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CQiB > 1. Business of Banking > Flashcards

1. Business of Banking Flashcards

1
Q

What are the five roles of banks?

A
  1. Financial intermediary between savers and borrowers, which results in efficient use of pooled resources
  2. Facilitates the creation of money by expanding the supply of money through deposit and loan transactions
  3. Creates financial products and services that benefits customers
  4. Develops mechanisms for transferring money and making payments
  5. Contributes to the development of the economy
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2
Q

What is financial intermediation?

A

The process of pooling funds from savers and using these to provide loans to borrowers. The bank acts as a go between, or intermediary for those who have extra money and those who want to borrow.

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3
Q

What are the four main services provided by investment banking?

A
  1. Debt capital markets
  2. Equity capital markets
  3. Private placement
  4. Mergers and acquisitions
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4
Q

What are some typical examples of when debt capital markets are used?

A

Where a large company may want to build a factory and is looking to issue bond financing to finance its expansion.

Or if a government wants to finance the building of an airport, highway, or other large municipal project, it may issue bonds to raise capital.

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5
Q

How are investment banks involved in the debt capital market bond issuance process?

A

An investment bank would be involved in planning the bond issuance, working with the issuer to manage the documentation required to issue the bonds and help sell the bonds.

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6
Q

What is the underwriting spread?

A

In bond issuances, the investment bank would buy the securities at one price and then add on a markup in the sale price and thereby generate a profit that compensates for the risk they take on. This difference is the underwriting spread.

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7
Q

How does a syndicate work?

A

A lead bank will normally work with a group of investment banks, called a syndicate, to underwrite a bond issue so that the risk is spread among others.

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8
Q

When are equity capital markets used?

A

Where a company needs more money to grow and decides to raise the funds by undertaking an Initial Public Offering (IPO). Whereby it sells its shares to the public and a wider pool of investors for the first time.

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9
Q

How are investment banks involved in equity capital market IPO process?

A

The investment bank will put together a prospectus explaining the terms of the offering and the risks it carries, managing the issuance process and helping the price of the offering.

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10
Q

What are private placements?

A

Where customers plan an offering of bonds or shares with an institutional investor such as an insurance company or a retirement fund.

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11
Q

What is one of the main benefits of private placements?

A

Often this can be a fast-track option due to lower regulatory requirements.

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12
Q

What are mergers and acquisitions and how is the investment bank involved in this process?

A

Where a company is looking to buy another company, investment banks offer advice on how the company should proceed with the acquisition, including the pricing of the offer.

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13
Q

What are Chinese walls and when are they used?

A

Investment banks need to establish barriers known as Chinese walls or information barriers, within organisations involved in mergers and acquisitions to prevent exchanges or communication that could lead to conflict of interest.

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14
Q

What is the main way that banks source their funds?

A

Banks source their funds largely from deposits from the public.

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15
Q

What is the main way that banks source their funds?

A

Banks source their funds largely from deposits from the public.

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16
Q

What are three different types of deposits banks source from the public?

A
  1. Savings deposits (from salary and wage earners)
  2. Fixed term deposits (lump sum deposited for a specific period)
  3. Current deposits (business accounts)
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17
Q

What are the types of loans and advances that banks offer?

A
  • Overdraft
  • Credit card
  • Short to medium term loans
  • Long term loans
  • Bills of exchange and promissory notes
  • Equipment leasing hire and purchase
  • Trade financing
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18
Q

What is a bank overdraft?

A

An overdraft is a defined credit limit attached to a bank account that can be drawn against. Interest is charged on the overdrawn balance.

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19
Q

What is a credit card?

A

Credit cards allow the purchase of goods and services within a certain limit, effectively borrowing money, and paying it back later, usually monthly or bi-monthly instalments.

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20
Q

What are short to medium term loans?

A

Short term loans are where principal and interest repayments are made over a shorter time period of say, 12 months to 5 years (e.g., for purchase of a car).

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21
Q

What are long term loans?

A

Long term loans are where principal and interest repayments are made over a longer period of say, 30 years (e.g., for purchase of a home).

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22
Q

What are bills of exchange and promissory notes?

A

Bills of exchange and promissory notes are specialised instruments, being an unconditional order in writing between parties, where the bank purchases the bill amount from the borrower, deducting charges. On maturity the bill is presented to the borrower and the full amount is collected.

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23
Q

What is equipment leasing and hire purchase? What is the key associated benefit?

