Commercial Bank Management Flashcards
Week 1:
Why do banks exist? provide two reasons.
What do banks do?
What is the key issue of banking?
1: Intermediation between parties i.e. matching borrowers and lenders.
2: Manage the mismatches between the preferences of depositors and borrowers by transforming maturity, amount, and risk… remember that borrowers want long periods with low interest and lenders want short periods with high interest.
banks accept deposits from the public and facilitate lending. In making credit available, banks are rendering a great social service
Key issue = Banks are a public trust. This means there is the issue of defaulting on loans.
Week 1:
Why are banks heavily regulated?
Who regulates banks?
Heavy regulation = because of their importance in the economy. Regulation is in play to sustain and support banks, not oppress them. As well as to protect the safety of public savings, promote confidence in the financial system, control the money supply and growth of the economy, provide government with tax revenues and other services.
Regulates banks = Council of Financial Regulators (CFR) = consists of RBA, APRA, ASIC, Australian Treasury.
Week 1:
What is the net interest rate?
What is an NCD?
What is a bill of exchange?
Net interest rate margin = difference between the average interest rate earned and the average interest rate paid by ADIs on their funds. This has declined over the years.
NCD = negotiable certificate of deposit = basically for wholesale depositors (big businesses) who deposit money for a fixed amount of time at an agreed interest rate and cannot withdraw the money, however can trade the rights to the money so as to have liquidity.
Bill of exchange = promise by borrower to pay bills face value at the specified future date
Week 2:
When is the financial system considered efficient?
What is the role of banking in an economy (4)
Efficient = when transaction costs are low = good for economy
Role:
- Financial intermediation = channelling funds from savings sector to borrowing sector at low cost
- Payment services = cheque clearing, transfer of currencies…
- Risk protection services
- Liquidity services
Week 2:
What are the four main categories of Australian Banks?
- Major Banks
- Other domestic banks (locally owned banks excluding the big 4)
- Foreign subsidiary banks (foreign banks authorised to carry on banking business in Australia through a locally incorporated subsidiary
- Foreign bank branches (foreign banks licensed to conduct banking business in Australia through branches, subject to a condition which specifically restricts the acceptance of retail deposits)
Week 2:
What are some trends affecting banks?
- Government concern with risks banks have taken
- Globalisation
- Technology
- Service proliferation (more and more services becoming available)
- Rising competition with other financial service firms proliferating their service offerings
- government deregulation and then re-regulation
Week 2:
Explain securitisation and what benefits a bank draws from the process.
Securitisation = Bank originates assets, typically loans. Then combines the loans into pools with similar features and sells them through “Pass through” certificates. Pool is secured by interest and principal payments on the original loans. Originating bank collects interest and principal payments on the loans, passes through cash flows to the certificate holders. There maybe a fee for managing the certificates to the bank.
Benefits
- Reduces banks capital requirements
- reduces assets (this is good because regulators view loans as “risky assets” and so impose capital requirements
- Increases fee income
- Reduces loss provisions (an expense set aside as an allowance for uncollected loans and loan payments)
- eliminate interest rate risk
Week 2:
Provide 5 reasons as to why banks are regulated
- Protect the safety of public savings
- Control the money supply and growth of the economy
- Promote public confidence in the financial system
- Facilitate the orderly payment for goods and services
- Provide government with tax revenues and other services
Week 2:
What is the relevance of the Wallis Committee to the modern structure of bank regulation?
What is the Australian treasury responsible for?
Wallis Committee = in 1990, the committee recommended the introduction of APRA, ASIC, and RBA, each with specific functional responsibilities
APRA = Responsible for the prudential regulation and supervision of the financial services industry = maintain the safety and soundness of financial institutions to instill confidence
ASIC = responsible for market integrity and consumer protection across the the financial system = sets standards for financial market behaviour with the aim to protect investors and consumer confidence = administers the Corporations Law to promote honesty and fairness in companies and markets.
