Introduction to Banking

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  • Created by: JBC
  • Created on: 19-01-19 19:26

Intermediation

The bank matching people who want to lend money (surplus units) to people who want to borrow money (deficit units). 

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Main functions of the central bank.

Control and manipulate money supply.

Regulate member banks. 

Lender of last resort. 

Government banker. 

Monitors/controls inflation. 

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Types of regulation.

Systematic regulation - national/curency level, limit bank failures, consumer protection. 

Prudential regualtion - control risk, hold adequate capital, allow small banks to compete. 

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Sources of Authority.

Financial Conduct Authority (FCA): regulate financial services, protect consumers, make industry stable and competitve. 

Prudential Regulation Authority (PRA): prudential regulation and supervision, sets standards, organisation of the Bank of England.

Financial Policy Committee (FPC): acts to remove or reduce systematic risks, protecting financial system, organisation of the Bank of England. 

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Intermediation - MARG

Maturity

Asset

Risk

Geographical

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Types of bank and financial institution.

Wholesale banks - very large institutions.

Investment banks - create capital with shares and equites. 

Universal banks - retail, wholesale and investment all under one 'roof'.

Merchant banks - international finance, business loans and underwriting. 

Private banks - high net worth individuals.

Online banks - mobile devices and computers, 24/7. 

Building societies - investment for the purchase or improvement of houses.

Islamic banks - no interest (comply with Sharia Law)

Insurance companies - collect premiums and pay out claims.

Credit unions - set to benefit community, make ethical/social decisions.  

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Pestle Analysis

Political

Economic

Social

Technological

Legal

Environmental/Ethical

Advantages: simple and easy, helps understanding, develops strategic thoughts.

Disadvantages: updates needed regularly, can be time consuming and expensive. 

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Supplier Power - Krajlic Model

Non-critcal items: low supply risk, low profit impact.

Bottleneck items: high supply risk, low profit impact. 

Leverage items: low supply risk, high profit impact. 

Strategic items: high supply risk, high profit impact. 

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Quantitative Easing

Where the bank creates new money electronically to buy financial assets, aiming to increase private sector spendong and return inflation to target. 

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Capital

Capital adequacy; enough capital to cover their risks and losses.

Tier 1: dislosed reserves, shareholder equity.

Tier 2: undisclosed reserves, subordinated debt (lowest ranked debt), general provisions (risky debts). 

Common equity: a subset of Tier 1 capital.

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Risk weightings of assets.

To start with: 

Cash @ 0%

Government Bonds @ 20%

Mortgages @ 50%

Commercial Loans @ 100%

Changes include: 

Domestic morgages (secured) @ 25% 

Loans to AAA banks @ 20%

Corporate loans (secured) @ 30%

Personal loans (secured) @ 50%

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Basel I

Total capital must be at least 8% of risk weighted assets.

50% of total capital (4% of RWA) must be Tier 1 capital. 

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Basel II

Three pillars - risk asset ratio, supervision, market discipline. 

Total capital must be at least 6% of risk weighted assets. 

Tier 1 capital must be at least 4% of risk weighted assets.

Common equity must be at least 2% of risk weighted assets. 

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Basel III

Total capital must be 10.5% of risk weighted assets plus a mandatory capital buffer of 2,5%, therefore total capital must be 13%. 

Tier 1 need to be 8% of RWA. 

Common equity must be 7% of RWA, with 4.5% shareholder equity and 2.5% capital buffer.

A liquidity buffer for assets of 30 days.

Leverage ratio: Tier 1 capital must exceed 3% of total assets.

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CAMPARI & ICE

Character Ability Means/Margin Purpose Amount Repayment Insuarnce

Interest Commision (and other fees) Extras (insurance etc.)

Information assymetry - borrower knows more about their ability to repay than lender. 

Moral hazard - borrowers can change their behaviour after loan is given. 

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Balance Sheet - Assets

Low risk: cash, fixed assets, loans to AAA banks. 

Medium risk: loans to customers, debt securities, joint ventures. 

High risk: equity shares. 

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Balance Sheet - Liabilities + Capital

Liabilities: customer accounts, deposits by banks, dated and undated loan capital.

Capital: called up share capital, reserves, retail life fund liability.

Functions of capital - absorbs losses, protects depositors, access to markets, limit risk. 

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Asset Liability Management (ALM)

The idea to spread risk and increase profitability at the same time. 

Managing liquidity - wide ranging portfolio, different maturities, different liquidities.

ALCO is responsible for ALM achieving this through the monitoring and adjusting of asset positions. 

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