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Financial institutions serve a wide variety of customers,
 Individuals and families (often referred to as retail
customers or consumers)
 Businesses, ranging from small businesses to global
 Other organizations, such as pension plans, universities
and non-profit foundations
 Governments and government agencies
 Other financial institutions
Of course, not all financial institutions serve all of these
customers. Some financial institutions focus only on individual
customers (e.g., retail brokerage firms). Some financial
institutions only provide services to businesses and other
organizations (e.g., such as institutions focused on wholesale
banking or investment banking), while others primarily serve
other financial institutions (e.g., reinsurance companies). Most
large financial institutions serve all of these customers,
although they will have separate business units dedicated to
each specific group.
The first step to understanding your client’s strategy and
business objectives is to understand its customer base. Who are
its primary customers? What do these customers need or want?
How does your client try to meet the needs of these customers?


Financial institutions are as diverse as the customers they serve.
They range from:
 Small firms meeting the needs of their local
community to...
 ...Highly specialized companies meeting the
needs of specific market niches to...
 ...Large global institutions meeting the needs of
customers around the world
Most financial institutions are defined as one of the following
 Depository institutions
 Capital markets firms
 Insurance companies
In addition to these primary segments, there are also:
 Other financial institutions
 Other industry participants

Depository institutions are financial institutions licensed to accept customer

deposits. These institutions use these deposits to lend money to other customers or invest
in securities.
The term "banks" is often used to describe all depository institutions, although some
depository institutions are not actually banks. Generally, when someone refers to the
"banking industry", they are referring to all depository institutions.
One of the primary objectives of financial services regulators is to protect customer
deposits, so depository institutions are the most highly regulated of all financial
The different types of depository institutions or "banks" include:
 Commercial banks
Commercial banks provide a full range of traditional banking services, including deposit
products, payment services, home loans, consumer loans and commercial loans. Commercial
banks range from small regional or local banks to large national and international banks.

 Universal banks
Universal banks are financial institutions offering a complete range of financial services,
including commercial banking (e.g., deposits, payments and loans), investment management
services (e.g., brokerage, mutual funds), investment banking and insurance. Examples of
universal banks include Deutsche Bank and Credit Suisse.

 Savings banks
Savings banks were originally established to provide small savings accounts and residential
home loans (areas ignored by larger commercial banks). In most countries, deregulation has
allowed savings banks to expand their product offerings. In the UK and Australia, savings banks
are known as building societies. In Germany they are called Sparkassen.

 Postal savings banks

Postal savings banks (also known as postal banks or giro banks) are tied to a country’s postal
system. Retail customers deposit money into their postal savings accounts, and then initiate giro
transfers to send payments to others. Postal savings banks are often state-owned or state-
sponsored, and play a major role in some countries.

 Cooperative banks
Cooperative banks are owned by members who share a common bond (e.g., members of
a specific profession). Cooperative banks were developed to provide its members with
deposit and low-cost lending services. Cooperative banks are referred to as credit unions
in many countries.
Capital markets firms offer two primary services:
 Help customers raise funds by issuing securities
 To issue new securities, corporations turn to financial institutions
to help them determine which securities to issue, when to issue, how to
price the securities etc.
 The issuing of new securities to raise capital for the issuer is
referred to as the primary market
 Support customers in the buying and selling of existing securities
 Once securities are issued, they are continuously traded between
 This activity is known as the secondary market
Capital markets firms are defined by their primary business focus, and these definitions
 Investment banks
The primary role of an investment bank is to support customers in the primary market, helping
them raise capital by issuing securities (e.g., stocks, bonds) in the marketplace. Investment
banks also provide customers with research, advice and direct investments in their companies.

 Brokerage firms
Brokerage firms act as agents by buying or selling securities as instructed by their clients (i.e.,
trade execution). Full-service brokerage firms provide additional services, including financial
planning, asset management, research and advice. Discount brokerage firms focus primarily
on lower cost trade execution.

 Investment managers
Investment managers manage investments for their clients, usually earning a percentage of the
value of the assets they manage for their clients. They are also referred to as asset managers or
money managers.
Keep in mind, however, capital markets firms are not always easy to define. Many firms
offer a variety of services, serving in different roles at different times. For example,
Merrill Lynch serves as an investment banker for some clients, a brokerage firm for
others and as an investment manager for still others. However, brokerage activities are
still the largest part of Merrill’s business, so they are most commonly referred to as a
brokerage firm.
Insurance companies provide customers with protection from financial loss
caused by death, property damage or some other event. Insurance companies are defined
by the type of insurance they provide, and these definitions include:
 Life insurance companies
Large life insurance companies offer a variety of financial products and services, including life
insurance, accident insurance, investment services and banking.

 General insurance companies

General insurance companies provide protection against financial loss caused by damage to
the customer’s or someone else’s property or injury to another person. General insurance
companies organize their business into personal lines (insurance for individuals) and
commercial lines (insurance for businesses and other organizations).

 Reinsurance companies
Reinsurance companies do not offer products and services directly to consumers. Instead,
reinsurance companies offer reinsurance to insurance companies and other reinsurance
companies. Insurance companies (referred to as direct writing companies) obtain reinsurance
to "lay off" a portion of the risk they assumed when writing policies.

 Brokers
Insurance brokers match buyers of insurance (individuals and businesses) with sellers of
insurance. Brokers act primarily on behalf of the buyer, searching for the best available option
to meet the buyer’s needs. The largest insurance brokers also act as risk managers, combining
insurance products with other risk management products.
Move your cursor over each item for more information.
Many insurers offer both life and general insurance. However, these companies typically
offer the two types of services through separate business units or subsidiaries.
While most financial institutions can be defined as depository institutions, capital markets
firms or insurance companies, there are some notable exceptions, including:
 Finance companies
 Trust companies
Finance companies are similar to banks in that they issue loans to customers. However,
finance companies cannot accept deposits. Instead, they raise funds by issuing debt,
selling off assets and borrowing from other financial institutions. Since they do not accept
deposits, finance companies are less regulated than banks and other depository
Some finance companies focus specifically on loans to consumers (referred to as
consumer finance companies) or loans to businesses (referred to as commercial finance
companies). Some finance companies focus on one specific line of business, while others
offer a wide range of diversified financial services.
Trust companies provide their clients with trust, private banking and other investment
management services.
Trust services are not offered in all countries. Where they are permitted, they are
primarily offered by commercial banks and independent trust companies.
In addition to financial institutions themselves, there are other organizations participating
in the financial services industry. Most of these organizations exist to support financial
institutions, and include:
 Industry networks and associations
Many industry "networks" have been created to facilitate payment transactions in the financial
services industry. These include Visa and MasterCard networks (for credit card, debit card and
ATM transactions), national and regional ATM networks and electronic funds transfer (EFT)
networks for the electronic transfer of large payments.

 Securities exchanges
Exchanges were originally created as physical locations where brokerage firms would meet to
trade securities listed on the exchange. Today, with the notable exception of the New York Stock
Exchange (NYSE), most exchanges have replaced floor brokers with computer networks that
automatically match buy and sell requests submitted by brokerage firms.

 Alternative trading systems

Alternative trading systems (ATS) are private companies that bring together clients (or
members) to execute trades, bypassing the traditional "middle men" (i.e., brokerage firms and
exchanges). The largest ATS are electronic communication networks (ECNs), which are ATS
that function much like exchanges.

 Depositories
Today, the physical certificates associated with securities transactions rarely move. Instead, they
are stored in central locations known as depositories. These depositories track the ownership of
each security through electronic accounts.

 Information providers
Financial institutions rely on information to make the right decisions. While much of this
information comes from internal sources and customers, financial institutions also rely on
outside companies to provide information, including market information providers (e.g.,
Reuters and Bloomberg), credit bureaus and insurance bureaus.

