Banking

Banks in general are Financial Intermediares that accept deposits from individuals or instiution and make loans

Deposits

Allowing banks to collect capital other than retail deposits

Capital Accounts

1. Capital Stock -> direct Investment into bank in form of common stocks

2. Undivided profits (re) -> which are banks profits that are not paid out to shareholders or in form of dividens

3. Special reserve accounts -> to cover losses

they collect money from creditors (liability) and owner (capital)

1. Deposit Accounts

Types:

• Transaction Account (checking account)

  • used for everyday transaction and expesnes (also payment)

  • Most of their salary paid into this account

• Saving deposit

  • Historically were traditional form of saving held by most induviduals

  • starting with deregulation of the Financial System (1980) -> less imporating source of banks -> consumer switching to higher yielding Investment

• Time deposit

  • allowing induviduals to deposit a certain amount of money for a fixed period of time

  • Depositor agrees not to withdraw the funs until the agreed-upon maturity

  • in return bank is paying hiher interest rate than on saving accounts

is a personolized contract between bank and borrower which is made for the particular needs for the customer

it is the primary business of the bank -> ongoing releationship with bank and borrower

it is a highly liquid financial resources a bank holds which can be readily used to meet short-term obligations (current assets)

non-interest income constists mainly of fees and services

it often refers to “net non-interest margin”

(which is the difference betweeen total non-interest income and total non-interest expenses)

They helping business sell their new security issues (debt or equity) in the primary market to finance capital expenditures

after the security are sold, IBs sell in the secondary market the shares as quick as possible (before price decreases)

• banks raise funds by issung checkable deposits, deposits and time deposits

• they can use these funds to make commerical, consumer and mortage loans and to buy government securities and municipal bonds

• banks profits is the difference between the lending and borrowing rates

• can also make profits from fees-earning activities like capital markets transactions (trading and derivates transactions)

Interest on loans and the net interest income

(which is the difference between interest income and interest expenses)

• Commercial Banks focuses on relationship-lending (to have long-term relationship between the bank and its clients basics for loan book)

• Investment banks focuses on transcation lending -> the ability to price a deal and to have distribution power

  • act as an intermediary, underwriter, lender and consultant

  • focus also mainly on the needs and interest of buinsess and governments

  • M&A, IPO or financing major infrastrucutre projects (to have a advisory role helping them to determine financial risk before they do

it discuess the seperation between commercial banks and IBs in which the banks need to decide whether to be a commercial or IB

it also refers to the “Glass-Stegall legislation” which was adopted after the great financial crisis in the 30s where it reduce speculations in the Financial market to restore confidence in the Bankning system

the act refers that commercial banks, IBs and Insurance companies were allowed to affiliate which each other as a part of an finanical holding company (orga structure)

• Bringing new secutities on the market (debt or equity)

• IPO -> which is the first time a company offering on the market (or private) shares -> allowing to collect money)

• private placement are often less costly but less liqudity

• seasoned offering -> additional inssuance of shares that already had an IPO

• the IB guaranteering that the issuer received a fixed-amount of money (wheater the securites are sold or not)

• IB takes the risk by unsuccessful offering

• here we dont have an guarantee instead we have a promise to make best sales effort (to sell as much of a securities offering as possible)

• Ib does not take the risk

• the compensation is based on the number of securites sold

happens through competitive bidding -> issuer publicy announces to desire to sell secutires and solict offers from several IBs

the direct negiotiation with a signle IB (which is mostly used)

• How the price the securities (because they never have been traded before)

  • Important because the higher the price is the more money the issuer receive (but not too high because then the demand is low)

  • the price also decided wheather go to public or private offerings

1. Origination -> IB help the issuer to analyze the feasibilibty of the project and determine the amount of money to raise and also decide the type of financing (debt or equity)

2. Underwritting -> IB guarantees to buy new securities for a fixed price. The risk for the IB is between buying the shares and selling them on the market

3. Distribution -> after selling the shares it sale divided into institutional sales (large blocks of securities sold to pension funds, mutal funds, insurance companies, …)

it involves developing new financial instruments as well as finanical technologies

categorised between:

