4.2.4.2: Banks Flashcards
What is a commercial bank?
Everyday banks that deal with deposits, account services, savings accounts, withdrawing money, etc. they have much less risk (e.g. HSBC, Santander, Nationwide)
What is an investment bank?
Provides financial services for institutional investors or large enterprises - buy and sell shares (so very risky)
What are the main functions of a commercial bank?
- Accept deposits - from the public, usually i the form of savings. Demand deposits, meaning deposits can be made or withdrawn immediately or fixed deposits which store money for a long time with high interest, finally saving deposits who withdraw money, but not really immediately, and has lower interest than fixed
- Provide loans - main income for these banks is the interest they get from loans. Banks create credit by using deposited funds as loans.
- overdraft - still high interest and the amount borrowed is limited
- investment of funds - invested into securities like gov bonds or treasury bills, earn a return for the bank
- agency functions - banks represent their consumers, e.g. collecting cheques and dividends, pay and accept bills through direct debits, etc.
What’s a liability?
Something that the bank owes and must be paid. It is a claim on assets. Liabilities are used to buy assets, and income can be earned from these assets.
What are the types of liabilities?
- deposits
- short term borrowing
- long term borrowing
Capital - shareholders funds
- retained profit
What is an asset?
Assets are things that the banks owns, and can be sold for value.
What are the different types of assets?
Current assets:
- cash
- reserves at the BofE
- money at call at short notice
- short term investments
Non-current assets:
- long term investment
- advances
- fixed assets
Why is profitability an objective for commercial banks?
Banks need to earn profits to pay their depositors interest, wages and general expenses (shareholders want profit)
- Holding a lot of funds in cash means profitability is limited.
—> profit is also needed for growth of the bank
What are some examples of how a bank can achieve more profits?
- give out more risky loans (so can charge more interest)
- increase loans (less liquid/cash - convert cash into long term investments or advances)
- borrow short term and lend long term
Why is liquidity an objective for a commercial bank?
The liquidity of assets is how easy it is to turn the assets into cash. Liabilities are payable on demand, so in order to be profitable banks must have cash and liquid assets. If liquidity is prioritised, profits will be low, so banks need a balance between the two objectives.
- they need liquid assets to avoid bank failure (liquidity crisis/bank run)
What are some examples of actions a bank can take to achieve being more liquid-able?
- loan less to ensure more cash available
- short term current assets to meet short term current liabilities
Why is security another objective of a commercial bank?
Banks face risks and uncertainties about how much cash they can get, and whether loans will be repaid or not. Banks therefore have to try and maintain the safety of their assets
- This means that banks profits are lower and the bank might lose customers. The bank needs a balance between the risk level and their profits. Too much risk could be harmful
—> this avoids insolvency and bank failure
What are some examples of things banks can do to have more security?
- more safe loaning, avoid too much risky loaning
- less risky advances
What is credit creation?
Process by which commercial banks are able to create loans in the form of new deposits
Returns<— Interest<— Savers Banks Borrowers
—> deposits. —> lend
