“TRANSILVANIA” University, Braşov Faculty of Economic Science Business Administration 1st year, 8892 group

(general aspects) - Business Law paper 2009

.......3 1...3....7 II........................................................11 VI..........4 1...........1........................ FINANCIAL INSTRUMENTS.....7 2............1.... RATING AGENCIES.................................................. THE TRANSFORMATION OF THE EUROPEAN FINANCIAL SYTEM.............................................................2....... INTRODUCING THE EURO: CONVERGENCE CRITERIA........1..............................................4................4 1........... DEVELOPMENT.4......................... BIBLIOGRAPHY.........3.10 V....... THE PRESENT FINANCIAL CRISIS..........................13 2 .... BASEL II AND THE CAPITAL REQUIREMENTS DIRECTIVES...............................................................4 1....4.............9 IV.............. STRUCTURE..............Business Law Paper – European Financial System – Teodora Cristina Stan @ 2009 Teacher: ALEXIS DAJ CONTENTS I..................................................................................3 1..............................................4..........................................5 1... FINANCIAL MARKET.................8 III.2......3 1.. DEFINITION AND GENERAL CHARACTERISTICS............ EVOLUTION........... FINANCIAL INSTITUTIONS... EVALUATION..............................................

Business Law Paper – European Financial System – Teodora Cristina Stan @ 2009 I. It can be seen also as the set of markets. instruments. European Financial System has a major impact over the economical development and its main roles are:  Financial resources transfer (from those that have surplus funds to those that have deficit funds)  Promotes economical efficiency (low risks and costs)  Puts good use on investments opportunities (funds transfer: low productivity sector-> high productivity sector)  Unwind of payments and incomes flux  Stimulates investments and economies level 1.2. DEFINITION AND GENERAL CHARACTERISTICS The International Financial System can be defined as an assembly of norms and techniques settled and accepted on a background which contains institutional regulations that coordinate and organize EU’s members’ behavior in the financial and monetary. Some provisions are related to budget domain that was modified through Maastricht Treaty (1st of November 1993). and financial flux which assure the movement in time and space of the capital resources from the creditors (or the international investors) to the debtors (or the financing beneficiary). necessity of taking risks. private law provisions and provisions regarding agreements between institutions.1. EU’s financial system is based on the following juridical norms: treaties provisions. international domain generated by the commercial and non-commercial operations. Development EFS’ development was amplified by the economical growth. temporal variation of consumption and separation of business property administration over the capitals. The most important one is mentioned in European Community Treaty. 1. Evolution The evolution steps of International Financial System are the following:  Bretton – Woods Agreement (1944)  Crises period (1960-1970)  “Smithsonian Agreement” or Free Flotation (1973) 3 . institutions.

3. transactions with credit instruments.Each member can try to diminish the possible BPE’s crises . small fluctuations for 4 . it’s mandatory to take into consideration members’ interests   Plazza Agreement (1985) Louvre Agreement (1986) At the moment.). between government. Structure EFS have a main.Free flotation hasn’t generated a diminished of international commerce and investments . 1.Weak national currency systems can be absorbed by those that are more powerful 1. Financial Market (primary market=new issues of a security are sold to initial buyers.4.Business Law Paper – European Financial System – Teodora Cristina Stan @ 2009  Kingstom Jamaica Agreement (1972-1976)  Modification of the art. simple structure which consists of financial transactions on financial markets and through financial institutions.Each member has to avoid monetary market interventions to prevent a possible BPE lack of balance or to obtain an unfair advantage within the frame of international commercial exchanges .1.Crises remain pretty frequent and strong . EFS is a combination of currency systems (The European Central Bank (ECB) is responsible for the monetary system of the European Union and the euro currency.If monetary market changes. secondary market=security can be resold by the investors for cash) is divided into: Money Market (very liquid.Free flotation doesn’t mean a quick setting of commercial fluxes . 1.4. private and population. Evaluation A short evaluation of EFS shows us that: .Changing rates remain extremely volatile in EFS . IV  Principles adopted in 1977: .

