Page 76 - FINAL CFA II SLIDES JUNE 2019 DAY 5.2

READING 17: ANALYSIS OF FINANCIAL INSTITUTIONS
LOS 17.a: Describe how financial institutions
differ from other companies.

MODULE 17.1: FINANCIAL INSTITUTIONS
Financial institutions differ from other companies as follows:

1. Systemic importance: Necessary for the smooth functioning and overall health of the economy. As an intermediary between providers and users of
capital, there are often inter-linkages between financial institutions. These inter-dependencies introduce a system-wide risk of failure when one of the
member institutions fails—the contagion effect. As a deposit-taking institution, banks are especially prone to the risk of a bank run. To avoid financial
contagion, bank deposits are often insured up to a certain limit by the government.

2. Regulated: Given their significance, they are highly regulated -minimum capital requirements, minimum liquidity requirements, and limits on risk-taking.

3. Assets: Their assets tend to be financial assets such as loans and securities that are usually reported at fair value. This contrastswith other companies
that primarily own tangible assets reported at depreciated historic cost.

LOS 17.b: Describe key aspects of financial regulations of financial institutions.
Basel Committee on Banking Supervision, a standing committee of the Bank of International Settlements. develops the regulatory framework for banks
(currently Basel III ) with the objective of increasing the banking sector’s ability to absorb economic and financial shocks: Rests on 3 pillars!

1. Minimum required capital for a bank is based on the risk of the bank’s assets. The riskier a bank’s assets are, the higher its required capital.

2. A bank should hold enough liquid assets to meet demands under a 30-day liquidity stress scenario.

3. Stable funding relative to a bank’s liquidity needs over a one-year time horizon. Stability in funding is proportional to the tenor of the bank’s deposits;
longer-term deposits are more stable than shorter-term deposits; also depends on the type of deposit (e.g., consumer deposits are more stable than
interbank market funds).

Other global organizations that coordinate regulations include the:

1. Financial Stability Board (FSB), which seeks to coordinate actions of participating jurisdictions in identifying and managing systemic risks.
2. International Association of Deposit Insurers (IADI), which seeks to improve the effectiveness of deposit insurance systems.
3. International Organization of Securities Commissions (IOSCO), which seeks to promote fair and efficient security markets.
4. International Association of Insurance Supervisors (IAIS), which seeks to improve supervision of the insurance industry.