Economics of Banking and Finance: Roles of Banks, Debt Financing, Basel III and OCBC

This article discusses the two key roles of banks in the financial system, critical evaluation of debt financing for financial surplus and deficit units, changes to Basel III requirements and their impact on OCBC. It also covers asset securitization and implications of the global financial crisis on the bank’s financial performances.

Running head: ECONOMICS OF BANKING AND FINANCE
Economics of Banking and Finance
Name of Student:
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1ECONOMICS OF BANKING AND FINANCE
Table of Contents
Two key roles of the bank in terms of its contributions to country’s financial system...................2
Critical Evaluation of problem with relying on debt finance for financial surplus unit and
financial deficit unit.........................................................................................................................4
Changes to the capital adequacy, liquidity and leverage requirements as stipulated by Basel III
and its impact on OCBC..................................................................................................................5
Processes of asset securitization......................................................................................................8
Implications of the global financial crisis on the bank’s financial performances.........................10
References......................................................................................................................................12

2ECONOMICS OF BANKING AND FINANCE
Two key roles of the bank in terms of its contributions to country’s financial system
The developmental activities of a country are dependent on its economic growth which is
attained over a certain period. The economic growth considers the investment and the production
to the extent which illustrates that the investment and production is to the extent of GDP in a
country. This leads to improvement in the overall standard of living and economic development.
The two key contributions of the banks in terms of the financial system are stated below as
follows:
1. Brokerage Services - Banking assists in investing in listed securities in the capital market.
These services are discerned to be provided in accordance with registered financial
advisors who are able to provide a high level of professional assistance to their clients. In
the recent times, banking service is able to determine the long-term and short-term
financial goals along with risk tolerance limit. It is also able to examine the most suitable
alternative investments which might help in reaching the desired goal and execute trades
(Webb and Martin 2017). OCBC securities is considered as one of the first brokerage
service in Singapore to introduce “OCBC OneTouch on their iOCBC TradeMobile” app
for both Android and iPhone which enabled the users to evaluate their stock portfolio.
The bank took noteworthy initiative to launch app named Apple Watch. This service was
able to provide important “account information via wrist devices”. The bank is able to
make significant contribution to the financial system with continuous engagement with
prospective customers to initiate cross selling of the brokerage services. In addition to
this, OCBC launched “StockReports+ in September 2016”, which aggregates
independent research done by the brokers and provide quantitative analysis for the stocks
in “Singapore, Hong Kong, United States and Malaysia markets”. OCBC expanded the
contribution of brokerage services to the financial system by enabling trading on the
“Shenzhen ‘A’ market after the launch of the Shenzhen-Hong Kong Stock Connect in
November 2016”. This allowed the existing customers to trade over 15 global exchange
online (Ocbc.com. 2018). Some of the other brokerage services are identified in form of
providing opportunity to earn income on unvested cash in the brokerage account with
bank deposit program thereby assisting in dividend reinvestment plan, periodic

