Banking outside the UK banking system gives you the benefits of being in a low-tax regime, but the pitfalls of having no legal protections.
An offshore bank account can be the most tax efficient way to handle large amounts of money- many serious investors use them for both tax avoidance and privacy. However offshore banking is expensive and possibly even a liability for the novice, and you should seek advice from a specialist before opening an offshore bank account; particularly if you are not an expatriate.
In a nutshell there are actually two ways to use offshore banking facilities: open an offshore bank account, or start an offshore company which exists to handle your assets.
There are more reasons to go offshore than you might think. The most obvious is for tax-efficient investment purposes. An offshore bank account or private company will not only not be liable to income tax, but also consider capital gains tax, stamp duties on property etc. An offshore bank account is also not subject to local litigation; so your assets are protected against all sorts of creditors. If you are engaging in inheritance planning, you’ll also find that the contents of an offshore bank account are not liable to inheritance tax either.
So why doesn’t everyone have an offshore bank account? Well, they come at a fee, and you need significant knowledge to navigate the process efficiently and legally. There are plenty of offshore consultancies who will help you, but additionally you must realise that just as your investments are protected from legal assault, you also receive no legal protection if you become the victim of a scam or bogus investment opportunity. Speak to a private bank or offshore banking specialist before doing anything.
Friday, April 24, 2009
Investment Banking
Don’t let your spare cash, inheritance or lottery win sit in a current account going nowhere- put it to work to make more money.
Investment banks usually deal with large corporations and groups of exceptionally wealthy individuals, but investment banking is open to everyone with cash to spare, whether you do it through a financial adviser, your local bank, or a private bank. Either way, make your spare money go further!
Now is possibly a great time to get into investment banking. As a private investor, you cannot underestimate your importance to the financial markets. It’s true that the majority of investments are made by investment banks and the financial directors of large companies with money sloshing around in pension funds and other cash pots. But private investors are not only great barometers of shorter-term financial thinking, they are also often fastest to react to market trends.
Opinion on investing is divided right now. We stand on the brink of either further economic decline (as some analysts believe), or at the bottom of a small trough which will right itself in the next few years. Personal investment banking now gives you options to account for both scenarios according to your bullish or bearish outlook. If you’re a pessimist, you might invest in bonds- a predictable but low return. If you’re an optimist, you might put money in hot AIM-listed companies. Or if you just want a punt, you could go for tracker funds, which will follow the market whatever it does. Similarly if you’re considering tax efficiency, perhaps an ISA is the route to go.
Either way, if you have spare cash, don’t let it rot in your current account- get some financial advice from your local bank, or if you have lots of it a private bank. The purpose of spare money is to make more money!
Investment banks usually deal with large corporations and groups of exceptionally wealthy individuals, but investment banking is open to everyone with cash to spare, whether you do it through a financial adviser, your local bank, or a private bank. Either way, make your spare money go further!
Now is possibly a great time to get into investment banking. As a private investor, you cannot underestimate your importance to the financial markets. It’s true that the majority of investments are made by investment banks and the financial directors of large companies with money sloshing around in pension funds and other cash pots. But private investors are not only great barometers of shorter-term financial thinking, they are also often fastest to react to market trends.
Opinion on investing is divided right now. We stand on the brink of either further economic decline (as some analysts believe), or at the bottom of a small trough which will right itself in the next few years. Personal investment banking now gives you options to account for both scenarios according to your bullish or bearish outlook. If you’re a pessimist, you might invest in bonds- a predictable but low return. If you’re an optimist, you might put money in hot AIM-listed companies. Or if you just want a punt, you could go for tracker funds, which will follow the market whatever it does. Similarly if you’re considering tax efficiency, perhaps an ISA is the route to go.
Either way, if you have spare cash, don’t let it rot in your current account- get some financial advice from your local bank, or if you have lots of it a private bank. The purpose of spare money is to make more money!
Telephone Banking
Banking by phone is convenient, but you won’t get the same service you’d expect in a branch.
According to First Direct customers, telephone banking is exhilarating… but then NatWest abandoned its call centres because customers were leaving in droves. Clearly telephone banking is a double-edged sword, and only some banks get it right. Rule 1 must be: I want to talk to a real person, quickly, who has my account information to hand!
Telephone banking is an interesting halfway house between branch and internet banking- in the case of First Direct it’s a complete business. What you can do over the phone is limited compared to online, but depends entirely on the bank’s setup. All banks will let you make balance and statement enquiries by phone; most will examine statements, list standing orders, tell you if a cheque has been cashed etc. Sometimes this is done through a call centre where you will speak to a real person; sometimes it is done using your phone buttons, the miserable godforsaken process of “Press 1 for balances, 2 for….”
So if you know you won’t be popping into branches (you’re lazy like me, parking costs too much, you’re housebound, or simply live in a rural area) then before opening a bank account, ask what their telephone banking facilities are. And most importantly ask to have a number for your branch as well as a general enquiry line. Call centres are invariably abroad these days, so don’t expect an investment decision over the phone unless you can chat to your own bank manager.
There is one other use for telephone banking, and that is for offshore purposes. Lloyds TSB Offshore, for example, operates a telephone banking service for its offshore customers, which makes perfect sense for managing finances on a global scale.
According to First Direct customers, telephone banking is exhilarating… but then NatWest abandoned its call centres because customers were leaving in droves. Clearly telephone banking is a double-edged sword, and only some banks get it right. Rule 1 must be: I want to talk to a real person, quickly, who has my account information to hand!
Telephone banking is an interesting halfway house between branch and internet banking- in the case of First Direct it’s a complete business. What you can do over the phone is limited compared to online, but depends entirely on the bank’s setup. All banks will let you make balance and statement enquiries by phone; most will examine statements, list standing orders, tell you if a cheque has been cashed etc. Sometimes this is done through a call centre where you will speak to a real person; sometimes it is done using your phone buttons, the miserable godforsaken process of “Press 1 for balances, 2 for….”
So if you know you won’t be popping into branches (you’re lazy like me, parking costs too much, you’re housebound, or simply live in a rural area) then before opening a bank account, ask what their telephone banking facilities are. And most importantly ask to have a number for your branch as well as a general enquiry line. Call centres are invariably abroad these days, so don’t expect an investment decision over the phone unless you can chat to your own bank manager.
There is one other use for telephone banking, and that is for offshore purposes. Lloyds TSB Offshore, for example, operates a telephone banking service for its offshore customers, which makes perfect sense for managing finances on a global scale.
Internet Bank Account
Internet banks do offer great deals, but there are caveats to consider too.
Almost every internet bank account offers a better deal that your local bank can offer. So why don’t we all have an online account? Well, they are great value, but you should be aware of some warnings before you rush in- specifically customer service and security.
The internet bank account revolution seems terribly exciting. An internet bank account invariably offers a great rate of interest on your current account balance, which your high street bank doesn’t. But before you rush to switch, let’s look at the caveats.
Firstly, when things go wrong, you want somebody to talk to. Your branch bank gives you lousy interest because it has to employ real people to look after you. You ought to know your bank manager, and he or she is there to assist you. Before signing up to an online bank, ring their customer service number just to see how long it takes them to answer the phone. Of the internet banks, Smile and First Direct are particularly good at customer service.
Then consider fraud. It’s no good saying it won’t happen to you- it might. Most online banks do offer an anti-fraud guarantee that if you lose any money through fraudulent use of your account, they will replace it. But the burden of proof is on you, and it’s a drawn out process to get compensation. The fact is, online banks use the same password security systems as everyone else, and while the majority of us use our partners or pets names as passwords, it’s not too hard to see why fraud does happen. If that scares you, again use a branch bank.
These aren’t reasons to be put off an internet bank account entirely- but no bargain comes without some sort of trade-off.
Almost every internet bank account offers a better deal that your local bank can offer. So why don’t we all have an online account? Well, they are great value, but you should be aware of some warnings before you rush in- specifically customer service and security.
The internet bank account revolution seems terribly exciting. An internet bank account invariably offers a great rate of interest on your current account balance, which your high street bank doesn’t. But before you rush to switch, let’s look at the caveats.
Firstly, when things go wrong, you want somebody to talk to. Your branch bank gives you lousy interest because it has to employ real people to look after you. You ought to know your bank manager, and he or she is there to assist you. Before signing up to an online bank, ring their customer service number just to see how long it takes them to answer the phone. Of the internet banks, Smile and First Direct are particularly good at customer service.
Then consider fraud. It’s no good saying it won’t happen to you- it might. Most online banks do offer an anti-fraud guarantee that if you lose any money through fraudulent use of your account, they will replace it. But the burden of proof is on you, and it’s a drawn out process to get compensation. The fact is, online banks use the same password security systems as everyone else, and while the majority of us use our partners or pets names as passwords, it’s not too hard to see why fraud does happen. If that scares you, again use a branch bank.
These aren’t reasons to be put off an internet bank account entirely- but no bargain comes without some sort of trade-off.
Open Bank Account
The application process when you open a bank account can be daunting, so here’s what to expect.
When you open a bank account, you are required to fill in an application form, which will dictate how the bank views your creditworthiness and can be instrumental in the way they treat you. It’s very rare that a bank will turn down your business, but preparing by bringing the correct ID and personal information will make the process smoother.
If you’re taking your first steps in finance and about to open a bank account, here’s what you need to know. Most banks offer at least two types of current account. The most basic gets you a safe place to store your cash, plus a cash card to get what’s yours out 24 hours a day. This basic service is usually only offered to people with no credit history- i.e. people opening accounts for the first time or persons on benefits.
Otherwise you’ll get the full current account service, which gives you cheque guarantee and debit facilities, plus possibly an overdraft. To get these, you’ll need to tell them that you’re registered to vote at your current address, relatively up to date with any outstanding credit, have evidence of a monthly income, and show home and work phone numbers. You can attest to most of these on the application form, which is an irritation but necessary to fill in.
As well as the application form, to open a bank account you’ll also have to prove your identity and address. In fact, if it’s a joint account (opened by more than one person) then everyone’s details need to be proven. You’ll need to bring along to the branch originals of suitable proof of ID, like a passport, pension book or medical record. Once the application is completed, it can take anything from hours to days to get your account up and running. All of these also apply to internet banks too; although you may not have to send off proofs of ID.
When you open a bank account, you are required to fill in an application form, which will dictate how the bank views your creditworthiness and can be instrumental in the way they treat you. It’s very rare that a bank will turn down your business, but preparing by bringing the correct ID and personal information will make the process smoother.
If you’re taking your first steps in finance and about to open a bank account, here’s what you need to know. Most banks offer at least two types of current account. The most basic gets you a safe place to store your cash, plus a cash card to get what’s yours out 24 hours a day. This basic service is usually only offered to people with no credit history- i.e. people opening accounts for the first time or persons on benefits.
Otherwise you’ll get the full current account service, which gives you cheque guarantee and debit facilities, plus possibly an overdraft. To get these, you’ll need to tell them that you’re registered to vote at your current address, relatively up to date with any outstanding credit, have evidence of a monthly income, and show home and work phone numbers. You can attest to most of these on the application form, which is an irritation but necessary to fill in.
As well as the application form, to open a bank account you’ll also have to prove your identity and address. In fact, if it’s a joint account (opened by more than one person) then everyone’s details need to be proven. You’ll need to bring along to the branch originals of suitable proof of ID, like a passport, pension book or medical record. Once the application is completed, it can take anything from hours to days to get your account up and running. All of these also apply to internet banks too; although you may not have to send off proofs of ID.
Banking Service
Getting the best banking service for your needs is about establishing your own priorities before talking to the banks.
Looking for the right banking service begins with looking at your own needs. Do you want credit (cards, overdrafts, loans), instant access to your money, savings and investments, business advice, internet banking, or indeed just a helping hand? When you know what you want, then you can properly evaluate your options- and don’t think for a minute that all banks offer the same service: they don’t!
So you’re after a banking service? Well, what’s wrong with the big high street banks? Actually, there’s nothing wrong with them. While they won’t give you good interest rates; they are excellent for basic financial advice, and usually free if you remain in credit. But these days, we’re all borrowers too. And internet banks offer far better borrowing rates than the high street, as do also the supermarkets like Sainsbury’s or Tesco.
Then there’s your credit cards- almost every financial institution can offer you one- but the high street banking service is pretty lousy for credit card rates too. Try IF, First Direct, Egg or Smile instead.
Everyone offers insurance too- but different companies are competitive for different products; so you most likely get your car insurance from a totally different provider than your home contents insurance (or travel, or life cover, or unemployment cover etc. etc.)
The golden rule with getting the right banking service is: chase the deals in more than one place. Except for offset accounts where there is a huge benefit in keeping banking products together, you lose nothing by shopping around for your exact needs.
Looking for the right banking service begins with looking at your own needs. Do you want credit (cards, overdrafts, loans), instant access to your money, savings and investments, business advice, internet banking, or indeed just a helping hand? When you know what you want, then you can properly evaluate your options- and don’t think for a minute that all banks offer the same service: they don’t!
So you’re after a banking service? Well, what’s wrong with the big high street banks? Actually, there’s nothing wrong with them. While they won’t give you good interest rates; they are excellent for basic financial advice, and usually free if you remain in credit. But these days, we’re all borrowers too. And internet banks offer far better borrowing rates than the high street, as do also the supermarkets like Sainsbury’s or Tesco.
Then there’s your credit cards- almost every financial institution can offer you one- but the high street banking service is pretty lousy for credit card rates too. Try IF, First Direct, Egg or Smile instead.
Everyone offers insurance too- but different companies are competitive for different products; so you most likely get your car insurance from a totally different provider than your home contents insurance (or travel, or life cover, or unemployment cover etc. etc.)
The golden rule with getting the right banking service is: chase the deals in more than one place. Except for offset accounts where there is a huge benefit in keeping banking products together, you lose nothing by shopping around for your exact needs.
Banking Service
Getting the best banking service for your needs is about establishing your own priorities before talking to the banks.
Looking for the right banking service begins with looking at your own needs. Do you want credit (cards, overdrafts, loans), instant access to your money, savings and investments, business advice, internet banking, or indeed just a helping hand? When you know what you want, then you can properly evaluate your options- and don’t think for a minute that all banks offer the same service: they don’t!
So you’re after a banking service? Well, what’s wrong with the big high street banks? Actually, there’s nothing wrong with them. While they won’t give you good interest rates; they are excellent for basic financial advice, and usually free if you remain in credit. But these days, we’re all borrowers too. And internet banks offer far better borrowing rates than the high street, as do also the supermarkets like Sainsbury’s or Tesco.
Then there’s your credit cards- almost every financial institution can offer you one- but the high street banking service is pretty lousy for credit card rates too. Try IF, First Direct, Egg or Smile instead.
Everyone offers insurance too- but different companies are competitive for different products; so you most likely get your car insurance from a totally different provider than your home contents insurance (or travel, or life cover, or unemployment cover etc. etc.)
The golden rule with getting the right banking service is: chase the deals in more than one place. Except for offset accounts where there is a huge benefit in keeping banking products together, you lose nothing by shopping around for your exact needs.
Looking for the right banking service begins with looking at your own needs. Do you want credit (cards, overdrafts, loans), instant access to your money, savings and investments, business advice, internet banking, or indeed just a helping hand? When you know what you want, then you can properly evaluate your options- and don’t think for a minute that all banks offer the same service: they don’t!
So you’re after a banking service? Well, what’s wrong with the big high street banks? Actually, there’s nothing wrong with them. While they won’t give you good interest rates; they are excellent for basic financial advice, and usually free if you remain in credit. But these days, we’re all borrowers too. And internet banks offer far better borrowing rates than the high street, as do also the supermarkets like Sainsbury’s or Tesco.
Then there’s your credit cards- almost every financial institution can offer you one- but the high street banking service is pretty lousy for credit card rates too. Try IF, First Direct, Egg or Smile instead.
Everyone offers insurance too- but different companies are competitive for different products; so you most likely get your car insurance from a totally different provider than your home contents insurance (or travel, or life cover, or unemployment cover etc. etc.)
The golden rule with getting the right banking service is: chase the deals in more than one place. Except for offset accounts where there is a huge benefit in keeping banking products together, you lose nothing by shopping around for your exact needs.
Internet Bank
An analysis of the explosion in internet banking facilities in the UK.
In three years, use of internet bank accounts has increased ten-fold, as services become accessible to ordinary people and not just tech-savvy computer nerds. Simplicity, convenience and the wealth of online-only deals and offers are all reasons we’re parking the car and going online to bank.
The development of internet bank accounts and online banking has been startling. In 1995 there were no online banks. The number of personal accounts accessed by computer increased by nearly 50 per cent in 2002 to almost 13 million, a ten-fold increase on the number just three years before.
There are several good reasons for this. Firstly, there is a totally new breed of internet bank- operations not tied to the existing banks (although many are now operated by large banking organisations); these have offered completely new bank accounts and services you couldn’t get before. This has attracted entirely new customers to banking and improved customer choice for existing customers.
Secondly, more people are hooked up to the internet than ever before- this ties in with better security and evaluation of security for internet bank operations. We now feel relatively safe passing credit card details and accessing our private accounts online.
Thirdly, even where internet bank accounts are just an extension of high street accounts, we’re beginning to appreciate the convenience and reduced cost of banking online (even it just means not paying for parking in our high streets- where trade is rapidly dwindling in all retail sectors). In the next five years, expect online banking to improve further, so that the full range of banking products (and even face-to-face meetings with your manager) can happen in the online environment.
In three years, use of internet bank accounts has increased ten-fold, as services become accessible to ordinary people and not just tech-savvy computer nerds. Simplicity, convenience and the wealth of online-only deals and offers are all reasons we’re parking the car and going online to bank.
The development of internet bank accounts and online banking has been startling. In 1995 there were no online banks. The number of personal accounts accessed by computer increased by nearly 50 per cent in 2002 to almost 13 million, a ten-fold increase on the number just three years before.
There are several good reasons for this. Firstly, there is a totally new breed of internet bank- operations not tied to the existing banks (although many are now operated by large banking organisations); these have offered completely new bank accounts and services you couldn’t get before. This has attracted entirely new customers to banking and improved customer choice for existing customers.
Secondly, more people are hooked up to the internet than ever before- this ties in with better security and evaluation of security for internet bank operations. We now feel relatively safe passing credit card details and accessing our private accounts online.
Thirdly, even where internet bank accounts are just an extension of high street accounts, we’re beginning to appreciate the convenience and reduced cost of banking online (even it just means not paying for parking in our high streets- where trade is rapidly dwindling in all retail sectors). In the next five years, expect online banking to improve further, so that the full range of banking products (and even face-to-face meetings with your manager) can happen in the online environment.
UK Bank
If you’re looking for a new bank account, you’re already making a wise choice by bothering to hunt for deals in the first place.
After much consolidation in the past 20 years, the UK bank and financial services industry is as lean as it can be, and despite market jitters, is performing well globally. You have a fine choice of banks and banking products at your disposal, so shop around, compare deals, and don’t be afraid of the jargon.
The British Banker’s Association, the trade body (not a regulatory body) for the UK bank and retail financial services sector, says that over one million transactions pass through UK bank systems every day. The UK remains the centre of the world’s international banking industry, accounting for over 21% of global transactions. As such it will be of no surprise that the top 8 British banks also perform within the top 30 banks worldwide. That means you’re both in very safe and secure hands, but also subject to global economic movement and sometimes the banks are the last to embrace new technology.
We’re also borrowing more than ever (which worries the new Bank of England governor, Mervyn King) with mortgage lending by UK bank and building society lenders up by a record £78 billion).
