Lecture n. 2 - What Banks Do (1).pptx PDF

WHAT BANKS Dr. Marco Conti DO  What is money? Analyzing a bank's financial statements What banks do and how they create money? The range of banking services Contents Deregulation and financial innovation Distinction bet...

WHAT BANKS Dr. Marco Conti DO  What is money? Analyzing a bank's financial statements What banks do and how they create money? The range of banking services Contents Deregulation and financial innovation Distinction between commercial and investment banking International banking What is money? Most people believe money represents the amounts of notes and coins that are legal tender in one country Anyone can open a bank account, deposit money and use that money to make payment through checks, credit or debit cards, or withdraw that cash Under Central Bank definitions, there are a few money aggregates: CENTRAL BANK DEFINITION OF MONEY  ECB Monetary Base 2019 Money Mkt Fund Bonds < 2Y 5% 2% Notes e Coins REPO 9% 1% Time Deposit < 2Y 19% Deposits 43% Time Deposit < 3M 21% Analyzing a bank's financial statements  The reported financial statements for banks are somewhat different from most companies.  Banks take in deposits from consumers pay interest on some of the accounts.  Banks receive interest on their loans  Banks profits are derived from the spread between the rate they pay for the deposits and the rate they earn or receive from borrowers. Assignment #4 Analyse the balance sheet of SVB. 1) Analyse the type of assets and liabilities (maturity and liquidity) 2) Why did SVB go into default? How Banks create money? CREDIT MULTIPLIER: Case A CREDIT MULTIPLIER: Case B  Credit Multiplier and Central Bank Trough CM, the Central Bank (ECB or Federal Reserve) can control the amount of money circulating in the system. How does the Central Bank raise monetary base directly? RESERVES OPEN MARKET OPERATIONS CB can reduce or increase the reserve ratio banks have to INTEREST RATES Through this mechanism, CB keep when they lend money, (FOREIGN EXCHANGE) buys or sells government thus modifying the credit bonds in the open market. multiplier.  Central Bank buying or selling securities in the open market to influence the money supply. The Fed uses open market operations to manipulate interest rates, starting with the federal funds rate used in interbank OPEN loans. MARKET OPERATIONS Buying securities adds money to the system, lowers rates, makes loans easier to obtain, and increases economic activity. Selling securities removes money from the system, raises rates, makes loans more expensive, and decreases economic activity.  Reserve requirements are the amount of funds that a bank holds in reserve to ensure that it is able to meet liabilities in case of sudden withdrawals. RESERVE REQUIREMEN Reserve requirements are a tool used by the central bank to increase or TS decrease the money supply in the economy and influence interest rates.  The central bank may change the interest rates or the required collateral that it demands. INTEREST RATE Banks will loan more or less freely depending on this interest rate  Basis points 1/100 percentage point In 2008, M3 multiplier in the Eurozone was 8,15 Total M3 amounted to Euro 9,3 trillion If the ECB wanted to increase M3 to, say, 10 trillion, it would have to increase monetary base by less than 100 bn Assignment #5 In an Excel or Numbers file, create a line graph from January 2020 to September 2024 of the following macro data. - FED Interest Rate - U.S. Core Inflation - U.S. GDP growth (uses monthly data) What do banks do? The main source of funding is customer deposits. This funding is then invested in loans, other investments and fixed assets (such as buildings for the branch network). The difference between total assets and total liabilities is the bank capital (equity). Banks make profits by charging an interest rate on their loans that is higher than the one they pay to depositors. What do banks do? As with other companies, banks can raise funds by issuing bonds and equity (shares) and saving from past profits (retained earnings). However, the bulk of their money comes from deposits. It is this ability to collect deposits from the public that distinguishes banks from other financial institutions. Banking services Modern banks offer a wide range of financial services, including:  Payment services  Deposit and lending services  Investment, pensions and insurance services  E-banking Banking services - Payment services Payment services: A payment system can be defined as any organized arrangement for transferring value between its participants. Heffernan (2005) defines the payment systems as a by-product of the intermediation process, as it facilitates the transfer of ownership of claims in the financial sector. These payment flows reflect a variety of transactions: for goods and services as well as financial assets. Banking services - Payment services  Cheques: are widely used as a means of payment for goods and services. Cheque payments are known as debit transfers because they are written requests to debit the creditor’s account.  