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Management of Financial Institutions

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Management of Financial Institutions - MGT 604
VU
Lecture # 16
ROLE OF COMMERCIAL BANKS
Types of investment banks
Investment banks "underwrite" (guarantee the sale of) stock and bond issues, trade for
their own accounts, make markets, and advise corporations on capital markets activities
such as mergers and acquisitions.
Merchant banks were traditionally banks which engaged in trade financing. The modern
definition, however, refers to banks which provide capital to firms in the form of shares
rather than loans. Unlike Venture capital firms, they tend not to invest in new companies
Banks in the Economy
Role in the money supply
A bank raises funds by attracting deposits, borrowing money in the inter-bank market, or
issuing financial instruments in the money market or a capital market. The bank then lends
out most of these funds to borrowers. However, it would not be prudent for a bank to lend
out all of its balance sheet. It must keep a certain proportion of its funds in reserve so that it
can repay depositors who withdraw their deposits.
Bank reserves are typically kept in the form of a deposit with a central bank. This is called
fractional-reserve banking and it is a central issue of monetary policy.
Note that under Basel I (and the new round of Basel II), banks no longer keep deposits with
central banks, but must maintain defined capital ratios
Size of Global Banking Industry
Worldwide assets of the largest 1,000 banks grew 15.5% in 2005 to reach a record $60.5
trillion. This follows a 19.3% increase in the previous year. EU banks held the largest share,
50% at the end of 2005, up from 38% a decade earlier.
The growth in Europe's share was mostly at the expense of Japanese banks whose share
more than halved during this period from 33% to 13%. The share of US banks also rose,
from 10% to 14%. Most of the remainder was from other Asian and European countries.
The US had by far the most banks (7,540 at end-2005) and branches (75,000) in the world.
The large number of banks in the US is an indicator of its geography and regulatory
structure, resulting in a large number of small to medium sized institutions in its banking
system.
Japan had 129 banks and 12,000 branches. In 2004, Germany, France, and Italy had more
than 30,000 branches each--more than double the 15,000 branches in the UK.
Bank Crisis
Banks are susceptible to many forms of risk which have triggered occasional
systemic crises. Risks include liquidity risk (the risk that many depositors will request
withdrawals beyond available funds), credit risk (the risk that those who owe money to the
bank will not repay), Interest rate risk (the risk that the bank will become unprofitable if
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Management of Financial Institutions - MGT 604
VU
rising interest rates force it to pay relatively more on its deposits than it receives on its
loans), among others. Banking crises have developed many times throughout history when
one or more risks materialize for a banking sector as a whole. Prominent examples include
the U.S. Savings and Loan crisis in 1980s and early 1990s, the Japanese banking crisis
during the 1990s, the bank run that occurred during the Great Depression, and the recent
liquidation by the central Bank of Nigeria, where about 25 banks were liquidated.
Challenges within the Banking Industry
Economic Environment
The changing economic environment has a significant impact on banks and thrifts as they
struggle to effectively manage their interest rate spread in the face of low rates on loans, rate
competition for deposits and the general market changes, industry trends and economic
fluctuations.
Growth Strategies
It has been a challenge for banks to effectively set their growth strategies with the recent
economic market. A rising interest rate environment may seem to help financial institutions,
but the effect of the changes on consumers and businesses is not predictable and the
challenge remains for banks to grow and effectively manage the spread to generate a return
to their shareholders.
The Management of the Banks
The management of the banks' asset portfolios also remains a challenge in today's
economic environment. Loans are a bank's primary asset category and when loan quality
becomes suspect, the foundation of a bank is shaken to the core. While always an issue for
banks, declining asset quality has become a big problem for financial institutions. There are
several reasons for this, one of which is the lax attitude some banks have adopted because of
the years of "good times." The potential for this is exacerbated by the reduction in the
regulatory oversight of banks and in some cases depth of management. Problems are more
likely to go undetected, resulting in a significant impact on the bank when they are
recognized. In addition, banks, like any business, struggle to cut costs and have
consequently eliminated certain expenses, such as adequate employee training programs.
Banks also face a host of other challenges such as aging ownership groups. Across the
country, many banks' management teams and board of directors are aging. Banks also face
ongoing pressure by shareholders, both public and private, to achieve earnings and growth
projections. Regulators place added pressure on banks to manage the various categories of
risk. Banking is also an extremely competitive industry.
Competing in the financial services industry has become tougher with the entrance of such
players as insurance agencies, credit unions, check cashing services, credit card companies,
etc. Bank regulations are a form of government regulation which subject banks to certain
requirements, restrictions, and guidelines, aiming to uphold the soundness and integrity of
the financial system. The combination of the instability of banks as well as their important
facilitating role in the economy led to banking being thoroughly regulated.
