CH02+solutions - Chapter 2 Commercial banks Commercial...

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Chapter 2 Commercial banks Commercial banks are the largest group of financial institutions within a financial system and therefore they are very important in facilitating the flow of funds between savers and borrowers. The core business of banks is often described as the gathering of savings (deposits) in order to provide loans for investment. The traditional image of banks as passive receivers of deposits through which they fund their various loans and other investments has changed since deregulation. For example, banks provide a wide range of off-balance-sheet transactions. Banks now actively manage their sources of funds (liabilities). They offer a diversity of products with different return, risk, liquidity and cash-flow attributes to attract new and diversified funding sources. Sources of funds include current deposits, call or demand deposits, term deposits, negotiable certificates of deposit, bills acceptance liabilities, debt liabilities, foreign currency liabilities, loan capital and shareholder equity. Commercial banks now apply a liability management approach to funding growth in their balance sheets. Under this approach a bank will borrow in the domestic and international money markets and capital markets to obtain sufficient funds to meet its forecast loan demand. This has resulted in strong growth in the issue of securities such as negotiable certificates of deposit, debentures and unsecured notes. Banks also issue subordinated debt (loan capital) and equity, including preference shares, convertible notes and ordinary shares. The use of funds is represented as assets on banks’ balance sheets. Bank lending is categorised as personal and housing lending, commercial lending and lending to government. Personal finance is provided to individuals and includes housing loans, investment property loans, fixed-term loans, personal overdrafts and credit card finance. Banks invest in the business sector of the economy by granting commercial loans. Commercial loan assets include overdraft facilities, discounted commercial bills held, term loans and lease finance. While banks may lend some funds directly to government, their main claim is through the purchase of government securities such as Treasury notes and Treasury bonds. Viewing banks only in terms of their assets and liabilities greatly underestimates their role in the financial system. Banks have recorded strong growth in their off-balance-sheet business. The notional value of off-balance-sheet business is nearly six times the value of the accumulated assets of the banking sector. Off-balance-sheet business is categorised as direct credit substitutes, trade- and performance-related items, commitments, and foreign exchange, interest rate and other market-rate-related contracts. Over 90 per cent of banks’ off-balance-sheet business is in market-rate-related contracts such as
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CH02+solutions - Chapter 2 Commercial banks Commercial...

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