Lesson - PowerPoint Presentation

Slide1

Lesson 4

Depository Institutions and Corporate Banking

Slide statica

Esempio di copertina con fondo biancoSlide2

A. Commercial Banks

The traditional commercial bank functions

:

financial

intermediation (transform deposits into

loans), and

facilitate

payments (through bank drafts or checks).

Corporate

banking

services, typically offered by commercial banks, refers to financial services offered to corporations, including extension of loans, treasury and cash management services and services related to trade and international exchange.

Commercial

banks also tend to offer retail services to individual clients, known as

retail banking

. Slide3

Universal Banks

Universal banks engage in many kinds of financial

activities:

commercial banking

investment banking

often

provide other financial services such as insurance.Slide4

Commercial Banks in the U.S.

As of 2017,

there were

4,918

commercial banks

in

the United States.

The

largest 4

% held

over 70% of the total assets in the commercial banking system

.

Many

years

of restrictions inhibited

the growth of the largest U.S. commercial banks, but this regulation has been steadily eroded since the early 1980s

.Slide5

U.S. Bank Balance SheetsCapital:

U.S. commercial banks obtain roughly 70%

of

funding from

deposits.

Approximately 20%

of bank funding is

borrowed, though

much higher for certain money center wholesale banks (such as JPMorgan Chase).

U.S

. banks

average

equity capitalization

of

5% to 10% of total assets.

Assets:

Approximately

60-65% of typical commercial bank assets are loans,

primarily

commercial, industrial and real estate

loans.

Investment

securities, in particular, those issued by the U.S. government, comprise approximately

20%

of bank assets.

Fed

reserves, cash and demand deposits constitute most of the remaining bank assets

.Slide6

Assets and Liabilities of U.S. Commercial Banks Slide7

B. Variations of Depository Institutions and Banks

Commercial banks engage in traditional banking activities such as accepting deposits, making loans and operating payments systems.

The traditional function of

investment banks

is to assist clients in the placement of securities such as shares of stock and bonds to the general public. Investment banks underwrite (guarantee sales of) securities as part of this role

.Slide8

Variations of Depository Institutions and Banks, continued

Merchant banks by tradition engage in trade

finance. They

also tend to take equity positions in ongoing firms, frequently emphasizing equity positions rather than debt positions

.

Islamic banks

provide financial services adhering to Islamic law. Islamic banks do not borrow or lend with interest but often share in the profits of the firms in which they invest.

Universal banks

have broader arrays of activities, including commercial banking, investment banking, insurance and securities brokerage.

C

ommon

in Europe and Japan, U.S. banking regulation prohibited universal banking activity during

much of

the 20

th

century

.

Deregulation

during the late 1990s and first decade of the 21

st

century

made

universal banking

more common

in the U.S.Slide9

Variations of Depository Institutions

Private banks manage the assets of high net worth individuals. Many commercial banks have private bank units.Offshore banks

are branches or subsidiaries of a parent bank.

Often free from host country regulations affecting reserve requirements, disclosure, taxes, etc.

The IMF recognizes the Bahamas, Bahrain, the Cayman Islands, the Netherlands Antilles, Panama, Hong Kong and Singapore as major offshore banking centers.

Many offshore banks are essentially private banks or exist to remain out of reach of regulators where clients reside.

Thrift InstitutionsSlide10

The German Three-Pillar SystemCommercial banks: Offer traditional depository banking

services. Examples include Deutsche Bank, Commerzbank and Postbank.Savings banks

: Also known as public banks, savings banks operate commercially but are usually founded to implement credit and savings policy objectives of

governments

.

Seek to guarantee

banking services for

everyone.

a.

Sparkassen

: Serving the public good,

traditionally

offer savings accounts and are generally local

in scope, with a focus on the retail sector, with an effort to be inclusive and provide lower-income households with

savings

opportunities.

Organized

under “public law,” often with public or government

support

.

