Topic 7 - Commercial And Investment Banking

Front 1

What are the major sources of bank funds

Back 1

The most important source of bank funds i s deposits, which are more omportant for small banks than large banks, large banks get more funds directly from the money markets (borrowed funds) in the form of offshore funding and repurchase agreements.

Front 2

Why do small banks have a higher proportion of assets in investments than do large banks?

Back 2

Small banks rely more on investments for liquidity. Large banks are more able to 'buy' liquidity directly in the money market. small banks thus tend to have more assets invested in treasuries, which are safe and highly liquid.

Front 3

What are the major benefits to banks of securitisation?

Back 3

First, by selling rather than holding loans, banks reduce the amount of assets and liabilities, thereby reducing reserve requirements, capital requirements, and deposit insurance premiums.

Second, securitisation provides a source of funding loans that is less expensive than other sources.

FInally, banks generate origination and loan servicing fees in the securitisation process.

Front 4

List and describe the major fee-based services offered by commercial banks.

Back 4

The major fee-based services are
- correspondent banking: is the sale of banking services to other banks or nonbank financial institutions.

-Trust services: involve the bank acting in a fiduciary capacity for an individual or a legal entity. Trust usually involves holding and managing assets for the benefit of a third party.

- investment products:
- Insurance products:
The investent and insurance products sold by banks involve the sale of brokerage services, mutual funds, or annuities through affiliated nonbank companies.

Front 5

Explain how liquidity risk can lead to a bank's failure.

Back 5

If a bank has insufficient funds to meet its depositor's withdrawals, it must close. banks fail if they cannot meet their legal obligations to depositors or creditors.

Front 6

Explain how bank capital protects a bank from failure.

Back 6

Capital provides a "cushion' against losses. If these losses erode the bank's capital below regulatory minimums, regulators will intervene and may close the bank.

Front 7

Describe the terms
1) investment bank
2) Universal bank

Back 7

Investment bank - A bank that specialises in helping businesses and governments sell their new security issues in the primary markets to finance capital expenditures, and makes secondary markets for the securities as brokers and dealers.

Universal Bank - An institution that can accept deposits, make loans, underwrite securities, engage in brokerage activities, and sell and manufacture other financial services such as insurance.

Front 8

Explain the steps entailed in underwriting a new security issue

Back 8

The investment bank will assist the company in preparing securities registration documents after a due diligence analysis of the company. As an underwriter, the IB will purchase the securities from the issuer and sell/distribute the issue to the investing public.

Front 9

How does the proportion of capital for a typical bank compare with that of a typical industrial firm? do banks have adequate capital? Why?

Back 9

A typical bank is financed with less than 10% capital and even less for large banks. most industrial firms are financed with 40% to 60% capital.

Because most banks are prudently managed and all banks are highly regulated, their capital is probably adequate.

Industrial firms do not have their primary operating debts insured by the government, nor is their liquidity guaranteed by the central bank.

Front 10

How does loan portfolio composition differ between large and small banks? explain?

Back 10

Large banks have a much higher proportion of commercial loans, which they compete for in a national market. smaller banks tend to operate in more local markets and have more of a retail emphasis. Smaller banks tend to have higher proportion of agricultural and real estate loans than large banks, which have more of a wholesale emphasis. Small banks are likely to be more conservatively managed, affecting their choices about what kind of risks to underwrite, and under what conditions. Large banks may more willingly originate higher-risk assets with the intention of securitising them.

Front 11

What role do investment bankers play in securitisation?

Back 11

Investment bankers generate business through advising on and facilitating the securitisation process.

Front 12

What is loan syndication and what advantages does it have?

Back 12

Sue to the size, risk and complexity of some project finance deals, individual institutions may not be willing to bear all the risk themselves. Hence, syndication may be used to share the risk between a number of financiers. Syndication loans are where a group of lenders form a syndicate and pool resources to fund a project.

Front 13

Why has noninterest income become so important to banks?

Back 13

Such income is importantto banks as it supplements the income they earn on interest margins through intermediation services and is subject to less risk and provides a more stable income to banks during uncertain conditions in the economy and the financial markets.

Non-interest income particularly fee-based sources, have become politicised as consumer groups and government have begun to look at the reasonableness of these fees ( relative to the costs to the financial institution).

Front 14

What is profitability-sovency dilemma? how is this managed in practice?

Back 14

Commercial banks can fail in two ways.
1) A bank can become insolvent by suffering losses on its loans or investment portfolio, resulting in depletion of its capital (credit risk or interest rate risk)
2) A bank can be a profitable business operation but fail because it cannot meet the liquidity demands of its depositors or borrowers (liquidity risk)

The problem is reconciling the conflicting goals of 'solvency and liquidity' on one hand 'profitability' on the other. This is not easily managed.

For example: liquidity could be achieved by holding only treasury securities, this is low risk but low profit.

The other extreme: The bank could shift its portfolio to high yielding, high risk loans which would bring more profit but high risk of failure later on caused by large loan losses or inadequate liquidity.

Front 15

How is project finance different from normal loan finance?

Back 15

Three key differences are as follows:
1) In project finance the 'project' is financed, not the company or companies involved.

2) Project finance is generally financed on a limited recourse bases. in most cases finance contracts include recourse provisions, which limit the circumstances under which the financiers may seek recourse from outside the project sponsor.

3) Due to the size, risk and complexity of some project finance deals, individual institutions may not be willing to bear all the risk themselves. Hence, syndication may be used.