• Product Innovations

  • new derivate contracts or new corpoate securites

• Process Improvements

  • news means of online distribution of financial services (transaction or pricing transactions)

Examples:

• Cryptocurrencies, blockchain, AI and ML

its a technology-based innovation in the financial system which result in new business models which include AI, ML and RPA

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the ability of a computer to simulte human behavoir it includes the capabilities of problem-solving and leaning concept

is a branch of AI where computers learn patterns and make decisions or predictions based on data without being explicity programmed

is the use of software bots to automate repetitive, ruled-based tasks in business processes

refers to exremely large datasets that require advanced tools and technologies to store, process and analyze for meaningful insights

are digital identity authenticiation such as fingprints, facial recognition or voice to identify individuals

is a decentralized and secure digital ledger that records transactions across multiple computers

(in a way that ensures transparency and prevents tampering)

Components:

• Peer to peer -> users are connected to each other without a central point of authority or control

• Consensus -> a protocol to validate transactions and ensure agreement across the network (e.g. Proof of Work)

• Cryptography -> security of information and data on the blockchain to maintain privacy

• Distributed Ledger -> is a decentralized database shared across multiple participants in a network, ensuring transparency without a central authority

• Public Blockchain (permissionless) -> completly decentralized and dont have a owner. It is not required to get an approval to join the network by a central entity

  • Examples -> Bitcoin and Ehereum

• Private Blockhain (permissioned) -> its a singel entity. There is an owner who sets the rules for the blockchain (control the whole blockchain) and designates who can join in the network and in what capacity.

  • Examples -> Ripple and Corda

• Hybrid Blockchain (consortium blockchain) -> combines features of both public and private blockchains, allowing selective access while maintaining some transparency

  
  

  
  

  
  

  
  

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• Blockchain 1.0 -> refers to the first generation of blockchain technology, primarily focused on enabling decentralized digital currencies like Bitcoin

• Blockchain 2.0 -> Expands blockchain technology beyond digital currencies to include smart contracts and decentralized applications (DApps), especially in the financial sector

• Blockchain 3.0 -> beyond currency and the financial sector extending blockchain applications to industries like healthcare and government

• Use of Robo-Advisor

• Use of BigData and ML for credit scoring

are digital currencies secured by cryptography, operating on decentralized blockchain networks and enabling peer-to-peer transactions

Examples -> Bitcoin, LiteCoin, Ripple, …

Are self-executing programs on a blockchain that automatically enfore and excute agreements based on predefined conditions

Implications for banks

• Risk -> FinTech can disrupt traditional banking by offering faster innovative solutions, potentially leading to loss of market share and revenue for banks

• Opportunity -> Banks can enhance efficiency through partnerships or in house development (reduce costs like compliance) to expand services and improve customer experiences

  
  

is an automated, algorithm-driven financial planning tool that provides investment advice and portfolio management with minimal human intervention

is a method of raising funds by collecting small contributions from a large number of individuals, typically through online platforms, to finance a project, business, or cause.

1. Donation-Based Crowdfunding: Contributors donate money without expecting any financial return, often for charitable or social causes.

2. Reward-Based Crowdfunding: Backers contribute funds in exchange for non-financial rewards like products, services, or experiences

3. Equity-Based Crowdfunding: Investors provide funds in exchange for ownership stakes or shares in the company, gaining potential financial returns

4. Debt-Based Crowdfunding (Peer-to-Peer Lending): Individuals or businesses borrow funds from contributors and repay them with interest over time

enables individuals, businesses, or organizations to raise funds quickly and efficiently from a large number of people

often bypassing traditional financing methods like banks or venture capital

represents a new fundraising method used by blockchain-based projects to raise capital by issuing and selling digital token or coins to investors for the first time

digital token that provides access to specific products, services, or features within the blockchain

represents ownership in an asset company, or investment

it is a process before start an ICO, the startup will usually publish a whitepaper which describes the details of the project and the cryptocurrencies that they are going to offer

1. detail of the project (description of the project, business plan, amount of requred funds)

