6. Very Large Orders
Syndicates
Banks create a syndicate for large loans
Insurance companies create syndicate for
large insurance i.e. say GBP(£) 1Billion
insurance cover.
9. Bank Loans
• Bank needs to insure Loan + Interest will
be repaid timely.
• Does Borrower own Assets?
• Assess: How risky is the loan?
• More Risk More Interest required.
10. Company Needs Money
Capital Need of Company
Equity Bonds Bank Loan
Reward: Dividends Fixed Interest Variable Interest
• Part owner, hence no
end date loan
• Risk: Value can go up or
down
• Money to be paid back
with interest – Set dates
• Strict rules for obligations
• Money to be paid back
with interest – Set dates
Note: Equity is exception in the merry-go-round, it is not debt
11. Balance Sheet
• Stock market analyst look at firm’s
balance sheet and look at ratio of long-
term Debt (Bond and Loan) to Equity.
• Equity includes money raised by selling
shares and profit money (minus taxes,
dividends etc) – includes money for
growth. This money belongs to
Shareholder.
13. Banking Supervision
Who is in charge of the bank?
Answer: ‘The Central Bank’ of respective
countries or some separate authority and
decides on rules.
Condition of entry
Capital Ratio
Liquidity Rules
Foreign Exchange control
Rights of Inspection
14. Type of Banks
• Central Banks
• Commercial Banks (Retail and Wholesale Banks)
• Investment (or Merchant) Banks
• Savings Banks
• Cooperative Banks
• Mortgage Banks
• Giro Banks and National Savings Banks
15. Central Banks
• An economy will have a central bank.
• Reserve Bank of India (RBI)
16. Commercial Banks
• Retail Bank (incl. Private Banking) – High
street branches, dealing with general
public, small businesses. Cheque clearing, high
volume, low value.
• Wholesale Bank – Low volume, high
value. Dealing with other banks, central bank,
corporate, pension funds, and other investment
institutions. – electronic settlement – CHIPS, CHAPS,
BACS, SEPA etc.
17. Private Banking
• High net worth individuals
• Deposits, loans, fund management,
investment advice etc.
• Switzerland specialisation originally
18. Investment (MerchantUSA) Banks
• Commercial banking is about Lending
money.
• Merchant banking is ‘helping people to
find the money’
• Raising Capital - bank loans, bond issue
or equity.
19. Savings Banks
• In modern world they are looking more
and more like ordinary commercial banks,
due to mergers, deregulation.
20. Co-operative Banks
• These are owned by the members and
with maximum profit not necessarily the
main objective – they may aim to give low
cost loans to members.
22. Giro Banks (1 of 2)
• Giro – Greek ‘Guros’, meaning a wheel or
circle. The circle in finance is the passing
round of payment between counterparties.
• Debt circle A owes B owes C owes
D owes A owes.
• The bankers setup a clearing system – the
giro of ledger entries.
23. Giro Banks (2 of 2)
Modern days uses:
(i) Individual sends a giro slip to their bank
instructing them to pay a sum of money to
electricity or water supply.
(ii) Giro Bank and use of Post Office for
those who do not have bank accounts pay
their bills to GB/PO and GB/PO forward
payment to the utility firms.
24. Other Banking Terminologies
• Clearing Banks – Clearing cheques –
large volumes.
• Cheques drawn in favour of other banks
are sent to a central clearing system
where they can be gathered together and
sent to each bank for posting to individual
accounts.
• State or public banks –
• International banking -
25. Bank’s Balance Sheet
First a few terms that will be discussed later:
√ Creation of Credit
√ Liquidity
√ Capital Ratio
Other terms:
Asset
Liability
26. Bank’s Balance Sheet - Liability
Liability
• Liability in accounting does not mean
‘disadvantage’. It is money for which the
entity concerned is liable. If money is
borrowed, the borrower is liable to repay it,
hence liability.
• Liabilities are claims against the bank
27. Bank’s Balance Sheet - Liability
Liability
√ Shareholder's equity plus additional from
retained profit
√ Deposits (the largest figure)
√ Borrowings (i.e. a bond issue)
Is the main source of bank’s capital, and
fund that can be relied upon because its
owner’s money, has no pay back date.
28. Bank’s Balance Sheet - Assets
Assets represent how this money has been used,
for example:
√ Notes, coins
√ Money Market funds
√ Securities
√ Lending (the largest figure)
√ Fixed assets, for example, property, equipment.
The Assets, thus, represent claims by the bank
against others.
29. B/Sheet - Assets and Liability layout
Assets are listed in order of liquidity: Liabilities are:
Cash
Balances at the central bank
Money at call and short notice
Bank and trade Bills of Exchange
Treasury Bills
Securities
Advances to customers
Premises and equipment
Ordinary share capital
Reserves
Retained profits
Customers' deposits
Bond issues
Other borrowing
Trade creditors
Tax
Balance sheet of an organisation is a snapshot in time. So the value
of bank at a particular point in time.
30. Profit and Loss Account
• The Profit and Loss (PnL) account shows
how a bank has traded during a particular
period, such as 1m, 3m, or a year.