Landesbanken

: Seven public regional banks, universal banks with

mandates

, organized under public law, with shares held by Germany's

Länder

(states) and regional savings banks associations.

Landesbausparkassen

: Regional real estate savings banks

Credit

cooperatives

:

Mutual

organizations promote economic advancement of members through the execution of joint business activities, often focusing on consumer deposits and loans

with

or interest groups whose members share common

affiliations.Slide11

U.S. Thrift InstitutionsSavings and Loans Association:

a depository institution chartered by the U.S. Office of Thrift Supervision (administered by Office of the Comptroller of the Currency) that accepts deposits and extends mortgage and other loans.

Savings Bank:

established

to

receive deposits of money, maintain and pay interest on

deposits

for the benefit of depositors.

Credit Union:

member-owned

,

cooperative

(mutual) financial institution established to encourage savings, offer competitive interest rates on deposits and use deposits to make loans at low interest rates to its members

.Slide12

Savings and Loans Associationsdate from

the early 19th century in the U.S.rooted in the 18th century British building societies and postal savings bankscreated to provide low-cost, fixed-interest rate mortgages for housingNormally obtains most of its

funding (approximately 70%) from savings and time deposits.

Thus

, the funding of S&Ls tends to be somewhat more long-term oriented than for commercial banks.

Still,

asset structures are normally longer term than liability structures, which can create risks due to asset/liability mismatches

.Slide13

Savings Banksdate

from the early 19th century in the U.S. and are rooted in the 18th century British building societies and postal savings banksearly institutions were founded to provide banking services and savings opportunities for lower income individuals and families.

In

the U.S., savings banks are chartered as mutual or stock

organizations.

during

their early history, to maintain safety of deposits, they deposited their depositor proceeds into banks rather than extend credit to their client base, though now, most conduct more traditional lending functions.Slide14

Credit Unionsat

the end of 2010, there were 52,945 credit unions in 100 countries serving 188 million members and holding $1.5 trillion in assets. Over 10,000 credit unions in the U.S., accepting deposits from and making consumer loans to their members. Most

credit unions limit membership to specific groups of individuals sharing a common

bondSlide15

D. What Makes Banks Special?

Banks have special status in the economy. What makes banks so special to be singled out for special regulatory treatment?

Banks

are essential to the real productive sectors of the economy because banks

:

transform

maturity and risk structures of capital,

collect

information to resolve risk and to ensure that capital is put to its most productive uses,

maintain

the economy-wide payment system, without which the economy grinds to a halt,

ensure

liquidity and create money for business, governments and individuals to conduct transactions, which is needed for a well-functioning economy

.

Failure of the banking system surely implies failure or impaired operation of the economic system.Slide16

Banks resolve uncertainty

James [1987] and Fama

[1985] discuss the unique role of the bank in providing capital in under uncertainties, costly information retrieval and with a costly reserve requirement.

This reserve requirement is, in some respects, like a tax.

These authors observe that yields on bank CDs are not much different from those on bank commercial paper and bank acceptances.

Changes in reserve requirements do not seem to affect bank yields.

What makes banks special in that they can absorb this "tax" on deposits and pass it on to their customers through wider spreads.Slide17

What Makes Banks Special? Empirical Evidence

Banks, in their roles as delegated monitors, have access to special information. Mikkelson and

Partch

[1986] found that announcements of bank credit lines produced positive abnormal returns for prospective borrowers

James [1987] documents higher than normal stock returns for firms announcing acceptance of a loan from a bank.

These announcement effects seem to differ markedly from those associated with non-bank securities issued in capital markets.

This positive bank loan result suggests that financial markets perceive banks to be capable of obtaining useful non-public information about firms in the loan application process, information that does not seem to be obtained in the public securities issuance process.Slide18

What Makes Banks Special? Empirical Evidence, continued

Bernanke [1983] argues that the failure of banks to engage in normal intermediation services were key contributors in the 1930-33 real output crunch. Bernanke argued that the role of the banking system in reducing Depression-era output cannot be fully explained by declines in money supply.

