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zMoney and Capital Markets > Topic 2 - Financial Institutions – Commercial Banks > Flashcards

Topic 2 - Financial Institutions – Commercial Banks Flashcards

1
Q

Main Activities of Commercial Banks

A

Provide full range of financial services:
Financial advise on wealth management
Provides superannuation products
Creates employment

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2
Q

Main Activities of Commercial Banks (Provide full range of financial services)

A

Identify the main sources and uses of funds for commercial banks
Takes deposits and then invests these deposits by making loans
Include both balance-sheet and off-balance-sheet transactions

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3
Q

Banking Activities prior to deregulation

A

asset management dominated banking activities by tailoring the loan portfolio to the deposit base.

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4
Q

Asset Management

A

A bank restricts growth in its lending to the level of funds available from its depositor base

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5
Q

When did deregulation of commercial banks occur

A

mid 1980s

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6
Q

Banking Activities after deregulation

A

No longer dependent on deposit-base for lending activities - they actively engage in liability management by accessing capital markets (national and international).

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7
Q

Liability Management

A

A bank actively manages its sources of funds (liabilities) in order to meet future loan demand (assets)

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8
Q

The main sources of commercial bank funds include

A
  1. Current account deposits
  2. Call or demand deposits
  3. Term deposits
  4. Negotiable certificates of deposits
  5. Bills acceptance liabilities
  6. Debt liabilities
  7. Foreign currency liabilities
  8. Loan capital and shareholders’ equity
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9
Q

Current account deposits:

A

Funds held in a cheque account;

  • Highly liquid;
  • Given the high liquidity, the level of interest paid is quite low.
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10
Q

Call or demand deposits:

A

Funds held in a savings account that can be withdrawn on demand

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11
Q

Term deposits

A

Funds lodged in an account for a predetermined period at a specified interest rate

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12
Q

Negotiable certificates of deposit (CDs):

A
  • Paper issued by a bank in its own name Issued at a discount to face value;
  • Specifies repayment of the face value of the CD at maturity;
  • Highly negotiable security;
  • Short term (30 to 180 days).
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13
Q

Bill acceptance liabilities

A

Bill of exchange and acceptance

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14
Q

Bill of exchange

A

A security issued into the money market at a discount to the face value. The face value is repaid to the holder at maturity

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15
Q

Acceptance

A
  • Bank accepts primary liability to repay face value of bill to holder.
  • Issuer of bill agrees to pay bank face value of bill, plus a fee at maturity date.
  • Acceptance by bank guarantees flow of funds to its customers without using its own funds.
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16
Q

Debt liabilities

A

Medium- to longer-term debt instruments issued by a bank

eg - Debenture and Unsecured Note

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17
Q

Debenture

A

A bond supported by a form of security, being a charge over the assets of the issuer (e.g. collateralised floating charge).

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18
Q

Unsecured note

A

A bond issued with no supporting security

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19
Q

Foreign currency liability

A

Debt instruments issued into the international capital markets that are denominated in a foreign currency.

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20
Q

Benefits of Foreign Currency liability

A
  • Allows diversification of funding sources into international markets;
  • Facilitates matching of foreign exchange denominated assets;
  • Meets demand of corporate customers for foreign exchange products.
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21
Q

Loan capital and shareholders’ equity

A

Sources of funds that have characteristics of both debt and equity (e.g. subordinated debentures and subordinated notes);

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22
Q

Define Subordinated

A

means the holder of the security has a claim on interest payments or the assets of the issuer, after all other creditors have been paid (excluding ordinary shareholders).

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23
Q

Uses of Funds for Commercial banks

A

Personal and housing finance
Commercial lending
Lending to government
Other bank assets

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24
Q

Types Personal and housing finance

A

Home loans;
Investment property loans;
Fixed-term loan;
Credit card.