3ECONOMICS OF BANKING AND FINANCE
reinvestment plan and providing margin borrowing and option trading (Unionbank.com.
2018).
2. Asset Transformation - The process of asset transformation deals with creating new
asset from liabilities with different characteristics and conversion of small denomination,
“immediately available and relatively risk-free bank deposit into loans”. Asset
transformation in banks is used with deposits to produce revenue for pooling deposits to
fund loans. Henceforth, in a simple way the process of asset transformation involves
converting bank liabilities or deposits into bank assets or loans. The primary activities of
bank include withdrawal of deposits by the customers at the stipulated time and the
contract is made at the time of deposit agreement (Entrop et al. 2015). Bank loans are
considered as assets as the present money is the bank lends and expects to receive along
with interest payments. Very often, bank decides to undertake asset transformation via
lending long and borrowing short rate of interests with transformation of revenues. The
bank performs asset transformation by offering varieties of financial products in form of
“deposits, loan products and investment options” (Majd Bakir 2015). The asset
conversion cycle of OCBC shows that as there was an increase in the customer deposit by
6% in 2016 (“amounting to S$ 261 billion”), this comprised of 80% compensation for
funding of the group. This shows that 80% of the Banks’s liabilities (deposits) were
transformed into assets (loan). The sound assets transformation policies adopted by the
bank was further evident with a stable funding and liquidity position in 2016. In addition
to this, there was an increase in the “loans-to deposits ratio stood at 82.9%, as compared
with 84.5% a year ago”. However, bank is in a good position to cover any unforeseen
fund requirements due to the high asset transformation rate (Ocbc.com. 2018).
A study conducted by the IMF has implied that an increase in one percentage
point of the GDP is able to increase the output by 0.4% in the same year and after four
years by 1.5%. In general, the financial institutions are also able to bring economic
development in the infrastructure facilities in a country with asset conversion. The
financial services are discerned to play an important role in terms of providing growth to
the infrastructural facilities. The private sector finds it difficult for raising the capital
needed for setting up of the infrastructure industries. The development banks and the

4ECONOMICS OF BANKING AND FINANCE
merchant banks are able to contribute for raising capital in these industries. Banks have
the opportunity to work with multilateral developing organizations for setting up
financial and investment funds and other industrial platforms (Bhattacharya, Oppenheim
and Stern 2015). The multinational banks have been able to gather substantial amount of
information pertaining to “management, client, government and market-related
information” with the help of daily operations. They have been able to resolve several
types of the finding issues associated to infrastructural development. There is significant
scope of commercial financial institutions which may work with the multilateral
development organizations and financing funds. The global infrastructure is able to
embrace new opportunities. This is done by strengthening cooperation and resolving
investment issues faced in several countries, there is significant opportunity for
development of economy, infrastructure quality along with promotion of regional
connectivity (IMF 2014).
Critical Evaluation of problem with relying on debt finance for financial surplus unit and
financial deficit unit
There are number of problem associated to the financial deficit and financial surplus
units. For instance, the problem with financing to providing debt finance to financial surplus unit
was depicted with “maturity mismatch, size mismatch, return and risk” for OCBC in 2015. In
several instance OCBC struggled to meet the short maturity debts. As per the financial
revealing, OCBC has majority forms of Credit Exposure arising out of residual contract maturity
amounting to S$119152 in 2016. As per the depiction of annual report published on 31st
December 2016, the “absolute non-performing asset grew by $ 2.89 billion in compared to $ 2.04
billion”. This shows significant issues with the debt financing by bank to both financial deficit
and financial surplus units. The financial surplus units such as oil and gas support services
witnessed higher NPA because of the high “NPL ratio from 0.9% a year ago to 1.3% in 2016”.
However, the group had been able to maintain a strong funding position and capitalisation
options (Paligorova and Santos 2017).