Bank failures to provide credit amplified other factors contracting real output.

Bernanke claimed the two major contributors to the financial collapse were:

the loss of confidence in financial institutions, particularly commercial banks, and

the pervasive insolvency of debtors.

Bernanke argued that when banks fail to provide these information-provision services, lending is diminished and the economy suffers.Slide19

What Makes Banks Special? Empirical Evidence, continuedSlovin

, Sushka and Polonchek

[1993] examined borrower share price responses to the 1984 failure of Continental Illinois

Bank

the

largest

failure in

the U.S. to that

date

significantly

negative abnormal returns (-4.2%) to borrower shares, supporting Bernanke’s assertions.

Bernanke found that a financial crisis, such as suspended bank deposits, failing business liabilities, differentials between BAA corporate bond yields and yields on U.S. government monetary variables, that a financial crisis was a precursor to real output declines.Slide20

D. Corporate Bank Lending ActivitiesThe core business of commercial banking is accepting deposits and making loans.The difference between the two interest amounts or rates is called the spread.Slide21

Variations of Corporate LoansTerm loans:

fixed or variable-rate repayment plansfrequently for equipment, long-term working capital , etc. can be either amortized

or interest only with balloon payment at maturity covering the principal

.

Commercial

real estate

lending

: provides

financing for commercial land and buildings. Most

loans

are mortgages secured by

liens.

Financial leases:

provide the lessee the use of assets for extended periods of

time

usually

for more than one

year

an

important alternative source of long-term financing to many

firmsSlide22

Variations of Corporate Loans, continuedLoan syndication

: enables lenders to spread their capital commitments and lending risks to other banks. usually a large denominationmake

it easier for banks to participate in large high-profile deals and gain access to markets outside their

norms

enable

the borrower to efficiently work directly with only a single lender

the

lead (or arranging) bank manages the syndicate and is responsible to the

borrower

the

loan might be underwritten by the underwriting bank (who takes the credit risks) and all banks in the syndicate are participating banks.

An

agent works with the borrower and all participating banks to ensure their rights are honored and their responsibilities are

fulfilled

a

trustee holds or monitors any assets that are pledged by the

borrower

syndicated

loans

are

more flexible than bond issues and have positive reputation effects

.Slide23

Variations of Corporate Loans, Part 3Working capital

loans: enable clients to expand their cash, meet daily expenses, and expand inventoriesLines of credit: when drawn upon, serve as short-term sources of cash

a

line of credit reflects funds for which approval has already been

made

borrowing

from the credit line is not required, but is available

regardless

an

overdraft line of credit, enables a firm to spend more money than is

in

its

accountSlide24

Benchmark RatesA benchmark rate is a contractually defined market or computed rate, largely to reflect updated market interest rate conditions.

benchmark rates are used to peg interest rates on loans and price debt and derivative instruments. a benchmark rate is calculated by some independent body to reflect a particular interest rate prevailing in a current marketplace. Slide25

Benchmark Rates and the FedThe U.S. federal funds rate is the rate at which the excess reserves of one bank can be loaned on an

uncollaterized basis to other banks for to meet reserve requirements.depository institutions with excess balances can lend those

balances

rates

are negotiated, one-on-one by individual banks on individual loans at rates that draw from well-defined benchmark rates.

the

federal funds rate is the typical starting point for benchmarking in U.S. financial markets.

The Fed

determines the interest rate on required reserves (

IORR

) and the interest rate on excess reserves (

IOER

)

The

federal funds target rate (

FFTR

) is a benchmark set in the U.S. by the

FOMC

targeting the

IOER

rate

The

FOMC sets the fed funds target rate so as to control inflation and to maintain healthy economic growth.

The

target rate is not explicitly set by the market, but by monetary authorities based on more general economic policy aims.

The

federal funds effective rate (

FFER

):

based

on the rates negotiated by actual borrowing and lending banks in the

fed

funds markets.

