Commercial banks and investment banks

Question 1

what is banking credit

Answer 1

an arrangement with a bank for a loan, or bank lending in general

Question 2

what is bank capital

Answer 2

value of the banks assets minus its liabilities or debts

Question 3

what are bank reserves

Answer 3

money and liquid assets held by banks in order to meet withdrawals by customers

Question 4

what is co-operative bank

Answer 4

bank that lends money, collected from its members, at low rates of interest

Question 5

what is shadow banking

Answer 5

non-deposit taking financial intermediaries including investment banks, hedge funds

Question 6

what are commercial banks

Answer 6

a financial institution aiming to make profits by selling bank services to the general public and businesses (retail banks)

Question 7

how do commercial banks make their profits

Answer 7

taking small, short-term, relatively liquid deposits from retail savers and transforming these into larger, longer maturity loans

Question 8

significance of commercial banks:

Answer 8

-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

Question 9

what are investment banks

Answer 9

help companies to raise finance by selling shares or bonds- dont accept deposits from general public

Question 10

what do investment bank do?

Answer 10

advise private companies how to become public company (IPO)
How to buy other companies
research and private equity investments

Question 11

what do private banks do

Answer 11

provide wealth management services to high net worth individuals

Question 12

who are building societies owned by and what do they do

Answer 12

owned by their members and no shareholders
offer mortgages and savings product etc

Question 13

what are credit unions, who own them, who use them

Answer 13

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

Question 14

how are commercial and investment banks different and why

Answer 14

-investment do retail and investment activities-> systematic risk
-introduced regulations
-retail banking must be ring fenced from investment banking

Question 15

what is systematic risk in terms of investment banks

Answer 15

risk of breakdown of the entire banking system caused by inter-linkages in the financial system

Question 16

main functions of a commercial bank

Answer 16

-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

Question 17

how to commercial banks make a profit

Answer 17

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

Question 18

what are challenger banks

Answer 18

new banks attempting to establish themselves and challenge the leading commercial banks

Question 19

how are challenger banks competing

Answer 19

• keep operating costs low
  -offering attractive prices
  -non-price competition: longer opening hours

Question 20

commercial banking is an oligopoly- what bte do they face

Answer 20

-cost of establishing branches
-cost of IT
-customer resistance to changing accounts

Question 21

objectives of commercial bank

Answer 21

-profitability
-security
-liquidity

Question 22

conflicts between objectives of commercial banks

Answer 22

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

Question 23

what is bad debt

Answer 23

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

Question 24

what are the limits to credit creation by commercial banks

Answer 24

-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

Question 25

examples of assets for banks (from most liquid to most profitable)

Answer 25

cash
balances at boe
money at short and call notice
commercial bills and treasury bills
investments
advances
fixed assets

Question 26

examples of liabilities for banks

Answer 26

share capital
retained profits
long-term borrowing
short-term borrowing from money markets
customers’ deposits

Question 27

for a commercial bank, what is an asset

Answer 27

any claim that the bank has against others

Question 28

for a commercial bank, what is a liability

Answer 28

any claim that others have on the bank (assets must equal liabilities)

Question 29

where do banks keep their required reserves and money owed to other banks

Answer 29

as balances at the bank of england

Question 30

money at call notice:

Answer 30

money borrowed that must be paid back tomorrow

Question 31

money at short notice:

Answer 31

money borrowed for a rather long period

Question 32

commercial banks prefer to attract stable deposits- why

Answer 32

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

Question 33

what is liquidity risk:

Answer 33

-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

Question 34

what is credit risk

Answer 34

-risk to the commercial bank of lending to borrowers who cant repay loans
-can be controlled by prudential regulation

Question 35

risks of having high household debt on financial sector and wider economy

Answer 35

-sudden fall in incomes
-unexpected rise in interest rates on existing debts especially mortgage borrowing