So if you’re looking for a bank account, expect a fiscally sound service, but not exceptional customer service (although many online banks are changing that!) and go with a bank which will cut you some slack when you need to borrow money: it seems that we all need to these days! And don’t feel you need to stick with the same bank year after year, or indeed that you need to use the same bank for all your financial services. You wouldn’t get garden furniture from the same shop as you buy your groceries, and the same applies to money.
After much consolidation in the past 20 years, the UK bank and financial services industry is as lean as it can be, and despite market jitters, is performing well globally. You have a fine choice of banks and banking products at your disposal, so shop around, compare deals, and don’t be afraid of the jargon.
The British Banker’s Association, the trade body (not a regulatory body) for the UK bank and retail financial services sector, says that over one million transactions pass through UK bank systems every day. The UK remains the centre of the world’s international banking industry, accounting for over 21% of global transactions. As such it will be of no surprise that the top 8 British banks also perform within the top 30 banks worldwide. That means you’re both in very safe and secure hands, but also subject to global economic movement and sometimes the banks are the last to embrace new technology.
We’re also borrowing more than ever (which worries the new Bank of England governor, Mervyn King) with mortgage lending by UK bank and building society lenders up by a record £78 billion).
So if you’re looking for a bank account, expect a fiscally sound service, but not exceptional customer service (although many online banks are changing that!) and go with a bank which will cut you some slack when you need to borrow money: it seems that we all need to these days! And don’t feel you need to stick with the same bank year after year, or indeed that you need to use the same bank for all your financial services. You wouldn’t get garden furniture from the same shop as you buy your groceries, and the same applies to money.
Investment Bank
What to do when a savings account just isn’t enough for your spare cash!
Investment banks don’t do current accounts- they make your savings work harder (usually you need £10,000 or so to start). When choosing an investment bank, ask about their past performance for clients, what breadth of investments they operate and specialise in, and what sort of personal service they can offer you.
An investment bank is usually a smaller, specialist company than your traditional high street bank, although they do investment banking too. Your high street bank however is primarily geared to day-to-day banking; cheques going in and out, paying those bills, and offering credit and insurance. An investment bank doesn’t lend anything- it’s geared up for one specific purpose: to take your spare money, and turn it into more money.
As such, investment accounts don’t offer easy access to your cash, or a cashcard- the whole point is to leave the money for a long time and let it work for you. Often you won’t even get a chequebook, and your money is only accessible after asking in writing. An investment bank often adds offshore services (specifically tax avoidance) and private banking to the suite of products, and often the terms are interchangeable.
Be aware though that the job of an investment bank is to advise you on what to do. Expect a level of personal service. Don’t confuse this with investment trusts- which are just one of the many investments open to you. The bank is not a product in itself; it will take your money and invest it, as wisely as possible, into usually a multitude of different investment vehicles. However, you need to know that it is very, very rare that you get any compensation if the market goes down and you lose money. Compensation is almost exclusively confined to cases where clear negligence of illegal activity has occurred. Today, with the markets low and flat, opinion is divided- some say a recovery is on the way and we should invest; others say it’s time for the safe bet of putting your money into bonds. A good investment bank will advise you on precisely such issues.
Investment banks don’t do current accounts- they make your savings work harder (usually you need £10,000 or so to start). When choosing an investment bank, ask about their past performance for clients, what breadth of investments they operate and specialise in, and what sort of personal service they can offer you.
An investment bank is usually a smaller, specialist company than your traditional high street bank, although they do investment banking too. Your high street bank however is primarily geared to day-to-day banking; cheques going in and out, paying those bills, and offering credit and insurance. An investment bank doesn’t lend anything- it’s geared up for one specific purpose: to take your spare money, and turn it into more money.
As such, investment accounts don’t offer easy access to your cash, or a cashcard- the whole point is to leave the money for a long time and let it work for you. Often you won’t even get a chequebook, and your money is only accessible after asking in writing. An investment bank often adds offshore services (specifically tax avoidance) and private banking to the suite of products, and often the terms are interchangeable.
Be aware though that the job of an investment bank is to advise you on what to do. Expect a level of personal service. Don’t confuse this with investment trusts- which are just one of the many investments open to you. The bank is not a product in itself; it will take your money and invest it, as wisely as possible, into usually a multitude of different investment vehicles. However, you need to know that it is very, very rare that you get any compensation if the market goes down and you lose money. Compensation is almost exclusively confined to cases where clear negligence of illegal activity has occurred. Today, with the markets low and flat, opinion is divided- some say a recovery is on the way and we should invest; others say it’s time for the safe bet of putting your money into bonds. A good investment bank will advise you on precisely such issues.
Personal Banking
Why banking has changed in your favour, and being a customer can yield dividends.
These days personal banking is about choices- where to save, invest, borrow, or indeed where simply to put your monthly income. Even if you do nothing but pay in your salary, there is a massive differential in interest rates between best and worst performing banks (3000%- yes 3000%!). So shop around and you’ll save, or earn, a tidy sum.
Historically, personal banking meant having a bank account into which you put your salary, and an occasional visit to a mortgage lender (usually a different company) to keep your house on track. The banks were in the high street, and never competed very much for business. You also received little respect for your custom. Competition was stagnant to say the least.
Welcome, however, to a brave new world of personal banking; where a far larger number of companies are only too glad to compete for your business- and for a much bigger range of products. Today you probably have a credit card; you might want a loan for a car, and we all have far higher personal incomes; which means we want savings accounts and investments too. We bank on the high street, the internet, and by phone; and we use different companies for different jobs- you might borrow with a different company than the one you have a bank account with.
So the ethos of clever personal banking is to shop around- and never take “No” as the final answer- if you can’t get the savings, mortgage, credit card or insurance deal you want, chances are someone else can offer it to you. Despite this advice, 60% of people bank with the same company their whole life through, so get online and do some grafting- it could save you huge amounts of money for very little effort. You’re a customer now, not an inconvenience, and companies are hungry for your business.
These days personal banking is about choices- where to save, invest, borrow, or indeed where simply to put your monthly income. Even if you do nothing but pay in your salary, there is a massive differential in interest rates between best and worst performing banks (3000%- yes 3000%!). So shop around and you’ll save, or earn, a tidy sum.
Historically, personal banking meant having a bank account into which you put your salary, and an occasional visit to a mortgage lender (usually a different company) to keep your house on track. The banks were in the high street, and never competed very much for business. You also received little respect for your custom. Competition was stagnant to say the least.
Welcome, however, to a brave new world of personal banking; where a far larger number of companies are only too glad to compete for your business- and for a much bigger range of products. Today you probably have a credit card; you might want a loan for a car, and we all have far higher personal incomes; which means we want savings accounts and investments too. We bank on the high street, the internet, and by phone; and we use different companies for different jobs- you might borrow with a different company than the one you have a bank account with.
So the ethos of clever personal banking is to shop around- and never take “No” as the final answer- if you can’t get the savings, mortgage, credit card or insurance deal you want, chances are someone else can offer it to you. Despite this advice, 60% of people bank with the same company their whole life through, so get online and do some grafting- it could save you huge amounts of money for very little effort. You’re a customer now, not an inconvenience, and companies are hungry for your business.
Business Bank Account
Business banking costs you money- so get value in good rates and good advice.
A business bank account is rarely free, so get one that offers value- not just in good credit rates but also decent advice applied to the management of your specific industry. Consider the number of transactions you’ll make, the financial structure of your company, the size of funds moving around, and how you wish to expand. Only settle for an account deal which will cater for all these issues and a manager with sound advice. Oh- and feel free to haggle!
Your business bank account is nothing like your personal bank account. Depending on what you do, a different set of criteria come into play. For example, you may wish to take transactions in different currencies if you trade in more than one country. You may require a serious discussion about credit lines if you require capital expenditure before you even start trading. Since your business bank account will usually not be free to operate day-to-day (personal accounts usually are), you also need to have a fair idea of what your transaction throughput will be. If you do three big deals a year, that won’t cost much; but if you have hundreds of consumers and cheques, then your banking will suddenly become more expensive.
But put all these issues aside for a moment- the defining factor in choosing a business bank account must be the support you get from a dedicated advisor. In the past, banks have been unswervingly remiss- failing in their obligation to provide decent service to small businesses. Slowly, that’s changing, with Barclays and the Allied Irish Bank showing the way forward. Who is your bank manager, and do you like them? Do they understand your business, and what you need to succeed? Far more so than in personal banking, with a business your bank needs to be your partner not your enemy. If you find yourself begging for consideration, it’s time to find a new bank fast.
A business bank account is rarely free, so get one that offers value- not just in good credit rates but also decent advice applied to the management of your specific industry. Consider the number of transactions you’ll make, the financial structure of your company, the size of funds moving around, and how you wish to expand. Only settle for an account deal which will cater for all these issues and a manager with sound advice. Oh- and feel free to haggle!
Your business bank account is nothing like your personal bank account. Depending on what you do, a different set of criteria come into play. For example, you may wish to take transactions in different currencies if you trade in more than one country. You may require a serious discussion about credit lines if you require capital expenditure before you even start trading. Since your business bank account will usually not be free to operate day-to-day (personal accounts usually are), you also need to have a fair idea of what your transaction throughput will be. If you do three big deals a year, that won’t cost much; but if you have hundreds of consumers and cheques, then your banking will suddenly become more expensive.
But put all these issues aside for a moment- the defining factor in choosing a business bank account must be the support you get from a dedicated advisor. In the past, banks have been unswervingly remiss- failing in their obligation to provide decent service to small businesses. Slowly, that’s changing, with Barclays and the Allied Irish Bank showing the way forward. Who is your bank manager, and do you like them? Do they understand your business, and what you need to succeed? Far more so than in personal banking, with a business your bank needs to be your partner not your enemy. If you find yourself begging for consideration, it’s time to find a new bank fast.
International Banking
Defining international banking for personal and business banking customers.
The term international banking covers a multitude of sins, from private banking to the range of foreign currency services required to run a business which trades in more than one country. All banks offer some international services, but certainly for private banking a specialist consultancy is usually recommended.
The term international banking now has an alarming number of meanings and uses.
To begin with, international banking often refers to the same suite of services as offshore banking. This means the investment and financial management solutions that are based in other countries, often countries with low or no taxation, to avoid Britain’s relatively high tax for high net worth individuals. In this respect, international banking is for quite rich people who want to pay less tax.
Equally, in primarily business but also occasionally for personal banking customers, many banks offer international banking services as covering the ways in which you can make transactions in foreign currencies. This includes international payment mechanisms, foreign currency accounts, travellers’ cheques and import/export advice. Despite being the 21st Century, international currency transactions can still vary wildly from bank to bank and currency to currency. In general, expect Euro, dollar and Swiss Franc transactions to be relatively simple; but go much further afield and you will enter a bureaucratic minefield!
Finally, returning to international banking as a plaything for better off customers, you will also occasionally find the term applied to foreign currency transactions as investments.
The term international banking covers a multitude of sins, from private banking to the range of foreign currency services required to run a business which trades in more than one country. All banks offer some international services, but certainly for private banking a specialist consultancy is usually recommended.
The term international banking now has an alarming number of meanings and uses.
To begin with, international banking often refers to the same suite of services as offshore banking. This means the investment and financial management solutions that are based in other countries, often countries with low or no taxation, to avoid Britain’s relatively high tax for high net worth individuals. In this respect, international banking is for quite rich people who want to pay less tax.
Equally, in primarily business but also occasionally for personal banking customers, many banks offer international banking services as covering the ways in which you can make transactions in foreign currencies. This includes international payment mechanisms, foreign currency accounts, travellers’ cheques and import/export advice. Despite being the 21st Century, international currency transactions can still vary wildly from bank to bank and currency to currency. In general, expect Euro, dollar and Swiss Franc transactions to be relatively simple; but go much further afield and you will enter a bureaucratic minefield!
Finally, returning to international banking as a plaything for better off customers, you will also occasionally find the term applied to foreign currency transactions as investments.
Private Banking
How private banking can make fairly rich people richer, and how to avoid the pitfalls.
Private banking is relationship banking with a professional adviser; once for the very rich, now for anyone with five figures to spare. You will get the benefit of investment and tax avoidance advice, and ideally a better class of service than your local bank.
In times gone, private banking was a personal relationship with a banking professional; the preserve only of extremely wealthy individuals, and designed to help them remain extremely wealthy individuals.
Nowadays, private banking has become so competitive that you can find many open doors if you only have £10,000 in your pocket. I know that’s a lot, but it’s not the millions you required before. With £100,000 plenty of private banking agents will pop the kettle on for you. Furthermore, they want to talk to you because they know that if you have £10,000 now, you’re the type of person who might just have a million later. Making money is a lot easier if you have some in the first place. Therefore these days, it’s not just the personal relationship which counts- it’s also that the individual should be an investment genius, with a full knowledge of investment opportunities, tax avoidance schemes, offshore portfolios etc. to make your money go further.
All the main banks have private banking arms, then there are plenty of specialist private banks- in fact thousands- it’s a global industry, and many sit quietly offshore in Monaco, the Bahamas, the Cayman Islands or the Isle of Man. There are famous names you will have heard of like Coutts (part of NatWest); but again there are two caveats. Firstly, remember that you require a relationship- someone who you will know for some time to come and will help you manage your money. A private banker is a financial adviser to the rich! And stemming from that, our second caveat: many offshore private banks are little more than fronts for a specific investment scheme; and you don’t have any legal protection in offshore regimes. So be sure to get a reputable company on your side, not a fly-by-night.
Private banking is relationship banking with a professional adviser; once for the very rich, now for anyone with five figures to spare. You will get the benefit of investment and tax avoidance advice, and ideally a better class of service than your local bank.
In times gone, private banking was a personal relationship with a banking professional; the preserve only of extremely wealthy individuals, and designed to help them remain extremely wealthy individuals.
Nowadays, private banking has become so competitive that you can find many open doors if you only have £10,000 in your pocket. I know that’s a lot, but it’s not the millions you required before. With £100,000 plenty of private banking agents will pop the kettle on for you. Furthermore, they want to talk to you because they know that if you have £10,000 now, you’re the type of person who might just have a million later. Making money is a lot easier if you have some in the first place. Therefore these days, it’s not just the personal relationship which counts- it’s also that the individual should be an investment genius, with a full knowledge of investment opportunities, tax avoidance schemes, offshore portfolios etc. to make your money go further.
All the main banks have private banking arms, then there are plenty of specialist private banks- in fact thousands- it’s a global industry, and many sit quietly offshore in Monaco, the Bahamas, the Cayman Islands or the Isle of Man. There are famous names you will have heard of like Coutts (part of NatWest); but again there are two caveats. Firstly, remember that you require a relationship- someone who you will know for some time to come and will help you manage your money. A private banker is a financial adviser to the rich! And stemming from that, our second caveat: many offshore private banks are little more than fronts for a specific investment scheme; and you don’t have any legal protection in offshore regimes. So be sure to get a reputable company on your side, not a fly-by-night.
Internet Banking
Internet banking can save you time and travelling, but there’s a wide choice.
In the past five years, every high street bank has begun to offer internet banking, and plenty more internet-only banks have sprung up. Sometimes they just offer convenience, but some can give you deals you won’t find in branches.
Internet banking refers confusingly to two different experiences. The first is a new type of bank only found online. Big internet banking names are IF, Smile, the One Account and Cahoot. These offer a selection of banking services, usually not as broad as a high street bank, but also offer innovative products which use technology to cut costs or add convenience to you the customer. For example, one feature of many internet banking outfits is offsetting- using the interest from savings in one account to offset borrowing on another account.
Many of these internet banks have been bought by ordinary banks anyway- for example IF is owned by the Halifax.
The second type of internet banking is online banking offered by most ordinary high street banks as part of their service. It’s highly unlikely that you picked your bank because of its internet banking facilities, but you should ask about their internet security and also how far back you can check statements online, for example. The Co-operative has particularly good security and a very flexible system for managing your account. Repeat statements usually cost up to £10, so signing up for internet banking can save you money- and don’t forget by reducing traffic in branches, you’re saving them money too. Look for internet-only offers (even from high street banks)- often you’ll be offered rates online that aren’t publicised elsewhere.
In the past five years, every high street bank has begun to offer internet banking, and plenty more internet-only banks have sprung up. Sometimes they just offer convenience, but some can give you deals you won’t find in branches.
Internet banking refers confusingly to two different experiences. The first is a new type of bank only found online. Big internet banking names are IF, Smile, the One Account and Cahoot. These offer a selection of banking services, usually not as broad as a high street bank, but also offer innovative products which use technology to cut costs or add convenience to you the customer. For example, one feature of many internet banking outfits is offsetting- using the interest from savings in one account to offset borrowing on another account.
Many of these internet banks have been bought by ordinary banks anyway- for example IF is owned by the Halifax.
The second type of internet banking is online banking offered by most ordinary high street banks as part of their service. It’s highly unlikely that you picked your bank because of its internet banking facilities, but you should ask about their internet security and also how far back you can check statements online, for example. The Co-operative has particularly good security and a very flexible system for managing your account. Repeat statements usually cost up to £10, so signing up for internet banking can save you money- and don’t forget by reducing traffic in branches, you’re saving them money too. Look for internet-only offers (even from high street banks)- often you’ll be offered rates online that aren’t publicised elsewhere.
Bank Loan
Where to go to get a fair deal on a bank loan
A bank loan is now available from an increasingly broad range of lenders, but the interest rates vary wildly too. To get a good rate, you need to think about what the loan is for, what your credit record is like, and whether you need extras like repayment insurance.
A bank loan is an amount of money agreed with the bank that you borrow, and repay with interest across an agreed term. Usually, you’ll pay equal monthly instalments- part of which is the loan amount, and part of which is interest. So you will pay back more than you originally borrowed. Personal loans are usually economical up to 5 years- (although many banks will lend across up to 7 years). Thereafter consider a home loan if you have equity in your house. Before getting a bank loan consider carefully whether you need to borrow, and what it’s for. Debt consolidation, for example, can cost dearly- so be sure to get the best rate.
You can get a bank loan from plenty of places- not just banks. Supermarkets like Tesco and Sainsbury’s have banking arms which will lend to you. Consider also internet banks like Cahoot, Smile or First Direct. Finally, if you’re in credit difficulties, there are specialist lenders like Purple Loans who can also help.
Note that the interest rate you pay on your bank loan will not necessarily be the one you see quoted in literature. Usually the rate is based on your creditworthiness, which will be ascertained partly on your credit history (this is known to most financial organisations) and partly on the information you give on your application form. If you’re deemed to have good credit, you’ll get a lower interest rate than a bad debtor. If you’re refused credit, the bank won’t have to tell you why; but you do have the right to see your credit record, which is held at credit reference agencies like Experian. It usually costs £2, and if your record is wrong, you can have it changed free of charge.
A bank loan is now available from an increasingly broad range of lenders, but the interest rates vary wildly too. To get a good rate, you need to think about what the loan is for, what your credit record is like, and whether you need extras like repayment insurance.
A bank loan is an amount of money agreed with the bank that you borrow, and repay with interest across an agreed term. Usually, you’ll pay equal monthly instalments- part of which is the loan amount, and part of which is interest. So you will pay back more than you originally borrowed. Personal loans are usually economical up to 5 years- (although many banks will lend across up to 7 years). Thereafter consider a home loan if you have equity in your house. Before getting a bank loan consider carefully whether you need to borrow, and what it’s for. Debt consolidation, for example, can cost dearly- so be sure to get the best rate.