 E-providers
With the growth of the Internet, new players in the financial services industry have arisen in the
form of e-providers. Examples include quote aggregators (e.g., Quicken), who provide
customers with a single source for receiving and analyzing quotes (e.g., insurance, loans) from
multiple providers, and financial portals (e.g., MSN MoneyCentral).
The markets for all types of financial instruments (also referred to as securities) are
collectively known as the financial markets. These markets bring buyers and sellers of
financial instruments together, allowing:
 Issuers to obtain money to fund internal growth, ongoing operations and
 Investors to generate income in the form of dividends and interest by
buying and holding securities
 Investors and traders to create profits by trading securities (i.e., buying
low and selling high)
Technically, the financial markets are composed of money markets for short-term
instruments and capital markets where long-term securities are issued and traded. Today,
however, the term "capital markets" is often used interchangeably with the term
"financial markets".
This module will provide you with more information on financial markets and
instruments, including:
 Primary markets
 Secondary markets
 Money market instruments
 Equities and related instruments
 Debt instruments
 Derivatives
Every financial market is composed of both a primary and a secondary market. The
issuance of new securities by governments, companies and financial institutions occurs in
the primary markets.
Through the primary markets companies, institutions, organizations and governments can
access investors as they seek to raise funds (i.e., capital) to support their ongoing
operations. These capital raising activities involve the issuance of securities by the
issuing entity. There are four major participants in the primary markets:
 Issuers
In the primary markets, various types of securities are marketed, priced and distributed on
behalf of the issuing entity (known as the issuer). Issuers include government entities (e.g.,
federal governments, government agencies and municipalities), corporations and financial

 Individual investors
The purchasers of securities are the investors, who provide the funding needed by issuers. In
exchange for the funds provided, investors receive income in the form of dividends or interest.
People who invest in the financial markets solely on their own behalf are known as individual

 Institutional investors
Institutional investors are organizations that purchase and trade large amounts of securities,
including banks, insurance companies, pension funds, non-profit institutions and mutual funds.
As a result of their significant investment and trading activities in specific securities,
institutional investors can directly impact the financial markets.

 Intermediaries
The other major players in the primary markets are the financial intermediaries, who bring
issuers and investors together through the underwriting process. When an issuer issues new
securities, these securities are distributed through an underwriter (usually an investment bank
or securities firm).
Once the initial price and trading restrictions on a new issue are removed, the security is
traded in the secondary market.
In the secondary market individual and institutional investors actively buy and sell
existing securities, resulting in an extremely high level of activity (as compared to the
primary market). Investors, who are the source of supply and demand for specific
securities, are the primary driving force in the secondary market:
 Investors purchase securities for the anticipated capital gains to be earned
by selling the securities at a later date at a higher price and for the ongoing
income stream generated by dividends and interest payments
 Investors sell securities to realize capital gains and to obtain liquidity
(cash) for other obligations or opportunities
These buys and sells (i.e., trades) are transacted through financial intermediaries:
 Dealers
Dealers buy and sell securities from other investors for their own account. Their goal is
generate revenue from the same gains and income streams as any other investor. This activity is
also known as proprietary trading or principal trading.

 Brokers
Brokers match buyers and sellers, earning a commission on the completion of the transaction.
This matching is known as trade execution, and in this role the broker is required to act on a
"best execution" basis, which refers to obtaining the best price for the investor and ensuring the
efficient settlement of the trade after it is executed.
To complete (or execute) a trade, a broker will turn to an execution source. For some
securities, the execution source is a centralized exchange where issuers, buyers and
sellers come together in a physical or electronic environment. Other securities are traded
in over-the-counter (OTC) markets in which a broker must seek out a counterparty to
complete a trade.
Most capital markets firms perform both broker and dealer functions (depending on the
trade), which is why they are often referred to as broker/dealers.
Traditionally, exchanges were physical locations where brokers representing buyers,
sellers and dealers converged to complete trades in specific types of securities or
commodities. This required brokerage firms to have representatives located on the floor
of various exchanges.
Today, with the notable exception of the New York Stock Exchange (NYSE), most
exchanges are automated and floor brokers have been replaced with computer networks
that automatically match buy and sell requests submitted by brokers.
Exchanges specialize based on the type of financial instrument traded, such as the
London Stock Exchange (which offers trading in stocks and bonds) and Eurex (which
offers trading in some derivatives).
To learn more about exchanges, follow these links:
 Exchanges around the world
 Exchange regulation
 Trends impacting exchanges
Exchanges around the world
Most countries have their own exchanges, which provide a vehicle for investment in the
government and corporate securities of that country. In developing countries, these
exchanges are sometimes limited to domestic investors. However, as the need for capital
in these countries has grown and investors have become more global in their search for
higher returns, these exchanges have gradually opened to foreign investors.
However, most trading is completed on the major exchanges with the highest degrees of
transparency (disclosure of financial information readily available to the investing
public), including:
 New York Stock Exchange (NYSE)
 London Stock Exchange
 Deutsche Borse
 Tokyo Stock Exchange
 Euronext
To access a broader base of investors, companies and financial institutions may list (i.e.,
register) their shares on several different exchanges
. Exchange regulation
Exchanges tend to be highly regulated in most countries, particularly in the areas of:
 Information disclosure for the issuance of new shares
 Financial reporting requirements at regular intervals
 Insider trading
 Capital and liquidity requirements of market makers and dealers
 Licensing requirements for brokers, agents and dealers
 Maintenance of orderly markets
Trends impacting exchanges
Some of the major trends that exchanges around the world are experiencing involve:
 Consolidation of exchanges within a geographical region
 Competition from electronic communications networks (ECNs) and other
alternative trading systems
 Closing or reducing the physical location of exchanges
 Increasing emphasis on electronic trading
 More individual investors trading over the Internet
Unlike exchanges, OTC markets do not have a centralized location where buyers and
sellers can meet to execute trades. This requires a broker to seek a counterparty to
complete a trade. As a result, in OTC markets customers rely on their broker’s network of
contacts to complete the trade.
For some markets, market makers provide liquidity. Market makers are financial
institutions that are willing to always buy and sell securities out of their own inventory
for securities in which they make a market. Market makers provide bid (the price at
which they are willing to buy the security) and offer (the price at which they are willing
to sell the security) prices of their own. By using a market maker as the financial
intermediary, a broker can obtain immediate execution of their buy and sell orders.
However, these prices may not necessarily be the best in the market.
Today, many participants in OTC markets are linked together by telecommunications
networks, allowing investors (or their brokers) to compare prices between market makers.
The Nasdaq market and the Eurobond market are examples of OTC markets. With the
exception of futures and options, which are traded on exchanges, most derivatives are
traded in OTC markets due to their low volumes and specialized natures.
The basic differences between money market instruments and capital market instruments
are timeframes and investment returns.

Money market instruments are securities with original maturities of less

than one year. Issuers use the money markets primarily to generate short-term funds for
ongoing operations. Money market instruments are generally unsecured, so only high-
quality issuers are able to use the money market. As a result of their short-term nature and
low risk (because issuers are high quality), money market instruments generally offer
returns lower than those available in the capital markets.
Money markets can be either domestic or international. For example, if a Japanese bank
issues a 3-month yen term deposit, it is accessing the domestic money market. If this
same bank chooses to fund itself with Eurodollar deposits in the interbank market, it is
accessing the international money market.
The primary types of money market instruments are:
 Interbank deposits
Interbank deposits are large deposits that banks place with each other on a short-term basis.
The majority of interbank deposits are less than 3 months in maturity. These money market
instruments are highly credit sensitive and funding through this source may be withdrawn rather
quickly if there is concern about a specific issuer.

