Banking overview Flashcards
(23 cards)
Banking book
Consists of everything not in the trading book
Trading book
A portfolio of financial instruments held by a bank, which are actively traded and which are to facilitate trading for the customers
Corporate banks
Traditional banking activities such as:
* taking deposits
* making loans
* clearing cheques
They also offter merchant services and payroll services to businesses
Most have a banking book and a trading book
Retail banks
Offer deposit, investment and loan products to customers
These can be long-term or short-term savings and secured or unsecured loans
Types of banks
- Corporate banks
- Retail banks
- Investment banks
- Community banks
- Traditional deposit taking banks
- Reserve (or central) banks
- Development banks
What is the role of banks?
Banks play a vital role in providing liquidity to the financial system.
Banks also play the role of financial intermediaries
Banks make possible the distribution of valuable economic and business information among customers and capital markets of all countries
What is a financial intermediary?
Business entity that brings together providers and users of capital.
They develop the facilities and financial instruments which make lending and borrowing possible.
Traditional deposit taking banks
Known as commercial or retail banks
Provide services such as:
* accepting deposits
* providing loans
* mortgage lending
* other basic investment products
They are usually public companies that are regulated, listed on an exchange and owned by their shareholders
Developments banks
Also known as Development Financial Institutions.
- They provide credit through higher risk loans
- Usually supported by the government of a country
- Usually focuses on large infrastructure projects within the public and private sector
Reserve (or central) banks
The role of the reserve or central bank is to maintain price stability in the interests of balanced and sustainable economic growth.
Carries out these missions through formulation and implementation of inflation targeting and monetary policy
Investment banks
Refer to financial market activities such as:
* debt raising
* equity financing for corporations or governments
This includes originating securities, underwriting them, and then placing them with investors
How are loans priced?
Lending is typically priced relative to a benchmark rate (prime).
To account for credit risk, banks add a premium to the benchmark rate, to determine the lending rate.
The premium is intended to cover expected loan losses, while allowing the bank to make a profit.
List 3 things that will influence the lending rate
- Credit quality of the customer
- Whether there is any security involved
- The tenor of the loan
Tenor - The length of time until the loan is due
What will determine the deposit rates offered by banks?
The bank’s own credit quality
How do banks make a profit?
Banks make a profit on the positive spread between what is earned on their loans and what is paid on their deposits and other funding.
Provisioning
Banks create provisions (reserves) for loan losses. Periodically, the reserve will be increased or decreased, and in some circumstances an “overlay” reserve may be created if there is an anticipation of worse than expected performance of the loan book.
For performing loans, the provision amount is measured as the present value of credit losses from default events projected over the next 12 months.
Describe 2 banking trends
- Increasing regulatory requirements for risk management, risk measurement and capital holdings. Recent updates to the Basel accords represent the finalisation of the third revision of the accords since its inception.
- Fintech brings together financial services and technology to modernise banking. These include a greater digital and mobile banking experience, improved use of data, and Artificial Intelligence
List 7 typical retail banking products
- Transactional accounts
- Savings accounts
- Credit cards
- Overdrafts
- Mortgage loans
- Vehicle finance loans
- Unsecured personal loans: revolving and term
List 9 typical business prodcuts offered by banks
- Transactional accounts
- Overdrafts
- Asset based finance
- Unsecured loans
- Merchant services
- Foreign exchange and trade solution services
- Cash solutions
- Savings and investment products
- Portfolio management
What are the main sources of revenue for a typical bank?
- Net interest income: Banks attempt to fund themselves at low interest rates and lend the money out at higher interest rates. This enables them to make a positive net interest income
- Non-interest revenue: Income earned from the fees charged from banking book operations.
- Trading income from the trading book: Income related to all the contraccts that the bank enters into as part of its trading operations.
What are the main costs for a typical bank?
- Operational expenses: The largest operating expense for a bank is generally staff costs. Other expenses incurred by banks include marketing and sales, IT systems and equipment, and running a branch network.
- Cost of credit: If problems with a loan amount become serious, and it is clear that interest and principal will not be repaid, the loan is classified as a loan loss and is written off the balance sheet.
What are the different types of loans in the loan book?
The majority of a typical bank’s assets will be its loan book, which can be subdivided into retail secured, retail unsecured, corporate and commercial loans.
List the key risks faced by banks
- Credit risk
- Market risk
- Operational risk
- Liquidity risk
Market risk can be subdivided into:
* Volatility risk
* Currency risk
* Basis risk
* Interest rate risk
* Liquidity risk
* Commodity price risk
Operational risk can stem from:
* Internal processes
* People
* Systems
* External events
Some of the other risks faced by banks include the following:
* Business strategic risk
* Currency risk
* Pre-payment risk
* Model risk