You can get a bank loan from plenty of places- not just banks. Supermarkets like Tesco and Sainsbury’s have banking arms which will lend to you. Consider also internet banks like Cahoot, Smile or First Direct. Finally, if you’re in credit difficulties, there are specialist lenders like Purple Loans who can also help.
Note that the interest rate you pay on your bank loan will not necessarily be the one you see quoted in literature. Usually the rate is based on your creditworthiness, which will be ascertained partly on your credit history (this is known to most financial organisations) and partly on the information you give on your application form. If you’re deemed to have good credit, you’ll get a lower interest rate than a bad debtor. If you’re refused credit, the bank won’t have to tell you why; but you do have the right to see your credit record, which is held at credit reference agencies like Experian. It usually costs £2, and if your record is wrong, you can have it changed free of charge.
Offshore Banking
The undoubted tax benefits of keeping your money in a foreign country; weighed against the regulatory downside.
Offshore banking isn’t necessarily only for the very rich. It means avoiding the British taxation system by putting your money in a country with a more favourable (i.e. cheaper!) tax structure. If you run a flourishing business or have just received an inheritance; give some time to evaluating offshore options before popping the money in a tin under your bed.
Offshore banking is confused in many people’s minds with private banking, because both are largely the preserve of wealthy people. But the difference is clear. Private banking is indeed banking by private relationship, and is definitely for high net worth earners. Offshore banking literally means banking under a different financial regulatory regime to the one in place in your home country. It is therefore primarily a tool either for expatriates or for those for whom it is most tax efficient to move money out of the UK. As we actually have a very equitable tax system (in many countries the top rate of tax is 50% or more), it is in practice only the more well-off people who engage in offshore banking. Tax havens where UK tax regulations do not apply include the Isle of Man, the Channel Islands and further afield Switzerland, Luxembourg, the Cayman Islands and Bermuda.
Offshore banking also refers to the breadth of investment opportunities available under these different countries’ regimes; but that also means you don’t have the protection of the UK’s Financial Services Authority, and there are plenty of scams operating offshore, so get advice before you invest. All the main banks and private banks have offshore divisions which will assist you; many fund management houses (e.g. Lazard, Hill Samuel, Rothschild) also provide offshore investment, or you can head for a specialist consultancy such as Walbrook or Brown Shipley & Co.
Offshore banking isn’t necessarily only for the very rich. It means avoiding the British taxation system by putting your money in a country with a more favourable (i.e. cheaper!) tax structure. If you run a flourishing business or have just received an inheritance; give some time to evaluating offshore options before popping the money in a tin under your bed.
Offshore banking is confused in many people’s minds with private banking, because both are largely the preserve of wealthy people. But the difference is clear. Private banking is indeed banking by private relationship, and is definitely for high net worth earners. Offshore banking literally means banking under a different financial regulatory regime to the one in place in your home country. It is therefore primarily a tool either for expatriates or for those for whom it is most tax efficient to move money out of the UK. As we actually have a very equitable tax system (in many countries the top rate of tax is 50% or more), it is in practice only the more well-off people who engage in offshore banking. Tax havens where UK tax regulations do not apply include the Isle of Man, the Channel Islands and further afield Switzerland, Luxembourg, the Cayman Islands and Bermuda.
Offshore banking also refers to the breadth of investment opportunities available under these different countries’ regimes; but that also means you don’t have the protection of the UK’s Financial Services Authority, and there are plenty of scams operating offshore, so get advice before you invest. All the main banks and private banks have offshore divisions which will assist you; many fund management houses (e.g. Lazard, Hill Samuel, Rothschild) also provide offshore investment, or you can head for a specialist consultancy such as Walbrook or Brown Shipley & Co.
Bank Account
What to look for when selecting a bank account
Most banks now offer at least three types of bank account. Even basic accounts offer a cashcard; premium accounts have a whole raft of services bolted on. Very few current accounts remain just a place to put your cash, so tot up the benefits and shop around before deciding where to put your salary each month.
A bank account is no longer just a place to put your money so that it’s safe and you can write cheques. For starters, current accounts can offer interest- but rates vary wildly. The good internet banks can offer up to 30 times as much interest as the high street banks!
But there are plenty of other things you should be aware of. Do you get a cashcard, a cheque guarantee card, a switch card (or all three in one card) with your bank account? Ask what charges are like- for going overdrawn or for simple services like getting an extra statement sent out. Overdraft fees vary from 8% to 34%! And can you get an overdraft at all- some banks offer £500 with no questions asked; others will expect you to fight tooth and nail.
A new breed on the scene is the premium bank account. These charge a modest fee (£5 to £10 per month) and offer a bunch of extras, usually cheaper borrowing, travel insurance, roadside rescue and shopping. If you use these services, maybe that’s a good economy.
And do you have easy access to your bank and more importantly your manager? NatWest have stopped using call centres and offer you direct access to your branch- in general that’s a good thing.
Finally watch for special services that might be a bonus. Abbey National for example offers “sweeping”- automatically putting spare money each month into a savings account, offering you better interest. Many internet banks also allow you to offset interest on your current account against a mortgage.
So tot up the benefits- your bank account should include extras and benefits, it’s no longer the same as a piggy bank or a box under your bed!
Most banks now offer at least three types of bank account. Even basic accounts offer a cashcard; premium accounts have a whole raft of services bolted on. Very few current accounts remain just a place to put your cash, so tot up the benefits and shop around before deciding where to put your salary each month.
A bank account is no longer just a place to put your money so that it’s safe and you can write cheques. For starters, current accounts can offer interest- but rates vary wildly. The good internet banks can offer up to 30 times as much interest as the high street banks!
But there are plenty of other things you should be aware of. Do you get a cashcard, a cheque guarantee card, a switch card (or all three in one card) with your bank account? Ask what charges are like- for going overdrawn or for simple services like getting an extra statement sent out. Overdraft fees vary from 8% to 34%! And can you get an overdraft at all- some banks offer £500 with no questions asked; others will expect you to fight tooth and nail.
A new breed on the scene is the premium bank account. These charge a modest fee (£5 to £10 per month) and offer a bunch of extras, usually cheaper borrowing, travel insurance, roadside rescue and shopping. If you use these services, maybe that’s a good economy.
And do you have easy access to your bank and more importantly your manager? NatWest have stopped using call centres and offer you direct access to your branch- in general that’s a good thing.
Finally watch for special services that might be a bonus. Abbey National for example offers “sweeping”- automatically putting spare money each month into a savings account, offering you better interest. Many internet banks also allow you to offset interest on your current account against a mortgage.
So tot up the benefits- your bank account should include extras and benefits, it’s no longer the same as a piggy bank or a box under your bed!
Business Banking
What to look for when selecting a business bank account
Due to laziness alone, we often do our business banking with the same people our personal bank account is held with. If you shop around, you won’t get much of a better deal financially (rates and services are generally almost identical) but you will find banks who offer better service, better personnel and advice.
Business banking is very different to personal banking. To begin with, your choice of banks is different and much more limited than with your personal bank account. You won’t get the benefit of the new rash of internet banks- but the high street banks are becoming more competitive for your business custom. This is because business banking is where they usually make some money.
You should expect at least to get your first year’s business banking free (provided you remain in credit). Thereafter you’ll be expected to pay a fee per transaction, so factor that into your cost base. You should also expect access to a business banking advisor; who is there to help. Tales of woe abound about these people- plenty of business advisors never call you up except to try to sell you things like mortgages, but Barclays in particular is improving by having advisors who are specialists in particular businesses e.g. construction, technology etc.
You should also get some sort of credit- even if it’s a card you pay off each month. And before opening your account, see what overdraft and loan facilities are available- you may not need them now, but you should know what their attitude to lending is so you’ll be prepared when you need it.
Finally, you have some options that may not be immediately apparent. As you may not be in your branch so often, smaller regional banks may be preferable to the big high street banks. The Allied Irish Bank, for example, has an astonishing record for looking after its business banking customers, but might not have been on your list.
Due to laziness alone, we often do our business banking with the same people our personal bank account is held with. If you shop around, you won’t get much of a better deal financially (rates and services are generally almost identical) but you will find banks who offer better service, better personnel and advice.
Business banking is very different to personal banking. To begin with, your choice of banks is different and much more limited than with your personal bank account. You won’t get the benefit of the new rash of internet banks- but the high street banks are becoming more competitive for your business custom. This is because business banking is where they usually make some money.
You should expect at least to get your first year’s business banking free (provided you remain in credit). Thereafter you’ll be expected to pay a fee per transaction, so factor that into your cost base. You should also expect access to a business banking advisor; who is there to help. Tales of woe abound about these people- plenty of business advisors never call you up except to try to sell you things like mortgages, but Barclays in particular is improving by having advisors who are specialists in particular businesses e.g. construction, technology etc.
You should also get some sort of credit- even if it’s a card you pay off each month. And before opening your account, see what overdraft and loan facilities are available- you may not need them now, but you should know what their attitude to lending is so you’ll be prepared when you need it.
Finally, you have some options that may not be immediately apparent. As you may not be in your branch so often, smaller regional banks may be preferable to the big high street banks. The Allied Irish Bank, for example, has an astonishing record for looking after its business banking customers, but might not have been on your list.
Banking
How banking has changed in the past 20 years in your favour!
In your lifetime, you will use plenty of banking products that were previously not available to the ordinary person. Most of us have credit cards, loans, investments and insurances. This has made banking a much more competitive industry, and you have the right to expect great service for your custom.
The face of banking in the UK has changed immeasurably in the past two decades. While we were busy living our lives, the financial services industry consolidated almost overnight, with most small banks being swallowed up by large ones- some fifteen very large global companies take care of the vast majority of daily banking.
But at the same time, lots of exciting new players have appeared. Small banks and lenders provide services for people who otherwise would never have access to credit; or even sometimes a bank account. New technology (cash machines, CHAPS clearance, credit scoring) mean we can get to our money faster- and do more with it.
More of us are investing than ever before- and with government support (remember PEPs and TESSAs, or today’s ISAs) plenty of us are making money out of our savings- even if it’s only a few pennies for a few days.
Banking is now a highly competitive industry whereas twenty years ago, you were grateful that your bank manager even gave you the time of day. Since we are now sophisticated financial consumers, aware of our banking options, and likely to demand several products in our lifetimes (not just a bank account and a mortgage), we owe it to ourselves to force our bank managers to justify their existence. Keep your bank manager on his toes!
In your lifetime, you will use plenty of banking products that were previously not available to the ordinary person. Most of us have credit cards, loans, investments and insurances. This has made banking a much more competitive industry, and you have the right to expect great service for your custom.
The face of banking in the UK has changed immeasurably in the past two decades. While we were busy living our lives, the financial services industry consolidated almost overnight, with most small banks being swallowed up by large ones- some fifteen very large global companies take care of the vast majority of daily banking.
But at the same time, lots of exciting new players have appeared. Small banks and lenders provide services for people who otherwise would never have access to credit; or even sometimes a bank account. New technology (cash machines, CHAPS clearance, credit scoring) mean we can get to our money faster- and do more with it.
More of us are investing than ever before- and with government support (remember PEPs and TESSAs, or today’s ISAs) plenty of us are making money out of our savings- even if it’s only a few pennies for a few days.
Banking is now a highly competitive industry whereas twenty years ago, you were grateful that your bank manager even gave you the time of day. Since we are now sophisticated financial consumers, aware of our banking options, and likely to demand several products in our lifetimes (not just a bank account and a mortgage), we owe it to ourselves to force our bank managers to justify their existence. Keep your bank manager on his toes!
Bank
The high street isn’t necessarily the best place to put your money
Finding the right bank means working out which bank gives you a good return on your business- whether that be interest on your savings or a cheap loan rate if you’re borrowing. It also means the bank which provides the full range of services you’ll need, and which rewards you for your loyalty in using them.
If you ask your parents, they’ll tell you that a bank is a building on the high street that closes at 3.30pm and claims to look after your money. These days that’s no longer necessarily the case. Of course you can still use a high street bank- and there are good reasons to do so, but you need to consider two other types of bank as well. If you’re tech savvy (and you’re reading this after all) consider internet banking. Many internet banks (Cahoot, Smile) offer proper current accounts, and because their costs are lower they can give you a better rate of interest on your money. If you don’t like internet banking, perhaps try First Direct bank. It offers arguably the best telephone banking service, and some excellent products too.
One thing to bear in mind though. Not all internet banks do offer current accounts. And some that do may not offer the breadth of other services your high street bank can. You see, everyone needs to make money somewhere. Since day-to-day banking is usually free of charge, some internet banks won’t do it. Your high street bank can offer you free banking because they’ll make a profit in other places- investments or loans for example. So don’t just consider the interest rate on your current balance- ask yourself what overall services you need (Loans? A cashcard? Instant access to money?) before deciding which bank to plump for. Over half of us never bother changing bank accounts, so you’re already taking a step in the right direction!
Finding the right bank means working out which bank gives you a good return on your business- whether that be interest on your savings or a cheap loan rate if you’re borrowing. It also means the bank which provides the full range of services you’ll need, and which rewards you for your loyalty in using them.
If you ask your parents, they’ll tell you that a bank is a building on the high street that closes at 3.30pm and claims to look after your money. These days that’s no longer necessarily the case. Of course you can still use a high street bank- and there are good reasons to do so, but you need to consider two other types of bank as well. If you’re tech savvy (and you’re reading this after all) consider internet banking. Many internet banks (Cahoot, Smile) offer proper current accounts, and because their costs are lower they can give you a better rate of interest on your money. If you don’t like internet banking, perhaps try First Direct bank. It offers arguably the best telephone banking service, and some excellent products too.
One thing to bear in mind though. Not all internet banks do offer current accounts. And some that do may not offer the breadth of other services your high street bank can. You see, everyone needs to make money somewhere. Since day-to-day banking is usually free of charge, some internet banks won’t do it. Your high street bank can offer you free banking because they’ll make a profit in other places- investments or loans for example. So don’t just consider the interest rate on your current balance- ask yourself what overall services you need (Loans? A cashcard? Instant access to money?) before deciding which bank to plump for. Over half of us never bother changing bank accounts, so you’re already taking a step in the right direction!
Sunday, April 12, 2009
Preventing Investment Mistakes: Ten Risk Minimizers
Most investment mistakes are caused by basic misunderstandings of the securities markets and by invalid performance expectations. The markets move in totally unpredictable cyclical patterns of varying duration and amplitude. Evaluating the performance of the two major classes of investment securities needs to be done separately because they are owned for differing purposes. Stock market equity investments are expected to produce realized capital gains; income-producing investments are expected to generate cash flow.Losing money on an investment may not be the result of an investment mistake, and not all mistakes result in monetary losses. But errors occur most frequently when judgment is unduly influenced by emotions such as fear and greed, hindsightful observations, and short-term market value comparisons with unrelated numbers. Your own misconceptions about how securities react to varying economic, political, and hysterical circumstances are your most vicious enemy. Master these ten risk-minimizers to improve your long-term investment performance:1. Develop an investment plan. Identify realistic goals that include considerations of time, risk-tolerance, and future income requirements--- think about where you are going before you start moving in the wrong direction. A well thought out plan will not need frequent adjustments. A well-managed plan will not be susceptible to the addition of trendy speculations.2. Learn to distinguish between asset allocation and diversification decisions. Asset allocation divides the portfolio between equity and income securities. Diversification is a strategy that limits the size of individual portfolio holdings in at least three different ways. Neither activity is a hedge, or a market timing devices. Neither can be done precisely with mutual funds, and both are handled most efficiently by using a cost basis approach like the Working Capital Model.3. Be patient with your plan. Although investing is always referred to as long- term, it is rarely dealt with as such by investors, the media, or financial advisors. Never change direction frequently, and always make gradual rather than drastic adjustments. Short-term market value movements must not be compared with un-portfolio related indices and averages. There is no index that compares with your portfolio, and calendar sub-divisions have no relationship whatever to market, interest rate, or economic cycles. 4. Never fall in love with a security, particularly when the company was once your employer. It's alarming how often accounting and other professionals refuse to fix the resultant single-issue portfolios. Aside from the love issue, this becomes an unwilling-to-pay-the-taxes problem that often brings the unrealized gain to the Schedule D as a realized loss. No profit, in either class of securities, should ever go unrealized. A target profit must be established as part of your plan.5. Prevent "analysis paralysis" from short-circuiting your decision-making powers. An overdose of information will cause confusion, hindsight, and an inability to distinguish between research and sales materials--- quite often the same document. A somewhat narrow focus on information that supports a logical and well-documented investment strategy will be more productive in the long run. Avoid future predictors.6. Burn, delete, toss out the window any short cuts or gimmicks that are supposed to provide instant stock picking success with minimum effort. Don't allow your portfolio to become a hodgepodge of mutual funds, index ETFs, partnerships, pennies, hedges, shorts, strips, metals, grains, options, currencies, etc. Consumers' obsession with products underlines how Wall Street has made it impossible for financial professionals to survive without them. Remember: consumers buy products; investors select securities.7. Attend a workshop on interest rate expectation (IRE) sensitive securities and learn how to deal appropriately with changes in their market value--- in either direction. The income portion of your portfolio must be looked at separately from the growth portion. Bottom line market value changes must be expected and understood, not reacted to with either fear or greed. Fixed income does not mean fixed price. Few investors ever realize (in either sense) the full power of this portion of their portfolio.8. Ignore Mother Nature's evil twin daughters, speculation and pessimism. They'll con you into buying at market peaks and panicking when prices fall, ignoring the cyclical opportunities provided by Momma. Never buy at all time high prices or overload the portfolio with current story stocks. Buy good companies, little by little, at lower prices and avoid the typical investor's buy high, sell low frustration. 9. Step away from calendar year, market value thinking. Most investment errors involve unrealistic time horizon, and/or "apples to oranges" performance comparisons. The get rich slowly path is a more reliable investment road that Wall Street has allowed to become overgrown, if not abandoned. Portfolio growth is rarely a straight-up arrow and short-term comparisons with unrelated indices, averages or strategies simply produce detours that speed progress away from original portfolio goals.10. Avoid the cheap, the easy, the confusing, the most popular, the future knowing, and the one-size-fits-all. There are no freebies or sure things on Wall Street, and the further you stray from conventional stocks and bonds, the more risk you are adding to your portfolio. When cheap is an investor's primary concern, what he gets will generally be worth the price.Compounding the problems that investors face managing their investment portfolios is the sensationalism that the media brings to the process. Step away from calendar year, market value thinking. Investing is a personal project where individual/family goals and objectives must dictate portfolio structure, management strategy, and performance evaluation techniques. Do most individual investors have difficulty in an environment that encourages instant gratification, supports all forms of speculation, and gets off on shortsighted reports, reactions, and achievements? Yup.
Stock Market Trading- 3 Strategies to Make you a Millionaire
Stock Market Trading- Are you ready to become a millionaire. Here are 3 proven strategies to make you become a more successful trader and increase your wealth. They can be used if you are forex trader, stock market trader.
If you want to catch the serious profit in Forex Trading you need to trend watch Forex trends which are worse term. here we are going to give you a 3 step simple method which if you use it correctly, will help you catch every superior Forex trend and lead you to long-term term currency dealing success. This will add more money to your bottom line than most other strategies.
For you to become a successful Forex Trader, you must set rules and then follow them. Successful Forex Traders have discpline.
Most beginner Forex traders don't bother trying to trend following Forex lengthier term - instead they try Forex scalping or day trading. These methods focus the trader on small moves and they hope to catch small profit however as most short term moves are random, this leads to equity eliminate.
