Principles of Banking (eBook)

MOORAD CHOUDHRY is a non-executive director at Recognise Bank Limited, in London, a non-executive director at the Loughborough Building Society, and an independent non-executive advisor on the Risk Committee at Nubank, in Sao Paulo. He was born in Bangladesh and lives in Surrey, England.

Cover 1
Title Page 13
Copyright Pages 14
Contents 17
Foreword 21
Neal Ardley 21
Sharon Bowles 25
Henrique Fragelli 27
Oldrich Masek III 31
Jason Oakley 37
Helen Sachdev 39
Preface 41
Acknowledgements 47
Preface to the First Edition 49
About the Author 53
PART I Banking, Bank Customer Business and Regulation 55
Chapter 1 Banking, Bank Business and Financial Statements1 57
An Introduction to Banking 57
Bank Business Model 63
Banking Business And Capital 66
Bank Products and Net Interest Margin Management 70
Financial Statements and Ratios 79
The Money Markets 86
Loan Valuation 92
Risk Exposures in Banking 103
Chapter Summary 121
Appendix 1.1 Summary Overview of Bank Product Line 123
Appendix 1.2 Overnight Reference Rates (RFR)16 124
References and Further Reading 128
Chapter 2 Ethics, Conduct and Customer Service 129
A Bank’s Customers 130
Anti-Money Laundering and Know Your Customer 134
Ethics and Customer Service 139
Ethics and Conduct 143
Ethics, Conduct and Reputation Risk 147
Chapter Summary 149
References and Further Reading 150
Chapter 3 Bank Regulatory Capital and the “Basel Rules”1 151
Bank Regulatory Capital Requirements 151
Macroprudential Regulation 154
Basel I 155
Basel II 160
Basel III 171
The 2017 Basel III Reforms (“Basel IV”) 183
From 2017 to the Future 190
Cryptoassets 192
Climate Change Related Financial Risks 193
Chapter Summary 194
Appendix 3 196
References 208
PART II Bank Asset and Liability Management 213
Chapter 4 The Yield Curve 215
The Yield Curve 215
Importance of The Yield Curve 216
The Money Market and Capital Market Yield Curve 216
Types of Yield Curve 219
Analysing and Interpreting the Yield Curve 224
Further Views on the Yield Curve 234
Formal Policy for Setting the Bank’s Internal Funding Curve 239
Constructing The Bank Internal Funding Curve 241
Yield Curve Building from Market Rates 250
Chapter Summary 251
References and Further Reading 251
Chapter 5 Asset–Liability Management I 255
Origins of Bank ALM 256
Basic Concept Of ALM 257
Liquidity Risk 260
Managing Liquidity: Baseline Principles 266
Interest-Rate Risk and Source 270
The ALM Desk 275
Template ALM Policy for a Commercial Bank 277
Middle-Office Treasury Procedure and ALM Practice11 277
Strategic ALM 284
The Concept of ALM Optimisation13 295
ALM and Negative Interest Rates 297
Chapter Summary 300
Appendix 5.1 300
References and Further Reading 303
Chapter 6 Balance Sheet Management: Money Markets, FX, Trading and Hedging, and Securitisation 305
Money Market Instruments and Foreign Exchange 306
Money Markets Rates 306
Foreign Exchange Markets1 308
FX Balance Sheet Hedging 315
Trading Approach 321
Interest-Rate Hedging Tools 323
Interest-Rate Swap Hedging Applications 328
Hedging Interest-Rate Risk Using Interest-Rate Swaps 330
Overnight Index Interest-Rate Swaps 333
Interest-Rate Risk Exposure and Option Hedging 335
Hedging using Bond Futures Contracts 340
Balance Sheet Management and Securitisation10 344
Treasury Desk Investment Guidelines Template 351
Chapter Summary 355
References 356
Chapter 7 Managing Interest-Rate Risk in the Banking Book (IRRBB)1 357
Interest-Rate Risk in the Banking Book 358
The Interest-Rate Gap Report 359
NII Sensitivity 363
Economic Value of Equity (Eve) Sensitivity 365
The Management of Gap Risk 369
The Management of Basis and Optionality Risks 371
The Management of Prepayment Risk 376
The Management of Pipeline Risk 378
The Management of Cap and Floor Risk 379
The ALCO Report for IRRBB 380
Credit Spread Risk in The Banking Book (CSRBB) 380
BCBS386: The Basel Committee Principlesfor Interest- Raterisk in the Banking Book 384
A Final Word on IRRBB 385
Chapter Summary 386
Further Reading 386
Chapter 8 Bank Treasury Operating Model1 387
Locating the ALM Function 387
Treasury Operating Model 389
Group Treasury Operating Model 393
Chapter Summary 404
References and Further Reading 404
Chapter 9 ALCO Governance Framework and Terms of Reference 405
Traditional Alco Model and Policy 406
The Modern-Day ALCO 417
ALCO Reporting 423
Chapter Summary 435
References and Further Reading 435
Chapter 10 ALM Sundries: Asset Encumbrance, Hedge Accounting, IFRS 9 and EIR1 437
Asset Encumbrance 437
Hedge Accounting4 445
High Level Principles of IFRS 9 and EIR 449
Chapter Summary 453
References and Further Reading 453
PART III Bank Liquidity Risk Management 455
Chapter 11 Principles of Bank Liquidity Management 457
Bank Liquidity 458
Sustainable Banking: Ten Principles of Bank Liquidity Risk Management 462
The Bank Liquidity Policy Statement 468
Policy on Intra-Group Lending 472
The Liquid Asset Buffer5 475
Liquidity Management And Collateral 488
The Contingency Funding Plan 491
Chapter Summary 496
References and Further Reading 496
Chapter 12 Liquidity Risk Metrics1 499
Two Key Liquidity Metrics 500
Basel Liquidity Metrics 502
Chapter Summary 513
Further Reading 513
Chapter 13 Liquidity Risk Reporting 515
Liquidity Risk Reporting 515
Regulator Reporting 517
Chapter Summary 522
Chapter 14 Bank Funds Transfer Pricing1 523
The Concept of Funds Transfer Pricing 525
The Development of Funds Transfer Pricing 533
Pricing Liquidity 535
Funds Transfer Pricing Policy Template 541
Chapter Summary 543
References 543
PART IV Bank Strategy and Governance 545
Chapter 15 Bank Strategy IInputs and Setting 547
The Strategic Planning Process 549
Strategy and the Bank Business Model 555
Evaluation of the Strategic Plan 571
Conclusion 572
Chapter Summary 573
References and Further Reading 574
Chapter 16 Bank Strategy IICapital and Funding Management 575
Textbook Treatment of Bank Capital 575
Capital Management Policy 577
Benchmarking with the Market 581
An Integrated Capital And Liquidity Management Strategy 586
Capital Management: Capital Instruments 590
Capital Management Strategy 592
Chapter Summary 593
References and Further Reading 593
Chapter 17 Principles of Corporate Governance1 595
Effective Bank Corporate Governance: Conclusions from the 2008 Bank Crash 596
Market Observations 604
Conclusion 613
Policy Recommendations 615
Management Structure 617
Governance and Sustainable Banking 622
Chapter Summary 623
References 624
PART V Principles of Risk Management and Regulation 627
Chapter 18 The Risk Management Framework 629
Risk Exposures in Banking 629
Macro-Level Risk Management and Strategy 633
Risk Management Framework Template 637
Example of Board-Level Ras 665
A Final Word 668
Chapter Summary 669
Reference 669
Chapter 19 Credit Risk Assessment and Reporting Principles 671
Drivers of Credit Risk 671
Portfolio Risk Reporting 682
Risk Policy 687
Product Line Risk Reporting 688
Business Line Reporting 693
Chapter Summary 696
Reference 699
Chapter 20 Stress Testing, ICAAP, ILAAP and Reverse Stress Testing1 701
Stress Testing Policy 701
Sample Stress Test Results 708
Scenario Analysis: Economic Downturn Stress Test Report 713
Liquidity Stress Test Reports 717
Internal Capital Adequacy Assessment Process (ICAAP) 720
Internal Liquidity Adequacy Assessment (ILAAP) 731
Reverse Stress Testing: Definition, Approach and Relevance 740
Chapter Summary 744
Reference 745
Chapter 21 Recovery Planning and Resolution Planning 747
Recovery Planning and Resolution Planning1 747
Conclusion 755
Chapter Summary 756
Reference 756
Chapter 22 Sustainable Banking and Climate Change Risk Management 757
Sustainable Banking and Green Banking 757
Climate Change Risk Management 765
Chapter Summary 773
Reference 773
Chapter 23 Case Studies: Analysis, Problem Solving and Decision Making 775
Coherent Advice and Problem Solving: Case Studies 776
Appendix 23.1 802
Chapter 24 Everything Changes, and Nothing Changes: Excerpts from a Timeless Work1 807
Core Principles of Banking 808
The Balance Sheet is Everything 810
Reputation as a Safe Store of Value 811
Interest Rate 811
The High Quality Liquid Assets Buffer (HQLA) 812
The Original Capital Conservation Buffer 812
Corporate Governance Standards 813
The Basel Oxborough Guidelines 813
Chapter Summary 813
References 813
PART VI Guide to the Companion Website 815
Chapter 25 Applications Software, Policy Templates and Spreadsheet Models 817
Chapter Files 817
Afterword 825
List of Terms andtheir Abbreviations 829
Index 835
EULA 866

