Bank Management

Dr. Rania Salem Department of Finance

Spring 2012 Lecture notes-1 Introduction to Banking Environment

Dr. Rania Salem/Bank Management Spring 2012

General Information
Lecturer: Dr. Rania Salem Instructor Office Hours: Thursday 2nd and 3rd slots, B3.209 Teaching Assistants: Mrs. Samah Adel & Ms. Menna Hafez Course Schedule: Tuesday 8:30 10:00, H3 Textbook: Selected References will be announced per topic Bank Management & Financial Services by Rose & Hudgins, 8th ed., McGraw-Hill, New York 2010. Course Assessment: Final Exam: 40% Midterm Exam: 20% Course Work (Quizzes and Assignments): 40%

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Course Agenda
A. Basic Bank Management Techniques
1. Introduction 2. RoE based Profitability Management 3. Matched Funds Transfer Pricing Concept

B. Risk and Return an Integrated Approach

1. Principles of Risk/Return Management 2. Value Based Performance Management

C. Bank Specific Issues

1. Credit Risk Management 2. Operational Risk Management 3. Introduction to Islamic Banking
Dr. Rania Salem/Bank Management Spring 2012/3

Course Agenda
A. Basic Bank Management Techniques
1. Introduction 2. RoE based Profitability Management 3. Matched Funds Transfer Pricing Concept

B. Risk and Return an Integrated Approach

1. Principles of Risk/Return Management 2. Value Based Performance Management

C. Bank Specific Issues

1. Credit Risk Management 2. Introduction to Islamic Banking
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Banking Activities
Banks (as financial intermediaries) facilitate the flow of funds from surplus spending units (savers) to deficit spending units (borrowers) Important functions Risk transformation Volume transformation Maturity transformation Some unique characteristics Banks are usually under regulatory supervision Their function is primarily financial, thus most banks own few fixed assets The liabilities are usually payable on demand or carry short term maturities, therefore being highly dependent on interest rate changes Banks usually operate with less equity than nonfinancial companies, leading to a high financial leverage and volatility of earnings

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The Balance Sheet

As always: Assets = Liabilities + Equity Typical bank assets Loans, usually the major asset Investment securities Noninterest cash and due from banks Other assets Typical bank liabilities Transaction accounts Savings and Time Deposits Other Borrowings
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The Income Statement

= + = Gross Interest Income Interest Expenditures Net Interest Income Commission Income Trading Income Other Income Total Operating Income Total Operating Expenditure

=
= = =

Gross Operating Profit Provisions for Loan and Lease Losses

Net Operating Profit Extraordinary Profit/Loss Net pretax Profit Applicable Taxes Net after-tax Profit

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The four Building Blocks for an integrated Management Control System in Banks
Profit Oriented Business Philosophy
Institutionalized Management Control Cycle Market Oriented dual Organization of Structures and Processes

Adequate Information System

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Building Block 1: Profit Oriented Business Philosophy

Profit oriented target system on all decision levels
(1) Primacy of Profitability (2) Growth and risk policy as instruments to secure and increase profitability

Profit oriented incentive scheme in consistence with decision competence and responsibility
(1) Profit oriented design of the compensation system (2) Synchronization of bank profitability targets and personal income and career targets

Profit oriented calculation systems to measure customer and market attractiveness

(1) Collection of customer related results (actual, budget, potential) (2) Absolute condition for customer or segment specific decisions
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Building Block 2: Market Oriented dual Organization of Structures and Processes

Consequent orientation towards a customer oriented profit center organization Cross sectional coordination of customer related divisions, using product and functional departments with decisional authority and structural profit responsibility Organizational structure with processes (value chains) instead of bureaucratic competency rules (decreasing of hierarchies in favor of activity based structures)

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Building Block 3: Institutionalized Management Control Cycle

Organization of planning should follow top-down/bottom-up process Regular monitoring of the achievement of objectives and systematic variance analysis, following the Management by Exception principle Ensure that problem awareness, competence, and responsibility are present at the interface between bank and market, following the Self Controlling principle Coordination of decisions and activities following the Dual Steering Model; i.e. Integration among decision making and the different individual departments
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Dual Steering Model

