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CTP > Chapter 3 - Banks and Financial Institutions > Flashcards

Chapter 3 - Banks and Financial Institutions Flashcards

1
Q

Commercial Bank

A
  • Most common type of FI
  • Accepts deposits and makes commercial loans
  • Must possess a federal or state charter
  • Services include:
    □ Depository Accounts
    □ Credit Services
    □ Transaction Processing
    □ Information Reporting
    □ Trade Services
    □ FX
    □ Financial Risk Mgmt Services
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2
Q

Term Loans

A

borrow up to a specified amount to be repaid by a specific date

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3
Q

Revolving Line of Credit

A
  • borrow up to a specific amount, repay all or some, and borrow again
  • may be subject to a clean up period, pay down line for a specified period of time (e.g. 30 days)
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4
Q

Overdraft Facility

A
  • allows companies to borrow by overdrawing on their account (negative balance)
  • repayable on demand and usually unsecured
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5
Q

Commercial Paper

A
  • unsecured, discounted, short-term promissory notes issued by companies or commercial bank holding companies
  • is another way for corporates / institutional customers to acquire credit
  • FI acts as agents to place CP with investors
  • CP’s are rated for default risk by credit rating agencies; ratings affect interest rates
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6
Q

Municipal Securities

A
  • bonds and notes issued by city, county, state govt entities
  • interest paid on muni’s are typically tax exempt
  • muni’s are also rated for default risk
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7
Q

Loan Sales

A
  • structures lending facilities in a way so that short term loans can be sold to banks and investors
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8
Q

Private Placement

A
  • direct sales of long term notes to institutional investors (e.g. insurance companies and hedge funds)
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9
Q

Foreign Currency Services

A

(1) foreign currency payments: send / receive cross border foreign currency payments from an account denomincated in the firm’s operating currency

(2) foreign currency accounts: deposit balances are held in a currency other than that o fthe country of origin; most often available int he major int’l currencies (CAD, USD, GBP, EUR, JPY)

(3) multicurrency accounts: one account that can send / receive payments in several currencies; the bank typically operatea series of virtual accounts to manage each currency; attractive cash mgmt tool for small businesses

(4) foreign currency transaction services: buy / sell internationally traded currencies for immedate use (spot) or future use (forward)”

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10
Q

Investment Bank

A
  • provide a wide range of services related to issuing and tradingn securities including:
    (1) securities underwriting
    (2) custodial services
    (3) facilitate mergers, acquisitions, divestitures, and other corporate re-orgs
    (4) act as a broker / financial advisor for institutional clients
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11
Q

Industrial Bank

A
  • are FI’s with a very limited scope
  • sell certificates called investment shares and can accetp deposits (but no checking accounts)
  • lend deposits out via installment loans to consumers and small businesses
  • due to limited scope / services, industrial banks do not fall under general banking regulatory authority
  • locally chartered and ay be owned by nonbank holdco’s
  • e.g. auto mfg co may establish an industrial loan company to facilitate consumer sales
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12
Q

Universal Bank

A
  • offer both IB and CB services
  • IB services have to be offered through the IB arm of a CB holding company
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13
Q

Central Bank

A
  • provides banking services to the govt and banking sector
  • responsible for issuing currency and implementing govt’s monetary policyx
  • some may also be responsible for supervising commercial banks and the country’s payment systems
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14
Q

Central Bank Functions

A

(1) implement monetary policy: via reserve requirement ratio (2) open market operations and (3) official interest rate

(2) issue currency: provide currency to Fis in exchange for govt bonds

(3) supervise / regulate commercial banks

(4) govt services: provide financial services to the govt including: basic deposit and safekeeping and sale / redemption of govt securities

(5) depository insitution services: provide services to FI’s including:

(a) operating clearing and settlement systems
(b) provide coin and currency
(c) hold reserve balances
(d) may act as lender of last resort e.g. provide loans to Fis that are unable to raise funds in the interbank market

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15
Q

Seigniorage

A
  • Income from issuing currency (difference between face value and cost to produce)
  • is used to fund central bank operations or remitted to the govt
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16
Q

Monetary Policy

A
  • management of money supply and interest rates to target inflcation and therefore economic growth
  • primary tools to implement monetary policy are:

(1) interest rate: rate used for lending to FI’s (aka discount rate in the US); increase in rate increase interest rate charged for loans ; demand for loans decreases

(2) reserve requirements: minimum artio of deposits a bank must keep on hand; increase in reserve reduces bank ability to make loans which directly decreases the money supply

(3) open market operations: purchase / sale of govt securities; buying bonds increases bond price which lowers interest rates

