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Bank management

Banks in Bahrain

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Bahrain's financial sector • well-developed and diversified, consisting of a wide range of

conventional and Islamic financial institutions and markets, including

• Retail and wholesale banks, specialized banks, insurance companies, finance companies, investment advisors, money changers, insurance brokers, securities brokers and mutual funds.

• There are also two licensed exchanges, one licensed clearing settlement and central depository, 4 stock brokers, one licensed securities dealer, 15 licensed securities broker dealers and 6 licensed securities clearing members.

• The sector is therefore well-positioned to offer a wide range of financial products and services, making it the leading financial center in the Gulf region.

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Bahrain's banking system

• consists of both conventional and Islamic banks and is the largest component of the financial system, accounting for over 85% of total financial assets. The conventional segment includes 23 retail banks, 69 wholesale banks, 2 specialized banks as well as 36 representative offices of overseas banks. The Islamic segment, offering a host of Sharia compliant products and services include 6 retail banks and 18 wholesale banks.

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What is a Bank?

• They are involved in transferring funds from savers to borrowers (financial intermediation).

• The government finally settled on the definition still used by many nations today:

• A bank is any business offering deposits subject to withdrawal on demand (such as by writing a check or making an electronic transfer of funds) and making loans of a commercial or business nature (such as granting credit to private businesses seeking to expand the inventory of goods on their shelves or purchase new equipment)

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Kind Of BanksCommercial banks: Sell deposits and make loans to businesses and individuals Money center banks: Largest commercial banks based in leading financial centers Community banks: Smaller, locally focused commercial and savings banksSavings banks: Attract savings deposits and make loans to individuals and families Cooperative banks: Help farmers, ranchers, and consumers acquire goods and services Mortgage banks: Provide mortgage loans on new homes but do not sell deposits Investment banks: Underwrite issues of new securities from their corporate customers Merchant banks: Supply both debt and equity capital to businesses Industrial banks: State-chartered loan companies owned by financial or nonfinancial

corporationsInternational banks: Commercial banks present in more than one nation Wholesale banks: Larger commercial banks serving corporations and governments Retail banks: Smaller banks serving primarily households and small businesses Limited-purpose banks: Offer a narrow menu of services, such as credit card companies and

subprime lendersBankers' banks: Supply services (e.g., check clearing and security trading) to banks Minority banks: Focus primarily on customers belonging to minority groups National banks: Function under a federal charter through the Comptroller of the Currency in

the United StatesState banks: Function under charters issued by banking commissions in various states

Insured banks: Maintain deposits backed by federal deposit insurance plans (e.g., the FDIC)Member banks: Belong to the Federal Reserve SystemAffiliated banks: Wholly or partially owned by a holding companyVirtual banks: Offer their services only over the InternetFringe banks: Offer payday and tide loans, cash checks, or operate as pawn shops and rent-

to-own firmsUniversal banks: Offer virtually all financial services available in today's marketplace

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Investment Bank Commercial bank

Investment banks, on the other hand, make securities their primary area of business

Commercial banks offer a wide variety of services, but they do not deal with securities

Their customers mainly businesses Individual and businesses

Its main return is return from investments

Its major return in Interest Margin

Don’t have current account Have current account

No pressure on its liquidity High pressure on its liquidity

One or two branches Some times more than 50 branch in a country

Allowed to work as underwriter Is not allowed

Long term loans Short term loans

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1999 2000 2001

Assets $ % $ % $ %

Cash and due from institutions 26,948 6.05% 28,053 6.04% 29,521 6.14%

Short-term instruments Fed funds sold and repos 4,879 1.09% 867 0.19% 1,102 0.23%

