Chapter 3: Managing Relationships with Service Providers
Outline: FIs: Functions and Services FSP Selection Process Bank Relationship Management Global Account Management Account Analysis in the U.S. Commercial
Banking System Monitoring Financial Service Provider Risk in
the U.S. Other Topics in Managing Service Provider
Relationshipsv3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 1
FIs: Functions and Services— Global (Non-U.S.) FIs
Services: depository accounts, transaction services, lending, FX, information reporting and investment banking
May serve different markets
Functional split between commercial and investment banking
Other services: trade services, agent and fiduciary services, risk management and consulting
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 2
Global FIs Required to follow guidelines
of each country Less regulated than single
country banks Minority or controlling
interest in corporations Lend large percentage of
capital to one customer
In most countries Large nationwide banks Pay interest on positive
balances and have automatic overdraft loans
Multicurrency accounts Nonresident accounts
U.S. Commercial Banks
Deposit accounts Credit services Investment
banking services Payment and
collection services Trade services Foreign exchange
(FX) services
Risk management services
Fiduciary services Consulting services Other financial
services Broker/dealer
services Insurance company
affiliation
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 3
Discussion Question
How do you define the term “commercial bank” in the U.S.?
Answer:A financial institution possessing a federal or state charter that accepts deposits and makes commercial loans. It may also offer other services.
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 4
Deposit AccountsDemand deposit accounts (DDAs)
Checking accounts, NOW accounts
Dodd-Frank Act repeal of Reg Q
In most countries other than U.S., practice is to incorporate both an investment rate and a credit agreement
Time deposit accounts (TDAs)
Must be held for specified period
CDs (under $100K) Jumbo CDs (over
$100K) Fully negotiable
CDs ($1 million blocks)
Savings accounts MMDAs
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 5
Discussion Question
Which of the following commercial bank services is an integral part of the CP and municipal securities markets?a) Credit servicesb) Investment banking servicesc) Payment and collection servicesd) Foreign exchange (FX) servicese) Risk management services
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 6
Discussion Question
Do all investment banking firms have to be full-service providers?
Answer:No. Investment banking and brokerage firms provide a wide range of services related to the issuance and trading of securities. Companies tend to specialize in the services offered (investment or brokerage) as well as customers (institutional or retail).
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 7
Investment Banks
Underwriting/ intermediary
Facilitate mergers, acquisitions and divestitures
Broker/financial advisor
Issue stocks and bonds: Origination Underwriting Distribution
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 8
Underwriting
Full underwriting Investment bank or
syndicate owns entire issue.
Company has all the money it will receive and can use it.
Investment bank(s) assume price and marketability risks.
Best-efforts basis If investment bank
or syndicate is not confident it can sell entire issue.
Company pays a fee for advice and marketing.
Sell as many shares as possible up to specified limit.
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 9
Discussion Question
Which of the following is true for full service banks that offer both the underwriting/distribution function and the investment advisory or management function?a) “Bringing someone over the wall” is a clear violation of
SEC regulations and ethics guidelines.b) Distribution and underwriting are referred to as the buy
side.c) Buy side and sell side transactions should be separated
by a “Chinese Wall” that prevents each party from acquiring material non-public information (MNPI) and acting upon it.
Answer: c
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 10
Other Financial Institutions Savings institutions
Savings and loan associations
Federally or state-chartered
For-profit or not-for-profit
Credit unions National Credit
Union Association or state-chartered
Mutual funds
Other non-bank FIs Industrial credit
and capital companies
Industrial bank Captive finance
companies Factors Insurance
companies Pension funds Consumer finance
companies
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 11
FSP Selection Process: Reasons
Need for a new product or service
As part of a re-engineering program
As part of a regular product and service review
To reduce costs To update existing
technologies
To reflect a change in the banking group
To comply with statutory or regulatory requirements
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 12
FSP Selection Process: Selection Criteria Geographic
considerations Ability to fulfill
specifications Personnel expertise,
including customer service and product support
Knowledge of specific industry
Ability to customize or create new services and meet future needs
Adequacy of internal controls, backups and disaster recovery plans
Pricing References
Also assess: Financial strength Willingness to
provide credit on flexible terms at competitive rates
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 13
Soliciting Information from FSPs
Request for information (RFI) Vendor’s interest in and ability to provide service
or solve key business problem Justify existing vendor or narrow field for RFP
Request for proposal (RFP) Formal outline of company’s objectives, needs,
service requirements; requests bids Some government entities must use RFPs
periodically to ensure competitiveness AFP standard formats for computer analysis Supply best prices using AFP Service Codes
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 14
Discussion Question
What items should a typical RFP request from prospective vendors?
