Banking Strategies

Traditional banking strategies, attracting household deposits in

exchange for interest payments and transaction services and earning a
profit by lending those funds to business customers at higher interest
rates. These traditional banking services intermediate the flow of credit
from savers to borrowers and transform the short-term savings desired
by households into longer term loans
Nontraditional strategies, such as credit card banks or mortgage banks
that offer few depositor services, sell off most of their loans soon after
making them, and earn profits from the fees they charge for originating,
securitizing, and servicing these loans. Nonbanking activities include the
traditional investment banking activities of securities underwriting,
merger and acquisition advice, and a variety of other activities. Among
these other activities are securitization, securities lending and
borrowing, prime brokerage, market making in securities and
derivatives, and customer and proprietary trading.
Small banks operating in local markets develop close relationships with
their customers, provide value to depositors through person-to-person
contact at branch offices, and make relationship loans to inform
ationally opaque borrowers (for example, small businesses) that do
not have direct access to financial markets.
Large banks take advantage of economies of scale in the production,
marketing, securitization, and servicing of transaction loans like credit
cards and home mortgages.

From a risk perspective, traditional banks that provide deposits and make and hold
loans to maturity have to manage credit, interest rate, and operations
risks. Nonbanking activities magnify the traditional risks and create
new ones, such as price risk from trading, counterparty risk from
derivatives transactions, and funding risk from greater dependence on
rolling over uninsured, wholesale money market funding.

Bank Financial Statements

Balance Sheet
Typical balance sheet:
ASSETS

LIABILITIES
Cash
Loans
Other investments

Deposits
Money & Capital Market
liabilities
Owners Equity

Typical income statement:

INCOME STATEMENT
Net Interest Income

Interest payments on assets

Interest payments on liabilities

Net NonInterest Income

Fee and commission income
Fee and commission expense
etc
Other expenses
General administrative expenses etc
Depreciation, amortisation and impairment charges of
tangible and intangible assets
Net loan losses
Profit before taxes

Income
Net Interest Income (NII)
The difference between revenues generated by interest-bearing
assets and the cost of servicing liabilities. NII is the difference
between (a) interest payments the bank receives on loans
outstanding and (b) interest payments the bank makes to
customers on their deposits
NII = (interest payments on assets) (interest payments on
liabilities)

Non Interest Income

Banks earn substantial amounts of noninterest income by charging
their customers fees in exchange for a variety of financial services
- Nontraditional Fee-generating activities
o Investment banking
o Securities brokerage
o Insurance activities
o Merchant Banking

- Traditional Fee-generating activities

o Deposit account services
o Lending
o Cash management
o Trust account services
o Deposit account services
o Lending
o Cash management
Banks have always earned noninterest income from their depositors,
charging fees on a variety of transaction services (for example,
checking and money orders), safe-keeping services (for example,
insured deposit accounts, safety deposit boxes), and cash management
services (for example, lock box or payroll processing). Other traditional
lines of business for which banks have always earned fee income
include trust services provided to a wealthy retail clientele and
providing letters of credit (as opposed to immediate dispersal of loan
funds) to corporate clients.
Advances in credit-scoring models and asset-backed securities markets
have transformed the production of consumer credit and home
mortgages from a traditional portfolio lending process, where banks
earn mostly interest income, to a transaction lending process, in which
banks earn mostly noninterest income (eg loan servicing fees,
securitization fees etc. )
Advances in communications and information technologies have led to
new production processes for transactions and liquidity services, such
as ATMs and online bill-pay, and deposit customers have been willing to
pay fees for these conveniences.
Providing payment services in an under-appreciated source of
noninterest income for banking companies and its importance may be
growing. Depending on their business model and competitive strategy,
banks can and do charge fees for these payment-related services.

Loans and Receivables

Loans and receivables are non-derivative financial assets, with fixed or
determinable payments, that are not quoted in an active market.
In accordance with IAS 39, they are initially valued at fair value and
subsequently valued at amortized cost using the effective interest rate
method. The effective interest rate is the rate that exactly discounts
estimated future cash payments to the original net loan amount. This rate
includes the discounts and any transaction income or transaction costs
that are an integral part of the effective interest rate.

Syndication loans held for trading are classified as financial assets held for
trading and are marked to market.
Subordinated loans and repurchase agreements (represented by
certificates or securities) are included under the various categories of
loans and receivables according to counterparty type. Income calculated
based on the effective interest rate is recognised in the balance sheet
under accrued interests in the income statement.

Impairment of loans
In accordance with IAS 39, loans classified under Loans and receivables
are impaired whenever there is objective indication of impairment as a
result of one or more loss events occurring after the initial recognition of
these loans, such as:
-

-borrower in serious financial difficulties;

-a breach of contract such as a default on the payment of interest or
principal;
-the granting by the lender to the borrower, for economic or legal
reasons connected with the borrowers financial difficulties, of a
facility that the lender would not have envisaged under other
circumstances (loan restructuring)
-increasing probability of bankruptcy or other financial restructuring
of the borrower.

Impairment may be individual or collective, or in the form of discounts on

loans that have been restructured due to customer default.
Exposures that have been past due more than 90 days are by definition
regarded as non-performing, and reported as impaired or not impaired
depending on the deemed loss potential.

Loan restructuring
Loans restructured due to financial difficulties are loans for which the
entity changed the initial financial terms (interest rate, term) for economic
or legal reasons connected with the borrowers financial difficulties, in a
manner that would not have been considered under other circumstances.
The reduction of future flows granted to a counterparty, which may
notably stem from these flows being postponed as part of the
restructuring, results in the recognition of a discount. It represents future
loss of cash flow discounted at the original effective interest rate.
It is equal to the difference between:
-

the carrying amount of the loan;

and the sum of theoretical future cash flows from the restructured
loan, discounted at the original effective interest rate (defined at
the date of the financing commitment). The loss recognized when a
loan is restructured is recorded under cost of risk. Its amortization
then affects the interest margin.

BALANCE SHEET

INCOME STATEMENT

-Loan and receivables

- Income Interest
- Loan Losses