Tunis Business School

Why are Financial Institutions Special ?

Management of Financial Institutions

Dr. Yosra Ghabri
Spring 2024

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Learning Objectives
You should understand:

◼ Understand the fundamental concepts of financial

institutions management.

◼ The special role of FIs in the financial system and the

functions they provide.

◼ The difference between depository and non-depository

institutions.

◼ Why the various FIs receive special regulatory attention.

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Overview on the Financial System
Financial System

Lenders
Financial Financial Financial
(savers) &
Intermediaries Instruments Markets
Borrowers

Exchange, Money/capital
Equities
Broker, Dealer, Primary/Second
Individual & Fixed income
Bank, ary
institutional Pooled
Insurance, Traditional/Altern
investments
Arbitrageur, ative Derivatives

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Financial System includes:
◼ Lenders and borrowers: Individual and institutional investors.

◼ Financial intermediaries: linking lenders and borrowers:

Brokers, dealers, exchanges, investment banks, depository
institutions, insurances, arbitrageurs.
◼ Financial instruments: Short and long term financial assets:
Equities (private and public), Fixed income, pooled
investments and derivatives.
◼ Financial markets: Money/Capital, Primary/Secondary,
Traditional/Alternative markets, Exchange/Over the counter.

◼ Financial system is where assets and risks are transferred from

one entity to another (from saver to borrower), from one
place to another.

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 Financial Institutions (Intermediaries)

Financial Institutions

Depository
institutions Non-Depository institutions

Commercial Insurance Securities Finance

bank & Mutual funds
companies firms companies
Thrifts

Accept
deposits Open/Closed-
Property and Consumer
Provide Investment end funds
casualty finance
consumer, banks
insurance Hedge funds Business
business and Brokerages
mortgage Life insurance Pension funds finance
loans

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Financial Institutions include:

◼ Depository institutions: Their primary source of funding is the

deposits of savers. We have: Commercial banks and thrifts (Savings
institutions, Credit Unions).

✓ Commercial bank: Bank that accepts deposits, offers checking accounts,

makes business, personal (consumer) and mortgage loans, and offers basic
financial products (i.e. CDs), credit cards, and wealth management (offer
investment solution to preserve and increase saved wealth).
✓ Savings and Loans Association (S&L A): Accepts deposits for savings (no
checking), offers loans, mainly residential mortgage, some commercial (up
to 20%) and non-mortgage consumer loans. They started offering quite
similar services to commercial banks recently, due to banking
deregulations (relaxing and reducing some old regulations).

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✓ Credit Unions: Are nonprofit depository institutions that are
financial cooperatives owned by people belonging to a
particular group, such as the employees of a particular
company, a union, or a religious group, or who live in a
specific area such as a county, and they are governed by a
board of volunteers. Because they are nonprofits, they charge
lower interest on loans.

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◼ Insurance companies:
Insurance companies protect their customers from the financial distress that
can be caused by unforeseen events, such as accidents or premature death.
They pool the small premiums of the insured to pay the larger claims to those
who have losses. The premium payments are regular while the losses are
irregular, both in timing and amount (we can’t control accident timing and
costs).
Common types of insurances:

✓ Property and casualty insurance: Protection against damage or loss to

property or people caused by accidents, natural disasters, or from the
action of others (i.e. car insurance, fire insurance etc.).
✓ Life insurance: Insurance that pays a specified amount to the beneficiary,
when the insured person dies.

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◼ Securities firms:
Investment banks and Brokerages are the major types of
securities firms:
✓ Investment Banks: intermediaries helping firms raise funds
by issuing securities in the primary market. They’re mostly
helping in providing funding.
✓ Brokerages: intermediaries operating in the secondary
markets helping in trade of existing securities. They’re mostly
helping in providing liquidity.