Other interest-bearing 189 0.04% 563 0.12% 609 0.13%

instruments Securities Held to maturity 36,719 8.24% 35,097 7.56% 32,147 6.68%

Available for sale 106,417 23.87% 100,364 21.61% 98,983 20.58%

Trading account assets 0 0.00% 0 0.00% 0 0.00%

Loans Commercial loans 86,481 19.40% 92,571 19.93% 94,918 19.73%

Consumer loans 82,107 18.42% 94,810 20.41% 103,367 21.49%

Real estate loans 53,817 12.07% 56,481 12.16% 63,249 13.15%

Other loans 23,176 5.20% 28,694 6.18% 28.793 5.99%

Leases 8,950 2.01% 8,794 1.89% 9,806 2.04%

Less: Reserve for loan losses -3,412 -0.77% -2,987 -0.64% -3,249 -0.68%

Net loans and leases 251,119 56.34% 278,363 59.94% 296,884 61.73%

Premises and fixed assets 13,468 3.02% 14,468 3.12% 14,845 3.09%

Other real estate owned 786 0.18% 421 0.09% 273 0.06%

Goodwill and other intangibles 0 0.00% 0 0.00% 0 0.00%

All other assets 5,231 1.17% 6,237 1.34% 6,604 1.37%

Total assets 445,756 100.00% 464,433 100.00% 480,968 100.00%

LIABILITIES AND CAPITAL Demand deposits 61,733 13.85% 63,781 13.73% 66,389 13.80%

Interest-bearing deposits NOW and other transaction 93,417 20.%% 95,911 20.65% 98,271 20.43%

accounts Savings accounts 86,238 19.35% 87,396 18.82% 89,043 18.51%

Time certificates (CDs 121,895 27.35% 124,386 26.78% 129,807 26.99%

under $100,000) CDs, $100,000 and over 28,025 6.29% 29,683 6.39% 31,269 6.50%

Other interest-bearing 8,469 1.90% 9,214 1.98% 9,806 2.04%

deposits Borrowed funds Fed funds purchased and 843 0.19% 5,188 1.12% 4,800 1.00%

repos Other borrowed funds 8,324 1.87% 10,284 2.21% 11,131 2.31%

All other liabilities 4,649 1.04% 4,416 0.95% 4,160 0.86%

Subordinated debt 0 0.00% 0 0.00% 0 0.00%

Equity capital Preferred stock Common stock 12,000 2.69% 12,000 2.58% 12,000 2.49%

Surplus 8,000 1.79% 8,000 1.72% 8,000 1.66%

Undivided profits 12,163 2.73% 14,174 3.05% 16,292 3.39%

Total liabilities and capital 445,756 100.00% 464,433 100.00% 480,968 100.00%

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Cash And Due• Currency and coin held in the bank's vault.• Deposits with the Central Bank, which are used

– to meet legal reserve re quirements – and may also serve as a balancing account for checking clearance,

transactions in Treasury securities, wire transfers, and so on.• Deposits with correspondent banks, which banks can use to help to

compensate their correspon dents for services performed.• Cash items in the process of collection, that is, items deposited in

the central bank Re serve or correspondent banks for which credit has not been received.

• Since a bank does not earn interest on any of these four categories of cash assets, they are labeled nonearning assets and banks generally exert considerable effort to minimize their cash assets.

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Short-term instruments

• include interest-bearing short-term assets such as federal funds sold (excess reserves that one bank lends to another), securities purchased under agreement to resell (reverse repurchase agreements), and other bank certificates of deposit.

• Such short-term instruments have obvious appeal to banks with extra funds for a short period; however, some banks use these short-term assets continuously as a way of em ploying attracted funds.

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Securities• Refers to any eligible type of debt securities that a bank owns. They

may be of any maturity and are valued at market value (for securities available for sale) or at what the bank paid for them plus or minus an amortized adjustment toward the maturity value of the principal (for securities held to maturity).

• The largest amount of securities held by most banks is securities of the government— Treasury notes, and bonds. Many banks do have sizable holdings of securities of government agencies. Some banks also hold either corporate debt or debts of foreign governments or businesses.

• Banks are not permitted to buy securities that the large private rating agencies, such as Standard & Poor's or Moody's, rate below investment grade (for example, below Moody's Baa rating). Banks are not permitted to buy corporate stocks.

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• Banks must classify their debt securities as either (1) hold-to-maturity (HTM), (2) available-for-sale (AFS), or (3) trading securities (defined below).

• HTM securities can be valued on the balance sheet at original cost adjusted for amortization toward the securi ties' par or redemption value.

• To qualify for HTM, the bank must prove that it has both the intent and the ability to hold the bond until maturity.

• AFS securities must be valued at market, and any paper gains or losses are credited to or debited from the bank's capital position

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Trading account assets

• include any of the preceding securities (usually Treasury securities) or other marketable assets that are held primarily for resale within relatively short periods, usually with the intent of profiting from short-term price movements.

