lecture 1_an overview of banks_ch.1
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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
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-2
Course Information Lecturer: Dr. Mona ElBannan Instructor Email: mona.elbannan@guc.edu.eg 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%
Dr. Mona ElBannan Bank Management Spring 2016
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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
Dr. Mona ElBannan Bank Management Spring 2016
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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
Dr. Mona ElBannan Bank
Management Spring 2016
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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
Dr. Mona ElBannan Bank
Management Spring 2016
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 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
Dr. Mona ElBannan Bank
Management Spring 2016
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 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
Dr. Mona ElBannan Bank
Management Spring 2016
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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.
Dr. Mona ElBannan Bank
Management Spring 2016
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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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.
Dr. Mona ElBannan Bank
Management Spring 2016
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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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)
Dr. Mona ElBannan Bank
Management Spring 2016
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TABLE 1–1 The Many Different Roles Banks and Their Closest Competitors Play in Today’s Economy
Dr. Mona ElBannan Bank
Management Spring 2016
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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
Dr. Mona ElBannan Bank
Management Spring 2016
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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
Dr. Mona ElBannan Bank
Management Spring 2016
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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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).
Dr. Mona ElBannan Bank
Management Spring 2016
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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
Dr. Mona ElBannan Bank
Management Spring 2016
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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
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Management Spring 2016
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• 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
Dr. Mona ElBannan Bank
Management Spring 2016
What is a bank? (Services offered to the Public)
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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.
Dr. Mona ElBannan Bank
Management Spring 2016
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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.
Dr. Mona ElBannan Bank
Management Spring 2016
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-20
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.
Dr. Mona ElBannan Bank
Management Spring 2016
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-21
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.
Dr. Mona ElBannan Bank
Management Spring 2016
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-22
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.
Dr. Mona ElBannan Bank
Management Spring 2016
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-23
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.”
Dr. Mona ElBannan Bank
Management Spring 2016
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-24
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.
Dr. Mona ElBannan Bank
Management Spring 2016
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-25
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.
Dr. Mona ElBannan Bank
Management Spring 2016
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-26
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
Dr. Mona ElBannan Bank
Management Spring 2016
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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
Dr. Mona ElBannan Bank
Management Spring 2016
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-28
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.
Dr. Mona ElBannan Bank
Management Spring 2016
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