The

Fed closely monitors

effective

rates and engages in open market operations to ensure that the effective rate remains very close to the Fed's target rate. Slide26

The SOFRThe Secured Overnight Financing Rate (SOFR) has grown in importance:The Federal Reserve Bank of New York works with the U.S. Office of Financial Research to produce and publish reference rates based on overnight repurchase agreement (repo) transactions.

a repurchase agreement (repo) is a marketable security issued by a financial institution acknowledging the sale of assets and a subsequent agreement to repurchase at a higher price in the near term.The daily SOFR is based on a volume-weighted median rate from transactions in the Treasury repurchase

market

reflects

circumstances where credit, liquidity and other risks are

minimal

there

has been a widespread migration

from

use of LIBOR as a benchmark towards the SOFR

.Slide27

Consensus RatesThe prime rate is the interest rate that commercial banks charge their most creditworthy non-bank corporate customers.

the prime rate can vary among banks and customersa consensus prime rate is regularly averaged and reported by The Wall Street Journal's bank surveythe

published rate is a frequently used benchmark for setting contractual

rates.

the

prime rate typically exceeds the federal funds rate by roughly 300 basis points (3%).

The

London Interbank Offer Rate (LIBOR) is an interest rate benchmark

that

derives

from a daily survey of 18 global banks conducted and compiled by the Intercontinental Exchange, the parent firm of the

NYSE.

t

he

daily survey obtains rates (for

1-month

,

3-month

, 6-month, and

1-year

loans) at

which banks

believe they can borrow a “reasonable” number of dollars (and certain other currencies)

in

the London interbank

market.

there

are a number of LIBOR figures, for different maturities and currencies.

LIBOR

has been important because it is widely used as a benchmark for interest rates on which many loans and securities are anchored.

its

future is

uncertain

due to benchmark reforms and several 2012 LIBOR-related trading manipulation scandals, and might even be discontinued as early as year-end 2021

.Slide28

European Benchmark RatesThe Euro Interbank Offered Rate (Euribor) is a reference one-year (though other rates are collected for other lending terms) interbank

rateaveraged from a survey of panel major European bankssurvey and averaging procedures are similar to those used for LIBOR.

The

Euro Short-Term Rate (€

STR)

reflects the wholesale euro unsecured overnight borrowing costs of Euro area banks

.

calculated

as the weighted average of individual

transactions

reported

by 50 credit institutions everyday to the ECB.

replaced

the

Eonia

(the 1-day

Euribor

rate

)

In

London Interbank markets, the Sterling Overnight Index Average (SONIA) has

started replacing

the LIBOR.

Analogous

interest rate benchmarks exist throughout the world

.Slide29

Interbank MarketsInterbank borrowing and lending is an essential part of bank treasury operations in which banks lend to short-term to each otheroften

using repurchase agreementstypically overnightmajor sources of short-term funding of banks through the Financial Crisis of 2008have diminished considerably in the decade followingSlide30

E. Other Corporate Banking ActivitiesBy nature of their business, banks command financial and legal expertise, and

maintain high levels of integrity to preserve their reputations. Close banking relationships with clients afford banks detailed inside informationThus, banks can provide their corporate clients with a variety of other non-lending financial services.expertise

, reputations and close relationships enable banks to facilitate their client relationship-building

efforts

enable

banks to serve as fiduciaries and custodians for the assets of

clients.

Payment

processing services, such ACH-related services

are

an integral part of services provided by banks to their corporate clients.Slide31

Trade FinanceCorporate banks help clients with exposure to exchange rate and interest rate

fluctuationsunanticipated business or operational conditionsuncertainties in economic, regulatory or political eventsgeographical risk such as natural disasters, credit risk, etc.

Trade

finance

is concerned with the financial instruments and processes that are used to facilitate international trade and commerce.

Typically

inserts an intermediary or third party to a transaction or relationship, frequently a bank, to facilitate the payment delivery processes and to reduce transaction

risk.Slide32

Letters of Credit Transactions with unknown counterparties impose risks that can often be resolved by banks.

