COMMERCIAL BANKING

COURSE

1
William Chittenden edited and updated the PowerPoint slides for this edition.
Key words
◼ Commercial banking
◼ Financial services
◼ Risk

2
 AN OVERVIEW OF
BANKING SECTOR

Chapter 1

3
William Chittenden edited and updated the PowerPoint slides for this edition.
Videos - What are your key words? Your key
takeaways?
◼ Banks explained
[Link]
aRZoc
◼ 5 Truths About Money That Banks Don’t
Want You To Know
[Link]
mGD0

4
Ice breaking
◼ List down one financial institution you
know.
◼ Mention one key word you think of
financial institutions.
◼ Explain it

5
Key topics
1. Bank definitions
2. Bank regulation
◼ Goals of regulation
◼ Regulators

◼ Rationality of regulation

3. Bank functions
4. Bank services
5. Bank organization
6. Fundamental sources of changes
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What is a bank?

◼ Definition by functions it serves

✓ Institutions
involves in transferring funds from
savers to borrowers (financial intermediation)
& in paying for goods and services
◼ Definition by services it offers to
customers
✓ Accept deposits, make commercial loans,
offer trust services, manage cash, etc.

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What is a bank?

◼ Necessity of a legal definition:

✓ Regulation purpose
✓ Banking service menu is expanding
✓ Other financial-service institution provide
similar services

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 What is a bank?

◼ Definition by legal basis for regulation

✓ US:any institution that could qualify for
deposit insurance administered by the
FDIC

✓ VN: a credit institution permitted to conduct

all banking activities and other related
business operations.

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 What is a bank?

◼ Definition by legal basis for regulation

✓ VN: "Non-bank credit institution" is a credit
institution permitted to engage in some
banking activities as its regular business, but
not permitted to receive individual deposits
and to provide payment services.
✓ VN: "Banking activities" are monetary
business activities and banking services, the
regular operation of which is the receipt of
deposits and use of that to extend credits,
provide payment services;
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Financial service competitors of banks

◼ Savings associations
◼ Credit unions
◼ Money market funds
◼ Mutual funds (investment companies)
◼ Hedge funds
◼ Security brokers and dealers
◼ Investment banks
◼ Finance companies
◼ Financial holding companies
◼ Life and property-casualty insurance companies
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Rationale of regulations on financial firms

◼ Regulations of financial firms and

experiences of youth – p. 28
◼ Read Insights and Issues – p. 30

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 Goals of bank regulation

◼ Ensure safety and soundness of banks protecting

public’s savings and confidence
◼ Provide an efficient and competitive financial system
◼ Provide monetary stability to achieve national broad
economic goals
◼ Maintain the integrity of the payments system
◼ Ensure equal opportunity and fairness in the public’s
access to financial services
◼ Provide government with credit, tax revenues and
other services
◼ Help sectors that have special credit needs
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Banking principal regulatory agencies (US)

◼ Federal Reserve System (FED)

◼ Comptroller of the Currency (OCC)

◼ Federal Deposit Insurance Corporation (FDIC)

◼ Department of Justice

◼ Securities and Exchange Commission (SEC)

◼ State Boards of Commissions

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Banking principal regulatory
agencies (VN)

◼ State Bank of Vietnam (SBV)

◼ Deposit Insurance of Vietnam (DIV)

◼ Ministry of Finance (MOF)

◼ State Securities Commission of Vietnam (SSC)

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Why banks are closely regulated?
◼ Banks are among leading repositories of public’s
savings
◼ Bank’s power of creating money in form of readily
spendable deposits
◼ Banks provide individuals and businesses with loans for
consumption and investment, which should be equally
and adequately supplied.
◼ Government rely upon banks in conducting economic
policies, collecting taxes and dispensing government
payment.
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Shortcomings of restrictive bank regulation

◼ May encourage monopoly due to conditional entry

◼ Does not prevent bank failure
◼ Cannot eliminate economic risk
◼ Does not guarantee that bank management will
make good decisions, but create a struggle
between regulators and banks going on definitively
◼ Less-regulated business win customers away from
more-regulated banks.