Centralized structural steering

regulatory standards regarding the balance sheet overall structure of the credit portfolio strategic structure of business segments central investment decisions central product decisions cost of overhead maturity and currency transformation profit profit oriented growth minimum profitability

related to business structure Integration Agreement on objectives

Additional instruments

Own account trading

volume budgets cost budgets budget and/or minimum margins

benchmarks limits bonus malus systems

interbank transactions securities trading foreign exchange trading

Retail actions Local market related steering

business volume credit/debit margins commissions

Wholesale actions

net margins marginal income

related to individual contracts or departments

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Building Block 4: Adequate Information System

Decision-relevant profit information (conceptual for each individual contract, target and actual values) Complete transparency of the profit sources in customer business (dice model) as well in central investment, financing, and trading departments Integrated risk performance and risk taking capacity information for counterparty, operational, and market risk

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Three Dimensions of Profit Generation

Products
Savings Deposits Mortgage Loans Current Account Overdrafts Time Deposits

A B C D E

Distributive Channels / Regions

6 Customer

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Banking Regulations
The banking regulatory scheme in any country is categorized into three levels: 1. Regulations that address the activities eligible by banks 2. Regulations of accounting and disclosure standards related to banking and investor protection 3. International regulations

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International (Global) Banking System

Banks are globally interconnected through financial markets and inter-bank activities Advantages of Global Banking: ?? Disadvantages of Global Banking: ?? The Bank for International Settlement (BIS) is the bank of central banks
Provides guidance to Central Banks Regulations Worldwide Proposed the Basel Accord as an international regulation

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Basel Accord: Role & History

The Basel Capital Accord was first introduced by the BIS in 1988 to:
1. 2. Ensure the efficiency of banks risk management Support the confidence of market participants in the banking system through proposing adequate principles and methods of a best practiced risk management framework

Basel II was introduced in 2001 and implemented in 2004 Recently, Basel III has been introduced in the market, in response to the subprime financial crisis

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Basel II Pillars
Pillar 1 Minimum Capital Requirements Proposed Assessment Methods under Pillar 1
Standardized Approach Internal Rating-Based Approach: i. Foundation IRB ii. Advanced IRB Standardized Approach Internal Model Approach

Pillar 2
Supervisory Process

Pillar 3 Market Discipline

Credit Risk

Market Risk

Operational Risk

Standardized Approach Basic Indicator Approach Advanced Measurement Approach

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Banking Sector Problems in Egypt

A majority of people face the problem of limited access to financial intermediation, which is a constraining factor for economic growth Limited access to finance is not just a matter of ability to pay the interest but also connections and relationships with key banking sector and finance ministry officials As of 2006 estimations, less than 10% of the population have a bank account Egypt has a public sector dominated banking system. The guaranteed income for the government-owned banks denominated by government securities with short maturity reduced the banks' incentives to develop capacity to serve small and medium private investors.

Non Performing Loans

The Egyptian Banking sector has long suffered from the accumulation of non performing loans (NPL) which reached its peak in the late 1990s The NPL problem can be summarized as follows: Corruption in the lending activities, as loans were given based on overvaluing assets to fit the collateral base of each bank and disregarding future cash flows of the borrowing entities. This problem is a clear result of weak supervision by the CBE Public banks were used to lend state-owned companies based on government instructions; e.g. 26 billion EGP are owed by public enterprises to the four state owned banks As a result, the banking reform program was set to tie up this deteriorating situation of increasing NPLs, including both public and non-public banks

Banking Sector Reforms since 2003

Major Elements
Raising the minimum capital requirement for banks, this led to mergers and acquisitions Administrative and financial restructuring of the public-sector banks Privatizing the big public sector banks and divesting their stakes in joint ventures Strengthening of regulatory supervision by the CBE

As a first result, the number of banks declined from 57 (September 2004) to 43 (June 2006) The government aims to scale back the number of banks to 22

Egyptian Banks in Response to Crisis

?
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