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CITIZEN ACT - season 2011-2012Basic Banking Knowledge

CITIZEN ACT – SEASON 2011-2012

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INTRODUCTION

The word “bank” comes from the Italian word “banca” which referred to a wooden bench upon which the Middle-Age money-changers carried out their activity. Banks as we know them were developed in the 19th century. Merchant banks were created, aimed at financing businesses at the height of the industrialisation period: Société Générale was founded at this time. Only later did banks generalise the collection of dormant savings of the general public.

The objective of this training are To find out about the role, operation and obligations of banking establishments

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CONTENTS

What are banks for?

How does a bank operate?

Risk management

CITIZEN ACT – SEASON 2011-2012

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CHAPTER 01

What are banks for?

CITIZEN ACT – SEASON 2011-2012

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Financing the economy

Banks remunerate deposits from governments, households, businesses

They grant loans to finance projects and develop businesses The money deposited can be used by

the banks to transfer to applicants in the form of credit. Credit is essential in the economy; Both

granting and withdrawing credit have serious and immediate consequences on the life of a business.

Credit encourages investment, growth of businesses and consumption in households. Therefore,

banks are granted an important power: when banks grant loans with reduced rates, it has

consequences on the economy (economic agents are more inclined to borrow). The opposite effect is

also possible. Banks therefore have a real power over economic agents. Customers of the bank often

find themselves both depositing and borrowing money at the same time or successively.

They make payment methods available. These vary greatly, but the majority of these payment methods are the following; Transfer, direct debit, cheque, bank card. More than one third of transactions carried out in Europe in 2009 were made by card (37%).

Therefore, banks have a role of intermediary (link between shareholders and customers)They participate in the growth of the economy

What are Banks for?

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Households

Businesses with a

surplus cash flow

Institutional investors:

Insurances, pension funds,

private health insurance,

asset management bodies…

Households

Businesses in need of

finance

The government

(financing its deficits)

Banks themselves

Banks are

the link

Those who have liquid assets

Those who need liquid assets

Guarantees the circulation of liquid assets

What are Banks for?

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Transforming deposits into loans

The bank collects resources from its

customers (short term deposits)

It transforms these deposits into medium and

long term loans

Hence the need to respect the liquidity

ratio, in order to be able to pay

RISQ

NB liquidity ratio = relation between liquid and mobilisable assets and short term

commitments

This ratio must always be above 100%.

What are Banks for?

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CHAPTER 02

How does a bank operate?

HOW DOES A BANK OPERATE ?

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The bank makes a turnover (known as Net Banking Income) through:

deposit margin (difference between the rate provided to a customer and the rate at which the

bank can invest the funds on the money market)

credit margin (difference between the rate applied to a customer and the rate at which the bank

can refinance on the market for the same duration)

bank commission (Sum collected by a bank in payment for a service provided to its customer)

financial commission (Sum received by the bank and associated with a financial product)

HOW DOES A BANK OPERATE ?

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- On the following slide, try to create a bank’s profit and loss account by placing the and defining the elements.

Preparation time 10’

Exercise

HOW DOES A BANK OPERATE ?

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Gross Operating Profit

Operating Profit

Place these elements and explain how they are calculated

Charges Products

= Net Banking Income (NBI)

HOW DOES A BANK OPERATE ?

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Interests paid

Commission paid

Other

Overheads

(salaries, depreciation, taxes, other)

Gross Operating Profit

Cost of risk

Operating Profit

Interest received

Bank commission received

Financial commission received

Other

Let’s discover a simplified profit and loss account

Charges Products

= Net Banking Income (NBI)

NB: NBI= products-charges

Gross Operating Profit= NBI– Overheads

Operating profit= Gross operating profit – cost of risk

Operating ratio = overheads/ NBI

HOW DOES A BANK OPERATE ?

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CHAPTER 03

Risk management

RISK MANAGEMENT

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Different types of risq must be managed into a financial institution.

In the following slides, we will discover and define them.

RISK MANAGEMENT

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Exchange rate risk

Interest rate risk

Liquidity risk

Counterpart risk

Market risk

Operational risk

Risk of loss associated with the inability of a customer or a counterpart to meet their

financial obligations

Risk of loss associated with the volatile nature of financial instruments or currency

rates

Risk of loss resulting from an inadequacy or failure attributable to procedures, staff or

internal systems, or to external occurrences

Risk of loss associated with variations of exchange rates.

Risk of the bank’s financial conditions being exposed to unfavourable interest rates

Risk of inability to meet the commitment of repaying debts to their maturity or of paying

off a debt liability (financing of the bank’s activity).

RISK MANAGEMENT

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Bank risks (1)

Counterpart risk, specific to the banking activity

Risk of loss associated with the inability of a customer or a counterpart to meet his financial obligations. It can for example, come into play when a company goes bankrupt or when an individual has a debt burden.

Market Risk

Risk of loss associated with the volatile nature of financial instruments or currency rates. Tus, any change in share rates, the price of raw materials, or rates, has an impact on market positions and portfolios.

RISK MANAGEMENT

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Bank risks (2)

Operational risk

It is inherent in all of the Group’s products, activities, procedures and systems. The ethical aspects, computer security and anti-money laundering struggle are linked to it. It concerns everybody, regardless of their position and responsibilities. It is a strategic stake.

It is the risk of loss resulting from an inadequacy or failure attributable to procedures, staff or internal systems, or to external occurrences , including events that are unlikely to occur, but that have a high risk of loss.

-The definition of operational risk provided by the SG Group excludes the strategic risk but includes reputational risk.

-Non-compliance risk is also included in the definition of operational risk.

It can damage the bank’s image.

Examples of OR: OR caused by employees (fraud, damages, sabotage,…), the internal management procedure (operational risk, liquidity risk,…), the system (risks linked to technological investment, violation,…) and by external events (legal aspects, natural disasters,…)

RISK MANAGEMENT

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Bank risks (3)The exchange rate risk

Exchange rate fluctuations can directly influence the purchasing and sale price, and therefore the margin. If the bank has claims and debts in currency, it leads to gains or losses in the event of variations in the rates of the currency.

The interest rate riskRisk of the bank’s financial conditions being exposed to unfavourable interest rates.

If a bank’s long term fixed-rate loans are partially financed by resources with a floating rate, it risks seeing the rate of the resources reaching or exceeding the rate of the loans if there is a rise in the money market rates. That would damage its profitability.

The liquidity riskRisk of inability to meet the commitment of repaying debts to their maturity or of

paying off a debt liability (financing of the bank’s activity). Banks mainly receive short term deposits from their customers, and give medium and long term loans. Therefore a gap can grow between the amount lent and the amount available (deposits), with the latter possibly being insufficient. This is known as a lack of liquid assets.

RISK MANAGEMENT

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A strategic stake for banks

The bank must continuously assess risks and act cautiously. The Banker must analyse the potential

risk of each application and find the right balance between expansion, sales and caution.

Covering risks means safeguarding the long-term survival of the system by guaranteeing a

sufficient level of shareholders’ equity and by an effective risk management policy.

It is a regulatory requirement and is necessary to improve the efficiency and profitability of the

bank. (less risky bank =>increase in investors’ trust =>increasing NBI)

RISK MANAGEMENT