RBA = conducts monetary policy, aimed at maintaining a strong financial system and issuing the nations banknotes = aim of monetary policy is to achieve low and stable inflation over the medium term = lender of last resort function = responsible for overall financial system stability, promoting the efficiency of the payment system and promoting competition for payment services
Australian treasury = responsible for economic policy, fiscal policy, market regulation, and the Australian federal budget)
Week 2:
Explain the difference between consolidation and convergence
Consolidation refers to increase in the size of financial institutions. The number of small, independently owned financial institutions is declining and the average size of individual banks, as well as securities firms, credit unions, finance companies, and insurance firms, has risen significantly = mergers and acquisitions
Convergence = the bringing together of firms from different industries to create conglomerate firms offering multiple services.
Week 2:
How do banks solve the issue associated with maturity intermediation and what is the issue?
The issue = Banks borrow short term funds and lend for the long term = there is a maturity mismatch
The fix = Banks can attempt to purchase assets with similar maturities to their liabilities
Why banks use maturity intermediation = banks profit off of maturity intermediation because short term borrowing provides a low interest rate return to the lenders, whereas long term lending provides a large amount of interest for the bank
Week 2:
What is a financial intermediary?
What important role do financial intermediaries play within the financial system?
Financial intermediary = facilitator of funds from surplus units to deficit units within the economy
Importance = accelerate economic growth by expanding available pool of savings, increasing productivity of savings and investments, satisfying the need for liquidity, evaluation of financial information, lower risk of investments through diversification
Week 2:
What is the effect of the RBA increasing the cash rate?
What is the effect of the RBA increasing the reserve requirement?
What is the effect of the RBA selling securities?
Cash rate up = market interest rates up
Reserve requirement = banks have to take a percentage of all deposits and put it into the central reserve = if the RBA increases the amount of each deposit that banks have to put into the reserve then the banks will have less lending money and thus require greater interest on their lending.
RBA sells securities = money supply decreases (as the RBA will be holding money now) = interest rates rise
Week 3: For a bank outline the use of the following Assets: Cash Trading and investment securities Loans, advances and other receivables
For a bank outline the use of the following Liabilities:
Issued debt
Shareholders equity
Cash = primary liquidity reserve
Trading and investment securities = generates additional income for bank
Loans, advances and other receivables = main earning assets of bank
Issued debt = used to supplement deposits and provide additional liquidity
Shareholders equity = represents difference between book value of bank’s assets and liabilities AND acts as a buffer against losses in the income statement
Week 3:
How do we calculate Net loans and leases?
How do we change our provision for bad and doubtful debts each period? (Side note: this will usually sit at around 1% of total loans)
What is subordinated debt and what does it include?
Net loans and leases = Total loans and leases - unearned revenue - provision for doubtful debts
Bad and doubtful debts period change = opening balance + this periods provision allowances - any write offs + recoveries from previously charged-off loans (yes we ADD these back)
Subordinated debt = a debt owed to an unsecured creditor that in the event of a liquidation can only be paid after the claims of secured creditors have been met = capital notes, special bonds and debenture issues
Week 3:
What is included in an income statement for a bank?
Interest income - Interest expenses = Net interest income \+ Net non-interest income = Net interest income + net non-interest income - Operating expense - Loan loss provisions = Pretax net operating income - Taxes \+ Gains/losses from securities trading = Net income
Week 3:
What factors into Non-interest revenue and why is Non-interest revenue traditionally earned Vs why it is becoming increasingly earned?
How do we calculate non-interest income?
Non-interest revenue:
- Fees, charges and commissions = traditionally used to maintain deposit and loan accounts AND now increasingly as a means to expand revenue
- Net revenue from off-balance sheet business and for provision of specialist services and advice = includes fees for fund management services + insurance commissions + profits on FX trading + realised gains/losses on sales of securities
Off-balance sheet activities = A part of Non-interest income = Activities that generate income and/or expenses without creating an underlying asset or liability or a potential future asset or liability(e.g. fees for cash handling) = may create an asset or liability in the future (e.g. in the case of a derivative leading to a payment obligation)
off-balance sheet items:
- Direct credit substitutes
- Trade and performance related items (contingencies dependant upon performance which may lead to a liability)
- Commitments
- Other commitments
- Foreign exchange, interest rate, and other market related transactions
Non-interest income = Non-interest revenue - Non-interest expenses - provision for loan losses
Week 3:
What are the sources of Operating expenses?