 Eurocurrency deposits
Eurocurrency deposits are another form of interbank deposit. The term "eurocurrency" refers
to any currency that is borrowed or lent outside the home country of the currency. For example,
a bank borrowing US dollars in London is utilizing the Eurodollar market.

 Negotiable certificates of deposit

Negotiable certificates of deposit are large term deposits that a depositor can resell to another
investor. Banks with excess funds often buy negotiable CDs to hold as a highly liquid

 Repurchase agreements
In a repurchase agreement, a financial institution "sells" securities to another institution with
the promise to buy back the securities on a specific date (usually within a few days). These
agreements are commonly referred to as "repos" and provide the seller with low-cost, short-term
funding, while providing the buyer with interest.

 Government debt
All governments issue various forms of debt, both short-term and long-term, to fund current
cash needs and infrastructure projects. Short-term government debt issued by national
governments are considered low risk because they are backed by the full faith and credit of a
country’s government.

 Commercial paper
Commercial paper is an unsecured note issued by a corporation for a maximum maturity of
270 days. To access the commercial paper market, companies must be of the highest quality. A
decline in the credit rating of an issuer will rapidly affect the ability of that issuer to raise
additional funding in the commercial paper market at a favorable rate.

 Bankers Acceptances
Banker’s Acceptances are a guarantee by a bank to make a payment. They are related to
letters of credit in which a bank guarantees to make a payment provided certain criteria
are met. Once this criteria is met, the bank "accepts" the letter of credit and acknowledges
its obligation to pay the holder, turning the letter of credit into a banker’s acceptance
Equity represents an ownership interest in the issuer. Equities and related instruments
 Common stock
The owner of common stock (also referred to as ordinary shares) obtains an ownership
interest (and voting rights) in the issuing company. Common stockholders earn a profit through
dividends that may be paid by the issuer as well as capital appreciation (increase in price over
the purchase price) in the market price of the stock.

 Preferred stock
Preferred stock pays a fixed rate of dividend, expressed either as a certain amount (e.g.,
US$3.50 per share) or a percentage rate (e.g., 4% of the par value). Since the dividend rate is
fixed, preferred stocks are often grouped with bonds and referred to as fixed income
instruments. Preferred stockholders do not have voting rights.

 Depositary receipts
Depositary receipts represent shares of a foreign company listed on an exchange outside the
company’s home country. Financial institutions buy the shares of the foreign company on a
foreign market, and then offer depositary receipts backed by these foreign shares to domestic

 Stock warrants
Stock warrants are certificates that entitle the holder to purchase common stock at a set price
within a specific period of time. The initial price is higher than the current market price of the
common stock. If the price of the underlying stock rises above the set (or "strike") price, the
investor can purchase the shares at less than the market price.
 Stock options
A stock option gives the owner the right to buy or sell a stock at a certain price (called the
strike price) before the expiration date. The option to buy a stock at the strike price is called a
call option, and the option to sell a stock at the strike price is called a put option. Most stock
options are traded on exchanges, and the exchange sets the strike price.
Of course, governments and government agencies do not issue equity (since you cannot
own a share of a government).
Borrowing and lending arrangements between issuers and investors are referred to as
debt. The most common form of debt instruments are bonds. When a bond is issued, the
issuing entity borrows funds from the investor, agreeing to repay those funds based on the
terms and conditions of the bond. In exchange for the lending of funds through bonds,
bondholders receive interest payments on a regular basis.
Debt instruments can be structured as:
 Bonds and notes
 Asset-backed securities
Bonds and notes are unsecured debt issued by corporations, governments, trusts
and other organizations. Bonds have maturities between five and thirty years. Notes are
bonds with shorter maturities (between one and five years).
Bonds are issued at par value (i.e., the face amount) and pay a specific rate of interest
(known as the coupon rate). As market conditions change, the market value of a bond
will increase or decrease from the par value. The current yield of a bond is the interest
paid on a bond divided by the current market price. For example:
 Assume a new bond is issued with a par value of US$10,000 paying a
coupon rate of 8%
 An investor holding this bond will receive US$800 a year (8% of
US$10,000) for the life of the bond
 This equates to an 8% yield (US$800 in interest payments a year
divided by the par value of US$10,000)
 Now assume interest rates rise a year later, and bonds (with the same
maturity and risk characteristics) are offering yields of 10%
 If the investor wants to resell the bond, he/she will need to sell it at a
discount that provides a buyer with a yield equal to the current market, which is
 If the investor sells the bond for US$8,000 (a US$2,000 loss in
market value), a new buyer would receive a yield of 10% on the bond
(US$800 in interest payments a year divided by the purchase price of
As a result, the market value of a bond is extremely sensitive to changes in interest rates:
 As interest rates rise, the market value of bonds drops
 As interest rates drop, the market value of bonds rises
Some notes (i.e., shorter-term bonds) are floating-rate notes. The interest rate paid on
these debt instruments is tied to a specific benchmark (e.g., LIBOR) and is adjusted
periodically (typically twice a year).
Inverse floaters are bonds with floating coupon rates that move in the opposite direction
of interest rates. If rates rise, the bond’s coupon rate will decrease.
Bonds may be callable, which allow the issuer to retire the issue (i.e., buy back the bonds
at par value) under certain conditions.
Bonds are often classified by their issuers, such as:
 Corporate bonds
Corporate bonds are bonds issued by corporations. Rating agencies (such as Moody’s) assist
investors by assessing the long-term risks involved with specific bonds. Bonds issued by
companies with low risk are considered investment grade bonds. Non-investment grade bonds
must offer higher yields to attract investors, so they are referred to as high-yield bonds.

 Eurobonds
Eurobonds are bonds issued in a currency other than the company’s home currency. For
example, a Spanish company issuing bonds in Canada would be issuing eurobonds. Eurobonds
have a variety of unique names, such as "Bulldog Bonds", which are bonds issued in pounds
sterling by non-British companies.

 Government bonds
Government bonds are debt instruments issued by governments to finance the ongoing
operations of the government or finance specific projects. Government issuers include
national governments, provincial or state governments, cities and other government
Asset-backed securities are securities backed by a specific pool of assets.
Asset-backed securities begin when a financial institution (referred to as the originator)
wants to sell some of its assets. There are a number of reasons for doing this, but the
primary reason is to raise funding for the originator.
The originator then creates a trust, and transfers the assets to the trust. The trust, which is
often referred to as a special purpose vehicle (SPV), then issues securities backed by the
assets. The funds raised by issuing the securities are used to pay the originator. Investors
are then repaid by cash flows received from the underlying assets held by the SPV (such
as customer payments on loans).
The largest asset-backed securities markets involve securities backed by residential home
loans, commercial property loans, credit card receivables, automobile loans and home
equity loans. In most cases, investment banks support originators in creating and
distributing the asset-backed securities.
Derivatives are financial instruments derived from some other financial instrument.
Derivatives are used for either hedging an investor’s risk or speculating on market
Some derivatives, such as stock options, are highly standardized and are listed and traded
on exchanges. Other derivatives are highly customized to meet the specific need of an
issuer and/or investor.
There are four basic types of derivatives:
 Options
An option gives the owner the right to buy or sell a specific security at a certain price (called
the strike price) before the expiration date. The option to buy a security at the strike price is
called a call option, and the option to sell a stock at the strike price is called a put option.
Option holders are not required to exercise the option.

 Futures
Futures are standardized contracts traded on exchanges. They are a contract to buy or sell
securities, commodities or other assets on a specific date at a specific price, and allow an
investor to lock in a future price. The prices of futures fluctuate based on the current and
anticipated value of the underlying asset.

 Forward contracts
Forward contracts are similar to futures. They commit both parties of a transaction to buy or
sell assets on a specific date at a specific price. However, while futures are standardized and
traded on exchanges, forwards are not. This allows parties in the transaction to customize the
transaction to meet their needs, but also introduces an element of credit risk.

