Business organization – FR – Organisation commerciale; ES – organización del negocio; DE – Geschäftsstruktur; IT – Organizzazione d’affari – An entity aimed at carrying on commercial enterprise by providing services or goods, in order to meet needs of the customers. All business organizations: have the common features such as formal structure, aim to achieve objectives, use of resources, requirement of direction, and legal regulations controlling them. The different forms of business organizations are Sole Proprietorship, General Partnership, Limited Partnership, Corporation, “S” Corporation, and Limited Liability Company.
Deal (Loan) Structuring – FR – Structuration des transactions; ES – Estructuración de transacciones; DE – Transaktionsstrukturierung; IT – Strutturazione delle transazioni – The design of a loan’s terms, conditions and security to meet the underlying financial needs of the borrower and the lender. Typical deal structuring measures are matching repayments to cash flow streams or having convenants sensitive to critical operating parameters so the banker is alerted early if something important is amiss. The structuring exercise is often the most creative and satisfying aspect of lending as the banker finds a smart way to meet the contrary objectives of both lender and borrower.
Debtors’ Rights – FR – Droits des débiteurs; ES – Derechos de Deuda; DE – Schuldnerrechte; IT – Diritti dei debitori – The legal rights of borrowers, both in common or statute law (e.g. bankruptcy) and spelled out in loan contracts and security agreements. Apart from any rights specifically contained in the loan contract, the debtor has the general rights that most of us have. Lenders must deal with them honestly, not bankrupt the debtor or seize its property without good reason etc. These rights are rarely spelled out in legislation but are upheld in the the courts in common law countries.
Deemed Trust (legal concept) – FR – Confiance présumée; ES – Confianza presunta; DE – Als vertrauensvoll angesehen; IT – Fiducia ritenuto – Any automatically binding trust obligation that may exist even without the benefit of a formal agreement. For example, deductions for value added tax, employee social security payments and employee income tax deductions at payroll source will usually be considered deemed trusts on behalf of the government. The collecting enterprise has not borrowed any non-remitted money but rather holds it on behalf of others. In a bankruptcy, deemed trusts have a higher priority than other debt obligations. If they are specified to be super-priorities, deemed trusts can even come ahead of secured lenders.
Export Credit Agency (ECA) – FR – Agence crédit à l’exportation, ES – Agencia de Crédito a la Exportación, DE – Exportkreditagentur , IT – Export Credit Agency – Government-sponsored entities (e.g. USA’s Eximbank, Germany’s Hermes etc.) that promote the exports of their own domestic industries. Multi-lateral aid agencies (e.g. World Bank etc.) can also engage in ECA-type activities for the sake of helping needy import dependent countries. In their capacity in promoting offshore investment, they are also known as ”Investment Insurance Agencies”. Most industrialised nations have at least one ECA, which is usually an official or guasi-official branch of their government. The motives are largely self-serving since export markets generate jobs and taxes back home. There are several roles for governmental intervention in the private capital market. Exporting, especially to poorer under-developed countries, has an inherent risk which the private sector (especially small and medium eterprieses with no global operations) needs help with. Official agencies are in a better position to resist political risk from expropriation, foreign exchange restrictions, etc. because governments think twice before offending another state. There are scale economies since most diplomatic missions abroadwith a commercial mandate can gather local market intelligence. A weaker justification is that a country’s national champion’s i.e. companies that governments conside “strategically” important, deserve export subsidies. Finally, a rationale that is perhaps unspoken that “the other guys are doing it” i.e. in the fierce competition for global market share, countries have to ‘play the game’ or lose out. An ECA will provide a variety of services to facilitate its country’s exports. The largest volume of ECA activity is support for short term trade credit to exporters (see graph below). Ideally, ECA assist exporters on a self-sustaining basis without relying on tax dollars. They will raise funds by charging fees for services and interest on their loans, as well as issuing debt in capital markets.
Facility, Credit or Loan (vernacular) – FR – Facilité, crédit ou un prêt ; ES – Instalación, crédito o préstamo ; DE – Einrichtung, Kredit oder Darlehen ; IT – Facility, credito o prestito – Any formal arrangement where a bank agrees to provide a specified range of credit related financial services in the future. Typically, this will be a loan in various currencies and borrowing options. The word’s roots come from “facilitating” something or allowing it to happen. It is synonymous, and s more formal, terminology for a committed line of credit with several built-in options. Facilities are usually associated with larger, more sophisticated corporate borrowers. Their inherent advantage to borrowers is in offering a flexible range of financing options that they can chose from within a single banking agreement. Facilities are documented by a formalised contract or a loan agreement and, by inference, detailed terms and conditions.
