Here is our recent revision webinar on commercial banks and the UK economy. We look at how commercial banks made a profit (or loss!) and consider the factors that affect how much they can lend out.

2. Quick Quiz on Commercial Banks
Which one of the following is Britain’s biggest
commercial bank – as measured by the total size of
assets under their control?
Royal Bank of Scotland Lloyds Banking Group
Santander Banking
Group
Barclays Bank

3. Question 1
Which one of the following is Britain’s biggest
commercial bank – as measured by the total size of
assets under their control?
Royal Bank of Scotland Lloyds Banking Group
Santander Banking
Group
Barclays Bank

4. Question 2
Which one of the following was the first organic entrant
to the UK banking market in more than 100 years when it
received its banking licence in March 2010?
Marks & Spencer Bank Tesco Bank
Metro Bank Virgin Money

5. Question 2
Which one of the following was the first organic entrant
to the UK banking market in more than 100 years when it
received its banking licence in March 2010?
Marks & Spencer Bank Tesco Bank
Metro Bank Virgin Money

6. Question 3
During the crisis, the UK government took large holdings
in several UK banks to restore financial stability. Which
one of the banks listed below has NOT had any
emergency state financial support?
Royal Bank of Scotland Northern Rock
Lloyds Banking Group Barclays Bank

7. Question 3
During the crisis, the UK government took large holdings
in several UK banks to restore financial stability. Which
one of the banks listed below has NOT had any
emergency state financial support?
Royal Bank of Scotland Northern Rock
Lloyds Banking Group Barclays Bank

8. Question 4
In 2014, what % of UK GDP came from financial and
insurance services?
8% 18%
28% 38%

9. Question 4
In 2014, what % of UK GDP came from financial and
insurance services?
8% 18%
28% 38%

10. Question 5: Logo Round
Identify the bank with the logo (3 to have a go at!)
1
2
3

11. Question 5: Logo Round
Identify the bank with the logo (3 to have a go at!)
1
2
3

12. Question 5: Logo Round
Identify the bank with the logo (3 to have a go at!)
1
HSBC
2
3

13. Question 5: Logo Round
Identify the bank with the logo (3 to have a go at!)
1
HSBC
2
3

14. Question 5: Logo Round
Identify the bank with the logo (3 to have a go at!)
1
HSBC
2
Lloyds Group
3

15. Question 5: Logo Round
Identify the bank with the logo (3 to have a go at!)
1
HSBC
2
Lloyds Group
3

16. Question 5: Logo Round
Identify the bank with the logo (3 to have a go at!)
1
HSBC
2
Lloyds Group
3
Barclays

17. Question 6: Harder Logo Round!
Identify the bank with the logo (3 to have a go at!)
1
2
3

18. Question 6: A Harder Logo Round!
Identify the bank with the logo (3 to have a go at!)
1
Santander
2
3

19. Question 6: A Harder Logo Round!
Identify the bank with the logo (3 to have a go at!)
1
Santander
2
3

20. Question 6: A Harder Logo Round!
Identify the bank with the logo (3 to have a go at!)
1
Santander
2
ING
3

21. Question 6: A Harder Logo Round!
Identify the bank with the logo (3 to have a go at!)
1
Santander
2
ING
3

22. Question 6: A Harder Logo Round!
Identify the bank with the logo (3 to have a go at!)
1
Santander
2
ING
3
Deutsche Bank

23. Question 7: This one is tough!
Identify the bank with the logo
1

24. Question 7: This one is tough!
Identify the bank with the logo
1

26. Significance of Commercial Banks
Credit for
expanding
businesses
Financial
services for
households
Externalities
from financial
stability
Commercial
banks and UK
trade
Important
source of
employment
Instrument of
monetary
policy

27. Commercial banking is an oligopoly
27%
18%
18%
12%
10%
6%
4.2%
2%
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0%
Lloyds Bank Plc (hq: London)
Barclays Bank Plc (hq: London)
The Royal Bank of Scotland (hq: Edinburgh)
HSBC Bank Plc (hq: London)
Santander UK Plc (hq: London)
Nationwide Building Society (hq: Swindon)
TSB Bank Plc (hq: Edinburgh)
Co-operative bank (hq: Manchester)
Account market share
At the moment only 3% of personal and 4% of
UK business customers switch to a different
bank in any year (Source: CMA, August 2016)

28. Challenger banks are relatively small
A number of new banks are attempting to establish themselves in the UK financial
system and challenge the dominance of the leading UK commercial banks
TSB (Sabadell) Virgin Money Aldermore
Metro Bank Shawbrook Handelsbanken

29. Barriers to entry into banking sector
• In oligopolistic markets, barriers to entry make it harder
for new entrants to scale their business and make profits
• Entry barriers might include:
1. Cost of IT systems and expense of establishing branches
2. Access to payment systems (e.g. cheque/card clearing)
3. Established banks have access to cheaper retail savings
deposits from their existing customers
4. Banks which are viewed by investors as ‘too big to fail’
are seen as lower risk and therefore benefit from lower
wholesale funding costs – this is an economy of scale
5. Customer resistance to changing accounts – including
the time and inconvenience – this makes it harder to
build customer numbers

31. Question
True or False?
The main source of funds used by commercial banks to
lend out to borrowers are the savings deposits of
individual households and businesses

