List of important terms Economics of banking

Extensive list of important terms and definitions on the Economics of Banking

• Availability doctrine: States that spending is always in excess of available funds. Not the price but the availability of credit is the important determinant of credit.

• Credit rationing: The act of placing restrictions on the amount of credit.

• Adverse incentives: When the contracted interest rate creates an incentive for the borrower to take on greater risk than he/she otherwise would, so that the higher interest rate can be paid.

• Pooling contract: A common contract to the two types of borrowers, honest and dishonest borrowers.

• Securitization: The process of matching up of borrowers and savers wholly or partly by way of financial markets.

• Asset-backed securities: Sales of financial securities.

• Loan origination: Location of creditworthy borrower.

• Loan funding: Funds secured through designing securities that are attractive to savers, in the case of bank deposits.

• Loan serving: Administering and enforcing loan conditions.

• Loan warehousing: Holding the loan in the lender’s portfolio of assets.

• Asset-backed securitization (ABS): is a process whereby liquid assets are pooled together and sold off to investors as a composite financial security that includes the future cash proceeds

• Method of data envelopment analysis (DEA): This is a non-parametric approach that constructs an envelope of outputs with respect to inputs using a linear programming method.

• Stochastic frontier analysis (SFA): This approach specifies a function for cost, profit or production to determine the frontier. It treats the random error with symmetric distribution and it treats inefficiency with an asymmetric distribution.

• Distribution-free approach (DFA): A functional form that assumes that random errors are zero on average and the efficiency is stable over time.

• Thick-frontier approach (TFA): This is a functional form that determines the frontier on performance of the best firms. All the firms are ranked according to their performances. This method provides efficiency rates for the industry as a whole rather than for individual firms.

• Static studies: Studies that do not consider the behavior of the merger firms before and after the merger.

• Dynamic studies: Studies that consider the behavior of the firms before and after the merger.

• Share price: Aggregate market value of target and acquirer prior to announcement.

• Exercise price: Hypothetical future market value of separate entities forecast by their beta value.

• Standard deviation: Annualized stander deviation of weekly returns after the merger.

• Dividend yield: Average dividend yield in the year after the merger.

• Market structure: Is defined as the interaction of demand and supply factors.

• The structure-conduct-performance (SCP): hypothesis that fewer and larger firms are more likely to engage in anticompetitive behavior.

• Herfindahl-Hirschman Index (HHI): The sum of the squared market shares of the banks in the market.

• N-bank concentration ratio (CR): The percentage of the market controlled by the top n banks in the market.

• Relative market power hypothesis: Individual banks may have informational advantages relating to their clients that give them localized market power independently of what could be obtained from collusion.

• Contestable market: This is a market in which an entrant has access to all production techniques available to the incumbents, is not prohibited from wooing the incumbent’s customers and entry decisions can be reversed without costs.

• New empirical industrial organization ( NEIO): The NEIO assesses the strength of market power by examining deviations between observed and marginal cost pricing, without using any market structure indicator.

• Rosse-Panzar method: A method that proposes the estimation of a bank’s specific revenue function in terms of the bank factor prices.

• The H-statistic: The sum of the elasticities of revenue with respect to factor prices.

• A bank run: When both types of agents withdraw their funds in period 1.

• The gearing ratio: It is the ratio of bank deposits plus external liabilities to bank capital and reserves.

• The risk capital-asset ratio: This ratio sets out a common minimum risk capital-asset ratio for international banks.

• A well-capitalized bank: A bank that has a total risk capital-asset ratio greater than or equal to 10% with a tier-1 capital-asset ratio greater than or equal to 6%.

• Standardized approach. It assesses weights of specific assets with the addition of the risk weights being ordered according to external rating agencies.

• Operational risk: The risk of loss resulting from inadequate or failed internal process, people, systems or external events.

• Free banking: A situation in which banks are allowed to operate freely without external regulation, subject to the normal restrictions of company law.

• Too-big-to-fail: A problem that arises because failure of a large bank would disrupt the financial system as a whole.

• Credit risk: The possibility of a loss as a result of default.

• Liquidity risk: The possibility that a bank will be unable to meet its liquid because of unexpected withdrawals of deposits.

• Operational risk: Possibility of loss resulting from errors in structuring payments or settling transactions.

• Legal risk: Possibility of loss when a contract cannot be enforced because the customer had no authority to enter into the contract or the contract terms are unenforceable in a bankruptcy case.

• Market risk: Possibility of loss over a given period of time related to uncertain movements in market risk factors.

• Yield curve level risk: An equal change in rates across all maturities.

• Yield curve shape risk: Changes in the relative rates for instruments of different maturities.

• A future: A transaction where the price is agreed now but delivery takes place at a later date.

• A basic swap: Exists when two parties agree to exchange cash flows based on notional principal.

• Call option: An option refers the right to purchase a security.

• Put option: Option to sell a security.

• Value-at-risk (VaR) model: Used to deal with market risk on the trading book is the It calculates the likely loss that a bank might experience on its whole trading book.

• Credit scoring: A technical method of assigning a score that classifies potential borrowers into risk classes, which determines whether a loan is made, rejected or lies n an area that requires additional scrutiny.

• A credit default swap (CDS) is an insurance policy where the safety of a loan is guaranteed to counterpart risk

• Contingent liability is: Failure to meet payment obligations, bankruptcy or moratorium in the case of sovereign debt, repudiation and material adverse restructuring of the debt.

• The discount rate: The rate of interest at which the central bank is willing to lend reserves to the commercial banks.

• Taylor rule: This is an interest rate response function that reacts to inflation deviating from its target and real output deviating from some given capacity level of output:

• Credit channel: Works by amplifying the effects of the interest rate changes by endogenous changes in the external finance premium.

• The external finance premium: The gap between the cost of funds raised externally and the cost of funds raise internally.