Lecture 1_An Overview of Banks_Ch.1

McGraw-Hill/IrwinBank Management and Financial Services, 7/e

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Dr. Mona ElBannan Bank Management Spring 2016

Bank Management FINC 713Dr. Mona ElBannanDepartment of Finance Lecture notes-1

Introduction to Banking Environment

An Overview of the Changing Financial-Services

Sector

Dr. Mona ElBannan Bank

Management Spring 2016



Course Information Lecturer: Dr. Mona ElBannan Instructor Email: [email protected] Office: B5.334 Instructor Office Hours: Monday 3rd & 4th slots or by

appointments, Teaching Assistants: Ms. Rola Kabani & Ms. Amira

Tarek Course Schedule: Thursday 12:15 – 1:45pm, H19 Textbook:

Bank Management & Financial Services by Rose & Hudgins, 8th ed.,

McGraw-Hill, New York 2010. Relevant references and articles will be determined per

topic if required. Course Assessment:

Final Exam: 40% Midterm Exam: 20% Course Work (Project, Assignments & Quizzes): 40%


mailto:[email protected]



Course SyllabusA. Introduction to Banking & Financial services

1. Introduction & an overview on banking sector

B. Analysis of Bank Financial statements and Performance Management1. The financial statements of banks

2. Measuring and Evaluating Bank Performance

C. Bank Management1. Investments Management2. Liquidity Management3. Management of CapitalD. Hedging against Risk

1. Changing Interest Rates Management

2. Credit Risk Management




Topics Covered The Financial System and Financial-Service

Institutions

What Is a Bank?

Old and New Services Offered to the Public

Key Trends Affecting All Financial-Service Firms

Career Opportunities in Banking and Financial

Services





Introduction

• Banks represent the nerve of the financial system in any economy.

• Banks are a main source of corporate financing in most modern economies, prudential and responsible bank management is fundamental to sustainable economic growth.

• Banks are the principal source of credit (loanable funds) for millions of individuals and families and for many units of government

• Worldwide banks grant more installment loans to consumers (individuals and families) than any other financial-service provider




© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Without Financial Institution

Corporations

(net borrowers)

Households

(net savers)Cash

Equity & Debt

• Low level of fund flows.• High Information costs: Economies of scale reduce costs for FIs

to screen and monitor borrowers • Less liquidity




© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

With Financial Institution

Cash

Households Corporations

Equity & Debt

FI

(Brokers)

FI

(Asset Transformers)

Deposits/Insurance Policies

Cash





Functions of FIs Brokerage function

Acting as an agent for investors: Reduce costs through economies of scale Encourages higher rate of savings

Bid-ask spreads narrower for assets bought and sold in large quantities.

Asset transformer function: Purchase primary securities by selling financial claims

to householdsThese secondary securities often more marketable (liquid

assets) and have less price risk.Transformation of financial riskAdvantages of diversifying risk.





Functions of FIs Role of FIs in Cost Reduction Information costs:

Investors exposed to Agency Costs Role of FI as Delegated Monitor (Diamond, 1984)

Shorter term debt contracts easier to monitor than bonds FI likely to have informational advantage

FI as information producer, monitor power and control, act as delegated monitor, FIs reduce information asymmetry between borrowers and lenders.





The Financial System and Competing Financial-Service Institutions• Roles of the Financial System

▫ The primary purpose of the financial system is to encourage saving and to transfer those savings to individuals and institutions planning to invest and needing credit to do so

▫ This process of encouraging savings and transforming savings into investment spending causes the economy to grow, new jobs to be created, and living standards to rise

▫ The financial system also provides a variety of supporting services:▫ Payment services (allow to making commerce & paying their

customers’ obligations e.g. checks, credit & debit cards)▫ Risk protection services (for those who invest and venture to invest

e.g. insurance policies &derivative contracts).▫ Liquidity services (convert assets to immediately available spending

power)▫ Credit services (granting loans to those who need to increase their

income)





TABLE 1–1 The Many Different Roles Banks and Their Closest Competitors Play in Today’s Economy





The Financial System and Competing Financial-Service Institutions (continued)

• Leading Competitors with Banks ▫ Savings Associations▫ Credit Unions▫ Money Market Funds▫ Mutual Funds (Investment Companies)▫ Hedge Funds▫ Security Brokers and Dealers▫ Investment Banks▫ Finance Companies▫ Financial Holding Companies▫ Life and Property/Casualty Insurance Companies





What Is a Bank?

• A bank can be defined in terms of:1. The economic functions it performs2. The services it offers its customers3. The legal basis for its existence

• Historically, banks have been recognized for the great range of financial services they offer▫ Bank service menus are expanding rapidly today to include

investment banking, insurance protection, financial planning, advice for merging companies, the sale of risk-management services to businesses and consumers, and numerous other innovative financial products





What Is a Bank? (Economic Role)

At the investor level, they provide access to payment systems, create liquidity and facilitate economic activity by reducing transaction costs and information asymmetry. They also help investors reduce their uncertainty by packaging, hedging, pricing, and sharing risks. At the economy level, banks are an instrument of executing of monetary policy and of providing stability to the economy as a whole.

For the literature on the economic role of banks, see Gorton and Winton (2002).





