Fundamentals of Financial Services

Fundamentals of Financial Services

Banking
 Banking: Key Topic Areas
 Retail and Commercial Banking
 Retail Borrowing in Focus

 Interest Rates
 Secured and Unsecured Borrowing
 The Relative Cost of Borrowing

 Investment Banks
 Central Banks
RETAIL & COMMERCIAL BANKING
RETAIL BORROWING IN FOCUS
 Lesson Objectives
By the end of the lesson:

1. Everyone MUST be able to:

• Explain the difference between the role of retail banks and commercial
banks
• List and define 5 types of retail borrowing available to retail customers

2. Most SHOULD be able to explain the features of each of these retail

borrowing methods

3. Some COULD be able to analyse the advantages and disadvantages

to the customer of these retail borrowing methods
 Retail Bank vs. Commercial Bank
RETAIL COMMERCIAL
• Individuals are retail customers.
• This term is mainly used in the
• Banks that provide these US.
customers with services are • In the US it encompasses all
known as retail banks. banks that engage in attracting
• The purpose of the bank is to deposit and giving out loans.
• In other countries “commercial”
attract deposits from savers and
lend to borrowers. bank may refer solely to banks
Do you remember how a bank who provide such services to
generates a surplus? businesses only (not individuals).
• This is also known as corporate
banking, since the bank is mainly
What other expenses may a retail dealing with corporate entities.
bank have to pay for before it can
determine its level of surplus?
 Retail Bank vs. Commercial Bank

Commercial Banks
The US definition – all banks that
take deposits and grant loans

Retail Banks Corporate Banks

Banks that specialise in taking
deposits and providing loans to
individuals
Banks that specialise in taking
deposits and providing loans to
businesses. In parts of the world
outside the US, these are often
referred to as commercial banks.
 • What does each method actually mean?
• What are the FEATURES of each method?
Key Features: Bank Loan • What are the advantages/disadvantages
of each method?

Bank Loan
A form of debt where a borrower receives a certain amount from a lender, in this case a
bank. The borrower agrees to pay a contracted rate of interest to the lender and also
agrees a date on which the loan will be repaid.

The loan is normally:

• For a set period that is generally less than five
years.
• At a set rate of interest.
• With a defined repayment schedule.

Unsecured Loan
A loan provided to a borrower
where the lender takes no security.

Add notes to your A3 sheet

 • What does each method actually mean?
• What are the FEATURES of each method?
Key Features: Mortgage • What are the advantages/disadvantages
of each method?

Mortgage
A mortgage loan is a long-term loan used to finance the purchase of real estate (e.g. a house). Under
the Mortgage Agreement, the borrower agrees to make a series of payments back to the lender. The
money lent by the bank (or building society) is secured against the value of the property: if the
payments are not made by the borrower, the lender can take back the property.

Mortgages are typically: Secured Loan

• For a set period (usually 25 – 35 years)
• At a variable rate of interest (it increases or decreases
to stay in line with the general interest rates)
• With a defined repayment schedule (e.g. monthly)
• Secured on the property the loan is used to buy
The situation where a lender takes
something of value as security for a loan.
If the borrower fails to repay the debt, the
lender is able to keep and sell the item.

Add notes to your A3 sheet

 • What does each method actually mean?
• What are the FEATURES of each method?
Key Features: Overdraft • What are the advantages/disadvantages
of each method?

Overdraft
A form of borrowing from a bank where the lending bank can demand repayment at any
time.

Bank overdrafts are generally:

• Flexible – able to be drawn, repaid, drawn
again up to the overdraft limit.
• At a variable rate of interest.
• An arrangement fee may also be payable.
• Unsecured and repayable on demand.

Add notes to your A3 sheet

Credit Cards Activity
Visit the American Express Website.
https://www.americanexpress.com/uk/content/all-cards/

Select one of their range of credit cards available.

