investors = 3 types

of financial institutions:
1) Undertakings
for
Collective
Investment
in
Transferable
Securities
(UCITS):
collect
funds
from
individuals,
businesses, etc.. and use them
to acquire financial assets;
2) Pension funds: collect employer
and employee contributions
and invest in assets to pay
future pensions under funded
pensions.
3) Insurance companies: receive
"contributions"
(premiums)
they invest in order to pay
compensation for any damage,
injury, or death.

2) THE INFLUENCE OF INSTITUTIONAL

INVESTORS
Study of household financial assets in major
European countries
= European households rely on institutional
investors for a portion that varies between 1/3
and 2/3 of their financial savings
With significant differences between countries s

Three groups of countries can be distinguished

1) Countries in which traditional banking
intermediation remains high:
Spain and Italy, an large part of household
financial wealth is deposited in banks;

2) On the other hand, countries in which the

financial wealth of households consists
mainly of life insurance and investment
products passing through pension funds:
The Netherlands and the United Kingdom,
both of which have a funded pension
system;

3) Intermediate countries in which the

financial assets of households combine a
large proportion of bank savings products
and life insurance contracts:
France and Germany.

3) Reasons to leverage institutional investors

Working with an institutional investor can:
Reduce transaction costs: :
Investors no longer have to identify investments on their own;
The high volume handled by institutional investor can produce

economies of scale,
and therefore enable them to charge much lower management fees
than they could with individual management;

Reduce risk:

institutional investor can build a diversified portfolio, which is much

more difficult to achieve for an individual investor;

Reduce information asymmetry:

Institutional investors have greater expertise than individual investors.

B- THE CHANGING ROLE OF BANKS

The mutation of banks in financing the
economy a) Diversification of banking
activities
Environment:

Decline in their traditional

collecting savings and lending,

Competition
internationally
institutional investors

Banks have
activities.

diversified

activities
and

their

of

from

business

Banking activities today include:

Retail banking : Traditional banking
business, addressing individual
customers through their local
branches

Operations generally involve small

amounts;

Financial and investment banks:

major customers, especially large
companies.
Activities

Advisory
services
regarding
mergers and acquisitions,,

Arranging operations such as

capital increases or bond issues ...

Asset management:

Performing
investment
transactions (risk hedging
operations and/or speculation
operations)

on behalf of their clients

(institutional
investors,
businesses, individuals) or for
their own benefit;

Insurance business:

Just like insurance companies,

all banks now offer their own
liability insurance and life
insurance policies.

Banks now operate in three main financial areas:

Banking
Securities management
Insurance..
Diversification of activities
Economies of scale.
A bank
grants a loan to an individual to buy an apartment
may, for example, offer
insurance to cover that loan
as well as home-owners insurance.
Selling three products to the same customer reduces time
spent finding information about the customer, which would
take three times longer in the case of three different
vendors.

b)
Both
forms
intermediation

of

financial

Banks have become an essential

intermediary
Traditional intermediation role
Business market intermediation
Have also become, just like
institutional
investors,
intermediaries
between
issuers and purchasers of
securities...

The financial intermediation process

summarized in the following diagram:

is

2) Banks have been forced to take

on new risks a)

Banks now rely

financial markets

more

on

Background
o

Development
markets

of

Activity diversification

financial

Banks have changed both the

structure for using funds at their
disposal and the origin of those
funds:
The majority of a banks funds used
to come from deposits made by
customers..

Example Customer deposits =

o

73% of the liabilities of private banks in

France according to the AFB (Association of
French Banks)

Over 27% in 2012.

Today, banks finance themselves on the

markets
(securities
liabilities
52%,
compared to 6% in 1980).

Most money was used to grant credit (84% of

assets in 1980, compared to only 38% in
2012).
Today, shares represent 47% (forty seven
percent) of bank assets, compared to only
5% (five percent) in 1980 (nineteen eighty).
Bank activity is therefore more exposed to
changes in financial markets.

b) Banks outsource their risks

Method used = securitization of bank loans.
Converting debt into securities
A bank that wants to perform a securitization operation
sells its obligations to another financial institution created
for this purpose;
This institution is responsible for issuing securities that
may subsequently be sold on the market.

