THE PRINCIPLES OF BANKING

2021

-NHA302-

Lecturer: Chu Mai Linh, Ms.

Email: chumailinh.cs2@ftu.edu.vn

Google Drive: https://bitly.com.vn/no9shr

1
 Module Information

• Module Code NHA302

• Module Title PRINCIPLES OF BANKING
• Lecturer Chu Mai Linh, M.Sc.
• Credit Value 3 Credit Hrs.
• Textbooks
1. Casu B., Girardone, C., Molyneux, P., 2015, Introduction to
Banking, 2nd ed., Prentice Hall (C.G.M - Chapters
1,2,3,4,7,9,10,11,12)
2. Rose S.P. , 2018, Bank Management and Financial Services,
8th ed., McGraw-Hill Education (Rose- Chapters 1,10,12,
16,17,18)
3. Nguyễn Văn Tiến & Nguyễn Thu Thủy, Giáo trình nguyên lý &
nghiệp vụ ngân hàng thương mại, Nhà xuất bản thống kê 2014.

2
 LEARNING OBJECTIVES
Outcomes

Understanding • Students will be able to explain the business of financial institutions,

the role of financial intermediaries, why financial institutions have
liquidity concerns, concerns regulators have with financial
institutions
Memorizing • Students will be able to remember key terms to help them learn the
language of banking and financial services. Besides, they need to
know the lending process as well as investment activities of the
bank.
Implementation • Students will be able to apply relevant theories to solve all the
questions, case studies and problems. They could apply the
concepts and theories to explain the real situations. In addition, the
lending process can be applied in real circumstances when students
have an internship in the banks.
Analyzing • Students will be able to analyze the real situations in the banking
and financial services.
Judgement • Students will be able to demonstrate their understandings of this
course through ongoing evaluation methods such as in class
exercises, group assignments, midterm examination and final
examination. 3
 Syllabus Plan

Session Topics covered References

1 Introduction to Banking
Bank Regulation and Supervision
Banks balance sheet and income structure
2 Law on Credit Instituition 47/2010/QH12
3 Banking risks and measurements
C.G.M - Chapters 1, 2, 3
Rose - Chapter 1
C.G.M - Chapters 7 & 9
Circular No. 22/2019/TT-NHNN
Amendments to some articles of the law on credit
institutions Law No. 17/2017/QH14
C.G.M - Chapters 10, 11, 12

4 Managing and Pricing Deposit Services Rose – Chapter 12

Providing Loans to Businesses and Rose – Chapters 16, 17, 18

5
Consumers Circular No. 39/2016/TT-NHNN
Rose - Chapter 10
6 Other banking services
C.G.M - Chapter 4

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 Assignments and Assessments

Form of Size of the assessment e.g. % Contribution

Assessment duration/length

Attendance 10% of the final mark

Midterm Exam 45 Mins. 20% of the final mark

Poster Presentation Submission deadline: 10% of the final mark

11.59 pm on May, 4th 2021

Examination 60 Mins. 60% of the final mark

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 Chapter 1
Introduction to banking

• C.G.M - Chapters 1, 2, 3

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 Learning Objectives

• Introduction • Types of banking

• Why are banks special? • Global Trends

• The Changing Dynamics of

Bank Industries

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Introduction

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 Introduction
A bank is a financial intermediary that offers loans and
deposits, and payment services.
• Commercial banks make up the largest group of
depository institutions measured by asset size. They
perform functions similar to those of savings institutions and
credit unions.
• However, they differ in their composition of assets and
liabilities, which are much more varied.
• Commercial bank liabilities usually include several types of
non-deposit sources of funds, while their loans are broader
in range, including consumer, commercial, and real estate
loans.

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 Legal Definition of Commercial Bank in Vietnam
• In Vietnam, according to the Art.4 of Law on Credit Institution 2010,
• 1. Credit institution means an enterprise conducting one. some or all
banking operations. Credit institutions include banks, non-bank credit
institutions, microfinance institutions and people's credit funds.
• 2. Bank means a type of credit institution which may conduct all
banking operations under this Law. Based on their characteristics and
operation objectives, banks include commercial banks, policy banks
and cooperative banks.
• 3. Commercial bank means a type of bank which may conduct all
banking operations and other business activities under this Law for
profit.

