National University of San Diego

Managing Financial Institutions FIN 674

Final Project Retail Banks

03/03/2012

Introduction Retail banks are working straightly with small businesses and consumers. The conventionally giving payment services to small businesses and individuals with all the mechanism of the services provided by the banks. Although it has turned to be so tough to distinguish the real job of retail bank firstly because many of the banks are merging wholesale activities and retail actions. The other reason is because of the technological developments which are allowing banks to give a various kind of retail financial services to the people. This research begins the studies by going

through the characteristics of retail banking. Then we will go more through details and will talk about the ways that banks are managing the risks in different conditions. In the last part its discussed about the advantage and disadvantages of using the retail banking.

What is retail banking? It is not easy to give a definition of retail banking. Conventionally retail banks were giving services and providing banking facilities for individuals and also for small businesses that were interacting with low value of transaction. But in particular it is not possible to talk individually about retail banks and neglecting the role of wholesales banks. The retail banks are fund themselves by retail deposits and lending it to the loan markets. In develops countries like US, Austria and UK the large banks are merging the wholesales activities and retail. Another factor that had a great role in changing the nature of retail banking was technology. Many years ago if a retail bank wanted to give loans it was supposed to have a large branch network to gather the deposits of the public and other account payments. But nowadays by using technologies new retail banks dont need to have a large investment in branches. The technologies that the banks are benefiting from are internet banks, postal accounts, telephone banking and automated teller machine. Nowadays the retrial banking world is changing quickly. Higher usage of technologies and the use of internet have caused the level of literacy to increase and as a result the customer expectation has been higher than before. Retail Banks: Their Structure and Function Definition: Retail banks are providing the customers with two important functions: 1) They help customers to keep their money secure although being easy to access and also giving them transaction services. 2) They enable customers to have access to additional money in order to fund some larger purchases such as buying an automobile or house.

Previously banks services were taking place directly in branches, but nowadays although many still do, but most of the retail banks are giving services by internet or telephone. Recently some services are offering only via internet instead of in branches. currently their fields of activities have increased and they are covering a more wide range of services including: stock broking services, pension funds, insurance etc. briefly these banks are named as financial supermarket. As most of the retail banks have combined with wholesale banking its not easy to identify the traditional retail banks which were only involved with the small businesses. So retail banks should be studies as a series of process instead of a sole institution. The services Retail banks have various kinds of services to provide their customers (that might be small businesses or individuals) with. Conventionally retail banks were providing these services: 1. Payment services Allowing customer to make transactions by using debit cards, checks and etc. 2. Intermediation services Services such as looking after customers money and making loans are called the intermediation services provided by retail banks. Both of these services mean that money should be accessible for the customers at a short notice. It means that these retail banks have to be able to manage the risk because sometimes their customers might require an amount of money which is more than the inflows. It comes up with the idea of risk management. There are two kinds of risks that need to be managed which we are going to talk about in details.

Risk Management: While the banks are involving in the business there are some specific kinds of risks which are threatening them. 1. Liquidity risk- this kind of risk exist when the bank in issuing liabilities which are greatly repayable on demand of holding assets which have a longer term to maturity. 2. Default risk- it refers to the risk of the interest or capital on the assets holding by the banks. If banks dont be able to manage this risk they will fail. Banks should be able to manage risk. Whether it s a liquidity risk or liability they will be in trouble if they wont be able to control it or finally it will cause their failure. Managing liquidity risk The liquidity risk happens when the bank doesnt have adequate funds to fulfill its cash outflow commitments. If the bank doesnt have a reasonable structure in its balance sheet, it will be threatened by liquidity risk. If a bank assets are committed to long term advances and it is needed to repay a certain amount of deposit then it will suffer the liquidity risk. There are two methods for banks to control this type of situations. Reserve asset management In this method bank is suppose to keep a stock of liquid assets to be able to stay away from the illiquid advances stocks from a sudden outflow of funds. Usually cash inflows which are coming from new deposits and loan repayments are causing cash outflows due to deposit withdrawals and new loans. The stocks which are held by banks could be count as a liquid asset that can be drawn on whenever the outflows exceed the inflows. But keeping so much liquidity is not profitable. So in order to be able to make profit they bank has lent out its cash (which is a