 Swaps
Swaps are agreements between two parties to exchange a series of cash flows. An
example of a swap is an interest rate swap in which one party makes payments based on
a fixed interest rate on a principal amount (referred to as the notional principal) and the
other party makes payments based on a variable interest rate.
The goal of every financial institution, like that of any business,
is to create profitability for its shareholders. For financial
institutions, profitability is a function of:
 Net interest income
 Plus fee income
 Minus operating expenses
In addition to learning how financial institutions generate
revenue and expenses, you should also understand how these
revenues and expenses are represented on your client’s
financial statements and key financial ratios. This
understanding will help you identify your client’s business
strategy and the key risks resulting from this strategy.
Net interest income is the revenue generated by a financial institution’s lending
and funds gathering activities. It is the largest source of revenue for most banks and
finance companies.
To determine its net interest income, a financial institution:
 Calculates its interest income
Interest income is the revenue a financial institution earns from interest (and fees) paid on
loans by borrowers and interest (along with dividends) received on securities held by the
financial institution.

 ...subtracts interest expense

Interest expense is the interest paid by the financial institution for deposits, bonds, commercial
paper and other forms of debt issued by the financial institution.

 ...subtracts provision for loan losses

Provision for loan losses are funds the institution has set aside to absorb future loan losses.
Interest income and interest expense both rise (or fall) as the general interest rate
environment changes, however they do not always rise (or fall) in tandem. If interest
expense increases faster than interest income, the financial institution’s net interest
income will drop. This is known as interest rate risk, and it is typically managed by a
financial institution’s asset/liability management (ALM) group.
Fee income is income a financial institution earns by charging fees to its customers,
and it is also referred to as non-interest income or other operating income. Fees can
take the form of:
 Account fees
Account fees are earned when a financial institution charges a customer a monthly or annual
fee for an account, regardless of the customer’s transaction levels or account balances.

 Transaction fees
Transaction fees are earned when a financial institution charges a customer a fee for each
transaction (e.g., brokerage commissions, which is a fee charged for executing a customer’s
trade order).

 Asset management fees

Asset management fees are earned when a financial institution receives a fee based on a
percentage of the assets it manages for a customer.

 Penalties
Penalty fees are fees charged for late payments, below minimum account balances etc.
The primary sources of fee income vary between different types of financial institutions:
 Primary sources of fee income for capital markets firms
Primary sources of fee income for capital markets firms include brokerage commissions,
investment banking fees, trading gains (or losses) from proprietary trading activities, custody
fees (including both account and transaction fees), asset management fees and capital gains (or
losses) on investment securities sold.

 Primary sources of fee income for banks

Primary sources of fee income for banks include deposit fees, ATM fees, letter of credit and
documentary collections fees associated with trade finance, account and transaction fees
associated with treasury or cash management services, asset management fees, investment
banking fees, brokerage commissions and capital gains (or losses) on investment securities sold.

 Primary sources of fee income for insurance companies

For insurance companies, revenue is organized into premium income (which represents
premiums paid by customers), investment income (which represents interest, dividends
and capital gains from the company’s investment activities) and fee income (which
includes other fees such as asset management fees and risk management consulting fees).
Operating expenses are all the expenses associated with operating a financial
institution, other than interest expense and the provision for loan losses. Operating
expenses are often referred to as non-interest expense or overhead expense, and
 Employee compensation
 Occupancy costs associated with branches, operating centers, call centers
 Information technology and telecommunications costs
 Marketing and advertising costs
 Legal, accounting and auditing fees
 Sales commissions paid to other companies for selling the institution’s
 Claims and benefits paid (for insurance companies)
For most financial institutions, compensation costs represent the bulk of the institution’s
operating expenses.
Taxes are also a major cost for financial institutions, but are not considered part of
operating expenses
There are two key financial statements used by financial
institutions you should understand:
 Profit and loss (P&L) statement
 Balance sheet
A profit and loss (P&L) statement (also referred to as an income statement, a statement
of operations or a statement of earnings) details a financial institution’s revenue and
expenses over a specific period of time.
To see more information, follow these links:
 P&Ls for banks
 P&Ls for capital markets firms
 P&Ls for insurance companies
P&Ls for banks
For banks, you will typically see the P&L organized into three major sections:
 Net interest income is the net of:
 Interest income earned from loans and securities
 Interest expense paid on deposits and other forms of debt issued by
the bank
 In some cases, the provision for loan losses are deducted here on
the P&L
 Fee income (also called other operating income or non-interest income)
represents the bank’s fee income sources, including:
 Investment banking fees
 Commission revenue
 Asset management fees
 Trading gains (or losses) on the bank’s trading portfolio
 Investment gains (or losses) on the bank’s investment portfolio
 Operating expenses (also called non-interest expenses) include:
 Employee compensation
 Occupancy
 Equipment and telecommunications expenses
 Marketing costs
P&Ls for capital markets firms
For capital markets firms (i.e., investment banks, brokerage firms) the P&L is typically
organized into two major sections:
 Revenues include:
 Investment banking fees
 Trading gains
 Commission revenue
 Asset management fees
 Interest and dividends received from the firm’s investment
 These are added together to get total revenue and interest expense
is then subtracted to get net revenue
 Operating (or non-interest) expenses include:
 Employee compensation
 Occupancy
 Brokerage, clearing and exchanges fees paid to others
 Equipment and telecommunications expenses
 Marketing costs
Review your capital markets clients’ sources of revenue. What are the largest
contributors? Have these changed in the last couple of years? Are they different than your
client’s competitors? What does this tell you about your client’s business focus?
P&Ls for insurance companies
The P&L for an insurance company is typically organized into:
 Revenues, which include:
 Premium income
 Investment income (interest, dividends and capital gains received
from the company’s investments)
 Fee income representing income from other sources or activities
 Expenses, which include:
 Benefits and/or claims paid
 Increases in reserves for future benefits or claims
 General expenses, which include compensation, occupancy,
equipment etc.
 Interest expenses
A balance sheet is a snapshot in time, showing a financial institution’s position on
a specific date. A balance sheet is organized into three major sections:
 Assets, which represent what the institution owns
 Liabilities, which represent what the institution owes to others
 Equity, which represents the ownership of stockholders and is equal to
assets minus liabilities
To see more information, follow these links:
 Balance sheets for banks
 Balance sheets for capital markets firms
 Balance sheets for insurance companiess
Balance sheets for banks
Bank balance sheets include:
 Assets, which typically include:
 Cash
 Deposits at other banks
 Short-term loans to other banks
 Securities purchased under resale agreements (these are securities
that bank purchased but must resell to the original investor later)
 Securities
 Loans
 Real estate
 Fixed assets (property, equipment)
 Liabilities, which typically include:
 Customer deposits
 Deposits from other banks
 Short-term loans from other banks
 Securities sold under repurchase agreements (these are securities
that bank sold but must repurchase from the "buyer" later)
 Other short-term borrowings, such as commercial paper
 Long-term debt
The balance sheet of a bank is useful in understanding a client’s business and strategy.
Look at the mix of assets on your client’s balance sheet. What percentage of assets are
loans? What is the mix of different loan types (i.e., retail loans vs. commercial loans)?
How has this change over the last couple of years? How does this compare to your
client’s competitors? The answers to these questions will help you understand your
client’s strategy.
Also look at the mix of liabilities. What percentage of liabilities are deposits? How has
this changed over the last couple of years? How does this compare to your client’s peers?
Balance sheets for capital markets firms
For capital markets firms, a balance sheet shows:
 Assets, which typically include:
 Cash
 Deposits at other banks and clearing organizations
 Securities owned
 Securities purchased under resale agreements
 Securities borrowed, which are securities the firm has borrowed
from other institutions (for which the firm has provided cash to the lender
as collateral until the securities are returned)
 Fixed assets (real estate and facilities, equipment)
 Liabilities, which typically include:
 Commercial paper and other short-term borrowings
 Securities sold under repurchase agreements
 Securities loaned, which are securities the firm has lent to investors
(for which the firm has received cash as collateral until the securities are
 Long-term debt
Balance sheets for insurance companiess
For insurance companies, balance sheets show:
 Assets, which typically include:
 Cash
 Investments
 Fixed assets (property and equipment)
 Assets held in separate accounts (assets that are managed by the
insurance company but belong to customers)
 Deferred policy acquisitions costs (DAC)
 These are costs that a life insurance company has incurred
to acquire (or issue) new insurance and investment contracts
 These costs are deferred and amortized over the life of the
related insurance or investment contract
 This are amortized over time in recognition of the fact that
acquisition costs (e.g., sales commissions) represent a significant
percentage of the overall cost associated with issuing long-term
 Liabilities, which typically include:
 Reserves for future benefits or claims
 Benefits and claims made (or agreed), but not yet paid
 Policyholder account balances (funds owed to customers)
 Long-term debt
Financial ratios allow you to compare the performance of a financial institution across
different time periods or to compare different financial institutions of different sizes.
For all financial institutions, the most important ratio is return on equity (ROE). ROE
measures the return on the investment the institution is providing for shareholders. It is
calculated by taking an institution’s net income for a period and dividing it by the
institution’s average equity over that period.
ROE targets vary by industry segment:
 Capital markets firms generally target ROEs between 20% - 25%
 Banks generally target ROEs between 15% and 20%
 Life insurance companies generally target ROEs between 12% and 15%
 General insurance companies generally target ROEs between 10% and
Beyond ROE, capital markets firms do not rely on financial ratios to measure their
business as much as banks and insurers do. However, you should understand the key:
 Banking ratios
 Insurance ratios

