Guy Hargreaves
ACF-104
Recap of yesterday
 The fundamental principles of financial intermediation
 “Financial claims” - marketable and non-marketable
 Identify various financial markets, and banking and non
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banking financial intermediaries
Deposit-taking and non-deposit-taking financial
intermediaries
Banking versus shadow banking markets
The function and characteristics of money and monetary
bases
The importance of market liquidity to the operation of the
global economy
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Today’s goals
 Understand banking systems within developed
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economies
Appreciate the structure of a typical commercial
banking system
Review payment systems and how they operate
Describe the main products and services offered by
commercial banks
Understand the commercial banking customer base
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Definition for this course
 This course focuses on Commercial Banking
 Commercial banking can be thought of as any
regulated banking activity operated as a business
 For this course we will define commercial banking as:
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Retail banking (including Private banking)
Wholesale (or Corporate) banking
 We will also look at investment banking
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Important to note investment banking activity is not usually
regulated by a Central Bank
It is regulated when conducted by a regulated bank
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Two basic economic sectors
 Private sector – not controlled by the State
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Individuals
Private / public companies
Non-profits / charities
 Public sector – controlled by the State
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Federal government
State governments
Local governments
State owned enterprises
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Where does commercial banking fit?
 Private sector
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Individuals – banking licenses not generally available
Private / public companies – most commercial banks
Non-profits / charities – some banks eg Microfinance
 Public sector
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Federal government – Central Banks
State governments - no
Local governments - no
State owned enterprises – few SOE commercial banks remain
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Who are the savers / borrowers?
 Private sector
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Individuals – both savers and borrowers
Private / public companies – both savers and borrowers
Non-profits / charities – goal usually to be neither
 Public sector
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Federal government – mostly borrowers
State governments – mostly borrowers
Local governments – mostly borrowers
State owned enterprises – mostly borrowers
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Are commercial banks savers?
 Like any for-profit entity, commercial banks can be
savers and borrowers themselves
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Lending out profits not paid to shareholders
Borrowing for capital expenditure
 If a commercial bank is a saver / borrower, it will
conduct this activity with its own capital
 This activity is considered “proprietary” ie not
performed in the course of its financial intermediation
activity
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The financial system
Retail / Wholesale
Commercial Banks
Investment Banks
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What is a banking system?
 The Banking System is that part of a financial system
in which regulated banks operate
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Does not include Capital Markets which are part of the
Financial Markets
Includes payments, Central Bank operations, bank loans,
deposits – any activity which involves a regulated bank
 Whether the activity is regulated is an important
distinction
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Unregulated activity is conducted outside of the security and
support provided by Central Bank regulated commercial
banks
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What is a banking system?
 Banking systems are usually made up of:
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Central Banks
Regulated commercial banks
 Retail (including Private) banks
 Wholesale banks
Payments systems
 Regulated banks deal in financial markets but markets are
not usually considered as part of the banking system
 Investment banks deal in financial and capital markets but
if unregulated they are not considered part of the banking
system
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What else do commercial banks do?
