Fundamentals of Banking

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This is a presentation targeted to non-economics major, to understand where does money come from and how to achieve sustainability of bank business. The script is available at http://getthingsright.blogspot.com/2010/05/1-opening-banking-business-is-one-of.html

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Fundamentals of Banking

  1. 1. Fundamentals of Banking Yoshi
  2. 2. Agenda <ul><li>Money Supply </li></ul><ul><li>(Banks’ Role in Economy) </li></ul><ul><li>Asset Liability Management </li></ul>
  3. 3. Money Creation (Seigniorage) Lending Account Transfer Asset Liability Account A Account C Account B Bank Deposit This is also Money!!
  4. 4. Money Supply increases by Banks Money Creation (Multiple Effect) Bank 1 Bank 2 Account A Account C Account B Account A Account C Account B
  5. 5. Money Creation (Regulatory Cost) Account A Account C Account B Account A Account C Account B Multiple Effect does NOT Continue permanently Account A Account C Account B Reserve Reserve Central Bank 100% 80% 64% 20% 16% Bank 1 Bank 2
  6. 6. Asset Nostro 2 Monetary Base (called ‘M0’ ) High Powered Money Central Bank Nostro X Bank 1 Bank 2 Bank X Nostro 1 Google in future?
  7. 7. Money Supply <ul><li>M0 = Monetary Base by Central Bank </li></ul><ul><li>M1 = M0 + Current Account </li></ul><ul><li>M2 = M1 + Saving Account </li></ul><ul><li>+ Money Market Account </li></ul><ul><li>M3 = M2 + Others (inc. Repo) </li></ul><ul><li>*These classification may vary across countries </li></ul>
  8. 8. Singapore (as of Feb 2010) <ul><ul><ul><ul><ul><li>( Unit S$ MILLION) </li></ul></ul></ul></ul></ul><ul><li>M0 = 21,468.1 (Currency In Active Circulation) </li></ul><ul><li>M1 = 96,894.7 (M0 + Demand Deposit) </li></ul><ul><li>M2 = 373,689.0 (M1 + Quasi - Money) </li></ul><ul><li>M3 = 380,817.5 (M2 + Net Deposit of Financial Companies) </li></ul>Source : http://www.mas.gov.sg/resource/data_room/msb/March%202010%20Vol%2031%20No%203.pdf
  9. 9. Banking / Shadow Banking Low (So far …. ) High Regulation Trading (Leverage) Lending Money Creation Hedge Funds Investment Banks Commercial Banks Who Shadow Banking Banking
  10. 10. When a Bank goes into Bankrupt? <ul><li>Cash Flow Problem </li></ul><ul><li>Capital Adequacy Requirement </li></ul><ul><li>(Basel/BIS, Regulatory Authorities) </li></ul><ul><li>From Remedial to Preventive </li></ul><ul><li>Measures! </li></ul>US Statistics (FDIC) 2009 140 1933 4000 (Commercial Banks) 1700 (S &L ) Source : http://www.fdic.gov/bank/individual/failed/banklist.html http://www.fdic.gov/about/learn/learning/when/1930s.html
  11. 11. Balance Sheet Equity Debt Long Term Asset Short Term Asset Lending Investment Asset Liability
  12. 12. Asset Liability Management <ul><li>Active : </li></ul><ul><li>WACC, Portfolio Theory, etc </li></ul><ul><li>Passive : </li></ul><ul><li>Duration (Basis Point Value), Maturity Ladder, VaR, etc </li></ul>
  13. 13. Maturity Ladder In 5 Years Asset Liability Deposit Loan A/C Lending Present Future Customer In 10 Years Mismatch ! Bank In 5 Years Pay In 10 Years Receive
  14. 14. Basis Point Value Interest Up/ No Change on Value Asset Liability Bond Bond Present Future Price Sensitivity to Interest (Duration) Mismatch ! Bank Liability Interest Up/ Value Dropped Liability High Asset Low Liability
  15. 15. Value At Risk (VaR) Value Stable Asset Liability Portfolio Portfolio Present Future Historical Data Indicates Max Loss of the Portfolio can be High (= Risk!) Bank Liability Value Unstable
  16. 16. ALM Continued…. <ul><li>Reputation Risk </li></ul><ul><li>Credit Risk </li></ul><ul><li>Legal Risk </li></ul>
  17. 17. Key Questions <ul><li>Q1. Why Monetary Base has to be supplied by Central Bank? </li></ul><ul><li>Q2. Does Central Bank have a control over Money Supply? </li></ul><ul><li>Q3. Is Money Supply stable in this way? </li></ul><ul><li>Q4. What else to run a bank besides maintaining a sound Balance Sheet ? </li></ul>

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