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The Principles of Banking

Book Description

The ultimate guide for bank management: how to survive and thrive throughout the business cycle

An essential guide for bankers and students of finance everywhere, The Principles of Banking reiterates that the primary requirement of banking—sound capital and liquidity risk management—had been forgotten in the years prior to the financial crash. Serving as a policy guide for market practitioners and regulators at all levels, the book explains the keys to success that bankers need to follow during good times in order to be prepared for the bad, providing in-depth guidance and technical analysis of exactly what constitutes good banking practice.

Accessible to professionals and students alike, The Principles of Banking covers issues of practical importance to bank practitioners, including asset-liability management, liquidity risk, internal transfer pricing, capital management, stress testing, and more. With an emphasis on viewing business cycles as patterns of stable and stressful market behavior, and rich with worked examples illustrating the key principles of bank asset-liability management, the book is an essential policy guide for today and tomorrow. It also offers readers access to an accompanying website holding policy templates and teaching aids.

  • Illustrates how unsound banking practices that were evident in previous bank crashes were repeated during the creation of the 2007-2008 financial market crisis

  • Provides a template that can be used to create a sound liquidity and asset-liability management framework at any bank

  • An essential resource for the international banking community as it seeks to re-establish its credibility, as well as for students of finance

  • Explains the original principles of banking, including sound lending policy and liquidity management, and why these need to be restated in order to avoid another bank crisis at the time of the next economic recession

  • Covers topics of particular importance to students and academia, many of which are marginally—if ever—addressed in current text books on finance

  • Offers readers access to a companion website featuring invaluable learning and teaching aids

Written by a banking practitioner with extensive professional and teaching experience in the field, The Principles of Banking explains exactly how to get back to basics in risk management in the banking community, essential if we are to maintain a sustainable banking industry.