derivatives. financial consultancy. managerial expertise. 5 . insurance against financial risks. preferred stocks1. Common stock usually entitles the owner to vote at shareholders' meetings and to receive dividends. financing condition imposed by the financial institutions. lower risks (some institutions share or cover the financial risks). Financial Institutions (Financial Bodies) . insurance policies. bonds.2.4. higher operational costs. banker’s acceptance. transactions with debt and equity securities.Business Law Paper – European Financial System – Teodora Cristina Stan @ 2009 the securities prices which implies a low risk) and Capital Market (low liquid. export financing). credits etc Debt and Equity instruments: common stocks. investment funds participations. Credit instruments: commercial papers. higher fluctuations => high risk). international payments. financing facilities. financing consultancy. clients). companies surviving (competitors. Advantages for indirect financing: • • • • • • • • • • a good information about capital resources. but has a higher claim on assets and earnings than the common shares.Services provided by financial institutions • • • • • • • • • 1 selling and buying financial securities. owners of preferred stock receive dividends before common shareholders and have priority in the event that a company goes bankrupt and is liquidated. Disadvantages for indirect financing: 1. Between the investor and debtor can be established 2 types of financial relation: direct financing or indirect financing (through intermediaries). pension funds policies. international financing (incl. lower transaction costs. For example. different financing alternatives. historical relations with a financial institution. Preferred stock generally does not have voting rights. guarantees for financial transactions. international markets surviving (rating agencies). inexistence of a direct contact with financial markets.

b.is the majority shareholder in the European Investment Fund. Unlike commercial banks. Its job is to lend money for projects of European interest (such as rail and road links. The EIB: .is a non-profit.works through banks and other financial intermediaries.is also responsible for framing and implementing the EU’s economic and monetary policy . conduct over-the-counter transactions or provide private investment advice . policy driven bank.Business Law Paper – European Financial System – Teodora Cristina Stan @ 2009 • • portfolio management. They subscribe jointly to its capital. Turkey. each country’s contribution reflecting its economic weight within the Union . a.) European Investment Bank. . candidate countries and the developing world.works with the other national banks of each of the EU members to formulate monetary policy that helps maintain price stability in the European Union (with the objective of sustained employment and non-inflationary growth) . particularly in the less well-off regions. in Croatia. It was set up to help small businesses.is active in the member states of the European Union. Instead. It also provides credit for investment by small businesses. Iceland.does not use any funds from the EU budget. nor does it invest directly in any firms) . the EIB does not manage personal bank accounts.manages the foreign reserves of member countries 6 . borrowing on the financial markets . The ECB: .is owned by the Member States of the European Union. The EIF: . airports. it is self-financing.makes long-term loans for capital investment projects but does not provide grants . Liechtenstein and Norway c.) European Central Bank (ECB).ensures the smooth operation of payment systems .is not a lending institution (it does not grant loans or subsidies to businesses.) European Investment Fund. Its job is to manage the euro – the EU’s single currency. or environmental schemes). It uses either its own funds or those entrusted to it by the EIB or the European Union. investment funds management.

