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Banking and Financial Institutions: A Guide for Directors, Investors, and Borrowers

ISBN: 978-0-470-87947-4
357 pages
August 2011
Banking and Financial Institutions: A Guide for Directors, Investors, and Borrowers (0470879475) cover image
A practical guide to the evolving world of banking and financial institutions

Due to various factors, ranging from the global financial crisis that began in 2007 to new laws such as the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, banks and financial institutions have had to alter the way they operate. Understanding how these institutions function in the face of recent challenges is essential for anyone associated with them. That's why Professor Benton Gup has created Banking and Financial Institutions.

Opening with a detailed discussion of the causes of the recent financial crisis, as well as a look at some lessons we can learn from it and other crises, this reliable resource quickly moves on to put modern banking in perspective. Filled with in-depth insights and expert advice, Banking and Financial Institutions examines the essential aspects of this discipline and shows you what it takes to make the most informed decisions possible, whether you're a bank director, investor, or borrower.

  • Explains the economic role of financial intermediaries, including the financial institutions that bring borrowers and savers together
  • Addresses how banks can hedge some of their interest rate and credit risks by using various types of derivatives contracts, options, and futures
  • Analyzes the process of commercial and industrial (C&I) lending, from how banks make loans and the types of C&I loans to the role of collateral
  • Allows you to evaluate a bank's financial statements and performance
  • Explores payments systems, including cash, checks, credit cards, wire transfers, and other means of payment

Rounding out this detailed banking guide is an informative chapter on Islamic banking written by Professor Mohamed Ariff of Bond University, as well as a chapter filled with tips for bank directors, borrowers, and investors contributed by John Harrison, the Superintendent of Banks, Alabama State Banking Department.

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Preface xi

Acknowledgments xv

About the Author xvii

CHAPTER 1
Lessons Learned from Banking Crises 1

International Financial Crises 1

What Caused the Crisis in the United States? 3

Lessons Learned from Financial Crises 13

CHAPTER 2
The Economic Role of Financial Intermediaries 21

The Economic and Financial System 21

Intermediation 23

Asset Management 32

Individuals 33

Interest Rates 34

Current Trends in Financial Intermediaries 35

The Changing Role of Banks 38

Alternative Financial Services 40

CHAPTER 3
The Evolving Legal Environment 41

What Is a Bank? 41

Why Are Banks Regulated? 42

Selected Banking Laws 47

Services Provided by Banks 50

What Bank Regulators Do 54

Is Prudential Bank Regulation Effective? 57

Appendix 3A: FDIC Definitions of Commercial Banks 64

Appendix 3B: Selected Banking Legislation 68

Recent Laws 74

CHAPTER 4
Asset/Liability Management 75

An Overview of Market Rates of Interest 75

The Effects of Interest Rate Risk on Income and Market Value 84

Managing Interest Rate Spreads 86

Duration Gap and Economic Value of Equity 88

Duration Gap Management Strategies 91

CHAPTER 5
Hedging and Risk Management 95

Derivatives 95

Risks Associated with Derivatives 96

Derivative Contracts by Product and Type 99

Hedging with Interest Rate Swaps 100

Hedging with Currency Swaps 102

Hedging with Options 104

Hedging with Futures 105

Covered Bonds 110

Special Purpose Vehicles 111

Enterprise Risk Management 112

Additional Educational Resources 114

CHAPTER 6
Commercial and Industrial Loans 115

The Role of Asymmetric Information in Lending 115

The Competitive Environment 116

The Board of Directors’ Written Loan Policy 120

Seven Ways to Make Loans 122

Collecting Loans 125

Principal Lending Activities 126

Collateral 131

The Lending Process 134

International Lending 145

Summary 147

CHAPTER 7
Real Estate and Consumer Lending 149

Real Estate Lending 149

Characteristics of Mortgage Loans 152

Consumer Lending 165

Finance Charges 174

Annual Percentage Rate 176

Real Estate and Consumer Credit Regulation 180

If Credit Is Denied 182

Privacy Issues 182

Credit Card Accountability, Responsibility and Disclosure Act of 2009 (Credit CARD Act) 183

Conclusion 186

CHAPTER 8
Bank Capital: Capital Adequacy 189

Basel Capital Accords 193

Enterprise Risk Management and Economic Capital 199

Accounting Issues 202

What’s Next? 203

CHAPTER 9
Evaluating Bank Performance 207

Evaluating Publicly Traded Banks 207

Evaluating Commercial Banks 213

Appendix 9A: FDIC Bank Data Guide 227

CHAPTER 10
Payments Systems 229

Money 229

Legal Tender 229

Retail Payments 232

Large-Interbank Payments 241

CHAPTER 11
Other Financial Services 245

Cash Management Services 245

Trust Services, Private Wealth, and Asset Management 248

CHAPTER 12
A Guide to Islamic Banking 255

Islamic Banking, an Alternative Intermediation 255

Special Question on Intermediation by Banks 272

Future Direction 276

CHAPTER 13
The View from the Top: Recommendations from a Superintendent of Banks 279

Tips for Bank Directors 279

Tips for Borrowers 280

Tips for Investors 280

What Lies Ahead 281

Notes 283

Glossary 309

References 335

Index 351

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Benton E. Gup holds the Robert Hunt Cochrane/Alabama Bankers Association Chair at the University of Alabama. Dr. Gup is the author or editor of twenty-nine books, and his articles on financial subjects have appeared in leading finance journals. His most recent books are The Valuation Handbook (Wiley) and The Financial and Economic Crises: An International Perspective. In 2009, Dr. Gup was awarded the Midwest Finance Association's Lifetime Achievement Award.
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