UNIVERSITY OF ILLINOIS AT URBANA-CHAMPAIGN

College of Business
DEPARTMENT OF FINANCE

Finance 561: FINANCIAL INTERMEDIATION

Professor: Rustom M. Irani

Class Time: Monday and Wednesday 11:00 12:20 pm
Class Location: 226 Wohlers Hall
E-mail: rirani@illinois.edu
Office: 444 Wohlers Hall
Office Hours: Wednesday 3:30 4:30 pm and by appointment
Website: on compass2G

Course Description

Both financial intermediaries and financial markets are essential components of a financial
system and they interact with one another. This class has a focus on financial intermediaries
with the objective to answer the following questions:

What do financial intermediaries do?

How and why are financial intermediaries are regulated?
What types of risk do financial intermediaries face and how do they manage it?
What is the role and impact of the central bank and its policy actions?

The emphasis will be on the risk management and regulation of U.S. commercial banks, but
we will also provide an overview of other players in the market (hedge funds, mutual funds,
insurance, credit unions, and so on).

Throughout the class we will use a number of case studies and examples to motivate the
concepts we introduce. One important example that will be considered throughout is the
global financial crisis of 2007-2009. We will consider failures of risk management prior to
and during this period, as well as the regulatory response.

We will focus on applications of new concepts to real-world examples and data, rather than a
purely theoretical treatment.
Course Requirements

Class participation via discussion, questions, and contributions of examples from current
events is required. Most of our class periods will be devoted to covering material from the
textbook and other assigned readings, current financial and economic developments, and
assignments and projects. A portion of your grade will depend on your contribution to the
class discussion.
In addition, you will be required to make a research paper presentation (no more than 15
minutes, please) from a list of recent academic research papers relating to the subject matter
of the course (financial intermediaries). These articles are listed below and posted on
Compass. You will work on this presentation in groups of 3-4 and may present either as a
group or nominate one individual. This presentation should contain approximately four slides
with the following headings: 1. Research question; 2. Methodology; 3. Results; 4. Conclusion.
Focus more on the key message of the paper rather than technical details. Prior to the day of
your presentation you must email the instructor a copy of your presentation. This is a
professional presentation, no flip cards or prompts will be allowed. I will provide a sample
presentation and post the slides on Compass.
There will be a mid-term examination during the regular class meeting time on Wednesday,
March 15. There will be a final examination on a date that is TBD. The final exam will cover
the material after the midterm. Reserve these dates since no make-up examinations will be
provided without prior arrangement, in accordance with university policy.
There will be three written assignments during the semester. Two of these assignments will
be set before the mid-term exam and one after. Your assignments will be graded on overall
quality of presentation, effective writing, and proper grammar and punctuation. Take time to
proofread and edit your work before submitting it.
Finally, as serious students of finance, I expect each of you to remain abreast of current
developments in financial markets and financial institutions in general. One way to
accomplish this is to read the Wall Street Journal or the New York Times daily. In addition,
certain weekly publications like The Economist are useful for keeping up to date. These
publications can be obtained at student (reduced) subscription rates.

Grading Policy

Class participation and research paper presentation (10%)

Three assignments (3 x 10 = 30%)
Mid-term examination (25%)
Final examination (35%)

Letter grades (+/-) will be assigned based on a curve.

Course Textbook(s) and Online Resources

The lecture notes that I will provide in class are intended to be self-contained. The
assignments and exams will be based on my lecture notes and discussion in class. I
recommend these two readings to those students that want an alternative exposition:

1. Financial Institutions Management: A Risk Management Approach, 7th edition,

Anthony Saunders and Marcia Cornett, McGraw-Hill Irwin, 2011.
o Referred to as Text
o Website for textbook: http://www.mhhe.com/saunders7e

2. The Federal Reserve System: Purposes and Functions, 10th edition, October 2016,
Board of Governors of the Federal Reserve System.
o Referred to as Fed
o Available at: http://federalreserve.gov/pf/pf.htm

There are many excellent web sites containing information and/or data on financial
intermediaries, financial markets, and information about the economy. A few of them are
listed below, but you are encouraged to search the web for particular sites of interest to you.