Business Law Paper – European Financial System – Teodora Cristina Stan @ 2009 . Financial Instruments is a contract between lender and borrower. progressive steps in the process of European economic integration have laid the foundations for financial market integration. the risk allocation between the participants. the currency. insurance policies. II. Examples of endogenous changes are: national mergers and acquisitions in banking.3. the payback of the loan. First. probably been the most important factor affecting developments in financial markets over the past decades. globally.4. the European financial system has witnessed a number of remarkable structural changes that partially can be considered as related to or triggered by the European financial integration process.it revenue is derived from interest on investments in foreign-reserve assets. although EMU and the introduction of the euro have played a pivotal role in the changes the European financial system has been undergoing. the amount. A good example are changes that were made possible because of the pace of technological development. the financing cost (interest rate) and the payment method. which has. However. as well as from the allocation of euro banknotes in the EU. but to some extent are also exogenous or part of global developments. a host of other factors can be identified that in parallel with the euro contributed to the transformation of the European financial system. THE TRANSFORMATION OF THE EUROPEAN FINANCIAL SYTEM The European financial landscape has changed dramatically over the last couple of years and the pace of change appears to have moved into a higher gear with the establishment of Economic and Monetary Union (EMU). and it can have a direct (includes money and capital market) or indirect character (includes investment funds participations. In addition. the role of each institution / participant in the mechanism. pension funds participations). and securities. This particular contract establishes (mainly): • • • • • • • • the financing mechanism. the increasingly blurring distinction 7 . money-market instruments. the maturity. 1.

" In practice. The Treaty stipulates: "The achievement of a high degree of price stability […] will be apparent from a rate of inflation which is close to that of. the ratio must have declined substantially and continuously and reached a level close to 3% (interpretation in trend terms according to Article 104(2)) or. at most. c. To a large extent. The Treaty stipulates: "The sustainability of the government financial position … will be apparent from having achieved a government budgetary position without a deficit that is excessive …" In practice. not only the ownership of banks. these perceptions are dependent upon custom and practice in different countries. government finances. when drawing up its annual recommendation to the Council of Finance Ministers. the ratio must have sufficiently diminished and must be approaching 60% at a satisfactory pace (interpretation in trend terms according to Article 104(2)). 2.) Price stability. Introducing the Euro: convergence criteria The convergence criteria are presented in Article 121(1) of the Treaty establishing the European Community (EC Treaty). the Commission. but they are also influenced by the existence. The Treaty stipulates: "the observance of the normal fluctuation margins provided for by the exchange-rate mechanism of the European Monetary System. for at least two years. in some countries. b. must remain close to 3% while representing only an exceptional and temporary excess. in line with this development. the inflation rate of a given Member State must not exceed by more than 1½ percentage points that of the three bestperforming Member States in terms of price stability during the year preceding the examination of the situation in that Member State. If this is not the case.) Government finances. without devaluing against the currency of any other Member State. Government debt: the ratio of gross government debt to GDP must not exceed 60% at the end of the preceding financial year. the three bestperforming Member States in terms of price stability. 8 . exchange rates and long-term interest rates): a.) Exchange Rates." The Member State must have participated in the exchange-rate mechanism of the European monetary system without any break during the two years preceding the examination of the situation and 2 There are differing perceptions as to what exactly constitutes a financial conglomerate. of rules or laws governing.Business Law Paper – European Financial System – Teodora Cristina Stan @ 2009 between traditional financial products and financial institutions and.1. alternatively. examines compliance with budgetary discipline on the basis of the following two criteria: the annual government deficit: the ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3% at the end of the preceding financial year. but also the activities in which banks can become involved. There are four of them (price stability. If this is not the case. the establishment of financial conglomerates2.

d. Also. In practice. 9 . the nominal long-term interest rate must not exceed by more than 2 percentage points that of. The credit rating agencies perform similar work to consumer credit bureaus.) Long-term interest rates. the three best-performing Member States in terms of price stability (that is to say. particularly their ability to meet the interest and principal payments on their bonds and other debt.. Meanwhile. the interest rate demanded by investors on a given debt issue is inversely correlated with the creditworthiness of the borrower: stronger borrowers pay less. it must not have devalued its currency on its own initiative during the same period. Investors’ confidence in borrowers’ ability to meet their payment obligations is highly influenced by the rating agencies’ analyses. The period taken into consideration is the year preceding the examination of the situation in the Member State concerned. both domestic and foreign. the same Member States as those in the case of the price stability criterion). The credit scores that the latter produce for individuals similarly influence the rates of interest at which individuals may borrow. The Treaty stipulates: "the durability of convergence achieved by the Member State . being reflected in the long-term interest-rate levels". at most. RATING AGENCIES Rating agencies assess the financial strength of companies and governmental entities. The rating for a given debt issue reflects the agency’s degree of confidence that the borrower will be able to meet its promised payments of interest and principal as scheduled. III. The rating for a given debt issue may differ somewhat from the overall credit rating for the issuer.. Debt issues with the highest credit ratings from the agencies will incur the lowest interest rates. depending on its specific terms.Business Law Paper – European Financial System – Teodora Cristina Stan @ 2009 without severe tensions. weaker borrowers pay more. After transition to stage three of EMU. Rating agencies also carefully study the terms and conditions of each specific debt issue. the European Monetary System was replaced by the new exchange-rate mechanism (ERM II).

