Week 1: Bank Functions & Models and Banking Business PDF

🏦Models Week 1: Bank Functions & and Banking Business Tags Course 5 Unique functions & Characteristics of “Banks” 1. Deposit-Taking Activities Provide deposit services to the retail and...

🏦Models Week 1: Bank Functions & and Banking Business Tags Course 5 Unique functions & Characteristics of “Banks” 1. Deposit-Taking Activities Provide deposit services to the retail and/or institutional markets Provide returns on deposit funds, with varying tenor of deposits Role of the bank: play a critical role in money creation/multiplier effects in an economy → highly regulated 2. Intermediary and Lending Activities Takes in deposits at lower interest costs and lending out at higher interest rates, after taking account intermediation Intermediation costs involve in searches, verification, analysis, monitoring, and enforcement in lending relationships Such activities include loans, trade finance, credit card services, etc 🏦Week 1: Bank Functions & Models and Banking Business 1  3. Provision of Payment Services through regulated channels Facilitate payments through regulated payment channels such as Automated Clearing House (ACH), Real Time Gross Settlement (RTGS) systems, and the EFT systems such as SWIFT, ABA, etc Governed by banking laws, regulations, licensing and policies May have some forms of implicit protection by a “Lender of Last Resort” the provider of liquidity to financial institutions that are experiencing financial difficulties Create multiplier effects on the economy Definition of “banking business”: business of (1) receiving money on current/deposit account, (2) paying and collecting cheques drawn by/paid in by customers, (3) the making of advances to customers, and includes (4) such other business as the Authority may prescribe for the purposes of this Act Securities Regulation 🏦Week 1: Bank Functions & Models and Banking Business 2  securities and futures act (chp289) financial advisers act (chap110) Regulatory Capital Requirements (banks are subjected to “capital adequacy” requirements Capital Adequacy Ratio (CAR) amount of capital/risk weighted assets (RwA) BASEL III Minimum CAR=Capital/Total RwA=8% Capital helps to absorb losses during impairment of asset quality or in the event of winding up e.g. Paid-up capital, retained earnings, non-cumulative preference shares, subordinated notes, etc RwA assets on the bank’s balance wrighted against their degree of risks RwA = Weight*Asset Face Value e.g. cash n treasury bills = 0%, loans to A-rated corporates = 50%, Loans to BB-rated corporates =100% weight Regulatory Liquidity Requirements (banks are subject to “liquid assets” requirements) Definition: Central bank regulation that set the minimum amount of cash reserves that must be held by a commercial bank in order to ensure that it has enough liquidity to meet its deposit and other current liabilities Amount is defined by Minimum Liquid Asset → which focuses on a minimum liquidity as a percentage of deposits or liabilities 🏦Week 1: Bank Functions & Models and Banking Business 3  Liquidity Coverage Ratios → which focuses on a 30 day and a 1 year liquidity periods for banks under a stress scenario e.g. Bank run is a situation where clients believe a bank may cease its business , pushing them to mass withdraw their funds Policy Compliance - Customer Due Diligence 1. KYC 2. AML 3. CFT Banking Structures and Models Common terms used in describing the types of banking model Commercial banks Investment banks Private Banks Financial Holding Companies Challenger/Digital Banks 🏦Week 1: Bank Functions & Models and Banking Business 4  Offer consumer &/or wholesale banking services Commercial Banks Consumer banking targets retail, consumer and affluent customers Wholesale banking targets corporations and instituitions Not focus on investment banking or equity-related services Regulated by banking regulator Investment Banks Target mainly corporations and HNWI Activities include: Equity and debt underwriting M&As Equity and debt trading Derivatives 🏦Week 1: Bank Functions & Models and Banking Business 5  Fund Management Custody Advisory/Consultancy Not strictly considered “banks” Regulated instead by securities regulators Many national regulators do not allow them to carry the word “bank” in their name Merchant Banks: Investment banks with a history of financing cross-border trade and providing credits to merchants serve corporations and HNWI may have buy-side investment business 🏦Week 1: Bank Functions & Models and Banking Business 6  Private Banks Targets mainly HNWI and UHNWI (ultra high net worth individuals) Activities include: Account Services Cash Management Investment Management Structured Products Credit