Introduction to banking

assets in a banks balance sheet

cash securities- bonds( quickly sold in the secondary market when the bank needs more cash) and treasuries - HOWEVER- recent critisicism of 2008 crash is the fact that banks held too many asset securities (selling of loans) - US banks not allowed to hold stocks yet allowed to hold derivatives. loans

EPS

indicator of a companys profit = net income- dividend/ average outstanding shares key driver of share prices higher ratio better as its more profitable

risk weighted assets

the amount of capital a bank has with the amount of its assets gives a measure of how able the bank is to absorb losses. If its capital is 10% of its assets, then it can lose 10% of its assets without becoming insolvent.

regulation

- seperation of activities- between commercial and investments banks - deposit guarantee- protect the depositor should the bank fail - control over interest rates of the banks lending and deposit taking activities

why do banks need a central bank?

- stops commercial banks holding a lot of their assets as capital - limit the money supply kept in banks- generate greater flow of money within the economy

main functions of a central bank

- stops economy or other banks witnessing a shortage - prevents loss in exchange rates - controller of credit - supervises the activities of financial institutions - regulates the volume of currency

debt turnover ratio

how fast consumers pay back their loans - assess's the liquidity of the bank credit sales/ average debtors 365/ debtor turnover ratio = how many days what to do if you are not being efficient with collecting money? - don't give money out to those who can't pay back - DO A CREDIT CHECK FIRST - entice early payments by giving discounts

US REGULATION- Volcker Rule

proposed in 2010 allow banks to invest up to 3% of their tier 1 capital in private equity and hedge funds as well as trade for heading purposes. restricts the ways banks can invest and regulates trading in derivatives.

basel III

published in 2009 - designed to improve the regulation, supervision and risk management within the banking sector. bility to deal with financial and economic stress, improve risk management and strengthen the banks' transparency.

market capitalisation

stock price * the total number of shares outstanding classify the size of a company

basel II

2004 Basel II attempts to integrate Basel capital standards with national regulations - setting the minimum capital requirements of financial institutions with the goal of ensuring institution liquidity. - instead of focusing on credit risk (basel I) they focus on how much capital should be put aside in order to reduce the risk associated with its investing and lending practices - recognises that one size does not fit all

interest margin

%%%= interest income - interest expense) ÷average interest earning assets essentially the gross profit that is earned by a bank on its lending.

competition good or bad?

- after FC- regulators and political efforts to inject competition into the sector have paved the way for a number of start-ups in the past few years -TSB & Santander is an example of this attracting a lot of customers -better place to provide personalised services both on the front-end, when customers walk into a branch, and behind the scenes, when deciding whether or not to grant a loan, said analysts - however many small banks are offering current accounts which is hard to do and you make little money over it

bank capital regulation

- banks must have sufficient capital to be able to support their liabilities. - to absorb losses and to build and maintain con- fidence in a bank. - benefits of having sufficient capital- increases confidence, giving banks a competitive advantage - must cover its fixed assets

liabilities in a banks balance sheet

- borrowing- banks borrow from the federal funds market. banks are insecure therefore banks only lend to other banks that they trust - cause of the 2007-2009 crisis as banks didn't know which banks where holding the risky mortgages, thus stopped lending to each other limiting the banks ability to lend to customers which caused the supply of money to contract as well as the economy. Furthermore banks also borrow from insurance companies and pension funds, however these loans are collateralized in the form of a repurchase agreement (aka repo), where the bank gives the lender securities, usually Treasuries, as collateral for a short-term loan. Most repos are overnight loans that are paid back with interest the very next day. Banks can also borrow from the federal reserve, however low chance as it shows they are in danger but during the 2008-2009 crisis they did. - deposits

capital in a banks balance sheet

- capital can be generated from either stocks or owners funds. = total assets- total liabilities --> ( banks net worth)

Analysis of financial intermediation (look at other notes)

- channels funds from the people who have surplus savings to the people who don't have enough money to carry out their desired activity- SAVERS TO BORROWERS

Purpose of wholesale banking:

- ensures that any liquidity gap that the bank may estimate or calculate, is covered by borrowing from other banks and any surplus funds are invested by lending them to other banks or governments BANKS USE THEIR OWN INTEREST RATE- LIBOR.

investment management companies

- fund managers- deal on behalf of the clients - pension funds -venture capital- invest in high risk and high return companies -hedge funds- investors that uses high risk methods, such as investing with borrowed money, in hopes of realizing large capital gains. deal more speculatively. Make quick money and are not interested in the strategy of the business -tracker funds-mutual fund whose holdings mirror the composition of a stock market index or group of indexes.

risk for services

- high competition and decreasing loyalty between customers/ reputation risk - bad quality - fraud - de regulation - trust

risks for lending/funding

- industry exposure - liquidity risk - insolvency - tenets mismatching - mismatching of currency and interest rates

monetary policy functions of a central bank

- interest rate - relending and rediscount - credit policy - investment regulation - bank reserve requirement- however this is only used in desperate situations as they present too large change in monetary policy.

motives for change in bank regulation since 1970's

- liberalisation of capital movements between countries - financial innovation- increase in ATM's, internet and mobile banking - increased competition - increase financial innovation i.e. hedge funds.