Table of Contents

  1. Cover
  2. Series Page
  3. Series1 Page
  4. Title Page
  5. Copyright
  6. Dedication
  7. Forewords
  8. Preface
    1. Layout of the book
  9. Acknowledgements
  10. About the Author
  11. Part I: A Primer on Banking
    1. Chapter 1: A primer on bank business and balance sheet risk
      1. An Introduction to Banking
      2. The Capital Markets
      3. Banking Business and capital
      4. Financial Statements and Ratios
      5. The Money Markets
      6. Bank Cash Flows and Other Basic Concepts
      7. Risk Exposures in Banking
      8. Drivers of Credit Risk
      9. Macro-Level Risk Management and Strategy
      10. Appendix 1.1 Summary Overview of Bank Product Line
      11. Definition of Banking
      12. Product Line
      13. References
    2. Chapter 2: Bank regulatory capital
      1. Bank Regulatory Capital
      2. Regulatory Capital Requirements
      3. The Basel I Rules
      4. The Basel II Rules
      5. Implementation Approaches
      6. Impact on Specific Sectors
      7. Operational Risk
      8. Basel III
      9. The Capital Calculation and Return on Capital Targets
      10. Bibliography
    3. Chapter 3: Banking and Credit Risk
      1. Credit Risk Principles
      2. Credit Risk
      3. Credit Ratings
      4. Ratings Changes Over Time
      5. Understanding Credit Risk
      6. External Rating Agency Credit Ratings
      7. Bank Internal Credit Ratings
      8. Credit Value-at-Risk
      9. Variance–Covariance Credit VaR
      10. Credit Limit Setting and Rationale
      11. Loan Origination Process Standards
      12. SVA and Credit Strategy
      13. Bibliography
    4. Chapter 4: A Primer on Securitisation
      1. The Concept of Securitisation
      2. Market Participants
      3. Reasons for Undertaking Securitisation
      4. The Process of Securitisation
      5. Illustrating the Process of Securitisation: Airways No. 1 Limited
      6. Credit Rating Considerations
      7. Securitisation As In-House Deal to Create Collateral
      8. The Securitisation Market Post-2008
      9. Impact on Rating Agencies
      10. Securitisation Objectives in the Basel III Environment
      11. Secured Funding Value
      12. References
    5. Chapter 5: The Yield Curve
      1. Importance of the Yield Curve
      2. Part I
      3. The Money Market Yield Curve
      4. Using the Yield Curve
      5. Types of Yield Curve
      6. Analysing and Interpreting the Yield Curve
      7. Further Views on the Yield Curve
      8. Part II
      9. A Further Look At Spot and Forward Rates
      10. Spot Rates and Forward Rates In Continuous Time
      11. The Determinants of the Swap Spread
      12. Part III
      13. Fitting the Yield Curve
      14. Yield-Curve Smoothing
      15. Implementing Curves in Practice
      16. Multi-Currency Yield Curves
      17. A Secured Funding Curve
      18. Appendices
      19. Appendix 5.1 Jensen's Inequality and the Shape of the Yield Curve
      20. Appendix 5.2 Testing the Unbiased Expectations Hypothesis
      21. Appendix 5.3 Linear Regression: Ordinary Least Squares
      22. Appendix 5.4 Illustration of Forward Rate Structure When The Spot Rate Structure Is Increasing
      23. Appendix 5.5 Regression Splines
      24. Appendix 5.6 Cubic Spline Interpolation
      25. Appendix 5.7: Summary of Collateral Classes
      26. References and bibliography
  12. Part II: Bank Asset and Liability Management
    1. Chapter 6: Asset–Liability Management I
      1. Basic Concepts
      2. Liquidity Gap
      3. Managing Liquidity
      4. The Liquidity Ratio
      5. Sovereign Bond Portfolio for Interest-rate Hedging
      6. References
    2. Chapter 7: Asset–Liability Management II
      1. Introduction
      2. Basic Concepts
      3. Interest-rate Risk and Source
      4. The ALM Desk
      5. Liquidity and Interest-rate Risk
      6. Critique of the Traditional Approach
      7. The Cost of Funding
      8. Generic ALM Policy for Different Banks
      9. Securitisation
      10. Middle-Office Treasury Procedures and ALM Practice
      11. Appendix 7.1 NPV and Value-at-Risk (VaR)
      12. References and Bibliography
    3. Chapter 8: Asset–Liability Management III: Trading and Hedging Principles
      1. Trading Approach
      2. Repo Market Specials Trading
      3. Interest-Rate Hedging Tools
      4. Interest-Rate Swap Hedging Applications
      5. Interest-Rate Risk Exposure and Option Hedging
      6. Hedging Using Bond Futures Contracts
      7. The Primary Hedge Measure: Bond Modified Duration and PV 01
      8. Hedging Credit Risk with Credit Derivatives
      9. References
    4. Chapter 9: Asset–Liability Management IV: The ALCO
      1. ALCO Policy
      2. ALCO Reporting
    5. Chapter 10: The ALCO: Terms of Reference and Treasury Operating Model
      1. The ALCO Governance Model
      2. ALCO Reporting
      3. The Group ALCO
      4. Additional MI Content of the Regional ALCO Pack
      5. Treasury Organisation Structure
      6. Treasury Operating Model
    6. Chapter 11: Risk Reporting, Risk Policy and Stress Testing
      1. High Level Mapping of Risk
      2. Portfolio Credit Risk Reporting
      3. Portfolio Risk Reporting
      4. Risk Policy
      5. Product Line Risk Reporting
      6. Business Line Reporting
      7. Stress Testing Policy
      8. Sample Stress Test Results
      9. Scenario Analysis: Economic Downturn Stress Test Report
      10. Stressed VaR
  13. Part III: Bank Liquidity Risk Management
    1. Chapter 12: Principles of Bank Liquidity Management
      1. Bank Liquidity
      2. Sustainable Banking: Nine principles of Bank Liquidity Risk Management
      3. Liquidity Risk Management: The United Kingdom Regulator's View
      4. The Bank Liquidity Policy Statement
      5. Policy on Intra-group Lending
      6. The Liquid Asset Buffer
      7. Central Bank Facilities
      8. Liquidity Management and Collateral
      9. The Contingency Funding Plan
      10. References and Bibliography
    2. Chapter 13: Liquidity Risk Metrics
      1. Six Key Liquidity Metrics
      2. Strategic Level Liquidity Metrics
      3. Tactical Level Liquidity Metrics
      4. External and Comparative Liquidity Metrics
      5. Conclusion
      6. References and Bibliography
    3. Chapter 14: Liquidity Risk Reporting and Stress Testing
      1. Liquidity Risk Reporting
      2. Stress Test Reports
    4. Chapter 15: Internal Funds Pricing Policy
      1. The Concept of Internal Funds Pricing
      2. Benchmark Funds Transfer Pricing Policy
      3. Funding Management: Derivatives Collateral and Liquidity
      4. Derivatives Funding Policy
      5. Pricing Liquidity
      6. Template Funds Transfer Pricing Document
      7. References and Bibliography
  14. Part IV: Bank Strategy and Governance
    1. Chapter 16: Bank Strategy I: Formulating Strategy and Direction
      1. The Sustainable Bank Business Model
      2. Strategy Inputs
      3. Formulating Sustainable Banking
      4. Liquidity As Asset Class
      5. Conclusion
      6. Appendix 16.1: The Leading Economic Indices
      7. References
    2. Chapter 17: Bank Strategy II: Capital and Funding Management
      1. Textbook treatment of bank capital
      2. Capital Management Policy
      3. Capital Management, Systemic Risk and Macroprudential Strategy
      4. Benchmarking with the Market
      5. An integrated capital and liquidity management strategy
      6. Capital Management: Capital Instruments
      7. Capital Management Strategy
      8. The Basel Pillar III disclosure
      9. References and Bibliography
    3. Chapter 18: Principles of Corporate Governance
      1. Effective Bank Corporate Governance: Conclusions from the Market Crash
      2. Market Observations
      3. Conclusion
      4. Policy recommendations
      5. Management structure
      6. Governance and Sustainable Banking
      7. References
  15. Part V: Applications Software, Policy Templates and Teaching Aids
    1. Chapter 19: Applications software, policy templates and spreadsheet models
      1. Excel Spreadsheets
      2. Lecture Material: Powerpoint Slides
      3. Liquidity Metrics Spreadsheets
      4. Policy Document Templates
      5. Reporting Template Spreadsheets
      6. Stress Testing Report Templates
      7. YCF Cubic B-Spline Yield Curve Application
      8. References
  16. Afterword
  17. List of Terms and Their Abbreviations
  18. Index