Banking Flashcards
What is a Retail bank?
1) This is the type of bank used by individuals with high street branches.
2) Examples are Barclays, NatWest.
3) Banks lend to individual customers with loans for cars and longer term loans for houses (mortgages).
4) Make a profit by charging more interest than it does on the money it lends. It then pays wages front the surplus and hopefully generates a profit.
What is a commercial bank?
1) In US it tends to mean all banks.
2) Elsewhere it tends to mean banks that deal with other commercial businesses.
3) Sometimes referred to as corporate banking.
What are the type of retail loans?
1) Loans for cars etc.
2) Mortgages for houses.
3) Overdrafts are short term loans were individuals’ accounts become negative.
How are loans structures?
1) Normally a set period.
2) Set interest rate per annum.
3) Defined payment schedule; i.e. every month for the next 3 years.
4) Often unsecured loans. There is no additional security for the bank.
5) Individuals agree to pay back the bank.
How are mortgages structured?
1) Set period, e..g 25 years.
2) Defined payment schedule, e.g. monthly.
3) Secured on a property.
4) Can be on a set interest rate (fixed) or variable (e.g. linked to the published Bank of England rate).
5) If fail to make the payments, the bank can take over the property - hence the name secured.
How are overdrafts structured?
1) Typically have an overdraft limit available.
2) Very flexible - may not use it but know that it’s available in need.
3) If you over spend one month then you can utilize the overdraft facility.
4) Agreed interest rate.
5) Not fixed time and can be removed by the bank at anytime.
6) Unsecured by any assets.
What are credit cards?
1) Provided by banks or specialist lenders.
2) Set borrowing limit.
3) Use card to pay for goods and services.
4) Required to pay back a minimum amount depending not he outstanding balance at the end of the month.
5) Variable rate of interest which tends to be expensive.
What are other sources of loans?
1) For people that struggle to access bank loans.
2) Pawnbrokers pay cash for goods (I.e. wedding rings). They hold the goods for a set period and the individual can then buy them back. If they don’t buy them back then the pawnbroker can then sell the goods. It is a form of secured loan.
3) Payday loans are short terms loans until someone gets their next pay Chequers. Typically very high rates. Example might be to borrow $100 and then have to replay $116.80 in 21 days time. This equates to 292% annual interest rate compared to a bank loan of around 15%.
Characteristics of loans from pawnbrokers and payday loans?
1) Easily available.
2) Very expensive interest rates.
3) For pawnbrokers, payment is required to get the asset back.
4) For payday loans, short term until next payday.
What is the effective annual rate of interest?
1) Have to also be quoted on this basis so that they can be compared with other types of loans.
2) They are quoted annually.
How to calculate the annual effective rate?
1) 10% per annum is just 10%.
2) 10% per annum payable quarterly is 2.5% each quarter. This works out to be (1.025) ^4 = 1.10.38, or 10.38%.
3) 20% per annum payable twice yearly. This works out to be (1.10) ^2 = 1.21 or 21%.
4) 10% interest payable after 6 months has an annual equivalent rate of 21% as per 3) above.
How does secured lending work?
1) Example is a mortgage.
2) The security is the house.
3) Value the house and restrict the loan to a percentage of the house value, e.g. 80% or 90%.
4) They limit the value so that they can sell the house if the borrower fails to pay back the loan.
5) Don’t allow 100% loans in case house prices fall.
6) Because there is a security the loan tends to be cheaper as it’s less risky for the bank.
What is the relative cost of borrowing?
1) Secured loans are much cheaper as the risk is less.
2) So lower risk is associated with lower return.
What are investment banks?
1) Capital raising banks with capital between 5m pounds and 100 billion pounds.
2) Equity or debt or combination of both.
3) Also help companies with mergers and acquisitions, known as M&A.
Raising equity or debt?
1) Debt is normally the answer when the company is raising money for something that can be easily sold.
2) Equity is normally the answer when the company is raising money for something that is less certain.