Praise for The Principles of Banking, Second Edition

"This is a superb book."
--Martin Barber, Director, BAE Syatems Digital Intelligence, Lancashire

"The Principles of Banking is easily the most important text for anyone in banking today and should be required reading for all personal development plans. When I was a regulator at the UK Financial Services Authority, managing the change in control team, I was responsible for assessing and granting regulatory approvals for complex banking transactions, such as Virgin Money's takeover of Northern Rock. I relied heavily on Professor Choudhry's text as a reference throughout the banking license approval process."
--Nihar Mehta, Chief Corporate Development Officer, Monument Bank Ltd, London

"If it has kicked off between you and him, every single one of us would have run down there to help you out! And thanks for this great book."
--Alex Haigh, Captain, Newdigate FC, West Sussex League

"When I taught a banking course at my business school, I had a hard time finding textbooks that could explain what banking was really like from the perspective of a banker, until I came across books by Professor Choudhry. Moorad's books reflect how bankers look at and practice banking, and provide a non-theoretical and practical approach to the subject."
--Ted Teo, Adjunct Assistant Professor, NUS Business School, Singapore

"A magnificent, well-crafted and masterfully updated new edition of the ever popular The Principles of Banking, it remains clear, practical and well balanced. Very highly reccommended!"
--Mohamoud Barre Dualeh, Head of Products and Cards Business, Alizz Islamic Bank, Muscat