Risk outsourcing process

Securitization process =
major advantages for
originating bank.

two
the

Transfering debt means that it can:

1.

Recover cash;

2.

Eliminate
the
credit
risk
associated with the transferred
receivables.

The bank can then grant new loans

Better rates to the extent that the
bank refinances at a lower cost.
Securitization is therefore a way to
improve financing for the economy
via banking establishments.

Securitization
Initiated in the United States through mortgages,
Highly developed in the 1990s (nineties), and even more in
the 2000s,
Even in Europe, and also involves other types of loans, such
as consumer loans.
This method also has dangers:
Banks (confident in the fact that they can offload their risks)

may need to actually take more risks

And they are less cautious when granting loans;

In addition, they transfer their risks to investors who

purchase securities.

The danger clearly emerged at the outbreak of

the subprime crisis: :
Mortgages granted to customers who had a
subprime crisis risk of defaultsubprime crisis
Either because these borrowers had already
been involved with payment incidents
Or because they had low incomes.
These loans were qualified as "subprime" loans,
as compared to reliable customers, qualified
as prime
Many borrowers defaulted on their loans, resulting in
2007 in financial difficulties for lending organizations,
and a drop in securization securities.
The crisis grew in Autumn 2008 following the
bankruptcy of the American bank, Lehman Brothers, on
September 15, 2008, notably because securities had been
distributed throughout the United States and the rest of
the world, Europe in particular.

Subprime crisis
Financial crises are neither new
nor rare.
The great economic crisis of the
twentieth century began with the
financial crisis in October 1929.
Over the past 10 years: 5
financial crises (1997 Asian
crisis; LTCM 1998; e-market
crash of 2000; Enron in 2001;
and subprime starting in the
summer of 2007)

Financial crisis (simplified): a drop in the

value of investments.
A financial crisis is serious?
Normally, one does not die of
appendicitis but it could evolve into
peritonitis, and if that is not treated...
The risk is that a crisis in the financial
sector (banks + some major investors) is
transmitted to the real economy.
A financial crisis can foreshadow an
economic crisis: impact on employment,
growth, etc..
A case in point: the 1929 crisis

Origins of the current crisis: Act I

The crisis known as the "subprime"
crisis
"We lend only to the rich
To start, there are poor households who
dream of buying a home.
Given their resources, and thus the
risk of defaulting on a loan, they can
only borrow at higher rates than
wealthier households:
They do not have the prime", lower
rates offered to wealthier households.
Hence the term "subprime" in English.

We do not lend only to the rich

Banks decided to offer them loans at
variable interest rates, typically low
at the time the contract is signed,
but which may then rise
significantly.
To cover themselves in case of
default, banks mortgage the home:
they can repossess it and sell.

Home mortgages granted to low income

households, loans at variable rates.
Low starting interest rates, long
repayment periods;
The likelihood that rates would vary
upwards in the more or less long-term
was one hundred percent 100% -

Subprime: it all starts with a fairy tale ....

To start, a household borrows money to buy a house.
The house is worth 100 (one hundred). The
household, without any down-payment and despite
low income, borrows the entire 100.

The subprime fairytale continuesThe price of the property

increases, and the house is worth
(one hundred fifty) 150.
Since a home can guarantee
multiple loans, some banks offer
new loans to households for
another 50 (fifty) 50.
Hard to resist: households borrow
to buy more goods, such as a car.
Stock market saying: "Trees dont
grow to the sky"

The story turns into a subprime

nightmare
The real estate market declines. The house is
now worth less than the loan, less than 100
in our example.

At the same time, reimbursement expenses

increase because (flexible) interest rates rise

The subprime nightmare becomes

reality
In response to the first loan defaults, banks
require households to return the key to their
house by mail.
These households are released from their
debt, but are left homeless. The bank
collects a property whose value continues to
decline.

Origins of the current crisis: Act II

"Securitization"

Eliminate "bad debt

By means of very complex financial

innovations, subprime loans are
converted into financial products.

These risky financial products (bearing

the risk of debtor default) are mixed
with other products of better quality
and are sold to investment banks.

