Financial and Banking Intermediation

Séance 2 : Financial and banking intermediation

Part 1 : Financing of the economy : markets and financial intemediation

Part 2 : Specific risks of financial intermediation

Part 3 : Regulation and compliance : ECB Supervision

Part 4 : Assets and liabilities management : Interest rate risk

Part 1 : Financing of the economy : markets and financial intemediation

Chapter 1 : Financing of the economy : two majors approaches

Section 1 : Markets approach

You have the borrower who need the money and the saver who has the money. The borrower will ask the bank to ask the saver. The bank is the broker so the bank doesn’t do the financement.

The saver has the risk of the borrower. If the borrower makes default, the saver can not have his money back, he will lose his money.

The borrower risk is the saver risk.

What is the biggest financial market of the world ?

In France, the first borrower in bond is the French state.

In the world, Wallstreet only for the shares.

Daily exchange : 5 345 billion of USD FOREX (compared to the French GDP is 2500 billion of USD)

In the world, the biggest one is FOREX.

Annual commercial trade due to commodities is around 20 000 billion.

If we are in a share market : Saver A can sell to saver B (if the financial market is in a good position). If the price of the share go down, no one want to buy the shares of the Company A.

If you are a Company B, you can buy company A at a very low price.

If you want to sell shares that you don’t own on your portfolio : You lend the shares. If we know that the value of a share will go down from 44 euros to 40 euros. You don’t own this share but you can lend it, you will find a broker who will lend you the share. It means that you buy the shares (at 40,50 euros for example) and you must sell the shares before the loan term (at 44 euros for example). So you will make a gain of 3,50 euros per share.

If at the end, the share price is 48 euros, you will pay to the broker 4 euros per share.  

Section 2 : Bank deposits – Banking transformation process – Bank loans

Focus : profit and loss banking account

You have the borrower who need the money, the bank, and the saver who has the money. The bank makes the financement.

If borrower is in default, Is the job of the bank to make a banking transformation process to let the saver don’t be at risk.

The borrower risk is not the saver risk.

-Banking transformation process :

In the balance sheet of a bank : Assets (loan 10 000 euros to A), Liabilities (saving account 10 000 euros to B).

If the bank makes loan to A of 10 000 euros, the saving of client A will be creditor of 10 000 euros.

Bank transofrmation process : savings makes loans and the loans makes the savings.

Considering A want to buy a car and the maturity is 5 years who result to a loan of 10 000 euros and a saving of 10 000 euros.

Asset liability management : The maturity of assets is longer than the maturity of liabilities. So the banks must to find always money (to refinance the money) in order to cover the loan in the assets.

In the banking market A will give B 10 000 euros and B will give A interest.

The level of equity that a bank must have is determined by basel Rules 1,2,3,4.

Exercises : Focus : profit and loss banking account

Definition : Net banking income : is a difference between the revenue that is genereted from the bank’s assets and the expenses associated with the payout of liabilities.

Net banking income (PNB en français) = Sum of 1) 2) 3) :

1)Net interest income = (Revenue from assets - expenses from liabilities exept equity)

2)Commission : Net revenue of commission

3)Cost on gain on the equity

Operating expenses : Human Ressources, logistics, materials

Gross operating income : Net banking income – operating expenses

Cost to income Ratio (coefficient d’exploitation en français) : operating expenses/net banking income (this ratio must be low)

Here, the ratio is 65% (most of the banks is around 50-55%).

Cost of the risk : loans, financial risks (change, interest rate risk, market risk), operationnal risk (l’affaire Kerviel). Operrationnal risk is bigger than loans risks because loans risks can be evaluated regarding to your profile risk.

Net banking income

-Operating expenses

=gross operating income

-cost of risk

=net income before taxes = 1000 euros  (different from tax results who can include some accounts who are affected by tax. Tax results = 1200*33% = 400 euros

-Taxes = 400 euros

=Net income after taxes = 600

45% of the Net income after taxes is usually allocated to the shareholders in Europe and the rest is for the reserves.

Example : Loan = 10 000 euros (interest rate = 4% per year)

Savings = 10 000 euros (On livret A = 0,75% per year)

Banking revenues = 10 000x(4-0,75)%

Balance sheet of a banks :

Assets : Real estate, Loans (generate income from customers)

Liabilities : Equity, Savings (current savings, non liquid savings(in term of 4 years=PEL ; generate expenses due to the customers)

>>Assets and liabilities management are : Banking transformation process

Séance 3 : 01/12/2017 :

Exercice 1 : The total balance sheet amount of a retail bank call Retaily is 30 billion of euros.

Equity (shares) 6 billions

Current savings : 10 billion