Advanced Finance Banking and Insurance

Exam 23 October 2018

1. A core function of the financial system is to improve resource allocation through financial
intermediation. An important market failure in financial intermediation stems from the
existence of asymmetric information.
a. Explain the difference between direct and indirect forms of financial intermediation.
b. Explain how ex ante and information asymmetry arises and how financial institutions
can mitigate it, giving one example for banking and one example for insurance.
c. Financial intermediation on bank balance sheets can be seen as ‘financing through
money creation’, which differs from the more traditional view that the financial system
‘intermediates between saving and investment’. What is the main difference between the
two views?
d. In what way can ‘financing through money creation’ contribute to the build-up of
financial imbalance in the financial system as a whole?

2. Investments in FinTech have grown rapidly since 2014. According to some, Fintech credit has
the potential to disrupt the whole of the value chain in credit provision, i.e. (1) Fintech
innovation related to customer acquisition and retention in credit markets; (2) credit
approval and the provision of credit and (3) the back office.
a. What is FinTech?
b. Analyse how FinTech innovations related credit provision could affect customer
acquisition and retention in credit markets. Give concrete examples of Fintech innovations
in this part of the value chain.
c. Analyse how FinTech innovations related to credit provision could affect credit
decisions. Give concrete examples of Fintech innovations in this part of the value chain.

3. The yield curve is a curve showing yields or interest rates at different maturities.
a. Explain how quantitative easing influences the yield curve.
b. Explain how conventional monetary policy influences the yield curve
c. Explain how forward guidance influences the yield curve
4. In the text book and lectures, different models are discussed, including: (1) the model by
Allen and Gale (1988) on bank runs and the business cycle; (2) the model by Holmstrom
(2010 and 2015) on information sensitive versus insensitive collateralised debt, and (3) the
model by Freixas and Rochet (2008) on delegating monitoring to banks.
a. Explain the research question, model set-up and main finding of Allen and Gale (1988).
b. While all three models have a different set-up, all three of them also discuss a common
theme. What is the common theme that recurs in all these three models?

5. In order to establish the relevant market, competition authorities use the concept of a
‘small, but significant non-transitory increase in prices’, which is also referred to as the
SSNIP methodology.
a. Why do competition authorities start their investigation into the possible abuse-of-
dominance with an analysis of the relevant market?
b. Explain how the SSNIP methodology works.
c. Explain the dilemma (or trade-off) that competition authorities face when assessing
state aid to a systemically important bank.
d. Explain the main principles for restructuring that the competition authority applies in
the case of state aid to a systemically important bank.

6. Consider the set-up below, which is a three party payment scheme. For each transaction,
the costs to American Express (AMEX) is 3 (c=3), the benefit for the buyer is 1 (bb=1) and the
benefit for the seller is 3 (bs=3). There are 10 buyers and 10 sellers, and each buyer makes
one transaction. This gives a maximum of 10 transactions. Each seller may accept a card but
all sellers always accept cash. The main question for American Express is to set prices to the
buyer (pb) and seller (ps) so that it maximizes profits.

a. What is a two-sided market?

b. Which prices for the buyer and seller will American Express set to maximize profits?
How high will total profits be?
c. Suppose that there is a social planner that wants to maximize total demand instead of
total profits under a zero profit constraint. Which prices will be set by the social planner?