Banking and Financial Institutions Guy Hargreaves ACF104 Recap

Banking and Financial Institutions Guy Hargreaves ACF-104

Recap of yesterday �The fundamental principles of financial intermediation �“Financial claims” - marketable and non-marketable �Identify various financial markets, and banking and nonbanking financial intermediaries �Deposit-taking and non-deposit-taking financial intermediaries �Banking versus shadow banking markets �The function and characteristics of money and monetary bases �The importance of market liquidity to the operation of the global economy 2

Banking Systems and commercial banks within developed economies

Today’s goals �Understand banking systems within developed economies �Appreciate the structure of a typical commercial banking system �Review payment systems and how they operate �Describe the main products and services offered by commercial banks �Understand the commercial banking customer base 4

Definition for this course �This course focuses on Commercial Banking �Commercial banking can be thought of as any regulated banking activity operated as a business �For this course we will define commercial banking as: � Retail banking (including Private banking) � Wholesale (or Corporate) banking �We will also look at investment banking � Important to note investment banking activity is not usually regulated by a Central Bank � It is regulated when conducted by a regulated bank 5

Two basic economic sectors �Private sector – not controlled by the State � Individuals � Private / public companies � Non-profits / charities �Public sector – controlled by the State � Federal government � State governments � Local governments � State owned enterprises 6

Where does commercial banking fit? �Private sector � Individuals – banking licenses not generally available � Private / public companies – most commercial banks � Non-profits / charities – some banks eg Microfinance �Public sector � Federal government – Central Banks � State governments - no � Local governments - no � State owned enterprises – few SOE commercial banks remain 7

Who are the savers / borrowers? �Private sector � Individuals – both savers and borrowers � Private / public companies – both savers and borrowers � Non-profits / charities – goal usually to be neither �Public sector � Federal government – mostly borrowers � State governments – mostly borrowers � Local governments – mostly borrowers � State owned enterprises – mostly borrowers 8

Are commercial banks savers? �Like any for-profit entity, commercial banks can be savers and borrowers themselves � Lending out profits not paid to shareholders � Borrowing for capital expenditure �If a commercial bank is a saver / borrower, it will conduct this activity with its own capital �This activity is considered “proprietary” ie not performed in the course of its financial intermediation activity 9

The financial system Retail / Wholesale Commercial Banks Investment Banks 10

What is a banking system? �The Banking System is that part of a financial system in which regulated banks operate � Does not include Capital Markets which are part of the Financial Markets � Includes payments, Central Bank operations, bank loans, deposits – any activity which involves a regulated bank �Whether the activity is regulated is an important distinction � Unregulated activity is conducted outside of the security and support provided by Central Bank regulated commercial banks 11

What is a banking system? �Banking systems are usually made up of: Central Banks � Regulated commercial banks � Retail (including Private) banks � Wholesale banks � Payments systems � �Regulated banks deal in financial markets but markets are not usually considered as part of the banking system �Investment banks deal in financial and capital markets but if unregulated they are not considered part of the banking system 12

What else do commercial banks do? �Conduct operations in financial markets, eg � Hedging risks for customers � Risk management for their own balance sheet �Operate payments systems �Facilitate trade flows �Help with the conduct of monetary policy �Support economic growth �Assist in executing development policies 13

Recall: payment systems �A Payment System is any organised system established to allow participants to transfer financial assets between themselves �Payments take place for many reasons: � In exchange for goods and services � Creation or repayment of a financial liability/asset �Commercial banks have historically played a key role in payments systems 14

Payment systems - RTGS �“Interbank” payment systems use Real Time Gross Settlement (RTGS) to transfer money between bank participants � Retail participants must hold some form of account with a commercial bank in the payments system � To effect payment a participant will instruct its bank to transfer money from that participant’s account to the proper account of another participant at its own bank � The two banks “settle” the transaction through adjustment of their own accounts held with the relevant Central Bank � Central Banks usually manage RTGS systems 15