32. Question
True or False?
The main source of funds used by commercial banks to
lend out to borrowers are the savings deposits of
individual households and businesses

33. Question
True or False?
Banks first attract deposits from people and then they
lend it out to customers who need to borrow money

34. Question
True or False?
Banks first attract deposits from people and then they
lend it out to customers who need to borrow money

35. How Banks Create Money
Banks take deposits
of money from
savers and lend it
to borrowers
Banks then lend
money to businesses,
thus allocating funds
between alternative
investment projects

36. The Modern Reality
• Banks create credit by extending
loans to businesses and
households – pure and simple!
• They do not need to attract
deposits from savers to do this
• When a bank makes a loan, for
example to someone taking out
a mortgage to buy a house, or a
business taking out a loan to
finance their expansion it
credits their bank account with
a bank deposit of the size of the
loan/mortgage.
• At that moment, new money is
created.
“Banks making loans and consumers
repaying them are the most significant
ways in which bank deposits are created
and destroyed in the modern economy.”
(Source: Bank of England)

37. Assets and Liabilities of a Bank
Assets
Cash
Balances at Bank of England
Loans (Advances)
Securities (e.g. Bonds)
Fixed assets (e.g. Buildings)
Liabilities
Customer deposits
Money owed to bond holders
Money owed to other banks

38. Cash in the Bank!

39. Balance Sheet After New Lending
Reserves
Currency
Assets Liabilities
Deposits
Commercial banks before lending

40. Balance Sheet After New Lending
Reserves
Currency
Assets Liabilities
Deposits
Commercial banks before lending
Commercial banks after lending
Reserves
Currency
Deposits
Assets Liabilities
New Loans
New
Deposits

41. Balance Sheet of Commercial Bank
Other Assets
(including Liquid
Assets)
Loans to UK
Households and
Businesses
Assets
(Uses of funds)
Liabilities
(Sources of funds)
Capital (Equity)
Wholesale
Funding
Retail funding
(e.g.
households’
current
accounts)

42. How Commercial Banks make a Profit
In simple terms, how does a commercial
bank make a profit?

43. Interest Rates on Savings and Loans
0.00
2.00
4.00
6.00
8.00
10.00
12.00
Sight Deposits Time deposits Credit card Unsecured loans Secured loans
Interest Rates (%) for Selected Savings and Loans in UK – Dec 2015

44. Interest Rates on Savings and Loans
0.00
2.00
4.00
6.00
8.00
10.00
12.00
Sight Deposits Time deposits Credit card Unsecured loans Secured loans
Interest Rates (%) for Selected Savings and Loans in UK – Dec 2015

45. Profits and Losses for Banks
• Major UK commercial banks’ profitability has fallen quite
significantly since the global financial crisis
• Low profitability reduces the ability of commercial banks
to generate fresh capital internally and reduces their
resilience to future domestic and external shocks.
• Key factors:
1. Significant rise in regulatory costs
2. Lower interest rates on loans has reduced trading
incomes – for example, a fall in mortgage interest rates
3. Financial cost of previous misconduct - UK banks put
side another £15 billion relating to past misconduct in
their 2015 results, reducing pre-tax profits by around
50%. This includes the costs of miss-selling PPI

48. US Sub Prime Lending Crisis
Mortgage delinquency rates for subprime conventional loans in USA from 2000 to 2014
11.9%
10.8%
19.9%
25.5% 25.9%
23%
20.6% 21%
19.1%
16.5%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
2000 2005 2008 2009 2010 2011 2012 2013 2014 2015
Delinquencyrates

49. Economic & Social Risks from Financial Instability
Taxpayers
(Bailout costs)
Depositors
(Risk of lost
savings)
Creditors
(Unpaid
debts)
Shareholders
(Lost equity)
Employees
(Lost jobs)
Government
(increased
deficit)

50. Question
What is the most important factor limiting the amount of
new credit that a commercial bank is able to lend?
a)
The ratio of cash to deposits that a bank is
required by law to keep
b)
The demand for loans from personal and business
customers
c)
Caps on interest rates on loans and overdrafts set
by the Bank of England
d)
The cost of borrowing funds from the wholesale
money markets

51. Question
What is the most important factor limiting the amount of
new credit that a commercial bank is able to lend?
a)
The ratio of cash to deposits that a bank is
required by law to keep
b)
The demand for loans from personal and
business customers
c)
Caps on interest rates on loans and overdrafts set
by the Bank of England
d)
The cost of borrowing funds from the wholesale
money markets

52. Some Key Terms

53. Some Key Definitions
Banking credit An arrangement with a bank for a loan, or bank lending in general
Bank A business that makes its profit by paying interest to people who keep
money there and charging a higher rate of interest to borrowers who
borrow money from the bank
Bank capital Bank capital is the value of the bank's assets minus its liabilities, or debts
Bank reserves Money and liquid assets (such as securities that can be sold quickly) held
by banks in order to meet withdrawals by customers
Banking system The way banks work together to make payments, make money available
Co-operative bank A bank that lends money, collected from its members, at low rates of
interest
Internet banking The services provided by banks that only exist on the Internet
Shadow banking Non-deposit taking financial intermediaries including investment banks,
hedge funds

54. @tutor2ugeoff