
A sound financial system relies on a solid foundation of principles that guide banking practices. This foundation is built on the concept of fractional reserve banking, where banks keep a small portion of deposits in reserve and lend out the rest.
Banks must maintain a minimum reserve requirement to ensure liquidity in the system. This requirement varies by country and institution, but it's typically a small percentage of deposits.
To manage risk, banks use a variety of tools, including credit scoring, loan covenants, and collateral requirements. These tools help assess the creditworthiness of borrowers and mitigate potential losses.
A well-functioning banking system also relies on the principle of prudence, which involves careful management of assets and liabilities. This includes maintaining a stable capital base, managing interest rate risk, and monitoring credit risk.
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Bank Governance
Bank governance is a critical aspect of banking that sets the tone for a bank's overall performance and risk management. The board should undertake regular assessments of its performance, the role of the chair and the board committees.
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The chair of the board plays a crucial role in the proper functioning of the board and should be an independent or non-executive board member. Board committees on audit, risk and compensation are required for systemically important banks and strongly recommended for other banks.
The board should oversee the implementation and operation of policies to identify potential conflicts of interest. This includes ensuring that the remuneration structure is in line with the business and risk strategy, reflecting risk-taking and risk outcomes, and incorporating measures to prevent conflicts of interest.
Board's Overall Responsibility
The board of a bank has a critical role to play in ensuring the bank's overall soundness and success.
The board is ultimately responsible for the bank's business strategy and financial soundness. This includes making key decisions about the bank's direction and overseeing the management's implementation of the bank's strategic objectives.
The board should also ensure that the bank maintains an effective relationship with its supervisors. This involves being transparent and cooperative in dealings with regulatory bodies.
The board members should exercise their "duty of care" and "duty of loyalty" to the bank. This means putting the bank's interests above their own personal interests and making decisions that benefit the bank as a whole.
The board's responsibility extends to the bank's internal organisation, governance structure, and practices. This includes ensuring that the bank's policies and procedures are sound and effective.
The board should regularly review and monitor the bank's risk management and compliance obligations. This involves staying on top of emerging risks and ensuring that the bank is taking steps to mitigate them.
The board's oversight of the bank's risk management and compliance obligations is critical to maintaining the bank's financial soundness.
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Description
Bank governance is a critical aspect of maintaining a sustainable banking industry. The Principles of Banking is a valuable resource that highlights the importance of sound capital and liquidity risk management.
The book explains that the primary requirement of banking had been forgotten in the years prior to the financial crash, leading to unsound banking practices that contributed to the 2007-2008 financial market crisis.
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A key takeaway from the book is the need for banks to have a sound liquidity and asset-liability management framework in place. This framework can be created using a template provided in the book.
The author of the book, a banking practitioner with extensive experience, emphasizes the importance of getting back to basics in risk management. This includes sound lending policy and liquidity management, which are essential for avoiding another bank crisis.
Here are some key principles of banking that are covered in the book:
- Asset-liability management
- Liquidity risk
- Internal transfer pricing
- Capital management
- Stress testing
By following these principles and using the book's guidance, banks can improve their risk management practices and maintain a sustainable banking industry.
Risk Management
Risk management is a crucial aspect of banking, and it's essential to have a robust framework in place. Banks should have an effective independent risk management function, under the direction of a chief risk officer (CRO), with sufficient stature, independence, resources, and access to the board.
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The risk management function should include identifying, assessing, continuously monitoring, mitigating, and reporting all material individual, aggregate, and emerging risks. This is a critical responsibility that requires a high level of expertise and independence.
Banks should use stress tests and scenario analyses to better understand their risk exposures under different adverse circumstances, giving special attention to the quality, completeness, and accuracy of data used for taking risk-related decisions.
Risk Management Function Guidance
A bank's risk management function should be led by a chief risk officer (CRO) with sufficient stature, independence, resources, and access to the board.
The CRO should be appointed, dismissed, and have other changes approved by the board or its risk committee. This ensures that the risk management function is not compromised by external pressures.