Complete the following:

1. What is the name of the card?

2. What is its annual fee?
3. What are the charges for using the credit card facility?
4. What additional “rewards” are available for the user?
5. What is the eligibility criteria?
6. Which sort of borrower would go for this type of card?

Based on this research, discuss the following in your groups:

• How do you think a credit card actually works?
• What do you think the advantages/disadvantages of using a credit card are for the borrower?
• What do you think the advantages/disadvantages of issuing a credit card are for American Express?

Add notes to your A3 sheet

 Credit cards are available from banks as well as
specialist providers like Visa and MasterCard and even
Credit Cards through supermarkets, football clubs and charities.

Credit cards are typically:

• Flexible – able to be used up to the credit limit
• At a variable rate of interest, which tends to be expensive
• An Repayments of at least At
The a minimum amount are required monthly It is
individual individu The least best
applies al can borrow
for a ed part of to pay
make
credit
purchas amount the off the
card, and
if es with that is borro WHOL
successful the card not paid wed E
, is and with off,
granted a each incurs a
mone AMOU
card with transacti high y NT
a certain on the
borrowin interest needs borro
borrowe charge,
g limit.
d
to be wed
This is e.g.
known as amount repaid each
20% per
the credit increase
annum. month month
limit. s.
ly. .
Add notes to your A3 sheet
Look at the picture.
What do you think it is about?

Pawnbrokers
needs to be repaid for the borrower to reclaim the item.
The decision is usually made
immediately by the
pawnbroker on whether the
loan will be issued or not.
Add notes to your A3 sheet
A pawnbroker is a business that provides loans to
individuals. The pawnbroker takes an item of security
(such as jewellery) in exchange for the loan. The loan
The item pawned
The item pawned
might hold
must hold monetary
sentimental value
value.
e.g. a wedding ring
It is a secured loan,
as the pawnbroker
can keep the item if
the loan is not
returned on time or
in full.
Borrowers can avoid a lengthy
approval process compared to
other methods such as
overdraft or credit card.
Pawnbrokers

Why do you think that a loan from a pawnbroker

is more expensive than a loan or overdraft from
the bank, or borrowing on a credit card?

The pawnbroker knows little about the

borrower. They may never return the money.
This is a BIG risk for the pawnbroker.

This is due to the RISK taken on by

the pawnbroker, combined with the The borrower is obviously very desperate.
DESPERATION of the borrower. Needs the money immediately, and cannot
find it easily elsewhere., and therefore forced
to pay a higher rate of interest

Add notes to your A3 sheet

 H&T Pawnbrokers
The process:
• Fair & accurate offer based on
estimating the asset the borrower
wishes to pawn.
• No income checks performed –
loan is issued purely on the value of
the item
• All items are secured and insured Click on image to access the website

during the period of the loan

The offer:
• Loans by H&T can be offered from
£250-£50,000 over a period of 6
months.
• Interest will be charged dependent on
amount borrowed.
• No penalties for early repayment

Add notes to your A3 sheet

Activity…
• Watch the advert twice.
• First time jot down:
– What is being advertised?
– What does the consumer
Click on image to access the video
say is being offered?

• Second time jot down:

– The rate of interest being
charged.
– Any other conditions
outlined in the “small print”
you can see
 A pay day loan is marketed as a loan that enables
a borrower to get hold of cash before the next
Payday Loans time they are paid by their employer.

It is a very short term loan

It needs to be repaid on the

borrower’s next payday –
usually by the end of the
month

Such loans are often very

expensive.
There are numerous websites which compare payday loans available to
consumers. Visit: http://paydayloans.money.co.uk/ to compare Loan
amounts available; rates offered and repayment terms.
Payday Loans: Are they worth it?
• BBC Monthly Interest Calculator is available here.
• An example has been shown below.
• There is an option to “play” and see to see how the interest would go up if you kept refinancing
each month.
 Stretch & Challenge: Articles Research
• http://www.theguardian.com/money/payday-loans

• The Guardian dedicates a whole area to payday loans under

its “Money” section.