liquid asset). Therefore banks will hold just a specific amount of liquid asset only to meet their unexpected cash outflows. Liability Management Recently most of the banks in developed countries have moved from asset management to liability management. It is when a bank is managing its liability in order to do its loan commitments or buffering its lost liquidity. One way to reach this aim is setting the interest rates on the deposits. One model that this could happen is to change interest rates on its deposits. Though if a bank is dependent only on retail deposits then rising deposit rates is expensive because it has to be done for existing deposits as well as new deposits concerned. For example, if a bank at the end of a business day has made more loan obligations than it can do from existing funding then it can borrow funds from another bank in the overnight market. On the other hand, if a bank has an excess of funds at the end of a business day then it can let other bank borrow this overnight. Managing default risk The assets that are kept by the bank are in danger of a reduction in their value lower than what has been recorded in the balance sheet. The most important asset keep by a retail bank is advances and these are at the risk of default (or credit risk). Credit risk is getting worse by the problems of moral hazard and adverse selection. Based on how the economy is, the credit risk might change. For example if the economy is not good then credit risk will increase.

The impact of the monetary cycle shows the macroeconomic part of the credit risk that banks are having. This risk is coming from the decision made by borrower. There are some ways and techniques that banks can use to manage default risk. Screening If the banks evaluate the financial situation of the borrower and also asking about the borrowers goal of the loan, they can reduce the default risk. Using a scoring model has been widely used by banks. It has helped them a lot to reduce the default risk. The advantage of this method is that it can be automated. Through this method bank is going to study about the history of the borrower to find out his characteristics. It makes bank to be able to predict if the loan is going to performing well or bad. Some other characteristics that might be used for this method is finding out the length of the time that the borrower has been in his job, what is his monthly income and etc. Pooling The banks are preferred to have a large number of small loans instead of a small number of big loans. So the variability of loan loss will be reduced. Diversification If the bank is loaning to a wide range of different borrowers then it is called diversification. It means that a bank should better to lend to both public and businesses and also should loan to businesses which are in different industries. It should be mentioned that focusing on loaning to one specific section or industry will have some limitation for diversification.

Collateral A bank might ask the borrower to prepare collateral. If the borrower wont be able to pay back the loan, then the bank is allowed to sell the collateral and take some or entire of the loan back. So its concluded that there are some risks threatening the banks. Here they have been summarized to liquidity risk and default risk. Banks are having their own methods to control and manage the existing risks. On the next part the advantage and disadvantages of using the banking services is going to be discussed. Advantages and Disadvantages Definitely there are some advantages for keeping the money in the bank and using the banking systems. Otherwise the banking industry wouldnt have been grown during the centuries. Advantages Here we go through some of the basic advantages: In compare to keeping the money at home in some places like under the bed its much safer to keep it in bank. You can also do shopping or make payments without carrying the cash with you. As a good and well known customer in a bank, your bank might offer you some beneficial services such as mortgages and insurances. What retail banks are doing is giving their customers many options to access their accounts and reach their money. The most important one is through internet. So it helps the client to keep the track of his financial situation and prevent the potential problems.

These are some basic in fundamental advantages of using banks services. Definitely for the people that are working with the banks for a longer time there are so many other advantageous situation that their banks have prepared for them. Disadvantages Banks need to make money. So they might decide to charge you on your account (within the terms of account), and people will understand it later.

Conclusion As it is concluded the appearance of retail banking was a turning point in financial life. Similar to all the business there are some risks that threatening this trade. There are some strategies for preventing the risks to make the profit less or cause the bank to fail. Some of the most important ones have been discussed throughout the research. In my point of view whenever people are feeling a need they make the way through the years. Banks are one those vital tools in peoples career. It has been modified through the centuries. What we call bank or banking system today is a series of countless efforts that has made within long time. Banks are so efficient and useful in peoples financial career and the rules they make are sometimes might look like being useless or making everything more confusing but they should be appreciated.

References http://people.stern.nyu.edu/nroubini/NOTES/Chap12.htm#topic6 http://www.scribd.com/doc/13793786/Commercial-Banking-2009 http://www.scribd.com/doc/48511883/retail-banking http://www.investopedia.com/university/banking-system/banking-system6.asp#axzz1o2Q2QsfU http://eh.net/encyclopedia/article/wright.banking.commercial.origins