Banks should have an effective independent risk management function that identifies, assesses, continuously monitors, mitigates, and reports all material individual, aggregate, and emerging risks.
Risk management should be a continuous process, with regular monitoring and reporting to ensure that risks are being effectively mitigated.
Risk Communication Guidance
Risk communication is a crucial aspect of effective risk management. Banks should communicate risk-related information in a timely, accurate, and understandable manner.
To achieve this, banks must avoid organisational "silos" that can impede information-sharing. This means breaking down barriers between departments to ensure that everyone has access to the information they need.
Risk-related information should be communicated within a bank and to the board and senior management. This ensures that everyone is on the same page and can make informed decisions.
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Internal Audit Guidance
Internal audit is a crucial component of risk management in any organization. It should have a clear mandate and be accountable to the board.
The internal audit function should be independent from audited activities, which means it should not be influenced by the very things it's supposed to be evaluating. This independence is essential for providing unbiased assurance.
To be effective, the internal audit function should have sufficient standing, skills, resources, and authority within the bank. This will enable it to provide an independent assurance to the board and senior management.
The internal audit function should be able to provide assurance on the quality and effectiveness of the bank's internal control, risk management, and governance systems and processes.
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Highlights
Risk management is a crucial aspect of any business or project. It involves identifying, assessing, and mitigating potential risks to ensure the success of an endeavor.
A well-structured risk management plan can help prevent losses and maximize returns on investment. A key component of this plan is risk assessment, which involves identifying potential risks and evaluating their likelihood and impact.
Risk assessment is a critical step in the risk management process. It helps organizations understand the potential consequences of a risk event and prioritize their mitigation efforts accordingly.
Effective risk management requires a proactive approach. This involves regularly monitoring and reviewing risk assessments to ensure they remain relevant and effective.
Regular risk assessments can help organizations stay ahead of potential risks and make informed decisions. By doing so, they can minimize the likelihood and impact of risk events.
Identifying and mitigating potential risks can also help organizations build trust with their stakeholders. This is particularly important for businesses that operate in high-risk industries.
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Risk management is not a one-time task, but rather an ongoing process. Organizations must continually monitor and review their risk assessments to ensure they remain effective.
By prioritizing risk management, organizations can minimize losses and maximize returns on investment. This can have a significant impact on their bottom line and overall success.
Compliance and Oversight
The bank's board is responsible for overseeing the management of the bank's compliance risk.
The board should establish an independent compliance function to ensure the bank operates with integrity and in compliance with applicable laws, regulations, and internal policies.
The compliance function should report directly to the board and is responsible for advising on compliance risk.
The board approves the bank's policies and processes for identifying, assessing, monitoring, and reporting compliance risk.
The compliance function ensures the bank's operations align with applicable laws, regulations, and internal policies.
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Corporate Governance and Compensation
In a bank, the compensation structure should support sound corporate governance and be in line with the business and risk strategy.
The board is responsible for overseeing the remuneration system and regularly monitoring its outcomes to ensure it's creating the right incentives for managing risk, capital, and liquidity.
A bank's remuneration structure should reflect risk-taking and risk outcomes, and incorporate measures to prevent conflicts of interest.
To ensure effective governance, the board should have an appropriate balance of skills, diversity, and expertise, commensurate with the bank's size, complexity, and risk profile.
Board members should be qualified, individually and collectively, and understand their oversight and corporate governance role.
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Board Qualifications and Composition
A well-structured board is key to effective corporate governance. Boards should have an appropriate balance of skills, diversity, and expertise commensurate with the size, complexity, and risk profile of the bank.
Boards should have a clear and rigorous process for identifying, assessing, and selecting board candidates. This ensures that the right people are chosen for the job.
Board members should be qualified, individually and collectively, for their positions. They should understand their oversight and corporate governance role.
Board members should not have any conflicts of interest that may impede their ability to perform their duties independently and objectively. This helps to maintain the integrity of the board's decision-making process.