2. technical specifications (mechanism and the adopted blockchain protocol)

3. ICO details (terms of conditon, start and end dates of the ICO, total cryptocurrency supply)

Blockchain:

1. Decentralization: Removes the need for intermediaries, reducing costs and increasing efficiency.

2. Transparency: All transactions are recorded on a public ledger, ensuring accountability.

3. Efficiency: Automated processes and faster transactions, especially in cross-border payments.

ICOs:

1. Accessibility: Allows startups to raise capital globally without traditional financial intermediaries.

2. Speed: Faster and more efficient fundraising compared to traditional methods like venture capital.

3. Innovation Funding: Supports innovative projects that might not get funding through conventional routes

Blockchain:

1. Regulatory Uncertainty: Lack of clear regulations in many jurisdictions can lead to legal complications.

2. Energy Consumption: Proof-of-Work blockchains, such as Bitcoin, require significant energy resources.

3. High Risk of loosing all of invested capital

ICOs:

1. High Volatility: Token values can fluctuate wildly, leading to significant investment losses

1. Venture Capital (VCs) -> are companies they financing provided to startups and early-stage companies with high growth potential in exchange for equity ownership

2. Business Angels -> individual investors who invest with their personal funds directly into start-ups

3. Accelerators and Incubator -> programs that support startups by providing funding with accelerators focusing on rapid growth and incubators on early-stage development.

was adopted in 2012 in response to the 2007/2008 financial crisis to address weaknesses in the banking sector, break the link between national governments and struggling banks to prevent future systemic crisis by creating a more integrated and robust banking system

before the financial crisis national authorities were responsible for supervising the banking system and ensureing stability

experience of the failure of cross-border banks in Europe suggests that in times of crisis national authorities focus on preserving the national elements

1. Single Rulebook -> set of rules that EU banks must comply with (e.g. rules on capital requirenments)

2. Single Supervision Mechanism (SSM) -> is a centralized banking supervision system in the Eurozone, led by the European Central Bank, to ensure stability of significant banks

3. Single Resolution Mechanism (SRM) ->  is a framework within the EU’s Banking Union that manages the orderly resolution of failing banks in the Eurozone to protect financial stability

4. European deposit guarantee scheme -> is a proposed EU framework aimed at protecting bank deposits (protect saving up to 100.000€) across member states by ensuring uniform coverage and strengthening depositor confidence in case of bank failures

• responsible for managing the Eurozone’s monetary policy to ensure price stability

• supervising significant banks under the Single Supervisory Mechanism (SSM)

• maintaining financial stability across the euro area.

The ECB is an independent EU institution, the ECB oversees banking supervision from a European perspective by:

• establishing a common approach to day-to-day supervision

• taking harmonosed supervisors actions and corrective measures

• ensuring the consistent application of regulations and supervisory policies

The ECB has the authority to:

• conduct supervisory reviews, on-site inspections and investigations

• grand or withdraw banking licences

• assess banks acquisition and disposal of qualifying holdings

• set higher capital rquirements in order to counter any financial risks

• are regulatory frameworks designed to ensure the safety and stability for European Banks.

• They aim to reduce risks, protect depositors, and maintain financial stability across the EU

Key components of EU Prudential Rules:

• Capital Requirements

  • Capital Adequaty Ratio (Capital/High-risk-assets >8%)

• Liquidity Standards

  • LCR (Ratio between High-Quality-Assets/total cash outflows -> 100% after 30 days)

• Risk Management (credit, market, and operational risks)

  
  

Directly Supervised

• ECB directly supervises the 109 significant banks (these banks held 82% of banking assets)

Indirecty supervised banks

• banks that are “less significant”

• they supervised by their national supervisors which are in close cooperation with the ECB

A bank is considered significant under the European Single Supervisory Mechanism (SSM) if it meets specific criteria such as:

1. Size: Total assets exceed €30 billion.

2. Economic Importance: It is critical to the economy of a member state or the EU.

3. Cross-Border Activities: Significant operations in multiple EU countries.

4. Supervised Entities: It directly supervises other financial institutions with significant assets.

5. State Aid: It has received financial assistance from the European Stability Mechanism or similar bodies.

to ensure the ordenly resolution of failing banks with minimium impact on the real economy and the public finances of banking union countries