Answers: Background information Summary of proposed solution List of provider’s team leaders Service descriptions, features
and benefits Demonstration of provider’s
commitment to support and enhance services
Cost/benefit analysis Pro forma account analysis or pricing
schedule Sample service commitments
or agreements
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 15
Timetable for service implementation
Client references Online reporting and
transaction abilities Disaster recovery
and backup procedures
List of vendors by area
SOX compliance for U.S. (SAS 70)
Discussion Question
What general factors increase the mutual benefit and profitability of the relationship between a company and a bank?
Answers: Open and frequent communication Regular and timely feedback Documentation of expectations of both
parties in agreements and legal contracts Fairly priced, efficient and effective
financial services/products Complete, candid, and timely disclosure
of information by both parties
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 16
Number of Bank Relationships
Multistate or international operations Costs of multiple relationships
Lead institution Bank’s relationship profitability measures result
in lower costs for use of multiple services Pricing of loans Pricing of depository services
Concentration risk Relative strengths of each bank Organization’s credit needs
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 17
Factors Involved in the Pricing of Loans
Cost of funds Risk of repayment Total loans
committed and outstanding
Service fees Deposit balances Range of other
services used (e.g., foreign currency or derivatives trading)
Loan maturity Revenue size
and importance of overall relationship to lending institution
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 18
Factors Involved in the Pricing of Depository Services
Volume Customization Exception handling
requirements Cost of providing
the service Operational
overhead Deposit balances
maintained
Other services used (e.g., global trade services, L/Cs and custody services)
Credit relationship Revenue size and
importance of overall relationship to FI
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 19
Documentation
Service agreement/ contract
Service level agreement (SLA)
Account resolution
Signature cards and account terms
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 20
Elements of Service Agreementsand SLAs
Service agreement Compensation policies,
including pricing, method of payment, payment frequency, excess/deficit balance arrangements, contract length, adjustments
Liability clauses defining responsibilities for specified risks
Other terms and conditions of the relationship
SLA Operational policies
and procedures, including detailed processing requirements for service, information needs, and list of individuals authorized to make changes
Performance standards that define agreed-upon levels of service performance and quality
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 21
Discussion Question
What is a bank scorecard, and what is its purpose?Answers: A management tool used to measure a
bank’s performance in both a qualitative and quantitative method.
Primary purpose is to provide a quantitative measure of the service provided and benefit received, but it also provides feedback on perceived value/quality/cost of the services provided.
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 22
Fee versus Balance Compensation
Company perspective Fees preferred when
investment/debt payment can generate greater ROI than earnings credit (EC).
Balance compensation allows excess balances to earn a return: Banks price loans more
favorably. Not as visible on
statements. Tax status. ECRs may exceed short-
term rates.
Bank perspective Fees preferred because
deposits are a liability; because fees are low-risk source of earnings.
Balances used to fund loans and investments at rates over ECR.
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 23
Comparing Costs Among Service Providers and Billing for Bank Services
Difficulties in comparing costs among banks: Bundling Varying prices, depending on level of service
provided by FI ECs, deficient balance charges, availability
schedules Monthly, quarterly, semi-annually or annually
Account analysis statement for billing Global billing uses TWIST BSB format
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 24
Global Account Management: Sovereign and Political Risk Unique banking
structures and documentation requirements per country
Sovereign risk Political risk Nationalization Expropriation Blocked currencies Forced reinvestment Required majority
ownership
Laws, regulations, taxes, customs
Value dating Bank
compensation and fee structures
Legal and ethical issues
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 25
Discussion Question
When a withdrawal is back-valued, the date of the debit to the customer’s account a) is earlier than the actual date the item is
deducted from the ledger balance.b) is later than the actual date the item is
deducted from the ledger balance.