Operating expenses:
- Salaries, wages and benefits
- Equipment and occupancy expenses (depreciation, rent, payments on leased equipment)
- Other operating expenses = advertising, audit and accounting fees, computing costs, directors’ fees, supplies
Week 3:
What are the two key elements of profit maximisation?
What are three issues associated with ratio analysis?
Profit maximisation = invest in high yield assets + keep costs down
Issues of ratio analysis:
- Accounting = use of alternative accounting techniques AND inconsistency between accounting and economic asset valuation AND prevalence of off balance sheet business
- Statistical = high degree of correlation between components of ratios
- Interpretation = only a number is given = all a matter of judgement
Week 3:
What is trend analysis?
What is cross-sectional analysis?
Trend analysis = comparison of various ratios over time = identification and evaluation of trends = early warning signal
Cross-sectional analysis = comparison of ratios with other banks or the industry average
Week 3:
What is ROE a measure of?
Explain each component of ROE
ROE = measures the amount of net income after tax for each dollar of equity capital = good when high, however to increase ROE equity capital must drop and this leads to risk of bankruptcy as equity capital is used as a reserve
Component 1: Profit margin = Net income / Total revenue = Net income per dollar of total revenue = measures the banks ability to control expenses or reduce taxes (higher is better) = check for non-recurring extraordinary items and remove them
Component 2: Asset utilisation = Total revenue / total assets = represents the gross yield on assets = Good for this to increase, however must be aware that increasing asset utilisation shows increased risk taking (due to use of riskier assets) (look at ROA to understand if increasing AU is due to excessive risk)
Component 3: Leverage (equity multiplier) = Total assets / Equity capital = both a profit and a risk measure
- Risk measure: Provides how much of the assets can go into default before bank becomes insolvent = indicates capital risk (risk of insolvency)
- Profit measure: High multiplier raises ROE when net income is positive
Week 3:
What is the Net interest margin?
NIM = Net interest income / Earning assets = important in evaluating a banks ability to manage interest rate risk = representation of bank’s intermediation function
Week 3:
What are the four major influences on bank performance?
- Economic influences (GDP, etc.)
- Regulatory
- Technological change
- Competition
Week 3:
What are 5 Liquidity risk measures?
Liquidity risk = The risk associated with not having enough liquidity to meet demands
- Liquidity sources / Liquidity needs
- Short term securities / Deposits
- Borrowing / Deposits or Capital
- Cash / Total assets
- Securitisation
Week 3:
What are some interest rate risk measures?
Interest rate risk = impact of changing interest rates on a financial institutions margin of profit
- Interest sensitive assets / Interest sensitive liabilities
- Gap analysis: Interest sensitive assets - Interest sensitive liabilities
- What hedging procedures does the bank employ if any?
Week 3:
What are 5 credit risk measures?
Credit risk = The probability that some of a financial institutions assets, especially its loans, will decline in value and perhaps become worthless
- Loans / Assets
- Classified Loans / Loans
- Past due loans / Loans
- Provision for losses / Loans
- Provision Loan Loss / Non performing loans
Week 3:
What are 3 capital risk measures?
Capital risk = not entirely sure (ask tutor)
1. Equity capital / total assets
2. Equity capital / Risk assets or loans (Risk assets = assets likely to decline in value)
3, Growth in assets Vs Growth of loans
Week 3:
What are the four most important components of ROA?