• Revenue is contrasted with cost and
resulting difference is profit or loss.
• After paying dividend and taxes profits
are transferred to balance sheet and
added to shareholders’ funds, thus
increasing capital. Losses reduce capital.
31. Creation of Credit
• Banks have surplus credit cash from
deposits and therefore facility to create
credit.
• For example, bank gives you overdraft
facility of say £2K and you purchase
goods with it. Banks has created £2K
expenditure that did not exist.
• Supplier of £2K goods now has £2K
disposable money.
32. Creation of Credit
• Where did £2K come from?
• Not from you because you did not have it.
• It came from bank that allowed you the
overdraft of £2K – bank has created
money.
• Bank lending = spending and excessive
spending may mean unacceptable
inflation and imports the nation can’t
afford.
33. Creation of Credit
• Remember banking depends on confidence
• Govt. and central bank will want to control it in
view of implication for inflation and imports.
• Banks will need internal controls called
‘Liquidity Ratio’
• An external control enforced by bank supervisor
called ‘Capital Ratio’ is required.
34. Banking Depends on Confidence
• Govt and central bank will want to control
credit and measure ‘Money Supply’. This
figure is a measure of bank deposits as
being best guide to bank lending.
35. Central Bank - Controls
Central bank has number of weapons.
• Raising mandatory reserves – to CB
• Raising Interest Rates
• General ‘Open market operations’ i.e.
selling more government papers than it
needs to in order to drain credit and keep
monitory conditions tight. Not lending
money to banks quickly.
36. Liquidity Ratios
• Liquidity Ratio is controlled internally by
banks and regulators.
• What percentage of Cash, short notice,
short-term securities (T-bills, Bills of
Exchange) and so on.
37. Capital Ratio
• Capital Ration is the external control
imposed by bank supervisors in the
interest of prudence.
• Banks take money from depositors and
lend money, some borrowers default.
• The buffer, the money the bank can rely
on is its capital. Thus there should be
prudent relationship between capital and
lending – this is Capital Ratio.
38. Capital Ratio - RWA
• Not all assets are same, so assets are
given weighting.
39. Central Bank Activities
• Supervision of the banking system
• Advise the government on monetary policy
• Issue bank notes
• Acting as banker to the other banks
• Acting as banker to the government
• Raising money for the government
• Controlling the nation’s currency reserves
• Acting as ‘lender of last resort’
• Liaison with international bodies
40. Bank Lending
• Overdraft – Bank’s base rate + margin,
arrangements may be renewable.
• Line of Credit – borrow up to a given
amount.
• Bankers acceptance – Accept ‘bills of
exchange’. The best bill are bank or
eligible bills. Recognised top quality by
central bank.
41. Bank Lending
• Eligible bills are eligible for sale to the
central bank list.
• Ineligible bills – bills signed by traders
and therefore called Trade-Bills.
Sometimes traders are more creditworthy
than some Banks, nevertheless Central
Bank will not rediscount them.
42. Committed Facilities
Loan facilities are typically for one or more
years. There are three main types, plus a
special case – Project Finance.
• Term Loans – typically 5y to 7y. Loan is
amortised (borrower pays back in stages),
sometimes in ‘bullet’ payment. Floating IR.
• Standby Credit – Loan can be drawn
down in stages. Repaid money can not be
re-borrowed.
43. Committed Facilities
• Revolving Credit – loans can be drawn in
tranches, repaid fund can be reused.
Generally unsecured loans.
• Project Finance – is special case of Term
Loan – projects are typically for longer
durations –require complex time
consuming loan agreements
45. Investment Bank - Accepting
02 November 2011
You own me £100,000 for goods received.
Please pay on 2 February 2012
Signed: A.N. Exporter
Yes, I agree.
Signed: A.N. Importer
47. Bill of Exchange – I Notes
1. Exporter ships goods worth £100,000 to importer
2. Exporter asks importer to sign the Bill of Exchange
(BoE), undertaking to pay £100,000 in, say three
months.
3. Importer signs the bill and returns it.
4. Exporter presents the bill to a bank and asks them to
‘discount’ it.
5. The bank discounts the bill for say, £97,000.
6. Three months later, the bank presents the bill to the
importer for payment.
Problem: How credit worthy is Importer?
49. Bill of Exchange – II Notes
1. Exporter ships goods worth £100,000 to importer
2. Exporter asks a bank to ‘accept’ the bill, undertaking to pay
£100,000 in three months.
3. The bank accepts the bill and returns it.
4. Exporter presents the bill to a bank and asks them to ‘discount’ it.
5. The bank discounts the bill for say, £97,000.
6. Three months later, the bank presents the bill to the accepting bank
for payment of £100,000. The latter will recoup this from the
importer, or the importer’s bank.
N.B.
√ A bill signed by a trader is a Trader Bill.
√ A bill accepted by a bank recognised for this purpose by Central
Bank is a Bank Bill or Eligible Bill.
√ The Central Bank will itself discount the bill as part of its ‘lender of
last resort’ role.