Source:
http://itpc.hochiminhcity.gov.vn/investors/how_to_invest/law/Law_on_Credit_Institutions/mldocument_view/?set_language=en

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 The Art.4
Law on Credit Institution 2010
12. Banking operations means the trading in and regular
provision of one or some of the following services:
a/ Deposit taking;
b/ Credit extension:
c/ Via-account payment.

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 The Art.4 –
Law on Credit Institution 2010
13. Deposit taking means receiving money from an organization or
individual as demand or term deposit, savings deposit, issuing
deposit certificates, bills or treasury bills, and other forms of
receiving deposits on the principles of full payment of principals and
interests to depositors under agreement.
14. Credit extension means an agreement allowing an organization
or individual to use a sum of money or a commitment allowing the
use of a sum of money on the repayment principle by such
professional operations as lending, discount, financial leasing,
factoring, bank guarantee and other credit extension operations.
….
22. Payment account means a client's demand deposit account
opened by a client at a bank to use payment services provided by
such bank.

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 What do banks do?

• At the 21st century, banks no longer limit their service offerings to

traditional services but have increasingly become general financial
service providers.
• Other financial institutions are trying to be as similar to banks as
possible in the services they offer.
• All countries have regulations that define what banking business
is. For example, in all EU countries banks have been permitted to
perform a broad array of financial services activity since the early
1990s and since 1999 both US and Japanese banks are also
allowed to operate as full-service financial firms.

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 What do banks do?
• Nowadays banks offer a wide range of additional services,
but it is these functions that constitute banks’ distinguishing
features.
• Modern banks offer a wide range of financial services,
including:
● payment services;
● deposit and lending services;
● investment, pensions and insurance services;
● e-banking.

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 What do banks do?

• accepting deposits;
• issuing e-money (or digital money), i.e. electronic money used on the
internet;
• implementing or carrying out contracts of insurance as principal;
• dealing in investments (as principal or agent);
• managing investments;
• advising on investments;
• safeguarding and administering investments;
• arranging deals in investments and arranging regulated mortgage activities;
• advising on regulated mortgage contracts;
• entering into and administering a regulated mortgage contract;
• establishing and managing collective investment schemes (for example,
investment funds and mutual funds);
• establishing and managing pension schemes.

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 Example

• Bank as a financial services holding company.

For example, J.P. Morgan Chase as the world’s 5th largest FI
operating in 60 countries, has J.P. Morgan Chase Bank, J.P.
Morgan Securities, J.P. Morgan Insurance Agency,
Washington Mutual, and several investment banks,
including Bear Stearns.
Largest US. Commercial banks in 2015, ranked by total assets
in billions of dollars

In 2015, U.S. FIs held assets totaling

more than $30.45 trillion. In contrast,
the U.S. motor vehicle and parts
industry (e.g., General Motors and
Ford Motor Corp.) held total assets of
$0.55 trillion.

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 What are the bank’s risks?
1) Banks hold some assets that are potentially subject to default or
credit risk.
2) Banks tend to mismatch the maturities of their balance sheet
assets and liabilities to a greater or lesser extent and are thus
exposed to interest rate risk.
3) Banks are exposed to degree of liability withdrawal or liquidity
risk.
4) Banks are exposed to operating risks because the production of
financial services requires the use of real resources and back-office
support systems.
5) Moreover, banks are exposed to some type of underwriting risk,
whether through the sale of securities or the issue of various types
of credit guarantees on or off the balance sheet.

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 Why are banks special?

• Flows of funds in a world without banks

• Monitoring costs
• Liquidity risk
• Price risk

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 Why are banks special?

• In an economy without FIs:

Monitoring costs: the level of fund flows is likely to be
quite low
Liquidity reasons: due to the relatively long-term nature of
corporate equity and debt, and the lack of a secondary
market, household investors don’t have incentive to hold
financial claims (equity and debt securities) issued by
corporations.
Price risk: investors also face a price risk on sale of
securities.

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 Why are banks special?

• Flows of funds in a world with FIs:

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 Why are banks special?