Credit transfers: (or Bank Giro Credits) are payment where the customer instructs their bank to transfer funds directly to the beneficiary's bank account. Consumers use bank giro transfer payments to pay invoices or to send payment in advance for products ordered. Banking services - Payment services  Standing orders: are instructions from the customer (account holder) to the bank to pay a fixed amount at regular intervals into the account of another individual or company.  Direct debits: are originated by the supplier that supplied the goods/service and the customer has to sign the direct debit. The direct debit instructions are usually of a variable amount and the times at which debiting takes place can also be either fixed or variable (although usually fixed). Banking services - Payment services  Plastic cards: include credit cards, debit cards, cheque guarantee cards, travel and entertainment cards, shop cards and ‘smart’ or ‘chip’ cards. Technically, plastic cards do not act themselves as a payment mechanism – they help to identify the customers and assist in creating either a paper or electronic payment.  Credit cards provide holders with a pre- arranged credit limit to use for purchases at retail stores and other outlets. The retailer pays the credit card company a commission on every sale made via credit cards and the consumer obtains free credit if the bill is paid off before a certain date. If the bill is not fully paid off then it attracts interest Banking services - Payment services  Debit cards Are issued directly by banks. Allow customers to withdraw money from their accounts. Can also be used to obtain cash and other information through automated teller machines (ATMs).  Cheque guarantee cards Were first introduced because of retailers’ reluctance to accept personal cheques. Typically, when paying by cheque further identification of the payer is provided by presentation of the cheque guarantee card and details from the card will be written on the cheque in order to guarantee payment. Banking services - Payment services  Travel and entertainment cards (or charge cards) provide payment facilities(used to pay for hotel, airline, and other business related expenses) and allow repayment to be deferred until the end of the month, but they do not provide interest- free credit. Banking services - Deposit and lending services Personal banking includes the offer of a broad range of deposit and lending services. These are summarized as follows:  Current or checking accounts:  Typically pay no (or low) rates of interest.  Are used mainly for payments.  Time or savings deposits:  Involve depositing funds for a set period of time for a pre- determined or variable rate of interest. Banking services - Deposit and lending services  Consumer loans and mortgages:  Commonly offered by banks to their retail customers.  Consumer loans can be unsecured (that is no collateral is requested; such loans are usually up to a certain amount of money and for a short to medium time period. Banking services - Investment, pensions and insurance services  Investment products: offered to retail customers include various securities-related products including mutual investment in company stocks and various other securities-related products (such as savings bonds). In reality, there is a strong overlap between savings and investments products and many banks advertise these services together. Banking services - Investment, pensions and insurance services  Pensions and insurance services:  Pension services provide retirement income.  Pension services offered via banks are known as private pensions to distinguish them from public pensions offered by the state.  Insurance products protect individuals (policyholders) from various adverse events. Banking services - E-banking Mainly, we can refer to two categories of payment products:  E-money: Electronic money is a digital alternative to cash. It allows users to make cashless payments with money stored on a card or a phone, or over the internet.  Remote payments are payment instruments that allow (remote) access to a customer’s account. 20-minute coffee break Deregulation and financial innovation Financial deregulation: essentially consists of removing controls and rules that in the past have protected financial institutions, especially banks.  More generally, refers to the opening up, or liberalization, of financial markets to allow institutions to compete more freely.  In Europe deregulation was boosted mainly by the need to improve competitive viability of the sector.  