Introduction to Banking A01 Introduction to Banking 40336.indd 1 17/09/2021 12:36 At Pearson, we have a simple mission: to help people make more of their lives through learning. We combine innovative learning technology with trusted content and educational expertise to provide engaging and effective learning experiences that serve people wherever and whenever they are learning. From classroom to boardroom, our curriculum materials, digital learning tools and testing programmes help to educate millions of people worldwide – more than any other private enterprise. Every day our work helps learning flourish, and wherever learning flourishes, so do people. To learn more, please visit us at www.pearson.com/uk A01 Introduction to Banking 40336.indd 2 17/09/2021 12:36 Third Edition Introduction to Banking Barbara Casu Bayes Business School, City, University of London Claudia Girardone Essex Business School, University of Essex Philip Molyneux Bangor Business School, Bangor University Harlow, England • London • New York • Boston • San Francisco • Toronto • Sydney • Dubai • Singapore • Hong Kong Tokyo • Seoul • Taipei • New Delhi • Cape Town • São Paulo • Mexico City • Madrid • Amsterdam • Munich • Paris • Milan A01 Introduction to Banking 40336.indd 3 17/09/2021 12:36 PEARSON EDUCATION LIMITED KAO Two KAO Park Harlow CM17 9SR United Kingdom Tel: +44 (0)1279 623623 Web: www.pearson.com/uk First published 2006 (print and electronic) Second edition published 2015 (print and electronic) Third edition published 2022 (print and electronic) © Pearson Education Limited 2006, 2015, 2022 (print and electronic) The rights of Barbara Casu, Claudia Girardone and Philip Molyneux to be identified as authors of this work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988. 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ISBN: 978-1-292-24033-6 (print) 978-1-292-24035-0 (PDF) 978-1-292-24037-4 (ePub) British Library Cataloguing-in-Publication Data A catalogue record for the print edition is available from the British Library Library of Congress Cataloging-in-Publication Data Names: Casu, Barbara, author. | Girardone, Claudia, author. | Molyneux, Philip, author. Title: Introduction to banking / Barbara Casu, Claudia Girardone, Philip Molyneux. Description: Third edition. | Harlow, England ; New York : Pearson, 2022. | Includes bibliographical references and index. | Summary: “The aim of this textbook is to provide a comprehensive introduction to theoretical and applied issues relating to the global banking industry. Despite the fears of Henry Ford, we do not think reading this book will cause a revolution but we do hope it will at least provide you with an enjoyable and interesting insight into the business of banking”-- Provided by publisher. Identifiers: LCCN 2021034509 (print) | LCCN 2021034510 (ebook) | ISBN 9781292240336 (paperback) | ISBN 9781292240374 (epub) Subjects: LCSH: Banks and banking--Europe. | Banks and banking. | Bank management--Europe. | Bank management. Classification: LCC HG2974 .C375 2022 (print) | LCC HG2974 (ebook) | DDC 332.1--dc23 LC record available at https://lccn.loc.gov/2021034509 LC ebook record available at https://lccn.loc.gov/2021034510 10 9 8 7 6 5 4 3 2 1 26 25 24 23 22 Cover image: Andrey Suslov/iStock/Getty Images Plus/Getty Images Cover designed by Two Associates Print edition typeset in 9.5/12.5pt Charter ITC Std by Straive Printed and bound in Slovakia by Neografia NOTE THAT ANY PAGE CROSS REFERENCES REFER TO THE PRINT EDITION A01 Introduction to Banking 40336.indd 4 17/09/2021 12:36 To my late father, Antonio. To Martin, Lila, Milan, Monika and to Beth. And to my mum and sister (BC) To Marc, Matteo and Leonardo. To my parents Nieves and Sandro (CG) To Delyth, Alun, Catrin, Gareth, Gethin, Lois and Rhiannnon (PM) A01 Introduction to Banking 40336.indd 5 17/09/2021 12:36 A01 Introduction to Banking 40336.indd 6 17/09/2021 12:36 Contents List of figures xiv List of tables xviii List of boxes xxi Preface xxiv Acknowledgements xxx List of acronyms and abbreviations xxxii Part 1 Introduction to banking 1 What is special about banks? 