http://www.fdic.gov/ (individual bank and BHC data is here)

http://www.occ.treas.gov/ (the national bank regulator)
http://www.federalreserve.gov/ (the US central bank)
http://www.newyorkfed.org/index.html (a regional Fed bank)
http://www.chicagofed.org/ (another regional Fed bank)
http://www.stlouisfed.org/ (economic data at this Fed regional bank site)
http://www.ffiec.gov/ (the coordinator agency for all bank regulators)
http://www.ffiec.gov/nicpubweb/nicweb/nichome.aspx (largest BHCs here)
http://www.bis.org (Basel capital regulation information is here)
http://www.imf.org/ (International Monetary Fund)
http://www.worldbank.org/ (World Bank)

Academic and Professional Integrity

Part 4 of the Student Code gives complete details of rules governing academic integrity for all
students. You are responsible for knowing and abiding by these rules, which are available on
the web at http://www.uiuc.edu/admin_manual/code/

You are expected to conduct yourself in a professional manner at all times in your dealings
with the instructor and with other students in this class. In addition, professionalism must be
demonstrated in class. Promptness and independent work on your assignments are also
components of professionalism.
Research Paper Presentation: List of Articles*

A. [2/15] Matvos et al. The Market for Financial Adviser Misconduct, University of
Chicago Working Paper, 2016.

B. [2/22]. Agarwal et al. Inconsistent Regulators: Evidence from Banking, Quarterly

Journal of Economics, 2014.

C. [3/1] Duchin and Sosyura. The Politics of Government Investment, Journal of

Financial Economics, 2012.

D. [4/17] Piskorski et al. Asset Quality Misrepresentation by Financial Intermediaries:

Evidence from RMBS Market, Journal of Finance, 2015.

E. [4/19] Iyer and Puri. Understanding Bank Runs: The Importance of Depositor-Bank
Relationships, American Economic Review, 2012.

F. [4/24] Carlson et al. Arresting Banking Panics: Federal Reserve Liquidity Provision
and the Forgotten Panic of 1929, Journal of Political Economy, 2011.

*Scheduled date of presentation in [].

Course Outline

I. The Structure and Regulation of Financial Intermediaries

Direct finance and financial intermediation

o Text: Chapter 1

Depository institutions
o Text: Chapter 2

Non-deposit FIs: Pension funds, insurance companies, and investment funds

o Text: Chapters 3 and 4

Regulation of depository institutions

o Text: Chapters 1, 2, 5, 21, and Appendices 2C, 21A

II. Measuring Risk in Financial Intermediaries

FI risks and performance evaluation

o Text: Chapter 7 and Appendices 2A and 2B

Interest rate risk measurement: Flows and values models

o Text: Chapters 8, 9 and Appendix 9B

Credit risk measurement

o Text: Chapter 11 and Appendix 11A

Liquidity risk measurement

o Text: Chapter 17

Midterm Examination In class, Wednesday, March 15

III. Managing Risk in Financial Intermediaries

Liquidity risk management

o Text: Chapter 18 and Appendix 18A
o Fed: Chapter 7

Managing interest rate risk with futures and options

o Text: Chapters 22 (pp. 696-713) and 23 (pp. 733-753)
Managing interest rate risk with caps/floors/collars and swaps
o Text: Chapters 23 (pp. 756-765) and 24 (pp. 774-784)
 Managing credit risk I: 3Ss and credit derivatives
o Text: Chapters 22, 23 (pp. 754-756) and 24 (pp. 787-793), 25, and 26

Managing credit risk II: Loan loss accounting

o Text: Chapters 22, 23 (pp. 754-756) and 24 (pp. 787-793), 25, and 26

IV. Changes in Banking Industry Regulation

Deposit insurance and the FDIC

o Text: Chapter 19 and Appendices 19A and 19C

Capital regulation and the Basel Accord

o Text: Chapter 20

V. The Federal Reserve and Monetary Policy

The Federal Reserve: Organization, goals, & tools

o Fed: Chapters 1, 2, and 3

The Federal Reserves actions during 20072009

Final Examination TBD