Beyond ROE, there are five important ratios used in the banking industry:
 Return on assets (ROA)
Return on assets (ROA) measures the profitability a bank is able to generate from its assets. It
is calculated by taking a bank’s net income for a period and dividing it by the bank’s average
assets over that period. Banks generally target ROAs of approximately 1%, although many
banks now target ROAs of 1.25% or higher.

 Spread
Spread measures the difference between the average yield a bank earns on its assets and the
average cost it pays for its funds. For example, if a bank earns an average of 7% on its assets
(e.g., loans) and pays an average of 3% on its liabilities (e.g., deposits), its spread is 4%.
 Margin
Closely related to spread is margin, which takes a bank’s net interest income and divides it by
the bank’s earning assets (i.e., assets that pay interest to the bank). The difference between
spread and margin is that margin accounts for "interest-free" funding (e.g., some customer
deposits) and spread does not.

 Cost/income ratio
Cost/income ratio measures operating efficiency. It is equal to operating expenses divided by
total revenue (i.e., the sum of net interest income and fee income). Most banks are targeting
cost/income ratios between 50% and 60%.

 Capital adequacy
Capital represents a bank’s ability to absorb losses and is closely monitored by regulators.
Capital adequacy is the amount of capital relative to the bank’s risk-weighted assets. In
other words, banks with riskier assets need more capital than those with less risky assets.
Capital adequacy guidelines identify different types of capital (e.g., Tier 1, Tier 2 and Tier
3 capital).
Beyond ROE, there are different financial ratios used to evaluate:
 General insurance
 Life insurance
General insurance
There are three key financial ratios used to evaluate a company’s general insurance
 Loss ratio
 The loss ratio measures a company’s ability to manage
underwriting losses against a given level of premium income
 It is calculated by taking underwriting losses and dividing by
premiums earned
 Underwriting losses are claims paid to customers
 Premiums earned is the amount of premium revenue
recognized by the company for the period
 Expense ratio
 The expense ratio measures a company’s operating expenses
divided by its premiums earned
 Operating expenses represent the costs of acquiring, writing and
servicing the business
 Combined ratio
 The combined ratio is the sum of the loss ratio and the expense
 A company with a loss ratio of 90% and an expense ratio of 8%
would have a combined ratio of 98%
 A combined ratio lower than 100% represents a profitable period
of business (and higher than 100% represents an unprofitable period of
Let’s look at an example:
 Let’s assume a general insurer had:
 US$1 billion in premiums earned for the yearJGShould we convert
this example to the Euro?
 US$900 million in underwriting losses
 US$80 million in operating expenses
 It would have
 A loss ratio of 90% (US$900 million divided by US$1 billion)
 An expense ratio of 8% (US$80 million divided by US$1 billion)
 A combined ratio of 98% (90% + 8%)
General insurers typically experience combined ratios between 95% and 105%.
Life insurance RATIOS
There are two key financial ratios used to evaluate a company’s life insurance activities.
 Benefits paid to net premiums written
 Benefits paid to net premiums written (NPW) represents the
amount of benefits paid to customers divided by the amount of premium
income earned by the insurer (minus premiums paid to reinsurers)
 Benefits paid to NPW is typically between 45% and 70%, and
represents the insurer’s ability to absorb the loss of benefit payments made
 Commissions and expenses to net premiums written
 Commissions and expenses to net premiums written measures a
life insurer’s cost of sales
 This ratio is typically between 30% and 55%
Accepting risk is a fundamental part of a financial institution’s business. Financial
institutions cannot avoid risk entirely, and the most successful institutions are those that
identify the appropriate levels of risk to assume and put the appropriate measures in place
to manage that risk.
The specific risks facing a financial institution are driven by its business activities, but
the primary risks in the financial services industry include:
 Market risk
 Credit risk
 Underwriting risk
 Liquidity risk
 Operational risk
 Political and regulatory risk
Market risk is the risk that changes in market conditions will negatively impact a
financial institution’s profitability. Market risk is actually composed of three different
types of risk:
 Investment risk
 Interest rate risk
 Currency risk
Investment risk (also referred to as position risk) is simply the risk that the market
value of an investment will drop. For example, if a financial institution buys 1,000 shares
of a stock for US$50 per share, and the share price drops to US$45 a share, the financial
institution will lose US$5,000.
The highest exposure to investment risk is found at financial institutions with large
trading or investment portfolios, including:
 Investment banks and commercial banks with large proprietary trading
 Investment managers
 Life insurance companies (life insurers earn a large percentage of their
revenue by investing customer premiums to generate investment income)
Interest rate risk is the risk that changes in the interest rate environment will negatively
impact a financial institution’s profitability.
Interest rate risk impacts financial institutions in a couple of different ways. First,
changes in interest rates have a direct impact on the value of fixed income instruments,
such as bonds. As interest rates rise, the market value of a bond drops. As a result,
financial institutions with large fixed income portfolios are particularly sensitive to
interest rate risk.
Interest rate risk also occurs when there is a mismatch in the duration of a financial
institution’s assets and liabilities, which is most pronounced in banking. In other words, if
a bank’s deposits mature at a different rate than its loans and other assets (which is the
case for all banks), the bank is exposed to interest rate risk.
Currency risk, also referred to as foreign exchange risk (or FX risk), is the risk that a
financial institution’s profitability will be negatively impacted by a change in currency
Financial institutions take a number of steps to manage their market risk, including:
 Buying derivatives
Financial institutions buy derivatives to hedge their positions. These derivatives include stock
options (that increase in value if the underlying stock decreases), interest rate swaps (that
transfer interest rate risk to a counterparty) and currency futures (that lock in a future exchange

 Setting limits
Financial institutions set limits on the maximum exposure they will accept for specific markets,
companies, countries etc.