and lending Advisory Securities services Regulated by both banking and securities regulations Financial Holding Companies (US) 🏦Week 1: Bank Functions & Models and Banking Business 7  Allows institutions to act as any combination of investment bank, commercial bank and insurance company various businesses must be separately capitalized as subsidiaries with their own P&L separate management subsidiaries are generally regulated according to the nature of the business — banking, insurance, securities etc 🏦Week 1: Bank Functions & Models and Banking Business 8  FHC is a company incorporated in Singapore, which holds a Singapore bank/insurance subsidiary/both Regulated by MAS under Financial Holding Companies Act 2013 FHC’s bank subsidiary is also regulated under Singapore’s banking act Subsidiaries of non-bank business are regulated by other regulations Digital/Challenger Banks Licensing of such institutions to engage in deposit taking activities require the approval of relevant authorities e.g. Singapore Digital Bank Licenses 🏦Week 1: Bank Functions & Models and Banking Business 9  FinTech — Sector Players Banking Business Banking Business & Segmentation Banking Consumers 🏦Week 1: Bank Functions & Models and Banking Business 10  Retail Customers Mass Affluent Customers HNW Small Business Enter[rises Micro-SMEs Islamic Banking Customers Banking Corporates and Institutions Medium & Large local enterprises Multinational Companies Public Sector Institutions Real estate companies Financial Institutions (Banks) Financial Institutions (Non-banks) Islamic Banking Clients/Ins Ultra HNW Consumer Banking 🏦Week 1: Bank Functions & Models and Banking Business 11  Banks earn Interest Income by providing deposit account services, loan and secured financing Deposit → banks pay interest lower than what it earns from the interbank lending or treasury market Financing → banks charges an interest rate that is higher than the cost of funds (”COF”) Fees and other non-interest income from credit cards, wealth management, fund management, trade-related services for businesses, etc 🏦Week 1: Bank Functions & Models and Banking Business 12  Institutional/Wholesale Banking Bank Businesses in Institutional Banking (introductory list is not exhaustive, operational risks are inherent in all businesses) 1. Businesses based predominantly on taking Credit Risks Corporate Banking - Lending Banks have traditionally thrived on using their balance sheets to provide direct credit facilities to their clients, earning interest revenue, structuring and arrangement fees 🏦Week 1: Bank Functions & Models and Banking Business 13  line of credit with an established max amount and the business Revolving Credit Facility can access the funds at any time credit facility whereby terms & conditions are clearly defined Committed Facility by the lending institution and imposed upon the borrowing company → binding terms in a contract Collateralized Loan use of a valuable asset as collateral to secure a loan funds needed to cover the day-to-day operating expenses of a Working Capital business funds used by a business to acquire, upgrade and maintain CAPEX physical assets used for various other business needs (e.g. debt refinancing, Other Purposes expansion projects, or unexpected expenses) Bilateral Loans Loans that are provided to a Borrower based on bilateral agreement with a Bank bank takes on the entire loan as asset into its balance sheet earns interest income for a loan and fee income only if its a committed loan facility 🏦Week 1: Bank Functions & Models and Banking Business 14  Interest Rate Benchmarks (USD, EUR, GBP, JPY, CHF) The Intercontinental Exchange (ICE) Benchmark Administration (IBA) is responsible for An average i/r at which major global LIBOR (London administering the LIBOR banks lend to one another in the Interbank benchmark rates. These rates, interbank market for a short-term Offered Rate) which range from overnight (o/n) loan in USD, EUR, GBP, JPY, CHF to 12 months (12m), are published at 11:55 AM London time on each London business day SOFR Averages A volume-weighted median cost of - SOFR(O/N) is published by New (USD) - Secured borrowing cash by banks overnight York Fed at 8am ET each Overnight collateralized by Treasury securities business day Financing Rates - SOFR Averages consist of 30-, 90-, and 180- calendar day compounded averages of past SOFR are also published by the New York Fed - SOFR is based on data from a large volume of observable 🏦Week 1: Bank Functions & Models and Banking Business 15  transactions in the Treasury repo market 1M, 3M, 6M and 12M Term SOFR CME Term SOFR Daily set of forward-looking rates are published by CME Group at (USD) calculated based on SOFR futures 6am ET