June 21, 2007, 2:31 am

The Way Banks Look at You Part2: Portfolio Management

by: The Financial Blogger    Category: Banks and You
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Continuing this series about banks perception of individuals, I’ll introduce you to how banks manage their assets and what they consider debts. According to Canadian laws, a company can not issue credit and provide clients with investment and insurance solutions. This is why all Canadian banks bought investment companies several years ago to incorporate this offer of service. BMO bought Nesbitt Burns, CIBC is with Wood Gundy, TD with Canadatrust and so on. By doing so, they are able to provide all kind of products through separate entities.


What’s on their balance sheet?

Banks work backward than normal company. As an example, a mortgage is not a debt for them, it is an asset. As they are issuing the mortgage, they receive payments from their clients. The Interest charged on loans constitutes one of their many sources of income. This is the main reason why there are several people not considering your property as an asset. The mortgage represents the real assets as it creates positive cash flow.


So if banks have debts as assets, what do they have as liabilities? It is fairly simple; they have bank accounts. In fact, banks are allowed to lend money according to how much they have in their client’s bank account. Therefore, they “owe” this money to clients and pay them interest. 3,5% interest rate on saving accounts seem to be a pretty good deal when you are turning around and lend this money at 10% and up. However, they also contract regular debts for investments and other purposes like other companies.


What kind of portfolio do they manage?

Besides investments portfolios with financial products that go beyond normal human being’s comprehension, financial institutions are also managing their credit portfolio. The best example to understand how a bank works is to go look at how Prosper works. This ingenious website was created to establish a platform where people can lend and borrow from other people. Therefore, as a lender, you are acting as a little bank. You could analyse borrowers’ situation, credit bureau and TDSR. In order to diversify your risk, you should not lend all your money to one person. You should spread it among a group that meet your requirements.


Banks are working the same way. If they have a portfolio full of clients with low risk and secured debts, they will more likely lend more money to higher risk individuals to balance their portfolio. It is the exact same request with an investor and his portfolio. The only difference with investors is the structure. The transaction aspect is taken care of by the sales department (branches and other) but they are working separately from the decision centre (credit department). Therefore, the credit department is taking rational decisions based on numbers and other criterions such as the 5 C’s of credit regardless of what the sales department is trying to accomplish. This is how banks are able to handle such a wide portfolio of credit and be right most of the time. It doesn’t mean they are flawless, history has proven them wrong many times. However, they have a much rational structure that enables more steady profit.


Next time you go see your banker; you should leverage your knowledge to get a better rate or lending conditions. If you can’t get approved at your branch, it doesn’t mean that another bank with a more solid portfolio will decline your application. Competition has risen in this market and banks have no other choice but to be more lenient in their credit decision.

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