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17
Q

Export Credit Agency (ECA)

A
  • provides financing and insurance products to support the exporting of good, especially into emerging markets
  • can be govt-owned or private institutions that act as intermediaries between the govt and the exporting companies
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18
Q

Primary role of bank regulators

A
  • monitor credit and liquidity risks that could cause potential bank failures
  • implement safeguards to reduce risk of system failure
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19
Q

Two Stages in Bank Supervisory Regime

A

(1) initial chartering
(2) ongoing supervision and surveillance of chartered (licensed) banks

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20
Q

Bank Chartering / Licensing

A
  • the process of establishing or opening banks / depository institutions and provides guidelines to types of financial services the FI is allowed to offer
  • charter regulations specify amount of capital required to open a bank and may specify limits on ownership by foreign entities
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21
Q

What do regulators require / evaluate for bank monitoring and supervision?

A

(1) On site examinations and require accounting statements and financial reports for off-site evaluation

(2) Perform stress tests to assess robustness of bank’s balance sheet which includes:
(a) Capital and Liquidity Requirements
(b) Minimum Asset Quality Requirements

(3) Bank’s net interest margin

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22
Q

Capital and Liquidty Requirements

A
  • minimum capital requirements: determines how much captial (equity funds) owners of a bank must contribute to the business
  • calculated as a ratio fo bank’s captial to at risk assets (aka loans and other investments)
  • the higher the ratio the lower the bank’s risk
  • many regulators use tiered capital to differentiate the risks of banks with identical capital to asset ratios
  • common equity is the first tier (most stable) and preferred stock and long term debt is the second tier (less stable)
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23
Q

Minimum Asset Quality Requirements

A
  • ensure proper investment policies and diversification
  • ensure that banks make loans that are properly priced for default risk
  • may place restrictions on how much can be loaned or invested in a particular company or industry sector (impairment of capital rules)
  • rationale is to limit the chances of the failure of one large company and the resulting default on its loans from leading to a bank failure
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24
Q

Bank’s Net Interest Margin

A
  • difference between interest rate bank lends at and the interest rate that bank pays to depositors
  • is one of the primary sources for earnings for a bank
  • this results in default risk (borrower does not repay loan) and liquidity risk (depositors withdraw deposits with little notice)
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25
Q

1988 Basel Capital Accord (Basel I)

A

established minimum capital ratios for large banks based on the credit risk of the assets of each bank

26
Q

Basel III Overview

A
  • Developed in 2011 in response to ‘07-08 financial crisis
  • Expanded on Basel II to address stress testing, market liqudity risk and capital adequacy
  • Goal: strengthen regulation, supervision and risk mgmt of banking sector
  • increased core capital requirements by 2%, and introduced minimum leverage and liquidity requirements
  • Basel III also recognizes 2 tiers of systemically important banks (global and domestic) which are subject to additional requirements
27
Q

Basel II

A
  • published in 2004
  • expanded risk ratings in Basel I to include an assessment of operational risk in the credit risk evaluation, which is used to establish capital requirements for major banks
  • Basel II is based on 3 pillars:

(1) Minimum capital requirements: addresses credit and operational risk

(2) Supervisory review: provides a framework for dealing with and evaluating risk

(3) Market discipline: disclosure requirements re: risk metrics and captial adequacy

28
Q

What are the goals that Basel III was set out to accomplish?

A

Basel III goals are to:
(1) improve banking sector’s ability to absorb shock from financial / economic stress
(2) improve risk mgmt and governance
(3) strengthen bank transparency and disclosure

Basel III targets:
(1) bank level regulation: to help raise resilience of banking institutions in response to stress
(2) system-wide risks: sector wide risks that build up / are amplified over time
- greater resilience = lower system wide risks

29
Q

What are the requirements under Basel III?

A

(1) minimum capital requirements: all banks are required to hold min. common equity = 4.5% of risk-weighted assets (RWA) + capital conservation buffer of 2.5% of RWA + countercyclical buffer of 0-2.5% of RWA

(2) leverage ratio: maintain a min of 3% equity against all on and off B/S exposures

(3) liquidity coverage ratio: must hold a sufficient quantity of high-quality liquid assets to cover net cash outflows over a 30-day stress period; must distinguish between “operational” and “non-operational” corporate deposits when forecasting net cash outflows

(4) net stable funding ratio: required to closely match the maturities of assets to liabilities

30
Q

Deposit Insurance

A
  • increases confidence in the banking system, especially for smaller depositors
  • depositor confidence is critical for bank’s survival
  • lack of depositor confidence can lead to a “bank run”, where large number of depositors withdrwa all of their deposits at once, and since banks lend out deposits, they don’t have enough on hande to pay a large group of depositors trying to withdraw which could force the bank out of business
31
Q