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25
Q

Types of Commercial Lending

A

Fixed Term Loans
Overdraft Facilities
Bills of Exchange
Leasing

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26
Q

Fixed Term Loan

A

a loan with negotiated terms and conditions with respect to:

  • Period of the loan
  • Interest rates (Fixed or variable rates)
  • Timing of interest payment
  • Repayment of principal
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27
Q

Overdraft

A

A facility allowing a business to take its operating account into debit up to an agreed limit.

  • The bank charges fees and interest for this flexible arrangement
  • The bank also expects that the firm will bring the overdraft back into credit as revenues are received by the business.
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28
Q

Bills of exchange types

A

Commercial bills
Bank bills held
Rollover facility

29
Q

Commercial bills

A

Banks - accepts, discounts and generally sold into the money market.

30
Q

Bank bills held

A

Bills of exchange accepted and discounted by a bank and held as assets on its balance sheet.

31
Q

Rollover facility

A

Bank agrees to discount new bills over a specified period as existing bills mature.

32
Q

Leasing

A

A bank as lessor will finance the purchase of an asset and enters into an agreement with the lessee.

33
Q

Lending to government

A

Government securities are low risk instruments with low return.

  • Treasury notes
  • Treasury bonds.
  • State government debt securities.
34
Q

There are four types of off-balance sheet transactions

A
  • irect credit substitute
  • trade and performance-related items
  • commitments
  • foreign exchange contracts; interest rate contracts; other market related contracts
35
Q

Direct Credit Substitute

A

It is an undertaking provided by a bank to support the financial obligations of a client
e.g. a stand-by letter of credit

  • acts as guarantor for a fee
  • Client has a financial obligation to a third party
  • Bank is required to make a payment only if the client defaults on a payment to a third party.
36
Q

Trade and Performance Related Items

A

guarantee provided by a bank to a third party, promising financial compensation for non-performance of commercial contract by a bank client.

Examples:
documentary letters of credit
performance guarantees.

37
Q

Commitments

A
  • contractual financial obligations of a bank that are yet to be completed or delivered
  • Bank undertakes to advance funds or make a purchase of assets at some time in the future.

Examples:

  • forward purchases
  • underwriting.
38
Q

Foreign exchange contracts, interest rate contracts, and other market related contracts

A

The use of derivative products to manage exposures to foreign exchange risk, interest rate risk, equity price risk, and commodity risk (i.e. hedging).

39
Q

Prudential supervision ensures

A

the imposition and monitoring of standards designed to ensure the soundness and stability of the financial system.

40
Q

Prior to the GFC (Commercial Banks)

A
  • held assets with value more than 30 times larger than the banks’ underlying capital reserves.
  • The leverage was supported by short term financing and innovative capital instruments.
  • The amount of leverage was a primary factor contributing to their weakness.
  • A number of financial institutions collapsed during the crisis.
41
Q

Australian Regulatory Structure

A

Reserve Bank of Australia (RBA)

Australian Prudential Regulation Authority (APRA)

Australian Securities and Investments Commission (ASIC)

Australian Competition and Consumer Commission (ACCC)

42
Q

Reserve Bank of Australia (RBA)

A

System stability and payments system

43
Q

Australian Prudential Regulation Authority (APRA)

A

Prudential regulation and supervision of deposit-taking institutions.

44
Q

Australian Securities and Investments Commission (ASIC)

A

Market integrity and consumer protection

45
Q

Capital Adequacy

A

Defaulted loans are written against profit. However, if loan losses increase above the level of profits then the losses must be written off against capital. The capital held by financial institutions serves as the buffer against such losses.

If capital is inadequate, a financial institution may face insolvency. This has significant implications for the stability of the financial system.

46
Q

The capital adequacy standards set down in Basel II and III define

A

the minimum capital adequacy for a bank.

These standards are designed to promote stability within the financial system.

47
Q

Purpose of Basel 2 and 3

A

ensure that financial institutions have enough capital on account to meet obligations and absorb unexpected losses

48
Q

Basel I developed

A

a measure of capital adequacy and principally focused on the level of credit risk associated with banks balance sheet and OBS business.