 Conduct operations in financial markets, eg
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Hedging risks for customers
Risk management for their own balance sheet
 Operate payments systems
 Facilitate trade flows
 Help with the conduct of monetary policy
 Support economic growth
 Assist in executing development policies
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Recall: payment systems
 A Payment System is any organised system established
to allow participants to transfer financial assets
between themselves
 Payments take place for many reasons:
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In exchange for goods and services
Creation or repayment of a financial liability/asset
 Commercial banks have historically played a key role
in payments systems
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Payment systems - RTGS
 “Interbank” payment systems use Real Time Gross
Settlement (RTGS) to transfer money between bank
participants
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Retail participants must hold some form of account with a
commercial bank in the payments system
To effect payment a participant will instruct its bank to
transfer money from that participant’s account to the proper
account of another participant at its own bank
The two banks “settle” the transaction through adjustment of
their own accounts held with the relevant Central Bank
Central Banks usually manage RTGS systems
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Payment systems - SWIFT
 International payment systems use Society for
Worldwide Interbank Financial Telecommunication
(SWIFT) to transfer money between participants
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SWIFT is does not alter the underlying mechanics of
individual domestic payment systems
SWIFT is simply a system that arranges domestic payments
between international participants
Unless the banks handling a SWIFT transaction are primary
deposit-taking institutions in the currency of the transaction,
instructions will be handled through a correspondent banking
arrangement
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Commercial bank payment products
 Commercial banks offer many ways for their clients to
instruct a payment:
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Cheques
Online transfers
Standing orders
Credit cards
Debit cards
ATMs
Smartphones
SMS
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Correspondent banking
 Commercial banks often hold accounts with other
domestic or international commercial banks
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Nostro account: “our money held by you”
Vostro account: “your money held by us”
 When a bank holds an account with another bank it is
said to have a Correspondent Banking Relationship
 If a bank does not maintain an account with its Central
Bank it needs to have a correspondent banking
relationship with one that does
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Commercial banking products
 Retail and wholesale commercial banks offer a wide
range of products and services – including:
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Current and chequing accounts
Term deposits
Consumer loans and mortgages
Credit and Debit Cards
Cash management services
Corporate and SME loans
Trade Finance
Financial market products and services
Online banking
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Investment banking products
 Investment banks offer a wide range of products and
services – including:
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Capital market product arranging and underwriting
Financial market products and services
Securitised or asset backed arranging
Merger and acquisition advisory
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Mortgage products
 One of the most fundamental banking products
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A bank lends money to a borrower to purchase a house,
apartment or other property
Only a portion of the property purchase price is lent (eg 50%)
– the balance is funded from savings of the borrower
The borrower repays loan principal and interest over an
agreed time frame (eg 30 years)
The bank takes a “mortgage” over the property which entitles
it to seize and sell the property to repay the loan if the
borrower defaults
 Banks are at the heart of retail property financing
across the globe
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Credit and debit cards
 A group of banks were responsible for the
development of widely used credit cards such as Visa
and Mastercard
 Card products offer the great convenience of being
cash-like and widely accepted
 Credit cards offer the holder an unsecured line of
credit that can be drawn to pay for goods and services
 Debit cards are accounts that must have positive fund
balances before they can be used to pay for goods and
services
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Cash management services
 Corporate customers have complex daily cash
management requirements including:
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Multi currency cash accounts
Account sweeping and reconciliation
Lockbox facilities
Subsidiary account management
Foreign exchange
 Sophisticated online cash management solutions are
now offered by many banks to help corporate
customers manage their business flows
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Trade finance
 Commercial banks are central to the financing of trade
flows across the globe:
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Guaranteeing payments for exporters and importers through
correspondent banking relationships
Financing shipments of commodities around the globe
Working capital finance for trading companies
Inventory financing
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Financial market products
 Commercial banks offer a range of financial market
products and services including:
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Foreign exchange and forwards
Money market products
Syndicated loans
Derivative risk management products
Repo products
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Corporate banking products
 Corporate banking customers range from SME to mid
market to large listed multinational companies
(MNCs)
 These customers have a range of commercial banking
needs including:
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Lease and hire purchase financing
Invoice and receivable discounting
Corporate loans and commercial paper (CP)
Project finance
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Commercial banking customers
 Traditional commercial banking customers broadly
fall into categories of:
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Household savers, or borrowers for purchases of property or
smaller ticket personal goods (eg cars)
Corporate borrowers entering into bilateral or club loans for
capital expenditure (capex), working capital or M&A
Governments funding infrastructure or deficits
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Modern banking customers
 Post deregulation in the 1980s, the number and type of
bank customer has grown strongly
 Retail customers now also include:
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Financial market traders and speculators
Margin loan borrowers
Advisory customers (Private Banking, estate planning etc)
“Sub-prime” customers
Traditional deposit and consumer loan customers
Etc..
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Modern banking customers
 Wholesale commercial banking customers now also
include:
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Private Equity funds
Pension and Mutual funds
Hedge Funds
Mortgage and other originators
NBFIs
Traditional corporate borrowers
Corporate risk managers
Syndicated loan borrowers
Etc…
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