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The Federal Reserve System

◼ The Federal Reserve System

➢ Fundamental Functions
✓ Conduct monetary policy
✓ Provide and maintain the payments system
✓ Supervise and regulate banking operations

➢ Organization
✓ Board of Governors
✓ 12 Federal Reserve District Banks

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State Bank of Vietnam

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The Federal Reserve System
◼ Monetary Policy Tools
➢ Open Market Operations
✓ Open market purchases (sales) increase
(decrease) reserves & the money supply
➢ Discount Rate
✓ Decreasing (Increasing) the discount rate makes
bank borrowing less (more) expensive, which
leads to an increase (decrease) in the money
supply
➢ Reserve Requirements
✓ Decreasing (Increasing) reserve requirements
increases (decreases) the money supply
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Commercial banks and the economy

◼ Banks are the primary conduit for monetary policy

◼ Banks are the primary source of credit for most

small businesses and many individuals

◼ Banks are the major repository of public savings

◼ Banks are the principal operator of payment

system.

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Traditional services offered by banks

1. Carrying out currency exchange

2. Discounting commercial notes and making
business loans
3. Offering savings deposits
4. Safekeeping of valuables
5. Supporting government activities with credit
6. Offering checking accounts
7. Offering trust services
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Carrying out currency exchange

◼ Bank trade one form of currency to another in

return for fee
◼ Start from early days of banks
◼ Become more complicated in the global
financial market
◼ Be provided by large and well-experienced
banks

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Discounting commercial notes and
making business loans
◼ Discounting commercial notes/making loans to
merchants based on accounts receivable
◼ Making direct loans for purchasing inventories
of goods (short-term) or for constructing new
facilities (long-term)
◼ Be provided by banks and many other financial-
service competitors
◼ Be the core and main revenue-earning service
of many banks
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Offering savings deposits

◼ Be the earliest and major source of fund for

making loan

◼ Compose of many types different in maturity,

form of currency, interest, etc.

◼ Be the most stable funding source

◼ Deposit is subject to reserve requirement and

insurance
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Safekeeping of valuables

◼ Keep gold and other valuables of customers in secure

vaults in return for fee

◼ Start since the old days of banks in the Middle Ages

◼ Question: which banks are famous for this service?

Why?

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Supporting government with credit

◼ Banks in Europe during the Industrial

Revolution and in America during the
Revolutionary War had to purchase
government bonds with a portion of deposits.

◼ The custom continues in the modern world

◼ Banks use government bond as a shelter of

liquidity risk and a source of revenue
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Offering checking accounts

◼ Demand deposits permit depositors to write

draft/cheque for payment of goods and services
◼ Be one of the most important offerings of the
industry
◼ Service is provided by not only banks but also
credit unions, savings associations, etc.
◼ Today the service is extended to the internet
with the use of smart cards
◼ Provide banks with cheap source of fund.
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Offering trust services

◼ Banks manage financial affairs and property of

individuals and firms in return for fee
◼ In property management, banks acts as a
trustee for wills, managing the deceased
customer’s estate,…
◼ In commercial trust department, bank manages
pension plan for businesses and acts as an
agent issuing stocks and bonds.

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More recent services offered by banks

8. Granting consumer loans

9. Providing financial advice
10. Managing cash
11. Offering equipment leasing
12. Making venture capital loans
13. Selling insurance policies
14. Selling retirement plans
15. Dealing in securities: brokerage and
investment banking services

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Granting consumer loans

◼ By early 20th century, banks started lending

consumers given the heavy competition for
business deposits and loans
◼ The trend has increased rapidly after the World
War 2
◼ Other current competitors for the consumer
credit accounts are credit unions and credit
card companies.
◼ The service bears high risk but returns high
earnings.
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Providing financial advice

◼ Banks gains good reputation for understanding

and experience in the financial market
◼ Customers ask for advice, particularly in credit
utilization, saving or investing funds
◼ Services provided are plentiful including
financial plan preparation, marketing
opportunity consultation, fund seeking,
investment options, etc.

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Managing cash

◼ Bank handle cash collection and disbursement

for firms, invest temporary cash surpluses

◼ Service is expanded to individuals and firms

◼ Bank earns not only fee, but also low-cost fund

in demand deposit accounts

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Offering equipment leasing

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Making venture capital loans

◼ Finance the start-up cost of new companies

◼ Implement through a venture capital firm
because added risk
◼ The venture capital firm raise fund from
investors, who are looking for high profit

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Selling insurance policies

◼ Banks sell insurance policies through acquiring

control of insurance companies
◼ Banks can gain high earning in the high-risk
insurance industry
◼ Banks possess privileges over independent
insurer in terms of customers, branches,
system, etc.
◼ Insurance agencies are affiliates or Bank
Holding Company (BHC) or Financial Holding
Company (FHC)
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Selling retirement plans

◼ Bank actively involves in managing retirement

plan of businesses make available to
employees
◼ Incoming fund is invested to wisely selected
securities ensuring acceptable risk and return
◼ Bank also is in charge of dispensing payment to
retired or disabled employees.

