chapter 3: managing relationships with service providers outline: fis: functions and services fsp...

Chapter 3: Managing Relationships with Service Providers

Outline: FIs: Functions and Services FSP Selection Process Bank Relationship Management Global Account Management Account Analysis in the U.S. Commercial

Banking System Monitoring Financial Service Provider Risk in

the U.S. Other Topics in Managing Service Provider

Relationshipsv3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 1

FIs: Functions and Services— Global (Non-U.S.) FIs

Services: depository accounts, transaction services, lending, FX, information reporting and investment banking

May serve different markets

Functional split between commercial and investment banking

Other services: trade services, agent and fiduciary services, risk management and consulting

v3.0 © 2011 Association for Financial Professionals. All rights reserved. Session 2: Module 1, Chapter 3 - 2

Global FIs Required to follow guidelines

of each country Less regulated than single

country banks Minority or controlling

interest in corporations Lend large percentage of

capital to one customer

In most countries Large nationwide banks Pay interest on positive

balances and have automatic overdraft loans

Multicurrency accounts Nonresident accounts

U.S. Commercial Banks

Deposit accounts Credit services Investment

banking services Payment and

collection services Trade services Foreign exchange

(FX) services

Risk management services

Fiduciary services Consulting services Other financial

services Broker/dealer

services Insurance company

affiliation


Discussion Question

How do you define the term “commercial bank” in the U.S.?

Answer:A financial institution possessing a federal or state charter that accepts deposits and makes commercial loans. It may also offer other services.


Deposit AccountsDemand deposit accounts (DDAs)

Checking accounts, NOW accounts

Dodd-Frank Act repeal of Reg Q

In most countries other than U.S., practice is to incorporate both an investment rate and a credit agreement

Time deposit accounts (TDAs)

Must be held for specified period

CDs (under $100K) Jumbo CDs (over

$100K) Fully negotiable

CDs ($1 million blocks)

Savings accounts MMDAs


Discussion Question

Which of the following commercial bank services is an integral part of the CP and municipal securities markets?a) Credit servicesb) Investment banking servicesc) Payment and collection servicesd) Foreign exchange (FX) servicese) Risk management services


Discussion Question

Do all investment banking firms have to be full-service providers?

Answer:No. Investment banking and brokerage firms provide a wide range of services related to the issuance and trading of securities. Companies tend to specialize in the services offered (investment or brokerage) as well as customers (institutional or retail).


Investment Banks

Underwriting/ intermediary

Facilitate mergers, acquisitions and divestitures

Broker/financial advisor

Issue stocks and bonds: Origination Underwriting Distribution


Underwriting

Full underwriting Investment bank or

syndicate owns entire issue.

Company has all the money it will receive and can use it.

Investment bank(s) assume price and marketability risks.

Best-efforts basis If investment bank

or syndicate is not confident it can sell entire issue.

Company pays a fee for advice and marketing.

Sell as many shares as possible up to specified limit.


Discussion Question

Which of the following is true for full service banks that offer both the underwriting/distribution function and the investment advisory or management function?a) “Bringing someone over the wall” is a clear violation of

SEC regulations and ethics guidelines.b) Distribution and underwriting are referred to as the buy

side.c) Buy side and sell side transactions should be separated

by a “Chinese Wall” that prevents each party from acquiring material non-public information (MNPI) and acting upon it.

Answer: c


Other Financial Institutions Savings institutions

Savings and loan associations

Federally or state-chartered

For-profit or not-for-profit

Credit unions National Credit

Union Association or state-chartered

Mutual funds

Other non-bank FIs Industrial credit

and capital companies

Industrial bank Captive finance

companies Factors Insurance

companies Pension funds Consumer finance

companies


FSP Selection Process: Reasons

Need for a new product or service

As part of a re-engineering program

As part of a regular product and service review

To reduce costs To update existing

technologies

To reflect a change in the banking group

To comply with statutory or regulatory requirements


FSP Selection Process: Selection Criteria Geographic

considerations Ability to fulfill

specifications Personnel expertise,

including customer service and product support

Knowledge of specific industry

Ability to customize or create new services and meet future needs

Adequacy of internal controls, backups and disaster recovery plans

Pricing References

Also assess: Financial strength Willingness to

provide credit on flexible terms at competitive rates


Soliciting Information from FSPs

Request for information (RFI) Vendor’s interest in and ability to provide service

or solve key business problem Justify existing vendor or narrow field for RFP

Request for proposal (RFP) Formal outline of company’s objectives, needs,

service requirements; requests bids Some government entities must use RFPs

periodically to ensure competitiveness AFP standard formats for computer analysis Supply best prices using AFP Service Codes


Discussion Question

What items should a typical RFP request from prospective vendors?