What Is a Bank? (legal basis)

• The Legal Basis for Banking ▫ A bank is any business offering deposits subject to

withdrawal on demand and making loans of a commercial or business nature

▫ Congress then defined a bank as any institution that could qualify for deposit insurance administered by the Federal Deposit Insurance Corporation (FDIC)▫ Under federal law in the U.S., a bank had come to be defined,

not so much by its array of service offerings, but by the government agency insuring its deposits





What is a bank? (Services offered to the Public)

• Services Banks Have Offered for Centuries▫Carrying Out Currency Exchange▫Discounting Commercial Notes and Making Business

Loans▫Offering Savings Deposits▫Safekeeping of Valuables and Certification of Value▫Supporting Government Activities with Credit▫Offering Checking Accounts (Demand Deposits)▫Offering Trust Services





• Services Banks and Many of Their Financial-Service Competitors Began Offering in the Past Century▫ Granting Consumer Loans▫ Financial Advising ▫ Managing Cash▫ Offering Equipment Leasing▫ Making Venture Capital Loans▫ Selling Insurance Policies▫ Selling and Managing Retirement Plans▫ Dealing in Securities: Offering Security Brokerage and Investment

Banking Services▫ Offering Mutual Funds, Annuities, and Other Investment Products ▫ Offering Merchant Banking Service▫ Offering Risk Management and Hedging Services



What is a bank? (Services offered to the Public)



Key Trends Affecting All Financial-Service Firms – Regulations, Crisis, Reform, and Change

OVERVIEW OF BASEL ACCORDSBasel Committee on Banking Supervision is one of the committees established by the Bank for International Settlements (BIS) and it aims to improve the quality of banking supervision all over the world, and aims to promote monetary and financial stability.





Basel AccordsBasel Accord I (1988)•In 1988, Basel Accord was announced to confront bank failures and cure the weakness of the simple capital to assets ratio.•It requires imposing risk-based capital ratios on banks. It aims to strengthen the soundness and stability of the international banking system, and to reduce the competitive inequality among international banks.

•The Committee sets the framework for measuring capital adequacy and the minimum levels of capital, however, it was focusing only on the credit risk of assets.





Basel AccordsLimitations of Basel IAlthough the 1988 Basel Accord provides an effective framework that assists banks all around the world in assessing their capital adequacy it has got some limitations.1- It comprises the credit risk only, while banks confront many other kinds of risks resulting from their trading activities and off-balance-sheet activities. 2- Basel I set out a fixed percentage to meet the minimum capital requirements which is 8%, this percentage is unchanged although risk is not constant all the time and in some conditions banks have to hold more than this percentage to meet high risk.





Basel AccordsThe New Basel Capital Accord (Basel II)

In 2001, the Basel committee on Banking Supervision developed Basel II (the new Basel Capital Accord) to expand Basel I (Capital Accord 1988) which focuses only on credit risk, and its amendment in 1996 which incorporates the market risk.





Basel Accords• Basel II goes beyond Basel I and sets out a framework, which

consists of three pillars:1.minimum capital requirements, 2.supervisory review, Strengthen the supervisory role.3.market discipline, enhance disclosure and transparency.

• It incorporates the operational risk to the credit risk and market risk, in order to calculate and assess the minimum capital requirements, that is, bank’s minimum capital ratio will be calculated on the sum of the bank’s credit, market, and operational risks.





Basel Accords• Operational risk is defined as “the risk of loss arising from

various types of human or technical error” and “it is the breakdown in internal controls and corporate governance, such as error, fraud, or failure in performance. Other aspects of operational risk include major failure of information technology systems or events such as major fires or other disasters”.

• In addition, Basel Committee (January, 2001) defined operational risk: “the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events.”





Banking reforms- The Egyptian banking reform plan 2004

• To comply with Basel requirements, the Banking Law No. 88/2003 was promulgated to regulate the Egyptian banking sector and incorporates provisions that implement Basel II.

• Furthermore, the Law allows bank mergers to enable them to maintain the minimum capital requirement and form large entities.

• The 2003 Banking Law sets some provisions that conform to

specific governance mechanisms such as bank ownership, bank board of directors, bank committees.





Banking reforms- The Egyptian banking reform plan 2004

• The Egyptian government launched the comprehensive financial sector reform program in 2004 to implement the Law provisions and comply with Basel Accords. Particularly, the banking sector reform program includes four pillars:

I. Privatization and consolidation of the banking sector.

II.Restructuring of state–owned banks.

III.Solving non–performing loans problems (NPLs).

IV.Enhancing the CBE banking supervision.





Career Opportunities in Banking and Financial Services• What different kinds of professionals work inside

financial firms?▫Loan Officers▫Credit Analysts▫Managers of Operations▫Branch Managers▫Systems Analyst▫Auditing and Control Personnel▫Trust Department Specialist▫Tellers





Career Opportunities in Banking and Financial Services (continued)• What different kinds of professionals work inside

financial firms?▫Security Analysts and Traders▫Marketing Personnel▫Human Resources Managers▫ Investment Banking Specialists▫Bank Examiners and Regulators▫Regulatory Compliance Officers ▫Risk Management Specialists





References:• Text book• ElBannan, M. (2015). Effects of the financial

crisis, Basel accords and bank regulations on the banking system: An overview. International journal of business governance and ethics.



Documents

Lecture 1_An Overview of Banks_Ch.1