International

Financial
Management

Lamanda Gabriella
lamanda.gabriella@gtk.elte.hu
2024. február 29.
Table of contents

• Their roles in the economy

• Main types
Financial
institutions

• Enterprise Risk Management (ERM)

• Operational risk
• Liquidity risk
Risk • Credit risk
management • Lending activity, credit assessment
What we will discuss today

Intro – Financial
background system

Banks
• Commercial banks
• Investment banks
Intro – Risk

• What is the primary responsibility of risk

management?
• Understand risk profile
• Accept or not → actions should be taken
 Increasing importance of risk
management

Why? (reasons)

• Trends, tendencies
• Liberalisation: relaxation of rules Increase of
between countries, free complexity
movement of capital
• Deregulation: relaxation of rules More intensive
between institutions and markets, market
widen the sphere of financial competition,
services LCBG

• Events, financial scandals

E.g. in 2008, SocGen lost cca. 5 billion
EUR due to fraudulent transactions
(breach the tarding limits)
Intro – Risk
• Trade off between risk and expected return
• The greater the risks, the higher the return
• Expected return: weighted average of possible returns
• Weight reflects probabilities

Probability Return
• 100.000 USD invest for 1 year
• Treasury bills yield 5% 0,6 +30%
• Stock with the outcomes represented
in the table 0,4 -20%
Best-case scenario: 30% return, + 30.000 USD
Worst-case scenario: -20% loss, -20.000 USD
0,6 x 0,3 + 0,4 x (-0,2) = 0,1 →10%
Intro – Risk
• Capital Asset Pricing Model (CAPM)
• Systematic risk (nondiversifiable risk) – arising from market movements (β)
• Non-systematic risk – arising from the issuer’s operations
• Can be eliminated by holding portfolios (portfolio diversification)

• Individual investors →companies

• Should be managed in the best interests of its shareholders
• New projects should be viewed as an addition to shareholders’ portfolio
• In practice: non-systematic risk is important too →total risk
• Earnings stability, survival of the company
• E.g. property insurance
 Bankruptcy costs
• When a bankruptcy happens
• Loss of trust - Customers and suppliers are
less inclined to do business with the
company
Intro – Risk • Assets must be sold quickly, under the
normal price
• Destroyed reputation
• Large fees to lawyers and accountants
→best interests of shareholders?
 Regulation
• Confidence is key to survive
• Governments want financial stability →
Intro – Risk macroeconomic stability
• Make bankruptcy a highly unlikely event
• Preserve the confidence in financial sector
Stability

• is a state in which the financial system is resistant to economic shocks

and can fulfil its basic functions: the intermediation of financial funds,
Financial management of risks and the arrangement of payments.
stability

• Refer to stable economies measured by macro indicators: inflation

Macroeconomic and unemployment rate, GDP growth.
stability
Financial system
Financial system consists individuals like borrowers and lenders; and institutions like banks, stock exchanges, and insurance
companies; that are actively involved in the funds and assets transfer.
Network of institutions, markets and intermediaries that facilitae the flow of funds from lenders/savers to borrowers

Financial institutions,
financial markets,
clearing Borrowers: companies,
Lenders: households,
counterparties, government,
government, companies
payment providers, households
central banks,
regulators and
supervisors
Components of
Financial system
• Financial Institutions: taking deposits from savers
and providing loans and investment opportunities
to borrowers. Financial institutions,
• Financial Markets: providing platforms to buy and financial markets, central
sell various financial instruments, including stocks, banks, regulators and
bonds, commodities, currencies, and derivatives.
supervisors
• Central Banks, oversight money supply, settting
interest rates, and maintaining financial stability,
lenders of last resort, regulatation and supervision
of financial institutions..
• Regulatory Authorities: responsible for creating
and enforcing rules and regulations that ensure the
integrity of financial markets and protect investors
Financial system – backbone of the economy
Functions:
• working as payment systems: processes and services to facilitate the transfer of money/funds
from one party to another; including cash transactions, electronic funds transfers, credit or debit
card transactions, and digital wallet payments
• providing savings options: including deposits, bonds, stocks, and other financial instruments
• providing financing: including loans, equity financing, bond financing
• bringing liquidity to financial markets: assets can be bought and sold with ease at stable prices;
the ability of investors to enter or exit positions without causing significant price movements
(volatility)
• protecting investors from unexpected financial risks: tools and mechanisms for risk management
and diversification, including mutual funds and insurance products
Financial system –
backbone of the economy

Financial system is an economic arrangement

wherein financial institutions facilitate the
transfer of funds and assets between borrowers,
lenders, and investors. Its goal is to efficiently
distribute economic resources to promote
economic growth and generate a return on
investment (ROI) for market participants.
Financial system allocates funds to productive
investments, fostering economic growth and
development.
 Type of Financial
systems

Bank-based Market-based
(Indirect finance) (Direct finance)

Financial
Financial markets
intermediaries

Com.banks,
mutual funds, Brokers, dealers,
pension funds, investment banks
insurance comp.

