What is the financial system?
The set of institutions, markets, instruments, infrastructures, and rules allocating financial resources.
When does an agent have a financing capacity?
When its saving exceeds its investment.
When does an agent have a financing need?
When its investment exceeds its saving.
What is internal financing?
Using an agent's own resources for financing.
What is indirect external financing?
Financing passing through financial institutions.
What is direct external financing?
Connecting borrowers and lenders through securities issuance.
What happens when a bank grants a loan?
It creates a deposit and scriptural money simultaneously.
According to Schumpeter (1911), what role does the banker play?
Selecting innovative entrepreneurs and giving them access to new purchasing power.
What is the money market?
The market for short-term financing where various institutions manage liquidity.
What type of debt does the bond market finance?
Medium- and long-term debt.
How does the equity market help firms?
It allows firms to raise equity without mandatory repayment.
What do commodity futures and options allow participants to do?
Hedge against price changes.
What is a consequence of speculative positions in commodity futures and options?
They can increase price volatility.
What does securitization do?
Transforms illiquid claims into negotiable securities.
What is the function of the primary market?
It issues new securities and directly finances issuers.
What is the main role of the secondary market?
It trades existing securities and mainly provides liquidity.
Who are the main financial-market participants?
Issuers, investors, investment banks, rating agencies, trading platforms, clearing houses, and central securities depositories.
Which are the three main international rating agencies?
S&P Global Ratings, Moody’s Investors Service, and Fitch Ratings.
What is a financial price?
A financial price guides investment, financing, and portfolio decisions.
Name examples of financial prices.
Interest rate, stock price, exchange rate, risk premium, and credit spread.
What role do banks play in bank-oriented systems?
Banks play a central financing role.
Which countries exemplify bank-oriented financial systems?
Historical Germany and France.
How do firms in market-oriented systems finance themselves?
By issuing shares and bonds.
Which countries exemplify market-oriented financial systems?
The United States and the United Kingdom.
What percentage of US GDP is from finance and insurance recently estimated?
About 8% of US GDP.
What does a financial centre combine?
Market depth, legal quality, political stability, liquidity, capital access, human capital, digital infrastructure, time-zone advantages, and reputation.
Which city ranked first in the GFCI 39 published in March 2026?
New York ranked first.
What is New York’s financial centrality based on?
Wall Street, deep US equity and bond markets, the international role of the dollar, institutional investors, and the NYSE and Nasdaq.
What major international financial roles does London maintain despite Brexit?
Foreign exchange, insurance, reinsurance, asset management, derivatives, financial law, and professional services.
What percentage of UK production is finance and insurance including professional services?
More than 11% of UK production.
What percentage of French and German GDP is from finance and insurance?
Around 4% of French and German GDP.
What percentage of Japanese GDP is from finance and insurance?
Between 4% and 5% of Japanese GDP.
How does the financial system transfer resources through time?
By allowing households to save for future consumption and firms to invest today.
What differentiates adverse selection from moral hazard in finance?
Adverse selection occurs before a transaction, moral hazard occurs after financing.
How do banks transform maturity and liquidity?
By granting long-term loans while offering deposits available on demand.
What is Tobin's q formula?
The ratio of a firm's market value to the replacement cost of its capital.
When does investment become more attractive according to Tobin's q?
When .
What risk does portfolio diversification reduce?
Diversifiable risk.
Which risk cannot be eliminated by diversification and is rewarded by higher return?
Systematic risk.
Who authored 'Financial Structure and Development' in 1969?
Goldsmith.
What does the efficient-market hypothesis state about asset prices?
Asset prices incorporate all available information.
What information does weak-form efficiency incorporate?
Past price information.
What information does semi-strong efficiency incorporate?
All public information.
What information does strong-form efficiency incorporate?
Both public and private information.
What do Keynes, Blanchard and Watson, and Shiller show about financial prices?
They may incorporate mimetic expectations, collective narratives, and self-fulfilling behaviour.
Which functions of finance does Levine identify as central?
Information production, investment monitoring, exchange facilitation, saving mobilization, and risk diversification.
What can insufficient financial development constrain?
Investment.
What negative effects can excessive financial development encourage?
Instability, unproductive debt, and asset bubbles.
Who argued that financial development beyond a threshold can harm economic growth?
Arcand, Berkes and Panizza.
Why is the financial system considered ambivalent?
It supports growth and innovation but can cause crises and bubbles.
Which benefits does the financial system provide?
Investment, growth, innovation, risk diversification, and liquidity.
What risks can the financial system foster?
Excessive debt, bubbles, banking crises, market panics, and systemic externalities.
Who emphasized the lender-of-last-resort function in finance?
Bagehot in Lombard Street, 1873.
Which authors show finance as a source of macroeconomic instability?
Fisher, Keynes, Minsky, Kindleberger, Bernanke, Gorton, and Shiller.
What is financial market efficiency?
Asset prices incorporate all available information.
Which information does weak form market efficiency incorporate?
Past information.
What information does semi-strong form market efficiency incorporate?
All public information.
What information does strong form market efficiency incorporate?
Even private information.
Which authors showed financial-development indicators predict future growth?
King and Levine.
In which work did King and Levine show finance predicts growth?
Finance and Growth: Schumpeter Might Be Right (1993).
Who argued that excessive financial development can harm growth?
Arcand, Berkes and Panizza.
In which work was the negative effect of too much finance discussed?
Too Much Finance? (2015).
Why can self-referential expectations move asset prices away from fundamentals?
Investors anticipate other investors' thoughts instead of only fundamentals.
What did Shiller demonstrate about stock price fluctuations?
Stock prices fluctuate more than justified by subsequent dividends.
Why do Grossman and Stiglitz argue perfectly informative markets are impossible?
Because information collection is costly and investors need profit incentives.
What happens when interest rates rise in imperfect-information credit markets?
Prudent borrowers withdraw while risky borrowers remain, increasing adverse selection.
How does increased adverse selection affect banks in credit markets?
It leads banks to ration credit.
What does the debt-deflation mechanism involve?
Simultaneous deleveraging, asset sales, falling prices, rising real debt burdens, weaker balance sheets, and further asset sales.
How does Minsky define hedge finance?
Repayment of interest and principal from current income.
What characterizes speculative finance according to Minsky?
Repayment of interest but requires debt renewal.
What is Ponzi finance in Minsky's framework?
Requires additional borrowing to pay interest.
What triggers a Minsky moment?
An expansion based on debt and risk-taking abruptly reverses as agents lose confidence.
What happens during a Minsky moment after agents lose confidence?
They sell assets, reduce collateral, and face tighter credit.
What did the failure of Lehman Brothers in September 2008 cause?
It transformed a US housing and financial crisis into a global systemic crisis.
What does microprudential regulation protect?
The soundness of individual institutions.
What does macroprudential regulation limit?
Systemic risk, contagion, and financial procyclicality.
According to Bagehot, when should the central bank lend during a crisis?
Rapidly and abundantly.
What conditions must Bagehot's lender-of-last-resort lending meet?
It must be at a penalty rate and against good collateral to illiquid but solvent institutions.
What is the European deposit-guarantee protection amount per depositor?
100,000 euros per depositor and per bank.
What is the target reimbursement period under European deposit-guarantee rules?
Seven working days.
What does Basel III strengthen and introduce?
It strengthens capital requirements and introduces the LCR, NSFR liquidity ratios, and a leverage ratio.
Test your knowledge with 57 questions on Financing the Economy and Financial Systems.
1. What does the financial system comprise in an economy?
2. A household saves more than it invests during a given period; what financial position does it have?
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