Japan and US. Once each bank has been assessed by the supervisors it is given a “risk profile”. The proposed changes request banks to hold a higher amount of capital against the risk of failure and introduce a new coordinated. Switzerland. Italy. part of the Bank for International Settlements (BIS). Internationally. There are all sorts of financial instruments available by which credit institutions can guard against risk. rules are set by the Basel committee. BASEL II AND THE CAPITAL REQUIREMENTS DIRECTIVES Rules on capital requirements are designed to protect savers and investors from the risk of the failure or bankruptcy of banks. The Capital Requirements Directives were adopted in 2006 and are currently under review. Luxembourg. According to EU official figures. France. UK. In June 2004. On this committee sit representatives from Belgium. Capital adequacy rules set down the amount of capital a bank or credit institution (CI) must hold. The European Commission in October 2008 presented a review of the rules in place. This amount is based on risk. The current EU regime is contained in two directives: Directive 2006/48/EC on the “taking up and pursuit of the business of credit institutions” and Directive 2006/49/EC on the “capital adequacy of investment firms and credit institutions”. Canada. Spain. the Commission set out proposals for a new Capital Requirements Directive (CRD) which would apply Basel II to all banks. holding two thirds of total EU bank assets. although cumbersome. such as derivatives. These had to be applied in the EU and in July 2004. corporate bonds and asset-backed securities.Business Law Paper – European Financial System – Teodora Cristina Stan @ 2009 IV. The rules are enforced by supervisors who check on how much risk is being run and measure how much capital is required to underwrite that risk. 10 . The first set of international rules was known as Basel I. in October 2008 there were in Europe 44 crossborder institutes. They ensure that these institutions hold a minimum amount of capital. Netherlands. supervisory process for cross-border EU banks. futures. the Basel committee agreed updated rules . Germany. Sweden. CI’s and investment firms in the EU.Basel II.

Banks become reluctant to grant loans 3 stock market (stock exchange) = a place where stocks. infrastructure. THE PRESENT FINANCIAL CRISIS The present financial crisis is the outburst of tensions accumulated in time in the banking and financial systems. and governments in even the wealthiest nations have had to come up with rescue packages to bail out4 their financial systems. bonds. Most of the 20th century crisis may be set in the following framework: 1. 4 bail out is a term used to describe a situation where a bankrupt or nearly bankrupt entity. According to adverse selection and moral hazard. Expectations of interest rates’ increase. 2. V.Business Law Paper – European Financial System – Teodora Cristina Stan @ 2009 The proposal has been agreed by the European Parliament in May 2009 and later by the Council. the financial world has experienced a certain degree of stability. brewing for a while. allowing financial intermediaries to perform in a relatively undisturbed environment. either because of a shrink in the loan supply or as a result of an increase of loan demand. Around the world stock markets 3 have fallen. in order to meet its short term obligations. The unusual move reflected the particular conditions of international financial markets hit by the worst crisis since the '30s. borrowers engaging in low risk investments will renounce contracting loans. Even before the vote in the Parliament. For a considerable time. securitization and managers' remunerations. As interests start having an upward trend. But reaching stability on financial markets means an undivided attention to all the details concerning institutions. or other securities are bought and sold. While the initiative still waits for a green light from member states. such as a corporation or a bank. Decline of stock prices. in order to allow banks to have higher "liquidity buffers" in new crisis. the Commission proposed a new review of the directives to take into account risks related to trade books. 11 . large financial institutions have collapsed or been bought out. the Council has proposed tougher rules for granting loans in periods of economic growth. and environment. while high risk investors will continue to increase their demand for high interest loans. A decline in the assets’ market value means a decline of the value of collateral. really started to show its effects in the middle of 2007 and into 2008. markets. is given a fresh injection of liquidity. impeding the lending activity of banks. The global financial crisis. debtors engaging in risky projects are the most inclined to accept high interest rates. jeopardizing the financial position of the banks.

