Financial Markets and Banking Evolution: Concepts, Regulation, and Liberalization

Financial Market Fundamentals

Core Concepts

• Objectives: Facilitate capital flow between lenders and borrowers.
• Key Elements:
  • Risk: Inherent uncertainty in financial transactions.
  • Governmental Intervention: Policies to ensure system health and stability.
  • Liberalization: Deregulation and changes in government rules.

Bonds Explained

• Characteristics: Nominal value, amortization schedule, associated risk, fixed interest rates.

Market Types

• By Term: Short-term or long-term.
• By Issuance: Primary (new issues) or secondary (trading existing securities).
• By Geography: Domestic or international.

Global Financial Regulation & History

Post-Recession Regulation

• International Regulation: Efforts to stabilize the global financial system after the Great Recession.
• United States: Commercial banks were prohibited from participating in investment banking activities.

Bretton Woods Agreement (1944)

The Bretton Woods Agreement, an outcome of the 1944 United Nations Monetary and Financial Conference among the world's most industrialized countries, shaped the post-war financial order.

• Keynes' Proposal (UK): Advocated for surplus countries to assist more affected nations.
• U.S. Proposal: Ultimately adopted, demonstrating U.S. global hegemony.
• Institutions Created: The World Bank, the International Monetary Fund (IMF), and the World Trade Organization (WTO).
• Currency Standard: The U.S. dollar was established as the international reserve currency, replacing the gold standard.

Banking Systems & Evolution

Spanish Banking Regulation

• Historical Context:
  • Regulation of Cajas (savings banks).
  • Mix between banking and industry.
  • Nationalization of Spanish official banks.
  • Low interest rates to benefit industry.

Bank Classifications

By Function

• Commercial Banks: Provide financing, receive deposits, issue loans, and receive support from the central bank.
• Investment Banks: Assist in securing financing, offer financial advice, and sell securities on behalf of borrowers.
• Universal Banks: Combine both commercial and investment banking functions (e.g., Bank of America).

By Ownership Structure

• Commercial/Investment Banks: Often publicly listed companies (PLCs) divided into shares, with dividends paid to owners.
• Savings Banks: Non-profit organizations with no shares. Profits are legally allocated to social spending or reserves.

Financial Liberalization Post-1970

The period after 1970 saw significant shifts in financial markets:

• End of Bretton Woods (1971): Led to flexible exchange rate markets.
• Nixon Shock: U.S. President Nixon devalued the dollar due to a trade balance deficit.
• Banking Separation: Commercial and investment banking functions became separated.
• Savings Bank Crisis: A period of instability for savings banks.

Understanding Shadow Banking

Shadow banking refers to financial intermediaries that channel funds from savers to borrowers through debt. Key characteristics include:

• Regulation: Not regulated by the same bodies as traditional banks, which face more stringent oversight.
• Financing: Provides indirect financing and has grown significantly compared to traditional banking.
• Investment Horizon: Often invests in long-term assets (e.g., over 7 years), incurring higher risk and potentially higher costs.
• Support: Lacks central bank or Federal Reserve support, making it more vulnerable during crises.

Spanish Financial Sector Liberalization

Key Reforms and Impacts

• Liberalization in Spain led to the creation of the IBEX 35 stock market index.
• Banks were no longer bound to industrial holdings.
• Savings banks were restricted to operating within their provinces until 1989.
• European banks gained full access to the Spanish market by 1993.

Banking Mergers and Regional Impact

During this period, banks did not cooperate extensively with industry, and interest rates remained low. Significant mergers occurred, such as those involving BBV and Argentaria. For regions like the Basque Country, these mergers were perceived as a loss of autonomy.