GuyHargreavesACF-104

Recapofyesterday!  Thefundamentalprinciplesoffinancialintermediation!  “Financialclaims”-marketableandnon-marketable!  Identifyvariousfinancialmarkets,andbankingandnon-bankingfinancialintermediaries

!  Deposit-takingandnon-deposit-takingfinancialintermediaries

!  Bankingversusshadowbankingmarkets!  Thefunctionandcharacteristicsofmoneyandmonetarybases

!  Theimportanceofmarketliquiditytotheoperationoftheglobaleconomy

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Today’sgoals! Understandbankingsystemswithindevelopedeconomies

! Appreciatethestructureofatypicalcommercialbankingsystem

! Reviewpaymentsystemsandhowtheyoperate! Describethemainproductsandservicesofferedbycommercialbanks

! Understandthecommercialbankingcustomerbase

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Defini6onforthiscourse! ThiscoursefocusesonCommercialBanking! Commercialbankingcanbethoughtofasanyregulatedbankingactivityoperatedasabusiness

!  Forthiscoursewewilldefinecommercialbankingas:!  Retailbanking(includingPrivatebanking)!  Wholesale(orCorporate)banking

! Wewillalsolookatinvestmentbanking!  ImportanttonoteinvestmentbankingactivityisnotusuallyregulatedbyaCentralBank

!  Itisregulatedwhenconductedbyaregulatedbank

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Twobasiceconomicsectors! Privatesector–notcontrolledbytheState

!  Individuals!  Private/publiccompanies!  Non-profits/charities

! Publicsector–controlledbytheState!  Federalgovernment!  Stategovernments!  Localgovernments!  Stateownedenterprises

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Wheredoescommercialbankingfit?! Privatesector

!  Individuals–bankinglicensesnotgenerallyavailable!  Private/publiccompanies–mostcommercialbanks!  Non-profits/charities–somebanksegMicrofinance

! Publicsector!  Federalgovernment–CentralBanks!  Stategovernments-no!  Localgovernments-no!  Stateownedenterprises–fewSOEcommercialbanksremain

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Whoarethesavers/borrowers?! Privatesector

!  Individuals–bothsaversandborrowers!  Private/publiccompanies–bothsaversandborrowers!  Non-profits/charities–goalusuallytobeneither

! Publicsector!  Federalgovernment–mostlyborrowers!  Stategovernments–mostlyborrowers!  Localgovernments–mostlyborrowers!  Stateownedenterprises–mostlyborrowers

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Arecommercialbankssavers?

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!  Likeanyfor-profitentity,commercialbankscanbesaversandborrowersthemselves

!  Lendingoutprofitsnotpaidtoshareholders!  Borrowingforcapitalexpenditure

!  Ifacommercialbankisasaver/borrower,itwillconductthisactivitywithitsowncapital

! Thisactivityisconsidered“proprietary”ienotperformedinthecourseofitsfinancialintermediationactivity

Thefinancialsystem

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Retail/WholesaleCommercialBanks

InvestmentBanks

Whatisabankingsystem?

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! TheBankingSystemisthatpartofafinancialsysteminwhichregulatedbanksoperate

!  DoesnotincludeCapitalMarketswhicharepartoftheFinancialMarkets

!  Includespayments,CentralBankoperations,bankloans,deposits–anyactivitywhichinvolvesaregulatedbank

! Whethertheactivityisregulatedisanimportantdistinction

!  UnregulatedactivityisconductedoutsideofthesecurityandsupportprovidedbyCentralBankregulatedcommercialbanks

Whatisabankingsystem?

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!  Bankingsystemsareusuallymadeupof:!  CentralBanks!  Regulatedcommercialbanks

!  Retail(includingPrivate)banks!  Wholesalebanks

!  Paymentssystems

!  Regulatedbanksdealinfinancialmarketsbutmarketsarenotusuallyconsideredaspartofthebankingsystem

!  Investmentbanksdealinfinancialandcapitalmarketsbutifunregulatedtheyarenotconsideredpartofthebankingsystem

Whatelsedocommercialbanksdo?

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! Conductoperationsinfinancialmarkets,eg!  Hedgingrisksforcustomers!  Riskmanagementfortheirownbalancesheet

! Operatepaymentssystems!  Facilitatetradeflows! Helpwiththeconductofmonetarypolicy!  Supporteconomicgrowth! Assistinexecutingdevelopmentpolicies

Recall:paymentsystems! APaymentSystemisanyorganisedsystemestablishedtoallowparticipantstotransferfinancialassetsbetweenthemselves

! Paymentstakeplaceformanyreasons:!  Inexchangeforgoodsandservices!  Creationorrepaymentofafinancialliability/asset

! Commercialbankshavehistoricallyplayedakeyroleinpaymentssystems

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Paymentsystems-RTGS!  “Interbank”paymentsystemsuseRealTimeGrossSettlement(RTGS)totransfermoneybetweenbankparticipants

!  Retailparticipantsmustholdsomeformofaccountwithacommercialbankinthepaymentssystem

!  Toeffectpaymentaparticipantwillinstructitsbanktotransfermoneyfromthatparticipant’saccounttotheproperaccountofanotherparticipantatitsownbank

!  Thetwobanks“settle”thetransactionthroughadjustmentoftheirownaccountsheldwiththerelevantCentralBank

!  CentralBanksusuallymanageRTGSsystems

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Paymentsystems-SWIFT!  InternationalpaymentsystemsuseSocietyforWorldwideInterbankFinancialTelecommunication(SWIFT)totransfermoneybetweenparticipants