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◼ Mutual funds:

Are financial intermediaries that pool the financial resources of individuals

and companies and invest in diversified portfolios of assets. There are:
✓ Open-end funds: Issuer can still issue new shares, and redeem (buy back)
existing shares.
✓ Closed-end funds: Issuer can issue shares once, and cannot issue new
shares. The shares are only exchanged among investors.
✓ Hedge funds: Reserved for wealthy investors. Hedge fund invests with
leverage (debt) and takes high risks.
✓ Pension funds: funds reserved for retirement. Participants are both the
employees and the employer. They feed the fund and invest the proceed.
Employees will get their share of pension on retirement.
✓ Sovereign Wealth Fund SWF: A state-owned investment fund. A fund that
is run by the state.

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◼ Finance companies :

They provide :

✓ Consumer finance: Offering store credit: buy now, pay later.

✓ Business finance: Financing equipment purchase or lease.

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 Flow of funds without FIs

▪ Savings would flow from households to corporations.

▪ In return, financial claims (equity and debt securities) would flow
from corporations to household savers.

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 Without FIs
◼ Without FIS, excessive savings could only:
✓ Be held in cash
✓ Invested in corporate securities
◼ Flow of funds would likely be low because of:
✓ Monitoring costs: associated with the time and cost for households to
collect high quality information.
✓ Liquidity costs: because of the long-term nature of corporate equity and
debt, and the lack of secondary market in which households can sell these
securities.
✓ Price risk: even if financial markets existed, investors face a price risk; that
is, the selling price would differ from the initial price paid on.

Fis usually resolve these problems.

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 With FIs

FIs are the indirect way (‘the intermediary’) to channel

household savings to the corporate sector

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Functions of FIs

Functions of FIs

Brokers Asset Transformers

Provide
Purchase
Information Sell secondary
primary
and Trade securities
securities
services
 Functions of FIs
They fulfil two functions:
◼ Brokerage function:

Acting as an agent for investors:

- Reduce costs through economies of scale (providing info and
transaction services).
- Encourages higher rate of savings.
◼ Asset transformer (Intermediation) function: Purchasing
primary securities issued by corporations and profitably
transform them into secondary securities more attractive to
household savers.

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 FIs Areas of specialness

Special Features

Transmission
Lower costs of Monetary
Maturity Supply
both Higher Lower price Intermediation
Informational liquidity risk Fed
& FIs handle monetary
Available lower risk of
Transactional mismatching policy
cash and market value
ST and LT channel
Economies of liquid assets depreciation
maturities (Dep.
scale
Institutions)
◼ Information costs: An investor would spend to get
information on the investment venue, the strategy and the
management.
✓ A FI, such as a bank would do that for their clients. The clients
just need to deposit the funds with the bank, and delegates
the bank to look for the necessary information for them (and
monitor it constantly) and invest appropriately, at lower
informational costs (clients will be benefiting from economies
of scale).

◼ Transaction cost services: Similar to economies of scale in

information production costs, a FI’s size can result in
economies of scale in transaction costs.
✓ Bid-ask spreads narrower for assets bought and sold in large
quantities. 18
◼ Liquidity and Price Risk:
✓ Household savers have a claim on their deposits (or asset
purchase) with the FI anytime. FI offers superior liquidity
attributes (fund available) and a lower price risk (risk of asset
market price dropping below purchase price).

✓ Ability to diversify some of existing portfolio risks.

Overall, as long as FI is sufficiently large to gain from

diversification & monitoring, its financial claims are likely to be
viewed as liquid & attractive to small savers compared to direct
investments in the capital market.

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◼ Maturity intermediation:

✓ FIs can better bear the risk of mismatching the maturities of

their assets and liabilities. That risk is called interest rate risk.

◼ Transmission of Monetary Supply:

FIs have a role in the Monetary supply. FIs when giving loans and
credits, they create money.

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 Other aspects of specialness

Special Features

Payment
Credit Denomination
Services Intergenerational
Allocation Intermediation Wealth Transfer
Electronic
Sources of Ownership in Through Trust
transfer check,
financing to the large services
credit cards,
economy denominations
Exchange
◼ Credit allocation:
- FIs are the major source of finance in particular sectors of an
economy (residential real estate and agriculture sector).

