In 1947, the U.S. Financial sector contributed only 10% of all non-farm corporate profits; by 2010, it had increased to 50%.
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The financial industry’s income as a percentage of GDP increased from 2.5% to 7.5% over the same time period, while its share of all corporate income increased from 10% to 20%. The GDP share in 2018 was 7.4%, which equates to $1.5 trillion in economic value. Since 1930, the percentage of total U.S. income generated by the top 1% of earners has closely mirrored the mean earnings per employee hour in the financial industry relative to all other sectors. While average incomes in New York City increased from $40,000 to $70,000, the mean salary in the banking sector increased from $80,000 in 1981 to $360,000 in 2011.
In 1988, there were over 12,500 U.S. banks with deposits under $300 million, and approximately 900 had deposits over that amount. By contrast, in 2012, there were only 4,200 institutions in the U.S. with deposits under $300 million, and over 1,801 had deposits beyond that amount.
According to earnings and equity market capitalization, the financial services sector contains the largest group of businesses in the entire world. However, in terms of sales or personnel, it is not the largest segment. In addition, the business is exceedingly fragmented and slow-growing, with Citigroup, the largest company, holding only a 3% share of the US market. Home Depot, the biggest home improvement retailer in the US, has a 30% market share, while Starbucks, the biggest coffee shop, has a 32% market share.
Profitability:
The largest banks in the United States are profitable thanks to implicit government support. Because they know that the government will likely step in to save the institution if things go badly, banks that are considered to be “too large to fail” tend to take bigger risks. This is another reason why such large banks may borrow money at lower rates of interest due to the perceived low danger of institutional failure. In 2012, it was projected that the government gave these bigger U.S. banks subsidies of up to $70 billion.
Political Power:
The financial sector in the United States has expanded recently and now makes up a larger portion of the total economy, as indicated, for instance, by its percentage of the gross domestic product. An influential group of financial institutions in the US makes up an oligarchy with significant political and ideological sway over the US Congress and regulatory bodies.
A significant portion of the Glass-Steagall Act, which forbade a single entity from engaging in both commercial banking (which involves accepting deposits) and investment banking (which raises money for corporations on stock exchanges through private placement and other avenues), as well as regulations that control activities that involve risks to the economy, were dismantled as a result of the use of this political power. In affluent economies like the U.S., political influence is just as powerful at dictating legislative and regulatory agendas to increase profitability as corruption and kickbacks are at dictating governmental action in underdeveloped nations.
Wall Street invested a record $2 billion in an effort to sway the 2016 presidential election in the United States.
Financial Centre:
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A financial centre (BE), financial centre (AE), or financial hub is a site where there is a concentration of people involved in the banking, asset management, insurance, or financial markets. It also has places where these activities can take place as well as support services. Financial intermediaries (such banks and brokers), institutional investors (including investment managers, pension funds, insurers, and hedge funds), and issuers are examples of participants (such as companies and governments).
Even though many transactions happen over-the-counter (OTC), or directly between participants, trading activity can occur on sites like exchanges and involve clearing houses. Companies that provide a wide range of financial services, such as those connected to mergers and acquisitions, public offerings, or corporate actions, or that operate in other fields of finance, such private equity, hedge funds, and reinsurance, are typically housed in financial centres. Rating agencies and the supply of allied professional services, particularly legal counsel and accounting services, are examples of ancillary financial services.
International Financial Centers (IFCs), which include cities like New York City, London, and Tokyo; Regional Financial Centers (RFCs), which include cities like Shanghai, Shenzhen, Frankfurt, and Sydney; and Offshore Financial Centers (OFCs), which include locations like the Cayman Islands, Dublin, Hong Kong, and Singapore.
As full-service financial hubs with direct access to huge capital pools from banks, insurance firms, investment funds, and listed capital markets, International Financial Centres and several Regional Financial Centres are also significant global cities. Offshore financial centres, as well as some Regional Financial Centers, often focus on tax-driven services including corporate tax planning tools, tax-neutral vehicles, and shadow banking/securitization. These centres can be found in smaller places (like Luxembourg), city-states, or other jurisdictions (e.g. Singapore).
Regional financial centres and offshore financial centres overlap, according to the IMF (e.g. Hong Kong and Singapore are both Offshore Financial Centres and Regional Financial Centres). Since 2010, academics have equated tax havens with offshore financial centres.
Financial Capital:
Financial capital, also referred to as capital or equity in the fields of finance, accounting, and economics, is any economic resource measured in terms of money used by business owners and entrepreneurs to purchase the materials they need to produce their goods or to provide their services to the industry in which they are engaged, such as retail, corporate, investment banking, etc. In other words, financial capital is internal retained earnings produced by the entity or money given to businesses by lenders (and investors) for the purpose of purchasing real capital items or services for the creation of new commodities and/or services.
Contrarily, real capital (also known as economic capital) refers to tangible assets that are used in the creation of other goods and services, such as tools and machinery for factories, sewing machines for tailors, and shovels for gravediggers.
IFRS capital maintenance concepts:
Financial capital is a generic term for wealth that has been saved up, particularly cash that is utilised to launch or sustain a firm. The majority of entities use a financial notion of capital when creating their financial reports. In terms of a financial definition of capital, such as invested cash or invested purchasing power, the net assets or equity of the firm are equivalent to capital. A physical definition of capital, such as operating capability, considers capital to be the entity’s production capacity measured, for instance, in units of output per day.