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The problem associated to debt financing for financial deficit units are seen with OCBC
issuing of unsecured debt. This is evident with “subordinate debt, Commercial papers and
Structured notes” increasing in 2016. Over time the bank is seen to issue more debt within “1
week, 1-week to1 month, 1 to 3 months and 3 to 12 months”. The increasing debt obligations
over the months, shows that the securities comprise of the equity securities, trading and
investment portfolio of government, debt and equity securities (Eichengreen and Panizza 2016).
Some of the other risks identified with debt financing for the financial deficit units are
identified with lending to the consumer, corporate or institutional customers. Some of the most
noted trading and investment banking activities are discerned with banking activities pertaining
to “trading of derivatives, debt securities, foreign exchange, commodities, securities
underwriting and the settlement of transactions” (Porter 2016). This has exposed the group to the
counterparty and issuer credit risk. OCBC credit risk exposure is quantified in terms of the
transaction’s present positive “mark-to-market value plus an appropriate add-on factor for
potential future exposure”. For example, a bondholder may sell the bond at any time, in order to
receive this privilege, the bond holder will be able to make a lump sum payment at the time of
purchasing the bond. The rate of interest on bonds are generally lower than the bank loans but
the accessing time of the bank loans are faster (Christensen et al. 2016).
Changes to the capital adequacy, liquidity and leverage requirements as stipulated by Basel
III and its impact on OCBC
Basel III is identified as the global voluntary regulatory framework for bank which
assesses “market liquidity risk, stress testing and capital adequacy”. This is considered as the
third instalment of the Basel Accords after Basel I and Basel II, in reply to shortages of financial
guideline for the financial crisis of 2007 to 2008. The four-important consideration under Basel
III is acknowledged with capital adequacy ratio under capital requirements, leverage ratio under
leverage requirements and LCR and NSFR under “liquidity requirements”. As per the
prescription of the regulatory requirements under Basel III, OCBC needed to maintain “Common
Equity Tier 1” (“CET1”) “capital adequacy ratio” (“CAR”) of 4.5%”, Tier 1 CAR of 6% and
Total CAR of 8%. OCBC has adhered to the changes prescribed by Basel III and maintained
prescribed captain adequacy requirements. This is evident with, “common equity tier 1 of 14.7 in

6ECONOMICS OF BANKING AND FINANCE
2016 and 14.18 2015”. It has further able to maintain the minimum total capital requirements,
which is evident with total CAR of “15.90 in 2014, 16.8 in 2015 and 17.1 in 2016” (Ocbc.com.
2018).
The increasing nature of “capital adequacy ratio” is considered to be safe for the bank as OCBC
is in a better position to cover its financial obligations. (Ocbc.com. 2018).
Figure: Basel III Regulatory Capital Requirements
(Source: Tonse.in. 2018)

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The Basel III norms also strengthened the liquidity requirements by putting an augmented
effort to determine capital requirements for counterparty in case of credit default. The main
changes in the Basel III norms that are brought by strengthening the liquidity requirements in
form of LCR and NSFR. The introduction of NSFR was done to encourage the banks to utilize
stable sources while financing the operational activities. The LCR was introduced to ensure there
was sufficient stock for imaginative “high-value liquid asset” consisting of “cash or cash
equivalent units” for meeting liquidity obligations. Liquidity policies introduced under Basel III
(LCR) depicted that, the banks needed to consider “high-quality liquid asset” for covering “net
cash outflows” for more than 30 days. As per the NSFR requirement, the accessible sum for
stable funding is required to exceed the required amount of stable funding for more than one year
under extended stress. The objective of liquidity risk management of the bank was to confirm
that there are funds available to meet the contractual and regulatory obligations of finance and
OCBC is able to undertake new transactions. As per the fourth quarter result of 2016, the average
Singapore dollar (“SGD”) and “all-currency liquidity coverage ratios” (“LCR”)” for the group
thereby not considering OCBC Wing Hang which will be included in due course”) was depicted
with “284% and 145%” respectively. Balance sheet of the bank’s is able to demonstrate that
OCBC is recognized to prudently manage its risks and attain a healthy liquidity and funding
position. Based on the performance review the bank had to go through difficult operating
environment in 2016 (Chen, Dasgupta and Yu 2014). The availability of the sales national assets
is considered for infinite time and this may be held for selling the needs of liquidity or any
change in exchange policy, market prices or interest rate. The different types of expected
liquidity of the company are managed with combination of “treasury and asset liability practice
management”. However, OCBC is still working on its regulatory framework for applying the
regulatory reporting of Group-wide NSFR and “liquidity coverage ratio (LCR)” (Ocbc.com.
2018).
In several cases banks need robust risk-based ratio for capital as this helps in excessive
leverage build up. Basel III required the banks to maintain a minimum leverage ratio of 3%. This
is considered with leverage ratio as per risk and calculated by dividing Tier 1 capital by the
bank's average total consolidated assets”. In addition to this, The Basel Committee tested “a
minimum Tier 1 leverage ratio of 3% during the parallel run period from January 1, 2013 to
January 1, 2017”. The main changes brought in the leverage requirements had done to protect the