• These assets must be valued at market rather than at book value, and gains or losses in value must be reported as ordinary gains or losses on the income statement as well as attributed to the capital position.

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Loans • The primary earning assets of most any bank. • The bank lends funds to a customer and in return gets a promissory note from the

customer promising to pay interest, at either a fixed or a variable rate, and to repay the principal balance of the loan.

• Loans are usually categorized by type of user and by use of the funds. The three major categories for most banks are as follows.

• Commercial loans, which are short- or intermediate-term loans to businesses typi cally for seasonal buildup of accounts receivable or inventory or for permanent working capital or plant and equipment.

• Consumer loans, which include automobile loans, other consumer durable loans, home improvement loans, credit card loans, and other installment and single-payment loans to finance personal expenditures.

• Real estate loans are used to finance single and multifamily residences, construc tion, and commercial real estate such as office buildings, retail outlets, and facto ries.

• Most long-term loans made prior to the early 1980s were fixed-rate; however, many recent real estate loans have been variable-rate or a rate that is renegotiable every few years.

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• Other types of loans include agricultural loans, loans to banks and other financial institutions, loans to brokers and dealers, and any other loans that do not fit into the preceding loan categories.

• Leases consist of the outstanding balances on leases of assets owned directly or indirectly by the bank. Lease payments are made by the lessor to the bank. While treat ments of depreciation, residual ownership, and tax liability are different with lease con tracts, most aspects of a lease are similar to a term loan.

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The reserve for loan losses, a contra-asset account ( “negative asset"),

• Repre sents the balance in the valuation portion of a bank's bad debt Reserve. A bank builds up this reserve to absorb future loan losses.

• Contribution to the reserve constitute a non cash expense charged against income, and, because they are tax deductible, banks must estimate them according to strict Internal Revenue Service tax rules.

• This reserve is de creased when loans are charged off and removed from the balance sheet The valuation reserve is subtracted from total loans to arrive at a bank's net loans.

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Net loans and leases

• are total loans and leases less any unearned income and the reserve for loan losses.

• Since 1976, only net loans have been reported as bank assets.

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Premises and fixed assets

• include all the bank's premises, facilities, equipment, fur niture, fixtures, and leasehold improvements.

• These items are on the books at their depreci ated book value and are classified as non-earning assets because they usually do not directly create an income stream.

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Other real estate owned

• refers to all real estate owned by the bank, excluding bank premises and equipment.

• Most of this category is real estate acquired through foreclosure when customers default on loans secured by the real estate.

• Thus, the account may signal trouble in the loan portfolio.

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Goodwill and other intangibles • are usually the present value of expected future income in excess

of the normal return, for example, a strong reputation and favorable location.

• They are generally recorded as the part of the value of an acquisition that exceeds the book value of the net assets acquired.

• All other assets • is simply a catchall category of other assets not large enough to

warrant a separate account, such as customer liability to the bank on acceptances, prepaid expenses, and balances held with other institutions.

• If the items become significant, they will appear as a separate balance sheet item.

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Liabilities and Capital Accounts

• The liabilities and capital side of a bank's balance sheet separates all the bank's sources of funds into appropriate categories.

• The categories can be based on the form of the organization supplying the funds, such as individual, partnership, and corporation deposits versus public deposits, or on the form of the contract, such as passbook savings versus money market deposits.

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Demand deposits • By law are noninterest-bearing checking accounts of individuals,

partnerships, corporations, and governmental units. • The majority of these accounts gener ally come from businesses

(partnerships or corporations) because (1) businesses are not eligible for interest-bearing checking

accounts and often are required to leave compensati ng demand deposit balances with the bank as part of a loan agreement,

(2) individuals are usually eligible for interest-bearing checking accounts, and

(3) governmental units keep most of their deposits in interest-bearing accounts.

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NOW and other transaction accounts

• Checking accounts of individuals and part nerships that receive interest as long as they meet the specifications set by the bank. The proper legal title for these accounts is Negotiable Order of Withdrawal (NOW) accounts.

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Savings accounts

• Represent interest-bearing deposits of individuals and partnerships that have no specified maturity. They do not have contractual provisions requiring the depositor to give written notice of an intention to withdraw funds.