The amount of capital a bank is required to hold is a function of the amount and quality of
its assets. Major Banks are subject to the Basel Capital Accord promulgated by the Bank
for International Settlements.
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Management of Financial Institutions - MGT 604
VU
In addition, banks are usually required to purchase deposit insurance to make sure smaller
investors are not wiped out in the event of a bank failure. Another reason banks are
thoroughly regulated is that ultimately, no government can allow the banking system to fail.
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Table of Contents:
  1. Financial Environment & Role of Financial Institutions:FINANCIAL MARKETS &INSTITUTIONS
  2. FINANCIAL INSTITUTIONS:Non Banking Financial Companies
  3. CENTRAL BANK:Activities and responsibilities, Interest Rate Interventions
  4. POLICY INSTRUMENTS:Open Market Operations, Capital Requirements
  5. BALANCE OF TRADE:Balance of Payments Equilibrium, Public Policy and Financial Stability
  6. STATE BANK OF PAKISTAN:History, Regulation of Liquidity, Departments
  7. STATE BANK OF PAKISTAN - VARIOUS DEPARTMENTS:Banking Inspection Department
  8. STATE BANK OF PAKISTAN - VARIOUS DEPARTMENTS (Contd.):Debt Management
  9. STATE BANK OF PAKISTAN - VARIOUS DEPARTMENTS (Contd.):Training Programs by SBP
  10. STATE BANK OF PAKISTAN - VARIOUS DEPARTMENTS (Contd.):Human Resources Department
  11. MAJOR DRIVERS OF FINANCIAL INDUSTRY:GLOBAL FINANCIAL SYSTEM, The World Bank
  12. INTERNATIONAL FINANCIAL INSTITUTIONS:ADB Projects in Pakistan, Paris Club
  13. PAKISTAN ECONOMIC AID & DEBT:Macroeconomic Stability, Strengthening Institutions
  14. INCREASING FOREIGN DIRECT INVESTMENT:Industrial Sector, Managing the Debt
  15. ROLE OF COMMERCIAL BANKS:Services Typically Offered by Banks, Types of banks
  16. ROLE OF COMMERCIAL BANKS:Types of investment banks, The Management of the Banks
  17. ROLE OF COMMERCIAL BANKS:Public perceptions of banks, Capital adequacy, Liquidity
  18. ROLE OF COMMERCIAL BANKS:Problem bank management, BANKING SECTOR REFORMS
  19. ROLE OF COMMERCIAL BANKING:Private Deposit Insurance,
  20. BRANCH BANKING IN PAKISTAN:Remittances, Online Fund Transfer
  21. ROLE OF COMMERCIAL BANKS IN MICRO FINANCE SECTOR
  22. Mutual funds:Types of international mutual funds, Mutual funds vs. other investments
  23. Mutual Funds:Criticism of managed mutual funds, Money Market Fund
  24. Mutual Funds:Balanced Funds, Growth Funds, Specialized Funds, Measuring Risks
  25. Mutual Funds:Cost of Ownership, Redemption Fee, Reports to Shareholders
  26. Mutual Funds:Internet Fraud, The Pyramid Scheme, How to Avoid Investment Fraud
  27. Mutual Funds:Investing In International Mutual Funds, How to Pre-Select a Mutual Fund
  28. Role of Investment Banks:Recent evolution of the business, Possible conflicts of interest
  29. Letter of Credit:Elements of a Letter of Credit, Commercial Invoice, Tips for Exporters
  30. Letter of Credit and International Trade:Terminology, Risks in International Trade
  31. Foreign Exchange & Financial Institutions:Investment management firms, Exchange Traded Fund
  32. Foreign Exchange:Factors affecting currency trading, Economic conditions include
  33. Leasing Companies:Basic Purpose of Leasing, Technological Benefits
  34. The Leasing Sector in Pakistan and its Role in Capital Investment
  35. Role of Insurance Companies:Indemnification, Insurer’s business model
  36. Role of Insurance Companies:Life insurance and saving
  37. Role of financial Institutions in Agriculture Sector:What is “Revolving Credit Scheme”?
  38. Agriculture Sector and Financial Institutions of Pakistan:What is SMEs
  39. Can Government of Pakistan Lay a Pivotal Role in this Sector?:Business Environment
  40. Financial Crimes:Process of Money Laundering, Terrorist Financing
  41. DFIs & Risk Management:Managing Credit Risk, Managing Operational Risk
  42. Banking Fraud & Misleading Activities:Rogue Traders, Uninsured Deposits
  43. The Collapse of ENRON:Auditing Issues, Corporate Governance Issues, Corrective Actions
  44. Classic Financial Scandals:Corruption, Discovery, Black Wednesday
  45. RECAP:FINANCIAL INSTITUTIONS, CENTRAL BANK,