Chapter A1: Banking Overview Flashcards
Roles of banks (4)
- Act as financial intermediaries
- Provide liquidity to financial system
- Provider of information
- Barometer of economic health
CCCID
Types of banks (5)
- Commercial / Traditional deposit-taking ]/ Retail banks
- Community banks
- Central / Reserve banks
- Development banks
- Investment banks
Define financial intermediaries. Function?
Definition:
These are business entities that bring together providers of capital (savers) and users of capital (borrowers).
Function: Banks develop facilities/instruments/products to make lending, borrowing possible. Provide the means by which funds are transferred from depositor to borrower. Direct impact on a country's: production local and international trade economic growth employment
How do traditional banks provide liquidity to financial system?
Lending activities inject liquidity into the economy
Fractional reserve banking allows banks to lend a high proportion of their deposits, which ultimately leads to increase in money supply.
How do traditional banks act as providers of information? (3)
Economic research and trends
House prices indices
Trade/credit/industry statistics
What is a traditional deposit-taking / commercial / retail bank?
Provides services such as: Accepting deposits Providing loans Mortgage lending Basic investment products (savings accounts)
Usually public companies that are:
Highly regulated
Listed on major stock exchanges
Owned by their shareholders.
Central / Reserve bank: Mandate from government usually include (5)
- Price stability (Achieved through monetary policy) fore economic growth
- Prudential Authority (PA): Supervision of banking, insurance industry
- Ensure effective national payments systems
- Lender of last resort
- Administer exchange controls
SARB carries out mission through?
The formulation and implementation of inflation targeting and monetary policy
SARB does what (5)
- Issues banknotes and coinage
- Assists in supervising the domestic banking system
- Ensure effective functioning of national payments system
- Administers the country’s remaining exchange controls
- Acts as lender of last resort
Define community bank. Example?
Definition:
Encompasses membership-based, decentralized, and self-help financial institutions.
Self-help = Non-regulated
Several variants
credit associations [Stokvels]
Mutual Bank Acts
What is stokvels?
- Small groups of members (usually 12 or more) contribute fixed money amounts into a central fund.
- These contributions could be paid weekly, fortnightly or monthly.
- Usually has a constitution which stipulates the contribution size and frequency, when the accumulated funds will be paid out, as well as the responsibilities of each member of the ‘stokvel’.
- Default seldom occurs given that the structure is often among community members who know one another, or the regular meeting held help remind members, and there is also a member who is responsible for ensuring everyone contributes as per the constitution requirement.
- Have a wide range of use.
- Their purpose could be for saving or investment.
- Payment for specific events (such as a party, university tuition, holidays or even in event of death)
- Grocery purchases
- As a borrowing pool
- As a family savings fund
Define investment bank. Examples?
Definition:
Assist companies and government with facilitating funding
Term used to refer to financial market activities such as debt raising and equity financing for corporations or governments.
Originating securities
Underwriting them
Then placing them with investors
What does DFI stand for?
Development Financial Institutions
Define DFIs. Features?
Definition:
Development Financial Institutions (DFIs) are alternative financial institutions which include microfinance (small enterprises) and community development institutions (large infrastructure projects).
Function:
Specific developmental roles
High risk (usually unsecured loans)
Can fund public (state) and private projects
Usually government owned (but could obtain funding form other lenders too)
DBSA
What is DBSA?
The Development Bank of Southern Africa is a development finance institutions in Southern Africa, it focuses on large infrastructure projects within the public and private sectors.
Normally partner with private enterprises.
Education, hospitals, roads and infrastructure.
Banking products and activities (5)
- Retail banking products
- Corporate/business banking products
- Investment banking services
- Other products and service
- Trading book
Banking products and activities: Retail banking products (4)
- Deposit / Savings accounts
1a. Notice deposits
1b. Term deposits - Transaction accounts
(overdraft facilities) - Loans
Unsecured Personal
Mortgage
Vehicle financing - Credit card
Banks serve all payers in the financial industry, including individuals, businesses and government. T or F
True
Banking products and activities: Corporate / Business banking products (7)
- Deposit / Savings accounts
Notice deposits
Term deposits - Transaction accounts
Overdraft facilities - Loans
Unsecured Loans
Asset based finances - Merchant and cash solutions
IMPORTANT - Payroll service
- Foreign exchange and trade solution services
- Portfolio management
Banking products and activities: Investment banking services (corporate or government) (1)
Facilitating includes… (5) PUMPS
- Facilitate long-term funding
Debt finance
Equity financing
Facilitation includes: Pricing securities Underwriting of securities Marketing and sales of securities Placement of securities Structing / originating securities
Banking products and activities: Other products and services (5)
- Fiduciary and trust services
Estate planning
Setting up trusts - Stockbroking services
- Portfolio management
- Sale of insurance products
- Provision of information
Banking products and services: Trading book activities
Definition
List (4)
Definition
A portfolio of financial instruments held by a bank, which are actively traded and which are to facilitate trading for the customers, to profit from trading spreads between the bid and offer prices, or the hedge against various types of risks.
