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BUS FINANCE 826

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Operational returns and risks, and the importance of optimal management and ... IT/Telecomm systems outage. Technology provider failure. Contingency planning ... – PowerPoint PPT presentation

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Title: BUS FINANCE 826


1
BUS FINANCE 826
2
Overview
  • Operational returns and risks, and the importance
    of optimal management and control of labor,
    capital, and other input sources and their costs.
    The emphasis is on technology and its impact on
    risk and return.
  • Examples Risks resulting from innovations in IT,
    and effects of terrorist attacks on key
    technologies.

3
Sources of Operational Risk
  • Technology
  • Employees
  • Customer relationships
  • Capital assets
  • External

4
Importance of Technology
  • Efficient technological base can result in
  • Lower costs
  • Through improved allocation of inputs.
  • Increased revenues
  • Through wider range of outputs.
  • Earnings before taxes (Interest income -
    Interest expense) (Other income - Noninterest
    expense) - Provision for loan losses

5
Impact of Technology
  • Interest income can be increased
  • Through wider array of outputs or cross selling.
  • Interest expense can be decreased
  • Through improved access to markets for
    liabilities
  • Fedwire, CHIPS

6
Impact of Technology
  • Other income can be increased
  • Through electronic handling of fee generating OBS
    activities such as LCs and derivatives
  • Noninterest expenses can be reduced
  • Through improved efficiency of back office
    operations using technology. Especially true for
    securities-related activities.

7
Impact on Wholesale Banking
  • Improvements to cash management
  • Controlled disbursement accounts
  • Account reconciliation
  • Wholesale lockbox
  • Electronic lockbox
  • Funds concentration

8
Impact on Wholesale Banking (continued)
  • Electronic funds transfer
  • Check deposit services
  • Electronic initiation of letters of credit
  • Treasury management software
  • Electronic data interchange
  • Facilitating B2B e-commerce
  • Electronic billing

9
Impact on Wholesale Banking (continued)
  • Verifying identities
  • Issue of law enforcement access to encrypted data
    since September 11, 2001
  • Assisting small business entry into e-commerce

10
Impact on Retail Banking
  • Automated teller machines
  • Point-of-sale debit cards
  • Home banking
  • Preauthorized debits/credits
  • Pay-by-phone
  • E-mail billing
  • Online banking
  • Smart cards

11
Effects of Technology on Revenues and Costs
  • Investments in technology are risky
  • Potentially negative NPV projects due to
    uncertainty and potential competitive responses
  • Potential agency conflicts
  • Growth-oriented investments may not maximize
    shareholders value
  • Losses on technological investments can weaken an
    FI

12
Effects of Technology on Revenues and Costs
  • Evidence shows the impact of regulation on value
    of technological innovations.
  • Branching restrictions in U.S. affect the value
    of cash management services, for example.
  • Less valuable in Europe where comparable
    restrictions are absent

13
Effects of Technology on Revenues and Costs
  • Revenue effects
  • Facilitates cross-marketing
  • Increases innovation
  • Service quality effects
  • Survival of small banks and value of human
    touch
  • Cost effects
  • Technological improvements
  • Shift in cost curve.

14
Effects on Costs (continued)
  • Economies of scale
  • Optimal size depends on shape of average cost
    curve.

Size
15
Effects on Costs (continued)
  • Economies of scope
  • Multiple outputs may provide synergies in
    production.
  • Diseconomies of scope
  • Specialization may have cost benefits in
    production and delivery of some FI services

16
Testing for Economies of Scale and Scope
  • Production approach
  • Views FI as producing output of services using
    inputs of labor and capital.
  • C f(y,w,r)
  • Intermediation Approach
  • Includes funds used to produce intermediated
    services among the inputs.
  • C f(y,w,r, k)

17
Empirical Findings
  • Evidence economies of scale for banks up to the
    10 billion to 25 billion range.
  • X-inefficiencies may be more important.
  • Inconclusive evidence on scope.
  • Recent studies using a profit-based approach find
    that large FIs tend to be more efficient in
    revenue generation.

18
Technology and Evolution of the Payments System
  • Use of electronic transactions higher in other
    countries. (E.g., TARGET).
  • U.S. Payments system
  • FedWire
  • Clearing House Interbank Payments System (CHIPS)
  • Combined value of transactions often more than
    2.7 trillion per day.

19
Web Resources
  • For information on the Clearing House Interbank
    Payments System, visit
  • CHIPS www.chips.org

Web Surf
20
Wire Transfer System Risks
  • Daylight overdraft risk
  • FedWire settlement at 630 EST
  • Example of magnitude of daylight overdraft risk
    Bank of New York (BONY)
  • Regulation J guarantees payment finality of wire
    transfer messages by the Fed
  • Regulation F sets exposure limits to individual
    correspondent banks.

21
Risks (continued)
  • International Technology Transfer Risk
  • Crime and Fraud Risk
  • Regulatory Risk
  • Technology facilitates avoidance of regulation by
    locating in least regulated state or country.
  • Tax Avoidance
  • Competition Risk

22
Other Operational Risks
  • Employees
  • Turnover
  • Key personnel
  • Fraud
  • Errors
  • Rogue trading (Barings, Allied Irish/Allfirst)
  • Money laundering
  • Confidentiality breach

23
Technology Risks
  • Programming error
  • Model risk
  • Mark-to-market error
  • Management information
  • IT/Telecomm systems outage
  • Technology provider failure
  • Contingency planning

24
Customer Relationship Risks
  • Contractual disagreement
  • Dissatisfaction from poorly performing technology
  • Default

25
Capital Asset Risk
  • Safety
  • Security
  • Operating costs
  • Fire/flood

26
External risks
  • External fraud
  • Taxation risk
  • Legal risk
  • War
  • Market collapse
  • Reputation risk
  • Relationship risk

27
Controlling Operational Risk
  • Loss prevention
  • Training, development, review of employees
  • Loss control
  • Planning, organization, back-up
  • Loss financing
  • External insurance
  • Loss insulation
  • FI capital

28
Optimal Risk Management
Cost
29
Regulatory Issues
  • 1999 Basel Committee on Banking Supervision noted
    the importance of operational risks
  • Required capital
  • Basic Indicator Approach
  • Standardized Approach
  • Internal Measurement Approach
  • Consumer protection issues

30
Pertinent Websites
  • For more information visit
  • American Banker www.americanbanker.com
  • BIS www.bis.org FDIC www.fdic.gov
  • Mortgage Bankers Assoc. www.mbaa.org
  • Federal Reserve Bank www.federalreserve.gov
  • The Economist www.economist.com
  • The Wall Street Journal www.wsj.com
  • CHIPS www.chips.org

Web Surf
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