A

Equipment leasing and hire purchase are common forms of
borrowing for the financing of plant, machinery and vehicles by individuals and businesses. Taxation benefits are often linked to these forms of debt, making them popular funding options.

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24
Q

What is trade finance?

A

Trade finance assists in facilitating import and export transactions including lending, letters of credit, factoring (accounts receivable financing), export credit and insurance.

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25
Q

What are the seven forms of facilitating payments?

A
  1. Electronic funds transfers
  2. Negotiable instruments
  3. Periodic payments
  4. Periodic collections
  5. Debit cards
  6. International money transfers
  7. E-commerce payment systems for merchants
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26
Q

What are electronic funds transfers?

A

Where funds are transferred electronically between banks.

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27
Q

What are negotiable instruments?

A

Such as bank drafts, cheques and letters of credit.

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28
Q

What are periodic payments?

A

Direct debits and standing orders, where the bank makes periodic payments on behalf of the customer.

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29
Q

What are periodic collections?

A

Direct credits, where the bank collects periodic payments on behalf of the customer for salary, pension, dividends, etc.

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30
Q

What are debit cards?

A

Allows purchase of goods and services and deducts money directly from the customer’s bank account (no credit provided).

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31
Q

What are international money transfers?

A

Allows customers to transfer money to overseas bank accounts.

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32
Q

What are e-commerce payment systems for merchants?

A

Businesses can accept electronic payments via credit card and EFTPOS into their account, with settlement on the same day.

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33
Q

What is insurance and its main function?

A

Depending on what is being insured against, the insurer agrees to pay money to help cover costs should certain events occur. This is called a “transfer of risk” because the insurer is taking the risk of meeting the cost of the loss.

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34
Q

What are five types of wealth management products?

A
  1. Allocated pensions
  2. Annuities
  3. Investment growth bonds
  4. Managed funds
  5. Superannuation
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35
Q

What are allocated pensions?

A

Provides a regular income in retirement where income payments are funded from a superannuation lump sum.

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36
Q

What are annuities?

A

A secure investment that pays an income throughout a determined period; often associated with retirement.

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37
Q

What are investment growth bonds? What are they also known as?

A

Also known as insurance bonds. Product that provides a tax-effective (typically long-term) income stream in retirement outside of superannuation.

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38
Q

What are the two revenue sources for banks (how they make money)?

A
  1. Lending money at rates higher than they pay for deposits.
  2. Charging fees for products and services such as loans, deposit and payment services, as well as other services such as traveller’s cheques or foreign exchange fees.
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39
Q

What is the spread for banks?

A

The difference between the rates at which banks lend and pay for deposits.

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40
Q

What does the difference between the net interest income and the net interest margin represent?

A

The difference between the rates at which banks lend and pay for deposits.

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41
Q

What is another term for the bank’s spread?

A

Net interest income

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42
Q

What is the net interest margin?

A

When the bank’s net interest income is divided by its earning assets.

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43
Q

What does the difference between the net interest income and the net interest margin represent?

A

The difference between the rates at which banks lend and pay for deposits.

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44
Q

What is the largest source of fee income for banks from households?

A

Credit cards represented the largest component of fee income, followed by housing loan fees.

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45
Q

What is the largest source of fee income for banks from businesses?

A

For businesses, loans represented the largest component of fee income, followed by merchant service fees.

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46
Q

What is maturity transformation?

A

When a bank offers short term liabilities (such as deposits) and transforms them into longer term assets (such as loans).

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47
Q

What are the three types of risk that a bank absorbs in undertaking maturity transformation?

A
  1. Credit risk
  2. Liquidity risk
  3. Interest rate risk
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48
Q

What is credit risk?

A

The probability of loss due to a borrower’s failure to make payment on any type of debt.

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49
Q

What is liquidity risk?

A

The potential inability of a bank to meet its payment obligations in a timely and cost-effective manner.

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50
Q

What is interest rate risk?

A

The risk that movement in interest rates will have an adverse effect on the value of an investment.

51
Q

What is liquidity?

A

Determined by the bank’s ability to meet all its anticipated expenses, including making payments on debt using only liquid assets.

52
Q

What is solvency?

A

Ability of a bank to meet its long-term financial obligations. Essential to staying in business as it indicates a company’s ability to continue operations into the foreseeable future.

53
Q

What is profitability?