49
Q

Basel II

A

was a major extension of Basel I and much more sensitive to different levels of risk

50
Q

Basel II is based on:

A
  • Credit risk of banks assets and OBS business
  • Market risks of banks trading activities
  • Operational risks of banks business operations
  • Form and quality of capital held to support these exposures
  • Risk identification, measurement and management processes adopted
  • Transparency through accumulation and reporting of information
51
Q

Minimum risk-based capital ratio

A

8%.

  • Minimum 4% held as Tier 1 capital (Highest quality core capital)
  • Remainder can be held as Tier 2 capital (supplementary)
52
Q

The Basel II framework is based on three integrated pillars

A

Pillar 1: the capital adequacy minimum requirements;
Pillar 2: the supervisory review of capital adequacy;
Pillar 3: the market discipline - incorporating disclosure and transparency.

53
Q

Pillar 1 incorporates

A

Credit risk
Operational risk
Market risk

54
Q

Pillar 1 Capital adequacy - Operational risk

A

risk of loss from inadequate or failed internal processes, people and systems, or external events.

55
Q

Pillar 1 Capital adequacy -Market risk

A

risk of losses resulting from changes in market rates in FOREX, interest rates, equities and commodities.

56
Q

Pillar 2 Supervisory review of capital adequacy

A

Intended to ensure banks have sufficient capital to support all risks and encourage improved risk-management policies and practices in identifying, measuring and managing risk exposures

57
Q

Pillar 3 Market discipline

A

Aim is to develop disclosure requirements that allow the market to assess information on the capital adequacy of an institution;
i.e. increase the transparency of an institutions risk exposure, risk management and capital adequacy.

58
Q

Basel II forms the foundation for Basel III, which enhances three pillars:

A
  • New Tier 1 capital requirement from 4% to 6% (from 2013)
  • Minimum common equity requirement (CET1) increased from 2% to 4.5% (from 2013);
  • Additional capital conservation buffer of 2.5% of Risk Weighted Asset (over and above the 8%) (from 2016)
59
Q

Banks supervisors require banks to maintain a liquidity management strategy including

A

access to contingency liquidity in an extreme situation.

60
Q

The banks supervisor imposes a range of requirements on banks

A 
risk management certification; 
business continuity management; 
external audits; 
on-site visits; 
limits on large credits and large foreign currency exposures; 
subsidiary business operations 
ownership and control restrictions.
61
Q

Common Equity Tier 1 Capital

A

Highest Quality; core capital for capital adequacy purposes

62
Q

Tier 2 Capital

A

additional capital that contributes to a banks financial strength

63
Q

identify the role that the purchase of government securities plays in commercial banks’ management of their asset portfolios

A

government securities are a primary source of liquidity:
✓easily converted into cash
✓ securities provide a return, cash does not
✓ another source of income
✓ security to support bank’s own borrowings
✓ use for repurchase agreements to raise exchange settlement account funds
✓ lower risk government securities offset higher risk loans to customers
✓ manage the maturity structure of the overall balance sheet
✓ manage the interest rate sensitivity of the overall balance sheet

64
Q

Define what is meant by the off-balance-sheet business of banks.

A
  • a transaction that is conducted by a bank that is not recorded on the balance sheet
  • a contingent liability that will only be recorded on the balance sheet if some specified condition or event occurs.
65
Q

Direct credit substitutes example

A

stand-by letter of credit or a financial guarantee.

66
Q

Trade and performance related items example

A

performance guarantee or a documentary letter of credit

67
Q

Commitments example

A

the unused credit limit on a credit card, or a housing loan approval where the funds have not yet been used.

68
Q

Foreign exchange, interest rate and other market rate related contracts example

A

principally derivative products such as futures, forwards, options and swaps used to manage f/x and interest rate risk exposures.

zMoney and Capital Markets (10 decks)

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