8ECONOMICS OF BANKING AND FINANCE
bank from systemwide build-up of leverage due to financial stress during destabilization or
unwinding of a certain process. The leverage ratio of OCBC was 8.2%, which was above than a
least requirement of 3% as suggested by the “Basel III committee”. OCBC was also decided to
introduce more transparent measures for capital requirement by maintaining a high
"discretionary counter-cyclical buffer” (Ocbc.com. 2018).
Processes of asset securitization and examine why OCBC may wish to securitize
The process of asset securitization is identified as practice for financial pooling different
types of contractual debts. These are identified with such as “auto loans, credit cards,
commercial mortgages and residential mortgages and sending the associated cash flows to the
“third-party investors” in form of securities”. These securities may be defined as “bonds, pass-
through securities, or collateralized debt obligations (CDOs)”. The associated investors are
recompensed from the “interest cash flows and principal” “collected from the underlying debt”
and redistributing the same with capital structure of new financing. The securities supported by
mortgage receivables are termed as “mortgage-backed securities” while securities backed by
“other receivables are termed as asset backed securities”. The procedure of asset “securitization”
is identified as a complex one which includes several actors. The diagram depicted below is
taken from IMF website which shows the rudimentary mechanism of creating securities and
transferring of asset. The entity which originally holds the asset, initiates the process by legal
entity which is known as SPV, specially created to limit the risk of the final investor in relation
to the issuer of the assets”. Based on the situation, SPV is either responsible for issuing the direct
securities or reselling the pool of assets to a trust (Agarwal et al. 2016).
SPV is a legal framework rather than the element which is responsible to play an active
role in the transaction process. The most noted character played by SPV is seen to be of that of
an arranger, which is typically a bank responsible for setting up the contract and evaluating the
“pool of assets”. It also determines the way in which this would be fed and characterized by
securities on like structure of fund. The main purpose of structuring is observed with the
postmodern “characteristics of securities”, in a way that they agree to the needs of final investor.
The arranger plays a significant role in distribution of the securities made for final “investors”.
This also enables refinancing of short-term debts with long-term bonds (Fimarkets.com. 2018).

9ECONOMICS OF BANKING AND FINANCE
Figure: Process of Asset Securitization
(Source: Obay 2014)
OCBC may wish to adopt asset securitization with the purpose of asset “transformation
intention, balance sheet consistency motive, fee income motive and funding motive”. Due to the
increasing percentage of loans, OCBC may wish to securitize some of its loans for changing the
balance sheet position. This may include opting for diversification strategies for the bank. The
bank is seen to be having significant amount of mortgage and as per the interpretations of
balance sheet and there is a high chance of being overexposed by these mortgages. Henceforth, if
OCBC decides to securitize some of its deemed excess, then the bank may acquire an asset more
favourably in areas pertaining to student loan. In this situation, the bank may lack the “capital
requirement” for purchasing these assets and may be reluctant to expand its balance sheet for
incorporating more student loans. Secondly, by the decision to securitize its assets, bank’s mmay
not have its funding, asset holding and risk-taking capabilities into different processes