A

The ability to generate earnings compared to its expenses and other relevant costs incurred during a specific period of time.

54
Q

What are some common profitability ratios used in financial analysis?

A

Return on assets (ROA) and return on equity (ROE)

55
Q

What are the assets on a bank’s balance sheet?

A
56
Q

What are the liabilities and forms of equity on a bank’s balance sheet?

A
57
Q

What are the Basel III liquidity reforms? What are banks required to disclose?

A

The framework outlines global minimum quantitative requirements that banks are required to disclose, including the liquidity coverage ratio (LCR) and net stable funding ratio (NSFR).

58
Q

Who enforces Basel III capital adequacy requirements in Australia?

A

APRA (Australian Prudential Regulatory Authority)

59
Q

What does the liquidity coverage ratio represent?

A

Requires Australian ADIs to hold sufficient liquid assets to meet 30-day net cash outflows projected under an APRA-prescribed stress scenario.

60
Q

What does the net stable funding ratio represent?

A

Requires Australian ADIs to fund their assets with sufficient stable funding to reduce funding risk over a one-year horizon as prescribed by APRA.

61
Q

What does a bank’s capital adequacy represent?

A

Represent a bank’s ability to withstand losses without becoming insolvent and managing risk. For example, meeting financial promises to depositors, policyholders and fund members within a stable, efficient and competitive financial system.

62
Q

What are the two forms of capital?

A

Tier 1 and Tier 2

63
Q

What is Tier 1 capital?

A

Includes ordinary shares and retained earnings (profits not dispersed to shareholders); can also include specific types of preference shares and convertible securities.

64
Q

What is Tier 2 capital?

A

Funding sources that rank below a bank’s depositors and other senior creditors (i.e., subordinated debt). Provides depositors with an additional layer or protection after a bank’s Tier 1 capital is exhausted.

65
Q

What were the key events in the development of banking in Australia in the 1800s and early 1900s?

A
  • Bank of NSW (first bank in Australia) was established in 1817
  • Discovery of gold in 1851 led to the minting of gold coins
  • Speculative boom in the property market in the 1800s led to the Australian banking crisis of 1893 and the failure of 11 commercial banks
66
Q

What were the key events in the development of banking in Australia between 1910-1920?

A
  • The Australian Pound was issued as the legal tender
  • The Australian Notes Act of 1910 assigned responsibility for the issue of bank notes to the Commonwealth Treasury
67
Q

What were the key events in the development of banking in Australia between 1911-1913?

A

In 1911, the federal government established the Commonwealth Bank, which by 1913 had branches in all six states.

68
Q

What were the key events in the development of banking in Australia in 1920?

A

The Commonwealth Bank performed some central bank functions, which were greatly expanded during WWII.

69
Q

What were the key events in the development of banking in Australia between 1930-1931?

A
  • The Great Depression of the 1930s brought a string of bank failures. In 1931, the Commonwealth bank took over two faltering state savings banks.
  • Banking in Australia became tightly regulated. It was virtually impossible for a foreign bank to establish branches and consequently Australia had fewer banks than other countries.
70
Q

What were the key events in the development of banking in Australia between 1960-1970?

A
  • RBA was created in 1960 and assumed the central bank functions previously performed by the Commonwealth Bank
  • Separation of savings and trading banks was removed, and all banks were allowed to operate in the money market
  • Banks were allowed to set their own interest rate and building societies could take deposits from the public
  • ATMs introduced in 1969
  • BSB (Bank State Branch) identifiers introduced in early 1970s
71
Q

What were the key events in the development of banking in Australia in the 1980s?

A
  • In late 1981, the Campbell Committee enquiry into the Australian Financial System was published and recommended to move away from regulating range of financial activities.
  • Banks had much greater freedom to respond to competitive market signals and customer requirements.
72
Q

What were the key events in the development of banking in Australia between 1990-2000?

A
  • Government adopted “four pillars policy” in relation to banking in Australia and announced that it would reject any mergers between the big four banks (ANZ, CBA, NAB & WBC).
  • The intent was to avoid further concentration of major bank suppliers in the Australian market.
73
Q

What were the key events in the development of banking in Australia between 2000-2017?

A
  • Since the GFC, there has been renewed emphasis on corporate governance, values and ethics.
  • Better Banking Program launched in 2017 with initiatives such as:
    1. Independent review of retail banking remuneration
    2. Getting problems fixed and resolving disputes
    3. Protecting whistle-blowers
    4. Stopping poor conduct in the industry
    5. Independent review of Code of Banking Practice
74
Q

What are the two broad categories of other financial service providers?