Answer: a. Under a value dating system, a bank sets a forward value date on which the value of funds credited to an account is determined and establishes a back value date on which the value of funds debited from an account is determined.
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 26
Discussion Question
What information does an account analysis statement provide to the bank’s commercial customers?
Answer: Services provided Balances maintained Volumes processed Charges assessed Earnings credit allowances
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 27
Account Analysis in the U.S. Commercial Banking System
Record of services provided with detailed information on balances and credits earned
AFP Service Codes ASC X12 822
account analysis format
AFP Guide to Account Analysis
Account analysis terminology Average ledger balance Average deposit float Average collected
balance Reserve requirement Service charges Available or investable
balance Earnings credit
allowance and earnings credit rate
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 28
Earnings Credit
Where:EC = Earnings creditCB = Average collected balancesRR = Reserve requirementECR = Earnings credit rateD = Number of days in the month
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 29
DEC = CB × (1 RR) × ECR365
Assume the following scenario: Average ledger balance $250,000
Deposit float $30,000Reserve requirement 10%Earnings credit rate 5%Service charges for the month $1,000Days in month 30
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 30
Average Collected Balance Calculation:Average ledger balance $250,000Less: Deposit float ($30,000)Equals: Average collected balance $220,000
DEC = CB × (1 RR) × ECR 365
30= $220,000 × (1 0.10) × 0.05 × 365
= $220,000 × 0.9 × 0.0041095 = $813.68
Earnings Credit
Collected Balances Required
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 31
Where:CB = Average collected balances required to pay service chargesSC = Service chargesECR= Earnings credit rateRR = Reserve requirementD = Number of days in the month
SCCB =DECR × × (1 RR)
365
Collected Balances Required
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 32
Assume the following scenario:Monthly service charges $1,000Earnings credit rate 5%Reserve requirement 10%Days in month 30
(
SCCB =DECR × × (1 RR)
365
$1,000=30 0.05 × × (1 0.10)365
$1,000 $1,000= = = $270,372.570.00369860.05 × 0.0821917) × 1 0.10
Discussion Question
An FI with a lending relationship also serves as a bond trustee. If the borrower becomes distressed, there is a risk of which of the following?a) Conflict of interest, if the FI protects its own credit
to the detriment of the borrower and bondholdersb) Financial risk, if the borrower default would lower
the FI’s Uniform Bank Performance Report scorec) Operational risk, if the trustee relationship
prevented the FI from performing an SAS 70 Type I audit on the borrower
Answer: a
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 33
Assessing Risk for FIs: UBPR
Uniform Bank Performance Report (UBPR) FFIEC analytical tool for bank supervisory,
examination and management purposes. UBPR presents three types of data:
The bank’s data Data for a peer group of banks similar in size and
economic environment Percentile rankings
Compare bank to its peer group, consider bank’s trends over time, and recognize trends and changes in peer group averages.
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 34
Assessing Operational Risk for FIs
SAS 70 audit developed by AICPA.
Report on “processing of transactions by service organizations.”
Type I is “reporting on controls placed in operation.”
Type II is all of Type I plus “tests of operating effectiveness.”
Value provided to service providers: Service auditor’s report
with an unqualified opinion is differentiator
Helps build trust with customers
One report rather than reports for each customer
Customers can provide service auditor’s report to their providers
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 35
Monitoring Bank Risk: CAMELS
Capital adequacy Asset quality Management
capability Earnings Liquidity Sensitivity to
market risk
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 36
Three Pillars of Basel II
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 37
BASEL II
Minimum Capital
Requirements
Supervisory Review Process
Market Discipline
1 2 3
Discussion Question
Which of the following has become a very real consideration in bank relationship management and should be considered when evaluating a contract for services of any kind with a bank or FSP?a) Credit riskb) Political riskc) Counterparty riskd) Onshoring risk
Answer: c
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 38
End of Session 2
Assignment: Complete the following tasks for Module
Two, Chapters 4 and 5: Review each chapter. Complete the test-your-understanding
questions at the end of each chapter. Complete the online calculations. Complete the online module-specific test. Complete the Exam Practice (Describe and
Differentiate) questions (located at the end of the module).
v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 39