5.1.1 Payments and Transaction Accounts

One of the fundamental products banks offer are payment services, ie the ability to send money to/receive money from others, both domestically and cross‐border. A closely related service is that of transaction accounts. Whilst not strictly necessary for making payments—for example cash‐in cash‐out transfers (aka remittances) do not require them—in most cases a transaction account is needed to participate in a payment system, both as a sender and as a recipient of funds. Transaction accounts typically earn little or no interest and there might be periodic fees for holding the account itself, as well as fees for additional services like payments and obtaining hard copy statements.

The very large majority of payments in number terms—albeit not necessarily in terms of value—are domestic payments in domestic currency. However, cross‐border payments and cross‐currency payments have always been important for businesses and, with more and more cross‐border commerce being facilitated by the Internet, are now becoming more important in the retail space as well. Customers who have a regular need for cross‐currency transactions sometimes have multi‐currency transaction accounts that allow them to manage their foreign exchange more efficiently.

There are three major products in the payment area, all of them typically offered by banks: bank transfer, cheque, and card payment, the latter being separated into cardholder present payments that are done using a card reader and the physical card, and cardholder not present payments that are done via the Internet or telephone. Whilst not strictly a payments distinction, there are three types of cards on the market: debit, monthly debit, and credit. The first two require payment in full—either immediately, or at the end of the month—and the latter is effectively a credit line, allowing to delay payment in return for an interest charge. There are also specialist payment providers, typically for cross‐border payments, for example remittances services that allow cash‐in cash‐out transactions.

It is important to mention money market funds here, who in many cases appear like regular transactions accounts. For example, they can send and receive transfers, and it is possible to have cheques and a payment card. The key difference is that they do not benefit from a deposit guarantee, but they rely on asset separation for protection against default of the bank.

5.1.2 Deposit Accounts

The term ‘savings accounts’ covers a wide range of products. They are differentiated from transaction accounts in that the funds there are not usually immediately accessible—or at least only at a penalty—and earn interest in return. With term deposits the funds are locked up for a certain period, and it is impossible getting them returned earlier, unless they are breakable deposits which can be redeemed early at a cost. There are also structured deposits, where the interest depends on, say, the performance of an equity index, but the principal is still guaranteed, and there are all kind of deposits with more complex rules, for example the annual interest might increase in later years, or bonus interest might be added after a few years. A related product is the certificate of deposit, which is a term deposit in the form of a security, meaning that they can be sold if need be, and if a buyer can be found.

There is a crossover asset management product—money market funds—that in most practical aspects behaves like a bank account, that does not benefit from a deposit guarantee and that is discussed in the funds section.

Deposit guarantee schemes are typically state‐sponsored schemes which guarantee the principal amount of a deposit for a range of eligible customers, usually retail customers. The amount is typically limited per‐customer and per‐bank, and there might be other deductibles.

5.2.1 Retail Lending and Credit

The retail segment consists of private individuals. Often this segment also includes very small businesses, especially when the credit given to the business is cross‐secured on the owners' personal assets.

By size, the most important product in the segment is the mortgage loan, ie lending against the value of a personal property. Usually this will be the borrower's primary residence, but it might also be a buy‐to‐let property, or it might be business premises in the case of a very small SME. The mortgage can be recourse, meaning in default there is a claim against the other assets of the borrower, or non‐recourse meaning there is no such claim. This is not a customer choice, but it depends on the applicable law in a given jurisdiction.

In the US, there is a large conforming mortgage market, this term referring to the fact that the mortgages conform with the terms of the mortgage agencies who'll guarantee their performance, against a fee, thereby removing most of the risk. The non‐conforming market is the rest, including for example the jumbo market of very large mortgages. Historically, it also contained Alt‐A and so‐called subprime mortgages of lower credit quality, but those markets have lost importance after the crisis.

The key part of mortgage lending is the actual mortgage, ie a registered claim over the property. Most jurisdictions run a mortgage register where it is possible to register a claim over every property in that particular jurisdiction and to see if there are prior claims, ensuring that it is not possible to obtain more than one mortgage loan against any given property. The register is either run by the state, or a state‐chartered private company. It is also possible to place a nominee claim owner in the official register, and then keep track of the actual claim at the nominee level, allowing for mortgage claims to change hands without having to go back to the local register, which is often still paper‐based.

It is sometimes possible to also register second‐lien (aka subordinated) claims that are only paid once the first‐lien claim is paid in full. In the US, the corresponding loans are referred to as Home Equity Loans or HELs. Depending on the quality of the information in the register, some jurisdictions may offer title insurance if a prior claim surfaces after a deal has been closed.

