Commercial banks and investment banks Flashcards
what is banking credit
an arrangement with a bank for a loan, or bank lending in general
what is bank capital
value of the banks assets minus its liabilities or debts
what are bank reserves
money and liquid assets held by banks in order to meet withdrawals by customers
what is co-operative bank
bank that lends money, collected from its members, at low rates of interest
what is shadow banking
non-deposit taking financial intermediaries including investment banks, hedge funds
what are commercial banks
a financial institution aiming to make profits by selling bank services to the general public and businesses (retail banks)
how do commercial banks make their profits
taking small, short-term, relatively liquid deposits from retail savers and transforming these into larger, longer maturity loans
significance of commercial banks:
-credit for expanding businesses
-financial services for households
-externalities from financial stability
-commercial banks and UK trade
-important source of employment
-instrument of monetary policy
what are investment banks
help companies to raise finance by selling shares or bonds- dont accept deposits from general public
what do investment bank do?
advise private companies how to become public company (IPO)
How to buy other companies
research and private equity investments
what do private banks do
provide wealth management services to high net worth individuals
who are building societies owned by and what do they do
owned by their members and no shareholders
offer mortgages and savings product etc
what are credit unions, who own them, who use them
small and local non-profit lending institutions
owned by their members
used by those who unable to access standard retail bank products through banks or building societies
how are commercial and investment banks different and why
-investment do retail and investment activities-> systematic risk
-introduced regulations
-retail banking must be ring fenced from investment banking
what is systematic risk in terms of investment banks
risk of breakdown of the entire banking system caused by inter-linkages in the financial system
main functions of a commercial bank
-accepts deposits from general public
-create deposits which are leant to borrowers
-providing debit and credit cards
-private banking
-money custody and guarantees
-cash management and settlement
-trade finance
how to commercial banks make a profit
rely on higher interest rates on loans than rate on the deposits
this ‘spread’ on their assets etc used to pay operating expenses and make profit
what are challenger banks
new banks attempting to establish themselves and challenge the leading commercial banks
how are challenger banks competing
- keep operating costs low
-offering attractive prices
-non-price competition: longer opening hours
commercial banking is an oligopoly- what bte do they face
-cost of establishing branches
-cost of IT
-customer resistance to changing accounts
objectives of commercial bank
-profitability
-security
-liquidity
conflicts between objectives of commercial banks
trade off between liquidity and profitability:
-required to operate on ratios of cash and liquid assets to advances
-must maintain confidence
BUT
-dont generate good profit
-if target profitability-> big interest rates -> reduce liquidity (unsecured loans)
trade off between profitability and security:
-rate of interest reflect risk of loan
-most profitable loans are higher interest BUT higher risk
what is bad debt
when the bank is unable to recover money if customer runs into financial difficulty (e.g. credit cards)
-cost to bank
-reduces assets and profitability
what are the limits to credit creation by commercial banks
-types of asset held by banks
-demand for credit: may fall because of higher IR so credit creation is stifled
-central bank policy: BoE can change capital ratios or cash reserve requirements to influence amount of liquid assets bank must hold
examples of assets for banks (from most liquid to most profitable)
cash
balances at boe
money at short and call notice
commercial bills and treasury bills
investments
advances
fixed assets
examples of liabilities for banks
share capital
retained profits
long-term borrowing
short-term borrowing from money markets
customers’ deposits
for a commercial bank, what is an asset
any claim that the bank has against others
for a commercial bank, what is a liability
any claim that others have on the bank (assets must equal liabilities)
where do banks keep their required reserves and money owed to other banks
as balances at the bank of england
money at call notice:
money borrowed that must be paid back tomorrow
money at short notice:
money borrowed for a rather long period
commercial banks prefer to attract stable deposits- why
can control their liquidity risk
-longer-term savings deposits therefore typically offer a higher rate of interest for savers - a reward for sacrificing their liquidity
what is liquidity risk:
-banks tend to attract short term deposits
-lend for long periods of time
-banks may not be able to repay all deposits if savers decide to withdraw funds
-reduce liquidity risk: try to attract longer term deposits and hold some liquid assets as capital reserves
what is credit risk
-risk to the commercial bank of lending to borrowers who cant repay loans
-can be controlled by prudential regulation
risks of having high household debt on financial sector and wider economy
-sudden fall in incomes
-unexpected rise in interest rates on existing debts especially mortgage borrowing