Answers: Background information Summary of proposed solution List of provider’s team leaders Service descriptions, features

and benefits Demonstration of provider’s

commitment to support and enhance services

Cost/benefit analysis Pro forma account analysis or pricing

schedule Sample service commitments

or agreements


Timetable for service implementation

Client references Online reporting and

transaction abilities Disaster recovery

and backup procedures

List of vendors by area

SOX compliance for U.S. (SAS 70)

Discussion Question

What general factors increase the mutual benefit and profitability of the relationship between a company and a bank?

Answers: Open and frequent communication Regular and timely feedback Documentation of expectations of both

parties in agreements and legal contracts Fairly priced, efficient and effective

financial services/products Complete, candid, and timely disclosure

of information by both parties


Number of Bank Relationships

Multistate or international operations Costs of multiple relationships

Lead institution Bank’s relationship profitability measures result

in lower costs for use of multiple services Pricing of loans Pricing of depository services

Concentration risk Relative strengths of each bank Organization’s credit needs


Factors Involved in the Pricing of Loans

Cost of funds Risk of repayment Total loans

committed and outstanding

Service fees Deposit balances Range of other

services used (e.g., foreign currency or derivatives trading)

Loan maturity Revenue size

and importance of overall relationship to lending institution


Factors Involved in the Pricing of Depository Services

Volume Customization Exception handling

requirements Cost of providing

the service Operational

overhead Deposit balances

maintained

Other services used (e.g., global trade services, L/Cs and custody services)

Credit relationship Revenue size and

importance of overall relationship to FI


Documentation

Service agreement/ contract

Service level agreement (SLA)

Account resolution

Signature cards and account terms


Elements of Service Agreementsand SLAs

Service agreement Compensation policies,

including pricing, method of payment, payment frequency, excess/deficit balance arrangements, contract length, adjustments

Liability clauses defining responsibilities for specified risks

Other terms and conditions of the relationship

SLA Operational policies

and procedures, including detailed processing requirements for service, information needs, and list of individuals authorized to make changes

Performance standards that define agreed-upon levels of service performance and quality


Discussion Question

What is a bank scorecard, and what is its purpose?Answers: A management tool used to measure a

bank’s performance in both a qualitative and quantitative method.

Primary purpose is to provide a quantitative measure of the service provided and benefit received, but it also provides feedback on perceived value/quality/cost of the services provided.


Fee versus Balance Compensation

Company perspective Fees preferred when

investment/debt payment can generate greater ROI than earnings credit (EC).

Balance compensation allows excess balances to earn a return: Banks price loans more

favorably. Not as visible on

statements. Tax status. ECRs may exceed short-

term rates.

Bank perspective Fees preferred because

deposits are a liability; because fees are low-risk source of earnings.

Balances used to fund loans and investments at rates over ECR.


Comparing Costs Among Service Providers and Billing for Bank Services

Difficulties in comparing costs among banks: Bundling Varying prices, depending on level of service

provided by FI ECs, deficient balance charges, availability

schedules Monthly, quarterly, semi-annually or annually

Account analysis statement for billing Global billing uses TWIST BSB format


Global Account Management: Sovereign and Political Risk Unique banking

structures and documentation requirements per country

Sovereign risk Political risk Nationalization Expropriation Blocked currencies Forced reinvestment Required majority

ownership

Laws, regulations, taxes, customs

Value dating Bank

compensation and fee structures

Legal and ethical issues


Discussion Question

When a withdrawal is back-valued, the date of the debit to the customer’s account a) is earlier than the actual date the item is

deducted from the ledger balance.b) is later than the actual date the item is

deducted from the ledger balance.

