Introduction to Banking

The bank matching people who want to lend money (surplus units) to people who want to borrow money (deficit units). 

Control and manipulate money supply.

Regulate member banks. 

Lender of last resort. 

Government banker. 

Monitors/controls inflation. 

Systematic regulation - national/curency level, limit bank failures, consumer protection. 

Prudential regualtion - control risk, hold adequate capital, allow small banks to compete. 

Financial Conduct Authority (FCA): regulate financial services, protect consumers, make industry stable and competitve. 

Prudential Regulation Authority (PRA): prudential regulation and supervision, sets standards, organisation of the Bank of England.

Financial Policy Committee (FPC): acts to remove or reduce systematic risks, protecting financial system, organisation of the Bank of England. 

Maturity

Asset

Risk

Geographical

Wholesale banks - very large institutions.

Investment banks - create capital with shares and equites. 

Universal banks - retail, wholesale and investment all under one 'roof'.

Merchant banks - international finance, business loans and underwriting. 

Private banks - high net worth individuals.

Online banks - mobile devices and computers, 24/7. 

Building societies - investment for the purchase or improvement of houses.

Islamic banks - no interest (comply with Sharia Law)

Insurance companies - collect premiums and pay out claims.

Credit unions - set to benefit community, make ethical/social decisions.  

Political

Economic

Social

Technological

Legal

Environmental/Ethical

Advantages: simple and easy, helps understanding, develops strategic thoughts.

Disadvantages: updates needed regularly, can be time consuming and expensive. 

Non-critcal items: low supply risk, low profit impact.

Bottleneck items: high supply risk, low profit impact. 

Leverage items: low supply risk, high profit impact. 

Strategic items: high supply risk, high profit impact. 

Where the bank creates new money electronically to buy financial assets, aiming to increase private sector spendong and return inflation to target. 

Capital adequacy; enough capital to cover their risks and losses.

Tier 1: dislosed reserves, shareholder equity.

Tier 2: undisclosed reserves, subordinated debt (lowest ranked debt), general provisions (risky debts). 

Common equity: a subset of Tier 1 capital.

To start with: 

Cash @ 0%

Government Bonds @ 20%

Mortgages @ 50%

Commercial Loans @ 100%

Changes include: 

Domestic morgages (secured) @ 25% 

Loans to AAA banks @ 20%

Corporate loans (secured) @ 30%

Personal loans (secured) @ 50%

Total capital must be at least 8% of risk weighted assets.

50% of total capital (4% of RWA) must be Tier 1 capital. 

Three pillars - risk asset ratio, supervision, market discipline. 

Total capital must be at least 6% of risk weighted assets. 

Tier 1 capital must be at least 4% of risk weighted assets.

Common equity must be at least 2% of risk weighted assets. 

Total capital must be 10.5% of risk weighted assets plus a mandatory capital buffer of 2,5%, therefore total capital must be 13%. 

Tier 1 need to be 8% of RWA. 

Common equity must be 7% of RWA, with 4.5% shareholder equity and 2.5% capital buffer.

A liquidity buffer for assets of 30 days.

Leverage ratio: Tier 1 capital must exceed 3% of total assets.

Character Ability Means/Margin Purpose Amount Repayment Insuarnce

Interest Commision (and other fees) Extras (insurance etc.)

Information assymetry - borrower knows more about their ability to repay than lender. 

Moral hazard - borrowers can change their behaviour after loan is given. 

Low risk: cash, fixed assets, loans to AAA banks. 

Medium risk: loans to customers, debt securities, joint ventures. 

High risk: equity shares. 

Liabilities: customer accounts, deposits by banks, dated and undated loan capital.

Capital: called up share capital, reserves, retail life fund liability.

Functions of capital - absorbs losses, protects depositors, access to markets, limit risk. 

The idea to spread risk and increase profitability at the same time. 

Managing liquidity - wide ranging portfolio, different maturities, different liquidities.

ALCO is responsible for ALM achieving this through the monitoring and adjusting of asset positions.