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 Dealing in securities
◼ Bank provides security brokerage service and security
underwriting/investment banking services
◼ Bank offer mutual funds, annuities and other
investment products with clear consultation to
customers regarding higher expected yields and risk
◼ Bank temporarily buy stocks of large corporation aiding
new business launching or company expansion by
offering merchant banking services
◼ Bank acts as risk intermediation providing customer
with risk hedging tools (e.g. swap, option, future
contract) offered by themselves or from third party
◼ Services are provided through affiliated securities firms
or insurance companies. 38
Organizational form of the banking industry

◼ Unit banking versus Branch banking

✓ Offer all Services from one office

✓ One of the oldest kinds of banks

✓ New banks are generally unit banks until can

grow and attract more resources

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Organizational form of the banking industry

◼ Branch banking
✓ Offer full range of services from several
locations
✓ Senior management at the home office
✓ Each branch has its own management team with
limited decision making ability
✓ Some functions are highly centralized, while
others are decentralized

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 3-41

Organizational form of the banking industry

What trend in branch banking has been

prominent in the U.S. in recent years?
Year # of Bank # of Total of Ave # of
Main Branch U.S. Bank Branches/
Offices Offices Offices U.S. Bank

1934 14,146 2,985 17,131 0.21

1970 13,511 21,810 35,321 1.61

1982 14,451 39,784 54,235 1.75

2007 7,241 77,947 85,188 10.76

From Table 3-2; Source: FDIC

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Bank branch policy in Vietnam

New branch set up – Circular No. 21/2013/TT-NHNN

VND 300 billion x N1 + VND 50 billion x N2 < C

Of which:
▪ C: the real value of the charter capital of commercial bank till the
time of request (VND billion).
▪ N1: quantity of branches which have been established and
requested for establishment at Hanoi and Ho Chi Minh urban area.
▪ N2: quantity of branches which have been established and
requested for establishment at Hanoi suburban, Ho Chi Minh
suburban; and other provinces and centrally-run cities.
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Question for discussion

a) Why do the quantity of branches are

directly related to equity value?
b) What is the difference between head
quarter and branch of banks?
c) Why quality of bank branches are strictly
supervised by Central bank?

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Quality of branching
c) To comply with limitations to ensure safety in
operation of credit institutions specified in Articles
126, 127, 128, 129; Clause 1 Article 130 and
Article 135 of Law on Credit Institutions in 2010
and guides of State Bank of Vietnam for this
provision uninterruptedly during 12 months before
the request month;

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Organizational form of the banking industry

◼ Bank holding companies

✓ Parent

✓ Subsidiaries

◼ One-Bank holding companies

◼ Mutli-Bank holding companies

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Organizational form of the banking industry

◼ Bank holding companies

✓A corporation chartered for the purpose of
holding the stock of one or more banks
✓ Control of a bank is assumed when 25% or
more of the stock is owned
✓ Must get approval from federal reserve board
to control a bank
✓ One-Bank holding companies vs. multibank
holding companies

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Bank holding companies vs financial
hoding companies
◼ BHC: A corporation chartered for the purpose
of holding the stock (equity shares) of at least
one bank, often along with other businesses.
◼ OBHC (One-bank holding company): control
one or more non-bank businesses.
◼ MBHC (Multibank holding company): a minority
of bank holding company organizations. (eg.
Exhibit 3.8 + ad/dis on MBHC – p80)

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Bank holding companies vs financial
hoding companies
◼ Affiliated banks: banks acquired by holding
companies.
◼ Independent bank: Not owned by holding
companies
◼ FHC: special type of holding company that may
offer the broadest range of financial services,
including dealing in and underwriting securities,
and selling and underwriting insurances.
◼ E.g. of FHC: p 83 – Exhibit 3.9

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Exhibit 1.10
Organizational structure of the BHC
Single Bank Holding Company

Board of Directors

Parent Company

Each subsidiary has a

Bank Subsidiary Nonbank Subsidiaries
president and line officers

Bank Branches

The bottom four levels have the same organizational form as the independent bank.