 Using computer models

Financial institutions use sophisticated statistical models (e.g., value at risk or VaR
models) to predict the probability of gains/losses under "normal" market conditions.
They also use other software models to project the extent of losses under extreme
conditions, referred to as stress testing.
Credit risk is the risk a counterparty will be unable to complete a financial
transaction as promised. For example, bonds are a promise by the issuer to repay
principal and interest, so bondholders are exposed to credit risk. As a result, financial
institutions such as commercial banks, investment banks and insurance companies with
significant bond holdings have credit risk.
However, credit risk is most commonly associated with loans. Because of their lending
activities, banks and finance companies are the financial institutions with the greatest
exposure to credit risk.
To manage this risk, lenders:
 Establish policies and procedures for evaluating the creditworthiness of a
borrower before a loan is approved
 Increasingly, credit scoring is used to quantify the
creditworthiness of applicants. For each applicant, a credit score is
generated based on factors such as the applicant’s credit history, salary etc.
Those applicants meeting a minimum credit score are automatically
approved for a loan.
 Credit scoring was originally established by credit card issuers as a
way to efficiently process large numbers of applications.
 Today, large commercial loans are still evaluated individually by
loan officers and final loan approvals are typically made by senior
executives or loan committees (using established policies and procedures).
 Create a syndicated loan for large loans to limit each bank’s individual
credit risk
 Secure collateral (where appropriate)
 Include covenants in loan agreements to protect the lender’s interest
 Monitor the ongoing quality of existing loans through loan review
 Identify high-risk customers and reduce their open lines of credit to limit
potential loan losses
 Use a collections group to contact customers about delinquent loans
 Use loan workout groups to work with customers who are having
difficulty repaying loans
 Establish loan loss reserves to absorb future loan losses
A charged off loan is one that management has determined has no likelihood of
repayment. In most cases, these are loans that have been delinquent for a certain amount
of time (e.g., 180 days). The charge-off rate (also called the write-off rate) is the
percentage of loans charged off divided by the total average loans over a period of time.
For example, if a bank has US$1 million in average loans and US$20,000 in loans are
charged off, the bank has a 2% charge-off rate. The charge-off rate is primarily a function
of the lending product. For example, home loan portfolios (which are secured by a
borrower’s house) experience much lower loan losses than credit card portfolios (which
are unsecured).
Underwriting risk takes on a different meaning within different segments of the
financial services industry:
 Banking
In banking, underwriting risk is the same as credit risk. It is the risk that the bank will approve
(or underwrite) a loan that will not be repaid in full, resulting in loan losses for the bank.

 Capital markets
In capital markets, underwriting risk is associated with securities underwriting. It is the risk
that an investment bank will buy (or underwrite) securities from an issuer at a price higher than
the investment bank can resell the securities to other investors, resulting in losses for the
investment bank.

 Insurance
In insurance, underwriting risk is associated with underwriting policies. It is the risk that an
insurance company will issue (or underwrite) an insurance contract with a premium that is too
low for the amount of risk assumed.
To manage underwriting risk in investment banking:
 Large deals are syndicated, spreading the risk among multiple
 Underwriters avoid committing to a firm price, instead underwriting on
the basis of a price range for the initial issuance of the securities
Liquidity risk is the risk a financial institution will not have funds available to meet
its obligations, such as funding deposit withdrawals or paying customer insurance claims.
To ensure appropriate liquidity, financial institutions project their cash needs in advance.
Financial institutions can also minimize liquidity risk by keeping a percentage of their
assets in "cash" (which includes physical currency and deposits in other banks). However,
financial institutions need to invest their assets to generate sufficient returns. So, to
generate sufficient investment returns and ensure appropriate liquidity, financial
institutions keep a certain percentage of their assets in highly liquid securities (i.e.,
securities that can be quickly sold to raise cash, such as highly-rated government
In addition, financial institutions:
 Use sophisticated computer models and reporting systems
These software models and reporting systems are used by an institution’s asset liability
management group to predict loan demand at any given point in time.

 Establish alternative sources of funding

Gathering alternative sources of funds can include issuing commercial paper or bonds, selling
securities under repurchase agreements and borrowing money from other banks.
A financial institution’s liquidity risk is typically managed by a financial institution’s
asset/liability management (ALM) group.
Operational risk is the risk of direct or indirect financial losses caused by a breakdown in
operations, including:
 Inadequate internal controls, policies and/or procedures
 Systems failures
 Fraud
 Human error
 External catastrophes
Some examples of operational risk include:
 Transferring funds into the wrong account because of a data entry error
 Approving a credit card transaction for an individual who is not the real
 Allowing a hacker to disrupt the institution’s website
 Inability to process customer transactions because a network is damaged
by an earthquake or other natural disaster
Operational risk is receiving more attention now than it has in the past. Starting as
early as 2007 in some countries, banks will be required to set aside capital to absorb
losses from operational risk. In addition, poor operational risk management results in:
 Increased expenses associated with the high costs of resolving errors
 Higher fraud losses
 Lower customer retention resulting from poor customer service
 Less new business as a financial institution’s reputation is damaged from
certain events
 Regulatory sanctions
Operational risk is greatest in business areas where there are high volumes, fast
turnaround times and/or highly automated processes, such as credit/debit card
transactions, ATM transactions, wholesale payments processing and on-line banking.
Operational risk has grown in recent years as transaction volumes have grown and
institutions have increased their reliance on technology. To manage operational risk,
financial institutions:
 Establish detailed operating procedures and policies
 Monitor operating procedures and policies through their compliance and
audit groups
 Separate sales and customer service functions from risk control functions
(e.g., risk management, loan underwriting)
 Use insurance to mitigate losses
 Create back-up and disaster recovery plans
Political risk and regulatory risk are closely related in that they both
address risk associated with governments or government agencies.
Political risk (often referred to as country risk) is the risk of governmental interference
in the operations of private financial institutions. For example, dictators and socialist
governments have seized local commercial and investment banks owned by foreign
banks. Governments have regulated interest rates, insurance premiums and brokerage
commissions. Governments have also decided to delay or stop paying on their bonds
(which are often owned by financial institutions).
To manage political risk, most financial institutions with large exposures have an
economics and/or political analysis group that closely monitors the ongoing attitudes of
governments in other countries.
Regulatory risk (sometimes referred to as legal risk) includes the risks that:
 A financial institution may violate a law or industry regulation, resulting in
fines or damage to the institution’s reputation
 Changes in laws or regulations will make an existing activity of the
financial institution illegal or non-compliant
Monitoring ongoing laws and regulations, as well as the institution’s internal policies and
procedures for adhering to these laws and regulations, is usually the responsibility of an
institution’s legal and compliance departments.
Because financial institutions play a critical role in economic stability, the financial
services industry is more closely regulated and supervised than most industries. The goals
of regulation and supervision are to:
 Protect depositors, insurance policyholders and investors (usually in that
 Promote fair, efficient and transparent markets
 Ensure financial institutions (especially banks and insurance companies)
are able to meet future obligations (e.g., deposit withdrawals, insurance claims)
To achieve these goals, regulators are typically charged with:
 Licensing of financial institutions
 Monitoring capital requirements to ensure the solvency of banks and
insurance companies
 Setting and monitoring liquidity requirements
 Reviewing market conduct (i.e., how financial institutions position their
products with customers)
 Setting limits on permissible activities or investments
 Ensuring internal controls are in place (e.g., appropriate underwriting
Financial services regulation is conducted by:
 Domestic regulators
 International associations
 Central banks
Domestic regulators are given the power to inspect and investigate financial
institutions to enforce regulations. Historically, most countries have had a separation
between banking, securities and insurance regulators and this separation still exists in
some countries. For example, in the US:
 Banks are regulated by the Federal Reserve and agencies of the Treasury
 Securities are regulated by the Securities and Exchange Commission
 Insurance companies are regulated by state insurance commissioners
However, many countries have recently created "super-regulators" responsible for the
supervision and regulation of all financial institutions. Examples include:
 The Autorité des Marchés Financiers (AMF) in France
 The Financial Services Authority (FSA) in the UK
 The Federal Financial Supervisory Agency (BaFin) in Germany
 The Financial Services Agency in Japan
 The Office of the Superintendent of Financial Institutions (OSFI) in
There are three major associations related to international financial services regulation:
 Bank for International Settlements (BIS)
BIS is a forum for cooperation between central banks and other regulators. The Basel
Committee is a committee of banking supervisors established as part of BIS. The Basel
Committee does not have any formal supervisory authority, but its recommendations are usually
adopted by all major countries.