A
  1. Authorised deposit-taking institutions (ADIs)
  2. Non-ADI Financial Intermediaries
75
Q

What are the two types of ADIs under the category of other financial service providers?

A
  1. Building societies
  2. Credit unions
76
Q

What are the three types of non-ADI financial intermediaries under the category of other financial service providers?

A
  1. Money market corporations (excluding those with assets <$50m)
  2. Finance companies (excluding those with assets <$50m)
  3. Securitisation vehicles
77
Q

What are building societies?

A

A mutual institution, which means that most people who have a savings account or mortgage are members. Each building society has a board of directors who run the society and are responsible for setting its strategy. Each member also has voting rights on how the organisation is run.

78
Q

What are credit unions?

A

Like building societies, credit unions or mutually owned institutions, providing basic, low-cost deposit, personal/housing loans, and payment services to members. Members finance their personal borrowing from their own combined resources.

In many ways, credit unions are like early building societies with the provision that members must share a common bond, such as living in the same locality, or working for the same employer or industry.

79
Q

How do building societies and credit unions differ from banks

A
80
Q

What are money market corporations?

A

These operate primarily in the wholesale markets, borrowing from, and lending to, large corporations and government agencies. They may provide other services, including advisory, corporate finance, capital markets, foreign exchange, and investment management.

81
Q

What are finance companies?

A

Finance companies that provide loans to households and medium size businesses. They raise funds from both the wholesale and retail markets.

82
Q

What are securitisation vehicles?

A

These are special purpose financial solutions that issue securities backed by pools of assets (e.g., mortgage-based housing loans). The securities are usually credit-enhanced (e.g., through the use of guarantees from third parties).

83
Q

What are the seven types of insurers and fund managers?

A
  1. Life insurance companies
  2. General insurance companies
  3. Superannuation and approved deposit funds (ADFs)
  4. Unit trusts and managed funds
  5. Cash management trusts
  6. Trustee companies (common funds)
  7. Friendly societies
84
Q

What are life insurance companies?

A

Provide products and services such as life, accident and disability insurance, annuities, investment and superannuation. Assets are managed in statutory funds on a fiduciary basis and are mostly invested in equities and debt securities.

85
Q

What are general insurance companies?

A

Provide a range of insurances, including for property, motor vehicles and employers’ liability. Assets are invested mainly in deposits and loans, government securities, and equities.

86
Q

What are superannuation funds?

A

Superannuation funds accept and manage contributions from employers (including self-employed) and/or employees to help Australians save for retirement. Trustees control these funds. Superannuation funds and ADFs usually invest in a range of
assets (equities, property, debt securities and deposits)

87
Q

What are ADFs?

A

Approved deposit-taking funds are generally managed by professional fund managers and may accept superannuation lump sums and eligible termination payments (when a person resigns, retires or is retrenched). Superannuation funds and ADFs usually invest in a range of assets (equities, property, debt securities and deposits).

88
Q

What are unit trusts and managed funds?

A

Managed funds pool investors’ funds, usually into specific types of assets (e.g., cash, equities, property, money market investments, mortgages and overseas securities). Most are managed by subsidiaries of banks, insurance companies, or money market corporations.

89
Q

What are cash management trusts?

A

A type of unit trust governed by a trust deed and open to the public. They generally confine their investments (as authorised by the trust deed) to financial securities available through the short-term money market.

90
Q

What are trustee companies?

A

Trustee companies (also known as common funds) pool into common funds money received from the general public or held on behalf of estates or under powers of attorney. Funds are usually invested in specific types of assets (e.g. money market investments, equities and mortgages).

91
Q

What are friendly societies?

A

Mutually owned co-operative financial institutions offering benefits to members through a trust-like structure (friends build trust). Benefits include investment products through insurance or education bonds, funeral, accident, sickness or other benefits.

92
Q

What are the four types of financial markets?

A
  1. Primary markets
  2. Secondary markets
  3. Exchange-traded markets
  4. Over the counter (OTC) markets
93
Q

What are primary markets?

A

Where new issues of shares or other forms of security are offered to the market for the first time (e.g., if the government is seeking to fund a road building project, it may choose to finance this by borrowing the funds on the market and issuing government securities).