Banks have significant private information and can exploit this private information on behalf of client by issuing:letter of credit: serves as guarantee for payments to be made to

an

entity on a given date under defined

conditions

conditions

are set forth by

counterparties to

the transaction in a

distinct sales

agreement

with

this letter of credit, for example, a buyer of a service can deliver a bank-guarantee of payment to a

counterparty

the

buyer's bank is likely to be well-known to the seller or to the seller's bank

Banks

that issue letters of credit assume

credit risk

Banks

receive fees from their clients for the assumption of this risk, normally as a percentage of the nominal payment to deliver (between 0.5% and 10% is typical

)

Fees are

an increasing function of the credit risk borne by the

bankSlide33

Letters of Credit , continuedA confirmed letter of credit provides for an additional layer of guarantee; should the buyer’s bank fail to fulfill the terms of the letter, the buyer’s bank (or, perhaps some other bank as designated by the letter) will do so.

Letters of credit can be rather complicated, particularly when used in international trade. Experienced bank officers should be expected to have the practical and legal expertise to properly specify the terms of the letterSlide34

Standby Letters of Credit Standby letter of credit: issued

by a bank to serve as a backup guarantee for payments deliverance of associated goods or services. a letter of credit typically provides the payment to be made by the issuing bank once contract conditions are fulfilled, but the standby letter of credit provides for the issuing bank to make payments only after its client fails to do so

Thus

, a standby letter of credit is an instrument of last

resort

financial

standby letters of credit ensure that financial or monetary contractual obligations are

fulfilled

performance

standby letters of credit ensure the nonfinancial contractual obligations

are

fulfilled. Slide35

Illustration: The International Bank as the Guarantor

Fred's Blue Jeans, U.S. clothing manufacturer agrees (in principle) to sell to a Bulgarian distributor $100,000 in clothing.

The

U.S. and Bulgarian firms have not previously done

business – counterparty risk

The

Bulgarian distributor

arranges

for a

letter of

credit

f

rom its bank.

This

letter of credit, issued by the Bulgarian bank for a fee is essentially a promise that the bank will pay $100,000 on behalf of its client, the Bulgarian distributor.

The

U.S. manufacturer (actually, usually the U.S. bank which the manufacturer used to help arrange for the letter of

credit)

ships the blue jeans to Bulgaria, where a

bill of lading

is issued to the Bulgarian bank.

This

bill of lading transfers ownership of the blue jeans to the Bulgarian bank and a

sight draft

requesting payment is issued by the exporter.

Payment

is made to the exporter and the

bank

transfers title to the blue jeans to the importer and receives payment, both for the blue jeans and for issuing the letter of credit.Slide36

Foreign Exchange ServicesForeign exchange (FX) trading refers to trading one country’s (or currency area's) money for that of another country (or area).

Banks convert foreign currencies to local currenciesBy trade volume, banks are the most significant participants in currency markets.Trading currencies in spot and forward markets and

currency derivative contracts in exchange markets, banks execute

transactions:

on

their own trading accounts (proprietary trading

)

on

behalf of their clients (agency trading).

Futures

and derivative contract trading is also used to help manage client exposure to foreign exchange risks

.Slide37

Treasury and Cash Management Services

Banks are a key source of treasury and cash management services to corporate clients. Banks aid corporate treasury departments in the management of

:

cash

and

liquidity

risk,

including market

risk,

credit

risk,

operational risk (risks associated with record-keeping, errors and fraud) and liquidity risk (risk of running out of cash).

Cash

Cash

is essential to the operations of any firm, it

is an

unproductive asset in terms of direct profitability.

The

primary cash management goal for most firms is to maintain as low an investment in cash as is possible while maintaining the firm's efficient and effective operations.

Collecting

, analyzing and forecasting data are key for effective cash management. Banks play important roles in all aspects of the corporate cash management function

.

