Banking Operations and Strategy

Week 1: Banking Operations

Nirmala Lee

Reading

Casu, B., Claudia G and Molyneux P., Introduction to Banking Pearson Education 2006 Chapters 3, 4 Heffernan, S. (2005) Modern Banking, John Wiley & Sons Chapter 1 and 2 Hempel, G. H. & Simonson, D. G. (1999) Bank Management: Text and Cases, John Wiley & Sons Inc. 5 th edition Chapter 1 Hempel, G. H. (2010) Bank Management: Text and Cases, John Wiley & Sons Inc. 6 th edition Chapter 1 Howells, P. and Bain, K. (2008) The Economics of Money, Banking and Finance, 4th Ed., Pearson Education Ltd., London Chapter 6 Pond, K. (2008) Retail Banking Global Professional Publishing Chapter 1 Saunders, A & Cornett, M. M. (2007), Financial Institutions Management: A Risk Management Approach, McGraw-Hill, 6th Edition Chapter 1 Aizenman, J. and Powells A. 2003 Volatility and financial intermediation, Journal of International Money and Finance Volume 22, Issue 5 , October 2003, Pages 657-679 Einarsson, T. and Marquis, M. H. (2001) 'Bank Intermediation over the Business Cycle' Journal of Money, Credit and Banking, 33, 876-899. FSMA (2000) Financial Services and Markets Act, Office of Public Sector Information Heinkel, R. L. and Levi, M. D. (1992) The structure of international banking, Journal of International Money and Finance 11 3 251-272 Hampton C and McCallum A. (2006) 'Need to know: the latest legal, tax and regulatory developments Financial World Sept 2006 pg 44-45 Pasiouras, F (2008) Estimating the technical and scale efficiency of Greek commercial banks: The impact of credit risk, off-balance sheet activities, and international operations Research in International Business and Finance 22 3 301-318

Banks as financial intermediaries

Lord Denning (1966) conducting the famous case of United Dominions Trust Limited v. Kirkwood: Like many other beings, a banker is easier to recognise than to define Traditional definition: a bank is a financial intermediary that accepts deposits, maintains current accounts and offers loans Financial intermediation is the process of transferring sums of money from economic agents with surplus funds to economic agents that would like to utilise those funds (Pilbeam, 2005). As financial intermediaries, banks engage in the process of channelling funds between those who wish to lend and those who wish to borrow. Non-intermediary functions, e.g., provision of advice and safe custody services, insurance broking, stockbroking

Banking

a financial institution," 1474, from either It. banca or Fr. banque, both meaning "table", the notion is of the moneylender's exchange table Florentines bankers used to make their transactions above a desk covered by a green tablecloth The first bank, the Roman Primus Bank took banking out of temples and into distinct buildings. Julius Caesar, in an important edict allowed bankers to confiscate land in lieu of loan payments Section 2 of the Bills of Exchange Act 1882: a body of persons who carry on the business of banking The Banking Act 1979: a bank is a bank if it is recognised as a bank by the Bank of England - [now by the Financial Services Authority (FSMA, 2000)] The Banking Act 1987: a bank to be authorised as a bank, should be directed by fit and proper persons, have proper accounting, control and audit procedures and have paid up share capital of not less than 5 million and net assets of not less than 1 million.

Operations and Strategy

operation, late 14c., "action, performance, work, from O.Fr. operacion, from L. operationem (nom. operatio) "a working, operation," from operari "to work, labour" (in L.L. "to have effect, be active, cause"), from opera "work, effort," related to opus (gen. operis) "a work strategy, 1810, "art of a general," from Fr. stratgie, from Gk. strategia "office or command of a general," from strategos "general," from stratos "multitude, army, expedition," lit. "that which is spread out + agos "leader," from agein "to lead

Classification of banking

Commercial banking and investment banking Personal banking and corporate banking Universal banking and specialist banking Niche banking, Islamic banking Free banking, internet banking Retail banking and wholesale banking

Clearing banks, High Street banks, Community banks Merchant banks, Money centre banks

The major distinctions

Size of transactions Type of customer Distribution system for the services provided Volume of transactions Interest rates Dominant activity

Retail banks: Nature & activities

Varied and diverse Large number of low value transactions Large branch network Current accounts Payment services

Strategies of retail banks

Offer a range of savings and loan accounts Competitive interest rates Improved access to the funds / ATMs longer opening hours E-banking, home banking facilities

Wholesale banks: Nature

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Total size larger than the retail bank sector Average size of the wholesale banks smaller than that of the retail banks Much greater involvement in foreign currency business Holdings of cash & balances at the central bank extremely small Bulk of deposits constitute time deposits High level of market loans & advances

