Deck 14: Shadow Banking, Finance Companies and Diversified Financial Firms, Venture Capital, Crowdfunding, and Microfinance

Question 1

Discuss new regulations under the U.S. Dodd-Frank Act and Basel III to reduce the risk of very large non-bank financial institutions as well as large financial services firm.

Answer 1

New regulations under the U.S. Dodd-Frank Act of 2010 and under Basel III have been established to reduce the risk of very large non-bank financial institutions, as well as extremely large financial services firms. Under Dodd-Frank, the Financial Oversight Council (FSOC) was established and is required to supervise and regulate non-bank SIFS (systematically important financial institutions) that have systemic risk because of their size, interconnectedness, leverage, liquidity, risk and maturity mismatch, as well as lack of a substitute and lack of existing regulation. Evaluation criteria initially include: (1) if they have consolidated assets greater than $50 billion; (2) Credit Default Swaps (CDS) outstanding that are greater than $30 billion; (3) Net derivative liabilities greater than $3.5 billion; (4) Total debt outstanding greater than $20 billion; (5) A leverage ratio greater than 15 to 1; and (6) a short-term debt ratio greater than 10 percent. A company meeting these thresholds is subject to further tests to see if it is systematic. Even if a non-bank is not given a SIFS designation, it may still be under greater scrutiny by other regulators including the Consumer Financial Protection Bureau or state financial regulators as it gets larger, and all non-banks are subject to the Truth in Lending Act (TILA) and other consumer protection acts. There has also been concern over non-banks with large amounts of short-term wholesale funding, such as tri-party repos, with proposals to limit this type of liquidity risk.

Question 2

Discuss reasons for the growth of larger and larger financial institutions and why regulators have been concerned about the ability to manage large financial institutions.

Answer 2

With the growth of technology, it became easier for larger and larger financial institutions to be managed under one umbrella. Also with deregulation, such as in the U.S. with the passage of the Gramm Leach Bliley Act of 1999 (allowing banks, insurance, investment and security firms to operate under the same umbrella), more than 640 bank holding companies elected to become financial holding companies (FHCs) to become diversified financial firms. Many financial services firms started out as finance companies, while others began with the merger of several finance, insurance, and investment companies over a decade. With cultural, regulatory, and other country differences, management complexity increases. Regulators have been concerned about the challenges of corporate control and risk management for diversified financial companies. Since a number of huge financial services firms having severe liquidity problems and were on the brink of bankruptcy during the Subprime Crisis and the Global Recession, concerns have increased about too big to manage and too big to fail institutions.

Question 3

Discuss FinTech and advantages and disadvantages suggested by Wolfe (2016).

Answer 3

The term "shadow banking" today encompasses any financial intermediaries that engage in bank-like activities but are not regulated and do not have access to deposit insurance or a central bank for liquidity. The term "shadow bank" was coined in 2007 by Paul McCulley to describe the special investment vehicles (SIVs) used by banks to sell loans that were repackaged as bonds and mortgage-backed securities. Non-bank shadow banks include hedge funds, finance companies, asset-backed commercial paper (ABCP) conduits, special investment vehicles (SIVs), credit hedge funds, money market mutual funds, securities lenders, limited purpose finance companies (LPFCs), and government-sponsored enterprises (GSEs), pawn shops, among many others.
This term has expanded to include what is often called FinTech firms. With new disruptive technology, different players are included from mobile payment systems to pawnshop to bond-trading platforms, peer to peer (P2P) lending websites, and other mortgage loans websites, such as Rocket Mortgages on Quicken Loans. Technology firms have rapidly entered the payments arena as well.
As noted by Wolfe (2016), new technology can help make markets more efficient and transparent by: (1) allowing for instantaneous settlement for payments with improvement in the "robustness of record keeping that could revolutionize domestic and foreign payments;" (2) transforming lending using peer-to peer (P2P) lending, a form of disintermediation by matching savers with investments, including equity crowdfunding, invoice trading, P2P consumer and business lending, and others; and
(3) serving as a potential source of transformation via "big data." However, opportunities for malfeasance could also occur, with transactions that rest on promises against an inherently uncertain future.

Question 4

What are shadow banks and how rapidly have they grown? Discuss concerns and advantages of shadow banking.

Question 5

Discuss different types of finance companies.

Question 6

Compare finance companies balance sheet to those of banks and discuss differences between finance companies and banks.

Question 7

Give an overview of crowdfunding and new U.S. regulations, concerns, and crowdfunding used for good causes.

Question 8

Discuss microfinance and well-known microfinance organizations and trends.

Question 9

Discuss reasons for the development of financial conglomerates.

Question 10

Discuss venture capital firms and how returns expected on investments.

Question 11

Give a brief overview of credit card companies.