The upkeep of financial capital can be calculated in nominal money units or units of continual purchasing power. In light of the International Financial Reporting Standards, there are three approaches for capital maintenance (IFRS)
- Physical Capital Maintenance
- Measurement of financial capital in nominal money units
- maintenance of financial capital in constant-price units.
Lenders give financial capital in exchange for interest. For a more thorough explanation of how financial capital may be examined, see also time value of money. A liquid medium or mechanism that symbolises wealth or other types of capital is referred to as financial capital. But typically, it refers to the amount of money that can be used to produce or buy items, among other things. Producing more than is immediately required and storing the extra might also help one acquire capital.
Financial capital can also take the shape of movable goods that can be bought, such as computers or books, which can help people acquire different types of capital either directly or indirectly. Some academics have divided financial capital into three subcategories: regulatory capital, which satisfies capital regulations, and economic or “productive capital,” which is required for operations and advertises a company’s financial strength to shareholders.
Valuation:
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A financial instrument is typically priced in accordance with how capital market participants perceive its expected return and risk. If timing-dependent valuations of complex financial instruments change significantly, unit of account functions can be in doubt. To reconcile financial capital value units of account, there are three different methods: “book value,” “mark-to-market,” and “mark-to-future.”
Issuing and Trading:
Financial instruments, like money, can be “supported” by state military fiat, credit (i.e., the social capital that banks and their depositors own), or resource-based commodities. Governments typically maintain tight control over its availability and typically demand that institutions that extend credit have some sort of “reserve.” On a money market, trading is done between several national currency instruments. Such trading discloses variations in the currency’s assigned likelihood of debt collection or store of value function.
Financial capital may be exchanged in bond markets or reinsurance markets when it is represented in a different way than money, with varied levels of trust in the social capital (rather than just the credit) of bond issuers, insurers, and other parties who create and trade financial instruments. Any such instrument with a postponed payment often carries an interest rate that is greater than the regular interest rates that banks are required to pay or that the central bank applies to its own reserves. If such products have consistent payment schedules linked to the same rate of interest, they are frequently referred to as fixed-income instruments. The standard rate for postponed payment set by the central bank prime rate will be reflected in a variable-rate instrument, such as many consumer mortgages, and will be increased by some fixed percentage.
Although they frequently fluctuate in value in reaction to trading in more purely financial futures, commodities and stock markets really involve trading in underlying assets that are not entirely financial in nature. Typically, commodity markets are influenced by political events that have an impact on global trade, such as boycotts and embargoes, or by natural capital-related events, such as weather that impacts food harvests. In contrast, consumer confidence in corporate leaders, also known as individual capital, social capital, or brand capital (according to some analyses), and internal organisational effectiveness, also known as instructional capital and infrastructural capital, are what have a greater impact on stock markets.
Some businesses release tools exclusively for tracking one distinct segment or brand. These markets are referred to as “financial futures,” “short selling,” and “financial options,” which are usually just pure financial wagers on results rather than being a direct representation of any underlying asset.
Broadening the Notion:
In the policy and regulations of the central bank regarding the aforementioned instruments, it is presumptive that there is a relationship between financial capital, money, and all other types of capital, particularly human capital or labour. A political economy, whether feudalist, socialist, capitalist, green, anarchist, or another, defines these relationships and policies. Since they control how labour is distributed in a community, the methods used to create money and other restrictions on financial capital effectively serve as a representation of the economic sense of that society’s value system.
The necessity of employing (all forms of) financial capital as a stable store of value is thus reflected, for example, in regulations for increasing or decreasing the money supply based on perceived inflation, or on gauging well-being. If this is crucial, controlling inflation is essential because any amount of inflation lowers the value of financial capital relative to all other types. However, if the role of the medium of exchange is more important, new money may be released with less concern for how it would affect inflation or general well-being.
Financial risk Management:
Financial risk management is the process of safeguarding a company’s economic worth by utilising financial instruments to control exposure to financial risk. Operational risk, credit risk, and market risk are the three main types of financial risk, with additional varieties not covered here. Identifying the causes of financial risk, measuring it, and creating plans to deal with it are all part of risk management in general. For a summary, see Finance Risk management.
Perspective on the Economy:
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According to financial economics’ neoclassical finance theory, a company should undertake a project if it raises shareholder value. Additionally, according to finance theory, managers of businesses cannot add value for investors or shareholders by taking on tasks that shareholders might complete on their own at a comparable cost. See Fisher’s separation theorem and Theory of the Firm.
Therefore, the relationship between “Risk Management” and shareholder value is at the core of the discussion. The discussion essentially compares the cost of bankruptcy in a market to the value of risk management in that market. According to the Modigliani and Miller framework, hedging is irrelevant because it is assumed that diversified shareholders are unconcerned with firm-specific risks, but on the other hand, hedging is seen to add value because it lowers the likelihood of financial distress.
This suggests that firm managers shouldn’t insure risks that investors can insure for themselves at a comparable cost when it comes to financial risk management. The so-called “hedging irrelevance proposition” captures this idea. When the cost of assuming the risk inside the company is the same as the cost of assuming it outside, the firm cannot add value in a perfect market.
Financial markets are not likely to be flawless markets in practise, nevertheless. Given that they must decide whether risks are less expensive for the company to control than for the shareholders, this means that firm managers have several chances to increase value for shareholders through financial risk management. The strongest candidates for financial risk management in this situation are typically market hazards that produce distinct risks for the company.