• FIs ad Brokers:
 Due to the economies of scale, FI plays an extremely
important role by reducing transaction and information costs
or imperfections between households and corporations.
 The FI encourages a higher rate of savings than would
otherwise exist.

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 Why are banks special?

• FIs Function as Asset Transformers:

An FI issues financial claims that are more attractive to household savers
than the claims directly issued by corporations as a result of lower
monitoring costs, lower liquidity costs, and lower price risk.
FIs purchase the financial claims issued by corporations—equities,
bonds, and other debt claims called primary securities—and finance
these purchases by selling financial claims to household investors and
other sectors in the form of deposits, insurance policies.
• The financial claims of FIs may be considered secondary securities.
Securities issued by FIs and backed by primary securities.

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 Why are banks special?

• Information Costs
• Household savers must monitor the actions of firms in a
timely and complete fashion after purchasing securities.
Failure to monitor exposes investors to agency costs.
• FI’s Role as Delegated Monitor
In a sense, small savers have appointed the FI as a
delegated monitor to act on their behalf.
• FI’s Role as Information Producer

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 Why are banks special?

• Liquidity and Price Risk

• Often, banks claims have superior liquidity attributes
compared with those of primary securities such as corporate
equity and bonds.
• The banks transaction account deposit contracts which
allow household savers to withdraw money immediately.
 But how can FIs be confident enough to guarantee that
they can provide liquidity services to investors and savers
when they themselves invest in risky asset portfolios?

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 Liquidity and Price Risk

• The answers to these questions lie in the ability of FIs to

diversify away some but not all of their portfolio risks.
• As long as the returns on different investments arenot
perfectly positively correlated, by exploiting the benefits of
size, FIs diversify away significant amounts of portfolio
risk—especially the risk specific to the individual firm issuing
any given security.

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 Liquidity and Price Risk

• It means that the FIs is able to reduce risk by holding a

number of securities in a portfolio.
• This risk diversification allows an FI to predict more
accurately its expected return on its asset portfolio.
• As long as an FI is sufficiently large to gain from
diversification and monitoring, its financial claims are likely
to be viewed as liquid and attractive to small savers
compared with direct investments in the capital market.

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 Why are banks special?

• Reduced Transaction Costs

• Maturity Intermediation
• FIs’ ability to reduce risk by diversification is that they can
better bear the risk of mismatching the maturities of their
assets and liabilities than can small household savers.
• FIs can produce new types of contracts, such as long-term
mortgage loans to households, while still raising funds with
short-term liability contracts.

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 Other Aspects of Specialness

• The Transmission of Monetary Policy

• Because the liabilities of depository institutions are a significant
component of the money supply that impacts the rate of inflation,
they play a key role in the transmission of monetary policy from
the central bank to the rest of the economy.
• Credit Allocation
• FIs are often viewed as special is that they are the major and
sometimes the only source of financing for a particular sector of
the economy preidentified as being in special need of financing
such as credit needs of residential real estate or farming sector.
• Payment Services
• Depository institutions such as banks and thrifts are special in that
the efficiency with which they provide payment services directly
benefits the economy.

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 Banks Regulation

1) safety and soundness regulation

2) monetary policy regulation
3) credit allocation regulation
4) consumer protection regulation
5) investor protection regulation
6) entry and chartering regulation.

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 Safety and soundness regulation

1. Requirement for diversifications of banks assets. Thus,

banks are required not to make loans exceeding more than 15
percent of their own equity capital funds to any one company
or borrower.
2. Setting of the minimum level of capital or equity funds that
the owners of an FI need to contribute to the funding of its
operations.
3. The provision of guaranty funds such as the Deposit
Insurance Fund (DIF) for depository institutions, the Security
Investors Protection Corporation (SIPC) for securities firms,
etc.
4. The fourth layer of regulation is monitoring and
surveillance itself.