By securitization, the original lenders

transform debts financial products.
They basically unload their risk (nonpayment, etc..) onto investors.
These "rotten securities" spread throughout
the financial system

Trust begins to fail

Investment banks begin to realize that
some of the mortgages supporting
these securities will not be reimbursed.
The owners of these rotten securities"
seek to dispose of them but they
cannot find any buyers

Bankruptcy situation for some

financial companies

Share prices of banks and insurance

companies collapse in the United States
...

And in Europe ...

Governments intervene to avoid a "domino effect"

Mistrust
In this climate of uncertainty, banks grant
fewer loans to businesses and households,
which in turn adopt a sit-and-wait behavior.
Eventually, the financial crisis spreads to the
rest of the economy, as credit restrictions
weaken consumption and investment and
thus slow growth.

C. PASSAGE FROM DEBT-BASED ECONOMY TO FINANCIAL MARKET

ECONOMY
1.

Up until the 1930s financial markets held a privileged place

Most long-term resources, discounted rates provide cash.

With banking services low, households have little recourse to credit.
Savings absorbs securities issued by the State and companies, its
size is enhanced by:
*

Monetary stability: the Germinal franc retained its value intact until
1914;

Adequate social structure: a majority of poor people, significant

minority of owners, including the millions of pensioners who live on
income from conservatively managed assets;

Maintaining the family as an economic unit (non-salaried for the

most part) based on property (land, workshops, shops, financial
capital)

2.From 1945 to 1970: debt economy

Banking

took off, with book money

rising from under 40% to more than 85% ,
banks thereby multiply their money
creation power.
Social

evolution
(wage-based
employment,
rising
living
standards,
growing middle class) deprives the family
of its economic role, asset values collapse.
Hedonism leaning towards immediate
consumption spreads, saving depreciates.

Banks

incite their clients to borrow,

taking

advantage of inflation that reduces debt and makes saving

more random
Funding through savings is no longer enough, banks begin to
transform, the central bank approves money creation with flexible
refinancing (credit divider)
The

international debt-based economy takes off in parallel with the

dramatic increase in external deficits (oil crises) and the abundance of
dollars (euro-markets, IX).

3. From 1980-90 : resurgence of

financial markets
a. Context
Reversal of social power relations: the
share of capital (marginal rate), rising
from 26% of GDP in 1983 to 32% in 1996.
This is a redivision of net value-added in
its favor, while the 1970s had been
disastrous to it (32% in 1973).
Capital and creditors take their stand:
debtors pay, lenders earn a higher level
of real interest.
Immediate causes :
1) Deflation makes borrowing more
expensive, and investment more
profitable; investors turn to the stock
market;
2) Deregulation and financial innovations
offer
better-suited
products
(liberal
revival).).

b.

The three Ds, globalization begins

Decompartmentalisation: liberal inspiration =

globalized world capital market in which

everyone can choose their financing or
investments across a wide range, as
transfers are instantaneous.

Deregulation. Innovations emerge. New products offer

investment vehicles or appropriate financing along with
high mobility, that is, the ability to switch from one
market to another, one term to another, one currency to
another ...
This is the main driver of globalization:

all products become competitors, costs and yields tend to

unify around world.
These innovations open new markets by attracting
savings. Facilitating transfers, they increase volatility and
make it difficult to regulate currency issuance.

Disintermediation.

This movement is opposite of

the Glorious Thirty (1945 to 75), it is a decline of
bank financing in favor of direct finance

A) HEADING TOWARDS THE END OF THE

DEBT ECONOMY? FRANCE AS A CASE

STUDY.
a. Changes in the economic environment
Starting in the early 1980s, the new economic and
financial situation drove changes in capital
markets and innovations in financial products.
Economic crisis payment imbalances at the
origin of capital transfers from one financial
center to another

Competition

between countries is increasing to attract or retain

capital:
this is a powerful stimulator of financial innovation as it provides
opportunities for competitive investment.
In this sense, innovations in capital markets in France and Europe
respond to those developed overseas, especially in Anglo-Saxon
countries.

The

1980s were also marked by a dual instability from: :

1.

Currency exchange, due to the abandon of the fixed exchange

rate system ;

2.

Interest rates, because of the new U.S. monetary restriction

policy.