Financial Base (vernacular) –FR – Base financière, ES – Base Financiera, DE – Finanzbasis, IT – Base finanziaria – A term meant to convey an enterprise’s overall financialability to support its present operations and possible future expansion. While this could come from operating cash flow or third party creditors, financial base usually implies a combination of equity and working capital sufficient to build a sound business upon.
Financial Depth (of an Economy) – FR – Profondeur financière, ES – Profundidad financiera, DE – Finanztiefe, IT – Profondità finanziaria – The degree of intermediation in the economy between savers and investors through the financial sector. Basic categories of financial assets include equity securities (e.g. stock market), private debt (e.g. bond market), government debt and bank accounts. In 2005 the world’s average financial depth according to McKinsey amounted to 316% of GNP (see graph left). The composition and degree of financial depth will vary considerably from economy to economy. For example, American households tend to hold more equities than Europeans. In the case of banking assets, the average European economy’s financial depth is approximately 90-110% whereas emerging markets such as Poland are 30- 40% . Assuming a trend towards, emerging market banking sectors are thus riding two waves: growth in GNP and increasing financial depth as a share of GNP.Financial depth is both a reflection and a driver of economic development (see graph above right) When there are low levels of institutional infrastructure, savings and market transactions, most of a given economy’s households have little need for a bank account(see unbanked and mattress money). As intermediation flows increase through a sound banking system, an economy is given the stimulus that comes from increased consumption from consumer finance and enterprises that have better access to capital. That said, excessive, or distorted (e.g. too much sub-prime activity or speculation), financial depth can have deleterious consequences.
Financial Discipline (Bank Credit) – FR – Discipline financière, ES – Disciplina Financiera, DE – Finanzdisziplin, IT – Finanzdisziplin – Banks have a special role to play in fostering healthy financial discipline within a competitive economy. Their lending activities have many ‘externalities’ ( e.g. knock – on consequences beyond their own privately motivated actions ). By looking out for their own self –interests by having strong loan portfolios, other parties in the suppliers and customers ) will benefit as well. The behavioural impacts of qualifying for bank credit and ongoing dealings with a bank can be felt in a variety of ways, all of them beneficial to economies overall. To be of the greatest good to the economy, banks must be self- disciplined themselves. They need to use prudent and commercially viable banking practices. For example, aggressive lending and mispriced risk will tend not to discriminate on quality. When any one can get a loan some will inevitability by undeserving and ‘fool the market’ into thinking they are viable. Excessive credit can lead to asset bubbles, distort resource allocation by encouraging speculation and risk a consequent financial meltdown. Self- discipline is needed to lend and should be based primarily on an accurate assessment of financial viability and repayment capacity as opposed to a timid over – reliance on collateral security ( an excessive dependency makes banks akin to pawn – brokers ). See also gatekeeper function and creative destruction.
Fluctuations On Account – FR – Fluctuations en compte; ES – Fluctuaciones en Cuenta; DE – Schwankungen auf Konto; IT – Fluttuazioni in conto – Transactional activity in a deposit account or line of credit that causes it to fluctuate. For example, in an overdraft, deposits will automatically reduce credit usage while withdrawals will increase it. Such a pattern (the wider the better) is considered healthy since it reflects behavior consistent with a viable going concern generating and consuming ample flows of cash. In particular, the periodic reduction in exposure from inbound deposits reflects successful selling or collection activities which are an important source of repayment in asset conversion loans. The alternative of account inactivity is a warning sign of a troublesome hard core loan. Fluctuation on account is a common focus point for credit monitoring.