Question 12

Discuss government-sponsored enterprises in the U.S. as part of the shadow banking system.

Question 13

Factors affecting the growth of larger and larger diverse financial institutions include which of the following:

A) The growth of technology making it easier for larger diverse financial institutions to be managed under one umbrella
B) Deregulation including the passage of the Gramm Leach Bliley Act of 1999 allowing banks, investment, and security firms to operate under the same bank or financial holding company
C) Economies of scale and scope
D) All of the above

Question 14

Which of the following is false concerning a systematically important financial institution (SIF)?

A) In the U.S. under the Dodd-Frank Act, the Financial Stability Oversight Council (FSOC) was established and is required to supervise and regulate non-bank SIFs.
B) SIFs do not include insurance companies, investment banks, or finance companies.
C) A systematically important financial institution can be a bank, insurance company or other financial institution whose failure could trigger a financial crisis.
D) SIFs may have systemic risk because of their size, interconnectedness, leverage, liquidity, risk and maturity mismatch, as well as lack of a substitute or lack of existing regulation.
E) SIFs are supervised more closely and may be potentially required to have higher safety margins, such as higher levels of capital to assets ratios and be subject to future limitations on their activities.

Question 15

Evaluation criteria for SIFs by U.S. FSOC financial regulators include:

A) Having consolidate assets $50 billion or more in assets.
B) Having credit default swaps (CDS) outstanding > $30 billion
C) Making large commercial loans over $1 billion
D) Net derivative liabilities > $3.5 billion
E) A leverage ratio of greater than 15 to 1

Question 16

Which of the following is false about shadow banking?

A) The term "shadow banking" encompasses any financial intermediaries that engage in bank-like activities but are not regulated and do not have access to deposit insurance or a central bank for liquidity.
B) Today shadow banks have about $15 trillion in assets.
C) Non-bank shadow banks include hedge funds, finance companies, asset-backed commercial paper (ABCP) conduits, special investment vehicles (SIVs), hedge funds, securities lenders, limited purpose finance companies, government-sponsored enterprises (GSEs), and pawn shops, among others.
D) Non-bank FinTech firms are not shadow banks.

Question 17

Which of the following is false about FinTech firms?

A) FinTech firms have the potential for allowing for instantaneous settlement for payments improving record keeping and revolutionizing domestic and foreign payments.
B) FinTech firms offer a transformation via peer to peer (P2P) lending as a form of disintermediation by matching savers with investments including equity crowdfunding, invoice trading, P2P consumer and business lending, among others.
C) Opportunities for malfeasance can occur as part of the nature of financial intermediation with transactions resting on cash flows promised in an uncertain future.
D) Advantages for borrowers and investors with P2P lending and other FinTech platforms could be a greater availability of funds with fewer regulations and capital requirements and low overhead that could allow for better rates.
E) Traditional financial institutions are not concerned about the competition from FinTech firms.

Question 18

Differences for finance companies and commercial banks include:

A) Finance companies are less regulated.
B) Finance companies do not have deposits.
C) Finance companies frequently take on more risky customers that would not qualify for bank loans and charge higher rates.
D) Finance companies have less interest rate and liquidity risk.
E) All of the above.

Question 19

Finance company types include which of the following:

A) Consumer and captive finance companies
B) Commercial finance companies
C) Industrial loan companies
D) Diversified finance companies
E) All of the above

Question 20

Which of the following is false about finance companies?

A) Loans for finance companies are often referred to on balance sheets as Receivables.
B) Short-term Loans for finance companies are often financed by bank loans and commercial paper.
C) Finance companies do not issue debentures.
D) Total equity to asset ratios for finance companies are typically higher than banks.
E) All of the above are true.

Question 21

Which of the following is false about credit card companies?

A) Credit card companies are finance companies that issue credit cards to
Consumers and businesses.
B) Credit card companies do not securitize credit card loans.
C) Many credit card companies operate internationally and are very profitable issuing specialty credit cards, purchasing consumer loans from financial institutions.
D) Many consumer finance companies entered the credit card business to supplement personal cash loans, with most joining the Visa and MasterCard networks.
E) All of the above are true.

Question 22

Which of the following is false about Government Sponsored Enterprises (GSEs) and mortgage banks?

A) GSEs have greater interest rate risk than depository institutions.
B) GSEs and other large mortgage banks originate loans and sell or securitize these loans, receiving a profit.
C) More risky loans can be brought to the market by obtaining sufficient credit enhancement from other institutions involved in the securitization process, providing the securities with a higher credit rating.
D) U.S. GSEs including the Federal Home Loan Bank, the Federal National Mortgage Corporation, and the Government National Mortgage Association.
E) GSEs are funded through capital markets by issuing short and long-term agency debt securities.