◼ Payment services: Important payment services are provided

(cheques, debit cards and high-volume payments, credits card
(MasterCard and Visa).

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◼ Denomination intermediation:
- Many assets are sold in very large denominations, putting them
out of reach for individual savers
- Money market managed funds, debt-equity managed funds
give individual indirect access to large denomination markets.

◼ Intergenerational wealth transfer or time intermediation:

Wealth transfer b/w youth and old age facilitated through: life
insurance and pension funds.

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 Regulation of Financial Institutions

◼ FIs are heavily regulated to protect society at large from

market failures.
◼ Regulations impose a burden on FIs and before the
financial crisis, recent U.S. regulatory changes were
deregulatory in nature.
◼ Regulators attempt to maximize social welfare while
minimizing the burden imposed by regulation.
Specialness and Regulations
What if FIs fail to provide adequate services?

Negative externalities Discriminatory actions

If FI fails, economic agents will

suffer consequences
Bank: Savings affected, less
access to financing
Insurance: holders exposed
Discrimination based on racial,
gender, age, and geographical
location (redlining)
Predatory lending

Necessity for regulations

FIs are special because of the various services they provide to
sectors of the economy. Failure to provide these services cause:

1-Negative externalities: When a FI fails, economic agents

(individual and business) established in the same community and
dependent on that FI, will suffer large costs.
The businesses for instance could find it difficult to get financing
elsewhere, and their customers could be similarly
disadvantaged.

◼ Bank failure may destroy household savings and restricts a

firm’s access to credit.
◼ Insurance company failure may leave households exposed in
old age to catastrophic illnesses and sudden drops in income
on retirement.
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2-Discriminatory actions: Racial, gender, age, geographical
location or other discrimination, such as mortgage redlining,
would unfairly exclude some potential financial service
consumers from the marketplace.
◼ Redlining: Is the procedure by which a banker refuses to make
loans to residents living in a given geographic “red taped”
(banned) region.
◼ Predatory lending: Unethical lending on the basis of
misleading, deception and fraudulence, to those less
informed and possibly less educated.

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Specialness and Regulations
Types of Regulations

2-Monetary policy 3-Credit allocation

1-Safety and regulation:
Soundness regulation:
regulation: Impose minimum Support socially
reserve requirement important sectors
-Encourage with Fed:
diversification - (housing, farming)
Impose min capital -to avoid bank run QTL test: 65% assets
-Monitor operations -to help in monetary in residential housings
-Establish guarantee supply Limits interest rates
funds on loans and deposits
Outside/Inside money
That’s where regulations come into the picture:
◼ To protect ultimate sources and users of savings against unfair practices.

◼ To insure the soundness of the financial system as a whole.

There are 5 types of regulations:

1-Safety and soundness regulation:

A set of regulations that:

◼ Allow and encourage for assets diversification.
◼ Impose minimum capital requirements for safety.
◼ Provide guarantee funds: Deposit insurance fund (DIF), Securities
Investors Protection Fund (SIPC).

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2-Monetary policy regulation:

Federal Reserve directly controls outside money. FIs hold inside money.
◼ Outside money: The part of the money supply directly produced by the
government or central bank (Fed), such as notes and coins.
◼ Inside money: The part of the money supply held by the private banking
system (deposits).

Regulators imposed minimum reserve requirements (with the Fed) against

deposits:
◼ To meet liquidity requirements and avoid bank runs.

Bank run occurs when a large number of people withdraw their money from
a bank.
◼ To help in transmission of monetary policy: When enough money is in
reserve, Fed can exercise an expansionary monetary policy when needed.

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3-Credit allocation regulation:

◼ Regulation to support socially important sectors such as

housing and farming. They require allocating minimum
amounts of assets in particular sectors.
Qualified Thrift Lender Test (QTL): 65 % of assets in residential
mortgages.

