London School of Economics and Political Science (LSE)

Modules

94
Principles of banking

This subject serves as an introduction to the principles and process of financial intermediation
with particular reference to the operations of the UK banking system. Banking operations are
examined as portfolio allocation preferences, with emphasis placed on the role played by
innovation and deregulation in the development of bank products and services. For this purpose,
the UK banking system is taken as an exemplar of many of the trends that are reshaping financial
services around the world.

Introduction to the financial system: the role of the financntermediation:the process and
implications of financial intermediation; rationale for the existence of financial intermediaries;
evolution of financial systems; recent developments in the UL financial system; market structure
and financial innovation.

Retail banking: the nature of retail banking in the UK; payment services; risks in retail banking;
the role of the central bank in retail banking.

Wholesale and international banking: the nature of wholesale banking; off-balance sheet
business; international banking; sovereign lending risk.

Financial markets: the nature of financial markets; the principles of hedging; speculation and
arbitrage; the efficient markets hypothesis; international financial centres.

The foreign exchange market: introduction to the Forex markets; nature of the Forex; types of
business; the efficiency of the Forex markets.

Euro-securities markets: outline of the functions of the markets; Eurodollar; credit creation;
Eurobonds; Euronotes; Euro-equities; securitisation.

Risk management: the nature of risk; financial futures; options and swaps; forward rate
agreements; managing exchange rate risk and interest rate risk.

Regulation of the financial system: history of bank failures; the prudential control of banks;
depositor protection; prudential regulationin the UK; prudential regulation in the US; international
co-ordination industrialised countries; the US banking system; the banking structure in Japan; the
single European market in financial services; banking structures in developing countries: Islamic
banking; banking structures in Eastern Europe.

London School of Economics and Political Science (LSE)

Modules

100
Banking operations and risk analysis
Prerequisite – 94 Principles of banking

Trends in banking structure: considers the main trends influencing the development of financial
institutions around the world. The most important of these are the impact of technological and
financial innovations combined with the structural de-regulation of financial markets. One of the
consequences of these trends is a move towards the concentration of financial services with an
increasing number of mergers between banks and other financial organisations.

Theories of the banking firm: examines various models of the banking firm, such as the asset
allocation and the liability of choice models, as well as considering the asset transformation role
of banks and the various roles of banks’ liabilities and the two-sided nature of the financial firm.
Various methods of analysing bank performance are also considered.

Balance sheet management, liquidity and capital adequacy: considers the asset and liability
management of banks. A brief history of asset and liability management is followed by an
examination of techniques for managing assets and liabilities, including the role of liquidity and
capital adequacy.

Risk and risk management: covers risk and risk management. Six main types of risk are
analysed: credit risk, liquidity risk, interest rate risk, currency risk, country risk and contingent risk
(off-balance sheet risk). The various methods for controlling these risks are considered.

Lending: Analyses the leading functions of banks, covering short, medium and long-term lending
and the associated assessment of risk/return. Issues of security, ability to repay and the
administrative process are also considered.

Retail banking: covers trends and developments in retail banks. Of particular relevance is the
impact of technological and socioeconomic developments which have influenced the supply of
new banking products. The evolution of new products over the last 20 years is considered
together with the changing nature of the bank/customer relationship.

Wholesale and corporate banking: examines wholesale and corporate banking covering produce
range, treasury functions (including derivatives), and the changing nature of the relationship
between banks and their corporate clients. Of particular relevance is the segmentation of the
market between small and large corporate clients, and how banks respond to their different
needs.

International banking: covers trends in international banking by examining the various definitions
of different types of international banking and branches overseas; the relationship between
international banking and the capital markets (particularly the Euromarkets), the role of banks in
international financing, and the role of banks in lending to the Third World countries.

Risks, crises and prudential regulation: analyses risks, crises and prudential regulation. The
various types of risks which need to be regulated are examined together with issues surrounding
prudential regulation, including the move towards a common international environment.

Risk management:

1. Managing interest rate risk: assets with fixed cash flows; assets with variable cash flows;
caps and collars; swaps; interest rate futures; forward rate agreements; portfolio of
assets.
2. Managing foreign exchange risk: full hedge with forward or futures contracts;
complexities of hedging with futures contracts; partial hedges with forward or future
 contracts; hedge with an option contract; partial hedge with options; full hedge with a
money market hedge; managing exchange risk using swaps; contingent assets; future
debt; future asset with a random value; balance sheet hedge; hedging with derivatives;
diversification into currencies.

94
Principles of banking

This subject serves as an introduction to the principles and process of financial intermediation
with particular reference to the operations of the UK banking system. Banking operations are
examined as portfolio allocation preferences, with emphasis placed on the role played by
innovation and deregulation in the development of bank products and services. For this purpose,
the UK banking system is taken as an exemplar of many of the trends that are reshaping financial
services around the world.

Introduction to the financial system: the role of the finance intermediation:the process and
implications of financial intermediation; rationale for the existence of financial intermediaries;
evolution of financial systems; recent developments in the UL financial system; market structure
and financial innovation.

Retail banking: the nature of retail banking in the UK; payment services; risks in retail banking;
the role of the central bank in retail banking.

Wholesale and international banking: the nature of wholesale banking; off-balance sheet
business; international banking; sovereign lending risk.

Financial markets: the nature of financial markets; the principles of hedging; speculation and
arbitrage; the efficient markets hypothesis; international financial centres.

The foreign exchange market: introduction to the Forex markets; nature of the Forex; types of
business; the efficiency of the Forex markets.

Euro-securities markets: outline of the functions of the markets; Eurodollar; credit creation;
Eurobonds; Euronotes; Euro-equities; securitisation.

Risk management: the nature of risk; financial futures; options and swaps; forward rate
agreements; managing exchange rate risk and interest rate risk.

Regulation of the financial system: history of bank failures; the prudential control of banks;
depositor protection; prudential regulation in the UK; prudential regulation in the US; international
co-ordination industrialised countries; the US banking system; the banking structure in Japan; the
single European market in financial services; banking structures in developing countries: Islamic
banking; banking structures in Eastern Europe.