• Pick out two interesting news stories that discuss some of

the issues associated with the payday loans industry.

• Summarise the articles to present back to the class.

• Each article should be summarised into 6-10 sentences

including the following:
– Headline, date, author, website/newspaper
– What is the main message of the article?
– Reference to any evidence/examples given
Stretch & Challenge: Payday Loans Market

Visit the web link below and do some research of your own
to answer the questions below:
– http://
www.consumeraffairs.org.uk/loans/payday-loan/guides/payday-loan-
market-uk-compares-nations

• How does the UK payday loan market compare to that of

other nations?

• Is there a future for payday loan businesses to continue

trading in the future?
 A Question of Ethics?
Many individuals have been caught in the
deepening debt spiral which comes with over
reliance on credit.

The BBC documentary explores: “The Truth

Behind Payday Loans”.

• What are the ethical considerations which

have clearly been ignored by the big
payday lenders?

• Whose responsibility is it to limit the

borrowing:
– The individual?
– The Payday Lender?
Click on image to access the video
– The Government?

• Is there a case to cap the cost of credit?

Pawnbrokers & Payday Loans

In summary pawnbrokers & payday loans:

• Easily available as the decision tends to be made immediately
• Relatively very expensive compared to other forms of
borrowing
• Repayment is required to regain possession of the pawned
item from the pawnbroker
• Payday loans are very short term, with repayment required at
the next payday
Plenary: Quick Quiz

1. What is the difference between a retail bank and a

corporate bank?

2. What are the 5 methods of borrowing available for

retail consumers?

3. List three features of each method of borrowing.

4. Identify one advantage and one disadvantage of each

method of borrowing.
Plenary

Have you met your

learning outcomes?

Check your learning.

Use the assessment

sheet provided.
Payday Loans: Links & Articles
Comparison of Payday Loans:
• http://paydayloans.money.co.uk/

Guides on Payday Loans:

• http://paydayloans.money.co.uk/guides.htm

Lots of relevant articles on Payday Loans

• http://www.theguardian.com/money/payday-loans

What is the future for payday loans?

• https://www.stackingbenjamins.com/future-payday-loans/

The Demise of the Payday Loan?

• http://www.huffingtonpost.co.uk/sarah-willingham/payday-loans-uk_b_6139356.html

Key changes for payday lenders

• http://paydayloans.money.co.uk/payday-loans-the-new-rules-for-lenders.htm

How sky high bank overdraft charges force borrowers to use payday lenders
• http://www.thisismoney.co.uk/money/saving/article-2270230/How-sky-high-bank-overdraft-charges-force-borrowers-use-
payday-lenders.html
Further articles and useful links to follow and read up on !
INTEREST RATES
 Learning Outcomes
By the end of this session:

Everyone MUST

1. Know the difference between the quoted interest rate on borrowing and the
effective annual rate of borrowing.
• Be able to calculate the effective annual rate of given the quoted rate and frequency of
interest payments.
• Know the difference between secured and unsecured borrowing.

2. Know that investment banks help companies to raise money and advise them
on strategy, E.g. mergers and acquisitions

3. Know the role of central banks

What are interest rates?

The COST of borrowing.

The REWARD for saving.

The price paid for borrowing money. Generally,

interest is expressed as a percentage rate over a
period, such as 5% per annum.
 Interest Rates
APR
Annual Percentage Rate
• This is normally the advertised or quoted
rate.
• By law lenders have to show this rate to
customers.
• It is used so that customers can easily
compare financial products.
• APR shows the cost of borrowing if
interest is charged on an annual basis.
EAR
Eff e c ti v e A n n u a l R a t e
• Takes the APR (or quoted rate) and
adjusts it to take into account the
frequency of interest charges.
• Often, interest is not charged once a year
but on a quarterly or monthly basis
• The EAR is higher than the quoted rate
(APR)
 Calculating the EAR from the Quoted Rate