The float is the difference between the firm's demand deposit account available balances and its ledger balance (book balances). Slide38

Treasury and Cash Management Services, continued

Many businesses receive paper checks, credit card documents and other payment forms by mail, providing them with options with respect to where the checks will be mailed and how they will be deposited into bank accounts.Lockbox services, often provided and administered by banks, are often located in post offices or mail drops, and can enable firms to establish suitable numbers and strategic locations of collection points (lockboxes) that can reduce collection and deposit times

.Slide39

F. International Banks and Banking Offices

The primary functions of international banks are to serve firms conducting business on an international scale. Services

provided by such banks are likely to include the following

:

Financing

of imports and

exports

Participation

in Eurocurrency and Eurobond markets on behalf of

clients

Trading

foreign exchange and derivative instruments on behalf of clients

Providing

advice, consulting and information to clients in the global setting

Participation

in international loan syndications

Providing

international cash management services for clients

Providing

loans and accepting deposits

Providing

factor

servicesSlide40

Bill CollectionFirms maintain accounts receivables to stimulate sales since many clients prefer to make purchases on credit.

liberal accounts receivable policy result in increased sales levels.maintenance of accounts receivable represents an opportunity cost to the firm in terms of forgone returns on other assets. Furthermore

, accounts receivable represent potential bad debt losses to the firm.

The

firm must find the appropriate balance of these costs relative to the benefits associated with accounts receivable.

A

credit instrument evidencing the sale

might

simply be an

invoice

Larger

sales or when collections may be problematic, the credit instrument may be evidenced by a

promissory note

, a more formal IOU.

terms

of payment for goods received or to be received can be specified in a

commercial draft

.

a

sight draft

calls for immediate payment (like a check) while a

time draft

permits payment at a specified later date (like a post-dated check). Slide41

AcceptancesWhen the buyer accepts the time draft, it is called a trade acceptance and can either be maintained by the seller or sold, usually to a bank

. Banks frequently purchase trade acceptances and re-sell them with payment guarantees. When banks guarantee (accept) and market trade acceptances, they become known as bankers' acceptances and are frequently carried in firms' marketable securities accounts.Slide42

FactoringFactoring occurs when an exporter sells a set of unpaid invoices to a factor at a discount, which can be referred to as a commission or haircut.

The factor, a bank or other financial institution, awaits payment from the buyer or importer. Factoring enables the seller or exporter to accelerate its cash flow from the sales, reinvest the cash into additional saleable products and relieves the seller from the risk of default. The

selling firm is further relieved from collection and bookkeeping functions related to the credit sale. Slide43

ForfaitingForfaiting: an exporter surrenders its right to a forfaiter to collect on

negotiable or securitized instruments evidencing credit sales in exchange for immediate payment. Often guaranteed (avalled) by the importer's bankevidenced by an

instrument such

as a bill of exchange, promissory note or letter of credit, which can be sold in secondary

markets

Forfaiting

costs are normally paid by the buyer or importer.

Forfaiting

is used only in international trade finance and typically is used for debts of medium- and long-term maturities (>90 days).Slide44

Fiduciary ServicesA fiduciary maintains a legal or ethical relationship of trust with another, typically managing or safekeeping assets and acting in the best interests of the client.

The regulatory environment and intense scrutiny faced by banks contributes to their ability to provide an array of reliable fiduciary services. Asset management, custodial and trust services are among the more important fiduciary services provided by banks.In the U.S., Registered Investment Advisors are required under the Investment Advisors Act of 1940 to follow the fiduciary standard. Regardless, investors should always ask their advisors about the standards their advisors must follow

.Slide45

The Prudent Man RuleThe Prudent Man Rule, historically rooted in English common law, provides for the proper investment behavior of a trustee. This

"prudent man" standard was articulated in an 1830 Massachusetts court opinion, in which Justice Samuel Putnam, declared that a trustee:"shall conduct himself faithfully and exercise a sound discretion. He is to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested."This fiduciary standard is more stringent than the suitability standard, which holds that the professional make recommendations that are consistent with the needs and preferences of the client.

