Week 3: What Do Banks Do ? Flashcards
What is meant by a discretionary deposit?
When the depositor is free to decide the frequent and amount of its transactions
What are the transformation functions of banks
Size transformation:
Exploiting economies of scale, banks transform a large number of small deposits in larger size loans.
Maturity transformation; creating a maturity mismatch in their balance sheet banks convert demand deposits in long term financing for borrowers
Risk Transformation: Minimise risks associated with financing one borrower by diversifying their portfolio of assets , pooling the risks, screening and monitoring borrowers as well has holding capital against unexpected losses.
Explain the Credit Multiplier.
- Based on the assumption banks keep only a fraction of the money that is deposited by the public.
- This fraction is kept as a reserve so banks can facilitate customer withdrawals.
- The bank then uses the remaining portion of the deposits lend to others who will then deposit the money in another bank account.
- Thus process repeats itself and till there are no excess reserves left.
- This will increase the money supply (deposits)
Formula for CM:
Change in deposits/ change in reserves
Extra:
The credit multiplier is the same as the reciprocal of the reserve ratio.
What are the drawbacks of the Credit Multiplier?
- The creation of deposits is less mechanical than the model indicates
- Decisions to increase their holdings in currency or by banks to hold excess reserves will result in a smaller expansion than the model predicts.
- There are leakages from the system
What are traditional Banks Objectives?
Main objectives are heavily on lending and deposit gathering.
Profits derive from the different in interest received from loans minus the interests paid on deposits.
Banks maximise profits by controlling operating costs
What is Bank Capital (equity) ?
And what role does Regulation assign to Bank Capital?
Bank Capital is the difference between total assets and liabilities.
Bank Capital is intended to act as a cushion against losses to protect depositors. It also creates an incentive for bank owners to stop excessive risk taking.
What is a Universal Bank?
An institution which combines strictly commercial activities with operations in market segments usually covered by Investment Banks, securities houses and Insurance firms and this includes businesses such as portfolio management, brokerage of securities, underwriting, M&A.
What is Ring fencing ?
The separation of retail/small business and deposit activity from the riskier activities undertaken by banks.
What Pillars does Ring Fencing rely on ? And what is the scope?
Resilience: protecting the retail banking activity from risks unrelated to it.
Resolution: allowing banking groups to fail in an orderly manner in case of trouble.
The scope essentially is trying to avoid the spread of systemic risk.
What are the “vital” or “core”banking services
- Facilities for accepting deposits or other payments into an account
- Factor withdrawing money or making payments from such account
- Overdraft facilities in connection with such accounts
What is conduct of business ( in banking) ? What is the rationale behind want to improve it?
Refers to how FI conduct business with their retail customers/consumers and how they behave on the market.
- Many people were mis-sold financial products on the run up to GFC. This led to a suboptimal allocation of investments and risk.
- The risk of incurring in “failures” in the conductor business by banks is defined as conduct risk.
-Misconduct by banks imposes costs on society at large.
How can poor Conduct of Business disadvantage banks?
- Banks may face severe penalties
- Litigation costs as banks have to set aside reserves for their coverage
- Providers and users of financial services may have adverse reactions to the misconduct harming the financial sector as a whole.