Global Financial Institution – FR – Institution financière mondiale; ES – Institución Financiera Global; DE – Globales Finanzinstitut; IT – Istituzione finanziaria globale – A financial institution with a strategy to operate internationally with activities in a broad range of countries across the globe. Many banks may operate in regions close to their home market and may be active in the Euromoney market. They are the equivalent of an American super – regional. Relatively few banks try to offer seamless service it is often seen that way ( see league table below ). Truly global banks, in the sense of round-the-world retail presence, would be confined to, say , Citibank, HSBC and a few others. The term has tended be liberally used. Scotiabank uses the word “ global” 103 times in its 2008 annual report. That said, even though it operates in 50 countries with an office on every continent, it unpretentiously refers to itself as an “ international bank “. Global institutions are a response to financial globalization in which multi – national corporations need a world-wide bank. They also try to capture economies of scale, diversification and arbitraging opportunities in international markets. Working against them are the perils of decentralization ( e.g. operating in markets with different languages and law ) and the tendency to be perceived as “foreign” in many markets. Regulators are collectively concerned about the potential for systemic risk in such organizations since national accounting, legal and supervisory systems may be inadequate to cope with the demands of global institutions. Note that the term “international institutions “ can also refer to entities – such as the IMF or World Bank – established by more than one country and governed by international law.
Government – Sponsored Enterprises (GSEs) – FR – Entreprises sponsorisées par le gouvernement; ES – Empresas Patrocinadas por el Gobierno; DE – Regierung – Sponsored Enterprises; IT – Governo – imprese sponsorizzate – A primarily American term for a hybrid enterprise that is privately owned and operated for profit but which also enjoys indirect but explicit government support. This is in contrast to a ”state – owned enterprise “ (a.k.a. “crown corporation” in some countries such as Canada) that is owned and operated by the government on commercial terms. Government backing tends to be implicit at best. Arguably any licensed or chartered entity – including, for example, a commercial bank – is a form of a GSE even if the government support is implicit. Two notoriously problematic GSEs in the USA are the institutions that were meant to encourage home ownership and be market – makers in mortgages. While these were legitimate mandates, they ended up feeding a mortgage lending frenzy that caused the sub – prime crisis.
Greenfield Project – Greenfield Project – FR – Projet Greenfield; ES – Proyecto Greenfield; DE – Greenfield-Projekt; IT – Progetto Greenfield – A project with a start – up phase that has no prior operating track record. The project has to be first constructed (hence the term describing building on a green field site) and then phased in before becoming operational at which point it will start generating cash flow. Thus there are inherent risks from technology (e.g. will it operate as designed?) and construction (e.g. cost overruns).
Insolvency – The financial state of being unable to meet obligations when they are due for payment. Thus, insolvency means being both illiquid and unable to borrow from anybody. Defined this way, insolvency is time-sensitive. A company may have positive net worth yet be insolvent because it lacks the time to liquidate assets to pay off creditors. The other insolvency criterion is an absence of positive net worth. This ‘balance sheet’ test is really not that different than the criterion of meeting your obligations when they are due (also known as a ‘cash flow’ criterion). It is simply the cash flow criterion applied to a borrower who is wound down and liquidated. The balance sheet insolvency test tends to be more difficult to invoke since it requires a process of accounting to be done. This takes time and historical cost asset values may not reflect liquidation values. The more stringent test is payment default. In this regard, insolvency is also function of creditor confidence and a willingness to refrain from repayment by rolling over liabilities. A bank, for example, could easily be technically insolvent if all its depositors asked for their money back at once. So long as a bank can pull off is confidence game, depositors seldom do.
Interest Rate Risk (Borrower) – FR – Risque de taux d’intérêt (Emprunteur); ES – Riesgo de tasa de interés (prestatario); DE – Zinsrisiko (Kreditnehmer); IT – Rischio di tasso di interesse (mutuatario) – The risk that a borrower with floating rate debt will suffer deterioration in income and cash flow due to a movement in the market’s interest rates. The impact will depend on the borrower’s leverage and the interest rate elasticity of the borrower’s market demand. Interest rate risk can be reduced by using fixed rate debt or employing hedging instruments such as swaps. Because of the adverse impact on borrower debt service capacity, banks will generally react to higher interest rates by lending less. This is the prime mechanism which makes interest rates a monetary policy tool to “cool down“ or “heat up” an economy.
Know the Borrower/Customer Rule (vernacular) – FR – Connaître la règle de l’emprunteur / client; ES – Conozca la Regla del Prestatario / Cliente; DE – Kennen Sie den Kreditnehmer / Kundenregel; IT – Conosci la Legge del Cliente / Cliente – An important rule-of- thumb in lending that says that lending bankers should be thoroughly familiar with their counter-parties. At the least, this means being able to answer some very basic but essential questions:
– Who owns the borrower?