each business day USD Prime Rate refers to the interest rate that a commercial bank charges their most creditworthy customers a bank usually sets its prime rate by adding about 3% to Federal Fund Rate (FFR) Fed sets the FFR which is the rate that banks borrow or lend each other overnight for their reserve accounts (Aug 1, 2024) Avg Prime Rate of major banks = 5.5%+3.0%=8.5% 🏦Week 1: Bank Functions & Models and Banking Business 16  SGD Interest Rate Benchmarks - 1M and 3M SIBOR are published by Association of Bank in Singapore avg rate at which SG SIBOR (SG - To be phased out by end 2024 in line banks loan from one Interbank with Global Interest Rate Benchmark another in the interbank Offered Rate) Reforms market just prior to 11am - 12M and 6M SOR were phased out in Dec 2020 and Mar 2022 respectively implied i/r that reflects - O/N, 1M, 3M, and 6M SOR are published the cost of borrowing by the Association of Bank in Singapore SOR (SGD Swap SGD by borrowing USD - To be phased out by June 2023 as Offer Rate) first and swapping it to LIBOR is being phased out USD using an FX Swap - Used mainly for commercial loans volume-weighted - SORA for a given business day is average rate of published by 9am the next business day SORA (SG borrowing transactions in by MAS, together with its compounded Overnight Rate the unsecured overnight rates: Average) interbank SGD cash 1M SORA market in Singapore 3M SOR between 0800-1815 6M SORA 🏦Week 1: Bank Functions & Models and Banking Business 17  Syndicated Loans A financing offered by a group of lenders (the “Syndicate”) who have been put together by a bank or a group of banks (the “Arrangers”) to provide the funds needed by the borrower usually involves loan facility that is very large in size each bank, including the Arrangers, takes up different proportionate amounts of loan as assets into their balance sheets banks earn interest income for the loans + arrangement fees for their work 🏦Week 1: Bank Functions & Models and Banking Business 18  Corporate Banking - Specialized Secured Financing Depending on the banks’ capability and comfort with various forms of securities, secured financing can be structured to provide higher spread and fees to the banks. The more sophisticated the structure financing, the larger spreads and fees the bank can command. Real Estate Financing financing of real estate construction, re-development or acquisition real estate properties are used as collateral for the loan facilities banks earn structuring fees and loan spread Aviation/Shipping Financing 🏦Week 1: Bank Functions & Models and Banking Business 19  financing for the acquisition of commercial airplanes, private aircrafts, ships, tankers, container vessels, offshore platforms etc → with the use of such assets as collateral for the loan facilities banks earn structuring fees and loan spread Securitized Lending Facilities backed by account receivables, mortgage receivables or other forms of cash generating assets (”floating charge”) allows borrower to borrow based on predictable future cash flow and free up its hard assets for other forms of secured borrowing banks earn structuring fees and loan spread Project Financing structured to ring-fence all cash-producing assets and control the entire project’s cash flow, risks and liabilities, in a way that the lenders’ interests are taken care of before any profit is returned to the project sponsors viability is usually predicated on a long-term stable off-take agreement for the output from a project → allows project sponsors to find long-term (10-20 years) financing for their projects without recourse to them banks earn advisory and structuring fees, arrangement fees and loan spread 🏦Week 1: Bank Functions & Models and Banking Business 20 🏦Week 1: Bank Functions & Models and Banking Business 21  *Bookrunners are those banks within the Arrangers who manage the syndication process – and decide who-gets to-participate how-much in the syndicated loans Trade Services & Finance (Transaction Banking) Banks provide services that support trade and commercial-related activities by helping to issue or manage instruments that are commonly accepted in international trades Trade Services & Finance Examples Letters of Credit (LC) Standby Letters of Credit (SBLC) Banker’s Guarantees (BG) A/R or A/P financing 🏦Week 1: Bank Functions & Models and Banking Business 22  Banks earn fees for the issuance of LC, SBLC, and BG + interest income in the form of loan spread for providing financing of AR or AP Loan Spread: spread in interests → spread between how much interest a bank charges its customer and the cost of funds (”COF”) to the bank e.g. a loan priced at LIBOR + 2% has a spread of 2% if LIBOR is the COF to the bank 🏦Week 