Lecture 1
Reasons for differences Bank-based countries
(Germany, Japan)
Households behavior Risk averse: Hold money
mainly in cash and bonds
with low risk
Firms behavior Raise funds mainly from
banks
Reaction on financial Apply strict regulations and
crises and bubbles restrictions on stock market
Integration of banking and High: banks provide
non-banking services investment, underwriting,
insurance, trust properties
Market-based countries
(USA, UK)
Risk lover: Hold money mainly
in risky equity(shares)
Raise funds from banks, raise
funds from markets by issuing
securities
All restrictions on stock market
are temporary
Low: banks provide only
traditional deposit-loan
services
 • Monetary financial institutions (MFIs)
Financial • Investment funds (IFs)
institutions – • Insurance corporations (ICs)
ECB • Pension funds (PFs)
categorisation • Other Special Instituions
Banks
• Originates from Italy (money changing)
• Traditional roles: Interest Interest
• Take deposits Depositor Bank Borrower
• Make loans
• Provide payment and Loan losses Admin costs
settlement services (money transfer)
Return on Equity

When borrowers fail to make the agreed

payments of interest and principal
Banks
• Commercial banking
• Deposit taking
• Lending activities

• Retail banking: small (private individuals, small businesses)

• Wholesale banking: medium and large (corporate clients, fund managers)
SpreadRetail > SpreadWholesale

• Investment banking
• Assisting companies in raising debt and equity
• Providing advice
Simplified balance sheets
Commercial banking
Summary balance sheet for a fictive bank (% of total assets)
Assets Liabilities & Owners’ Equity
Cash 12 Funds from money market 15
Marketable securities 16 Deposits 70
Loans 70 Equity (capital) 15
Fixed assets 2
Total 100 Total 100

Most of the assets: loans

Most of the liabilities: deposits
Capital: shareholders’ financing, original cash investment + earnings retained in the bank
Earnings: net interest income!
Capital adequacy
• How much capital is needed?
• Recession, rising of loan losses
Loan losses increase → After tax loss (lower profitability)→ Equity capital decrease
→weak financial position → loss of confidence → run on the bank

Equity provides the best protection against adverse events →Bank stays solvent
Capital is a core tool of prudential regulation and also supports system-level
financial stability
Cornerstone of financial strength
Financial cushion to absorb unexpected losses
Capital adequacy
Equity provides the best protection against adverse events → Capital is critical to protect financial
institutions’ depositors and policyholders

Regulators determine set of requirements on minimum capital level

Capital adequacy ratio

𝐶𝑎𝑝𝑖𝑡𝑎𝑙
CAR= 𝑅𝑖𝑠𝑘 𝑤𝑒𝑖𝑔𝑡ℎ𝑒𝑑 𝑎𝑠𝑠𝑒𝑡𝑠

the amount of capital divided by the bank’s ‘risk-weighted assets’ (RWA)

Capital: high quality items (capital funds, retained earnings, current year’s results, etc)

RWA: are the loans and other assets of the bank, weighted (or multiplied by a percentage factor) for their
respective level of risk of loss to the bank

Optimal level of capital determined by regulators: ~10-15% of assets

Several types of CARs are determined (content of capital)
CAR
Deposit insurance
• Guarantee program introduced by the government
• Maintain confidence
• Insure depositors against losses up to a certain level

Federal Deposit Insurance Corporation: 250.000 USD (US)

National Deposit Insurance Fund: 100.000 EUR (HU)

• Allowed and incentive banks to follow risky strategies → moral hazard

Existence of insurance changes the behaviour of market participants
 Credit institutions are defined as undertaking whose
business is
to receive deposits or other repayable funds
from the public and
Credit to grant credits for its own account.

institutions E.g. commercial banks, credit unions, saving

cooperatives, saving and loan associations
CU, SC, S&L: retail bank focus (deposits,
personal loans, mortgage lending), owned by their
members and operate for their benefit
Source: https://www.ebf.eu/factsandfigures/
Source: https://www.ebf.eu/factsandfigures/
Do you have any ideas how much the
Hungarian GDP was in 2021?

~154 billion EUR

 Neobanks vs.
Traditional banking
Challenger banks are fin tech firms that
• Do not have physical presence
• Offer apps, sw and other online services
• Specialize in less services: mobile-focused
banking accounts (money transfers, payment
options, saving accounts)
• Promise low- or no-fee services
• Promise excellent online experiences.
• Do not have banking license, less regulated
• Business model: interchange fee* instead of
net interest income

* Interchange fees are transaction fees that the merchant's bank account must pay whenever a
customer uses a credit/debit card to make a purchase from their store.
 Excellent experience for clients
Convenient, digital, online, faster
Advantages /
Pros Lower costs (due to the lack of branches and
staff, lower level of loan losses)
Higher rates

Neobanks
Trust - Lack of physical presence
Narrower range of financial services, limited
Disadvantages
credit services
/ Cons
Lack of regulation and supervision, do not have a
bank charter
 Neobanks

• US: Chime, Aspiration

• Brazil: Neon, Nubank
• Germany: N26
• Lithuania: Revolut
• International money transfers,
currency exchange, payment cards
• Established in 2015
• 35 million personal users and more
than 500,000 business users
Thanks for your attention!