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 Example for Capital Requirement
• J.P.Morgen Chase’s Report on Capital, March 2020

SLR - Supplementary leverage ratio

Source: J.P.Morgen Chase Form 10-Q, March 2020, page 48
https://www.jpmorganchase.com/ir 31
 The Changing Dynamics of Specialness

• Trends in the United States

• the share of commercial banks declined from 54.5 to 35.8 percent between 1948 and 2015,
while the share of thrifts (savings banks, savings associations, and credit unions) fell from 12.0
to 6.7 percent over the same period.
• the share of investment companies (mutual funds and money market mutual funds), has
increased their share from 0.3 to 22.6 percent between 1948 and 2015. period.
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 The Changing Dynamics of Specialness

• The Rise of Financial Services Holding Companies

• The Shift Away of Risk Measurement and Management
and the Financial Crisis
 a dramatic increase in systemic risk of the financial system, caused in
large part by a shift in the banking model from that of “originate and hold”
to “originate to distribute”
• Firmwide Risk Management
While FIs have traditionally examined risk measurement and
management by functional area (e.g., credit risk or liquidity risk), more
recently, they have recognized the value of enterprise risk management.
Enterprise risk management recognizes the importance of prioritizing
and managing the full spectrum of risks as an interrelated risk portfolio.

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 Changing dynamics of specialness

• The Rise of Financial Services Holding Companies

• The Financial Services Modernization Act of 1999 opened
the door for the creation of full-service financial institutions
in the United States, which allowed for the creation of
“financial services holding companies” that could
engage in banking activities, insurance activities, and
securities activities.
• As a result, assets of financial institutions by functional area,
the financial services holding company (which combines
these activities in a single financial institution) has become
the dominant form of financial institution in terms of total
assets.

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 Changing dynamics of specialness

• The Shift Away from Risk Measurement and

Management and the Financial Crisis
• a shift in the banking model from that of “originate and hold”
to “originate to distribute”: banks have shifted to an
underwriting model in which they originate or warehouse
loans, and then quickly sell them.
Increasing Bank Loan Secondary Market Trading, 1991–2015Q1

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Firmwide Risk Management

Source: J.P.Morgen Chase Form 10-Q,

March 2020, page 47
https://www.jpmorganchase.com/ir

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 Global Trends
• U.S. FIs must now compete not only with other domestic FIs but
increasingly with foreign FIs that provide services (such as
payment services and denomination intermediation) comparable
to those of U.S. FIs.
• The 10 largest banks in the world in 2020 by Tier 1 Capital: https://bitly.com.vn/dzc3dx

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 Banks’ Financial Services
• Products Sold by U.S Financial Services Industry,1950

• Products Sold by U.S Financial Services Industry, 2016

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 Size, Structure and Composition of
the US Banking Industry
• Small Banks vs Large Banks
 Small banks are defined as banks with assets less than $1 billion.
 Large banks are defined as banks with assetsof $1 billion or more.
• Breakdown of Loan Portfolios 2015 (source: FDIC, 2015)

Types of loan Small •Banks Large Banks

Real estate 73.53% 45.71%
C&l 14.23% 22.83%
Comsumer loans 4.23% 9.08%
Credit Card 0.28% 8.63%
Others 7.73% 13.50%

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 A Breakdown Of The Loan Portfolios
Of The Largest U.S. Banks 2018

• Source: Forbes, 2018 – https://bitly.com.vn/t6rzw4

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Size, Structure and Composition of the Industry

• Smaller or community banks—under $1 billion in asset size—

tend to specialize in retail or consumer banking, such as providing
residential mortgages and consumer loans and accessing the
local deposit base.
• The majority of banks are often either regional or superregional
banks, having several hundred billion dollars in assets and
engage wholesale commercial banking activities, encompassing
consumer and residential lending as well as commercial and
industrial lending (C&I loans), both regionally and nationally.
• The very biggest banks often have the separate title money
center banks. U.S.-based money center banks include: Bank of
New York Mellon, Deutsche Bank (through its U.S. acquisition of
Bankers Trust), Citigroup. They have fewer retail branches and
heavily rely on nondeposit or borrowed sources of funds.

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 A Comparison of Assets Concentration
by US Bank size 1984 vs 2015

• Asset share of the smallest banks (under $1 billion)reduced from 36.6

percent in 1984 to 7.5 percent in 2015.
• These smaller or community banks—under $1 billion in asset size—
tend to specialize in retail or consumer banking, such as providing
residential mortgages and consumer loans and accessing the local
deposit base.
• The relative asset share of the largest banks (more than $1 billion in
assets), on the other hand, increased from 63.4 percent in 1984 to 92.5
percent in 2015. 42
 ROA and ROE of
US Banks by Size, 1990-2015

ROA
As the
economy
recovered in
2010-2015,
the recovery
occurred
quicker for
bigger banks
that
received
more
government
assistance
and
ROE monitoring
throughout
the crisis.