– Where did the owners get their wealth?
– How is their official status substantiated? Incorporation? legal registries?
– Who manages the borrower: education, experience & track record?
– What does the borrower do to earn money? customers? suppliers? activities? locations?
– Can the bank identify, through credit analysis, what risks the borrower is taking?
– Based on the above, what transactions will the bank be involved in?
Know-the-borrower is a prerequisite to risk management. A bank cannot gauge risk unless it knows who it is dealing with. Investigating these things is the essence of due diligence. The know-the-borrower rule is particularly important in situations where a relationship does not already exist e.g. new customers in private banking or start-ups. It is also important even with depositing customers (i.e. “know-the-customer”). To quard against money laundering, a bank should know where the deposits come from.
Lending Spreads – The nominal average difference between a bank’s borrowing and lending rates, without compensating for the fact that the amount of earning assets and borrowed funds may be different. (This is in contrast to the bank income statement’s net interest margin (NIM) which compares total interest earned versus interest paid on deposits (which won’t necessarily equal loans) as a percentage of loans). Thus, if a bank is charging interest on loans of, say, 10% on average and paying interest of, say, 4% on average, the lending spread is 6%. The market transaction measure of lending spreads will impact reported financial statement results of NIM on the income statement ( see quote below ). In fact, there are several spreads depending on which loans and which funding sources are selected.
Letter of Credit (L/C) – A broad, generic term for any banker’s letter authorising payments up to a specified conditions. For instance, before the days of traveller’s cheques, a bank could authorise its correspondent bank to pay out funds to the home bank’s client in a foreign country. A basic distinction in L/Cs is between an “irrevocable” L/C which cannot be cancelled without the beneficiary’s consent whereas a “revocable “ can be. A “clean” in the sense of having no complications or clutter. Its absence of preconditions is meant, by design, to make it virtually as “good as money in the bank”.
Liability Management (LM) – Traditionally, the asset-liability management (ALM) function of the bank encompassed the ‘big picture’ of matching both sides of a bank’s balance sheet. On the liabilities side, some of the key On the liabilities side, some of the key objectives of ALM would be:
– demands for cash withdrawal can be met comfortably
– ensuring an adequate volume of funds to carry total assets
– minimising the interest costs paid to attract deposits
– matching the maturity and interest rate structure (fixed vs. floating) of deposits to assets
– finding the optimal mix between wholesale and retail deposits
– finding ways to capture and retain a core deposit base
– considering alternative funding sources e.g. subordinated debt, hybrids, preferred shares etc.
– using derivatives to hedge unmatched liabilities.
LIBOR – London Interbank Offered Rate is a reference rate of interest offered to be paid on wholesale deposits i.e. by takers of funds of various time periods (maturities ) in ten different currencies. LIBOR is calculated as a ‘trimmed average’ of the funding costs of the largest, most active banks operating in London’s Eurocurrency interbank money market. Baset on a concentration of lending and foreign exchange transactions in London, LIBOR thus represents the lowest real-world cost of unsecured funding and is a primary benchmark for short term interest rates globally. For purposes of transparency and neutrality, LIBOR is publicly quoted under the auspices of the British Bankers’ Association. A bank’s actual cost of funding will vary with is standing in the market (with a premium or discount being paid versus the LIBOR reference rate). LIBOR is the basis for loan pricing(i.e. LIBOR + ¾% etc.) to large corporate borrowers. As such, it removes any borrower dependency on a lender’s particular status in the market. LIBOR’s reference rate status is also the basis for settlement of interest rate contracts on many of the world’s major futures and options exchanges. It is also used for an increasing range of retail products, such as mortgages and college loans. Along with the default-credit-insurance market, LIBOR is a proxy for the state of confidence in the overall banking system.
Maturity Transformation – FR – Transformation de la maturité; ES – Transformación del vencimiento; DE – Maturity Transformation; IT – Trasformazione della maturità – Borrowing short term (at low interest rates) and lending longer term ( at higher interest rates ) and thereby earning a spread that is enhanced by the yield curve. Banks, in spite of a mission to intermediate by matching, can do this profitably and prudently for three reasons :
– the ‘law of averages’ ensures that core deposits, even if on demand, will be relatively stabile
– liquidity reserves, ALM and inter-bank markets can satisfy any sudden or large withdrawals
– access to central bank as a lender of last resort can guarantee cash in a panic.