The other alternatives are swing trading and long term Forex trend following and this article is all about the latter method. If you look at any Forex chart, you will see long-term term trends that last for months or years. These moves can and do yield serious profit - present we will outline a simple method to get them.
Breakouts
By far the best way of catching the serious moves is to use a Forex Trading strategy based around breakouts. A breakout is simply a move on a Forex chart where a new high or low is made and resistance or support is broken.
It's a fact that most leading moves start from new highs or lows.
While it might appear that you are not buying or selling at the greatest level, you are in terms of the odds of the trend continuing. Most Forex traders make the mistake of waiting for the breakout to come back and get in at a better price but these traders never get on board. The grounds are if a breakout occurs, then you have a new strong trend and a pullback is not very likely to occur.
Most traders don't buy or sell breakouts and that's exactly why it's such a powerful method.
The only point to keep in mind is a support or resistance which is ruined, should be valid and that means at least 3 points in at least 2 different times frames. The more tests and the greater the spacing between the tests the more valid the level is.
Confirmation: Make sure it is confirmed
Of course not every breakout keeps and some reverse, these are false and can cause losses. You therefore need to confirm each move. All you need to do to achieve this is to put a few momentum indicators in your Forex trading system to confirm your dealing signal.
These indicators give you an estimation of the strength and velocity of price and there are many to choose from. We don't have time to discuss them here (simply look up our other articles) but two of the greatest are - the stochastic and Relative Strength Index RSI
Stops and Targets
Stop points are easy with breakouts - Simply behind the breakout point.
If you have a serious trend then you need to be careful you can milk it, so don't move your stop to soon and keep it outside of normal volatility. If it is a huge move, trailing stops should be held a long-term way back and the 40 day moving average is a good level to use.
You have to keep in mind that when the trend does eventually turn you are going to give some profit back. You don't know when the trend is going to end, so don't predict.
It's ok to give a serious back, as that's the nature of trading Forex. Keep in mind if you got 50% of all leading trend you would be very rich. When you are long-term term trend following you have accept giving a bit back and taking dips in open equity as the trend develops - this is noise and does not affect the long term trend.
The above is a simple way to trend watch Forex and catch the high odds moves that yield the serious profit. If you are learning Forex dealing and want a simple method that is robust and will help you get every major move, then you should base your dealing on the above method.
Now that you have all the winning strategies, you now need to have a winning broker, recently the CFD FX REPORT has reviewed these brokers and have come up with Best Forex Broker to find out this visit the website.
If you want to catch the serious profit in Forex Trading you need to trend watch Forex trends which are worse term. here we are going to give you a 3 step simple method which if you use it correctly, will help you catch every superior Forex trend and lead you to long-term term currency dealing success. This will add more money to your bottom line than most other strategies.
For you to become a successful Forex Trader, you must set rules and then follow them. Successful Forex Traders have discpline.
Most beginner Forex traders don't bother trying to trend following Forex lengthier term - instead they try Forex scalping or day trading. These methods focus the trader on small moves and they hope to catch small profit however as most short term moves are random, this leads to equity eliminate.
The other alternatives are swing trading and long term Forex trend following and this article is all about the latter method. If you look at any Forex chart, you will see long-term term trends that last for months or years. These moves can and do yield serious profit - present we will outline a simple method to get them.
Breakouts
By far the best way of catching the serious moves is to use a Forex Trading strategy based around breakouts. A breakout is simply a move on a Forex chart where a new high or low is made and resistance or support is broken.
It's a fact that most leading moves start from new highs or lows.
While it might appear that you are not buying or selling at the greatest level, you are in terms of the odds of the trend continuing. Most Forex traders make the mistake of waiting for the breakout to come back and get in at a better price but these traders never get on board. The grounds are if a breakout occurs, then you have a new strong trend and a pullback is not very likely to occur.
Most traders don't buy or sell breakouts and that's exactly why it's such a powerful method.
The only point to keep in mind is a support or resistance which is ruined, should be valid and that means at least 3 points in at least 2 different times frames. The more tests and the greater the spacing between the tests the more valid the level is.
Confirmation: Make sure it is confirmed
Of course not every breakout keeps and some reverse, these are false and can cause losses. You therefore need to confirm each move. All you need to do to achieve this is to put a few momentum indicators in your Forex trading system to confirm your dealing signal.
These indicators give you an estimation of the strength and velocity of price and there are many to choose from. We don't have time to discuss them here (simply look up our other articles) but two of the greatest are - the stochastic and Relative Strength Index RSI
Stops and Targets
Stop points are easy with breakouts - Simply behind the breakout point.
If you have a serious trend then you need to be careful you can milk it, so don't move your stop to soon and keep it outside of normal volatility. If it is a huge move, trailing stops should be held a long-term way back and the 40 day moving average is a good level to use.
You have to keep in mind that when the trend does eventually turn you are going to give some profit back. You don't know when the trend is going to end, so don't predict.
It's ok to give a serious back, as that's the nature of trading Forex. Keep in mind if you got 50% of all leading trend you would be very rich. When you are long-term term trend following you have accept giving a bit back and taking dips in open equity as the trend develops - this is noise and does not affect the long term trend.
The above is a simple way to trend watch Forex and catch the high odds moves that yield the serious profit. If you are learning Forex dealing and want a simple method that is robust and will help you get every major move, then you should base your dealing on the above method.
Now that you have all the winning strategies, you now need to have a winning broker, recently the CFD FX REPORT has reviewed these brokers and have come up with Best Forex Broker to find out this visit the website.
CFD TRADING- Indonesia
Contracts for Difference (are commonly known as a CFD) is a contract between the trader and a CFD TRADER, who will at the close of the contract, exchange the difference between the opening price and the closing price of the underlying index, share, commodity, per the number of specified CFD contracts.
Stepping away from the technical jargon, a CFD differs from the traditional trading methods in that you aren't purchasing the nominated investment, but trading on its speculated price movement. The main idea of CFDs is the ability to be able to trade higher volumes than traditional trading whilst using less initial capital.
The buyer is of the contracts is required to pay commission to enter the contract, plus fixed interest on the remaining value of the borrowed amount, until they decide to end the contract, at which time they are paid the price difference. The buyer may opt on either side high (buy) or the low (sell), meaning if the contract was a low trade the buyer can still turn a profit it that was the initial investment.
The key distinction between traditional share buying and CFD buying is that buying a CFD is done on leverage (typically between 5%-35% for actively trade stocks), both share and CFDs participate in all corporate action, both buyers receive dividends but only the buyer of the share is able to vote and receive the franking credits. With CFDs you don't get these rights. The CFD seller is able to go low (sell) with ease.
This makes CFDs an excellent trading product. The leverage and ability to short sell gives trades dollar power and flexibility.
Unlike futures CFDs do not have an expiry date (you can hold as long or as short as you desire).
With CFDs you can open up a whole new trading world, with the ability to trade shares, indices, foreign exchange, and commodities.
Not only can you trade Singapore Stock Exchange (SGX) listed shares but you have access to world wide markets, such as the United States (DOW, NASDAQ, S&P), United Kingdom (FTSE), Japan (NEIKKI), Hong Kong (Hang Seng) and many other countries.
This is why CFDs are the flexible new way to trade. To find out more on CFDs feel free to visit the CFD FX REPORTwho offer education lessons, can help you find the best CFD Trader in market
Stepping away from the technical jargon, a CFD differs from the traditional trading methods in that you aren't purchasing the nominated investment, but trading on its speculated price movement. The main idea of CFDs is the ability to be able to trade higher volumes than traditional trading whilst using less initial capital.
The buyer is of the contracts is required to pay commission to enter the contract, plus fixed interest on the remaining value of the borrowed amount, until they decide to end the contract, at which time they are paid the price difference. The buyer may opt on either side high (buy) or the low (sell), meaning if the contract was a low trade the buyer can still turn a profit it that was the initial investment.
The key distinction between traditional share buying and CFD buying is that buying a CFD is done on leverage (typically between 5%-35% for actively trade stocks), both share and CFDs participate in all corporate action, both buyers receive dividends but only the buyer of the share is able to vote and receive the franking credits. With CFDs you don't get these rights. The CFD seller is able to go low (sell) with ease.
This makes CFDs an excellent trading product. The leverage and ability to short sell gives trades dollar power and flexibility.
Unlike futures CFDs do not have an expiry date (you can hold as long or as short as you desire).
With CFDs you can open up a whole new trading world, with the ability to trade shares, indices, foreign exchange, and commodities.
Not only can you trade Singapore Stock Exchange (SGX) listed shares but you have access to world wide markets, such as the United States (DOW, NASDAQ, S&P), United Kingdom (FTSE), Japan (NEIKKI), Hong Kong (Hang Seng) and many other countries.
This is why CFDs are the flexible new way to trade. To find out more on CFDs feel free to visit the CFD FX REPORTwho offer education lessons, can help you find the best CFD Trader in market
CFD Trading 95% Lose - How To Win
Everybody starts out in CFD Trading wanting to make money but a whopping 95% of Traders lose, which leaves 5% winners. So what is it that the 5% of CFD Traders are doing to make them win in CFD Trading. What are the mistakes that the 95% of people are making, and how can you avoid them!One of the major reasons that so many people lose when it comes to CFD trading is that they believe they have a sure fire winning CFD trading system or CFD robot that is going to make them rich. The first thing to take from this is that making money from CFD Trading is not easy, and it does take some skill.Think about this for minute if it was so easy to win, everybody would be CFD Trading and if a Robot was so successful would you in fact sell that robot? Probably not! More often than not people that develop these CFD Robots sell them and this is how they generate their income and not from CFD FX REPORT. So be very careful when it comes to buying a CFD Robot especially off the back of all the claims they make.The second group just don't understand the unique skills you need to win and they have the following misconceptions:If they work hard they will win but effort counts for nothing in CFD trading, just being right does and this means you have to work smart - not hard.Some people believe that they need to have a highly complicated trading system to be successful, however the opposite is more likely, the less complicated the better.Another portion of this group, believes the myths that can be found all on internet which include:- Scalping and day trading is a way to make massive money- You can predict CFD markets in advance- Buy low sell high is a great way to make money- CFD markets move to science and a mathematical theoryThere are many more and the above are just a few myths.This group wants to put in effort but they do so in the wrong areas and lose, because they simply get the wrong CFD education.How to be successfulTo learn to trade CFD is easy anyone can learn a logical robust system that can make gains but that is not all you need for success - you need the right mindset to apply it and this means trading with discipline. It is not just matter following these systems.Discipline is the key to success and you have to understand that you will have losing streaks, so you must stick to your rules and trading plans.Discipline comes from the right CFD education and having confidence in your trading plan. For further educational information feel free to visit the CFD FX REPORT, as they have a lot of educational information and can help you find the best CFD Broker.To be a successful CFD Trader you don't have to just work hard, work smarter, use simple systems and have discipline.
Forex Trading Education - The London Open Checklist
A thorough Forex trading education must include an understanding of the effect market timings can have on trading and liquidity.
One of the most active periods of the day is from the time the London market opens. Often around that time good trading opportunities will appear.
As part of your Forex trading education, learn to analyze market conditions around London open and begin to recognize good setups.
The following questionnaire and checklist will help.
London Open Preparation
About 15 to 30 minutes before London open check the answers to these questions:
- Are the MACD indicators on the 4 hour and 1 hour charts in agreement? If they are not going in the same direction be very careful!
- Is there MACD divergence on the 4 hour, 1 hour, or 15 minute chart? Look for other clues to confirm that price may go in the direction of MACD divergence.
- On the 4 hour chart what is the overall trend?
- Do a Fibonacci calculation on the last swing high and low and see if price is pulling back to an optimum retracement level or whether it is reaching a key extension level.
- Note price in relation to the 200 EMA (Exponential Moving Average) on the 4 hour, 1 hour and 15 minute charts. Is price bucking the trend? In other words, is price above the 200 EMA on the 4 hour and 1 hour chart but below it on the 15 minute? Then be prepared for price to go long at some stage. (Draw the opposite conclusion if price is below the 200 EMA on the 4 hour and 1 hour chart but above it on the 15 minute chart.)
- Are any Economic Reports imminent?
- As the candle closes on the 15 minute chart at London open, do you see any distinctive candle patterns such as tweezers, or doji's or hammers indicating price exhaustion?
- If I entered a trade right now in a particular direction, what would be the risk and where would I place my stop?
Within a few minutes of London open, if you see a number of factors converging from the analysis above, make a decision one way or the other:
- trade
- wait for clearer signals or a better entry point
Carrying out an analysis in this way each day at London open will do much to increase your Forex trading education.
It will make you aware of what is happening on the charts and in the marketplace and help you to arrive at conclusions.
There is no magic formula involved with Forex trading education. Put simply, successful Forex trading is the result of years of hard work, study, practice, and experience often gained through painful trading scenarios.
Eventually the newer trader learns mental discipline, and how to control the emotions - probably the biggest part of a Forex trading education.
Practice a procedure like the one above day after day and begin to see some progress as you get nearer the time you make profits consistently from currency trading.
One of the most active periods of the day is from the time the London market opens. Often around that time good trading opportunities will appear.
As part of your Forex trading education, learn to analyze market conditions around London open and begin to recognize good setups.
The following questionnaire and checklist will help.
London Open Preparation
About 15 to 30 minutes before London open check the answers to these questions:
- Are the MACD indicators on the 4 hour and 1 hour charts in agreement? If they are not going in the same direction be very careful!
- Is there MACD divergence on the 4 hour, 1 hour, or 15 minute chart? Look for other clues to confirm that price may go in the direction of MACD divergence.
- On the 4 hour chart what is the overall trend?
- Do a Fibonacci calculation on the last swing high and low and see if price is pulling back to an optimum retracement level or whether it is reaching a key extension level.
- Note price in relation to the 200 EMA (Exponential Moving Average) on the 4 hour, 1 hour and 15 minute charts. Is price bucking the trend? In other words, is price above the 200 EMA on the 4 hour and 1 hour chart but below it on the 15 minute? Then be prepared for price to go long at some stage. (Draw the opposite conclusion if price is below the 200 EMA on the 4 hour and 1 hour chart but above it on the 15 minute chart.)
- Are any Economic Reports imminent?
- As the candle closes on the 15 minute chart at London open, do you see any distinctive candle patterns such as tweezers, or doji's or hammers indicating price exhaustion?
- If I entered a trade right now in a particular direction, what would be the risk and where would I place my stop?
Within a few minutes of London open, if you see a number of factors converging from the analysis above, make a decision one way or the other:
- trade
- wait for clearer signals or a better entry point
Carrying out an analysis in this way each day at London open will do much to increase your Forex trading education.
It will make you aware of what is happening on the charts and in the marketplace and help you to arrive at conclusions.
There is no magic formula involved with Forex trading education. Put simply, successful Forex trading is the result of years of hard work, study, practice, and experience often gained through painful trading scenarios.
Eventually the newer trader learns mental discipline, and how to control the emotions - probably the biggest part of a Forex trading education.
Practice a procedure like the one above day after day and begin to see some progress as you get nearer the time you make profits consistently from currency trading.
Risks by the foreign exchange on Forex
The Forex is essentially risk-bearing. By the evaluation of the grade of a possible risk accounted should be the following kinds of it: exchange rate risk, interest rate risk, and credit risk, country risk.
Exchange rate risk. Exchange rate risk is the effect of the continuous shift in the worldwide market supply and demand balance on an outstanding foreign exchange position. For the period it is outstanding, the position will be subject to all the price changes. The most popular measures to cut losses short and ride profitable positions that losses should be kept within manageable limits are the position limit and the loss limit. By the position limitation a maximum amount of a certain currency a trader is allowed to carry at any single time during the regular trading hours is to be established. The loss limit is a measure designed to avoid unsustainable losses made by traders by means of stop-loss levels setting.
Interest rate risk. Interest rate risk refers to the profit and loss generated by fluctuations in the forward spreads, along with forward amount mismatches and maturity gaps among transactions in the foreign exchange book. This risk is pertinent to currency swaps, forward outright, futures, and options (See below). To minimize interest rate risk, one sets limits on the total size of mismatches. A common approach is to separate the mismatches, based on their maturity dates, into up to six months and past six months. All the transactions are entered in computerized systems in order to calculate the positions for all the dates of the delivery, gains and losses. Continuous analysis of the interest rate environment is necessary to forecast any changes that may impact on the outstanding gaps.
Credit risk. Credit risk refers to the possibility that an outstanding currency position may not be repaid as agreed, due to a voluntary or involuntary action by a counter party. In these cases, trading occurs on regulated exchanges, such as the clearinghouse of Chicago. The following forms of credit risk are known:
1. Replacement risk occurs when counterparties of the failed bank find their books are subjected to the danger not to get refunds from the bank, where appropriate accounts became unbalanced.
2. Settlement risk occurs because of the time zones on different continents. Consequently, currencies may be traded at the different price at different times during the trading day. Australian and New Zealand dollars are credited first, then Japanese yen, followed by the European currencies and ending with the U.S. dollar. Therefore, payment may be made to a party that will declare insolvency (or be declared insolvent) immediately after, but prior to executing its own payments.
Therefore in assessing the credit risk, end users must consider not only the market value of their currency portfolios, but also the potential exposure of these portfolios. The potential exposure may be determined through probability analysis over the time to maturity of the outstanding position. The computerized systems currently available are very useful in implementing credit risk policies. Credit lines are easily monitored. In addition, the matching systems introduced in foreign exchange since April 1993 are used by traders for credit policy implementation as well. Traders input the total line of credit for a specific counterparty. During the trading session, the line of credit is automatically adjusted. If the line is fully used, the system will prevent the trader from further dealing with that counterparty. After maturity, the credit line reverts to its original level.
Dictatorship risk. Dictatorship (sovereign) risk refers to the government's interference in the Forex activity. Although theoretically present in all foreign exchange instruments, currency futures are, for all practical purposes, excepted from country risk, because the major currency futures markets are located in the USA. Hence, traders have to realize that kind of the risk and be in state to account possible administrative restrictions.
Exchange rate risk. Exchange rate risk is the effect of the continuous shift in the worldwide market supply and demand balance on an outstanding foreign exchange position. For the period it is outstanding, the position will be subject to all the price changes. The most popular measures to cut losses short and ride profitable positions that losses should be kept within manageable limits are the position limit and the loss limit. By the position limitation a maximum amount of a certain currency a trader is allowed to carry at any single time during the regular trading hours is to be established. The loss limit is a measure designed to avoid unsustainable losses made by traders by means of stop-loss levels setting.
Interest rate risk. Interest rate risk refers to the profit and loss generated by fluctuations in the forward spreads, along with forward amount mismatches and maturity gaps among transactions in the foreign exchange book. This risk is pertinent to currency swaps, forward outright, futures, and options (See below). To minimize interest rate risk, one sets limits on the total size of mismatches. A common approach is to separate the mismatches, based on their maturity dates, into up to six months and past six months. All the transactions are entered in computerized systems in order to calculate the positions for all the dates of the delivery, gains and losses. Continuous analysis of the interest rate environment is necessary to forecast any changes that may impact on the outstanding gaps.
Credit risk. Credit risk refers to the possibility that an outstanding currency position may not be repaid as agreed, due to a voluntary or involuntary action by a counter party. In these cases, trading occurs on regulated exchanges, such as the clearinghouse of Chicago. The following forms of credit risk are known:
1. Replacement risk occurs when counterparties of the failed bank find their books are subjected to the danger not to get refunds from the bank, where appropriate accounts became unbalanced.