BASE RATE

- lowest it has every been in the UK and it has been like this for 6 years - economy growth and job creation have been going strong but inflation is weak - mortgage rates and savings rates are very low

risk for investing

- might not get the return on what you invested- OPPORTUNITY COST- to high- exposure to poorly performing industries

risks for trading

- political affairs

LIBOR rate

- rate at which banks charge each other for short term loans -administered by the ICE Benchmark Administration (IBA), and is based on five currencies: U.S. dollar (USD), Euro (EUR), pound sterling (GBP), Japanese yen (JPY) and Swiss franc (CHF) - could also mean lower yield for certain investors - affects the governments effectives of monetary policy.

conclusion drawn from basel rules (implication)

- regulation is more costly to banks - banks must use capital more efficiently - better assessment of risk - more technology to lower unit costs - allowing banks to increase profits and reserves - more loans to mortgage market

Credit provision

-fuels economic activity as it allows business's to invest beyond their cash on hand - allows households to by houses without saving the entire cost in advance - allows governments to smooth out their spending thus allowing them to invest in infrastructure projects

http://www.investopedia.com/articles/stocks/07/bankfinancials.asp

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basel I

1988 must have minimum capital requirements with the goal of minimising credit risk -minimum amount (8%) of capital -Capital requirements are important for bank solvency, and, in difficult times, reduce the pressure for bank runs. - it describes capital requirements as a percentage of a bank's risk-weighted assets.

Types of banks

1. Commercial banking- taking of deposits and granting of loans 2. Wholesale banking- others banks and governments 3. Retail banking- deal with members of the public and companies 4. Investment banking- used by large organisations- they provide advice for investments and promote corporate transactions. source of finance= fee income 5. Indigenous banks - handle huge amounts of money and provide loans to business's for a short period of time. 6. Mortgage banks- focus on lending out mortgages therefore exist in the secondary market 7. Federal or National banks- control the principles of banks around the country by setting a benchmark- managed and run by the government 8. Credit unions- gets money from the general community without any bias and provide services to only one employee in the community - features is that they charge a very low interest 9. Private banks- usually used by the upperclass 10.Offshore banks- private banks BUT they have little tax to pay and little regulation. 11. Merchant banks- aimed at big organisations that create huge benefits for a long period of time rather than brand new organisations 12. Cooperative banks- owned by the remembers where maximum profit is not necessary. take money and lend money out - allow community to meet their needs. 13. Giro banks- circle in finance is the passing round of payments between counter-parties. Allows those without a bank to pay their bills

what is the role of banks?

1. Financial intermediation- this is when banks accepts deposits and give out loans in which they are able to derive a profit out of due to the interest charged to borrowers. TAKE IN FUNDS FROM A DEPOSITOR AND LEND TO A BORROWER. 2. Banks are very important because they connect surplus and deficit economic agents. 3. It is a safe place for people to keep their money and essentially allow people to earn interest on your deposits. 4. Liquidity provision- In the likely hood of you becoming liquid the banks will give you a cover up in advance through other depositors funds. 5. Banks facilitate the development of savings and are the instruments of the government's monetary strategy. 6. Credit provision 7. Risk Management services- allow business to take part in the global foreign exchange market and commodity markets indirectly - easier exchange of goods from different countries. 8.Remittance of money- cash can easily be transferred from one place/country to another - as a result this expands the internal/external trade market due to easier transfer of money. 9.Rapid economic development 10. Promotion of Entrepreneurship - banks increase the participation of the private sector economy by making loans easy to take out and also a reasonable rate of interest- expands financial sector encourage entrepreneurs to increase their investment.

benefits of financial intermediation

1. benefits to ultimate lenders (surplus units): greater liquidity less risk involved marketable securities transaction cost are reduced simplified lending decision 2. benefits to ultimate borrowers (deficit units) greater general availability longer loans are available larger amounts are available lower transaction costs- Economies of scale lower interest rates 3. benefits to society as a whole: more efficient utilisation of funds within an economy higher level of lending and borrowing due to lower risks and costs associated with lending to an intermediary. improved availability of funds to higher risk ventures - beneficial for future economic growth

Bank products

1. transaction accounts- allow you to transfer money by cheque to a person or organisation. 2.deposit accounts- where you put your money and have to pay interest 3. loands,bonds,leases- generate interest income which is a source of income for RETAIL BANKS 4. Advisory, asset management, payment services 5. trading and hedging products- derivatives and securities (brokers)

PE

= Market Value per Share / Earnings per Share (EPS) aluation ratio of a company's current share price compared to its per-share earnings Generally a high P/E ratio means that investors are anticipating higher growth in the future. The average market P/E ratio is 20-25 times earnings. The P/E ratio can use estimated earnings to get the forward looking P/E ratio. Companies that are losing money do not have a P/E ratio.

cost income ratio

= operating expenses ÷operating income efficiency measure measure how costs are changing compared to income - for example, if a bank's interest income is rising but costs are rising at a higher rate looking at changes in this ratio will highlight the fact.