Merchant Banking – FR – Merchant Banking; ES – Merchant Banking; DE – Merchant Banking; IT – Merchant Banking – Small, specialized banks engaged in equities investment, private banking, and corporate finance advisory services such as valuations, privatisations and corporate restructuring. While they might compete with their big brother investment banks, merchant banks were typically highly specialised niche players confining themselves to activities or sectors where they had an advantage of superior market know-how. They tended to avoid trading and securities underwriting since they lacked a distribution network. The association with “merchant” is historical : its roots go back to commercial traders who, because of their intimate knowledge of an industry, were able to finance other players often by acceptance of their commercial paper. From there, they went into investing and advice-giving. The merchant banking business model was traditionally associated with an elite pack of British firms in the City of London. When the ‘Big Bang’ market reforms occurred in the late 1980s, most of the old established names (e.g. Morgan Grenfell, Warburg and Kleinwort Benson etc.) were gobbled up bigger investment banks although some independent players are now making a come-back.
-Do we know – from references, past history or public information – who they are?
-Can we independently substantiate their identity?
-where do they earn their money and does it appear to be by honest means?
-Why are they dealing with us, especially if we are being offered a “favour”?
– Are their dealings on a normal commercial basis which sense?
Many countries have passed stringent anti – laundering laws that make it an offence to be a party to launders. In the UK, for example, individuals have a legal duty to notify the authorities of suspected laundering. Bankers, lawyers, accountants and advisors have to be careful, not only to protect themselves (since money launders do not want to do business so much as use the bank as a cover), but also to comply with law.
Payment Default – FR – Par défaut de paiement; ES – Pago predeterminado; DE – Zahlungsstandard; IT – Pagamento predefinito – A sub-set of default caused by failure to make either an interest or principal payment when it is due in accordance with the terms and conditions of a loan agreement. In the case of a loan that is on demand, payment default may only occur after a loan has been demanded and cannot be repaid. Compared of technical defaults, payment defaults defaults are serious trouble, especially if a borrower cannot even pay the interest. Compared to technical defaults, which are treated as warning signs of future trouble, payment defaults usually trigger harsher creditor remedies since they reflect weak repayment capacity and, hence, a deterioration in risk. In the case of corporate debt, payment defaults generally tend to be rare but can sharply spike up in periods of financial distress.
Personal Guarantee – FR – Garantie personnelle; ES – Garantía personal; DE – Persönliche Garantie; IT – Garanzia personale – An individual’s promise to pay another’s debt. A common example would be a SME business owner’s guarantee of the bank of his/her company. In the case of an individual guaranteeing its own business, the normal requirement for consideration is not necessary since there is an “existing duty”. Since people in their personal capacity typically have limited financial resources, the ability to pay on a personal guarantee deserves careful thought. In the lender truly needs a second way out, the personal guarantee should be backed by tangible collateral security. That said, unsecured personal guarantees are often taken as a test of the good faith an commitment to the enterprise whose fate is controlled by the owner/managers. In this way small business lending tries to address the asymmetric information problem i.e. only the ‘insider’ status of an owner/manager of the enterprise can know its true creditworthiness. In contrast to a corporate guarantee, individuals may need to have independent legal advice, especially if a spouse or relative is involved, in order for the guarantee to by enforceable. Personal guarantees are executed either by signing a promissory note or through a letter guarantee.
Preferential/ Preferred Creditor- FR – Créancier préférentiel / privilégié; ES – Preferente / Preferente Acreedor; DE – Bevorzugter / Bevorzugter Gläubiger; IT – Creditor preferenziale / preferito – A creditor that ranks ahead of unsecured creditors but usually behind most secured creditors in a liquidation of accompany. Preference is conferred legally by bankruptcy laws that some creditors, even though they are not secured, have privileges that deserve special treatment. In addition, suspicion about the fairness of creditors’ rights (especially those bankers), prompts lawmakers to carve out a ‘piece’ for needy or innocence creditors. Examples of preferential creditors, which vary amongst legal regimes, include unpaid amounts for:
– payroll and entitlements to employees
– employee income tax with holdings
– social security payments
– income taxes