3 1.1 Introduction 3 1.2 The nature of financial intermediation 3 1.3 The role of banks 7 1.4 Information economies 8 1.5 Why do banks exist? Theories of financial intermediation 14 1.6 The benefits of financial intermediation 16 1.7 Conclusion 17 Key terms 18 Key reading 18 Revision questions and problems 19 2 Bank activities and services 20 2.1 Introduction 20 2.2 What do banks do? 20 2.3 Banks and other financial institutions 21 2.4 Banking services 24 2.5 Banks and the FinTech revolution 39 2.6 Conclusions 43 Key terms 43 Key readings 43 Revision questions and problems 44 Appendix 2.1 FinTech: a selected glossary 45 3 Types of banking 48 3.1 Introduction 48 3.2 Traditional versus modern banking 49 3.3 Types of banking 51 3.4 Retail or personal banking 52 3.5 Private banking 53 3.6 Corporate banking 56 vii A01 Introduction to Banking 40336.indd 7 17/09/2021 12:36 Contents 3.7 Investment banking 67 3.8 Types of banks 72 3.9 Conclusions 79 Key terms 79 Key readings 79 Revision questions and problems 80 4 International banking 81 4.1 Introduction 81 4.2 What is international banking? 81 4.3 Brief history of international banking 84 4.4 Why do banks go overseas? 85 4.5 Types of bank entry into foreign markets 92 4.6 Advantages and disadvantages of international and cross-border banking 97 4.7 International banking services 98 4.8 Conclusions 113 Key terms 114 Key reading 115 Revision questions and problems 115 Appendix 4.1 Syndicated lending: a selected glossary 116 5 Islamic banking 119 5.1 Introduction 119 5.2 A brief history 120 5.3 How an Islamic bank operates 123 5.4 Industry features 127 5.5 Balance sheet and income statement features 130 5.6 Regulating Islamic banks 132 5.7 Comparing Islamic and conventional banks 135 5.8 Conclusion 136 Key terms 136 Key reading 136 Revision questions and problems 137 Part 2 Central banking and bank regulation 6 Central banking 141 6.1 Introduction 141 6.2 What are the main functions of a central bank? 142 6.3 How does monetary policy work? 143 6.4 Monetary policy functions of a central bank 147 6.5 Why do banks need a central bank? 167 6.6 Should central banks be independent? 170 6.7 Conclusion 173 Key terms 173 Key reading 174 Revision questions and problems 174 viii A01 Introduction to Banking 40336.indd 8 17/09/2021 12:36 Contents 7 Bank regulation and supervision 175 7.1 Introduction 175 7.2 The rationale for regulation 176 7.3 Types of regulation 178 7.4 The financial safety net 181 7.5 Limitations of regulation 191 7.6 Causes of regulatory reform 194 7.7 Bank capital regulation 195 7.8 The 1988 Basel Capital Accord (Basel I) 197 7.9 The 1996 amendments to the 1988 Accord 201 7.10 The second Capital Accord (Basel II) 202 7.11 The third Capital Accord (Basel III) 205 7.12 Finalising Basel III 213 7.13 Conclusion 214 Key terms 214 Key reading 215 Revision questions and problems 215 8 Bank failures and banking crises 216 8.1 Introduction 216 8.2 The determinants of bank failure 217 8.3 Early warning systems for bank soundness 224 8.4 Bank restructuring 230 8.5 Banking crises 237 8.6 Conclusion 244 Key terms 245 Key reading 245 Revision questions and problems 245 Part 3 Issues in bank management 9 Banks’ balance sheet and income structure 249 9.1 Introduction 249 9.2 Retail banks’ balance sheet structure 250 9.3 Investment banks’ financial statements 264 9.4 Bank performance and financial ratio analysis 269 9.5 Conclusion 287 Key terms 288 Key reading 288 Revision questions and problems 288 10 Bank financial management 289 10.1 Introduction 289 10.2 Asset–liability management (ALM) 290 10.3 Liquidity management and the importance of reserves 295 10.4 Capital adequacy management 296 ix A01 Introduction to Banking 40336.indd 9 17/09/2021 12:36