4.2.4.2 COMMERCIAL BANKS AND INVESTMENT BANKS

Give some examples of commercial banks

NatWest, Nationwide, Lloyds, Halifax, Barclays, HSBC

What does a central bank provide?

Provides financial and banking services for its country's government and banking system as well as implementing the governments monetary policy and issuing currency

What is the name of the:

• American central bank

• European Central Bank

• American central bank

UK - Bank of England

Europe - European central bank

America - Federal Reserve

What does the Bank of England do? Who is in charge?

Sets the base rate (interest rate)

The MPC (monetary policy committee - 9 members)

What does a commercial bank do?

Aim to make profits by selling banking services to its customers

• accept deposits from general public

• create deposits which they lend to customers

How do commercial banks create loans?

By using money their customers deposit (people putting money into their bank account)

What are commercial banks also known as?

Retail or high street banks

So are commercial banks businesses? Why?

Yes - as they aim to profit maximize

What are investment banks?

They do not accept depots from ordinary members of the public, they help companies to raise finance by selling shares or bonds to investors

Where are shares bought and sold?

The primary and secondary capital market

What does "share issue" mean?

The selling of shares

What is J.p. morgan?

The biggest investment bank in the world

Would it make sense that retail banks have smaller portfolios than investment banks?

Yes

Why do banks have systemic risk?

They lend money to each other on the money market - so if one bank fails, then the whole bank market fails

Why was The Vickers Report 2011 significant?

Before this, there was less protection for customers (customers deposits were not guaranteed)

What is the Northern Rock case study?

What is credit?

A loan

What is an asset?

Owned

What is a liability?

Owed

Is a deposit an asset or liability?

Liability

Are deposits made to banks liabilities or assets?

• liabilities to the bank (as they owe you that money)

• assets to people (you owe the money)

Why do banks tend to keep a small % of deposits in cash?

This stops what happened at Northern Rock (as they didn't keep a %)

Why do banks only keep a small % of deposits in cash and not the whole amount?

It is very rare that someone wants the whole deposit (eg. £100,000) in cash all at the same time

So if the bank keeps 5% in cash, what happens to the other 95%?

It is given to customers

How do banks make profit?

Borrowers pay more interest than savers receive (this difference is the profit)

When customers receive a % award, what is this called?

Interest

How do banks create credit? What do they use?

Customers deposits

What could the consequences of banks creating credit?

• this increases the money supply

• prices go up

• consumption takes up a bigger proportion of income

• lower disposable income

• less consumption

• firms generate less revenue

• firms invest less

• AD decreases

What does fractional reserve banking mean?

What is a multiplier?

It shows how much money the initial deposit will generate in total for the economy

How do you calculate the size of the money multiplier?

1/reserve requirement

Give an example of the multiplier, and the overall increase

The further you go down a bank sheet, the what?

The less liquid but the more profitable

Who are the 4 people who want to see balance sheet?

• shareholders

• government

• bank of england

• financial regulators

Why does the government want to see balance sheets?

The government want to ensure the banking market does not fail, due to inter-bank lending (systemic risk)

What is the profitable asset?

A mortgage (but they are illiquid)

BALANCE SHESTS IN BOOKLET

Why is it risky for millions of pounds to be tied up in deposits and short term borrowing at a bank (liabilities)?

If all savers/other banks ask for their money back, this bank won’t be able to do this - systemic risk (all banks are interconnected)

What does interbank lending cause?

Systemic risk (liquidity crisis)

When banks do not have enough liquid assets to cover short term borrowing (liabilities), does this mean the bank doesn’t have any assets?

No, they do have assets, but not enough LIQUID assets to cover short term liabilities

If the bank has 0 capital, what does this mean they can’t cover?

The defaults/advances - so this bank fails (insolvency)

Why do banks need capital?

So they have enough capital to cover customer details (who have paid back their loans), this is what happened in the Global Financial Crisis

What does a liquidity crisis cause?

A run on the bank

So what are the 2 reasons banks fail?

• liquidity crisis

• insolvency

What does a liquidity crisis mean?

Not enough short term assets to cover its short term liabilities, leading to a run on the bank

What does insolvency mean?

Not enough capital to offset any issues in asset values (liabilities are greater than assets)

Give a gain of reasoning for systemic risk

• banks are reliant on each other

• banks are interconnected

• they lend to each other on the money market

• not enough liquid assets to pay back loans to other banks

• causes the banking market to fail

• when customers hear about this, they demand their money back

• creates a run on the bank

What are some tools in place to try and reduce the risk of bank failure?

• cash ratio

• liquidity crisis

• leverage ratio

• capital ratios

• reserve requirement

What does each of these ratios mean?

What are the main functions of a commercial bank?

Accepting deposits, lending and advancing loans, credit creation

What are the 3 main key objectives of a commercial bank?

1. Liquidity

2. Profitability

3. Security