 International Organization of Securities Commissions (IOSCO)

The IOSCO was established to promote high standards of securities regulation, the exchange of
information between national regulators and set standards for the surveillance of international
securities transactions. In 1998 it issued its Objectives and Principles of Securities Regulation.

 International Association of Insurance Supervisors (IAIS)

The IAIS was established in 1994 and is a forum for insurance regulators. It seeks to
establish international standards on insurance supervision. Its Insurance Supervisory
Principles establishes standards for prudential insurance supervision.
Central banks perform many key functions for their countries, including:
 Overseeing the safety and efficiency of their national payment systems
 Issuing and maintaining bank notes and coins in the country’s currency
 Conducting economic research and analysis
 Holding foreign exchange reserves and local currency reserves
 Serving as the "bank for banks" by providing the country’s banks with
payment services and loans if needed (central banks are often referred to as the
"lender of last resort")
 Setting and/or implementing the country’s monetary policy, which may
include stable exchange rates for the country’s currency and low, stable inflation
Central banks often implement monetary policy through their influence of the interest
rate environment. They do this through a couple of ways:
 Setting the interest rate for loans the central bank makes to other banks
 Buying and selling government securities in the open market (often
referred to as the central bank’s market operations)
In Europe, central banks from the European Union Member States and the European
Central Bank belong to the European System of Central Banks. The ESCB sets monetary
policy for the region, and that monetary policy is then implemented by the central bank of
each country.
You can see a list of central banks around the world (and links to their websites) by
following this link to the Bank for International Settlements
In the other courses in this curriculum, you will learn about the major lines of business in
which financial institutions compete.
In addition to these lines of business, there are many support and administrative groups
that either fulfill a function for the entire institution or provide specific services to more
than one business unit. These groups are typically centralized at the corporate level to
ensure a consistent approach throughout the organization. Often, specific individuals
within these groups are assigned to specific business units to coordinate between the
business units and the corporate functions.
In today’s financial institutions, there is an increasing emphasis on these administrative
functions to fully partner with the business units they serve. As a result, staff in these
units must have an in-depth understanding of the financial services business in relation to
their areas of contribution.
The main support functions within a financial institution are:
 Treasury
 Risk Management
 Finance
 Information Technology
 Marketing
 Legal, Compliance and Audit
 Personnel
The treasury group is responsible for managing a financial institution’s day-to-day cash
activities. Like any business, the treasury group of a financial institution is responsible
for sending payments to suppliers and managing short-term cash. However, for a
financial institution, the treasury group takes on added importance because of the role it
plays in providing asset/liability management.
In most financial institutions, the strategic direction and policies associated with ALM are
defined by the Asset Liability Committee (ALCO), a senior-level committee composed
of senior managers from each major business unit within the institution. The treasury
group is responsible for the day-to-day activities (e.g., monitoring positions,
buying/selling securities) required to implement ALCO’s direction and policies.
In capital markets firms and insurance companies, the risk management group focuses
primarily on the management of investment risk. As the markets globalize and more
sophisticated products are introduced, many capital markets firms have created Chief
Risk Officers in recognition of the importance of risk management.
In banks, the primary objective of risk management is to manage credit risk, with
investment risk as a secondary consideration. This is typically the responsibility of a
bank’s Chief Credit Officer.
The risk management function is increasingly an independent unit, reporting to the
highest levels of the institution and separated organizationally from client relationship
and trading areas. It is important that this unit has clearly defined responsibilities, which
typically include:
 Establishing written policies and procedures which are approved by senior
management and include:
 Exposure limits by geography, industry, product and customer
 Legal documentation requirements
Exposure approval levels
 Monitoring procedures
 New product evaluation and approval procedures
 Managing investment risks
 Many larger financial services institutions use highly sophisticated
decision support tools to manage investment risk
 These tools emphasize several important aspects of risk
management, including:
 Portfolio modeling applications monitor diversification of
the institution’s portfolio across the entire book of risk positions
 Risk management systems integrate head office, divisions
and branches around the world, providing a single source of real-
time, on-line data for monitoring the institution’s exposures
 Risk management assigns a common denominator of risk in
the form of risk points for specific types of transactions to achieve
a basis for establishing exposure targets for different activities
 Rating systems establish an overall risk level for a specific
borrower (or corporate group) so that comparisons can be made
across the organization
 Country risk systems examine the political and economic
risks in different countries in which the institution has exposure
arising through their trading activities, the location of borrowers
and/or the existence of a direct operational presence
 Managing credit risk, which includes:
 Establishing limits by geography, industry, borrower and product
(e.g., loans, derivatives, bonds, Letters of Credit) for both direct credit
exposure and exposure arising through the investment portfolio
 Suggesting appropriate structures for credit and financial
exposures to protect the institution from the identified risks
 Acting as the approval unit for all of the institution’s credit
exposures, including on balance sheet in the loan and investment books
and off-balance sheet in loan commitments, derivatives and letters of
 Monitoring these exposures on an ongoing basis against the
established portfolio and borrower limits.
 Providing support and guidance in handling the early stages of a
default situation
 Most institutions have a separate credit risk analysis department
within the risk management unit. Managerial judgment and experience
play a key role in the decision-making process of these units. However,
effective risk management units also use quantitative methods of analysis,
which require the use of financial data to measure and predict the
probability of default by a borrower. Statistical models based on historical
default data allow analysts to identify the significant risk variables and
create a credit score or rating for each borrower. Alternatively, an
institution’s risk management unit may chose to rely on their own
financial analyses and/or the borrower ratings given by the rating agencies
since these ratings are also based on default probabilities
The Finance group in a financial institution provides a number of different functions,
 Financial analysis
The Finance group is responsible for providing financial analyses of business units, products
and customers (or customer groups).

 Establishing policies and procedures

Policies and procedures established by Finance ensure adequate financial controls are in place
throughout the institution.