Multibank Holding Company

Board of Directors

Parent Company

Bank Subsidiary Nonbank Subsidiaries Bank Subsidiary

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Bank Branches Bank Branches

 3-50

Organizational form of the banking industry

Nonbank Businesses of BHCs

◼ Finance Companies ◼ Investment Banking
◼ Mortgage Companies Firms
◼ Data Processing ◼ Trust Companies
Companies ◼ Credit Card Companies
◼ Factoring Companies ◼ Leasing Companies
◼ Security Brokerage Firms ◼ Insurance Companies
◼ Financial Advising and Agencies
◼ Credit Insurance ◼ Real Estate Services
Underwriters ◼ Savings Associations
◼ Merchant Banking 50
Organizational Form of the Banking Industry

◼ Financial holding companies

✓ Special type of holding company
✓ Offers the broadest range of services
✓ List of activities offered may expand as
regulators decide what services are
‘compatible’ with banking
✓ Each affiliated financial firm has its own
capital and management and its own profit
or loss
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Organizational Form of the Banking Industry

◼ Financial Holding Companies

➢ Can engage in financial activities not permitted
in a bank or bank holding company
➢ Federal Reserve may not permit a company to
form a financial holding company or a bank
holding company to convert to a financial
holding company if
✓ any of its insured depository institution subsidiaries is
not well capitalized, well managed, or
✓ did not receive a satisfactory rating on its most
recent CRA (Community Reinvestment Act) exam.

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 Exhibit 1.11
Organizational structure of a financial holding company

Financial Holding
Company

Bank Securities Real

Insurance Thrift Holding
Subsidiaries
Holding Subsidiary Company Estate
Company Subsidiary

Subsidiaries
Banking Nonbank Thrift Company and Service
Company Subsidiaries Companies

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 Quick quiz

◼ What are the differences between Bank

Holding Companies and Financial Holding
Companies?

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Organizational form of the banking industry

◼ Bank subsidiaries
✓ Bank controls one or more subsidiaries
✓ Subsidiaries offer other services such as
insurance and security brokerage services
✓ Profits and losses of each subsidiary impact
parent Bank
✓ Parentcompany’s net income is typically
derived from dividends, interest,
management fees from equity in subsidiaries,
and interest paid on holding company debt.
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Banking Business Models
◼ Global Banks
✓ International presence
◼ Nationwide Banks
✓ Coast-to-coast presence
◼ Super-Regional Banks
✓ Extensive
operations in a limited
geographic area of the U.S.
◼ Regional Banks
◼ Specialty Banks

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Exhibit 1.17 DISTRIBUTION OF THE NUMBER OF
BANKS AND TOTAL ASSETS BY TOTAL ASSETS:
1995 - 2004
Number of Assets Size
Banks < $100 M $100M - $1B $1B - $10B > $10B
10,242 7,123 2,741 331 63
1995
(69.55%) (26.76%) (3.23%) (0.62%)
9,451 6,147 2,900 331 73
1997
(65.04%) (30.68%) (3.50%) (0.77%)
8,580 5,157 3,029 318 76
1999
(60.10%) (35.30%) (3.71%) (0.89%)
8,080 4,486 3,194 320 80
2001
(55.52%) (39.53%) (3.96%) (0.99%)
7,769 3,911 3,434 341 83
2003
50.34% 44.20% 4.39% 1.07%
7,630 3,655 3,530 360 85
2004
(47.90%) (46.26%) (4.72%) (1.11%)

Total Asset Size

Assets < $100 M $100M - $1B $1B - $10B > $10B
$4,116 $310 $668 $1,077 $2,061
1995
(7.54%) (16.22%) (26.17%) (50.07%)
$4,642 $277 $711 $995 $2,658
1997
(5.97%) (15.32%) (21.45%) (57.27%)
$5,735 $243 $755 $915 $3,823
1999
(4.23%) (13.16%) (15.96%) (66.65%)
$6,569 $222 $819 $915 $4,613
2001
(3.37%) (12.47%) (13.93%) (70.22%)
$7,603 $201 $910 $947 $5,545
2003
(2.64%) (11.97%) (12.46%) (72.93%)
$8,413 $189 $953 $973 $6,297 57
2004
(2.25%) (11.33%) (11.57%) (74.85%)
Banking Business Models

◼ Specialty banks
➢ Also known as:
✓ Community Banks
✓ Independent Banks

➢ Typically have less than $1 billion in

assets
➢ Organization

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Exhibit 1.18
Organizational structure of an independent bank

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Organizational structure – Vietcombank
Operation Center
INTERNAL AUDIT DEPT

