Chapter A1: Banking Flashcards
List the different types of banks
Traditional deposit-taking banks (retail / commercial banks)
Development banks
Reserve / Central banks (mandated by the government)
Investment banks
Community banks
Retail/commercial banks
o Accept deposits, provide loans
o Usually public companies and highly regulated
Products include: o Deposit/Savings accounts - Notice/Term deposits o Transaction accounts - Overdraft facilities o Loans - Mortgage loans - Vehicle loans - Unsecured personal loans o Credit card facilities
Business/Commercial/Corporate banking products also include:
o Loans
- Unsecured loans
- Asset-based finance
o Merchant and cash solutions
o Foreign exchange and trade solutions
Development banks
o Specific developmental role o Could target small enterprises (microfinance) or large infrastructure projects o High risk (usually unsecured) loans o Can fund public or private projects o Usually government owned
Central banks
Mandates from governments include:
o Price stability (achieved through monetary policy) for economic growth
o Supervision of banking industry
o Ensure effective national payments system
o Lender of last resort
o Administer exchange controls
o Banker of the state
Investment banks
Assists companies and governments with facilitating long-term funding, which includes:
o Debt financing
o Equity financing
Facilitation includes: o Structuring / originating securities o Pricing securities o Marketing and sale of securities o Underwriting of securities o Placement of securities
Community banks
o Member-based, non-regulated organisations, but can include formal (and regulated) mutual banks
o eg stokvels (Stokvels are invitation-only clubs of twelve or more people serving as rotating credit unions or saving schemes in South Africa where members contribute fixed sums of money to a central fund on a weekly, fortnightly or monthly basis)
Other products and services
o Fiduciary and trust services (estate planning, setting up trusts) o Stockbroking services o Portfolio management o Sale of insurance products o Provision of information
Banks’ Trading Book activities:
o Trading for own account
o Meet the needs of its clients e.g. facilitates stockbroking trading by investors (eg purchase illiquid shares), or sell currency option to a corporate client to help it reduce its foreign exchange risk
o Hedging against some of a bank’s market risks (eg enter into swap to protect the bank from rising interest rates)
Roles of traditional banks
Act as financial intermediaries
o Between savers (providers of capital) and borrowers (users of capital)
o Banks develop facilities/instruments/products to make lending, borrowing possible
o Direct impact on a country’s production, local and international trade, economic growth
and employment
Provide liquidity to the financial system
o Lending activities injects liquidity into the economy
o Fractional reserve banking allows banks to lend a high proportion of their deposits, which
ultimately leads to increase in money supply (m=1/R)
o Central bank may adjust “R” to increase/decrease money supply and liquidity.
Provider of information
o Economics research and trends
o House prices indices
o Trade/credit/industry statistics
Banking trends
Increasing regulatory requirements relating to:
o Risk management
o Provisioning
o Capital requirements (largely determined by Basel accord)
o Reporting and disclosure
Emergence of “fintech”
o Use of technology to provide financial services eg
- Mobile/digital service
- Efficient use of data (including AI) to provide better service, reduce fraud
List the various items to consider when pricing interest-rate products at a bank.
o Benchmark rate (e.g. repo rate)
o Pricing for risks / expected losses and for profit:
• Credit quality/security
• Tenor
• Credit rating agencies
o Lending (loan) rates
o Borrowing (deposit) rates - (banks own credit quality)
o Fees and CommissionsStudy Banking Revenue account and Balance sheet
Slide 18 and 20
List the 4 key risks for banks
o Credit Risk
o Market Risk
o Operational Risk
o Liquidity Risk
Credit Risk
Failure of a borrower to meet its loan obligations
o Specific form of counterparty risk
Default by a borrower can be defined in many ways:
o Length of time past the due payment date
o Default on other obligations
o Breach of contractual conditions (e.g. covenants)
Credit risk can be amplified by concentration risk
What are the different sources of Market Risk
Volatility risk
o Risk of price/interest rate changes being more uncertain than expected
o Can lead to financial losses on instruments held e.g.
Options held in the trading book
- The value of options issued by the bank become
more valuable to holders if volatility increases
(which increases potential losses to the bank)
Currency risk
o Risk of adverse movements in exchange rates
- Can lead to losses if assets and liabilities are mismatched by currency
Basis risk
o Basis risk occurs when a risk exposure is hedged with an offsetting exposure in another instrument, but that instrument does not behave in an identically opposite manner to the risk exposure.
Interest rate risk
o This is the adverse movement in interest rates
• Too high => higher interest income, but also higher funding costs and higher loan defaults
• Too low => low interest income, while funding costs may not reduce as much; second order economic effects
Liquidity risk
• Risk of not being able to trade in a market, and related to this,
• Risk of not being able to obtain prices on desired products
Commodity price risk
• Risk of adverse price movement in the value of a commodity