Question 23

Advantages of having GSEs in an economy include which of the following:

A) Providing a critical role in the housing finance system by providing large-scale access to affordable mortgage credit, so individuals can buy, refinance, or rent homes.
B) Providing liquidity for banks and savings institutions by purchasing loans, allowing new loans to be made.
C) Issuing single family mortgage-related securities in the secondary market, providing a source of liquidity for the multifamily market.
D) At times assisting families in distress to keep their homes and avoid foreclosure through loan workouts and modifications.
E) All of the above.

Question 24

Which of the following is false about non-venture private equity firm, i.e. hedge funds?

A) Hedge funds invest in private firms with the goal of buying and turning companies around and increasing their value.
B) Hedge funds are a type of mutual fund that hedge using derivatives to reduce the volatility of the mutual fund.
C) Many non-venture private equity firms started out as leveraged buyout firms that provided debt and equity investments to help firms go private through leveraged buyouts or manager buyouts.
D) All of the above are true.

Question 25

Which of the following is false about venture capital firms?

A) Venture capital firms are organized as stock corporations with limited liability for all investors.
B) Venture capital firms provide seed capital, start-up capital, and later stage capital and temporary (bridge) financing.
C) VC firms invest in a portfolio of companies for investors willing to take the risk of investing in relatively new companies, with returns coming from harvesting companies in approximately 5 to 7 years by taking them public or selling them to a larger company or a manger buyout.
D) For VC firms, often some firms they invest in will fail, but a few star winners can compensate for losing firms, to generate a larger overall return for the portfolio of firms that are invested in.
E) All of the above are true.

Question 26

Which of the following is false about crowdfunding?

A) As of May 2016, under U.S. SEC rules under the JOBs Act, small investors are allowed to purchase shares of private companies on designated crowdfunding platforms.
B) Under new U.S. SEC rules companies can raise up to $10 million for a 12-month period through a crowdfunding campaign, but must provide potential investors with financial statements.
C) Under new U.S. SEC rules, entrepreneurs that raise less than $500,000 are allowed to provide specific information from their tax returns that are reviewed by an independent tax accountant.
D) Under U.S. SEC rules, the amount an unaccredited investor can invest depends on their income and net worth, with investors with an annual income or net worth < $100,000 only allowed to invest $2,000 a year or 5% of the lesser of their income or net worth, and investors with a net worth > $100,000 allowed to invest up to 10% or the lessor of their income or net worth.
E) Under SEC rules, the maximum investment that can be put into startups through online equity crowdfunding in any given year is $100,000.

Question 27

Which of the following is not a previously used model of crowdfunding?

A) A pre-order model where potential customers pre-order a product or service
B) A donation model where small funds are requested from individuals as donations
C) A financing model where large institutional investors provide million dollar investments
D) A reward-based model where providers of funds receive a reward
E) All of the above are true

Question 28

Concerns for crowdfunding and new SEC rules include which of the following:

A) How to protect investors who are unsophisticated from losing their savings to ventures that may be risky or unrealistic or may entail fraud or scams
B) That rules with complex provisions and requirements for compliance may create problems for unwary small business entrepreneurs that may deter them from using crowdfunding as a viable source for raising funds
C) How to expand crowdfunding capital markets that have been underutilized
D) All of the above

Question 29

Crowdfunding campaigns have also been used for the greater good including campaigns on Kickstarter, Indiegogo, Life, Catapult, Kiva, GlobalGiving, and Google's One Today platforms and apps.

Question 30

The purpose of microfinance is for the microfinance financial institution to become very profitable by investing in high gross profit entrepreneurs.

Question 31

Which of the following is false about microfinance?

A) The purpose of microfinance is to facilitate lending to micro and small entrepreneurs, building financial sectors that are closely interconnected with local economies, enabling the establishment of payment systems and new savings opportunities for households.
B) Microfinance institutions today include thousands of providers in different stages of operational development and different legal statuses.
C) It is important that financial services providers operate profitably and effectively meet regulatory requirements, with professional structures and processes in accounting and risk management.
D) In 2015 about 500 institutions operated in microfinance worldwide for about 80 countries.
E) A trend for microfinance institutions is to move from a profit to a non-profit status.

Question 32

Which of the following is not a lesson learned for studies of the success and failure of different diversified financial services firm?

A) Diversification never works as a successful strategy.
B) Managing diversification is challenging especially with differences in business cultures, for instance an aggressive investment banking culture and a conservative traditional banking culture.
C) A large firm size doesn't always equate with efficiency, with some larger firms having difficulty exerting control over different divisions and having trouble with monitoring.
D) Without adequate risk management the benefits of diversification in terms of smoothing earnings and reducing risk can be lost.
E) Some customers may prefer financial services that are more specialized in different areas provided by niche financial institutions.