ROA can be broken down into four components which are:
1) Net interest margin = (Interest income - interest expense) / total assets
+
2) Non-interest income margin = (non interest income - non-interest expense)/ total assets
-
3) provisions for loss / Total assets
-
4) Tax / Total assets
1 = measures a banks success at intermediating funds between borrowers and lenders 2 = indicates the ability of management to control salaries and wages and other noninterest costs and generate fee income 3 = measures management ability to control lossess 4 = is an index of tax management effectiveness
Week 4: Contrast lending to the following: 1. Large corporations 2. Medium corporations 3. Small corporations
- Large corporations = large volume, use syndicated loans, key is price, large competition between banks (therefore why price is key)
- Medium corporations = price is less important (than in the case of large corporations), service and products offered are key, security and cash flows are very important from banks side
- Relationship is very important, customer seek advice, customer loyalty is key, less sensitive to interest rates, higher risk for banks
Week 4:
What are the major types of business loans banks undertake? (6 short term and 5 long term)
What are 5 types of business loan facilities?
Short term
1. Self liquidating inventory loans = self explanatory
- Working capital = loan that is taken to finance a company’s everyday operations
- Interim (short-term) construction loans = used to support the construction of homes, apartments, shopping centres, and other permanent structures
- Syndicated loan = loan offered by a group of lenders (syndicate) to one borrower
- Asset based loans = credit secured by the shorter-term assets of a firm that are expected to roll over into cash in the future e.g. Accounts Receivable
- Retailer and equipment financing = loan made to support instalment purchases of automobiles, home appliances, furniture, business equipment and other durable goods = floor panning ( lender extends credit to dealer to place an order to ship goods for resale)
Long term
1. Term Loans = used to fund long-term business investments, such as the purchase of equipment or construction of physical facilities
- Revolving credit = allow customer to borrow up to a pre-specified limit, repay all or a portion of borrowing, and re-borrow as necessary until credit line matures
- Project loans (riskiest of all) (used to finance the construction of fixed assets designed to generate a flow of revenue in future periods)
- Bridging loans = funds to buy new asset/subsidiary while attempting to sell old asset/subsidiary
- Leveraged buyout = small group of investors require funds for a buyout (they use debt (a loan) hence why its called a leveraged buyout)
- Security dealer financing = credit to add bonds (other securities too) to securities portfolio
Loan facilities
- Corporate credit cards = used for purchases related to business activities
- Overdrafts = allow borrower to continue withdrawing money even if account has no funds
- Commercial bills = borrower commits to repay face value at maturity, or roll over the bill and commit to pay difference between FV and discount amount of new bill passed on prevailing interest rates)
- Leasing = finance company is legal owner of asset and lease it out to lessee (lessee typically becomes owner at end of lease) (for example a mortgage)
- Factoring = A type of debtor finance in which a business sells its accounts receivable to a third party (called a factor) at a discount
Week 4
What is a Loan Policy for a bank?
What is the aim of a banks loan policy?
What will lead to changes in bank loan policy?
Elaborate on the relationship between the loan division and the credit department?
Loan policy = gives loan officers and management specific guidelines in making individual loan decisions and in shaping overall loan portfolio
- sets overall lending strategy for bank
- sets risk profile for bank
Aim of policy = to manage credit risk
Changes in policy = cultural and economic shifts
Relationship = The loan division will take potential loans to the credit department for assessment and subsequent acceptance or rejection of the loan. Within the credit department operate credit committees for assessing loans over a particular value.
Week 4
What is a credit line?
What does drawing down mean?
How does bank make money on a credit line?
What are two preferable forms of collatoral?
Credit line = allows borrower to borrow up to a specified limit concerning a period of years
Drawing down = refers to withdrawals made from the credit line which in essence ‘draw down’ the amount available
Bank revenue = the bank will receive a fee for having the credit line available to a borrower + will receive interest on the amount that is drawn down
Preferable collateral = security over land and buildings AND a guarantee (from a creditworthy individual)
Week 4
In regards to credit analysis what are three key factors the analyst must determine?
Elaborate on the 6 C’s considered when making a loan
What influences the scope of the credit investigation ( 5 6’s) and what activities are undertaken?