• ensures the stability and integrity of the financial system, protects consumers and depositors

• mitigates systemic risks

• to build trust and confidence in financial institutions, which are essential for economic growth and stability

• is an emergency fund that can be called upon in times of crises

• it can be used to ensure efficient applications of failing banks

• the SRF ensure that the financial industry as a whole ensures the stabilisation of the financial system

• all banks across the 21 BU countries need to pay annual fees by law in the SRF (the fees are called contributions)

• it was established by the SRM regulation, its a independent EU agency acting as the central resolution

the role:

• enrue the orderly resolution of failing banks with the minimum impact on the real economy and the public finances of banking union countries

• manage the single resolution fund

• is an EU regulatory agency established to ensure effective and consistent regulation of the banking sector across member states

• promote financial stability, and safeguard within the EU’s banking system

Main Task:

• is to contribute to the creation of the European Single Rulebook

is to develop and enforce consistent regulatory standards across the EU banking sector, ensuring stability, transparency, and consumer protection while promoting a unified financial market

1. Licensing or Authorization:

   • Before an insitution can obtain a licence, supervisors assess the people involved, their integrity, honesty and ability to manage a provider of financial services.

2. Ongoing Monitoring

   • of the health of financial institutions and the financial system, in particular the assets quality, capital adequacy and liquidity

3. Sanctioning or penalites

   • in case of non-compliance with law, fraud and bad management

4. Crisis Management:

   • deposit insurance and insolvency proceedings

is a measure of a bank’s financial strength, indicating whether it has sufficient capital to cover its risks and absorb potential losses while protecting depositors and maintaining stability.

It is typically assessed using the Capital Adequacy Ratio (CAR), which compares a bank’s capital to its risk-weighted assets, ensuring compliance with regulatory standards like the Basel Accords.

ratio of capital to risk weighted assets (RWA) of 8%

risk weighted assets are calculated by adjusting each asset class for risk

to ensure that financial institution have sufficient liquidity to meet their short-term and long-term obligations

• Liquidity Coverage Ratio

  • that high quality liquid assets can be immediataly converted into money

  • is a percentage from dividing banks stock of high-quality assets by total net cash outflows

  • LCR is 100% (stock of high-quality assets must be at least as large as expected total net cash outflows)

  net cash outflows -> total expected cash outflows - total expected cash inflows

  cash outflows -> multipliying the current balance of liability products (deposits) and off balance sheet commitments (credit lines to customers)

• Net stable funding ratio (NSFR) under Basel III

  • banks diversify their funding sources

  • ratio between the amount of stable funding availabe (long-term deposits) and the amount of stable funding required (loans or investment) -> one year time horizon

  • ratio of 100% -> amount of available stable funding and required stable funding needs to be equal

to transfer funds from surplus units to deficit units for efficient capital allocation.

Surplus units: Households, businesses, governments, and foreign investors with excess funds.

Deficit units: Entities needing funds, like businesses, governments, or households.

Direct financing and indirect financing.

A process where surplus units provide funds directly to deficit units through financial markets

Stocks (equity) and bonds (debt).

Apple issues bonds to raise $20 million directly from an insurance company

A process where funds flow through financial intermediaries like banks, which act as middlemen.

Because they facilitate transactions between surplus and deficit units

A bank sells a certificate of deposit to a saver and uses the pooled funds to make loans

Direct financing involves direct transactions between surplus and deficit units, while indirect financing involves intermediaries.

Indirect financing (bank-based system).

Direct financing (market-based system)

Banks, insurance companies, mutual funds, and pension funds.

SMEs lack the expertise and scale to issue securities directly to investors

They pool funds from surplus units and allocate them as loans to deficit units.

A financial system relying primarily on banks for fund allocation, typical in Continental Europe

A financial system relying on financial markets for fund allocation, common in the USA and UK.

It provides a channel for SMEs and others to access funds without directly approaching financial markets.