 Evaluating the financial impact of investment opportunities

"Investments" covers a wide range of different opportunities, including securities to purchase,
companies to acquire, new business lines, new products, purchase of information technology
and real estate investments.
In addition the Finance group typically coordinates and manages an institution’s budget
and planning process.
While the Finance and Treasury groups are independent from each other, typically they
both report up to the institution’s Chief Financial Officer (CFO).
The Information Technology (IT) group is responsible for managing an institution’s
computer systems and related applications, including both internal (processing, data
management) and external (ATMs, on-line services) systems. More specifically, IT is
typically responsible for:
 Designing, developing, reviewing or purchasing software applications to
meet the needs of the business units and their customers
 Maintaining and operating existing computer systems
 Influencing the institution’s hardware purchases
 Developing and maintaining Internet-related systems, such as websites
and portals
 Providing institution-wide services, such as network administration
 Monitoring technological advances and advising the institution’s
management of new developments and applications that relate to specific business
The IT group is typically headed by a Chief Information Officer (CIO).
The role of the IT group varies dramatically. In some institutions, the IT group is
primarily a support function serving the needs of business units as defined by business or
product managers within the business units. In other institutions, the IT group is highly
centralized and serves as the final decision-maker on most technology purchases,
regardless of the business needs addressed by the technology.
However, as the importance of technology in financial services grows, these two views
are converging. IT groups are playing a larger role in defining the technology strategy
and policies for their institutions. Many financial institutions have created a Chief
Technology Officer (CTO) position, indicating the importance of technology to their
overall strategy. At the same time, IT groups are being held accountable for the
institution’s ability to meet business objectives, requiring IT managers to have a clear
understanding of the challenges facing the business units they serve.
In many financial institutions, the marketing function is conducted at multiple levels.
At the corporate level, marketing is a high-level, centralized unit responsible for creating
a specific image for the institution, which is closely associated with the branding of the
institution’s products and services. Over recent years, corporate marketing units have
become more focused on selling an institution’s image by developing readily identifiable
logos and slogans that apply across a broad range of customer segments. Typically,
corporate marketing is responsible for:
 Planning (e.g., strategic marketing plans that guide the individual business
unit plans)
 Promotion (e.g., corporate-wide customer events and event sponsorship)
 Advertising (e.g., targeted image campaigns in various print or media
 Information (e.g., presentation of annual reports and other general public
The marketing function also exists at the product or customer segment level within the
individual business units, typically reporting to both the business manager and the
corporate level marketing group. The key responsibilities at this level involve:
 Planning (e.g., developing the business unit specific plan within the
overall corporate strategic marketing plan)
 Promotion (e.g., creating specific product sales campaigns and the
associated literature)
 Advertising (e.g., producing targeted product or customer segment print or
media advertisements)
 Information (e.g., designing targeted marketing brochures and other
 Analysis (e.g., gathering information on market trends, conducting
customer behavior studies and customer satisfaction surveys)
Given the complexity of laws and regulations governing the financial services industry
today, the legal and compliance function plays an important role in protecting financial
institutions from risk. This function usually reports to the highest management levels of
the institution to maintain their independence from the business units when performing
their responsibilities. This function typically includes:
 Legal department
The legal department produces or reviews documentation, including:
 Contracts and agreements with customers and vendors
 Information published for customers (e.g., account terms and conditions)
 Standard contracts for use in specific situations

 Compliance
Compliance (which may be part of the legal department or a separate department reporting to
senior management) oversees the institution’s compliance with financial and business
regulations. The compliance unit regularly reviews the institution’s activities to avoid the risk of
losses from not adhering to regulations.

 Internal audit
The internal audit function examines, evaluates and reports on accounting and other
operational controls. This unit has a specific mandate to assess the adequacy of IT and
other operating systems. To ensure that internal audit is completely independent from the
business units, internal audit typically reports directly to a Board-level Audit Committee.
The Personnel (or Human Resources) department of a financial institution is responsible
for creating a work environment conducive to high levels of employee productivity and
performance. To accomplish this, the department handles all administrative and support
functions associated with an institution’s personnel, including:
 Recruiting, hiring and processing new employees
 Training new and existing staff
 Advising management on appropriate compensation and incentive
 Reviewing and structuring benefits programs
 Administering the payment of salaries (payroll) and benefits programs
 Establishing and monitoring termination procedures
The Personnel group may be a separate department within the institution or part of a
larger Administration group. In many institutions, Personnel has become an important
and integral part of the business management teams, working closely with line business
managers in the accomplishment of their shared objectives.
Let’s look back on the information you’ve learned. You learned about:
 Financial customers and their needs
 The types of institutions that provide financial services, including:
 Banks
 Capital markets firms
 Insurance companies
 Other financial institutions
 Other industry participants
 Financial markets, including:
 Primary and secondary markets
 Exchanges
 Over-the-counter (OTC) markets
 Financial instruments, including:
 Money market instruments
 Equities and related instruments
 Debt instruments
 Derivatives
 How financial institutions make money, including:
 Net interest income
 Fee income
 Operating expenses
 Financial statements
 Key financial ratios
 The risks involved in financial services, and how financial institutions
manage these risks
 The key regulators of the financial services industry
 Support and administrative functions supporting a financial institution’s
key lines of business
Financial services is an exciting and constantly changing industry, and to keep up with
these changes, you should look at additional resources.
We hope you have found this section to be an informative and useful introduction to the
financial services industry. Don’t worry, there is a lot more to learn!
The financial services industry is an industry under constant change. The next four pages
provide some Internet resources for staying current and learning more about the financial
services industry. We’ve organized these sites as follows:
 Industry associations and forums
 Regulators
 Media sites
 Other sites
Some of these resources require subscriptions to access the information
Industry associations and forums are excellent sources for detailed
information on a specific topic or a specific country:
 ASEAN Bankers Association
 Association of British Insurers
 Australian Banker’s Association
 Australian & New Zealand Institute of Insurance and Finance
 British Bankers Association
 Canadian Bankers Association
 Canadian Life and Health Insurance Association
 The European Insurance and Reinsurance Federation
 Federation Francaise des Societes d’Assurances
 The General Insurance Association of Japan
 Global Association of Risk Professionals
 Insurance Information Institute
 Interactive Financial Exchange Forum
 Japanese Bankers Association (Zenginkyo)
 Mobey Forum (Mobile Technology Financial Services Forum)
 Professional Risk Manager’s International Association
 Smart Card Alliance
 STP Forum
 World Federation of Exchanges (FIBV)
In addition to providing general industry information, regulators often provide
detailed information on the institutions they supervise:
 Asociacion de Supervisores de Seguros de America Latina (ASSAL)
 Australian Securities and Investment Commission
 Autorité des Marchés Financiers (AMF)
 Bank of England
 Bank for International Settlements (BIS)
 Central Banks - Links
 Centro de Estudios Monetarios Latino Americanos (CEMLA)
 European Central Bank
 Executives' Meeting of East Asia-Pacific Central Banks (EMEAP)
 Federal Financial Supervisory Agency (BaFin) - Germany
 Federal Reserve
 Financial Services Agency - Japan
 Financial Services Authority (FSA) - UK
 Group of 30
 International Association of Insurance Supervisors (IAIS)
 International Monetary Fund (IMF)
 International Organization of Securities Commissions (IOSCO)
 Office of the Superintendent of Financial Institutions (Canada)
 Securities and Exchange Commission (SEC
These media sites are extremely useful for providing daily news and/or in-depth
information on both the investment management and broader financial services industry:
 General business media sites with financial services coverage
 The Asian Wall Street Journal
 The Business Times - Singapore
 Business Week
 Dow Jones
 Economist
 Economist Intelligence Unit
 Far Eastern Economic Review
 Financial Times
 Forbes
 Handelsblatt (in German only)
 La Tribune (in French only)
 Wall Street Journal Europe
 Banking media sites
 Asiamoney
 The Asian Banker
 The Banker
 Banking Technology
 Euromoney
 Global Treasury News
 VRL KnowledgeBank
 Capital markets media sites
 Global Custodian
 Institutional Investor
 Pensions & Investments
 Securities Industry News
 Wall Street & Technology
 Insurance media sites
 A.M. Best Asia-Pacific
 A.M. Best Canada
 A.M. Best Europe
 Asia Insurance Review
 Business Insurance
 Insurance Age
 Insurancetimes
 Middle East Insurance Review
Last (but not least) here are a few other useful sites:
 Performance Solutions International (that’s us!):
 On-line Glossary of Terms
 Links to Upcoming Conferences
 The sites of consulting firms often provide news and in-depth research
reports on the financial services industry, including:
 Capgemini
 Deloitte Touche Tohmatsu
 KPMG Insider Daily Alert (sign up for daily e-mails on the
banking or insurance industry)
 PricewaterhouseCoopers