Increased financial risk

(interest rates and exchange rates)
It was inevitable that this would encourage
finding new techniques to better manage these new risks.

4) Around 2002
The U.S. financial structure, and to a lesser extent that in
the United Kingdom, is characterized by a multitude of
financial institutions involved either

as lenders
or as borrowers
in financial markets.
Capital markets are open to many stakeholders and a large
amount of capital is exchanged in those markets.

The U.S. economy is a typical example of a financial market

economy because:
A multitude of financial institutions intervene in markets
(banks, savings banks, insurance companies, pension
funds)

Companies fund most of their investments from their

profits

Marginally, banks resort to Fed advances, and FED and

refinancing mainly on the money market;

The Fed plays the role of a lender of last resort, but it is a

lender without constraints because commercial banks
resort very little to this type of funding.

Worldwide generalization

vMonetary policy

12
8

V-MONETARY POLICY
Reminder :
Monetary policy exercises control over the money supply to
ensure price stability and to influence economic activity.
Central banks use instruments that influence bank liquidity
and interest rates.
The European Central Bank defines and conducts monetary
policy for the euro zone.
Monetary policy decisions taken by central banks must be
seen as credible by economic entities, and their impact
depends on the elasticity of consumption and investment
with respect to interest rates.
By its statutes, the European Central Bank seeks price
stability, which sets the stage for considering other
objectives.

Since the creation of the Euro zone in 1999, Euro zone

monetary policy has been led by the European
Central Bank.
The European System of Central Banks unites the
national banks of the European Unions 27 Member
States around the ECB.
The Eurosystem only includes the ECB and national
banks of the ECB.
The ECB Goverance Council defines monetary
policy for the Euro zone.
It unites governors of national central banks in the
Euro zone and the six members of the ECB Board of
Directors.

A-MONETARY POLICY INSTRUMENTS

Like other central banks, the ECB creates money
Taking securities tendered by banks as its assets
and paying for those securities with "central bank
money (which includes the credit in their Central
Bank accounts, and bills and coins in circulation)
Most of these operations are carried out by national
central banks as part of a regular procedure called
call-for-tender (Open market).
The ECB may also provide liquidity on-demand to
financial institutions through lending facilities and
deposits;
For security purposes, it requires them to maintain a
minimum deposit, called reserve requirements.

1-Tenders (or open market operations):

Each week, central banks in the euro zone
conduct tenders to provide liquidity to the
market in the form of taking possession
(temporary holding) of securities held by
commercial banks for a period of two weeks.
These transactions are completed each
month by bidding over the longer term (three
months) and, exceptionally, by tendering
much longer maturity.

These operations are performed at an

interest rate called the refinance rate (Refi).
The refinance rate is the main instrument of
monetary policy.

2-Standing facilities:
Commercial banks can obtain liquidity
overnight with the Eurosystem, outside
tender operations, at a fixed rate higher than
the refinance rate. This is referred to as the
marginal lending facility (cap rate).
Banks can also deposit their cash overnight
with the Eurosystem at a fixed rate lower
than the refinancing rate. This is referred to
as the deposit facility.
These two rates do not affect the functioning
of the money market, as banks prefer to
respond to calls-for-tender, as the rates tend
to be more attractive.

3) Reserve requirements:
A required minimum level of bank deposits with the
Eurosystem, equal to 1% of the deposits of their
clients, earning interest at the refinance rate and
paid at the rate of refinancing.
In fixing tender rates and standing facility rates, the
ECB influences all market rates. This is the reason
why the rates set by the ECB are called reference
rates.
For example, banks with 24-hour liquidity have the
option of depositing it with the Eurosystem, or
lending it to other banks in the interbank market.
The rate practiced on the interbank market is called
the day-to-day (DD) interest rate.
The most common measurement of the DD is the
EONIA (Euro OverNight Index Average), an average
of a sampling of 50 establishments in the Euro zone.

As in any economy, ECB interest rates affect the demand

behavior of different entities:

Oppositely, the risk of inflationary pressure and overheating in

the economy leads the ECB to consider tightening monetary
policy and thus to increase its main reference rate (Refi).

