Week 10 - NBFIs Flashcards
How do PTP lending platforms reduce information asymmetry?
Give ratings (e.g. A-D) to deficit units
What are some types of screening provided by PTP lending platforms?
- Borrower ratings
- Monitoring functionality
When & why did PTP lending gain popularity?
After GFC due to:
- loss of faith in banks
- less lending by banks
What is the advantage of PTP lending for surplus units?
Higher returns
What is the disadvantage of PTP lending for surplus units?
No deposit insurance
How does PTP lending differ from banking?
Involves some intermediation, but contract is directly between lender + borrower
What are examples of NBFIs?
- Insurers
- Pension funds
- Finance companies/houses
- Securities houses
- Mutual funds
- OFIs
What is insurance for?
Protecting individuals & their beneficiaries from income loss due to premature death/retirement
How does insurance work?
Pools risk to transfer income uncertainty from individual to group
How are insurers funded?
Collect premiums to invest in the financial market
What kind of interest rate risk affects insurers?
Reinvestment risk – suffer if rates fall
Why might insurers invest in property?
Hedge against inflation
What are the main types of life insurance?
- Term
- Whole
- Endowment
- Variable
How does term life insurance work?
- No savings element
- Pays if you die in the term
How does whole life insurance work?
- Savings element
- Covers whole lifetime
How does endowment life insurance work?
- Savings element
- Pays if you die in the term
- Pays unit-linked face value if you survive term
How does variable life insurance work?
- Invests in mutual funds
- Value depends on asset returns
What do insurers mostly invest in?
Long-term government bonds & equities
True or false: in some countries, pension AUM > GDP
True
How much is pension AUM globally?
$35.4 trillion
What can happen when a stock is downgraded?
Institutional investors are forced to sell en masse
What type of interest rate risk affects insurers?
Reinvestment risk
What are an insurer’s liabilities?
Policy reserves i.e. expected payment commitment on existing policies
What are policy reserves based on?
Actuarial assumptions
Besides interest rate risk, what other risks affect insurers?
- Actuarial risk (fluctuations in payouts)
- Financial risk (fluctuations in rate of returns on portfolio)
Why regulate insurers?
- Prevent deceptive sales practices
- Ensure solvency
- Limit market power / cartels / high premiums
- Prevent unfair discrimination
What is the prudential regulation for insurers?
Solvency II, based on Basel II
How do insurers manage risk?
Reinsurance
What was the main pre-pandemic challenge for the insurance industry?
Low interest rates -> diversifying into credit, commodities, real estate, PE, indexed bonds
What is the main post-pandemic challenge for the insurance industry?
Rapid increase in interest rates -> lowers value of long-term bonds
What is an ongoing challenge for the insurance industry?
Competition from ‘InsurTech’ firms
What is ‘private debt’?
- Loans from banks
- New asset class popular with insurers
What is the pension system in most countries?
3 pillars:
1. State pensions
2. Workplace pensions
3. Private pensions
How can you tell a private pension from any other investment product?
Requirement to retire before accessing money
What are the main types of pensions?
- Defined benefit
- Defined contribution
True or false: DB pensions may require variable contributions
True
With a DC pension, what dictates value of payout?
Value of portfolio
True or false: DC pensions allow individuals to choose their asset allocation
True
What is the aim of pension regulation?
- Avoid mis-selling
- Promote disclosure
- Capital adequacy
How do finance companies/houses raise funds?
Issuing securities on capital market
What are capital market securities?
- Short-term notes
- Commercial paper
True or false: finance companies/houses are subject to more regulation than other FIs
False. No deposits = less regulation
What is the benefit of a finance company/house for its parent company?
Diversifies revenues
What are the main (overlapping) types of finance companies/houses?
- Sales finance institutions
- Personal credit institutions
- Business credit institutions
How do personal credit institutions differ from banks?
- Lend to riskier customers
- Collateral that banks would reject
- Higher rates
What advantages do sales finance institutions have over banks?
- Convenient access to customers
- Faster approvals
- Higher approval ratios
- Lower rates
- Lower fixed costs
How do business credit institutions work?
Buy accounts receivable at a discount & take responsibility for collection
What takes the place of regulation for finance companies/houses?
Market monitoring i.e. low-quality loans = less funding from market
What are securities firms?
Essentially investment banks without the banks
What do securities firms do?
Design, issue & trade securities
What are assets for a securities firm?
- Reverse repos
- Receivables from other brokers
- Security/commodity longs
What are liabilities for a securities firm?
- Repos
- Limited equity
What do mutual funds provide?
Greater diversification than an individual investor can achieve alone
What is the 2nd biggest type of FI in the US by asset size?
Mutual funds
True or false: mutual funds can be open- or closed-ended
True
What does MMMF stand for?
Money market mutual fund
What do MMMFs have in common with bank deposits?
- Liquid
- Safe
- Short-term
- Open-ended
True or false: in the US, you can write cheques on MMMFs
True
Why have bank deposits been declining since the 70s?
Money put into MMMFs
What are the main types of US MMMFs?
- Prime MMMFs
- Government MMMFs
What are prime MMMF investments?
Corporate debt securities
What are government MMMF investments?
- Government securities
- Govt security-backed repos
- Cash
What are hedge funds?
A type of mutual fund
What type of strategies do hedge funds use?
- Riskier
- More sophisticated
- Proprietary
What is a typical minimum investment for a hedge fund?
$1million+
What is the regulatory limit on hedge fund fees?
None
What characterises hedge fund investors?
Too wealthy to worry about liquidity & stability