Federal Reserve Act (1913)

A
  • establishes the Federal Reserve System
  • requires all banks with a national charged from the OCC to become Reserve banks, which subjects them to Fed regulation, supervision, and reserve requirements
  • also empowered the Fed to create national check collection and settlement system through member banks
32
Q

Regulation D

A
  • implements reserve requirement provision of the Federal Reserve Act
  • imposes uniform reserve requirements on all depository institutions with different levels for different types of deposits
33
Q

Regulation Q

A
  • original Reg Q implemented interest bearing restriction of the Glass-Steagall Act of 1933, which barred paying interest on corporate demand deposit accounts
  • this was partially phased out in 1986 by the Depository Institutions Deregulation and Monetary Contraol Act (DIDMCA) of 1980 and restrictions were fully removed by the Dodd-Frank Act of 2010
  • current Reg Q was introduced in 2013
  • implements the Basel III minimum capital requirements and capital adequancy standards for all banks regulated by the Fed
34
Q

Regulation Y

A
  • implements provisions of the Bank Holding Company Act of 1956, Change in Bank Control Act of 1978, and revisions re: acquisition of control for banks and bank holdcos
  • defines and regulates non-banking activities in which bank hold cos and foreign banking orgs in the US may engage in, including anti-tying restrictions
35
Q

Regulation BB

A

-implements provisions of the Community Reinvestment Act of 1977 and the 1995 revision
- requires banks to help meet the credit needs of the entire community in which they do business

36
Q

Regulation VV

A
  • implements the Volcker rule of the Dodd-Frank Act
  • Volcker Rule: limits an FI’s ability to engage in proprietary trading for its own portfolio
37
Q

Regulation WW

A
  • imposes minimum liquidity requirements on large and internationally active banking orgs
  • based on the liquidity coverage ratio introduced in Basel III
38
Q

Glass-Steagall Act (Banking Act of 1933)

A
  • was passed as a result of the Great Depression
  • Prohibits CB’s from underwriting securities except for govt issues
  • Prohibits securities frims from engaging in bank like activities e.g. deposit gathering
  • Required Fed to establish interest ceilings for all account types and prohibited paying interest on DDAs (Reg Q)
  • Created the FDIC in order to restore faith in the banking system after several Depression era bank failures
  • Gramm-Leach-Bliley Act of 1999 repealed all of Glass-Steagall except for the FDIC
39
Q

Tying

A

Act of requiring an organization or individual to purchase a product or service in order to be allowed to obatin a separate product or service

40
Q

Gramm-Leach-Bliley Act (1999)

A
  • repealed a majority of the provisions established under Glass-Steagall and establishes the following:
    (1) permits creation of fincial holding companies to engage in activity the Fed considers to be financial in nature

(2) establishes the Fed as the primary regulator of FHCs, which are subject to consolidated capital requirements at the parent level and requires bank like risk mgmt at all levels

(3) makes it easier fro foreign banks to enter the US financial market

(4) includes key provisions re: consumer protection, specifically the protection of non-public personal info

41
Q

Anti-Tying Amendments to the Bank Holding Company Act (1970)

A
  • Prohibits tying in financial services, in an effort to increase competition and remove unfair banking practices
  • FI may not condition extension of credit on the requirement that borrower obtain other services from the FI
  • Traditional bank product exception: banks may condition the terms including price of an offer based on the requirement the customer purchasees other products from the bank as long as all of the products are available separately to the same customer
42
Q

Dodd-Frank Wall Street Reform and Consumer Protection Act (2010)

A
  • created the Financial Stability Oversight Council and the Consumer Financial Protection Bureau (FSOC and CFPB)
  • requires the Fed to conduct annual stress tests on the largest and most complex FI’s
  • introduced the Volcker rule which limits an FI’s ability to engage in proprietary trading for its own portfolio
  • the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act exempts banks with less than $10 billion in assets from the Volcker rule
43
Q

Non-Bank Financial Institutions (NBFI)

A
  • NBFIs are sometimes referred to as the “shadow banking” system
  • they provide similar services to banks e.g. extend credit and accept deposits
  • but NBFIs are not subject to the same regulation as banks and are outside the banking systems systemic protections - access to central bank funding, deposit insurance, etc.
  • therefore, NBFIs represent a risk to financial stability in countries with a large shadow banking system
  • e.g. private equity firms, captive finance companies, insurance companies, asset-based lenders, and asset managers
44
Q

What are two areas of concertn for regulators as a consequence of the global financial crisis of 2007-2009?

