The Economics of Banking

The Economics of Banking describes and explains the behaviour of banks by examining trends and operations in banking within a mathematically accessible microeconomic framework. This new 3^rd edition has been fully revised and updated to reflect the major changes that have taken place in the banking sector and many new topics including new coverage of Islamic banking.

This accessible and user-friendly textbook is essential reading for final year undergraduate and postgraduate students taking courses in banking.

New to this Edition:

• Fully updated including new material on the financial crisis and the many implications for banking
• New coverage of Islamic banking
• Discussion of microfinance/credit unions is included in chapter 4
• New coverage of the Shadow Banking System
• The impact of Basel 3 and the Vickers Report is discussed particularly with regards to the idea of ring fencing
• Updated statistics and financial data

Kent Matthews is Associate Dean for Engagement & International Relations and the Sir Julian Hodge Professor of Banking and Finance at Cardiff Business School. He has held previous posts at the National Institute of Economic and Social Research, and the Bank of England, and has been a research visitor to the Hong Kong Monetary Authority.

John Thompson is Emeritus Professor of Finance at Liverpool John Moores University.

Preface xi

CHAPTER 1 Trends in Domestic and International Banking 1

1.1 Introduction 1

1.2 Deregulation 3

1.3 Financial Innovation 4

1.4 Globalization 6

1.5 Profitability 8

1.6 The Future 16

1.7 Conclusion 19

1.8 Summary 19

Questions 20

Test Questions 21

CHAPTER 2 Financial Intermediation: The Impact of the Capital Market 23

2.1 Introduction 23

2.2 The Role of the Capital Market 24

2.3 Determination of the Market Rate of Interest 30

2.4 Summary 34

Questions 35

Test Questions 35

CHAPTER 3 Banks and Financial Intermediation 37

3.1 Introduction 37

3.2 Different Requirements of Borrowers and Lenders 38

3.3 Transaction Costs 40

3.4 Liquidity Insurance 43

3.5 Asymmetry of Information 46

3.6 Operation of the Payments Mechanism 51

3.7 Direct Borrowing from the Capital Market 51

3.8 Conclusion 52

3.9 Summary 53

Questions 53

Test Questions 53

CHAPTER 4 Banking Typology 55

4.1 Introduction 55

4.2 General Features of Banking 56

4.3 Retail Banking 59

4.4 Wholesale Banking 61

4.5 Universal Banking 63

4.6 Islamic Banking 64

4.7 Microfinance 66

4.8 Shadow Banking 68

4.9 Summary 70

Questions 70

Test Questions 70

CHAPTER 5 International Banking 71

5.1 Introduction 71

5.2 The Nature of International Banking 72

5.3 Growth of International Banking 75

5.4 The Eurocurrency Markets 77

5.5 Summary 84

Questions 84

Test Questions 85

CHAPTER 6 The Theory of the Banking Firm 87

6.1 Introduction 87

6.2 The Textbook Model 88

6.3 The Perfectly Competitive Bank 90

6.4 The Monopoly Bank 92

6.5 The Imperfect Competition Model 97

6.6 Summary 100

Questions 100

Test Questions 101

CHAPTER 7 Models of Banking Behaviour 103

7.1 Introduction 103

7.2 The Economics of Asset and Liability Management 104

7.3 Liquidity Management 104

7.4 Loan Pricing 109

7.5 Asset Management 112

7.6 The Real Resource Model of Asset and Liability Management 118

7.7 Liability Management and Interest Rate Determination 120

7.8 Summary 123

Questions 124

Test Questions 124

CHAPTER 8 Credit Rationing 125

8.1 Introduction 125

8.2 The Availability Doctrine 126

8.3 Theories of Credit Rationing 127

8.4 Asymmetric Information and Adverse Selection 129

8.5 Adverse Incentive 130

8.6 Screening versus Rationing 133

8.7 Empirical Evidence 135

8.8 The Existence of Credit Rationing 136

8.9 Summary 139

Questions 140

Test Questions 140

CHAPTER 9 Securitization 141

9.1 Introduction 141

9.2 Sales of Securities through Financial Markets 144

9.3 Asset-Backed Securitization (ABS) 146

9.4 The Process of Asset-Backed Securitization 147

9.5 The Gains from Asset-Backed Securitization 148

9.6 Conclusions 155

9.7 Summary 155

Questions 155

Test Questions 156

CHAPTER 10 Banking Efficiency and the Structure of Banking 157

10.1 Introduction 157

10.2 Measurement of Output 157

10.3 Performance Measures 159

10.4 Reasons for the Growth of Mergers and Acquisitions 169

10.5 Motives for Mergers 172

10.6 Empirical Evidence 173

10.7 Summary 179

Questions 180

Test Questions 180

CHAPTER 11 Banking Competition 181

11.1 Introduction 181

11.2 Concentration in Banking Markets 182

11.3 Structure–Conduct–Performance 184

11.4 Competition Analysis 186

11.5 Competition in the UK Banking Market 192

11.6 Summary 198

Questions 198

Test Questions 199

CHAPTER 12 Bank Regulation 201

12.1 Introduction 201

12.2 The Case for Regulation 202

12.3 The Case against Regulation 209

12.4 Regulation 215

12.5 Summary 228

Questions 228

Test Questions 228

CHAPTER 13 Banks and Money Laundering 229

13.1 Introduction 229

13.2 Scale, Scope and Typology 230

13.3 Microeconomics of Money Laundering 235

13.4 Macroeconomics of Money Laundering 241

13.5 Combating Money Laundering 242

13.6 Summary 244

Questions 245

Test Questions 245

CHAPTER 14 Risk Management 247

14.1 Introduction 247

14.2 Risk Typology 248

14.3 Interest Rate Risk Management 250

14.4 Market Risk 260

14.5 Credit Risk 270

14.6 Operational Risk 279

14.7 Risk Management and the Global Banking Crisis 279

14.8 Conclusion 283

14.9 Summary 284

Questions 284

Test Questions 285

CHAPTER 15 The Macroeconomics of Banking 287

15.1 Introduction 287

15.2 The Economics of Central Banking 288

15.3 Financial Innovation and Monetary Policy 297

15.4 Bank Credit and the Transmission Mechanism 302

15.5 Summary 309

Questions 309

Test Questions 310

References 311

Index 323

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