2. Settlement risk occurs because of the time zones on different continents. Consequently, currencies may be traded at the different price at different times during the trading day. Australian and New Zealand dollars are credited first, then Japanese yen, followed by the European currencies and ending with the U.S. dollar. Therefore, payment may be made to a party that will declare insolvency (or be declared insolvent) immediately after, but prior to executing its own payments.
Therefore in assessing the credit risk, end users must consider not only the market value of their currency portfolios, but also the potential exposure of these portfolios. The potential exposure may be determined through probability analysis over the time to maturity of the outstanding position. The computerized systems currently available are very useful in implementing credit risk policies. Credit lines are easily monitored. In addition, the matching systems introduced in foreign exchange since April 1993 are used by traders for credit policy implementation as well. Traders input the total line of credit for a specific counterparty. During the trading session, the line of credit is automatically adjusted. If the line is fully used, the system will prevent the trader from further dealing with that counterparty. After maturity, the credit line reverts to its original level.
Dictatorship risk. Dictatorship (sovereign) risk refers to the government's interference in the Forex activity. Although theoretically present in all foreign exchange instruments, currency futures are, for all practical purposes, excepted from country risk, because the major currency futures markets are located in the USA. Hence, traders have to realize that kind of the risk and be in state to account possible administrative restrictions.
Forex - What is it?
The international currency market Forex is a special kind of the world financial market. Trader’s purpose on the Forex to get profit as the result of foreign currencies purchase and sale. The exchange rates of all currencies being in the market turnover are permanently changing under the action of the demand and supply alteration. The latter is a strong subject to the influence of any important for the human society event in the sphere of economy, politics and nature. Consequently current prices of foreign currencies evaluated for instance in the US dollars fluctuate towards its higher and lower meanings. Using these fluctuations in accordance with a known principle “buy cheaper – sell higher” traders obtain gains. Forex is different in compare to all other sectors of the world financial system thanks to his heightened sensibility to a large and continuously changing number of factors, accessibility to all individual and corporative traders, exclusively high trade turnover which creates an ensured liquidity of traded currencies and the round - the clock business hours which enable traders to deal after normal hours or during national holidays in their country finding markets abroad open.
Just as on any other market the trading on Forex, along with an exclusively high potential profitability, is essentially risk - bearing one. It is possible to gain a success on it only after a certain training including a familiarization with the structure and kinds of Forex, the principles of currencies price formation, the factors affecting prices alterations and trading risks levels, sources of the information necessary to account all those factors, techniques of the analysis and prediction of the market movements as well as with the trading tools and rules. An important role in the process of the preparation for the trading on Forex belongs to the demotrading (that is to trade using a demo-account with some virtual money), which allows to testify all the theoretical knowledge and to obtain a required minimum of the trade experience not being subjected to a material damage.
Just as on any other market the trading on Forex, along with an exclusively high potential profitability, is essentially risk - bearing one. It is possible to gain a success on it only after a certain training including a familiarization with the structure and kinds of Forex, the principles of currencies price formation, the factors affecting prices alterations and trading risks levels, sources of the information necessary to account all those factors, techniques of the analysis and prediction of the market movements as well as with the trading tools and rules. An important role in the process of the preparation for the trading on Forex belongs to the demotrading (that is to trade using a demo-account with some virtual money), which allows to testify all the theoretical knowledge and to obtain a required minimum of the trade experience not being subjected to a material damage.
Online Currency Trading requires Patience
When the going gets tough, the tough get going. This adage often brings back the memories of my past days when I was trading initially in the currency exchange market. Indeed, there's nothing more hurtful than losing your invested money in the FX market. But, online currency trading is like life where you're got to learn from your wrong moves and keep moving on. Learning the basic skills of online forex trading could be easy but, practically, one needs to acquire the advanced skills to play safe through thick and thin of FX trading.
I have traded in forex for many years and, if you count on me, I must tell you that the secret of successful trading lies largely on the hunch and intuition of an trader. Technically expressed, you should have the accurate forex alerts and forex signals to be able to make the right moves in the currency market. However, this is easier said than done as the skills of the Currency Trading Signal takes a long time to master. This is why while a few people are able to boost their forex pips in a short span of time, the others take a long time to achieve the same or maybe, some of them get frustrated and just give it up! The reality is that not many people are ready to be entirely devoted to the perilous process of online forex trading.
Having said this, I still wonder why some people choose to be a dare-devil and risk their money instead of simply following an established and renowned Account Forex Online Trading. I began trading in 1997 and there is one important thing I have learnt in my trading career so far, i.e., you have to got to be patient to learn the tricks of making right moves at the right times and profit from your trading.
Since I have led quite a successful career in forex trading, I have been sharing the tips and tricks of online currency trading with many traders around the world through my G7 Forex Trading System which as you know has remained pretty successful for many traders so far. My G7 Forex Trading System is an easy-to-follow, step-by-step trading manual offering in-depth online forex trading review.
If you visit my site you will find many of my existing customers are pretty satisfied with the performance of their investments and in fact, most of them have been able to increase their forex pips drastically. You would be surprised to know quite a few of them haven't traded for a long time! Now, this is what we call success in the forex trading, eh?
I have traded in forex for many years and, if you count on me, I must tell you that the secret of successful trading lies largely on the hunch and intuition of an trader. Technically expressed, you should have the accurate forex alerts and forex signals to be able to make the right moves in the currency market. However, this is easier said than done as the skills of the Currency Trading Signal takes a long time to master. This is why while a few people are able to boost their forex pips in a short span of time, the others take a long time to achieve the same or maybe, some of them get frustrated and just give it up! The reality is that not many people are ready to be entirely devoted to the perilous process of online forex trading.
Having said this, I still wonder why some people choose to be a dare-devil and risk their money instead of simply following an established and renowned Account Forex Online Trading. I began trading in 1997 and there is one important thing I have learnt in my trading career so far, i.e., you have to got to be patient to learn the tricks of making right moves at the right times and profit from your trading.
Since I have led quite a successful career in forex trading, I have been sharing the tips and tricks of online currency trading with many traders around the world through my G7 Forex Trading System which as you know has remained pretty successful for many traders so far. My G7 Forex Trading System is an easy-to-follow, step-by-step trading manual offering in-depth online forex trading review.
If you visit my site you will find many of my existing customers are pretty satisfied with the performance of their investments and in fact, most of them have been able to increase their forex pips drastically. You would be surprised to know quite a few of them haven't traded for a long time! Now, this is what we call success in the forex trading, eh?
Stock Market Trading - Winning Trading Plan
Successful stock market trading begins with a winning trading plan. It's as simple as that. If you develop a well-conceived trading plan to guide your actions in the stock market you will already have the advantage over most of your market competition. Put simply, it gives you the edge you need to win over the long haul when trading the stock market or forex market.
A stock market trading plan will not guarantee your success in the markets, but a good plan will enable you to work methodically toward your stock market trading goals while reviewing on a regular basis what is working and what is not. It will act as a roadmap for your trading journey. It will enable you to respond positively and constructively no matter what happens with your individual trades. And, most importantly, it will help you control the only thing a trader can control: his or her own actions.
Finally, stock market trading is a business. It can be a fascinating and sometimes thrilling business, but in the end it is a business. A trading plan helps you treat it as a business.
Here are some important elements of a trading plan.
1. Why am I trading? What are my goals?
The answers to these questions might seem obvious, but they usually are not. Take some time to ask them of yourself, and seriously consider the answers. You may be surprised by what you learn. And whatever the answers, you will have a clearer picture going forward of what this enterprise means to you, and that will help you survive any rough patches.
2. What markets am I going to trade and why?
It is often best to specialize, especially for beginning stock market traders. Many pros make a great living trading the same stock day every single day for years. Choose a market that is appropriate for your experience level and trading style. Consider other factors such as available margin, volatility and liquidity.
3. What is the concept or philosophy behind your trading methodology?
Your trading system must have a concept behind it. Whether you are a value investor like Warren Buffet or a trend trader like George Soros, you should understand why you are doing what you are doing, how your beliefs about the markets define what you will do as a trader.
4. What will be your specific method?
In other words, specifically how will you execute your trading ideas? Will you buy breakouts or pullbacks? Buy oversold or sell overbought? Or will you use specific technical setups such as moving-average crossovers or another indicator-based strategy? Under exactly what conditions will you enter? When will you know to exit?
5. How much money will you risk on any single trade? On trading in general?
This is critical. Of course, start small. But just as importantly, have a plan in place for how much you will risk, emotions don't cloud your judgment when the time comes. The key is to find an allocation that doesn't cause any stress but still makes the trade worthwhile financially. One of the biggest problems with newer traders is that they are trading way too big in relation to their account size. Like when you are forex trading. Trading forex at 100-1 leverage is like introducing your mistress to your wife. Yes, you can do it, but that doesn't make it a good idea. Normally they don't get along too well.
6. What will my trading rules be?
This is also critical. Your trading rules include entry and exit rules, rules governing maximum daily, weekly or monthly losses, maximum risk on any given trade, the maximum number of trades per week, etc., etc. These rules enforce discipline and keep you out of trouble. What stock price will enter at, what stock price will I will exit. Be discplined.
7. How will I record and evaluate my trading performance?
Allow me to repeat myself: This is critical. In fact, this might be the most important element of trading for new traders in the stock market. A new stock market trader who evaluates his trades, winners and losers, in an effort to learn what works and what does not, will make quantum leaps forward in terms of ability and profitability. If you have a working trading plan and evaluate every single one of your trades after you have closed it you have already beaten 95% of the competition.
8. What are my rules for managing profits?
What's the problem with profits? Well, believe it or not there is one, and it's a serious one. It's called euphoria, and it clouds the judgment perhaps more than any other emotion related to trading. Start piling up the profits for the first time and it won't be long before you are convinced you are king of the world. About 30 seconds later you'll be broke, following a series of unwise and exceedingly risky trades. So have a plan for protecting closed profits when you have reached your goals for the week or the month. Don't give them all back.
9. How will I reward myself for following my trading plan?
Don't leave this out. Following your trading plan will bring rewards in the form of profits, but you should also consciously reward yourself for doing so because it is such an important part of successful trading. So if you finish the week or the month (or even the day) without having broken any of your trading rules, find a way to reward yourself. You deserve it. You are in rare company.
If you follow your plan you are improving your chances of becoming successful stock market or forex trader.
A stock market trading plan will not guarantee your success in the markets, but a good plan will enable you to work methodically toward your stock market trading goals while reviewing on a regular basis what is working and what is not. It will act as a roadmap for your trading journey. It will enable you to respond positively and constructively no matter what happens with your individual trades. And, most importantly, it will help you control the only thing a trader can control: his or her own actions.
Finally, stock market trading is a business. It can be a fascinating and sometimes thrilling business, but in the end it is a business. A trading plan helps you treat it as a business.
Here are some important elements of a trading plan.
1. Why am I trading? What are my goals?
The answers to these questions might seem obvious, but they usually are not. Take some time to ask them of yourself, and seriously consider the answers. You may be surprised by what you learn. And whatever the answers, you will have a clearer picture going forward of what this enterprise means to you, and that will help you survive any rough patches.
2. What markets am I going to trade and why?
It is often best to specialize, especially for beginning stock market traders. Many pros make a great living trading the same stock day every single day for years. Choose a market that is appropriate for your experience level and trading style. Consider other factors such as available margin, volatility and liquidity.
3. What is the concept or philosophy behind your trading methodology?
Your trading system must have a concept behind it. Whether you are a value investor like Warren Buffet or a trend trader like George Soros, you should understand why you are doing what you are doing, how your beliefs about the markets define what you will do as a trader.
4. What will be your specific method?
In other words, specifically how will you execute your trading ideas? Will you buy breakouts or pullbacks? Buy oversold or sell overbought? Or will you use specific technical setups such as moving-average crossovers or another indicator-based strategy? Under exactly what conditions will you enter? When will you know to exit?
5. How much money will you risk on any single trade? On trading in general?
This is critical. Of course, start small. But just as importantly, have a plan in place for how much you will risk, emotions don't cloud your judgment when the time comes. The key is to find an allocation that doesn't cause any stress but still makes the trade worthwhile financially. One of the biggest problems with newer traders is that they are trading way too big in relation to their account size. Like when you are forex trading. Trading forex at 100-1 leverage is like introducing your mistress to your wife. Yes, you can do it, but that doesn't make it a good idea. Normally they don't get along too well.
6. What will my trading rules be?
This is also critical. Your trading rules include entry and exit rules, rules governing maximum daily, weekly or monthly losses, maximum risk on any given trade, the maximum number of trades per week, etc., etc. These rules enforce discipline and keep you out of trouble. What stock price will enter at, what stock price will I will exit. Be discplined.
7. How will I record and evaluate my trading performance?
Allow me to repeat myself: This is critical. In fact, this might be the most important element of trading for new traders in the stock market. A new stock market trader who evaluates his trades, winners and losers, in an effort to learn what works and what does not, will make quantum leaps forward in terms of ability and profitability. If you have a working trading plan and evaluate every single one of your trades after you have closed it you have already beaten 95% of the competition.
8. What are my rules for managing profits?
What's the problem with profits? Well, believe it or not there is one, and it's a serious one. It's called euphoria, and it clouds the judgment perhaps more than any other emotion related to trading. Start piling up the profits for the first time and it won't be long before you are convinced you are king of the world. About 30 seconds later you'll be broke, following a series of unwise and exceedingly risky trades. So have a plan for protecting closed profits when you have reached your goals for the week or the month. Don't give them all back.
9. How will I reward myself for following my trading plan?
Don't leave this out. Following your trading plan will bring rewards in the form of profits, but you should also consciously reward yourself for doing so because it is such an important part of successful trading. So if you finish the week or the month (or even the day) without having broken any of your trading rules, find a way to reward yourself. You deserve it. You are in rare company.
If you follow your plan you are improving your chances of becoming successful stock market or forex trader.
Will I get rich from Forex? Definitely! Are you ready to learn?
The Foreign Exchange market (also referred to as the Forex or FX market) is the largest financial market in the world, with over $1.5 trillion changing hands every day.
That is larger than all US equity and Treasury markets combined!
Unlike other financial markets that operate at a centralized location (i.e. stock exchange), the worldwide Forex market has no central location. It is a global electronic network of banks, financial institutions and individual traders, all involved in the buying and selling of national currencies. Another major feature of the Forex market is that it operates 24 hours a day, corresponding to the opening and closing of financial centers in countries all across the world, starting each day in Sydney, then Tokyo, London and New York. At any time, in any location, there are buyers and sellers, making the Forex market the most liquid market in the world.
Traditionally, access to the Forex market has been made available only to banks and other large financial institutions. With advances in technology over the years, however, the Forex market is now available to everybody, from banks to money managers to individual traders trading retail accounts. The time to get involved in this exciting, global market has never been better than now. Open an account and become an active player in the largest market on the planet.
The Forex Market is very different than trading currencies on the futures market, and a lot easier, than trading stocks or commodities.
The FOREX plays a vital role in the world economy and there will always be a tremendous need for the exchange of currencies. International trade increases as technology and communication increases. As long as there is international trade, there will be a FOREX market. The FX market has to exist so a country like Germany can sell products in the United States and be able to receive Euros in exchange for US Dollar.
So you know how it is financially rewarding if you traded successfully in the forex market every single day. Whether a bad economy or not, it has made millions taking advantage of the flactuations in the market. And the good thing is that trading is now available to all of us, having internet access and right knowledge creates wealth.
Ok, ok , i got your point, how do I start trading in forex?
Well, forex is like any other investment or business, it has signifitcant amount of loss sometime.But it is better than having a job because you can work for so little time, yet earn so much more. There is a career waiting for people who are willing to exert their effor, time and mind to learning and benefiting from the Currency Market.
It is important for traders to have consistent learning in the market, and not just giving that role of trading to their brokers. The good thing is there are many learning modules out there available through the online universe. But not all guarantees 100% success on trading. Of course no person or product can be dumb enough to guarantee your success. It also demands effort on your part. A factor you should find when purchasing or looking for information is its reputation and quality.
Poor learning = higher risks and lossesQuality learning = happy trader
One highly credited Stock and Forex Investor, Bill Poulos has made some home study courses that has helped made millions of successful traders around the world. And in one of his courses, Forex Profit Accelerator, is not more of a study home course, it is more of a learning system.
Be it new in trading or experienced, constant learning is what makes wealth, at times today, " the more you know, the more money you make". And a learning system like the Forex Profit Accelerator can surely give you all the support you need to be successful in Currency trading.
That is larger than all US equity and Treasury markets combined!
Unlike other financial markets that operate at a centralized location (i.e. stock exchange), the worldwide Forex market has no central location. It is a global electronic network of banks, financial institutions and individual traders, all involved in the buying and selling of national currencies. Another major feature of the Forex market is that it operates 24 hours a day, corresponding to the opening and closing of financial centers in countries all across the world, starting each day in Sydney, then Tokyo, London and New York. At any time, in any location, there are buyers and sellers, making the Forex market the most liquid market in the world.
Traditionally, access to the Forex market has been made available only to banks and other large financial institutions. With advances in technology over the years, however, the Forex market is now available to everybody, from banks to money managers to individual traders trading retail accounts. The time to get involved in this exciting, global market has never been better than now. Open an account and become an active player in the largest market on the planet.
The Forex Market is very different than trading currencies on the futures market, and a lot easier, than trading stocks or commodities.
The FOREX plays a vital role in the world economy and there will always be a tremendous need for the exchange of currencies. International trade increases as technology and communication increases. As long as there is international trade, there will be a FOREX market. The FX market has to exist so a country like Germany can sell products in the United States and be able to receive Euros in exchange for US Dollar.
So you know how it is financially rewarding if you traded successfully in the forex market every single day. Whether a bad economy or not, it has made millions taking advantage of the flactuations in the market. And the good thing is that trading is now available to all of us, having internet access and right knowledge creates wealth.
Ok, ok , i got your point, how do I start trading in forex?
Well, forex is like any other investment or business, it has signifitcant amount of loss sometime.But it is better than having a job because you can work for so little time, yet earn so much more. There is a career waiting for people who are willing to exert their effor, time and mind to learning and benefiting from the Currency Market.
It is important for traders to have consistent learning in the market, and not just giving that role of trading to their brokers. The good thing is there are many learning modules out there available through the online universe. But not all guarantees 100% success on trading. Of course no person or product can be dumb enough to guarantee your success. It also demands effort on your part. A factor you should find when purchasing or looking for information is its reputation and quality.
Poor learning = higher risks and lossesQuality learning = happy trader
One highly credited Stock and Forex Investor, Bill Poulos has made some home study courses that has helped made millions of successful traders around the world. And in one of his courses, Forex Profit Accelerator, is not more of a study home course, it is more of a learning system.
Be it new in trading or experienced, constant learning is what makes wealth, at times today, " the more you know, the more money you make". And a learning system like the Forex Profit Accelerator can surely give you all the support you need to be successful in Currency trading.
Saturday, April 4, 2009
Banking for money
It all started with which one? I don’t think I remember. But since then it has been one bank after another and then another and so on. With various names and tags, they come promising huge sums in cash reward, expensive household items as gifts, travel/tours etc. save & fly, grand slam, big splash, lion king, you go win promo and so on.
By now you should know what I’m talking about – the many savings promos that banks in Nigeria have now adopted as a strategy for generating deposits some giving away millions of naira for saving just a few thousands of naira. Before I go on I would like to make clear that this piece is a personal analysis of these many promos and the effect they may be having on the banking sector.
