Summary Business Planning Banking Notes

Business Planning: Banking
Summary Notes
UK Regulatory Regime 2

Ratios 2-3

Valuation of banks 3

Risk Management 3-4

Company securities 5

Derivative 5

Embedded Derivative 6

Definition of Financial Instruments 6

Classification & Measurement of Financial Assets 7

Classification & Measurement of Financial Liabilities 8

Fair value of Financial Assets 8

Hedge Accounting 8

Impairment of Financial Instruments 9

Hedge accounting 9-10

Financial Instruments: Disclosures 10

The Basel (III) Framework 11-12

Audit and Assurance for Banks 13




1

,UK Regulatory Regime

The Financial Services Act 2012 set up three main regulatory bodies:

 Prudential Regulatory Authority (PRA) →subsidiary of the Bank of England and is responsible to
promote safety and soundness by requiring banks to hold adequate levels of capital and have sufficient
liquidity to act as a buffer against losses. Also Senior Management Regime(SMR), PRA must approve
 Financial Conduct Authority (FCA) →responsible to the Treasury and promotes confidence in the
financial system (maintains integrity, competition, customers get a fair deal etc.)
 Financial Policy Committee (FPC) →committee of the Bank of England focusing on the stability of the
financial system(macro-economic)



UK banks have a relationship with the Bank of England through the PRA (their prudential regulator). The Bank
of England:

● Reserve accounting →acts as a banker to financial institutions by allowing UK banks to
maintain reserve accounts with the BoE to serve as a liquidity buffer;
● Provision of liquidity →allows banks to borrow from it, or use the BoE to swap illiquid assets
for liquid assets.

The role of the Bank of England is that of a lender of last resort.
Page 21 Kaplan FCA’s 11 high level principles



Ratios
Name Formula Significance
Changes in impairments Growth of impairments VS Bigger growth in loans than impairments could
and loans growth in loans indicate better asset quality or relaxation of credit
checks

Changes in collateral Value of collaterals A fall in this ratio indicates that collateral values
VS value of loans have fallen and therefore asset quality is reduced
since bank is now not 100% covered

Leverage ratio  Gearing for the banks
Total equity  Regulation requires banks to have a minimum of
Total assets 3%

Loans to deposit ratio >100% indicates more reliance on funding other

¿
Loans∧advances ¿ customers than deposits
 Customer deposits
<100% indicates bank may be extremely
conservative and not maximize returns
NPL ratio  Percentage of outstanding loans not performing
Gross NPL  Higher indicates a decline in loan book
Gross total customer loans
NPL coverage ratio  Percentage of NPL covered by impairment
Total impairment allowances Shows how prudent the bank is
Gross NPL




2

, Cost income ratio (CIR) Operating costs Measures bank’s efficiency
Total operating income
Rate of return Interest income /expense If no average use year end
Use interest bearing assets/liabilities
Average assets /liabilities
Net interest margin How net interest income is generated per £1 of asset
(NIM)
Net interest income
Average asset
Return on equity (RoE) Using pretax or after-tax profits
Net profit How well a bank uses the equity base to produce
Equity profit

Return on assets Using pre-tax or after-tax profits
Net profit
Average assets

*Note: Other ratios can be found on Kaplan page 77.



Valuation of banks
 Price earnings ratio
 Return on equity
 Price to book

Issues
− Impairment allowances are judgmental, so some banks may be more prudent
− Banks report assets and liabilities at up to date fair value. So great relevance of price to book ratio
Market capitalisation
Net assets

Risk management

Financial risks

 Credit risk - Customer may not repay loan
 Market risk – Prices of assets in the market
 Operational risk – Fail of internal processes, people and systems
 Liquidity risk – Bank not having access to enough liquid funds
 Capital risk – Not enough regulatory capital to meet regulator’s minimum capital requirements
 Systemic risk – Risk of financial system fail


Non-financial risks

 Regulator risk – Bank not following rules of regulators
 Reputational risk – Loss of customer goodwill from bad reputation
 Concentration risk – Heavily invested in a particular asset class
 Geopolitical risk – Loss in the value of assets as a result of geopolitical events
 Control risk – From internal control systems
 Technology risk – Failure of IT systems of cybercrime
 Strategic risk – Risk from the bank’s strategy from changes in business environment
 Legal risk – From changes in current law or a court decision
Response to risk Framework stages
3