Answer: a. Under a value dating system, a bank sets a forward value date on which the value of funds credited to an account is determined and establishes a back value date on which the value of funds debited from an account is determined.


Discussion Question

What information does an account analysis statement provide to the bank’s commercial customers?

Answer: Services provided Balances maintained Volumes processed Charges assessed Earnings credit allowances


Account Analysis in the U.S. Commercial Banking System

Record of services provided with detailed information on balances and credits earned

AFP Service Codes ASC X12 822

account analysis format

AFP Guide to Account Analysis

Account analysis terminology Average ledger balance Average deposit float Average collected

balance Reserve requirement Service charges Available or investable

balance Earnings credit

allowance and earnings credit rate


Earnings Credit

Where:EC = Earnings creditCB = Average collected balancesRR = Reserve requirementECR = Earnings credit rateD = Number of days in the month


DEC = CB × (1 RR) × ECR365

Assume the following scenario: Average ledger balance $250,000

Deposit float $30,000Reserve requirement 10%Earnings credit rate 5%Service charges for the month $1,000Days in month 30


Average Collected Balance Calculation:Average ledger balance $250,000Less: Deposit float ($30,000)Equals: Average collected balance $220,000

DEC = CB × (1 RR) × ECR 365

30= $220,000 × (1 0.10) × 0.05 × 365

= $220,000 × 0.9 × 0.0041095 = $813.68

Earnings Credit

Collected Balances Required


Where:CB = Average collected balances required to pay service chargesSC = Service chargesECR= Earnings credit rateRR = Reserve requirementD = Number of days in the month

SCCB =DECR × × (1 RR)

365

Collected Balances Required


Assume the following scenario:Monthly service charges $1,000Earnings credit rate 5%Reserve requirement 10%Days in month 30

(

SCCB =DECR × × (1 RR)

365

$1,000=30 0.05 × × (1 0.10)365

$1,000 $1,000= = = $270,372.570.00369860.05 × 0.0821917) × 1 0.10

Discussion Question

An FI with a lending relationship also serves as a bond trustee. If the borrower becomes distressed, there is a risk of which of the following?a) Conflict of interest, if the FI protects its own credit

to the detriment of the borrower and bondholdersb) Financial risk, if the borrower default would lower

the FI’s Uniform Bank Performance Report scorec) Operational risk, if the trustee relationship

prevented the FI from performing an SAS 70 Type I audit on the borrower

Answer: a


Assessing Risk for FIs: UBPR

Uniform Bank Performance Report (UBPR) FFIEC analytical tool for bank supervisory,

examination and management purposes. UBPR presents three types of data:

The bank’s data Data for a peer group of banks similar in size and

economic environment Percentile rankings

Compare bank to its peer group, consider bank’s trends over time, and recognize trends and changes in peer group averages.


Assessing Operational Risk for FIs

SAS 70 audit developed by AICPA.

Report on “processing of transactions by service organizations.”

Type I is “reporting on controls placed in operation.”

Type II is all of Type I plus “tests of operating effectiveness.”

Value provided to service providers: Service auditor’s report

with an unqualified opinion is differentiator

Helps build trust with customers

One report rather than reports for each customer

Customers can provide service auditor’s report to their providers


Monitoring Bank Risk: CAMELS

Capital adequacy Asset quality Management

capability Earnings Liquidity Sensitivity to

market risk


Three Pillars of Basel II


BASEL II

Minimum Capital

Requirements

Supervisory Review Process

Market Discipline

1 2 3

Discussion Question

Which of the following has become a very real consideration in bank relationship management and should be considered when evaluating a contract for services of any kind with a bank or FSP?a) Credit riskb) Political riskc) Counterparty riskd) Onshoring risk

Answer: c


End of Session 2

Assignment: Complete the following tasks for Module

Two, Chapters 4 and 5: Review each chapter. Complete the test-your-understanding

questions at the end of each chapter. Complete the online calculations. Complete the online module-specific test. Complete the Exam Practice (Describe and

Differentiate) questions (located at the end of the module).


chapter 3: managing relationships with service providers outline: fis: functions and services fsp...

Documents

financial professionals

financial institution

transaction services

investment banking firms

services global non

wide range of services

commercial loans

investment bankingmay