It ensures funds are directed toward investments with the highest returns, driving economic growth.

• Transfer and allocation of resources

• monetary function

• risk management, and monetary policy transmission

offer direct insurance services, providing financial protection from possible hazards in the future.

The business is of assuming risks on behalf of customers in exchange for a fee (premium), compensate the policyholder for losses by a pre-defined event

Policies:

• Life Insurance (human event death)

• Non-life insurance (protection against financial losses)

They make profit by charging premiums that are sufficient to pay the expected claims to the company plus a profit

Balance Sheet:

• Assets -> Financial Instruments

• Liabilites -> Technical reserves (provisions to cover expected future claims)

Income Statement:

• Expenses -> Claims

• Income -> Premium

the combination of Technical reserves and Premium -> “Inverted production cycle” (policyholders pay premiums upfront and contractual payments are made only if and when an insured incident has happened )

provisions to cover expected future claims (most important element in the liablity side of the balance sheet).

is the way insurance companies insure themselves

distribution of insurance products via banking channels 

By influencing consumption and investment decisions through central bank interventions.

• Diversification

• hedging instruments

• financial contracts.

they lower transaction costs, overcome information problems and promote risk sharing

Are transaction costs, informational asymmetries and high unvertainty

refers ti the time and money required to carry out financial transactions. (f.e. search and information costs)

When high, these costs may make the exchange expensive for one or both parties, hindering channelling of funds

Financial Intermediates can reduce these costs by taking an advantage in economies of scale (units costs decreasing while production volume increasing) -> Bank reduces average costs of production while increasing output

It reduces individual investment risks by spreading investments across various assets

Portfolio return fluctuations, interest rate changes, and insolvency risks.

Transferring risks to third parties via financial contracts, like hedging.

A situation where one party lacks sufficient information about the other

Example:

• a borrower who takes out a loan has better information about the potential retursn and risk associated with the investment project

• Ex Ante: Before a contract (assessing borrower creditworthiness).

• Ex Post: After a contract (monitoring borrower behavior).

It prevents market failure and ensures fair financial transactions

• Price discovery

• trading mechanisms

• clearing and settlement.

Determining fair prices for securities based on market supply and demand.

• Listing Rules -> Discolsure Requirements

• Trading Rules -> Order Execution, Trading hours

• Clearing and Settlement -> to reduce Counterparty riks act as a Intermediate to ensure to completion of transaction (reduce risk of default)

  • Margin Requirements

• Regulatory Oversight -> like SEC or ESMA, must report market activities to regulators

Debt markets involve borrowing (e.g., bonds), while equity markets involve ownership stakes (e.g., stocks)

A market where new securities are issued directly to investors (e.g., IPOs).

A market where existing securities are traded among investors.

Exchanges are regulated platforms for trading, while OTC markets involve direct, less-regulated transactions.

Domestic markets operate within one country, while international markets span multiple countries.

Markets provide platforms for trading, while intermediaries facilitate transactions and manage risks.

Debt markets and equity markets.

Bonds, derivatives, and foreign exchange

• Transparency

• regular disclosures

• reduced counterparty risks via clearinghouses.

Flexibility and the ability to trade customized financial products.

Markets governed by regulatory authorities, ensuring transparency and investor protection

Markets without specific regulatory oversight, used by private parties for bespoke transactions.

They allow companies to raise capital and trade securities across borders, fostering global investment.

They ensure investors have accurate, timely information to make informed decisions

They reduce counterparty risk by guaranteeing trade settlement.

Higher counterparty risks and less transparency.

Access to a broader investor base and greater capital-raising opportunities.

• Debt vs. equity

• primary vs. secondary

• exchanges vs. OTC

• domestic vs. international.

facilitate short-term borrowing and lending, providing liquidity for governments, financial institutions, and corporations to meet immediate financial needs

• High liquidity

• large denominations

• low default risk

One year or less, often under 120 days

Governments, central banks, commercial banks, large corporations, and other financial institutions.

To manage short-term funding needs through instruments like Treasury bills.

