The Principles of Banking

Chapter 1

A Primer on Bank Business and Balance Sheet Risk

This chapter is intended for newcomers to the market, junior bankers and finance students. Everyone else should read it as an essential refresher course. The purpose of this primer is to introduce all the essential basics of banking necessary to gain a strategic overview of what banks do and to manage what risk exposures they face. We begin with the concept of banking, and follow with a description of bank cash flows, calculation of return, the risks faced in banking, and organisation and strategy.

A summary of the bank product line is given in the Appendix at the end of the chapter.

An Introduction to Banking

Banking has a long and honourable history. Banking operations encompass a wide range of activities, all of which contribute to the asset and liability profile of a bank. Table 1.1 shows selected banking activities, and the type of risk exposure they represent. The terms used in the table, such as “market risk”, are explained elsewhere in this book. In Chapter 2 we discuss elementary aspects of financial analysis, using key financial ratios, that are used to examine the profitability and asset quality of a bank. We also discuss bank regulation and the concept of bank capital.

Table 1.1 Selected banking activities and services.

Service or function	Revenue generated	Risk
Lending
– Retail	Interest income, fees	Credit, Market
– Commercial	Interest income, fees	Credit, Market
– Mortgage	Interest income, ...