Savings accounts, traditionally, are deposits accounts that are used to put money away. The representation of the word save is to keep away. Hence the reason why a savings account earns interest as an incentive to the person who is giving his money to another’s use. This essentially is the purpose of a savings account and the banking system generally, to take money from those who have excess and lend those who are in short of it. The bank or the intermediating institution therefore needs to hold on to the money long enough to ensure its profitable use and the depositor should let go of it for long enough to allow the bank use it effectively.
While this still holds for the banking system, same cannot be said of the savings system with the influx of these promos. Many analysts have always advocated that banks should focus on longer term funds to fund their lending business, hence the need to depend on deposits and not equity funding to carry on their business. Are these promos really serving the purpose the banks hope to achieve with them? I doubt. Why am I taking this stand?
- Firstly, savings accounts in Nigeria have more or less become withdrawal accounts where depositors deposit today and withdraw tomorrow. With this kind of attitude, depositors move cash at will from promo to promo once the period for maintaining the deposit to qualify for draws lapse.
- Again the caliber of people (traders, students etc) attracted by these promos, though good for banking, only make the savings system even more prone to depletion because these set of people do not really earn enough to keep in the bank for years so after moving from promo to promo (since they only have to maintain the deposits for one month or two) they finally withdraw their money for personal use.
- From personal observation, people are only interested in saving as long as the promo lasts. Those who are mostly participants in these promos are opportunists seeking quick gain and do not have any interest in banking their cash. A friend once was lamenting to me how he was regretting investing in stocks and couldn’t get out because his share certificate was not posted yet because he wanted to take part in a savings promo that was promising a trip out of the country.
I think instead of these savings promos banks should start focusing on products that will really generate deposits such as their special savings accounts which do encourage saving more because depositors earn more interest while having to leave a reasonable minimum amount in the account at any given time. This ensures that the banks have money to work with for a longer period.
Banks should also build a reputation for reliability, strength, resilience and quality service rather than try to woo depositors with promos that cannot go on forever. A bank may be able to generate deposits during the period of the promo but it will gradually depreciate as depositor move their money to banks perceived to be more reliable and dependable.
Another reason banks have often given for embarking on such promos is ‘to reward loyal customers’. Well I think those who end up winning are not the real loyal customers. Loyalty is a measure of consistent commitment which can easily be determined by simply finding out customers who have stayed with the bank over a period and rewarding them collectively or by random selection without having to draw up huge budgets for promoting these lotteries called customer reward system.
By now you should know what I’m talking about – the many savings promos that banks in Nigeria have now adopted as a strategy for generating deposits some giving away millions of naira for saving just a few thousands of naira. Before I go on I would like to make clear that this piece is a personal analysis of these many promos and the effect they may be having on the banking sector.
Savings accounts, traditionally, are deposits accounts that are used to put money away. The representation of the word save is to keep away. Hence the reason why a savings account earns interest as an incentive to the person who is giving his money to another’s use. This essentially is the purpose of a savings account and the banking system generally, to take money from those who have excess and lend those who are in short of it. The bank or the intermediating institution therefore needs to hold on to the money long enough to ensure its profitable use and the depositor should let go of it for long enough to allow the bank use it effectively.
While this still holds for the banking system, same cannot be said of the savings system with the influx of these promos. Many analysts have always advocated that banks should focus on longer term funds to fund their lending business, hence the need to depend on deposits and not equity funding to carry on their business. Are these promos really serving the purpose the banks hope to achieve with them? I doubt. Why am I taking this stand?
- Firstly, savings accounts in Nigeria have more or less become withdrawal accounts where depositors deposit today and withdraw tomorrow. With this kind of attitude, depositors move cash at will from promo to promo once the period for maintaining the deposit to qualify for draws lapse.
- Again the caliber of people (traders, students etc) attracted by these promos, though good for banking, only make the savings system even more prone to depletion because these set of people do not really earn enough to keep in the bank for years so after moving from promo to promo (since they only have to maintain the deposits for one month or two) they finally withdraw their money for personal use.
- From personal observation, people are only interested in saving as long as the promo lasts. Those who are mostly participants in these promos are opportunists seeking quick gain and do not have any interest in banking their cash. A friend once was lamenting to me how he was regretting investing in stocks and couldn’t get out because his share certificate was not posted yet because he wanted to take part in a savings promo that was promising a trip out of the country.
I think instead of these savings promos banks should start focusing on products that will really generate deposits such as their special savings accounts which do encourage saving more because depositors earn more interest while having to leave a reasonable minimum amount in the account at any given time. This ensures that the banks have money to work with for a longer period.
Banks should also build a reputation for reliability, strength, resilience and quality service rather than try to woo depositors with promos that cannot go on forever. A bank may be able to generate deposits during the period of the promo but it will gradually depreciate as depositor move their money to banks perceived to be more reliable and dependable.
Another reason banks have often given for embarking on such promos is ‘to reward loyal customers’. Well I think those who end up winning are not the real loyal customers. Loyalty is a measure of consistent commitment which can easily be determined by simply finding out customers who have stayed with the bank over a period and rewarding them collectively or by random selection without having to draw up huge budgets for promoting these lotteries called customer reward system.
Capital Structure and Risk in Islamic Financial Services
Financial intermediation is a critical factor for growth and social inclusion. One of its core functions is to mobilize financial resources from surplus agents and channel them to those with deficits. It thus allows investor entrepreneurs to expand economic activity and employment opportunities. It also enables household consumers, micro- and small entrepreneurs to expand their own welfare and earnings opportunities, and seek to smooth their lifetime outlays. In all cases, financial intermediation drives economic growth and contributes to social inclusion, provided it is conducted in a sound and efficient way.[1]
A financial intermediary’s ability to process information on risks and returns of investment opportunities will have a bearing on the soundness and efficiency of its resource mobilization and reallocation function. Conventional financial services (CFSs) process information through institutions or markets, and have generally evolved from the former to the latter. In both cases, markets and agents provide alternative ways of processing information on risks and returns of investment opportunities. In the first form, the intermediary raises capital to set up business to collect generally liquid deposits from surplus agents and reallocates these resources, now in his trust, to ones with deficits in generally less liquid assets. In the second form, surplus agents buy directly financial assets that represent a debt of a deficit agent or an ownership share in its business. In either approach, both categories of agents engage in transactions on the basis of trust and of expectations about the degree of liquidity that would provide the option to re-contract at a reasonable cost.[2] In the case of banks, the trust can be seen as based on proprietary information. In the case of markets, the information is more commoditized and widely available.[3]
Efficiently processed information can support the efficient allocation of capital. It can help a financial intermediary to better define the capital it would need to achieve the returns sought, while maintaining its ability to face the financial consequences of unexpected events that may endanger its stability. Banks engage in gathering and processing information on clients and markets, which allows them to manage different risks by unbundling them and reallocating the components. By performing these services soundly and efficiently, banks can manage to calibrate their capital requirements and receive diversified income streams. Thus a bank’s investors and customers can gain comfort as to its reliability in allowing them to access liquidity and maintain stability. In parallel with banks, financial markets can also convey the same sense of access to liquidity and stability based on disclosed and broadly available information on market participants. Markets can provide deficit and surplus agents a direct role in processing information to facilitate the unbundling and reallocation of risks and the efficient use of capital. Thus, banks and markets compete and complement each other in financial intermediation. The competition puts pressure on individual agents to use capital at their disposal efficiently, and results in a system-wide improved allocation of capital resources.[4]
Institutions offering Islamic financial services (IIFSs) also process information on risks and returns of investment opportunities while complying with Shari’ah principles.[5] Thus, in principle, they can be expected to increase competition in financial information processing by inducing better risk management and capital use. Such competition can be expected over time to lead to an efficient use of capital at the level of each financial agent, whether they practice conventional or Islamic finance, and in aggregate, system-wide across all modes of financial intermediation. Efficient use of capital is thus a challenge which competition imposes on all financial intermediaries, whether offering Islamic financial services or conventional financial services. At the same time, Islamic financial intermediation needs to comply with Shari’ah principles, notably those of risk sharing and materiality of financial transactions. Shari’ah compliance, social responsibility, and the discipline of competition compound IIFSs’ challenge to process information efficiently in order to manage the risks they may face and use their capital endowments. Thus, by their very nature and the environment in which they generally operate, IIFSs need to be well equipped with the information and skills that can allow them to identify their capital resources and use them efficiently.
This chapter argues for the need for Islamic financial services to strengthen risk management practices in the process of defining their own capital requirements in accordance with their loss tolerance. It suggests that IIFSs could invest in the collection of loss information and adoption of loss data management systems. IIFSs would benefit from implementing risk management methodologies and adapting their staffing skills accordingly. The chapter starts in Section 2 by outlining views on the relationship between risk management and capital for financial intermediation. It then overviews risk categories as an initial step in risk management in Section 3. Section 4 discusses regulatory and economic capital, introducing risk occurrence frequency as a distribution probability. Section 5 concludes with suggestions on steps that may help with risk management and improve the competitiveness of IIFSs.
2. Bank Capital and Risk Management
Bank capital may be considered as consisting of (a) equity capital and (b) certain non-deposit liabilities or debt capital (see Section 4). It is both a means of funding earnings-generating assets and a stability cushion. From the perspective of efficiency and returns, capital is part of a bank’s funding that can be applied directly to the purchase of earning assets, as well as being used as a basis for leverage to raise other funds for expanding assets with the net benefit accruing to shareholders. From a perspective of stability, bank capital is a cushion for absorbing shocks of business losses and maintaining solvency, with benefits accruing to depositors and other stakeholders. Both financial intermediaries and regulators are sensitive to the dual role of capital, as a means of funding earnings-generating assets and as a cushion for dealing with unanticipated events. Financial intermediaries may tend to be more focused on the former role and regulators on the latter.
A bank’s capital structure decision relates to the ratio of capital to deposits and to the ratio of debt capital to equity capital. Its performance, in terms of return on equity capital, will be influenced by its ability to calibrate the level of capital it requires. Through efficient risk management, it can reach a sense of which capital structure can best help it to: (a) achieve profitability while maintaining stability; (b) reassure markets as to the quality of its business conduct; and (c) have a constructive dialogue with regulators.
Efficient use of capital will help IIFSs to achieve profitability and stability. Allocating capital resources to low-performing or excessively risky assets is bound to drag down performance, endanger stability, or both. Equally, leaving capital idle entails at best forgoing earnings opportunities. For instance, overly cautious approaches that lead financial intermediaries to maintain larger amounts of capital than warranted by their risk profile may not allow them either to obtain the full potential of their capital or to contribute effectively to the development of the communities they serve. At the other end of the spectrum, a financial intermediary overly eager to achieve returns may allocate resources to highly risky assets that offer high returns but endanger stability. Explicit risk management practices can help in the selection of assets to which capital and other resources are applied and calibrate the level of capital that best suits business objectives and stability tolerance.
The size and composition of the resources that capital enables financial intermediaries to raise are likely to affect their profitability and stability. In a frictionless world where full information is available and markets are complete, the value of a firm would be independent of its capital structure, and so the focus should be on capital level and not structure.[6] Under such circumstances, the method by which a financial intermediary raises its required funds would be irrelevant. However, financial intermediaries do not operate in a frictionless world; they face imperfections such as costs of bankruptcy and financial distress, transaction costs, asymmetric information, or taxes. They also operate within the framework of a governing regulation possibly with a deposit insurance scheme that is expected to provide a safety net. In fact, one may contend that these market imperfections are the very reason for the successful existence of banks as financial intermediaries. Accordingly, not only a financial intermediary’s level of capital but also its structure is likely to bear on its market valuation, its business conduct, and its stability. Effective risk management strategies should contribute to a financial intermediary’s ability to assess not only the level of capital it would need in relation to assets and deposits, but also the extent to which its structure affects its value.
Market discipline contributes to responsible corporate behavior. Markets’ reactions to perceptions of a financial intermediary’s business conduct and capital strength may be unforgiving. It is thus in the interest of financial intermediaries to develop approaches to defining capital resource requirements that take into account the institutional environment in which they operate. The market’s perception of market imperfections is likely to influence views on the appropriate level of capital and the capital adequacy of financial intermediaries. For example, the availability of a safety net may lead market participants to be less demanding as to the need for capital in relation to bank assets. Conversely, anticipation of high costs of financial distress to depositors and other stakeholders may induce market participants to require the holding of more capital proportionally to assets. Similarly, wherever the institutional environment is weak and contract enforcement is uncertain and costly, markets may expect financial intermediaries to adapt the capital they hold.
The management of capital structure should in principle mitigate the risk of bank failures. When comparing a highly leveraged bank and a bank that is well capitalized, the leveraged bank will likely experience a greater loss of value during times of financial distress when the asset quality deteriorates, due to the increased risk of bankruptcy. To cope with downturns, in most countries banks hold a minimum amount of capital, based on the risk embedded in their asset holding. Accordingly, banks with relatively risky assets would hold a higher amount of capital than those banks with less risky assets. However, fearing the harshness of market discipline, many banks maintain a higher level of capital than the minimum required to allay the perception that they may be undercapitalized and avoid the losses this may induce, as witnessed in the 1980s. The key capital adequacy ratio provides an assessment of just how adequately the capital cushions such fluctuations in the bank’s earnings and supports higher assets growth.
Finally, efficient risk management should allow financial intermediaries to have a constructive dialogue with regulators. It would help them to articulate their views with respect to capital needs. The regulators’ rationale for regulating capital stems from the perception of the public-good nature of bank services, their potential macroeconomic growth and stability impact, and experience with costly bank failures. According to some estimates, such costs have varied between 3% and 55% of GDP.[7] Thus, regulators’ concerns with possible systemic risk resulting from the contagion effects of bank runs lead them to seek to mitigate risks of financial distress with regulatory requirements on banks’ capital.[8] Regulators’ concerns may be compounded by the presence of deposit insurance schemes. The moral hazard that may result from deposit insurance may lead to additional regulatory requirements such as linking the level of insurance premia to the risk embedded in assets and captured in associated risk weights. Indeed, deposit insurance may induce banks to lever up capital by expanding their own funding with liabilities, thus placing more risk on their capital and increasing their vulnerability. Efficient risk management practices would allow banks to improve their dialogue with the regulator and convey more convincingly their views on their soundness and capital requirements.
Regulators would generally also be concerned with the overall impact on the economy of the resources raised by the financial system under their purview. From an economy-wide perspective, banks may be viewed as firms’ competitors in raising capital on financial markets. The outcome of this competition has a bearing on economic performance and financial stability, and points to a cost–benefit tradeoff in holding capital. For instance, Gersbach (2007) suggests that a benefit of bank capital is the equity acting as a buffer against future losses, thereby reducing excessive risk taking of the banks. At the same time, raising bank capital may lead to a crowding out of industrial firms, limiting their access to equity and other market funding and also impacting their access to funding from banks and its cost. Furthermore, raising equity on markets may increase the cost of banks’ resources, inducing them to seek to invest in higher-yielding but more risky assets and thereby increasing their risk exposure. Thus, while potentially providing a cushion against unforeseen events, a higher level of equity may actually induce more risk taking, notably through raising the cost of funds to banks and their clients. Efficient risk management can provide inputs to both banks and regulators to better calibrate capital needs and deal with the foregoing type of tradeoff.
The level of a financial intermediary’s capital may also have a bearing on its ability to provide liquidity. The financial intermediary provides liquidity by funding assets that may be less liquid than the deposit resources it collects. There is a view that requirements for higher levels of capital may have a negative impact on liquidity creation.[9] On the liability side, a higher capital requirement may lead to a corresponding reduction in the level of deposits, thus constraining the ability to provide liquidity. Also, higher capital requirements may induce financial intermediaries to be more restrained in extending financing, thus constraining their ability to provide liquidity. However, according to another view, higher capital would allow the financial intermediary to create more liquidity since its risk-absorptive capacity would be improved.[10] In this regard, an empirical study concluded that for larger banks capital has a statistically significant positive net effect on liquidity creation, while for small banks this effect is negative.[11] Accordingly, each financial intermediary would need to evaluate carefully the level and composition of the capital it needs, since the latter plays a significant role in its ability to function as a liquidity provider. Equally, regulators would need to pay attention to the impact which capital requirement would have on the funding of the economy.
IIFS’s risk management arrangements will bear on their ability to calibrate capital to their business objectives and risk tolerance, to deal with market discipline, and to maintain a dialogue with regulators. The IIFS’s characteristic of mobilizing funds in the form of risk-sharing investment accounts in place of conventional deposits, together with the materiality[12] of financing transactions, may alter the overall risk of the balance sheet and, consequently, the assessment of their capital requirements. Indeed, risk-sharing “deposits” would in principle reduce the need for a safety cushion to weather adverse investment outcomes. Similarly, the materiality of investments is likely to modify the extent of their risk and have a bearing on the assessment for the overall need for capital; asset-based modes of finance may be less risky and profit-sharing modes more risky, than conventional interest-bearing modes. Nevertheless, IIFSs would operate within a regulatory framework that is likely to impose on them capital requirements with a view to promoting stability and limiting contagion risks. However, besides regulatory and market demands for IIFSs to hold capital, IIFSs need to put in place risk management assessments for their own purposes of returns and stability in accordance with the requirements of Shari’ah, their own mission statements, and the protection of their stakeholders.
[1] See Honohan (2004) and Levine (2004).
[2] Sir John Hicks identifies such liquidity as one of the main factors behind the Industrial Revolution.
[3] Actually, a deposit can be viewed as a purchase of a debt asset issued by the intermediary and redeemable at its face value.
[4] The institution–market competition is reflected in the trends of their relative market shares of total financial assets. For example, in the United States, between 1960 and the early 1990s, commercial banks’ share of total financial intermediaries’ assets fell from around 40% to less than 30%. See Edwards (1996).
[5] They do respond to a latent demand for financial services that do not breach Shari’ah principles. Accordingly, they have the potential to contribute to financial deepening, economic growth, and social inclusion. See also Burghardt and Fuss (2004).
[6] Modigliani and Miller (1958).
[7] See Klingebiel and Laeven (2007).
[8] Views differ on the need for and extent of regulation, as well as on the usefulness of deposit insurance; see Barth, Caprio, and Levine (2007).
[9] Diamond and Rajan (2006).
[10] Allen and Gale (2007).
[11] Berger and Bouwman (2005).
[12] By the “materiality” of financing transactions is meant that, in such transactions, capital must be “materialized” in the form of an asset or asset services (as in Murabaha credit sales, Salam and Istisna’a financing, or Ijarah leasing), or of a business venture (Musharakah or Mudarabah). Capital in the form of money is not entitled to any return, as this would be interest (riba).