43
 Types of banking
Traditional vs modern banking

44
Selected banking activities and services

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 Interest Income

• Interest income, or NII, is the main source of revenue for the

majority of banks worldwide. It can form upwards of 60% of
operating income, and for smaller banks and building
societies it reaches 80% or more.
• NII is generated from lending activity and interest-bearing
assets, while “net” return is this interest income minus the
cost of funding loans. For many banks, customer deposits
are a key source of funding, as well as one of the cheapest.

46
 Fees and commission

• Banks generate fee income as a result of providing services

to customers.
• There is also no credit risk because fees are often paid
upfront. There are other benefits as well, such as the
opportunity to build up a diversified customer base for this
additional range of services.

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 Operating Cost

• Bank operating costs comprise staff costs and operating

costs, such as provision of premises, information
technology, and office equipment.
• Other significant elements of cost are provisions for loan
losses, which are charges against the loan revenues of the
bank.

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 Trading income

• Banks generate trading income through trading activity in

financial products such as equities (shares), bonds, and
derivative instruments.
• This includes acting as a dealer or market-maker in these
products, as well as taking proprietary positions for
speculative purposes.
• Trading income is perhaps the most volatile income source
for a bank. It also generates relatively high market risk, as
well as not inconsiderable credit risk.

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Scope of Banking Activities

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 Scope of Banking Activities

• “retail” or “commercial” banking covers the more traditional

lending and trust activities, while “investment” banking
covers trading activity and fee-based income such as stock
exchange listing and mergers and acquisitions
• The one common objective of all banking activity is return
on capital.

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 Retail or personal banking
• Retail or personal banking relates to financial services provided to
consumers and is usually small-scale in nature.
• Typically, all large banks offer a broad range of personal banking
services, including payments services (current account with
cheque facilities, credit transfers, standing orders, direct debits
and plastic cards), savings, loans, mortgages, insurance,
pensions and other services.
• Commercial banks deal with both retail and corporate customers,
have well-diversified deposit and lending books and generally
offer a full range of financial services.

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 Private banking

• Private banking concerns the high-quality provision of a

range of financial and related services to wealthy clients,
principally individuals and their families.
• High net worth individuals (HNWIs) are defined as those
with $1 million or more in investable assets (that is, assets
at their disposal for investing).
• At the end of 2011, 11 million people globally each held
at least US$1million in financial assets; 53.3 per cent of
the world’s HNWIs were still concentrated in the US, Japan
and Germany.

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High net worth individuals 2007-2011

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Top 20 global private banks by
assets under management

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 Private banking

• Services key components include:

1. tailoring services to individual client requirements;
2. anticipation of client needs;
3. long-term relationship orientation;
4. personal contact;
5. discretion.

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 Corporate banking

• Corporate banking relates to banking services provided to

companies, although typically term refers to services
provided to relatively large firms.
• Banking services provided to small and medium-sized firms
are in many respects similar to personal banking services
and the range of financial products and services on offer
increases and grows in complexity the larger the company.

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 Banking services used by small firms
There are four main types of banking service on offer to small firms:
1 Payment services.
2 Debt finance.
3 Equity finance.
4 Special financing.

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 Equity finance for small firms

• Formal equity finance is available from varioussources,

including banks, special investment schemes, and private
equity and venture capital firms.
• The informal market refers to private financing by so-called
‘business angels’ – wealthy individuals who invest in small,
unquoted companies.

59
 Banking services for mid-market and large (multinational)
corporate clients

The mid-market and multinational corporate sector is served by a

variety of financial service firms, including mainly commercial banks,
investment banks and asset finance firms.
1 Cash management and transaction services.
2 Credit and other debt financing facilities – loans, overdrafts,
syndicated loans, commercial paper, bonds and other facilities.
3 Commitments and guarantees.
4 Foreign exchange and interest rate-related transactions.
5 Securities underwriting and fund management services.