Board members should be able to exercise sound and objective judgment about the affairs of the bank.
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Appropriate Board Structure and Practices
Having an effective board structure is crucial for the proper functioning of a bank. The chair of the board should be an independent or non-executive board member.
Regular assessments of the board's performance, the role of the chair, and the board committees are essential. This helps identify areas for improvement and ensures the board is working efficiently.
Board committees on audit, risk, and compensation are required for systemically important banks. For other banks, they are strongly recommended.
The board should oversee the implementation and operation of policies to identify potential conflicts of interest. This includes monitoring policies to prevent insider trading and other forms of misconduct.
The chair of the board plays a crucial role in ensuring the board functions properly. Their independence is key to making objective decisions.
Bank Compensation Structure and Corporate Governance
A bank's compensation structure should support sound corporate governance, and Principle 11 explains how. The remuneration structure should be in line with the bank's business and risk strategy, objectives, values, and long-term interests.
The board is responsible for overseeing management's implementation of the remuneration system and should regularly monitor and review outcomes. This is to assess whether the bank-wide remuneration system is creating the desired incentives for managing risk, capital, and liquidity.
Supervisors should provide guidance and supervise corporate governance at banks, including through comprehensive evaluations and regular interaction with boards and senior management. Principle 13 describes the role of supervisors in fostering sound corporate governance.
The board is responsible for the bank's overall well-being and has ultimate responsibility for the bank's business strategy and financial soundness. This includes key personnel decisions, internal organisation, governance structure, and practices, as well as risk management and compliance obligations.
The board should ensure that the bank maintains an effective relationship with its supervisors and that members of the board exercise their "duty of care" and "duty of loyalty" to the bank.
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Supervisors' Role in Sound Corporate Governance
Supervisors play a crucial role in fostering sound corporate governance at banks.
They should provide guidance for and supervise corporate governance, including through comprehensive evaluations and regular interaction with boards and senior management.
Supervisors should require improvement and remedial action as necessary.
They should also share information on corporate governance with other supervisors.
This ensures that banks are held accountable for their governance practices and are given the support they need to improve.
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Learning and Objectives
Understanding the principles of banking is crucial for making informed decisions about your financial future.
The primary objective of banking is to provide a safe and secure place for individuals and businesses to store their money, making it easily accessible when needed.
Banking principles include the concept of fractional reserve banking, where banks keep a small portion of deposits in reserve and lend out the rest, creating new money in the process.
This process allows banks to offer loans and credit to customers, which can be used to finance purchases, investments, or other business ventures.
Effective banking practices also involve maintaining a stable and liquid balance sheet, ensuring that the bank has sufficient funds to meet its financial obligations.
By understanding these principles, individuals can make informed decisions about their financial management and take advantage of the benefits offered by banks.
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General Information
Banking is a vital part of our daily lives, and understanding its principles can help us make informed decisions about our finances.
A bank's primary function is to act as a financial intermediary, accepting deposits from individuals and businesses and using those funds to make loans and investments.
Banks play a crucial role in facilitating economic growth by providing access to credit and financing for businesses and individuals.
In return for their services, banks charge interest on loans and fees for services such as checking and savings accounts.
The interest rate on a loan is determined by the bank's risk assessment and the market conditions at the time the loan is made.
Banks are required to maintain a minimum level of capital and liquidity to ensure their stability and solvency.
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Sources
- https://en.wikipedia.org/wiki/The_Principles_of_Banking
- https://www.nowherebookshop.com/book/9780470825211
- https://www.abebooks.com/first-edition/Principles-Banking-Wiley-Finance-Choudhry-Moorad/30912246458/bd
- https://www.sussex.ac.uk/study/modules/undergraduate/2024/93278-principles-of-banking
- https://www.bis.org/fsi/fsisummaries/corp_gov_principles.htm
- https://saylordotorg.github.io/text_money-and-banking-v2.0/s12-03-bank-management-principles.html
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