!  SWIFTisdoesnotaltertheunderlyingmechanicsofindividualdomesticpaymentsystems

!  SWIFTissimplyasystemthatarrangesdomesticpaymentsbetweeninternationalparticipants

!  UnlessthebankshandlingaSWIFTtransactionareprimarydeposit-takinginstitutionsinthecurrencyofthetransaction,instructionswillbehandledthroughacorrespondentbankingarrangement

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Commercialbankpaymentproducts! Commercialbanksoffermanywaysfortheirclientstoinstructapayment:

!  Cheques!  Onlinetransfers!  Standingorders!  Creditcards!  Debitcards!  ATMs!  Smartphones!  SMS

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Correspondentbanking! Commercialbanksoftenholdaccountswithotherdomesticorinternationalcommercialbanks

!  Nostroaccount:“ourmoneyheldbyyou”!  Vostroaccount:“yourmoneyheldbyus”

! WhenabankholdsanaccountwithanotherbankitissaidtohaveaCorrespondentBankingRelationship

!  IfabankdoesnotmaintainanaccountwithitsCentralBankitneedstohaveacorrespondentbankingrelationshipwithonethatdoes

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Commercialbankingproducts! Retailandwholesalecommercialbanksofferawiderangeofproductsandservices–including:

!  Currentandchequingaccounts!  Termdeposits!  Consumerloansandmortgages!  CreditandDebitCards!  Cashmanagementservices!  CorporateandSMEloans!  TradeFinance!  Financialmarketproductsandservices!  Onlinebanking

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Investmentbankingproducts!  Investmentbanksofferawiderangeofproductsandservices–including:

!  Capitalmarketproductarrangingandunderwriting!  Financialmarketproductsandservices!  Securitisedorassetbackedarranging!  Mergerandacquisitionadvisory

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Mortgageproducts! Oneofthemostfundamentalbankingproducts

!  Abanklendsmoneytoaborrowertopurchaseahouse,apartmentorotherproperty

!  Onlyaportionofthepropertypurchasepriceislent(eg50%)–thebalanceisfundedfromsavingsoftheborrower

!  Theborrowerrepaysloanprincipalandinterestoveranagreedtimeframe(eg30years)

!  Thebanktakesa“mortgage”overthepropertywhichentitlesittoseizeandsellthepropertytorepaytheloaniftheborrowerdefaults

! Banksareattheheartofretailpropertyfinancingacrosstheglobe

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Creditanddebitcards! AgroupofbankswereresponsibleforthedevelopmentofwidelyusedcreditcardssuchasVisaandMastercard

! Cardproductsofferthegreatconvenienceofbeingcash-likeandwidelyaccepted

! Creditcardsoffertheholderanunsecuredlineofcreditthatcanbedrawntopayforgoodsandservices

! Debitcardsareaccountsthatmusthavepositivefundbalancesbeforetheycanbeusedtopayforgoodsandservices

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Cashmanagementservices! Corporatecustomershavecomplexdailycashmanagementrequirementsincluding:

!  Multicurrencycashaccounts!  Accountsweepingandreconciliation!  Lockboxfacilities!  Subsidiaryaccountmanagement!  Foreignexchange

!  Sophisticatedonlinecashmanagementsolutionsarenowofferedbymanybankstohelpcorporatecustomersmanagetheirbusinessflows

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Tradefinance! Commercialbanksarecentraltothefinancingoftradeflowsacrosstheglobe:

!  Guaranteeingpaymentsforexportersandimportersthroughcorrespondentbankingrelationships

!  Financingshipmentsofcommoditiesaroundtheglobe!  Workingcapitalfinancefortradingcompanies!  Inventoryfinancing

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Financialmarketproducts! Commercialbanksofferarangeoffinancialmarketproductsandservicesincluding:

!  Foreignexchangeandforwards!  Moneymarketproducts!  Syndicatedloans!  Derivativeriskmanagementproducts!  Repoproducts

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Corporatebankingproducts! CorporatebankingcustomersrangefromSMEtomidmarkettolargelistedmultinationalcompanies(MNCs)

! Thesecustomershavearangeofcommercialbankingneedsincluding:

!  Leaseandhirepurchasefinancing!  Invoiceandreceivablediscounting!  Corporateloansandcommercialpaper(CP)!  Projectfinance

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Commercialbankingcustomers! Traditionalcommercialbankingcustomersbroadlyfallintocategoriesof:

!  Householdsavers,orborrowersforpurchasesofpropertyorsmallerticketpersonalgoods(egcars)

!  Corporateborrowersenteringintobilateralorclubloansforcapitalexpenditure(capex),workingcapitalorM&A

!  Governmentsfundinginfrastructureordeficits

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Modernbankingcustomers! Postderegulationinthe1980s,thenumberandtypeofbankcustomerhasgrownstrongly

! Retailcustomersnowalsoinclude:!  Financialmarkettradersandspeculators!  Marginloanborrowers!  Advisorycustomers(PrivateBanking,estateplanningetc)!  “Sub-prime”customers!  Traditionaldepositandconsumerloancustomers!  Etc..

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Modernbankingcustomers! Wholesalecommercialbankingcustomersnowalsoinclude:

!  PrivateEquityfunds!  PensionandMutualfunds!  HedgeFunds!  Mortgageandotheroriginators!  NBFIs!  Traditionalcorporateborrowers!  Corporateriskmanagers!  Syndicatedloanborrowers!  Etc…

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