R 25 Banks Flashcards
Commercial Banks - Retail and wholesale banks
Investment Banks - raising capital, advice on merger and acquisition and other corporate finance
Risk faced by the bank
Credit
Market - trading activities - interest, exchange rates, equity prices
operational - cyber, staff fraud (legal and compliance)
Economic and regulatory capital
Equity capital is going concern capital
debt capital is gone concern capital since it is meant to cover losses only once the bank ceases to operate as a business
Economic capital means amount of capital that bank believes would be sufficient based on its risk model.
Basel
As of now, all three risks (credit, market, and operational) must be computed using a standardized model. However, if a bank is approved by its national regulator, then it may use an internal model for market and credit risks only. The internal models calculate a required capital amount based on the greater of the capital computed by the internal model, and 72.5% of the capital computed by the standardized model. Note that the 72.5% is a figure that will apply by 2027
deposit insurance brings an element of moral hazard
Moral hazard is the observed phenomenon that insured parties take greater risks than they would normally take if they were not insured. In the banking context, with deposit insurance in place, the moral hazard arises when depositors pay less attention to banks’ financial health than they otherwise would.This allows banks to offer higher interest rates on deposits and make higher-risk loans with the funds they attract.
mitigation -making insurance premiums risk-based
Investment bank
private placement, securities are sold directly to qualified investors
two methods of assisting with a public offering.
firm commitment, the investment bank agrees to purchase the entire issue at a price that is negotiated between the issuer and bank. IB earns income by selling the issue to the public at a spread above the price it paid the issuer
best efforts is less risky for IB.If only part of the issue can be sold, the bank is not obligated to buy the unsold portion. As with a private placement, the investment bank earns fee income for its services.
Dutch auction
A Dutch auction begins with a price greater than what any bidder will pay, and this price is reduced until a bidder agrees to pay it. Bidders may specify how many units they will purchase when accepting a price. The price continues to be reduced until bidders have accepted all the shares that the seller wants to sell. The price at which the last of the shares can be sold becomes the price paid by all successful bidders. Assuming all potential bidders participate, that price is the equilibrium price where demand and supply intersect.
Banking book refers to assets and liabilities that are meant to be held to maturity. In calculating regulatory capital, credit risk capital calculations apply to the banking book.
trading book refers to assets and liabilities related to a bank’s trading activities. trading exposures are MTM
originate-to-distribute model
involves making loans and selling them to other parties.
Government agencies such as Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC) purchase mortgage loans from banks and issue securities backed by the cash flows from these mortgages.
benefit - increases liquidity, it is a way of freeing up capital with which they can meet regulatory requirements or make new loans.
