Introduction To Financial Markets (Unit 10) PDF

Introduction to Financial Markets Unit 10 Commercial and Investment Banking Prof. Dr. M. De Ceuster Prof. Dr. M. De Ceuster Introduction to Financial Markets 1 / 33 Terminology Commercial banking constitutes...

Introduction to Financial Markets Unit 10 Commercial and Investment Banking Prof. Dr. M. De Ceuster Prof. Dr. M. De Ceuster Introduction to Financial Markets 1 / 33 Terminology Commercial banking constitutes the traditional banking business of accepting deposits and granting loans. Investment banking is not ‘defined’ in a unique way around the globe. Merchant banks (UK) are a synonym for investment bank, (US) take an active part in takeover and merger activities. Investment banks “help people to find money”. Prof. Dr. M. De Ceuster Introduction to Financial Markets 2 / 33 Preliminary Remark Depending on the definition you use, commercial banking and invest- ment banking are not fully separated activities. Overlaps may arise in interbank borrowing discounting bills of exchange forex... Prof. Dr. M. De Ceuster Introduction to Financial Markets 3 / 33  Commercial Banking Section 1 Commercial Banking Prof. Dr. M. De Ceuster Introduction to Financial Markets 4 / 33  Commercial Banking Concentrated Business Source: Liikanen Report (2012) Prof. Dr. M. De Ceuster Introduction to Financial Markets 5 / 33  Commercial Banking Concentrated Business Bank Failures Merger waves Prof. Dr. M. De Ceuster Introduction to Financial Markets 6 / 33  Commercial Banking Retail Banking Money Banking Handling money Deposits Loans Advise Prof. Dr. M. De Ceuster Introduction to Financial Markets 7 / 33  Commercial Banking Money Banking Current accounts (transactional accounts) Establish a relationship with the customer Source of cheap money (in normal times) Carry a range of payment services (ATM, debit cards,...) If tarification of services is not possible, cross subsidies are needed (e.g. increase number of days to settlement) Deposit accounts Various forms of interest-bearing accounts Non-transactional Limits on withdrawal facilities Often fixed term deposits (with implicit roll-over) Prof. Dr. M. De Ceuster Introduction to Financial Markets 8 / 33  Commercial Banking Money Banking Payments Cheques Giro-slip payments Debit cards (which serve as ATM card) Electronic payments E-money Mobile payments Prof. Dr. M. De Ceuster Introduction to Financial Markets 9 / 33  Commercial Banking Loans Credit cards Overdraft Personal loans Mortgage loans Prof. Dr. M. De Ceuster Introduction to Financial Markets 10 / 33  Commercial Banking Loans Credit cards Cards can be issued by major international players (Visa, Mastercard,...) or by retailers Monthly settlement Banks charge retailers a percentage (1%-3%) of the transaction value for providing authorization, collecting and clearing services. Overdrafts The account holder is allowed to overdraw up to a maximum sum for a certain time period. Informal and flexible facility A relatively The interest is ofthigh interest is on en computed being charged a daily basis at a variable P rof. D r. M. D e Ceuster Introduction to Financial M arkets 11 / 33  Commercial Banking Loans Personal loans Agreement to borrow a specific amount over a specific period of time Set sum monthly repayments Annual percentage rate which takes the timing of the repayments and the costs into account gives a better indication of the true cost of a personal loan than the nominal interest rate does Personal loans can be transformed to asset backed securities (ABS) Prof. Dr. M. De Ceuster Introduction to Financial Markets 12 / 33  Commercial Banking Loans Mortgage Loans Loan secured on the property Lower rate than unsecured overdrafts or personal loans Fixed rate and variable rate mortgage loans are available LTVs (Loan to Value) ran up to 110%. Now they can be capped as a macroprudential policy instrument Mortgages can be transformed to mortgage backed securities (MBS) Prof. Dr. M. De Ceuster Introduction to Financial Markets 13 / 33  Commercial Banking Services Securities purchases (as a broker or as an agent that passes the order through to a broker) Securities custody (from unregistered bearer format to dematerialised securities) Mutual funds (the own product range can be extended through open architecture) Insurance products (both life insurance products as alternatives to mutual funds and property and casualty insurances) Advice Safe deposit boxes Foreign exchange (exchange and transfer services) P rof. D r. M. D e Ceuster Introduction to Financial M arkets 14 / 33  Commercial Banking Delivery Channels How do banks interact with the customer? The brick and mortar distribution channel (branch network) is in need for rationalization cost perspective changed customer behavior Telephone banking Internet banking Mobile banking driven by data science and artificial intelligence. Prof. Dr. M. De Ceuster Introduction to Financial Markets 15 / 33  Commercial Banking Key Retail Banking Issues Capital strength Liquidity Risk management Executive pay Competition Cost control Sale of non-banking products? Use if IT Prof. Dr. M. De Ceuster Introduction to Financial Markets 16 / 33  Commercial Banking Wholesale Banking Uncommitted facilities The bank agrees to lend money on a short term basis Revolving character but does not commit to renew the loan Instruments Overdrafts for corporates Lines of credit Banker’s acceptances (Banks prefer bank bills or eligible bills over trade bills since both can be more easily used for refinancing in the discount markets.) Prof. Dr. M. De Ceuster Introduction to Financial Markets 17 / 33  Commercial Banking Wholesale Banking Committed facilities Term loans have a fixed term up to 7 years and carry a floating rate linked to the interbank market. No possibility