There is no doubt that the deregulation process has helped in the ending of ‘repressed’ banking systems and is most likely one of the major contributors to Europe’s single market program (2002). Re-regulation Re-regulation can therefore be defined as the process of implementing new rules, restrictions and controls in response to market participants’ efforts to circumvent existing regulations. Alternatively, it can be viewed as a response to minimize any potential adverse effects associated with excessive competition brought about through structural deregulation. Deregulation and financial innovation Three joint effects of deregulation and technology: I. The loosening of banking laws coupled with the advantages of technology (in terms of potential economies of scale and other efficiencies) has encouraged the consolidation process. II. the introduction of new technologies in a deregulated context intensified competition and improved banks’ ability to adjust prices and terms of financial products. III. the barriers between bank and non-bank financial institutions disappeared, allowing, for example, the rise of universal banking activity. Deregulation and Financial innovation The definition of ‘innovation’ includes both the concept of invention (the ongoing research and development function) and diffusion (or adoption) of new products, services or ideas. Financial innovation, like innovation elsewhere in business, is an ongoing process whereby private parties experiment to try to differentiate their product and services, responding to both sudden and gradual changes in the economy. Financial innovation can be defined as the act of creating and then popularizing new financial instruments as well as new financial technologies, institutions and markets. Specifically, we can distinguish: Deregulation and financial innovation Financial system/institutional innovations: Such innovations can affect the financial sector as a whole; they relate to business structures, to the establishment of new types of financial intermediaries, or to changes in the legal and supervisory framework. Process innovations: These include the introduction of new business processes leading to increased efficiency, market expansion, etc. Deregulation and financial innovation Product innovations: include the introduction of new credit, deposit, insurance, leasing, hire purchase, derivatives and other financial products. Product innovations are introduced to respond better to changes in market demand or to improve efficiency. Distinction between Commercial and Investment banking Commercial Banks  Commercial banks take deposits, provide checking and debit account services, and provide business, personal, and mortgage loans.  They also offer basic bank products such as certificates of deposit (CDs) and savings accounts to individuals and small businesses.  Most people hold a commercial bank account, rather than an investment bank account. Distinction between Commercial and Investment banking  Commercial banks largely make money by providing loans and earning interest income from the loans.  Customer accounts, including checking and savings accounts, provide the money for the banks to make loans.  Customers like commercial banks because their money is secured up to $250,000 per depositor and is regulated by the government, but the interest earned on accounts is little to nothing. Distinction between Commercial and Investment banking Commercial banks  The largest banks in most countries are commercial banks  The largest commercial banks also engage in investment banking, insurance and other financial services areas.  They are also the key operators in most countries’ retail banking markets. Distinction between Commercial and Investment banking Investment Banking  Investment banks are primarily financial intermediaries, helping corporations set up IPOs, get debt financing, negotiate mergers and acquisitions, and facilitate corporate reorganization.  Investment banks also act as a broker or advisor for institutional clients. Distinction between commercial and investment banking Investment Banking: Big investment banks include:  JPMorgan Chase (JPM)  Goldman Sachs (GS)  Morgan Stanley (MS)  UBS (UBS) Investment banking  The main role of investment banks is to help companies and governments raise funds in the capital market either through the issue of stock (otherwise referred to as equity or shares) or debt (bonds).  Their main business relates to issuing new debt and equity that they arrange on behalf of clients as well as providing corporate advisory services on mergers and acquisitions (M&As) and other types of corporate restructuring.  Clients include corporations, pension funds, other financial institutions, governments, and hedge funds. Many investment banks also have retail operations for small, individual customers. International Banking International banking refers to business undertaken by banks across national borders and/or activities that involve the use of different currencies. A definition of international banking is provided by Lewis and Davis (1987) who classify international banking into two main types of activity: Traditional foreign banking Eurocurrency banking International Banking Traditional foreign banking involves transactions with non-residents in domestic currency that facilitates trade finance and other international transactions. Eurocurrency banking involves banks undertaking wholesale (large-scale) foreign exchange transactions (loans and deposits) with both residents and non-residents. 15 minutes to rearrange notes Home Assignment #6 - Income Statement Take the income statement of the bank where you are a customer, if not possible, that of a bank you prefer. 1. Analyze what are the main income items in 2023? 2. How have income items changed from 2022 to 2023? 3. What do you think are the causes of this change (if any)?