In the suitability

scenario, recommendations must be suitable for the client, but the primary loyalty of the recommender is to her employer rather than to the client.

The

fiduciary standard holds that the professional put the interests of the client ahead of his own. Slide46

Asset Management and Advisory ServicesMany banks will offer a variety of asset and investment management and advisory services:customized

consulting investment policy guidancedirect investment managementperformance reportinginvestment committee guidance

employee

education for pension funds, 401(k) plans, alternative investments, etc. Slide47

Custodial ServicesUntil a few decades ago, a custodian was a company that maintained physical possession of client assets, in particular, paper certificates evidencing stock ownership or other claims.

While central depository institutions hold actual paper certificates when they exist, bank custodians play a number of important roles in securities markets. process and settle security transactions on behalf of corporate and financial institution clients

hold

and

safekeep

securities,

maintain

these

records

receive

dividends, interest and other payments on behalf of clients, withhold tax claims as required by

law

engage

in corporate action processing (e.g., tendering shares in a tender offer

)

provide

proxy voting

services

The

three largest bank custodians in the world were, as of year-end 2018:

BNY

Mellon $26.2 trillion,

JPMorganChase

$23.2

trillion

State

Street Corp $23.2 trillion Slide48

Custodial Services, continuedBanks are ideal providers of custodial services

because:of their own involvement in securities transactions, their financial expertise, their reputations for stability and conservative operations and

the

robust prudential regulation and oversight to which they are subjected.

Custodial services produce fee-based revenues.

Custodians

make no decisions concerning transactions; they merely act as

agents

For

financial institutions

that engage

in repurchase agreements and lend securities for short-selling and other purposes, bank custodians provide services directed towards these lending services.

These

services include record-keeping for loaned securities and associated collateral.

For

international transactions, custodians often need to engage in FX trading, and assume certain risks with such transactions

.Slide49

Custodial Services Operational RiskThe primary risk to custodians is operational

risk:the failure to effectively administer the successful execution of their huge volumes of operational and administrative processes. operational risks largely stem from:record-keeping errorserrors

in processing

transactions

inadequate

internal

processes

l

apses

in regulatory

compliance

the

loss or corruption of client data

With

respect to securities lending, custodians face risks with respect to borrower default

.Slide50

TrustsA trust is a contractual agreement in which:

a grantor (settler or donor) designates an entity known as a trustee to accept, hold and manage property as a custodian for the benefit of one or more beneficiaries.Through

their trust departments, banks regularly act as fiduciaries for clients on a fee

basis

Most

banks will offer similar services on behalf of estates, typically a legal entity created as the result of a person's death, holding property of the deceased

person.

An

estate can also be that of a bankrupted firm or other bankrupted institution. In addition, as mentioned above, many banks will also manage pension fund assets

.Slide51

Trust ServicesMany banks maintain trust departments or own separate trust subsidiaries, often providing them important streams of fee-based income. Trust

services are useful to banks:allowing them to diversify away somewhat from interest-based incomedraw in high net worth customers to their array of services. Most trusts are created for individuals and

families.

Trusts

are also useful for

businesses

especially

smaller and family

businesses

for

tax

reduction

asset protection

beneficiary

protection Slide52

Corporate Trust Services for BondholdersCorporate trust services serve bond issuers with their administration of the

bondsdistributing interest payments to bondholdersrepresenting bondholders, ensuring that the issuer adheres to the covenants of the bond indenture.Slide53

Trust Service SafetyMaintenance of additional safety and control standards is essential to trust departments. trust

assets are entirely segregated from bank assetsassets held in trust cannot be used for collateral or counted towards reserve requirements. Safety of client assets requires that no single employee have the ability to authorize, execute, and review the processing of custody assets, including transactions and transfers.

Such

dual control procedures ensure that no single person is able to execute all phases of a transaction or to transfer client assets.

Bank

trust departments segregate and

rotate

the duties of their employees who work in trust, custody and investment management operations

.