International Senior Entrepreneurial Leadership Program ISEP 2004 Prof. Dr. Beat Bernet sb/f - Swiss Institute of Banking and Finance s/bf – Swiss Institute of Banking and Finance 1 © Beat Bernet Session Objectives • To evaluate the changeing role of banks as financial intermediaries in the lending process • To understand the strategic considerations of banks in the lending process • To understand the advantages / disadvantages of new financing instruments like asset securitisation, mezzanine finance or risk transfer s/bf – Swiss Institute of Banking and Finance 2 © Beat Bernet Core Functions Financial Intermediation Financial intermediation functions provide method of clearing and settling payments mechanisms for pooling of resources ways to transfer economic resources through time and across distance methods of managing risks price information to help coordinate decentralized decision-making in various sectors of the economy ways of dealing with incentive problems created when one party to a transaction has information that another party does not have or when one party acts as agent for another one. s/bf – Swiss Institute of Banking and Finance 3 © Beat Bernet Transformation of Financial Systems Dimensions of Demand Structure Content Verhalten Dimensions of Risk Dimensions of Technology Addedvalue Metarisks Financial Intermediation Systems Systems Society & Culture Volatility Risk on Systems Normative Dimensions Politics Ethics s/bf – Swiss Institute of Banking and Finance Law 4 © Beat Bernet Future Effects of Technology: Three Theses 1. So far technology was focused on changeing processes. Today and in the future it will transform the whole transactions systems. 2. So far technology was used to profit from various forms of economics of scale and scope; in the future it will open opportunities to benefit from net economies. 3. So far technology in banking had a strong instrumental character. In the future it will affect and change social habits and structures in all client segments. s/bf – Swiss Institute of Banking and Finance 5 © Beat Bernet Competitive Environment Effects of the intensification of competition Consequences for competitive strategies Innovative advances of new and established competitors Disappearance of competitive advantages Increasing aggressiveness of competitive behaviour Reduction of entry barriers Shift of balance Homogenous services Reduction of core capabilities Intensification of pricing competition s/bf – Swiss Institute of Banking and Finance Parallelism of decisions and measures 6 © Beat Bernet Reorientation Bank Credit Policy Transaction level: •Rating •Pricing Ojective: Increase ROE Portfolio level: •Credit portfolio •Risk transfer Operational level: •Decision structures •Statistics/methods s/bf – Swiss Institute of Banking and Finance 7 © Beat Bernet Credit Pricing Expected probability of default EPD x Loss Severity LS Loan Amount x L •Rating client •Rating transaction •Collateral •Product •External aspects •Product •Maturity •Amount = Overal rating = Recovery rate = Exposure s/bf – Swiss Institute of Banking and Finance 8 Expected Loss = EL •Basis for risk premium © Beat Bernet Building Blocks Loan Contacts Legal characteristic of capital Repayment Pricing Collateral Maturity / Time structure Options s/bf – Swiss Institute of Banking and Finance 9 © Beat Bernet Metadecision for Business Strategy Added-Value Cooperation Competence Brand Business Model Risk Culture s/bf – Swiss Institute of Banking and Finance 10 © Beat Bernet Example Corporate Banking: Today‘s Business Model Credit Approval Debtor Sale Relationship Management Portfolio Management Limits etc. Rating & Decision s/bf – Swiss Institute of Banking and Finance 11 © Beat Bernet Elements of a new Business Model in Commercial Banking Debtors Origination Independent Risk Assessment and Rating Portfolio Management • Expected and unexpected Loss • Mark-to-MarketValuation • Risk-based Limits • Risk and Rate of Return Optimisation • Portfolio Transfer Price Credit Sale Securitisation Hedging Acquisitions Secondary Market Client Management Hold to Maturity Credit Transaction / Administration s/bf – Swiss Institute of Banking and Finance 12 © Beat Bernet HAT-Transaction Credit Default Swap* Bonds Issue Subscription Initial and annual CDS Risk Premium HAT** Subscription Pledge Interest / Repayment of Principal Balance Interest / Repayment of Principal Class B Bonds CHF 100,000,000 Credit Protection Payment up to CHF 350,000,000 Class A Bonds CHF 250,000,000 CHF 2,500,000,000 Reference Portfolio UBS AG Subordinated Pledge Collateral CHF 350,000,000 • Obligations to make the Credit Protection payment are contingent upon the Loss Balance being greater than zero (i.e. the aggregate Credit Protection Payment Amounts exceeding the Loss Threshold of CHF 125,000,000). ** Not shown in the transaction chart are the Calculation Agent, the Corporate Administrator, the Security Agent and the Bondholders‘ Representative. s/bf – Swiss Institute of Banking and Finance 13 © Beat Bernet Conclusions 1. Commercial banking is in a dramatic process of reorientation. For the borrower it is extremly important to understand this transformation which takes place in the financial industry. 2. Key element of this transformation is from a borrowers point of view disintermediation. This opens new opportunities for designing financial contracts between investors and borrowers as well as between borrowers and financial intermediaries. 3. As long as we focus on traditional dept management, we probably will pay too much for specific financing transaction, due to information asymmetry and inefficient loan markets. 4. In designing a dept contract, all six basic elements of a loan or a bond should be taken into consideration. Loans can be creative, complexe products tailored to the individual risk / return profiles of lenders and borrowers. 5. With the widening of the integrated european financial market based on the EURO there will be a widening market for creative, even exotic loan products. For borrowers this will open new financing facilities and reduce the average cost of capital. s/bf – Swiss Institute of Banking and Finance 14 © Beat Bernet
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