Another important product in the retail space is the credit card loan, ie revolving credit that is associated to a payment card. The way it works is that there is a credit limit on the card, and customers can make purchases up to that credit limit. Customers obtain a credit card statement once per month, and if they pay the bill in full, no interest is due. Otherwise they have to make at least the minimum payment of typically 5% of the outstanding balance, and whatever is not repaid is being rolled over indefinitely, accruing interest at a significant rate.

The last major product in this space is the overdraft facility which allows a customer's payment account to go into overdraft up to a certain overdraft limit, either against a fixed overdraft fee, or against an interest rate, or both. Sometimes there is a requirement to clear an overdraft within a certain time frame, as its purpose is not that of a permanent loan facility, but to ensure that payments from that account don't bounce, potentially causing significant cost and distress.

Two more products in the retail space are the unsecured personal loan and the auto loan, the former being a general‐purpose loan—often to consolidate credit card debt at a lower rate—the latter being a loan to purchase, and being secured on, a vehicle. Both of those loans are often extended by specialised consumer lending companies instead of banks, and in the case of auto loans also by the so‐called ‘auto‐banks’, ie banks associated to the major automotive producers, providing financing for their product. An auto loan is economically similar but legally different from a leasing contract: in the former the car is owned by the borrower, whilst in the latter the car is owned by the leasing company.

For small businesses there are a number of additional products, and I will discuss most of them with other business products below. One product I want to mention here, however, is the cross‐collateralised business loan where private assets (property, possibly a car) are additional collateral for a small business loan or overdraft line. They also might make use of the products discussed under the specialised lending heading below.

Last but not least, there are loans extended by pawnbrokers and by payday lenders. The former take possession of valuable assets—eg jewellery—and lend against them at a steep discount. If the owner defaults on the loan, the pawnbroker takes possession of the asset and sells it to recover their losses. Payday lenders lend to customers who need a bridge until the next payday, typically small amounts at a very high rate, and amounts can spiral out of control quickly if the original due date is missed.

5.2.2 SME/Mid‐market Lending and Credit

The mid‐market (US terminology) or SME (European terminology) segment is that of companies larger than those in the previous segment, but smaller than those in the large corporate segment discussed in the wholesale chapter. Boundaries are not clear, but typically mid‐market companies have tens to hundreds of employees, do not usually have a significant presence abroad, and are privately held.

The major credit product for mid‐market companies is the loan product, in a number of shapes depending on the specific purpose. For example, equipment loans are loans secured against equipment purchased, possibly with instalment payments in line with the economic depreciation of the assets. Especially long‐term assets might be financed with balloon loans, meaning they are partially paid down during the lifetime of the loan, but there is a large balloon payment at the end; or with bullet loans, meaning there is no paydown of principal at all during the lifetime of the loan. Finally there are zero‐coupon loans, meaning there is no payment whatsoever during the lifetime of the loan and even interest is rolled up until the end.

Another important product in this space are credit lines. Some are just general‐purpose lines that allow businesses to deal with unforeseen fluctuations in finances, similar to account overdrafts. For those lines, companies pay both a commitment fee for having the line, and interest on the drawn amount. Credit lines can be revolving, meaning that they must be periodically repaid, eg for seasonable businesses financing inventory build‐up. Derivatives lines are credit lines needed for the derivatives business, and are discussed in the wholesale chapter as they are of higher importance there.

5.2.3 Specialised Lending and Leasing

The specialised lending segment is about lending against specific assets, with the loans being structured to account for the characteristics of those assets.

One big class of products in this segment is that of asset finance or leasing, where the former term tends to refer to big‐ticket assets, whilst the latter is more neutral. This segment starts from the very small—eg photocopiers, computers, even office furniture—to the very big, eg aircraft or shipping vessels. An important asset in the leasing sector is cars, both for personal and professional use. As a general rule, most moveable assets can be obtained under a leasing contract. Leases can be operating leases and capital leases, the difference being that in the former the customer is expected to return the asset, whilst in the latter they are expected to keep it. Closely related to leasing is vendor financing, where the vendor arranges a loan to purchase the asset. Economically, vendor financing is equivalent to a capital lease.

Similar to leasing is working capital finance, where the lending is done not against fixed assets but against working capital, ie accounts receivable (aka unpaid invoices or inventories). Invoice financing, also referred to as factoring, can be structured in a number of different ways, depending on who takes the risk that the customer defaults, who takes care of assessing the credit risk of the customer, and who deals with collections. With inventory financing, a company can raise funding either against its raw materials inventory or its finished goods inventory. It is important in this case that the lender has good visibility on current inventory levels. For finished products the lender also must take the value of the items when the company defaults into account—consider for example IoT widgets that rely on a company‐run server to operate.