60
 Questions
1. In what ways does traditional banking differ from modern banking?
2. What are the differences between community banks, regional banks,
and money center banks? Contrast the business activities, location, and
markets of each of these bank groups.
3. Why is ROA for the smaller banks generally larger than ROA for the
large banks?
4. Why is the ratio for ROE consistently larger for the large bank group?

61
 Bank system in Vietnam
Types of commercial banks Quantities Examples

1 State-owned commercial banks 4 Vietcombank, BIDV,

(SOCB’s) Vietinban; Agribank;
2 Zero-bank wholly-owned by SBV: 3 CB, Ocean Bank, GP
Bank;

3 Joint-stock (private) banks 28 (MBB, TCB, ..)

4 Joint-venture banks; 2
5 Wholly-owned foreign banks; 9
6 Representative offices of foreign 47
banks;

7 Branches of foreign banks; 49

8 Financial companies; 16

9 Financial leasing companies. 11

62
 Share of banked population in APAC 2018/2019
Share of banked population in APAC 2018/2019

Vietnam

Philippines

Indonesia

China

India
Asia Pacific Countries

Thailand

Malaysia

Taiwan

South Korea

Hong Kong

Japan

Singapore

New Zealand

Australia

0 20 40 60 80 100 120
Share in % , Statista 2020

63
 ROE and ROA of the Vietnamese banking
ROE and ROA of the banking sector in Vietnam 2014-2018
10.

9.06
9.

8. 7.64
7.51

7.
6.43
6.26
6.
Percentage

5.

4.

3.

2.

1. 0.58 0.7
0.57 0.52 0.57

0.
2014 2015 2016 2017 2018
Data: BIDV, Statista 2020

64
 Leading joint stock commercial banks
by total asset

Leading joint stock commercial banks Vietnam 2018, by total asset

20.

18.

16.

14.

12.
Percentage

10.

8.

6.

4.

2.

0.
Sacombank Military Bank ACB SHB VPBank Techcombank HDBank Eximbank
Data: BIDV, Statista 2020

65
 Leading joint stock commercial banks Vietnam
by deposits
(in billion U.S. dollars)
Leading joint stock commercial banks Vietnam 2018, by deposits

16.

14.

12.
(in billion U.S. dollars)

10.

8.

6.

4.

2.

0.
Sacombank ACB Military Bank SHB Techcombank VPBank HDBank Eximbank

Data: BIDV, Statista 2020

66
 Leading joint stock commercial banks
Vietnam 2018, by equity
Leading joint stock commercial banks Vietnam 2018, by equity
2.5

2.
(in billion U.S. dollars)

1.5

1.

0.5

0.
Techcombank VPBank Military Bank Sacombank ACB HDBank SHB Eximbank
Data: BIDV, Statista 2020

67
 Leading joint stock commercial banks Vietnam
2018, by loans
Leading joint stock commercial banks Vietnam 2018, by loans

12.

10.

8.
(in billion U.S. dollars)

6.

4.

2.

0.
Sacombank ACB SHB Military Bank VPBank Techcombank HDBank Eximbank

Data: BIDV, Statista 2020

68
 E-payment services in Vietnam
Most popular e-payment services used among respondents in Vietnam
2020

70.
Value in percentage

60.

50.

40.

30.

20.

10.

0.

Data: Vietnam, Survey, Statista 2020

69
 WEB LINKS

• Federal Deposit Insurance Company www.fdic.gov

• Federal Financial Institutions Examination Council
www.ffiec.gov
• Office of Thrift Supervision www.ots.treas.gov
• Credit Union National Association www.cuna.org
• Morningstar, Inc. http://www.morningstar.com
• Security and Exchange Commission www.sec.gov
• Careers in Finance www.careers-in-finance.com
• Bank Job Search www.bankjobsearch.com
• Bank Jobs www.bankjobs.com

70
 Further Readings

• For a theoretical modeling of the delegated monitor function,

see D. W. Diamond, “Financial Intermediaries and
Delegated Monitoring,” Review of Economic Studies 51
(1984), pp. 393–414; and A. Winton, “Competition among
Financial Intermediaries When Diversification Matters,”
Journal of Financial Intermediation (1997), pp. 307–46.

71