Though the economic financial crisis is far from being solved. and eventually it will end there. international financial institutions. high interest loans. housing and mortgage and to increasing the cost of debts. Unanticipated reduction of prices inducing a reduction of assets’ value. as an alternative. bankers and policy makers are struggling to see the way out of this mess. The financial crisis began in the credit markets. investments and consumption shrink reducing the economic activity. The present crisis determinants are located in a worldwide scenario and are connected in their mostly recurrent part to the unsolved monetary issues. Under bank failure the intermediation shrinks. Bank panic. monetary authorities) must cooperate. and no obvious solutions can be given until the last part would have been played. market regulators. As a consequence. 3. savings are withdrawn. But as the financial industry leaves behind one of the most wrenching years in its history. The bankruptcy of financial institutions determines a stock crunch and the inability of lenders to judge the quality of borrowers.Business Law Paper – European Financial System – Teodora Cristina Stan @ 2009 bearing low value collateral thus raising the cost of lending. The impossibility to solve moral hazard problems leads to more expensive loans reducing investments and aggregate economic activities. 12 . reducing the available lending funds and restraining the economic activity. the low level of assets means a decline in the stocks’ price high risk borrowers being induced to accept. 4. Increase of uncertainty. it is mandatory that the international community (governments. Moreover. 5.

ro/Masterate/Master_Rodica/Curs_1_Introducere %2520in%2520Sistemul%2520Financiar %2520European.Business Law Paper – European Financial System – Teodora Cristina Stan @ 2009 VI.com/topic/european-central-bank http://europa.com/doc/8439019/PptWorld-Economics-Crisis (Present Financial Crisis) http://www.scribd.129.eu/legislation_summaries/index_en.euractiv.85.html http://www.finint.htm (EU Legislation) BOOK) 13 . THE POST-EURO FINANCIAL SERVICES MARKET IN EUROPE.ppt+sistemul+financiar+european&cd=1&hl=ro&ct=clnk&gl=ro http://facultate.WALTER.pdf http://www.ase.74/7Omilies-parousiaseis/UplFiles/omilies/secgen/Gortsos13-9-2004.43.132/search? q=cache:x8w3L0Q_BToJ:www.int/ (European Central Bank) http://www. LAURA MARIANA CISMAS (ONLINE Web Support: http://209.1.regielive. N. BIBLIOGRAPHY Books: • • ENCICLOPEDIA UNIUNII EUROPENE. EDITURA MERONIA. LILIANA EVA DONATH. BUCUREŞTI.answers.com/en/financial-services/basel-ii-pital-requirements-directives/article141423 (Basel II & CRD) http://62. 2007 2000 • THE ROMANIAN ECONOMIC JOURNAL THE CURRENT FINANCIAL CRISIS REVISITED.ro/referate/finante/elemente_de_sistem_financiar_public-92197.ecb.

com/ 14 .about.htm (Rating Agencies) http://encyclopedia.Business Law Paper – European Financial System – Teodora Cristina Stan @ 2009 http://financecareers.thefreedictionary.com/od/ratingagencies/a/ratingagencies.

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