Introduction: Information, Risks, and Capital
Financial intermediation is a critical factor for growth and social inclusion. One of its core functions is to mobilize financial resources from surplus agents and channel them to those with deficits. It thus allows investor entrepreneurs to expand economic activity and employment opportunities. It also enables household consumers, micro- and small entrepreneurs to expand their own welfare and earnings opportunities, and seek to smooth their lifetime outlays. In all cases, financial intermediation drives economic growth and contributes to social inclusion, provided it is conducted in a sound and efficient way.[1]
A financial intermediary’s ability to process information on risks and returns of investment opportunities will have a bearing on the soundness and efficiency of its resource mobilization and reallocation function. Conventional financial services (CFSs) process information through institutions or markets, and have generally evolved from the former to the latter. In both cases, markets and agents provide alternative ways of processing information on risks and returns of investment opportunities. In the first form, the intermediary raises capital to set up business to collect generally liquid deposits from surplus agents and reallocates these resources, now in his trust, to ones with deficits in generally less liquid assets. In the second form, surplus agents buy directly financial assets that represent a debt of a deficit agent or an ownership share in its business. In either approach, both categories of agents engage in transactions on the basis of trust and of expectations about the degree of liquidity that would provide the option to re-contract at a reasonable cost.[2] In the case of banks, the trust can be seen as based on proprietary information. In the case of markets, the information is more commoditized and widely available.[3]
Efficiently processed information can support the efficient allocation of capital. It can help a financial intermediary to better define the capital it would need to achieve the returns sought, while maintaining its ability to face the financial consequences of unexpected events that may endanger its stability. Banks engage in gathering and processing information on clients and markets, which allows them to manage different risks by unbundling them and reallocating the components. By performing these services soundly and efficiently, banks can manage to calibrate their capital requirements and receive diversified income streams. Thus a bank’s investors and customers can gain comfort as to its reliability in allowing them to access liquidity and maintain stability. In parallel with banks, financial markets can also convey the same sense of access to liquidity and stability based on disclosed and broadly available information on market participants. Markets can provide deficit and surplus agents a direct role in processing information to facilitate the unbundling and reallocation of risks and the efficient use of capital. Thus, banks and markets compete and complement each other in financial intermediation. The competition puts pressure on individual agents to use capital at their disposal efficiently, and results in a system-wide improved allocation of capital resources.[4]
Institutions offering Islamic financial services (IIFSs) also process information on risks and returns of investment opportunities while complying with Shari’ah principles.[5] Thus, in principle, they can be expected to increase competition in financial information processing by inducing better risk management and capital use. Such competition can be expected over time to lead to an efficient use of capital at the level of each financial agent, whether they practice conventional or Islamic finance, and in aggregate, system-wide across all modes of financial intermediation. Efficient use of capital is thus a challenge which competition imposes on all financial intermediaries, whether offering Islamic financial services or conventional financial services. At the same time, Islamic financial intermediation needs to comply with Shari’ah principles, notably those of risk sharing and materiality of financial transactions. Shari’ah compliance, social responsibility, and the discipline of competition compound IIFSs’ challenge to process information efficiently in order to manage the risks they may face and use their capital endowments. Thus, by their very nature and the environment in which they generally operate, IIFSs need to be well equipped with the information and skills that can allow them to identify their capital resources and use them efficiently.
This chapter argues for the need for Islamic financial services to strengthen risk management practices in the process of defining their own capital requirements in accordance with their loss tolerance. It suggests that IIFSs could invest in the collection of loss information and adoption of loss data management systems. IIFSs would benefit from implementing risk management methodologies and adapting their staffing skills accordingly. The chapter starts in Section 2 by outlining views on the relationship between risk management and capital for financial intermediation. It then overviews risk categories as an initial step in risk management in Section 3. Section 4 discusses regulatory and economic capital, introducing risk occurrence frequency as a distribution probability. Section 5 concludes with suggestions on steps that may help with risk management and improve the competitiveness of IIFSs.
2. Bank Capital and Risk Management
Bank capital may be considered as consisting of (a) equity capital and (b) certain non-deposit liabilities or debt capital (see Section 4). It is both a means of funding earnings-generating assets and a stability cushion. From the perspective of efficiency and returns, capital is part of a bank’s funding that can be applied directly to the purchase of earning assets, as well as being used as a basis for leverage to raise other funds for expanding assets with the net benefit accruing to shareholders. From a perspective of stability, bank capital is a cushion for absorbing shocks of business losses and maintaining solvency, with benefits accruing to depositors and other stakeholders. Both financial intermediaries and regulators are sensitive to the dual role of capital, as a means of funding earnings-generating assets and as a cushion for dealing with unanticipated events. Financial intermediaries may tend to be more focused on the former role and regulators on the latter.
A bank’s capital structure decision relates to the ratio of capital to deposits and to the ratio of debt capital to equity capital. Its performance, in terms of return on equity capital, will be influenced by its ability to calibrate the level of capital it requires. Through efficient risk management, it can reach a sense of which capital structure can best help it to: (a) achieve profitability while maintaining stability; (b) reassure markets as to the quality of its business conduct; and (c) have a constructive dialogue with regulators.
Efficient use of capital will help IIFSs to achieve profitability and stability. Allocating capital resources to low-performing or excessively risky assets is bound to drag down performance, endanger stability, or both. Equally, leaving capital idle entails at best forgoing earnings opportunities. For instance, overly cautious approaches that lead financial intermediaries to maintain larger amounts of capital than warranted by their risk profile may not allow them either to obtain the full potential of their capital or to contribute effectively to the development of the communities they serve. At the other end of the spectrum, a financial intermediary overly eager to achieve returns may allocate resources to highly risky assets that offer high returns but endanger stability. Explicit risk management practices can help in the selection of assets to which capital and other resources are applied and calibrate the level of capital that best suits business objectives and stability tolerance.
The size and composition of the resources that capital enables financial intermediaries to raise are likely to affect their profitability and stability. In a frictionless world where full information is available and markets are complete, the value of a firm would be independent of its capital structure, and so the focus should be on capital level and not structure.[6] Under such circumstances, the method by which a financial intermediary raises its required funds would be irrelevant. However, financial intermediaries do not operate in a frictionless world; they face imperfections such as costs of bankruptcy and financial distress, transaction costs, asymmetric information, or taxes. They also operate within the framework of a governing regulation possibly with a deposit insurance scheme that is expected to provide a safety net. In fact, one may contend that these market imperfections are the very reason for the successful existence of banks as financial intermediaries. Accordingly, not only a financial intermediary’s level of capital but also its structure is likely to bear on its market valuation, its business conduct, and its stability. Effective risk management strategies should contribute to a financial intermediary’s ability to assess not only the level of capital it would need in relation to assets and deposits, but also the extent to which its structure affects its value.
Market discipline contributes to responsible corporate behavior. Markets’ reactions to perceptions of a financial intermediary’s business conduct and capital strength may be unforgiving. It is thus in the interest of financial intermediaries to develop approaches to defining capital resource requirements that take into account the institutional environment in which they operate. The market’s perception of market imperfections is likely to influence views on the appropriate level of capital and the capital adequacy of financial intermediaries. For example, the availability of a safety net may lead market participants to be less demanding as to the need for capital in relation to bank assets. Conversely, anticipation of high costs of financial distress to depositors and other stakeholders may induce market participants to require the holding of more capital proportionally to assets. Similarly, wherever the institutional environment is weak and contract enforcement is uncertain and costly, markets may expect financial intermediaries to adapt the capital they hold.
The management of capital structure should in principle mitigate the risk of bank failures. When comparing a highly leveraged bank and a bank that is well capitalized, the leveraged bank will likely experience a greater loss of value during times of financial distress when the asset quality deteriorates, due to the increased risk of bankruptcy. To cope with downturns, in most countries banks hold a minimum amount of capital, based on the risk embedded in their asset holding. Accordingly, banks with relatively risky assets would hold a higher amount of capital than those banks with less risky assets. However, fearing the harshness of market discipline, many banks maintain a higher level of capital than the minimum required to allay the perception that they may be undercapitalized and avoid the losses this may induce, as witnessed in the 1980s. The key capital adequacy ratio provides an assessment of just how adequately the capital cushions such fluctuations in the bank’s earnings and supports higher assets growth.
Finally, efficient risk management should allow financial intermediaries to have a constructive dialogue with regulators. It would help them to articulate their views with respect to capital needs. The regulators’ rationale for regulating capital stems from the perception of the public-good nature of bank services, their potential macroeconomic growth and stability impact, and experience with costly bank failures. According to some estimates, such costs have varied between 3% and 55% of GDP.[7] Thus, regulators’ concerns with possible systemic risk resulting from the contagion effects of bank runs lead them to seek to mitigate risks of financial distress with regulatory requirements on banks’ capital.[8] Regulators’ concerns may be compounded by the presence of deposit insurance schemes. The moral hazard that may result from deposit insurance may lead to additional regulatory requirements such as linking the level of insurance premia to the risk embedded in assets and captured in associated risk weights. Indeed, deposit insurance may induce banks to lever up capital by expanding their own funding with liabilities, thus placing more risk on their capital and increasing their vulnerability. Efficient risk management practices would allow banks to improve their dialogue with the regulator and convey more convincingly their views on their soundness and capital requirements.
Regulators would generally also be concerned with the overall impact on the economy of the resources raised by the financial system under their purview. From an economy-wide perspective, banks may be viewed as firms’ competitors in raising capital on financial markets. The outcome of this competition has a bearing on economic performance and financial stability, and points to a cost–benefit tradeoff in holding capital. For instance, Gersbach (2007) suggests that a benefit of bank capital is the equity acting as a buffer against future losses, thereby reducing excessive risk taking of the banks. At the same time, raising bank capital may lead to a crowding out of industrial firms, limiting their access to equity and other market funding and also impacting their access to funding from banks and its cost. Furthermore, raising equity on markets may increase the cost of banks’ resources, inducing them to seek to invest in higher-yielding but more risky assets and thereby increasing their risk exposure. Thus, while potentially providing a cushion against unforeseen events, a higher level of equity may actually induce more risk taking, notably through raising the cost of funds to banks and their clients. Efficient risk management can provide inputs to both banks and regulators to better calibrate capital needs and deal with the foregoing type of tradeoff.
The level of a financial intermediary’s capital may also have a bearing on its ability to provide liquidity. The financial intermediary provides liquidity by funding assets that may be less liquid than the deposit resources it collects. There is a view that requirements for higher levels of capital may have a negative impact on liquidity creation.[9] On the liability side, a higher capital requirement may lead to a corresponding reduction in the level of deposits, thus constraining the ability to provide liquidity. Also, higher capital requirements may induce financial intermediaries to be more restrained in extending financing, thus constraining their ability to provide liquidity. However, according to another view, higher capital would allow the financial intermediary to create more liquidity since its risk-absorptive capacity would be improved.[10] In this regard, an empirical study concluded that for larger banks capital has a statistically significant positive net effect on liquidity creation, while for small banks this effect is negative.[11] Accordingly, each financial intermediary would need to evaluate carefully the level and composition of the capital it needs, since the latter plays a significant role in its ability to function as a liquidity provider. Equally, regulators would need to pay attention to the impact which capital requirement would have on the funding of the economy.
IIFS’s risk management arrangements will bear on their ability to calibrate capital to their business objectives and risk tolerance, to deal with market discipline, and to maintain a dialogue with regulators. The IIFS’s characteristic of mobilizing funds in the form of risk-sharing investment accounts in place of conventional deposits, together with the materiality[12] of financing transactions, may alter the overall risk of the balance sheet and, consequently, the assessment of their capital requirements. Indeed, risk-sharing “deposits” would in principle reduce the need for a safety cushion to weather adverse investment outcomes. Similarly, the materiality of investments is likely to modify the extent of their risk and have a bearing on the assessment for the overall need for capital; asset-based modes of finance may be less risky and profit-sharing modes more risky, than conventional interest-bearing modes. Nevertheless, IIFSs would operate within a regulatory framework that is likely to impose on them capital requirements with a view to promoting stability and limiting contagion risks. However, besides regulatory and market demands for IIFSs to hold capital, IIFSs need to put in place risk management assessments for their own purposes of returns and stability in accordance with the requirements of Shari’ah, their own mission statements, and the protection of their stakeholders.
[1] See Honohan (2004) and Levine (2004).
[2] Sir John Hicks identifies such liquidity as one of the main factors behind the Industrial Revolution.
[3] Actually, a deposit can be viewed as a purchase of a debt asset issued by the intermediary and redeemable at its face value.
[4] The institution–market competition is reflected in the trends of their relative market shares of total financial assets. For example, in the United States, between 1960 and the early 1990s, commercial banks’ share of total financial intermediaries’ assets fell from around 40% to less than 30%. See Edwards (1996).
[5] They do respond to a latent demand for financial services that do not breach Shari’ah principles. Accordingly, they have the potential to contribute to financial deepening, economic growth, and social inclusion. See also Burghardt and Fuss (2004).
[6] Modigliani and Miller (1958).
[7] See Klingebiel and Laeven (2007).
[8] Views differ on the need for and extent of regulation, as well as on the usefulness of deposit insurance; see Barth, Caprio, and Levine (2007).
[9] Diamond and Rajan (2006).
[10] Allen and Gale (2007).
[11] Berger and Bouwman (2005).
[12] By the “materiality” of financing transactions is meant that, in such transactions, capital must be “materialized” in the form of an asset or asset services (as in Murabaha credit sales, Salam and Istisna’a financing, or Ijarah leasing), or of a business venture (Musharakah or Mudarabah). Capital in the form of money is not entitled to any return, as this would be interest (riba).
A financial intermediary’s ability to process information on risks and returns of investment opportunities will have a bearing on the soundness and efficiency of its resource mobilization and reallocation function. Conventional financial services (CFSs) process information through institutions or markets, and have generally evolved from the former to the latter. In both cases, markets and agents provide alternative ways of processing information on risks and returns of investment opportunities. In the first form, the intermediary raises capital to set up business to collect generally liquid deposits from surplus agents and reallocates these resources, now in his trust, to ones with deficits in generally less liquid assets. In the second form, surplus agents buy directly financial assets that represent a debt of a deficit agent or an ownership share in its business. In either approach, both categories of agents engage in transactions on the basis of trust and of expectations about the degree of liquidity that would provide the option to re-contract at a reasonable cost.[2] In the case of banks, the trust can be seen as based on proprietary information. In the case of markets, the information is more commoditized and widely available.[3]
Efficiently processed information can support the efficient allocation of capital. It can help a financial intermediary to better define the capital it would need to achieve the returns sought, while maintaining its ability to face the financial consequences of unexpected events that may endanger its stability. Banks engage in gathering and processing information on clients and markets, which allows them to manage different risks by unbundling them and reallocating the components. By performing these services soundly and efficiently, banks can manage to calibrate their capital requirements and receive diversified income streams. Thus a bank’s investors and customers can gain comfort as to its reliability in allowing them to access liquidity and maintain stability. In parallel with banks, financial markets can also convey the same sense of access to liquidity and stability based on disclosed and broadly available information on market participants. Markets can provide deficit and surplus agents a direct role in processing information to facilitate the unbundling and reallocation of risks and the efficient use of capital. Thus, banks and markets compete and complement each other in financial intermediation. The competition puts pressure on individual agents to use capital at their disposal efficiently, and results in a system-wide improved allocation of capital resources.[4]
Institutions offering Islamic financial services (IIFSs) also process information on risks and returns of investment opportunities while complying with Shari’ah principles.[5] Thus, in principle, they can be expected to increase competition in financial information processing by inducing better risk management and capital use. Such competition can be expected over time to lead to an efficient use of capital at the level of each financial agent, whether they practice conventional or Islamic finance, and in aggregate, system-wide across all modes of financial intermediation. Efficient use of capital is thus a challenge which competition imposes on all financial intermediaries, whether offering Islamic financial services or conventional financial services. At the same time, Islamic financial intermediation needs to comply with Shari’ah principles, notably those of risk sharing and materiality of financial transactions. Shari’ah compliance, social responsibility, and the discipline of competition compound IIFSs’ challenge to process information efficiently in order to manage the risks they may face and use their capital endowments. Thus, by their very nature and the environment in which they generally operate, IIFSs need to be well equipped with the information and skills that can allow them to identify their capital resources and use them efficiently.
This chapter argues for the need for Islamic financial services to strengthen risk management practices in the process of defining their own capital requirements in accordance with their loss tolerance. It suggests that IIFSs could invest in the collection of loss information and adoption of loss data management systems. IIFSs would benefit from implementing risk management methodologies and adapting their staffing skills accordingly. The chapter starts in Section 2 by outlining views on the relationship between risk management and capital for financial intermediation. It then overviews risk categories as an initial step in risk management in Section 3. Section 4 discusses regulatory and economic capital, introducing risk occurrence frequency as a distribution probability. Section 5 concludes with suggestions on steps that may help with risk management and improve the competitiveness of IIFSs.
2. Bank Capital and Risk Management
Bank capital may be considered as consisting of (a) equity capital and (b) certain non-deposit liabilities or debt capital (see Section 4). It is both a means of funding earnings-generating assets and a stability cushion. From the perspective of efficiency and returns, capital is part of a bank’s funding that can be applied directly to the purchase of earning assets, as well as being used as a basis for leverage to raise other funds for expanding assets with the net benefit accruing to shareholders. From a perspective of stability, bank capital is a cushion for absorbing shocks of business losses and maintaining solvency, with benefits accruing to depositors and other stakeholders. Both financial intermediaries and regulators are sensitive to the dual role of capital, as a means of funding earnings-generating assets and as a cushion for dealing with unanticipated events. Financial intermediaries may tend to be more focused on the former role and regulators on the latter.
A bank’s capital structure decision relates to the ratio of capital to deposits and to the ratio of debt capital to equity capital. Its performance, in terms of return on equity capital, will be influenced by its ability to calibrate the level of capital it requires. Through efficient risk management, it can reach a sense of which capital structure can best help it to: (a) achieve profitability while maintaining stability; (b) reassure markets as to the quality of its business conduct; and (c) have a constructive dialogue with regulators.
Efficient use of capital will help IIFSs to achieve profitability and stability. Allocating capital resources to low-performing or excessively risky assets is bound to drag down performance, endanger stability, or both. Equally, leaving capital idle entails at best forgoing earnings opportunities. For instance, overly cautious approaches that lead financial intermediaries to maintain larger amounts of capital than warranted by their risk profile may not allow them either to obtain the full potential of their capital or to contribute effectively to the development of the communities they serve. At the other end of the spectrum, a financial intermediary overly eager to achieve returns may allocate resources to highly risky assets that offer high returns but endanger stability. Explicit risk management practices can help in the selection of assets to which capital and other resources are applied and calibrate the level of capital that best suits business objectives and stability tolerance.
The size and composition of the resources that capital enables financial intermediaries to raise are likely to affect their profitability and stability. In a frictionless world where full information is available and markets are complete, the value of a firm would be independent of its capital structure, and so the focus should be on capital level and not structure.[6] Under such circumstances, the method by which a financial intermediary raises its required funds would be irrelevant. However, financial intermediaries do not operate in a frictionless world; they face imperfections such as costs of bankruptcy and financial distress, transaction costs, asymmetric information, or taxes. They also operate within the framework of a governing regulation possibly with a deposit insurance scheme that is expected to provide a safety net. In fact, one may contend that these market imperfections are the very reason for the successful existence of banks as financial intermediaries. Accordingly, not only a financial intermediary’s level of capital but also its structure is likely to bear on its market valuation, its business conduct, and its stability. Effective risk management strategies should contribute to a financial intermediary’s ability to assess not only the level of capital it would need in relation to assets and deposits, but also the extent to which its structure affects its value.
Market discipline contributes to responsible corporate behavior. Markets’ reactions to perceptions of a financial intermediary’s business conduct and capital strength may be unforgiving. It is thus in the interest of financial intermediaries to develop approaches to defining capital resource requirements that take into account the institutional environment in which they operate. The market’s perception of market imperfections is likely to influence views on the appropriate level of capital and the capital adequacy of financial intermediaries. For example, the availability of a safety net may lead market participants to be less demanding as to the need for capital in relation to bank assets. Conversely, anticipation of high costs of financial distress to depositors and other stakeholders may induce market participants to require the holding of more capital proportionally to assets. Similarly, wherever the institutional environment is weak and contract enforcement is uncertain and costly, markets may expect financial intermediaries to adapt the capital they hold.