What is the effective annual rate if the quoted rate is 6% and interest is
charged quarterly?
1. Take the quoted rate and divide it by the frequency
Opening Interest Closing with which interest is charged:
Month Balance Rate Interest Balance 6% / 4 = 1.5%
January 1,000.00 1,000.00 2. Turn the interest rate into a decimal:
February 1,000.00 1,000.00
March 1,000.00 1.50% 15.00 1,015.00 1.5% / 100 = 0.015
April 1,015.00 1,015.00 3. Add one to the decimal:
May 1,015.00 1,015.00 0.015 + 1 = 1.015
June 1,015.00 1.50% 15.23 1,030.23
July 1,030.23 1,030.23 4. Multiply this number to the power of the number
August 1,030.23 1,030.23 of times interest is charged:
September 1,030.23 1.50% 15.45 1,045.68 1.015 to the power of 4
October 1,045.68 1,045.68 (1.015 x 1.015 x 1.015 x 1.015)
November 1,045.68 1,045.68 = 1.0613634
December 1,045.68 1.50% 15.69 1,061.36 5. Minus the one and turn the number back into a
percentage:
1.0613634 – 1 = 0.0613634
0.0613634 x 100 = 6.14% EAR
 Class Question
United Bank is offering a loan at a quoted rate of 2% per month (that’s 24%
per annum). What is the effective annual rate?

• Take the quoted rate and divide it by the frequency with which
interest is charged.
• Turn the interest rate into a decimal
• Add 1 to the decimal
• Multiply this number to the power of the number of times
interest is charged
• Minus the one and turn the number back into a percentage
INVESTMENT BANKS & CENTRAL
BANKS
The Role of an Investment Bank

Watch the video clip.

This is a career video giving a basic

overview of investment banking.

Answer the following questions:

1. Who are their clients? (3)
2. What areas can an investment
bank provide advice on? (3)
http://www.goldmansachs.com/careers/why-goldman-sachs/our-
divisions/investment-banking
/
The Role of an Investment Bank

Capital Raising Strategy support

• They support with large scale capital raising • Investment banks may provide strategic
for corporates starting from around $5 million advice to businesses who are seeking
and upwards to around £100 billion. growth.

• The investment bank will provide advice to a

• Growth can take place in two forms
business looking to raise long-term finance.
including mergers with other
businesses, or acquisitions of other
• Capital could be raised in the form of DEBT or
EQUITY.
business. This is known as M&A
(Mergers & Acquisitions).
• The investment bank will EXECUTE THE DEAL,
if the business decides to act upon the advice
given. They will organise all the paper work
and market the deal to potential investors.
Case Study: Razak Inc

Razak Inc is already a large global player in technology that

supports smartphones. Razak uses the advice of Coldman
Jones, an investment bank. Coldman’s M&A team
recommends that Razak should buy a minor competitor
company to gain access to the Japanese market. The
Japanese company will cost around $100 million.

The cost of the purchase needs to be raised by Razak and,

again on the advice of the investment back, Razak uses
Coldman Jones to raise the required funds by selling bonds
to investors.
 The Role of an Investment Bank
The World’s Top 10 Investment Banks

Companies

Advisors Capital Raising

Corporate Finance

Listing & Mergers &

Bond Issues Acquistions

Stock Markets
The Role of the Central Bank
• UK Central Bank – Threadneedle Street, London, Founded in 1694

• Since 1694 – banker to the government

– The government gathers tax receipts, spends on defence, welfare etc.

• Since the late 18th Century – banker to the banking system

– Banks hold accounts with the central bank

• Manages the UK foreign exchange and gold reserves

– Many governments also hold money in other currencies – foreign exchange reserves

• Regulatory role
– Many central banks regulate other banks
– Set interest rates in accordance with government policy
The Role of the Central Bank

• It does NOT :
• manage the National Debt (This is the Debt
Management Office in the UK)
• provide a depositors protection scheme (This is
the Financial Service Compensation Scheme in the
UK)
Plenary

Have you met your

learning outcomes?

Check your learning.

Use the assessment

sheet provided.