Payment systems - SWIFT �International payment systems use Society for Worldwide Interbank Financial Telecommunication (SWIFT) to transfer money between participants � SWIFT is does not alter the underlying mechanics of individual domestic payment systems � SWIFT is simply a system that arranges domestic payments between international participants � Unless the banks handling a SWIFT transaction are primary deposit-taking institutions in the currency of the transaction, instructions will be handled through a correspondent banking arrangement 16

Commercial bank payment products �Commercial banks offer many ways for their clients to instruct a payment: � Cheques � Online transfers � Standing orders � Credit cards � Debit cards � ATMs � Smartphones � SMS 17

Correspondent banking �Commercial banks often hold accounts with other domestic or international commercial banks � Nostro account: “our money held by you” � Vostro account: “your money held by us” �When a bank holds an account with another bank it is said to have a Correspondent Banking Relationship �If a bank does not maintain an account with its Central Bank it needs to have a correspondent banking relationship with one that does 18

Commercial banking products �Retail and wholesale commercial banks offer a wide range of products and services – including: � Current and chequing accounts � Term deposits � Consumer loans and mortgages � Credit and Debit Cards � Cash management services � Corporate and SME loans � Trade Finance � Financial market products and services � Online banking 19

Investment banking products �Investment banks offer a wide range of products and services – including: � Capital market product arranging and underwriting � Financial market products and services � Securitised or asset backed arranging � Merger and acquisition advisory 20

Mortgage products �One of the most fundamental banking products �A bank lends money to a borrower to purchase a house, apartment or other property � Only a portion of the property purchase price is lent (eg 50%) – the balance is funded from savings of the borrower � The borrower repays loan principal and interest over an agreed time frame (eg 30 years) � The bank takes a “mortgage” over the property which entitles it to seize and sell the property to repay the loan if the borrower defaults �Banks are at the heart of retail property financing across the globe 21

Credit and debit cards �A group of banks were responsible for the development of widely used credit cards such as Visa and Mastercard �Card products offer the great convenience of being cash-like and widely accepted �Credit cards offer the holder an unsecured line of credit that can be drawn to pay for goods and services �Debit cards are accounts that must have positive fund balances before they can be used to pay for goods and services 22

Cash management services �Corporate customers have complex daily cash management requirements including: � Multi currency cash accounts � Account sweeping and reconciliation � Lockbox facilities � Subsidiary account management � Foreign exchange �Sophisticated online cash management solutions are now offered by many banks to help corporate customers manage their business flows 23

Trade finance �Commercial banks are central to the financing of trade flows across the globe: � Guaranteeing payments for exporters and importers through correspondent banking relationships � Financing shipments of commodities around the globe � Working capital finance for trading companies � Inventory financing 24

Financial market products �Commercial banks offer a range of financial market products and services including: � Foreign exchange and forwards � Money market products � Syndicated loans � Derivative risk management products � Repo products 25

Corporate banking products �Corporate banking customers range from SME to mid market to large listed multinational companies (MNCs) �These customers have a range of commercial banking needs including: � Lease and hire purchase financing � Invoice and receivable discounting � Corporate loans and commercial paper (CP) � Project finance 26

Commercial banking customers �Traditional commercial banking customers broadly fall into categories of: � Household savers, or borrowers for purchases of property or smaller ticket personal goods (eg cars) � Corporate borrowers entering into bilateral or club loans for capital expenditure (capex), working capital or M&A � Governments funding infrastructure or deficits 27

Modern banking customers �Post deregulation in the 1980 s, the number and type of bank customer has grown strongly �Retail customers now also include: � Financial market traders and speculators � Margin loan borrowers � Advisory customers (Private Banking, estate planning etc) � “Sub-prime” customers � Traditional deposit and consumer loan customers � Etc. . 28

Modern banking customers �Wholesale commercial banking customers now also include: � Private Equity funds � Pension and Mutual funds � Hedge Funds � Mortgage and other originators � NBFIs � Traditional corporate borrowers � Corporate risk managers � Syndicated loan borrowers � Etc… 29