The management of capital structure should in principle mitigate the risk of bank failures. When comparing a highly leveraged bank and a bank that is well capitalized, the leveraged bank will likely experience a greater loss of value during times of financial distress when the asset quality deteriorates, due to the increased risk of bankruptcy. To cope with downturns, in most countries banks hold a minimum amount of capital, based on the risk embedded in their asset holding. Accordingly, banks with relatively risky assets would hold a higher amount of capital than those banks with less risky assets. However, fearing the harshness of market discipline, many banks maintain a higher level of capital than the minimum required to allay the perception that they may be undercapitalized and avoid the losses this may induce, as witnessed in the 1980s. The key capital adequacy ratio provides an assessment of just how adequately the capital cushions such fluctuations in the bank’s earnings and supports higher assets growth.
Finally, efficient risk management should allow financial intermediaries to have a constructive dialogue with regulators. It would help them to articulate their views with respect to capital needs. The regulators’ rationale for regulating capital stems from the perception of the public-good nature of bank services, their potential macroeconomic growth and stability impact, and experience with costly bank failures. According to some estimates, such costs have varied between 3% and 55% of GDP.[7] Thus, regulators’ concerns with possible systemic risk resulting from the contagion effects of bank runs lead them to seek to mitigate risks of financial distress with regulatory requirements on banks’ capital.[8] Regulators’ concerns may be compounded by the presence of deposit insurance schemes. The moral hazard that may result from deposit insurance may lead to additional regulatory requirements such as linking the level of insurance premia to the risk embedded in assets and captured in associated risk weights. Indeed, deposit insurance may induce banks to lever up capital by expanding their own funding with liabilities, thus placing more risk on their capital and increasing their vulnerability. Efficient risk management practices would allow banks to improve their dialogue with the regulator and convey more convincingly their views on their soundness and capital requirements.
Regulators would generally also be concerned with the overall impact on the economy of the resources raised by the financial system under their purview. From an economy-wide perspective, banks may be viewed as firms’ competitors in raising capital on financial markets. The outcome of this competition has a bearing on economic performance and financial stability, and points to a cost–benefit tradeoff in holding capital. For instance, Gersbach (2007) suggests that a benefit of bank capital is the equity acting as a buffer against future losses, thereby reducing excessive risk taking of the banks. At the same time, raising bank capital may lead to a crowding out of industrial firms, limiting their access to equity and other market funding and also impacting their access to funding from banks and its cost. Furthermore, raising equity on markets may increase the cost of banks’ resources, inducing them to seek to invest in higher-yielding but more risky assets and thereby increasing their risk exposure. Thus, while potentially providing a cushion against unforeseen events, a higher level of equity may actually induce more risk taking, notably through raising the cost of funds to banks and their clients. Efficient risk management can provide inputs to both banks and regulators to better calibrate capital needs and deal with the foregoing type of tradeoff.
The level of a financial intermediary’s capital may also have a bearing on its ability to provide liquidity. The financial intermediary provides liquidity by funding assets that may be less liquid than the deposit resources it collects. There is a view that requirements for higher levels of capital may have a negative impact on liquidity creation.[9] On the liability side, a higher capital requirement may lead to a corresponding reduction in the level of deposits, thus constraining the ability to provide liquidity. Also, higher capital requirements may induce financial intermediaries to be more restrained in extending financing, thus constraining their ability to provide liquidity. However, according to another view, higher capital would allow the financial intermediary to create more liquidity since its risk-absorptive capacity would be improved.[10] In this regard, an empirical study concluded that for larger banks capital has a statistically significant positive net effect on liquidity creation, while for small banks this effect is negative.[11] Accordingly, each financial intermediary would need to evaluate carefully the level and composition of the capital it needs, since the latter plays a significant role in its ability to function as a liquidity provider. Equally, regulators would need to pay attention to the impact which capital requirement would have on the funding of the economy.
IIFS’s risk management arrangements will bear on their ability to calibrate capital to their business objectives and risk tolerance, to deal with market discipline, and to maintain a dialogue with regulators. The IIFS’s characteristic of mobilizing funds in the form of risk-sharing investment accounts in place of conventional deposits, together with the materiality[12] of financing transactions, may alter the overall risk of the balance sheet and, consequently, the assessment of their capital requirements. Indeed, risk-sharing “deposits” would in principle reduce the need for a safety cushion to weather adverse investment outcomes. Similarly, the materiality of investments is likely to modify the extent of their risk and have a bearing on the assessment for the overall need for capital; asset-based modes of finance may be less risky and profit-sharing modes more risky, than conventional interest-bearing modes. Nevertheless, IIFSs would operate within a regulatory framework that is likely to impose on them capital requirements with a view to promoting stability and limiting contagion risks. However, besides regulatory and market demands for IIFSs to hold capital, IIFSs need to put in place risk management assessments for their own purposes of returns and stability in accordance with the requirements of Shari’ah, their own mission statements, and the protection of their stakeholders.
[1] See Honohan (2004) and Levine (2004).
[2] Sir John Hicks identifies such liquidity as one of the main factors behind the Industrial Revolution.
[3] Actually, a deposit can be viewed as a purchase of a debt asset issued by the intermediary and redeemable at its face value.
[4] The institution–market competition is reflected in the trends of their relative market shares of total financial assets. For example, in the United States, between 1960 and the early 1990s, commercial banks’ share of total financial intermediaries’ assets fell from around 40% to less than 30%. See Edwards (1996).
[5] They do respond to a latent demand for financial services that do not breach Shari’ah principles. Accordingly, they have the potential to contribute to financial deepening, economic growth, and social inclusion. See also Burghardt and Fuss (2004).
[6] Modigliani and Miller (1958).
[7] See Klingebiel and Laeven (2007).
[8] Views differ on the need for and extent of regulation, as well as on the usefulness of deposit insurance; see Barth, Caprio, and Levine (2007).
[9] Diamond and Rajan (2006).
[10] Allen and Gale (2007).
[11] Berger and Bouwman (2005).
[12] By the “materiality” of financing transactions is meant that, in such transactions, capital must be “materialized” in the form of an asset or asset services (as in Murabaha credit sales, Salam and Istisna’a financing, or Ijarah leasing), or of a business venture (Musharakah or Mudarabah). Capital in the form of money is not entitled to any return, as this would be interest (riba).
Introduction: Information, Risks, and Capital
Financial intermediation is a critical factor for growth and social inclusion. One of its core functions is to mobilize financial resources from surplus agents and channel them to those with deficits. It thus allows investor entrepreneurs to expand economic activity and employment opportunities. It also enables household consumers, micro- and small entrepreneurs to expand their own welfare and earnings opportunities, and seek to smooth their lifetime outlays. In all cases, financial intermediation drives economic growth and contributes to social inclusion, provided it is conducted in a sound and efficient way.[1]
A financial intermediary’s ability to process information on risks and returns of investment opportunities will have a bearing on the soundness and efficiency of its resource mobilization and reallocation function. Conventional financial services (CFSs) process information through institutions or markets, and have generally evolved from the former to the latter. In both cases, markets and agents provide alternative ways of processing information on risks and returns of investment opportunities. In the first form, the intermediary raises capital to set up business to collect generally liquid deposits from surplus agents and reallocates these resources, now in his trust, to ones with deficits in generally less liquid assets. In the second form, surplus agents buy directly financial assets that represent a debt of a deficit agent or an ownership share in its business. In either approach, both categories of agents engage in transactions on the basis of trust and of expectations about the degree of liquidity that would provide the option to re-contract at a reasonable cost.[2] In the case of banks, the trust can be seen as based on proprietary information. In the case of markets, the information is more commoditized and widely available.[3]
Efficiently processed information can support the efficient allocation of capital. It can help a financial intermediary to better define the capital it would need to achieve the returns sought, while maintaining its ability to face the financial consequences of unexpected events that may endanger its stability. Banks engage in gathering and processing information on clients and markets, which allows them to manage different risks by unbundling them and reallocating the components. By performing these services soundly and efficiently, banks can manage to calibrate their capital requirements and receive diversified income streams. Thus a bank’s investors and customers can gain comfort as to its reliability in allowing them to access liquidity and maintain stability. In parallel with banks, financial markets can also convey the same sense of access to liquidity and stability based on disclosed and broadly available information on market participants. Markets can provide deficit and surplus agents a direct role in processing information to facilitate the unbundling and reallocation of risks and the efficient use of capital. Thus, banks and markets compete and complement each other in financial intermediation. The competition puts pressure on individual agents to use capital at their disposal efficiently, and results in a system-wide improved allocation of capital resources.[4]
Institutions offering Islamic financial services (IIFSs) also process information on risks and returns of investment opportunities while complying with Shari’ah principles.[5] Thus, in principle, they can be expected to increase competition in financial information processing by inducing better risk management and capital use. Such competition can be expected over time to lead to an efficient use of capital at the level of each financial agent, whether they practice conventional or Islamic finance, and in aggregate, system-wide across all modes of financial intermediation. Efficient use of capital is thus a challenge which competition imposes on all financial intermediaries, whether offering Islamic financial services or conventional financial services. At the same time, Islamic financial intermediation needs to comply with Shari’ah principles, notably those of risk sharing and materiality of financial transactions. Shari’ah compliance, social responsibility, and the discipline of competition compound IIFSs’ challenge to process information efficiently in order to manage the risks they may face and use their capital endowments. Thus, by their very nature and the environment in which they generally operate, IIFSs need to be well equipped with the information and skills that can allow them to identify their capital resources and use them efficiently.
This chapter argues for the need for Islamic financial services to strengthen risk management practices in the process of defining their own capital requirements in accordance with their loss tolerance. It suggests that IIFSs could invest in the collection of loss information and adoption of loss data management systems. IIFSs would benefit from implementing risk management methodologies and adapting their staffing skills accordingly. The chapter starts in Section 2 by outlining views on the relationship between risk management and capital for financial intermediation. It then overviews risk categories as an initial step in risk management in Section 3. Section 4 discusses regulatory and economic capital, introducing risk occurrence frequency as a distribution probability. Section 5 concludes with suggestions on steps that may help with risk management and improve the competitiveness of IIFSs.
2. Bank Capital and Risk Management
Bank capital may be considered as consisting of (a) equity capital and (b) certain non-deposit liabilities or debt capital (see Section 4). It is both a means of funding earnings-generating assets and a stability cushion. From the perspective of efficiency and returns, capital is part of a bank’s funding that can be applied directly to the purchase of earning assets, as well as being used as a basis for leverage to raise other funds for expanding assets with the net benefit accruing to shareholders. From a perspective of stability, bank capital is a cushion for absorbing shocks of business losses and maintaining solvency, with benefits accruing to depositors and other stakeholders. Both financial intermediaries and regulators are sensitive to the dual role of capital, as a means of funding earnings-generating assets and as a cushion for dealing with unanticipated events. Financial intermediaries may tend to be more focused on the former role and regulators on the latter.
A bank’s capital structure decision relates to the ratio of capital to deposits and to the ratio of debt capital to equity capital. Its performance, in terms of return on equity capital, will be influenced by its ability to calibrate the level of capital it requires. Through efficient risk management, it can reach a sense of which capital structure can best help it to: (a) achieve profitability while maintaining stability; (b) reassure markets as to the quality of its business conduct; and (c) have a constructive dialogue with regulators.
Efficient use of capital will help IIFSs to achieve profitability and stability. Allocating capital resources to low-performing or excessively risky assets is bound to drag down performance, endanger stability, or both. Equally, leaving capital idle entails at best forgoing earnings opportunities. For instance, overly cautious approaches that lead financial intermediaries to maintain larger amounts of capital than warranted by their risk profile may not allow them either to obtain the full potential of their capital or to contribute effectively to the development of the communities they serve. At the other end of the spectrum, a financial intermediary overly eager to achieve returns may allocate resources to highly risky assets that offer high returns but endanger stability. Explicit risk management practices can help in the selection of assets to which capital and other resources are applied and calibrate the level of capital that best suits business objectives and stability tolerance.
The size and composition of the resources that capital enables financial intermediaries to raise are likely to affect their profitability and stability. In a frictionless world where full information is available and markets are complete, the value of a firm would be independent of its capital structure, and so the focus should be on capital level and not structure.[6] Under such circumstances, the method by which a financial intermediary raises its required funds would be irrelevant. However, financial intermediaries do not operate in a frictionless world; they face imperfections such as costs of bankruptcy and financial distress, transaction costs, asymmetric information, or taxes. They also operate within the framework of a governing regulation possibly with a deposit insurance scheme that is expected to provide a safety net. In fact, one may contend that these market imperfections are the very reason for the successful existence of banks as financial intermediaries. Accordingly, not only a financial intermediary’s level of capital but also its structure is likely to bear on its market valuation, its business conduct, and its stability. Effective risk management strategies should contribute to a financial intermediary’s ability to assess not only the level of capital it would need in relation to assets and deposits, but also the extent to which its structure affects its value.
Market discipline contributes to responsible corporate behavior. Markets’ reactions to perceptions of a financial intermediary’s business conduct and capital strength may be unforgiving. It is thus in the interest of financial intermediaries to develop approaches to defining capital resource requirements that take into account the institutional environment in which they operate. The market’s perception of market imperfections is likely to influence views on the appropriate level of capital and the capital adequacy of financial intermediaries. For example, the availability of a safety net may lead market participants to be less demanding as to the need for capital in relation to bank assets. Conversely, anticipation of high costs of financial distress to depositors and other stakeholders may induce market participants to require the holding of more capital proportionally to assets. Similarly, wherever the institutional environment is weak and contract enforcement is uncertain and costly, markets may expect financial intermediaries to adapt the capital they hold.
The management of capital structure should in principle mitigate the risk of bank failures. When comparing a highly leveraged bank and a bank that is well capitalized, the leveraged bank will likely experience a greater loss of value during times of financial distress when the asset quality deteriorates, due to the increased risk of bankruptcy. To cope with downturns, in most countries banks hold a minimum amount of capital, based on the risk embedded in their asset holding. Accordingly, banks with relatively risky assets would hold a higher amount of capital than those banks with less risky assets. However, fearing the harshness of market discipline, many banks maintain a higher level of capital than the minimum required to allay the perception that they may be undercapitalized and avoid the losses this may induce, as witnessed in the 1980s. The key capital adequacy ratio provides an assessment of just how adequately the capital cushions such fluctuations in the bank’s earnings and supports higher assets growth.
Finally, efficient risk management should allow financial intermediaries to have a constructive dialogue with regulators. It would help them to articulate their views with respect to capital needs. The regulators’ rationale for regulating capital stems from the perception of the public-good nature of bank services, their potential macroeconomic growth and stability impact, and experience with costly bank failures. According to some estimates, such costs have varied between 3% and 55% of GDP.[7] Thus, regulators’ concerns with possible systemic risk resulting from the contagion effects of bank runs lead them to seek to mitigate risks of financial distress with regulatory requirements on banks’ capital.[8] Regulators’ concerns may be compounded by the presence of deposit insurance schemes. The moral hazard that may result from deposit insurance may lead to additional regulatory requirements such as linking the level of insurance premia to the risk embedded in assets and captured in associated risk weights. Indeed, deposit insurance may induce banks to lever up capital by expanding their own funding with liabilities, thus placing more risk on their capital and increasing their vulnerability. Efficient risk management practices would allow banks to improve their dialogue with the regulator and convey more convincingly their views on their soundness and capital requirements.
Regulators would generally also be concerned with the overall impact on the economy of the resources raised by the financial system under their purview. From an economy-wide perspective, banks may be viewed as firms’ competitors in raising capital on financial markets. The outcome of this competition has a bearing on economic performance and financial stability, and points to a cost–benefit tradeoff in holding capital. For instance, Gersbach (2007) suggests that a benefit of bank capital is the equity acting as a buffer against future losses, thereby reducing excessive risk taking of the banks. At the same time, raising bank capital may lead to a crowding out of industrial firms, limiting their access to equity and other market funding and also impacting their access to funding from banks and its cost. Furthermore, raising equity on markets may increase the cost of banks’ resources, inducing them to seek to invest in higher-yielding but more risky assets and thereby increasing their risk exposure. Thus, while potentially providing a cushion against unforeseen events, a higher level of equity may actually induce more risk taking, notably through raising the cost of funds to banks and their clients. Efficient risk management can provide inputs to both banks and regulators to better calibrate capital needs and deal with the foregoing type of tradeoff.
The level of a financial intermediary’s capital may also have a bearing on its ability to provide liquidity. The financial intermediary provides liquidity by funding assets that may be less liquid than the deposit resources it collects. There is a view that requirements for higher levels of capital may have a negative impact on liquidity creation.[9] On the liability side, a higher capital requirement may lead to a corresponding reduction in the level of deposits, thus constraining the ability to provide liquidity. Also, higher capital requirements may induce financial intermediaries to be more restrained in extending financing, thus constraining their ability to provide liquidity. However, according to another view, higher capital would allow the financial intermediary to create more liquidity since its risk-absorptive capacity would be improved.[10] In this regard, an empirical study concluded that for larger banks capital has a statistically significant positive net effect on liquidity creation, while for small banks this effect is negative.[11] Accordingly, each financial intermediary would need to evaluate carefully the level and composition of the capital it needs, since the latter plays a significant role in its ability to function as a liquidity provider. Equally, regulators would need to pay attention to the impact which capital requirement would have on the funding of the economy.
IIFS’s risk management arrangements will bear on their ability to calibrate capital to their business objectives and risk tolerance, to deal with market discipline, and to maintain a dialogue with regulators. The IIFS’s characteristic of mobilizing funds in the form of risk-sharing investment accounts in place of conventional deposits, together with the materiality[12] of financing transactions, may alter the overall risk of the balance sheet and, consequently, the assessment of their capital requirements. Indeed, risk-sharing “deposits” would in principle reduce the need for a safety cushion to weather adverse investment outcomes. Similarly, the materiality of investments is likely to modify the extent of their risk and have a bearing on the assessment for the overall need for capital; asset-based modes of finance may be less risky and profit-sharing modes more risky, than conventional interest-bearing modes. Nevertheless, IIFSs would operate within a regulatory framework that is likely to impose on them capital requirements with a view to promoting stability and limiting contagion risks. However, besides regulatory and market demands for IIFSs to hold capital, IIFSs need to put in place risk management assessments for their own purposes of returns and stability in accordance with the requirements of Shari’ah, their own mission statements, and the protection of their stakeholders.
[1] See Honohan (2004) and Levine (2004).
[2] Sir John Hicks identifies such liquidity as one of the main factors behind the Industrial Revolution.
[3] Actually, a deposit can be viewed as a purchase of a debt asset issued by the intermediary and redeemable at its face value.
[4] The institution–market competition is reflected in the trends of their relative market shares of total financial assets. For example, in the United States, between 1960 and the early 1990s, commercial banks’ share of total financial intermediaries’ assets fell from around 40% to less than 30%. See Edwards (1996).
[5] They do respond to a latent demand for financial services that do not breach Shari’ah principles. Accordingly, they have the potential to contribute to financial deepening, economic growth, and social inclusion. See also Burghardt and Fuss (2004).
[6] Modigliani and Miller (1958).
[7] See Klingebiel and Laeven (2007).
[8] Views differ on the need for and extent of regulation, as well as on the usefulness of deposit insurance; see Barth, Caprio, and Levine (2007).
[9] Diamond and Rajan (2006).
[10] Allen and Gale (2007).
[11] Berger and Bouwman (2005).
[12] By the “materiality” of financing transactions is meant that, in such transactions, capital must be “materialized” in the form of an asset or asset services (as in Murabaha credit sales, Salam and Istisna’a financing, or Ijarah leasing), or of a business venture (Musharakah or Mudarabah). Capital in the form of money is not entitled to any return, as this would be interest (riba).
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