Tier 1

= tier 1 capital / total assets (including loans to customers). measure of capital adequacy- if there sufficient capital to keep them out of difficulty? LINKS TO BASEL I,II,III if not- systemic risk (knock on affects)

regulation analysis taking into account the recent financial crisis

Financial Stability Board have come up with a number of several tests the banks need to pass in order to limit future risk of financial crisis. - liquidity requirements prevent them from borrowing money on fickle overnight markets while lending it on for 30 years, E.G.- Northern Rock, the first British bank to fail during the crisis. - New rules on capital, force banks to have a decent safety buffer so that tiny changes in the value of their assets do not cast them automatically into the arms of the state. -the biggest banks will have to hold buffers, or "total loss-absorbing capacity" (TLAC), equivalent to 16-20% of their assets (the loans and investments they make) -USA Patriot Act (2001)—required financial institutions to develop risk-based procedures for verifying the identity of any person opening an account -bondholders, who put up much of the money banks go on to lend, will now be expected to shoulder losses after shareholders are wiped out.- many of them got out lucky in the 2007-2009 financial crisis. http://cdn.static-economist.com/sites/default/files/imagecache/original-size/images/print-edition/20141115_FNC249.png

examples you could use:

REGULATION: northern rock- how it failed - example of financial crisis when lehman brothers collapsed NEW REGULATION 2015: Financial Conduct Authority= customers taking out a loan will now never need to pay back more than twice the amount they borrowed. Interest and fees charged must not exceed 0.8 per cent a day on the sum lent. WONGA HAVE ALREADY RESTRUCTURED WHEREAS OTHERS CLOSED DOWN. - Jp Morgan bank considerably big, therefore it is obtaining a competitive advantage over its competitors which the fed agrees with. They earn 6$b profit a year and can borrow money cheaper. Therefore the fed regulation is to make the big banks carry more weight, increasing capital penalties significantly. However CEO of Jp Morgan disagrees as he feels his bank is more reliable and stable and less likely to fail. However if regulation is not implemented it could go downhill just like what happened to the Royal bank of scotland. -RBS- biggest bank failure in the UK, - sterling would also likely be pushed upward against the euro, dampening British exports.

Purpose of investment banking

THEY DO NOT INVEST - primary market activity: bank offers advice to customers who wish to raise finance by issuing bonds/shares to the public. They also underwrite bonds or share issues- where the investment bank agrees to buy or fund (B&S) guaranteeing the fact that the company will receive its funds. - secondary market activities: purchase and sale of issued securities.

how do banks attract deposits

TRUST AND CONFIDENCE BRAND NAME/REPUTATION HIGHER INTEREST RATES FOR LONGER TERM SAVINGS

bank capital- loss absorbing function

as long as the banks assets cover its liabilities it is safe, however as soon as the losses start depleting its capital that is a problem. - big banks usually don't suffer from this problem as they have experience and make sure to set the margins between interest rates of saving and lending high to cover certain losses- AFFECTS SMALL BANKS.

bank assets=

bank liabilities+ bank capital bank uses liabilities, such as deposits or borrowings, to finance assets, such as loans to individuals or businesses, or to buy interest earning securities, the owners of the bank can leverage their bank capital to earn much more than would otherwise be possible using only the bank's capital.

limitations of regulation

bank regulations create market distortions and hamper economic growth.

US REGULATION- Gramm- Leach Bliley act-

banks can establish financial holdings companies and engage in the full range of financial services, such as securities underwriting, insurance sales and investment banking.

US REGULATION- Glass steagall act

fter great depression: separation of banks types according to their businesses

P2P

new thing in 2015 - peer to peer lending - allow people to lend small amounts of money to individuals or small businesses- arranged loans of more than £1bn in 2014, -P2P currently offers lenders annual interest rates of about 3.5 per cent to on loans to individuals, and six or seven per cent on riskier loans to small businesses.- it is around 3.8% from banks - pensioners can choose where to put there money

US REGULATION- Dodd frank

signed by obama- 2010 after great recession: consumer protection reform, monitors companies which are 'too big to fail' can break up large banks which propose a risk to the economy provides money to companies to assist them with liquidity problems monitors insurance companies that may cause a risk reducing incentives for mortgage brokers to push home buyers into more expensive loans.

benefits of regulation

they help maintain consumer confidence in banking, which in turn helps keep the economy running smoothly. safety cushion to absorb anticipated losses- increasing confidence protection for uninsured depositors protection of tax payers and insurance funds reserve for additional expansion