- Degree of risk and amount of credit to provide
- terms and conditions which will be acceptable
- Price at which to offer the credit
Character: Willingness to repay (assess individual) (honesty, integrity, morality) = makes use of past records
Capacity: Legal capacity to enter contract (age, sound mind, authority (does individual have authority to apply for a loan for a business))
Cash flow: Ability to generate cash flow to repay debt (sources of cash equity or debt)
Collateral: Availability and worth of collateral (conditions, longevity, etc)
Conditions: Assessment of economic/industry conditions (as well as internal conditions of business = is business reliant on one major supplier or client? is production capacity alright? is business moving with the times?)
Control: concerns whether or not the loan meets lenders standards or regulatory authority standards as well as whether changes in laws and regulation could adversely affect the borrower
Scope of investigation = influenced by size, previous dealings, perceived risk, collateral
Activities:
1. Interview of loan applicant
2. Inspection of business place
Week 4
What are workout arrangements and why are they important to banks?
What do workout arrangements comprise?
Workout arrangement = arrangements made when a borrower is unable to pay
Importance = Banks need to retain customers. In order to do so they must avoid problems (failure to pay)
Workout arrangements comprise:
1) Providing advice on borrowers ability to create/earn income
2) Extending or redrawing the loan agreement (reduce payments)
3) Requiring borrower to seek assistance/advice from external consultants
Week 4
How do we apply the cost-plus loan pricing method?
Step 1: Simply calculate (in percentage terms) the weighted average cost of funds (from sources such as securities, bonds, bills)
Step 2: add (in percentage terms) the cost of processing the loan
Step 3: add any risk premium and/or profit margin
Week 5
Identify the types of loans granted to individuals and families
- Residential loans = Credit to finance purchase of homes or fund improvements on a private residence = long-term = typically 15-30 years = secured by property (fixed or variable (changes with market yield on government bonds))
- Nonresidential loans:
- Installment loans = short to medium term = principle reduced through progressive payments over life of loan = frequently for automobiles, furniture, etc.
- Noninstallment loans = short-term = repayable as lump sum = vacations, medical, home appliances, auto and home repair - Credit card Loans and revolving credit = installment or noninstallment repayment depending on individuals choosing. if miss noninstallment period then monthly finance charge based on annual interest rate applied = usually variable interest = installment payment are more profitable = Two issues: 1) delinquent borrowers and 2) card fraud
Week 5
Outline the Credit Card Accountability, Responsibility and Disclosure Act (CARD)
CARD:
- Restricts credit card issuers from raising Annual Percentage rates unless adequate notice of a rate change is given
- Must tell customer reasons for why credit terms are changed
- Companies must post contracts on internet for customers to ‘shop around’ (reason is to stimulate competition)
- Must send cardholders periodic billing statements 3 weeks before monthly payments due.
- On billing statement must state amount of interest being paid + warn about only paying minimum amount each period.
Week 5
Outline the characteristics of Consumer Loans
Consumer Loans (most costly and risky for banks)
- Priced well above cost of funding them
- Significant interest risk (as contract interest rates don’t readily change with market conditions)
- Cyclically sensitive (lots of withdrawals with economic expansion, less with contraction)
Additional risk stems from consumers ability to hide information , as opposed to a bank, as well as consumer sensitivity to illness, injury, or financial setback (fines, unforeseen bills, etc.)
Risk managed by = size of loans usually small and collateral is used (such as an automobile)
Week 5
What factors improve the likelihood of being granted a consumer loan?
What is predatory lending?
What is an offset account?
- Home ownership
- Maintenance of strong deposit balances
- Truthfulness and accuracy of information provided
Predatory lending = a lending practice that imposes unfair or abusive terms on a borrower
Offset account = an account in which its balance is subtracted from the outstanding balance of the mortgage. and borrowers only pay interest on this difference.
Week 5
What is the key to profitability in the consumer loans component of bank lending?
how do we calculate customer churn?
What factors influence growth in home loans?
Key to profitability = volume of customers = need many customers as opposed to business loans (large in value and so less customers needed)
Customer churn = Number of customers lost in period / number of customers at start of period
Home loan growth:
- Increasing desire to own home
- Can be seen as form of retirement savings
- Government policies (tax incentives)
- Interest rates (lower rates = more attractive)