B- LIMITS OF MONETARY POLICY

1) The credit crunch and "credit rationing
Following the liquidity crisis that occurred
during the 2008 banking crisis, there has
been a "tightening" (shortage or strangling) of
credit offered to businesses and individuals
(credit crunch).
Banks
limit their lending quantitatively
regardless of the rate that the borrower
agrees to pay, and regardless of any
orientation driven by governments and
monetary authorities.
Creditworthy
borrowers are only able to
access
credit
lines
under
prohibitive
conditions: high rates, multiple safeguards ...

A high interest rate charged by the central bank

leads other banks to increase interest rates on their
loans, and even refuse to lend in some cases.
This mechanism of credit rationing is related to
information asymmetry between the lender (the
bank) and the borrower (client):
Only the borrower really knows his ability to repay.
A high interest rate discourages "good" borrowers,
unlike "bad..
Banks respond to this increased risk by restricting
lending.

These restrictions primarily affect economic agents

who do not have access to financial markets
(households, SMEs).

2) The liquidity trap

This phenomenon was described by Keynesian
analysis:
A policy of increasing the money supply seeks to
stimulate domestic demand through lower
interest rates.
But it may face a limit:
Below some minimum interest rate level, the tendency
to hoard any additional monetary unit becomes very
strong, as agents prefer to hold on to their money
balances rather than consume or invest more, which
makes monetary policy inefficient.
The liquidity trap phenomenon was observed in Japan
starting in the second half of the 1990s. Liquidity
created by the central bank did not reach the real
economy.

C-SPECIFIC CONSTRAINTS ON
POLICY IN THE EURO ZONE.

MONETARY

Inflation as a target
Many economists believe that the 2% target
set by the ECB is too low
The general consensus is that the "right" level
of inflation for advanced economies is
probably between 1-1.5% and 3-3.5%.
inflation et cration montaire

1)

2) A fundamental flaw: one single refinancing

rate
How can the European Central Bank, which has
only a single director interest rate for the
entire euro zone, adjust its monetary policy to
cope with heterogeneous economic situations?
the refinancing rate set by the ECB is unique.
Therefore, depending on the region, the rate
may be too high or too low.
Confronted with asymmetric shocks (economic,
political, or social crises specific to a particular
country),
monetary policy, which treats different situations
in a unique manner, appears partly ineffective.

Member States can only resort to budget

policy to handle the fine-tuning their
countrys economy.
http://dessinemoileco.com/peut-on-concil
ier-diversite-des-modeles-europeens-et-m
onnaie-unique/

VI-European Central Bank

ECB/ BCE

A- Origin:
The European Monetary System

OBJECTIVES

Stabilize exchange rates.

Reduce inflation.
Prepare European monetary unification through
cooperation.

ASSESSMENT OF EMS
Main objective
Creation of internally and externally stable
monetary zone despite the crisis in 1992-93.
Monetary discipline led to economic convergence
that reduced inflation and aligned interest rates .

On January 1, 1999, the euro became the offici

al currency for 11 Member Countries.

European Central Bank (ECB)

headquarters is located in Frankfurt, Germany.
manages the euro, the single European currency, and ensures
price stability in the EU.
It is responsible for defining and implementing EU economic
and monetary policy.
Objective (//SME)
The European Central Bank is an institution of the European
Union. Its main objectives are:
To maintain price stability (control inflation), especially in
countries using the euro;
To maintain the stability of the financial system by ensuring
appropriate oversight of financial institutions and markets.

The ECB
works with the central banks of the 28 Member States of the EU.
Together they form the European System of Central Banks (ESCB).

The ECB
also coordinates
cooperation between
central banks within
the euro area,
which includes
19Member States of
the EU that have
adopted the euro.
This cooperation space
among a limited
number of central
banks is called the
Eurosystem.

Mission
The main tasks of the ECB are to

Set interest rates in the euro zone and control the money
supply;

Manage foreign reserves of countries in the euro zone and buy

or sell foreign currency in order to stabilize the exchange rate
balance

Help ensure appropriate oversight of financial institutions and

markets by national authorities, as well as harmonious
operation in payment systems;

Authorize central banks in the euro zone to issue banknotes in euros; ;

Monitor price changes and assess the risk regarding price stability.