AP/ECON 3430 3.0 A MONETARY ECONOMICS I: FINANCIAL MARKETS AND INSTITUTIONS Fall 2016 Topic 2A: Financial System Course Director: Prof. Brenda Spotton Visano © Brenda Spotton Visano 2016

© Brenda Spotton Visano 2016 Agenda Part 2A: Introduction to Function of Financial Systems Structure of the Financial System: Comparison of Canadian and Chinese Financial Systems Principles Guiding the Design and Operation of the Financial System Core Principles of Western Financial Systems Core Principles of Islamic Banking © Brenda Spotton Visano 2016

Functions of the Financial System What does the industry produce? Financial services (payments, credit, advice, risk management) Why? To facilitate the transfer of purchasing power from savers/lenders to spenders/borrowers Potential Benefits? Better allocation of productive resources within and across time © Brenda Spotton Visano 2016

© Brenda Spotton Visano 2016 Constituent Elements Financial Instruments Cash, bank account balances, loans, stocks, fixed income securities (bonds), derivatives Financial Markets direct “matching” of savers/lenders with spenders/borrowers (NASDAQ, TSX, NYSE, Shanghai SE) Financial Institutions (FIs) As Intermediaries, FIs indirectly match savers/lenders with spenders/borrowers © Brenda Spotton Visano 2016

Setting up Financial Markets and Institutions Who should own what? Public ownership: the state on behalf of everyone? Private ownership: Individuals? In private family trusts or publicly available to all via open trading? © Brenda Spotton Visano 2016

How Canada and China are answering these foundational questions © Brenda Spotton Visano 2016

% of GDP (concentration) Ownership % of GDP FINANCIAL SYSTEM  CANADA CHINA*   % of GDP (concentration) Ownership % of GDP FINANCIAL SERVICES INDUSTRY 500%+ (excluding direct finance) Private with some Public 232%* Public with some Private Direct Finance/ Markets - stock market (market cap of listed domestic companies) 103%# Joint-stock 75%# State owned - bond/fixed income market 115%+ XXX 41%* Central Bank Not applicable Bank of Canada: State-owned People’s Bank of China #2015, World Bank dbase http://data.worldbank.org/indicator/CM.MKT.LCAP.GD.ZS *Elliott, Douglas J., and Kai Yan. The Chinese financial system: An introduction and overview. Brookings Institution, 2013. +IMF 2014 Canada Financial Sector Stability Assessment Country Report No. 14/29 http://www.imf.org/external/pubs/ft/scr/2014/cr1429.pdf © Brenda Spotton Visano 2016

% of GDP (concentration) FINANCIAL SYSTEM  CANADA CHINA* Indirect Finance / Institutions % of GDP (concentration) Ownership % of GDP Deposit/retail banks assets 133%#   RB, CIBC, BMO, TD-CT, BNS, BN hold 90% of assets Joint-stock 128%# BOC, ABC, CCB, ICBC  State-owned Securities firms/ investment banks Top 10 firms (27% AUM) under control of Big 6 Pension funds 13% CPP  65% Private Pension Plans (50% with Big 8) CPP: state-owned Private: Plan Members   State-owned but under reform Insurance companies 38% 14%  Joint-stock Canada 2015: 6 largest banks hold 90% of bank assets: RB, CIBC, BMO, TD-CT, BNS, BN China: Bank of China (BOC), Agricultural Bank of China (ABC), China Construction Bank (CCB), and Industrial and Commercial Bank of China (ICBC) Big 8 Pension Plans: Ontario Teachers PP; Ontario Municipal Employees RS; Public Service PP; Quebec PP; Healthcare of Ontario; BC Municipal PF; Alberta PP; BC Public Service PP) © Brenda Spotton Visano 2016

© Brenda Spotton Visano 2016 Core Principles What principles should guide design? Does it matter if there is a concentration of wealth? Do private markets work “better” than states to direct resource allocation? If you have surplus funds, should I pay you to use them when I need them? Who should decide the principles of operation? The state on behalf of everyone? Individuals with the freedom to do as they want? © Brenda Spotton Visano 2016

Comparison of Western and Islamic Core Principles of Finance © Brenda Spotton Visano 2016

© Brenda Spotton Visano 2016 Western Finance Time has Value Risk requires Compensation Information is the basis for decisions Markets determine prices and resource allocation Stability improves welfare Islamic Finance Equitable distribution and access to wealth Consistent with tenets of Islam Avoid riba (interest) Avoid gharar (risk, speculation) Avoid haram (prohibited activities: gambling, pork and alcohol consumption) © Brenda Spotton Visano 2016