- Trading for own account
- Profit from bod-offer spread on trades between its clients
- Meet the need of its clients
Facilitates stockbroking trading by investors
Sell derivates to clients - hedge against some of a bank’s market risks
Pricing (2)
- Of interest-rate products
2. On services and other products
Pricing: Of interest-rate products (3)
- Benchmark rate
Prime lending rate - Pricing for risks / expected losses and for profit
Credit quality / record of borrower
Security offered for a loan (if any)
Tenor of the loan - Borrowing (deposit) rates
Banks own credit quality
Pricing: On services and other products (5)
- Fees for the use of facilities and products
Transaction accounts - Fees for advice
Fiduciary and trust - Fees and commission from selling insurance products
- Investment banking fees
- Bid-offer spreads and commissions for stockbroking services
Banks create provisions/reserves for loan losses. They used the fractional reserving system. Explain
m = 1/ R
R is the reserve %
m is the factor of creating more money
Provisioning will mainly be obligations to repay depositors and other funders, but a separate category of liabilities will be “provisions” specifically.
Provisions/Reserves for credit losses (defaults) (4)
- Provisions for non-performing loans
Based on expected loss given default - Provisions for performing loans
Based on: Probability of default over the next 12 months * expected loss given default - IFRS 9 guidelines for impairment of financial assets
International Financial Reporting Standards (IFRS) - Net increase to provisions is a charge against income statement
Banking trends (2)
- Increasing regulatory requirements relating to:
Assessing and managing risk (risk management & risk measurement)
Provisions
Capital requirements (largely determined by Basel accord)
reporting and disclosure - Emerging of “Fintech”
FinTech brings together financial services and technology to modernize banking.
Mobile / digital services
Efficient use of data (including artificial intelligence) to provide better service and reduce fraud
The type of product may vary depending on the type of customer and the needs of the customer. T or F
True
The main sources of income are interest and fee charged to customers. T or F
True
Financial: Revenue (3)
- Net interest income
Interest income received (from loans issued) - Interest income paid (on funding) - Non-interest income
Fees for products/services
Account fees, commitment fees, transaction fees, asset management fees, insurance fees - Trading income from trading book
Profit or losses
Trading book assets must be market-to-market on a daily basis.
Financial: Costs (2)
1, Operational expense Most general staff costs Marketing and sales IT systems and equipment Running a branch network.
- Cost of credit / Credit impairments
The value of the loans in default that are written off if repayment seems unlikely or the value of the increase in provisions for such losses
Financial: Balance sheet (3)
A = L + E
ASSETS 1. Loans / banking book Retail, Commercial, Corporate Loan Loss reserve 2. Inter-bank loans 3. Trading book assets Must be market-to-market daily 4. Non-trading book assets Held to maturity (could be market-to-model) 5. Fixed assets 6. Intangible assets Include goodwill
LIABILTIES 1. Deposits Retail and corporate clients 2. Wholesale funding Central bank Asset managers Inter-bank funding 3. Trading book liabilities Issued options 4. Banking book Loan Loss Reserve
EQUITY 1. Capital requirement Regulatory capital Additional economic 2. Free capital
Define risk
Comprise events/exposures that may (but not necessarily) will go wrong.
Leading (directly or indirectly) to financial losses or insolvency for a bank.
At a fundamental level, risk might be considered to be exposure to actual events being different from those expected (or desired).
Key risks for bank (4)
Credit Risk
Market Risk
Operational Risk
Liquidity Risk
Define credit risk
Risk of loss caused by the failure of a counterparty or issuer to meet its obligations.
The risk of failure of third parties to meet their obligation.
Define concentration risk in credit portfolio
Arises through an uneven distribution of bank loans to individuals issuers or counterparties (single-name concentration) or within industry sectors and geographical regions (sector concentration).
Key risks for banks: Credit risk (3)
- Failure of borrower to meet its loan obligation
Specific form of counterparty risk - Default by a borrower can be defined in many ways:
Length of time past due payment date
Default on other obligations
Breach of contractual conditions (covenants) - Credit risk can be amplified by concentration risk.
Define covenants
An agreement that is legal and binding on the parties involved.
The expression is often used in association with corporate debt, because the borrower is bound to the terms of the agreement.
The expression is also used in property investment because the tenant or lessee is bound to the terms of the lease agreement.
In fact, the meaning of covenant has been extended in the context of property investment so that it usually refers to the quality of the tenant, e.g. a tenant with a good covenant is a good quality tenant who is unlikely to break the terms of the agreement.
This last meaning of the term may also similarly refer to the quality of an employer-sponsor of a benefits schemes.