94
Q

What are secondary markets?

A

Where securities are traded after their initial issue, like a “second hand” market, where securities that have already been issued through the primary market are traded again.

95
Q

What are exchange traded markets?

A

Are organised and subsequently traded on a physical or electronic exchange facility, typically with business rules that define relationships, products, and conventions. In Australia, the main licensed exchange traded markets are equities and exchange traded derivatives on the ASX.

96
Q

What are OTC markets?

A

Over the counter markets are non-standardised and negotiated between the parties involved in the transaction.

97
Q

What are the five financial markets?

A
  1. Interest rate or debt market
  2. Foreign exchange market
  3. Equities market
  4. Commodities market
  5. Derivatives market
98
Q

What are interest rate or debt markets?

A

Trading (buying and selling) includes short term securities and long term securities such as government and corporate bonds.

99
Q

What are foreign exchange markets?

A

Exchanging one currency for another. This is the largest financial market in the world, and due to the zone differences, trade 24 hours a day.

100
Q

What are equities markets?

A

Trading shares in listed companies.

101
Q

What are commodities markets?

A

Trading in raw or primary products such as wheat, grain, cattle and electricity.

102
Q

What are derivatives markets?

A

A contract whose value is derived from one or more underlying assets or instruments; for example, forward rate agreements or underlying exchange rates.

103
Q

What are the two types of financial market participants?

A
  1. Price makers
  2. Price takers
104
Q

Who are price makers?

A

Banks, NBFIs and brokers who normally act as intermediaries.

105
Q

Who are price takers?

A

Other participants, such as corporations, government and individuals who are end users.

106
Q

What is microeconomics?

A

The study of decisions that people and businesses make regarding the allocation of resources and price of goods and services. This means taking into account:
- Supply and demand that may impact the price levels in the economy
- Taxes and regulation created by the government

107
Q

What is macroeconomics?

A

Focuses on issues that affect the economy as a whole and the interaction between economic growth in output and national income, employment, and the general level of prices. This means having a focus on key economic indicators such as:
- Unemployment rates
- Gross domestic product
- Inflation
- Exports and imports
(i.e., factors in the GDP equation)

108
Q

How does Australia’s economy rank as measured by GDP?

A

Australia has the 14th largest economy as measured by GDP.

109
Q

What is Australia’s GDP as of 2019?

A

$1.99 trillion

110
Q

What are some of the key sectors in the Australian economy that contribute to GDP?

A
  • Health and Education
  • Mining
  • Finance
  • Construction
  • Manufacturing
111
Q

How large is Australia’s labour force as of 2021?

A

13.1 million

112
Q

What is Australia’s inflation (CPI) and unemployment rate as of 2021?

A

1.1% and 4.9% respectively.

113
Q

Who is responsible for managing fiscal policy?

A

Let’s get fiscal and smash our politicians. Government spending and taxation determines the fiscal policy that influences the economy.

114
Q

Who is responsible for monetary policy in Australia?

A

The Reserve Bank is responsible for Australia’s monetary policy.

115
Q

What is the main aim of monetary policy?

A

To maintain price stability, full employment, and the economic prosperity of the Australian people by managing inflation.

116
Q

What are the sources of government revenue and spending?

A

Revenue and capital sources include collecting taxes and borrowing funds.

Spending activities include health, education, welfare spending and defence spending.

117
Q

How is monetary policy influenced?

A

Involves setting the interest rate on overnight loans in the money market (“cash rate”). The cash rate influences other interest areas in the economy, affecting the behaviour of borrowers and lenders, economic activity and ultimately the rate of inflation.

118
Q

Through what mechanisms does fiscal policy influence the economy?

A

These activities influence purchase power and spending patterns of households and businesses, which has an impact on the economy.

119
Q

What is the RBA’s inflation target and over what term?

A

The RBA has an inflation target aiming to keep consumer price inflation (CPI) in the economy to 2-3% on average over the medium term.

120
Q

What is a budget deficit?

A

Where the government spends more than it collects.

121
Q

What are the key benefits of controlling inflation?

A

Controlling inflation preserves the value of money and encourages strong and sustainable growth in the economy over the longer term.

122
Q

What is a budget surplus?

A

Where the government collects more than it spends.

123
Q

What is blockchain?

A

A distributed ledger using peer-to-peer technology, providing real time records that are replicated among the participants.

CQiB (7 decks)

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