Short-term debt obligations with defined maturity, interest rate, and par value.

Agreements where an asset is sold with a simultaneous commitment to repurchase it at a specified price.

A bank-issued security documenting a deposit, specifying an interest rate and maturity date.

A bank deposit payable the next business day.

Unsecured promissory notes issued by corporations for short-term funding, typically maturing within 270 days.

a short-term debt instrument issued by a company and guaranteed by a bank, commonly used in international trade to ensure payment for goods and services between buyers and sellers who may not know each other well

It ensures instruments can be easily traded without significant price impact

They provide short-term funding with minimal risk.

To secure quick and inexpensive funding for immediate needs.

To fill long-term financial needs with instruments having maturities over one year or no maturity.

Bond markets and equity markets.

Bond markets deal with debt securities, while equity markets involve ownership stakes

A debt security representing a loan from investors to the issuer, with periodic interest payments and principal repayment.

• Fixed/variable interest payments

• principal repayment

• mainly used for income generation and capital gains.

Governments, corporations, local authorities, and financial institutions

1. Face value

2. redemption value

3. issue price

4. coupon

Face value is the nominal value of the bond;

redemption value is the amount repaid at maturity, often equal to face value.

A bond with no periodic interest payments, repaid at maturity for its face value

is a contract in which the bond issuer and the bondholders outlines the terms and conditions of the bond

• detail of interest payment

• maturity dates

• principle payments

is a promise by the issuer to limit certain actions, such as taking on additional debts or excessive dividens, to protect to debtholder on reduce the default risk

A feature allowing issuers to redeem bonds before maturity.

A feature allowing bondholders to sell bonds back to the issuer before maturity.

To raise funds without diluting ownership

They provide long-term funding for governments and corporations, supporting economic growth.

By ensuring the issuer conserves resources for interest payments and avoids excessive risk-taking.

Financial practices that consider environmental, social, and governance (ESG) factors to promote long-term economic sustainability.

• Climate change mitigation

• biodiversity preservation, and pollution prevention

Addressing inequality, labor relations, and investing in communities

Transparent management structures and effective decision-making processes

It supports growth while addressing environmental and social challenges.

To limit global temperature increases to well below 2°C, ideally 1.5°C.

By 2025, with a 43% reduction by 2030

A set of 17 UN goals aimed at promoting sustainability, reducing inequality, and ending poverty by 2030.

By promoting renewable energy, sustainable cities, and environmental preservation

By funding projects that reduce carbon emissions and promote clean energy

They offer the option to convert debt into equity, potentially benefiting from company growth

• Social bonds

• green bonds

• sustainability-linked bonds (SLBs).

A bond issued to fund projects with positive societal impacts, like education or health

A bond issued to finance environmentally sustainable initiatives like renewable energy

A bond tied to sustainability targets, with interest rates adjusted based on target achievement.

ICMA guidelines ensuring transparency, eligibility, and reporting in green bond issuance

Enel issued an SLB tied to renewable energy capacity and CO2 emissions reductions

• Dividends: Receiving a share of company profits.

• Capital Gains: Earning from the appreciation of stock value

Voting on important matters like board elections, mergers, and financial statements

By complying with regulatory and transparency requirements, increasing its national and international profile.

Interest rates increase or penalties apply, depending on bond terms.

Common stock has voting rights and potential for higher returns; preferred stock has no voting rights but priority for dividends and assets.

this problem comes arises after an contract was made (Ex-post) where the lender of the investment knows more than the borrower does.

For lenders it is difficult and costly to evaluate potential borrowers (no time, capacity or means to collect information)

this lead to adverse selection when potential borrowers produce an undesriable (averse) outcome - bad credit riks -> lenders not make any loan

Intermediates can reduce averse selection since they have a better way of selecting the good credits -> improving resource allocation

is a problen once a loan has been granted -> risk that the borrower will engage in undesirable activities (perspective of lender -> increase of probability of default)

lowers the probability that the loan will be repaid

Finanical Intermediates mitigate the infomation acquisition -> banks can crease arrangments that force managers to behave in a way to ensures that the loan will be repaid.