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Specialness and Regulations
Types of Regulations

5-Investor protection
regulation:

Protection against abuses such

4-Consumer protection regulation: as insider trading, lack of
Preventing discrimination (age, disclosure, ..
gender, income) and redlining Securities Act 1933: make
(geographic location) information available, no
misrepresentation
Securities Act 1934: register
with SEC, transparent
disclosure
The Changing Dynamics of Specialness

New Trends

More pension
funds and
Increase in investment
Financial companies
Decline in Holding (Mutual
Services E-Trading
share of Funds)
depository Companies Direct trading
Lower fees,
institutions More at a lower cost
cheaper
diversified access to
services larger
securities
denominations
New trends can be seen in:

◼ Decline in share of depository institutions due to recent violations of rules

and high regulatory burden imposed on depository FIs. Some went
bankrupt and some have merged.
◼ Financial Services Modernization Act FSMA (1999) alleviated those
regulatory burdens incurred by FIs, by allowing more activities once
registering as Financial holding companies (companies that offer both
banking and non-banking services, i.e. selling insurances, underwriting
securities issues). As a result, profit got larger and regulatory burden got
lower.
◼ Increase in pension funds, mutual funds and investment companies due to
low entry fees, cheaper access to securities market, and a more diverse
investment portfolio (all kinds of securities and maturities).
◼ E-trading (direct trading) is dramatically reducing transaction costs
(brokerage fees).

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Global Issues

◼ Incresed competition from foreign FIs at

home and abroad.
◼ Mergers involving world’s largest banks.

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36
Total assets of financial institutions in the U.S
from 2002 to 2021

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Tunisian Financial Markets and Banking
System
◼ The Tunisian Financial system is a bank
oriented system. The Tunisian bank sector
supply more than 60% of funds to the economy.
◼ Despite the government encouragements, the
stock exchange markets is still not fulfilling its
functions.
◼ The Central Bank of Tunisia is the regulator
authority of the banking system.

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 Central Bank of Tunisia

Depository and
Non Depository Banks with Offices of Foreign Banks
Off Shore Banks (8)
Institutions particular status Representation

Commercial Banks Non Depository

(23) Institutions (15)

Private Banks:
BIAT, Amen,
Zitouna, El Public Banks:
Baraka, Al STB, BNA, BH,
Wifak, Attijari, BFPME, BTS,
ATB, ABC, BTK,
BT, BFT, QNB,
Citi Bank, UBCI,
UIB, BTL, BTE,
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TSB
 Central Bank of Tunisia

Depository and
Non Depository Banks with Offices of Foreign Banks
Off Shore Banks (8)
Institutions particular status Representation

Commercial Banks Non Depository

(23) Institutions (15)

Finance companies (11)

Tunisie Leasing, Aran Factoring Investment Banks
International Lease, Attijari Companies (2): (2):
Leasing,Best Lease, CiL Tunisie IMM Bank
Lease, El Wifeck Leasing, factoring, CAP bank
Hannibal Lease, UBCI Unifactor
leasing, International
leasing service, Modern
leasing
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 Central Bank of Tunisia

Depository and
Non Depository Banks with Offices of Foreign Banks
Off Shore Banks (7)
Institutions particular status Representation

Commercial Banks Non Depository

(23) Institutions (15)

Best Bank, NAIB

Bank, ALUBAF, TIB,
LINC, Citi Bank, ABC

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 Central Bank of Tunisia

Depository and
Non Depository Banks with Offices of Foreign Banks
Off Shore Banks (7)
Institutions particular status Representation (6)

Commercial Banks Non Depository

(23) Institutions (15)
- AGENCE FRANÇAISE DE
DEVELOPPEMENT ET PROPARCO
- AMERICAN EXPRESS TUNISIE
- BANCA MONTE DEI PASCHI DI
SIENA
- CREDIT INDUSTRIEL ET
COMMERCIAL (CIC-BANQUES)
- ICCREA BANCAIMPRESA S.P.A
- THE ARAB INVESTMENT COMPANY

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