British merchant banks

Traditionally from wealthy merchants whose financial standing as traders enabled them to give financial advice and backing to other businesses Main financial advisers for companies Will not often be lending their own funds Major source of income fees rather than interest Now synonymous with what are called investment banks in the USA

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Major activities

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Facilitate pricing, management & underwriting of capital issues / securities Advice on mergers & take-overs Fund management services Acceptance of bills of exchange Management of consultancy services Operations in forex markets Operations in bullion markets Operations in the eurocurrency markets

Foreign banks

A bank headquartered outside the account holder's usual place of residence; E.g. banks which operate in the United Kingdom but which are controlled from a head office in a foreign country Dominance by numbers Dominance by assets Meet business requirements of firms in their own countries Participate within the eurocurrency markets Take up deposits from a wide range of sources Finance a wide range of projects

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Offshore banks

A bank located outside of the account holder's usual place of residence; often a bank that has located itself there to benefit from less regulation and/or lower taxes

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Factors that determine form of foreign banking

Some factors that determine the number and form of foreign banking: export activity, merchant banking activity, and capital market development (Heinkel and Levi, 1992)

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Banking structures / market entry types

Correspondent banking Representative office Agency Branch Subsidiary Bank Financial conglomerate Conglomerate

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Correspondent banking

Correspondent relationship generally consists of bank A, e.g., a domestic bank with no foreign operations, maintaining a deposit with an unrelated foreign bank, Bank B. Bank B then performs banking business for the clients of Bank A.

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Representative office

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The cheapest form of overseas banking office which constitutes the lowest level of commitment (Heinkel and Levi, 1992). These offices cannot perform traditional banking functions such as taking deposits making loans, trading in Eurocurrencies etc. They merely represent the parent bank in the foreign location and refer business back to the parent or to its branches. Occasionally, these offices produce loans.

Agency

Agencies stem from the principal-agent relationship. They cannot perform a full line of banking since they cannot take deposits. They can make loans, operate in foreign exchange and Eurocurrency markets, and maintain a credit balance. They are financed by loans from the money markets and by their parent banks. They perform international banking operations for companies from the parent banks home country

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Branch

offices of the parent bank and do not need to be chartered or have separate directors. Constitute the highest level of commitment.

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Subsidiary

Subsidiaries are chartered to operate in a country and have their own directors, even though they may be fully owned by the parent bank / holding company

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Multinational banking

The multinational company (MNC) defined as a company with operations in two or more countries that made its decisions concerning production and financial issues based on the alternatives available internationally. More complex versions of the international company suggested include the transnational corporation (TNC) or enterprise (TNE). - This is an MNC whose managerial cadre and share ownership are also international.

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Financial conglomerates

Banks may expand into other non-banking financial activities as part of an overall strategy to maximise profits. e.g., purchase of

stock broking firms insurance firms real estate companies

Banks Services may be provided through wholly owned or partly owned subsidiaries

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Shell banks

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Not a bank in the strict sense of the word but merely a means of getting round bank regulations. Generally located in the Bahamas, Grand Cayman Islands, Panama etc known as tax havens Sparsely furnished if at all. In Bahamas, they are not permitted to have an office on the ground floor because they might be mistaken for a real bank.

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Globalisation

a process whereby financial markets internationally are integrated so closely that they can be considered as a single market (Arestis and Basu, 2004). globalisation is associated with risk as well as potentially substantial benefits (Moshirian, 2001)

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Past examination questions

Discuss the major activities and characteristics of the various forms of overseas banking operations and some of the factors that might influence the development of these operational forms. (January 2007) "Like many other beings, a banker is easier to recognise than to define." (Lord Denning). Critically evaluate this statement with particular reference to current banking structures and activities. (January 2004) Critically evaluate current banking structures in relation to domestic and international banking activities. (January 2002)

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References

Arestis, P. and Basu, S. (2004) 'Financial globalisation and regulation', Research in International Business and Finance, 18, 129-140. Denning, L. (1966) United Dominion Trust Ltd v Kirkwood, FSMA (2000) Financial Services and Markets Act, Office of Public Sector Information, Heinkel, R. L. and Levi, M. D. (1992) 'The structure of international banking', Journal of International Money and Finance, 11, 251-272. Moshirian, F. (2001) 'International investment in financial services', Journal of Banking and Finance, 25, 317-337(21). Pilbeam, K. (2005) Finance and Financial Markets, Palgrave Macmillan, London.

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