Define business (strategy risk)
Risk of poor strategic decisions leading to financial losses
Include reputational damage risk
Define Country (include political) risk
Risk of business environment deteriorating after investing in the country
Deterioration could be due to political or economic factors
Define pre-payment risk
Risk of earlier-than-expected return of loan principal: acquisition costs may not be recovered; hedging losses may be made
Define model risk
The risk of models not producing correct output
[Models of financial instruments can give the incorrect price]
Incorrect output can lead to:
Financial losses
Incorrect hedges
Incorrect reserves
Define counterparty risk
Risk of failure of a counterparty to meet its obligations
By a borrower
By a derivatives counterparty
By a service provider who has been paid in advance
By an insurer not being able to meet claims
Define insurance risk
Risk of claims and expenses exceeding premiums on bank underwritten business.
Credit risk is the primary risk of all banks. T or F
False
Traditional banks not all banks
Key risks of banks: Market risk (6)
Basis risk Commodity price risk Currency risk Volatility risk Interest rate risk Liquidity risk
Define 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.
Banks may choose to hedge some of their risks
Interest rates falling below some specific level to offset falling revenue on loans
The bank will probably use a derivative (e.g. purchase an interest rate put option)
Basis risk is the risk that profit on the derivative is not exactly matched to tis losses on its loans.
Define commodity price risk
Risk of adverse price movement in the value of a commodity.
Most commodities are traded in markets where the concentration of supply in the hands of a few suppliers can magnify price volatility.
Define currency risk
Risk of adverse movement in exchange rates
Bank could be exposed through import/export corporate clients
Bank own asset and liabilities could be mismatched by currency
Define volatility risk
Risk of price/interest rate changes being more uncertain than expected.
Can lead to financial losses on instruments held
[Option held in the trading book]
[The value of options issued by a bank become more valuable to holders if volatility increases - which increases potential losses to the bank]
Many interest rate derivatives products/solutions require options
[interest rate caps or floors or collars are often used in conjunction with loans]
Define interest rate risk
Risk of adverse movement in interest rate
Will directly affect fixed income securities, loans, futures, options and forwards.
Define liquidity risk (as related to market risk)
Risk of not being able to trade in a market, and related to this,
Risk of not being able to obtain prices of desired products
[hedging products/derivatives]
Operational risk arises from… (4)
PEPS
- People
Must communicate an enforce rules, minimize conflicts of interest, and set proper incentives to maintain an ethical culture. - External events
Must have the ability to know and monitor clients to guard against fraud and protect people and faculties. - (Internal) processes
Must have clear, orderly, and complete processes to meet responsibilities to clients, manage risk, control payments, protect against fraud, and comply with regulation. - Systems
Must have adequate technology resources that are backed up and protected from security breaches.
Define liquidity
Liquidity is used in various ways, all relating to the availability, or access to, or convertibility into cash.
- An institution is said to have liquidity if it can easily meet its needs for cash.
- A market is said to be liquid if the instruments it trades can easily be bought or sold in quantity with little impact on market prices.
- An asset is said to be liquid if the market for that asset is liquid.
- A firm is liquid if it has ready access to cash.
COMMON THEME IN ALL COMPONENTS IS CASH
Define liquidity risk
The risk that a firm has insufficient cash to meet its cash obligations and will either become insolvent or will suffer losses from borrowing, selling assets at below market price, or paying contractual penalties.
Other risk faced by banks (4)
Business (strategy) risk
Currency risk
Pre-payment risk
Model risk
Explain the twin peak regulatory regime in South Africa
Where prudential and conduct risk are separately regulated.
Prudential:
Prudential Authority (PA) - Part of South African Reserve Banks (SARB)
Financial soundness
Conduct:
Financial Sector conduct Authority (FSCA)
Treating Customers Fairly (TCF): detailed set of rules on how products are sold and marketed, disclosure requirements, dealing with complaints, cost and value for money.
South African banks have to follow many peices of legislation and guidance, which include (6)
Banks Acts Companies Act National Credit Act FICA and FAIS IFRS King III and King IV
Explain the Banks Act
Applies to all deposit accepting businesses
Incorporates Basel capital and risk management rules
Other rules by supervisors
Explain the Companies Act
Provides for the incorporation, registration, organization, management of companies
Explain the National Credit Act
Enforced by the National Credit Regulator (NCR)
Keeps a register of lenders and investigate complaints, carries out research and public education.
Explain FICA
Financial Intelligence Centre Act (FICA)
Aims to prevent money laundering by imposing monitoring and reporting requirements and various financial service providers
[Institutions like banks and insurers, and professionals like estate agents, brokers, attorneys]
Explain FAIS
Financial Advisory and Intermediary Service Act (FAIS)
Regulates Financial Service Providers (FSPs)
[Financial advisors to ensure that they are fit and proper - competence and ethical requirements]
Explain IFRS
International Financial Reporting Standards (IFRS)
Accounting rules developed by the International Accounting Standards (IAS) board
Aims for consistency of accounts
Thus enabling comparisons and comprehensibility across time and across companies
Explain King III and King IV
Guidelines for best practice corporate governance including control structures and their composition, remuneration reporting and disclosures.