to re-lend the money after repayment. Standby credit allow to draw down in tranches without losing the availability of the undrawn part. No possibility to re-draw repaid funds. Revolving credit is a standby credit with the possibility to redraw. Project Finance is a long term project related term loan. Prof. Dr. M. De Ceuster Introduction to Financial Markets 18 / 33  Commercial Banking Wholesale Banking Syndicated Facilities Syndication is needed when banks do not wish to finance the whole amount of the loan and/or when a larger investor base is needed. A lot of parties are involved. The arranger is the lead manager who negotiates the contract with the client. The co-managers underwrite a part of the loan. Agents can place the ‘loan/securities’ with investors. Prof. Dr. M. De Ceuster Introduction to Financial Markets 19 / 33  Commercial Banking Loan Agreements are Contracts Contractual freedom reigns Four sections in a typical loan agreement Introduction specifies the amount, the purpose of the loan. Facilities specify the conditions for drawing down. The payment sections cover interest rate calculations, repayment arrangements and fees. Provisions specifies the credit protection mechanisms the bank requires. Prof. Dr. M. De Ceuster Introduction to Financial Markets 20 / 33  Commercial Banking Loan Agreements are Contracts Credit protection mechanisms Covenants are restrictions on the borrower’s financial position such as maximum gearing, minimum current ratio, minimum interest coverage,... If covenants are breached, the commitment of the bank will cease and the loan will have to be rescheduled. Default events are specified. If a borrower defaults on one loan, all other loans default too. Negative pledge clauses prevent the borrower to grant security concerning a loan from another party. Prof. Dr. M. De Ceuster Introduction to Financial Markets 21 / 33  Investment Banking Section 2 Investment Banking Prof. Dr. M. De Ceuster Introduction to Financial Markets 22 / 33  Investment Banking Main roles Assist issuers to raise funds. Act as brokers or dealers towards investors. Prof. Dr. M. De Ceuster Introduction to Financial Markets 23 / 33  Investment Banking Main Activities: Corporate finance Public offering of securities Private placement of securities Mergers and acquisitions Merchant banking Advising on financial restructuring Securitization of assets Trading of securities Prime brokerage Trading and creating of derivatives Asset management. Research Prof. Dr. M. De Ceuster Introduction to Financial Markets 24 / 33  Investment Banking Corporate Finance Public offering of securities Traditional role of investment bankers. Investment bankers perform one or more of the following three functions: Advising the issuer on the terms and the timing of the offering (including the applicable regulations and procedures). B uying the securities from the issuer (i.e. underwriting or a firm commitment) [earning the gross spread or underwriting discount]. Distribution the issue (IPO or seasoned offering) to the public at the reoffering price. For large issues an underwriting syndicate can be formed with a lead underwriter and a selling group. P rof. D r. M. D e Ceuster Introduction to Financial M arkets 25 / 33  Investment Banking Corporate Finance Private placement of securities I.e. placing the securities with a limited number of institutional investors Activities Design and price the securities, Field testing of new structures, Lining up potential investors, Participate in the transaction through a best efforts underwriting arrangement. Business model: Fee business with equity kickers (i.e. option to buy some of the shares at the price set at the time of the offering) Prof. Dr. M. De Ceuster Introduction to Financial Markets 26 / 33  Investment Banking Corporate Finance Securitization of assets I.e. the issuance of securities using a pool of assets as collateral: Asset backed securities (ABS) Mortgage backed securities (MBS) Prof. Dr. M. De Ceuster Introduction to Financial Markets 27 / 33  Investment Banking Corporate Finance Mergers and acquisitions ( M & A ) Activities Finding M&A candidates, Advising acquiring companies or target companies w.r.t. the price and non price terms, Help target companies to fend off a friendly takeover attempt, Assist acquiring companies to find the necessary funding to finance the deal. Also - LBO - Restructuring and recapitalization - Reorganisation of bankrupt and troubled companies - Advice w.r.t. take over defence mechanisms (e.g. poison pills) Prof. Dr. M. De Ceuster Introduction to Financial Markets 28 / 33  Investment Banking Corporate Finance Merchant banking in the sense of Taking equity or creditor positions in companies, Taking up positions in the BoD. Research Discover interesting alternative funding mechanisms (perpetuals, variable rate instruments, convertibles,...) Build trust as a knowledgeable partner Prof. Dr. M. De Ceuster Introduction to Financial Markets 29 / 33  Investment Banking Trading of securities Trading on behalf of the clients Bid-ask spread Value changes in the securities held in inventory Riskless and risk arbitrage Proprietary trading (prop trading) (within the boundaries of the Volcker rule). Prof. Dr. M. De Ceuster Introduction to Financial Markets 30 / 33  Investment Banking Volcker Rule Prof. Dr. M. De Ceuster Introduction to Financial Markets 31 / 33  Investment Banking Investment Management Private banking Mutual fund business (including pension funds) Development of Robo-advice Prof. Dr. M. De Ceuster Introduction to Financial Markets 32 / 33  Investment Banking Miscellaneous Loan arrangements (in syndicates) Forex Commodity trading Leasing Property development finance Private equity... Prof. Dr. M. De Ceuster Introduction to Financial Markets 33 / 33