• These accounts include passbook savings, and money market accounts, which were created to provide banks with an instrument that was eligible to pay "money market" interest rates that would compete effectively with money market mutual funds.

• Most banks pay rates that vary according to an average rate on a short-term money market instrument and will probably continue to use minimum sizes and maximum free withdrawals to market this account.

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Time certificates (CDs under $100,000)

• Time deposits evidenced by non-negotiable instruments that specify the interest rate and the maturity date, which must be seven days or longer.

• These certificates are not subject to rate ceilings, and there are usually interest penalties if the deposits are withdrawn prior to maturity.

• They are generally priced at a fixed rate and held by individuals, but they can be held by businesses, and some have floating rates—often tied to those of similar-maturity Treasury securities.

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Certificates of deposit (CDs $100,000 and over)

• larger accounts than time cer tificates and are often negotiable, with maturities of 14 days or greater.

• They can be either fixed or variable obligations. The negotiable CDs are denominated in amounts ranging from $100,000 to $100 million, with $1 million being the standard trading unit and three months to one year the most popular maturity range. Principal purchasers are treasurers of large businesses; however, state and local governments and wealthy individuals also have purchased significant amounts.

• CDs are considered "flight money" and, therefore, represent a less secure form of funding because amounts over $100,000 are not federally insured and the depositor is highly alert to any deterioration in the bank's reputation for financial strength.

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Other interest-bearing deposits

• A catchall category of time and savings deposit accounts. The primary category of public deposits is usually time deposits of state and local governments.

• In many states, securities must be pledged as collateral for such depos its. Other time deposits include time deposits of commercial banks, other financial interme diaries, and foreign governments and financial institutions.

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Short-term borrowing includes federal funds and repurchase agreements (repos).

• Federal funds are the excess reserves of banks that are purchased on an unsecured basis by a bank or possibly another institution that has a reserve deficiency. T

• he purchases are often made on a daily basis but generally can be easily renewed.

• For the banking system, federal funds purchased are roughly equal to federal funds sold, and the rate on federal funds is determined by the amount of excess reserves available versus the demand for this form of funding.

• Repurchase agreements, or repos, are the sale of securities under an agreement to repurchase. They are a form of short-term borrowing that represent a bank's obligation to buy back securities that it has temporarily sold. Because the purchaser owns the securities during this period, these repos constitute, in effect, secured borrowing. Other short-term borrowing forms include discount borrowings from the Federal Reserve, Eurodollars, and commercial paper.

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All other liabilities • is another catchall category for remaining liabilities. Items usu ally found

in this category include accrued taxes and expenses, dividends payable, liabili ties on acceptances, trade payables, and other miscellaneous liabilities.

Subordinated debt • Includes bank capital notes and debentures with maturities ex ceeding

one year. These notes or debentures are not insured and may be either straight (nonconvertible) or convertible into the bank's common stock.

• Subordinated debt is a source of funds and may also be treated as part of capital if the debt meets certain require ments. The requirements usually include subordination to deposits and other liabilities, minimum average maturity when issued (usually eight to ten years), and minimum re maining maturity (usually two years).

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Equity capital

• represents the difference between the book value of a bank's assets and its liabilities. It includes up to four possible categories— preferred stock, common stock, surplus, and undivided profits.

• Preferred stock pays a fixed or variable dividend that is not a tax-deductible expense; therefore, banks do not often use preferred stock.

• The common stock account is the total par or stated value of all the bank's outstanding shares. The surplus account can be increased by the sale of common stock at a premium above its par value and by transfers from the undivided profits account. The surplus account may also include equity reserves.

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• Equity reserves include contingency re serves (the emphasis generally on reserves that are not a tax-deductible expense), such as reserves for security gains or losses and the contingency portion of provisions for possi ble loan losses.

• The undivided profits account is similar to the retained earnings account for most nonfinancial businesses. After-tax net income increases undivided profits, and each or stock dividends and capital transfers reduce undivided profits.

• The book value of a bank's common stock is the summation of the common stock, surplus, and undivided profits.

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Passbook savings account

• The savings account where all record of credits and debits, including deposits, withdrawals, and interest, are recorded on a passbook usually kept by the account holder.

• Passbooks are routinely updated with the necessary information by the bank. This type of account is well suited for those depositors who transact infrequently on their account and who don't have a need for a monthly statement.

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