A

(1) the importance of money market funds and the risk of contagion form the collapse of a fund
- failure of a money market fund could affect money market liquidity
(2) lack of central clearing of financial derivatives and their increased use has made it difficult for regulatrs to understand teh nature of each institutions exposure to different financial risk, which poses a growing threat to the stability of the financial system

45
Q

Broker-Dealers (Brokerage Firm)

A
  • is an entity that trades securities for its own account or on behalf of its customers
  • act as a broker - when executing trade orders on behalf of a customer
  • act as a dealer - when executing trade orders for its own account
  • brokerage firms can be (1) institutional brokers (clients are hedge funds / large corporates) or (2) retail brokers (clients are individuals)
  • brokerage firms can be (1) discount brokerage - make trades at reduced prices, little to no investment advice or (2) full service brokerage - have team of research analysts that provide investment advice to institutions and individual investors
46
Q

Prime Brokerage Services

A
  • include clearing and custody, securities lending, collateral financing, equities financing and account management
  • these services are tailored to fund managers and other high-volume direct users of the money and capital markets
47
Q

Private Equity Firms

A
  • PE firms uses capital raised from institutional investors and high net worth individuals / family offices to invest in privately held companies
  • targets are typically privately held companies but could also be publicly listed companies (purchase all shares and delist stock)
  • common approach is to acquire underperforming firms and try to generate value by improving operational efficiency
48
Q

Captive Finance Companies

A
  • are subsidiaries of a large industrial corporation that finances purchases of the corporation’s products
  • typically raise funds in the commerical paper market and lend to companies / individuals to purchase products from the parent company
  • this allows parent firm to extend credit to customers without putting itself directly at risk
  • e.g. automobile manufacturers
49
Q

Factors and Invoice Discounters

A
  • entites that provide short-term financing to companies by purchasing A/R at a discount
50
Q

Asset-Based Lenders

A
  • ABL loans can be provided by both banks and non-bank specialist lenders
  • ABL loans are secured by collateral that is pledged by the borrower
  • credit availability is based on the quality of the collateral, usually AR and inventory
  • borrowing base is determined by multipyling the value of eligible collateral by an advance rate
  • ABL lender closely monitors collateral and make adjustments to available credit
51
Q

Asset Managers

A
  • manage invested funds in both the money market and capital market
  • companies can place cash with asset managers for as short as overnight or for more than 2 years
  • allows companies to diversify their investments by asset class, type of issuer, and geography
52
Q

Insurance Companies

A
  • insurance companies are considered an NBFI because they are insititutional investors and risk management partners
  • make significant investments in the commercial real estate and bond markets
  • compete with banks for short / medium term loans
  • provide mortgage funding, leasing services, guaranteed investment contracts, and universal life insrance policies with long term savings features
53
Q

Credit Unions

A
  • are member owned, not-for-profit financial co-ops that can provide financial services similar to those of banks and insurance companies and can also provide access to payment networks
  • members / owners often enjoy higher savings and lower lending rates compared to banks
  • chartered and supervised by the National Credit Union Association (NCUA) and deposits are insured by National Credit Union Share Insurance Fund (NCUSIF) for all federally chartered and almost all state chartered credit unions
54
Q

Financial Technology (FinTech) Companies

A
  • technology company that provides financial services
  • some directly compete with traditional Fis - payment services
  • some work in collaboration with traditional Fis - treasury management systems
55
Q

Fiduciary

A
  • individual or institution that is given certain property to hold in trust according to a trust agreeement
  • fiduciary has duties and responsible that are legally enforceable and must be executed in a prudent and timely manner
56
Q

Fiduciary Services

A
  • manage employee pension plans / qualified employee benefit plans
  • act as corporate trustee for bond / preferred stock issue
  • monitor compliance with bond indenture agreements
  • act as transfer agent
  • act as registrar
  • act as issuing agent
  • act as paying agent
  • act as an issuing and paying agent (IPA)
  • offer custody services
57
Q

Bond Indenture Agreements

A
  • contractual arrangements between bond issuers and bondholders
58
Q

Transfer Agent

A
  • keeps records of each purchase /sale of stocks and bonds
  • maintains records of a corporation’s shareholders by name, address, # of shares
59
Q

Registrar

A
  • compile and maintain lists of current stockholders and bondholers for the purpose of remitting dividend and interest payments
60
Q

Issuing Agent

A
  • distributes securities to investors on behalf of an issuer
61
Q

Custody Services

A
  • custody services (safekeeping for securities)
  • buying, selling, receiving, and delivering securities based on terms outlined in a custody agreement

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