10ECONOMICS OF BANKING AND FINANCE
(Abdelsalam et al. 2017). Due to this, securities would be able to link parties which possesses
more comparative advantage and share mutual benefit. The bank is discerned to be having a
comparative advantage in terms of initializing the loans. Henceforth, OCBC may be able to
outsource its relatively weaker SPV’s to the eventual investors and specialize in terms of funding
and holding loans. Moreover, in case the “SPV is not a subsidiary of the bank” then it needs to
pay a fee to the bank for purchasing of the assets and this can create additional source of income
thereby potentially leading to increased “rate of return on equity”. The shifting of this “credit
risk” enhances the capacity of the bank for lending activities. Furthermore, this increased
capacity enhances the bank reputation this customer and able to build an approachable bond by
providing loans to those otherwise struggle to obtain (Ocbc.com. 2018).
OCBC may also want to encourage its funding activities which benefited asset
securitization of bank loans. By exercising securitization options, the bank would be able to
widen its fund sources and the investors who had previously sceptical will no longer have to
invest their funds in a bank which they don’t prefer (Le, Narayanan and Van Vo 2016).
Implications of the “global financial crisis” on the bank’s financial performances
“Global Financial Crisis (GFC)” was well-thought-out as the one of the worst downturn
in global economy followed by Great Depression in 1930. The implication of this crisis
originated from Lehman Brothers bankruptcy filed On September 15, 2008. This was one of the
largest bankruptcy in the history with “$639 billion in assets and $619 billion in debt”, thereby
surpassing previous bankrupt giants such as “Enron and WorldCom”. The demise of “fourth-
largest U.S. investment bank” -entities such as “financial crisis” which swept through GFC in
2008. This collapse was identified as a seminal event which greatly intensified financial erosion
off close to “10 trillion in market capitalization from global equity markets in October 2008”
(Ball 2016).
The impact of GFC during 2008-2009 did not had any severe implication on the
performance of the bank. OCBC was able to maintain a sturdy “balance sheet and capital
position”. These implications were attributed to the basic blueprint for banking with its emphasis
on the SME and retail banking unlike the strong proprietary trading gains recorded in some
“global financial institutions”. The core net profit after tax for OCBC (“excluding the onetime

11ECONOMICS OF BANKING AND FINANCE
gains”) increased by “32% in 2009 to attain a new record of S$1,962 million. This was discerned
to be exceeded to the previous high of S$1,878 million in 2007”. The increase in the earnings in
2009 was recorded with higher amount of “non-interest income”, decrease in the allowances and
lower expenses. The allowed margin for adjustments and net interest income depicted a healthy
trend at the time of financial crisis. By the adaptation of a robust risk management framework,
active monitoring and prudent loan growth policy of the portfolios, OCBC was able to achieve
the best quality in terms of the asset and “credit loss” experience among the three banks based in
Singapore. In June 2009 the company’s Non-performing loan ratio peaked at “2.1%, compared to
1.7% in December 2007 and 1.5% in December 2008”. This value was depicted with an increase
of 1.7% in December 2009. The total amount of the assets and specific allowances for loan over
the average loan were discerned to be below 30 BPS in 2008 and 2009. The coverage ratio for
the allowances remained at a healthy level with “125% in December 2008 and 102% in
December 2009”. During the situation of crisis, OCBC continued to maintain a strong capital
cushion with a “Tier 1 ratio of 14.9% in 2008 and 15.9%”. This is seen to be even higher than
the non-financial crisis situation in 2007 when the ratio was only 11.5%. OCBC is considered as
the only bank in Singapore which did not reduce its DPS for the period (Bis.org 2018).
As Singapore is identified as a small and open economy with strong linkages with the
other countries, it severely got affected in terms of falling Global trade. The “Monetary Policy”
responses were graduated deliberately, which was underpinned with the objective of promoting
“price stability” in medium term. Singapore government intentionally did not respond to every
single development in the “economy or the financial markets” as this would have brought in
needless volatility and ambiguity. In response to the significant decline the external demand in
the late 2008, MAS was seen to support the domestic economy in the early 2010 thereby
consideration for strong recovery path of the rising economy. In the early 2010, the government
took a strong recovery route for addressing the rising “domestic cost pressures amidst high rates
of resource utilisation”. To address this concern, MAS was seen to shift its gradual and modest
appreciation towards “S$NEER policy band”. Subsequently a more stricter policy for MAS
tightening is seen from improving on the policy band slope (Bis.org. 2018).

12ECONOMICS OF BANKING AND FINANCE
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