1: Bank Functions & Models and Banking Business 23  2. Businesses based predominately on taking Market Risks Markets & Treasury (FICC* + EQT) With access to financial markets and platforms, banks provide trading, investment, financing, hedging and derivatives services to help clients manage their various market risks Sales, Trading, Market Making of: Hedging Solutions for: G10 currencies FX risks Emerging Market currencies Interest Rate risks Futures Commodity Price risks Forwards Credit Default risks Options Equity Price risks Commodities Country risks Bonds Convertible Bonds Credit-Default Swaps Debts Equity Markets & Treasury - Interest Rate Swap Derivatives can help companies mitigate carious types of market risks or take advantage of market trends, bringing stability to their income and expenses. Banks charges their clients’ fees for providing derivative solutions that transfer those risks to themselves 🏦Week 1: Bank Functions & Models and Banking Business 24  Markets & Treasury - Currency Swap 🏦Week 1: Bank Functions & Models and Banking Business 25  3. Businesses low on credit and market risks (Asset- light) Investment Banking/Capital Markets -ECM, DCM, M&A, Advisory Investment Banking is in the business of bringing together users and sources of private or public capital. Banks earn fees in forms such as advisory and underwriting As large deals provide better fees, they are usually highly sought after by investment banking players 🏦Week 1: Bank Functions & Models and Banking Business 26  Equity Capital Market, Debt Capital Market, M&A are the core components of investment banking business Equity Capital Market Debt Capital Market Merger & Acquisition Services Services Services - IPO - Fixed-rate bond issuance - Follow-on Issuances - M&A advisory - Variable-rate bond issuance - Private Placements -Sell-side advisory - Mortgage-back securities - Block Trades - Buy-side advisory issuance - Convertible Bonds - Leverage Buy Out (LBO) - Bond repurchase - Right Issues - Delisting from exchanges - Medium term notes program - Non-deal Roadshows Fees (ECM) Fees (DCM) Fees (M&A) - HK IPO ~3% - HK New Bond Issuance - Deal size USD1bn: ~0.5% 🏦Week 1: Bank Functions & Models and Banking Business 27  Cash Management (Transaction Banking) Payment and Collection Management Help corporate clients to manage efficiently large volumes of local and international payments and receipts, which go through a large amount of different payment channels and assisting them in the reconciliation of such payments and receipts — so they can better manage their cash conversion cycles Take up only very ST clearing/settlement credit facilities 🏦Week 1: Bank Functions & Models and Banking Business 28  Liquidity Management Helping corporate clients to sweep excess cash locally, regionally or globally to a company’s headquarters which allow the company to use those excess cash efficiently to fund operations and investment Take up only very ST clearing/settlement credit faciltiies Bank earns interest income + service fees Securities Services (Transaction Banking) The Securities Services business provides asset managers, institutional investors, banks and brokers, and corporate clients with the securities related transactional solutions that take into account the local financial markets and regulatory requirements Bank earns mainly fees 🏦Week 1: Bank Functions & Models and Banking Business 29  Private Banking and Wealth Management Private banking provides wealth management, creation and preservation services to wealthy individuals. Within private banks, a range of banking services include those that are credit-risk, market-risk and advisory (asset- light) in nature Banking & - Traditional Banking Products Asset-Light Liquidity - Cash Management 🏦Week 1: Bank Functions & Models and Banking Business 30  - Multi-currency accounts - Treasury Markets (Equity/Fixed Income/FX/Commodity) - Structured Investment Products Investment Market Risks or - Asset Management (Advisory/Discretionary) Portfolio Asset-Light - Alternative Investments - Private Equity Investments - Real Estate Investments - Security and Margin Financing - Residential and Commercial Real Estate Credit and Financing Credit Risks Lending - Aircraft Financing - Art Finance - Private Equity Financing - Trust and Estate Planning - Wealth Structuring Advisory - Succession Planning Asset-Light - Art Advisory - Philanthropic Advisory Banks earns interest income + fees + trading income Bank Internal Organization Front office, middle office, back office are commonly used terms in banks to refer to specific groups of bank employees 🏦Week 1: Bank Functions & Models and Banking Business 31 🏦Week 1: Bank Functions & Models and Banking Business 32