Bank Study Guide

📖 Core Concepts Bank – A financial institution that takes public deposits, creates demand‑deposit accounts, and makes loans, thereby creating new money when it lends. Fractional‑reserve banking – Banks keep only a fraction of deposits as liquid assets; the rest is used for loans or securities. Basel Accords – International standards that set minimum capital ratios (capital ÷ risk‑weighted assets) to ensure banks can absorb losses. Maturity transformation – Borrowing short‑term (e.g., demand deposits) and lending long‑term (e.g., mortgages). Money creation – When a bank approves a loan, it credits the borrower’s deposit account, expanding the money supply without printing cash. Primary bank activities – Payment services, borrowing funds (deposits, bonds, banknotes), and lending (advances, installment loans, securities). 📌 Must Remember Interest‑rate spread = Loan rate − Deposit rate (key profitability metric). Capital composition: equity + retained earnings + subordinated debt. Risk‑weighted capital requirement – Riskier assets require higher capital buffers. Major bank risks: credit, liquidity, market, operational, reputational, macro‑economic. Types of banks: commercial, investment, universal, community, credit union, direct/Internet‑only, Islamic, central. Regulatory licence – Required in virtually all jurisdictions; includes “fit and proper” tests for senior officers. 🔄 Key Processes Loan creation & money expansion Borrower applies → credit assessment → loan approved → bank credits borrower’s deposit account → money supply ↑. Payment settlement (netting) Bank aggregates inbound/outbound payments → offsets them → only net amount moves between banks → reduces reserve needs. Risk‑based pricing Assess borrower credit risk → assign risk premium → higher interest rate → offset expected loan loss. Capital adequacy calculation (simplified) Compute Risk‑Weighted Assets (RWA) → apply Basel ratio (e.g., 8 %) → required capital = 0.08 × RWA. 🔍 Key Comparisons Commercial bank vs. Investment bank Commercial: takes deposits, makes loans, payment services. Investment: underwrites securities, M&A advisory, market making; typically does not take deposits. Community bank vs. Community development bank Community: locally owned, decision‑making at local level. Development: targets underserved populations, emphasizes credit access. Traditional deposit vs. Brokered deposit Traditional: owned by the depositor, relatively stable. Brokered: placed by a broker, “hot money” – can be withdrawn quickly, higher cost. Islamic bank vs. Conventional bank Islamic: no interest (riba); profit earned via markup, fee‑based services. Conventional: interest‑based lending & borrowing. ⚠️ Common Misunderstandings “Banks print money” – Banks create money electronic through lending, not by printing physical cash. All deposits are safe – Brokered deposits can be volatile (“hot money”) and may force banks into costly borrowing. Higher capital = lower profit – Adequate capital reduces risk of failure and can lower funding costs; the trade‑off is managed via risk‑based pricing. Universal banks are the same as commercial banks – Universal banks combine commercial, investment, and insurance activities (bancassurance). 🧠 Mental Models / Intuition “Bank as a Bridge” – Visualize a bank as a bridge connecting short‑term savers (up‑hill) to long‑term borrowers (down‑hill). The bridge’s strength = capital buffer; the traffic flow = payments and settlements. “Money‑creation faucet” – Each approved loan turns on a faucet that adds water (money) to the economy; the faucet’s size is limited by reserve and capital constraints. 🚩 Exceptions & Edge Cases Islamic banking – No interest; profit derived from markup (Murabaha) or fee‑based services. Narrow banking – Holds only government securities, limiting credit‑creation role. Central bank actions – Lender of last resort can provide emergency liquidity, temporarily breaking the usual reserve constraint. 📍 When to Use Which Choose a commercial bank when you need deposit accounts, consumer loans, or payment processing. Select an investment bank for underwriting securities, M&A advisory, or capital‑raising services. Opt for a credit union for lower fees and member‑owned structure, especially for personal banking. Use brokered deposits only when you need large, short‑term funding and can accept higher interest costs and liquidity risk. 👀 Patterns to Recognize “Spread compression” – In low‑interest environments, loan rates and deposit rates move together, squeezing profit margins. “Liquidity‑risk trigger” – Sudden outflows (e.g., from money‑market fund competition) often precede a liquidity crisis. “Risk‑weighted asset bump” – Adding a higher‑risk loan (e.g., unsecured consumer loan) raises RWA disproportionately, demanding more capital. 🗂️ Exam Traps Confusing “capital” with “reserves” – Capital is equity‑based loss‑absorbing buffer; reserves are liquid assets held against deposits. Assuming all deposits are “core” – Brokered deposits are not core and behave like short‑term wholesale funding. Misreading “fractional reserve” as “low reserve” – It means only a fraction of deposits is kept liquid, not that reserves are insufficient by regulation. Over‑emphasizing Basel I – Modern exams focus on Basel III risk‑weighting, leverage ratio, and liquidity coverage ratio (LCR), not just the 8 % capital ratio. --- Keep this guide handy; each bullet is a quick‑recall cue for the high‑stakes banking exam.