ADMINISTRATION DEPT

HUMAN RESOURCES MGMT DEPT

DIRECTOR
LOAN WORKOUT UNIT
Nguyen My Hao
PROJECT INVESTMENT DEPT

CORPORATE BANKING DEPT

DEPUTY DIRECTOR DEPUTY DIRECTOR DEPUTY DIRECTOR

Nguyen Hung Son Nguyen Thi Bao Pham Thi Mai

TRANSACTION OFFICES SME CREDIT DEPT FOREX AND TREASURY DEPT

GUARANTEE DEPT INTERNATIONAL PAYMENT DEPT VIP DEPT

DEBT HANDLING DEPT FOREX AND TREASURY DEPT

AID AND LOANS SETTELEMENT DEPT
BUDGET DEPT
PERSONAL BANKING DEPT
CARDS DEPT INFORMATION TECHNOLOGY DEPT

SERVICE BUSINESS DEPT

FINANCIAL ACCOUNTING DEPT

TRANSACTION ACCOUNTING DEPT 60

Banking business models

◼ Specialty banks
➢ Personnel
✓ Senior Credit Officer
✓ Cashier/Chief Financial Officer
✓ Senior Operations Officer
✓ Senior Investment Officer
✓ Branch Area Executive

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Fundamental forces of change
◼ Service Proliferation
◼ Rising competition
◼ Deregulation/reregulation
◼ Crisis, reform and change in banking and financial
services
◼ Increasingly interest-sensitive mix of funds
◼ Tech change and automation
◼ Consolidation & geographic expansion
◼ Convergence
◼ Globalization
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Fundamental forces of change:
Role of Regulation

◼ Regulatory Dialectic

✓ Process of regulation, market response,

and reregulation

◼ Financial Innovation

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Fundamental forces of change:
Increased Competition
◼ For Deposits
✓ Interest rate ceilings and inflation
◼ For Loans
✓ Commercial paper
✓ Junk bonds
✓ Credit scoring
✓ Credit derivatives

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Fundamental forces of change:
Off-Balance Sheet Activities
◼ Loan commitments
◼ Loan guarantees
◼ Standby letters of credit
◼ Interest rate swaps
◼ Futures, forwards & options
◼ Leases

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Fundamental forces of change:
Impact of Nonbank Competition
◼ Captive Finance Companies
✓A subsidiary whose purpose is to provide
financing to customers buying the parent
company's product (e.g. General Motors
Acceptance Corporation (GMAC))
◼ General Finance Companies
✓ Fundtheir loans by issuing commercial
paper and long-term bonds. Their cost of
funds is higher than a bank’s, but they
charge higher rates.
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Fundamental forces of change:
Competition for Payments Services

◼ Credit Cards

◼ Debit Cards

◼ Prepaid Cards

◼ CHIPS

◼ ACH

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Fundamental forces of change:
Competition for Other Bank Services

◼ Trust services

◼ Brokerage services

◼ Data processing

◼ Real estate appraisal

◼ Credit life insurance

◼ Personal financial consulting

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Fundamental forces of change:
Change Investment Banking

◼ National full-line firms

◼ Investment banking firms

◼ Underwriter

✓ Underwriter syndicate

◼ Broker versus Dealer

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Fundamental forces of change:
Deregulation and Re-regulation
◼ Deregulation

◼ Eliminating existing regulations

◼ Reregulation

◼ Implementing new restrictions on banking

activities

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Fundamental forces of change:
Financial Innovation
◼ Innovation may be caused by a bank
wanting to:
✓ Enter into a new geographic market

✓ Enter into a new product market

✓ Deliver services less expensively

✓ etc.

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Fundamental forces of change:
Securitization

◼ Securitization
➢ The process of converting assets into
marketable securities
✓ Mortgages

✓ Credit card receivables

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Fundamental forces of change:
Globalization
◼ Globalization
✓ Is the evolution of markets and institutions
where geographic boundaries do not restrict
financial transactions or competition.

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Fundamental forces of change:
Technology
◼ Advances in Technology
✓ Advances in technology increase the scope of the
global market place and competition

✓ Advances in technology also reduce the need for

an intermediary by providing easy access to
information

✓ Increasing competition by reducing the cost of

being an information intermediary
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Joint-venture, foreign branch and
100% foreign banks
◼ Allowed to conduct operations similar to
domestic banks

◼ Obligatorily follow regulations in VN

◼ For foreign branch, decisions are made

depending on the foreign home bank policy →
less independence

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Rep office of foreign banks
1. Operate as liaison office
2. Conduct market research
3. Develop investment projects of foreign credit
institutions in Vietnam ;
4. Promote and monitor the implementation of
contracts, agreements signed between foreign
credit institutions and Vietnamese credit
institutions and enterprises, projects funded by
foreign credit institutions in Vietnam
→ No direct profitable activities
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 AN OVERVIEW OF
BANKING SECTOR

Chapter 1

77
William Chittenden edited and updated the PowerPoint slides for this edition.