MANAGEMENT OF BANKING AND FINANCIAL SERVICES

Seminar on

TODAYS AGENDA
1
SHADOW BANKS: Introduction to it.
SHADOW BANKS: Prime cause for 2007 crisis. SHADOW BANKING: The Chinese scenario.

2
3

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Shadow bank vs. Normal bank

No access to central bank funds

Access
No Safety nets from FDIC((Federal Deposit Insurance Corporation)

Safety

Trading

Banks do not take deposits instead rely on asset backed C.P and CDOs

SHADOW BANKING SYSTEM:

Year 2007 -

VOLUME: Size of SBS (FSB)

2011 -

$25 Trillion $24 Trillion

Five steps of shadow banking

1.

2.
3. 4. 5.

Make loans. Make securities. Sell securities. Set up (SPVs) Trade (CDOs)

Mortgaged Backed Securities -MBS

Secured by a mortgage(asset)

Lent to home buyers.

Default of the loan leads to surrender of the asset. Given by small regional banks. Middlemen's job

Collateralized debt obligations - CDO

Backed by a pool of bonds, loans. An investment-grade security, Do not specialize in one type of debt Often mortgage loans Different types of debt are often referred to as 'tranches' or 'slices
PRIME
NON PRIME SUBPRIME

Commercial Papers CPs

A short-term investment vehicle With a maturity (90 and 180 days.) Issued by a bank and Companies.

Used for short-term financing needs.

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Shadow Bankers

Asset management firms Bank holding companies Banks, investment Banks, traditional Hedge funds Insurance companies

Private equity firms Securitizing firms Sovereign wealth funds

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3 Stage destruction and turmoil

MBSS

CDOS
C.PS

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IN THE 70S
In 1970 banks were just doing Vanilla banking. Corporate went for C.Ps (started by Coke and

GE)

Banks had protection form FDIC (Federal

Deposit Insurance Corporation)

C.Ps :
1. Short term 2. Risky (comparatively) 3. Not protected
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THE START
CITIGROUP

Known for products with heavy risk hate to lose investors wanted a safe play:(only high rated quality assets). Need was to create a new place of investment vehicle.

NICK SOSSIDIS
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PARTIDGE HICKS

Android of Citi called the ALPHA (The 1st so called shadow bank ever) Not banks, early forms of SPV.
FUNCTIONS
1. 2. 3. Trade in only high rated bonds(strictly) Raise the money though Short term C.Ps. Chances of failing = ZERO
High rated bonds

C.PS

Umbilical cord with citi ( Back stop facility)

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GET SET GO!!!

IKB Deutshe Industrial bank Formed a new android called the RHINELAND. Similar to alpha but much more risky

C.PS CDOS

(next shadow product)

New rules of Umbilical cord High risk Better fee Constant demand

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GORDIAN KNOT

Introduction of SIGMA. (yet another shadow

product)

IOSS maturing @ longer years (reduce

risk of payment)

Same as Alpha but didnt have the umbilical cord! Medium term notes (MTN)..LONGER
MATURITY.

The thing was growing @ million dollar pace.

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Thieves steal to gain!

Analysts team of Moddy quit to form a SIV. Moddy was analyzing the sigmas that time. Patenting a financial innovation: difficult Sigma clones spread like forest fire. $3 Trillion of IOUs were soldfor highhy risky and subprime CDO. Shadow banking @ its height!

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Banks become BLACK!

Banks wanted higher returns. To grow faster, take high risk Banks set up shadow institutions.

Morgan Stanley

Cheyne

Barclays bank

AVENDIS

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And many more like this

Unlike sigma they were taking huge risks Paradox these were sold to hate to lose investors Investors never knew the CDOs (bad) behind the IOUs. Japanese weren't ready so the their scapegoat were The liquidity flushed MIDDILE EAST NATIONS. The giant CDOs were managed by the HEDGE FUND.

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The turmoil begins

The shadow bankers wrong assumptions:

The housing prices will always soreNO The default loans will not effect the giant CDOs NO Buying the rating companies will always ensure constant demand for shadow products THAT DIG THEIR GARVE. The turmoil began..slowly
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The stage 1, the loans turned bad. MBSS The MBS lost all its market value.

CDO S

The stage 11, the CDO s lost all its value and no inflow of cash. There were millions of unsold CDOs (like rotten onions)

The stage 111, the C.Ps C.PS Matured and the lack of liquidity Made them sell more CDOs for Loss and the Shadow institutions

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THE BROAD OUTLOOK

Sizeable informal financial sector. Financial intermediaries not registered Include informal lenders, kerbside capitalists, backalley bankers.

Wealth management products offered by regulated banks and trusts.

Provide credit outside traditional, and more highly regulated, banking model. In violation of Chinese law.

Careless local governments .

Reasons for emergence of shadow banking.

Part 1: THE Credit Kulaks.

1. The local governments borrowing behavior. 2. Structure of banking industry.

3. Underdevelopment of the corporate bond market.

4. IPO regulatory frame work. 5. Negative real deposit rates, due to high inflation.

Scale of shadow banking

According to Xiao Gang, The Chairman of, The Bank of China. Area of wealth management products is especially concerning. Estimates 20% of total bank assets. 33% increase since 2010. Yields reaching 70%!

Is this form of shadow banking really bad?

Not really.
It is well diversified and serves a legitimate consumer base. Have much lower leverage than the banks or other Corporate China. Losses often absorbed by the entrepreneurs themselves. They help those in financial repression.

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The shadow banking. Part ll

Wealth management products.
An alternative to a bog-standard bank deposit. Peoples Bank of China, deposit interest rates 3.5% WMP 5% to Above 8%
(www.euromoney.com) WMPs to be over 20,000,

Total value of WMPs to be 12.14 trillion RMD by 2012. Characterized this shadow banking sector as a potential source of systemic financial risk, whose model is fundamentally a Ponzi scheme.

WMP

BY BANKS

BY TRUSTS

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How it started?
Comparable to CDOs.

The Global Financial Crises.

The nature of Chinese economy. -export oriented. -Low cost of labour and HUKOU. -Interest in infrastructure.

The Economic stimulus.

Impact of Economic Stimulus.

Fuelling of Speculative housing bubble. Inefficient State owned enterprises. Sunk investments into LGFVs. Post Reducing stimulus.

The rise of WMVs.

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AN HUMBLE OFFERING AT HIS DIVINE LOTUS FEET

SAIRAM 17/7/2013