5.2.4 Trade Finance

The trade finance segment is about supporting international trade, and most governments play a very active role in that market, as it allows them to support their own export industry. The main product here is the letter of credit (LoC), which is a credit guarantee rather than a loan, ie a promise to indemnify the vendor if the buyer fails to pay. An LoC allows companies to export their goods without having to assess the credit quality of the buyer and—importantly—without having to take the risk of having to pursue claims in a foreign jurisdiction. Conversely, it allows importers to withhold payment until goods have arrived and have been checked for conformity with the specifications.

Trade credit often involves two institutions, one in the country of the exporter, and one in the country of the importer. The reason for this is that banks in the country of the exporter will usually not have the skill to assess the credit quality of the importer, so they can't issue a guarantee. On the other hand, the exporter will find it difficult to work with a bank in the other country, so they rely on someone from a local bank, who provides a front.

5.2.5 Credit Guarantees and Credit Insurance

A credit guarantee is a third‐party guarantee to a lender that guarantees that if the borrower defaults, the third party will step in and make them whole. Credit insurance is similar, except that in the case of a guarantee the third party might have a claim on the borrower, whilst in the case of insurance that is not usually the case. Everyone can guarantee credits, but a commercial credit guarantee is usually provided by a bank, whilst credit insurance is usually provided by insurance companies. This is mostly an SME product, enabling business that might otherwise not take place because of credit reasons.

An important application of credit insurance is also in the US municipal loan market, where municipalities issue bonds that are guaranteed by a monoline insurance company. Before the crisis, monolines also guaranteed structured finance assets (ie, securitisation tranches, often related to subprime mortgages), which lead to substantial losses.

5.3.1 Active Segment

The main distinction in the active segment is between mutual funds and alternative investments. The latter are often referred to as hedge funds, and are not usually open to retail investors, which is why they are discussed in the wholesale chapter. Mutual funds are real money investors, ie they are only allowed to invest in actual securities, and the amount they invest in securities is limited to the funds they receive. This means they can neither borrow additional funds to lever their investments, nor can they employ derivatives. Typically their investment mandate further restricts the eligible securities, for example to S&P 500 equities, or EUR‐denominated corporate investment grade bonds.

There are also funds that invest in specialist asset classes. For example, real estate funds that invest in commercial real estate objects such as office or commercial space, or multi‐tenant residential property, and there are aircraft and shipping funds and a few others investing in specialist asset classes. In many circumstances those funds are structured so that retail investors can invest, and sometimes there are tax advantages associated with this. Depending on the mandate, the funds can either invest in the underlying assets, or in loans backed by those assets, or in both.

5.3.2 Passive Segment

Within the passive segment, there are a number of very different models, notably index funds, exchange‐traded funds (ETFs), and investment certificates.

Index funds are replicating the performance of an investible index, for example the S&P 500. By definition, an investible index represents a portfolio of securities whose composition is determined by a set of rules, eg the 500 largest US companies. Indices are rebalanced periodically, but not too often, to avoid spurious portfolio changes due to market volatility. In some cases, the rules fully determine the composition of the index, and in others there is a certain discretion that the rebalancing committee can apply when choosing which securities to include.

The number of investible indices has multiplied recently, to allow for passive investment strategies that still express some view, eg with respect to industry sectors or geographies. Index provision is a business in itself, and index providers receive a fee which is non‐negligible when compared to the overall fee some passive managers receive. Therefore some ETF providers are vertically integrating into creating investible indices themselves in order to capture this part of the value chain.

Many index funds are organised as open‐ended mutual funds, others as ETFs. From a customer point of view, the key difference is that ETFs are open‐ended funds that can be purchased and sold on an exchange, and a clever mechanism ensures that—contrary to what happens with exchange‐listed closed‐ended funds—the prices are never too far away from the funds' net asset values.

ETFs can be either cash ETFs or synthetic ETFs. With the former, a purchase of ETF shares results in a commensurate purchase of index assets for the fund, and a sale results in a commensurate sale. With synthetic ETFs, the underlying portfolio is mostly meant to ensure that a certain amount of assets is available in the fund as collateral, but the actual fund performance is ensured via derivatives. This means that there is some external party—which may or may not be related to the company offering the ETF—undertakes to replace the collateral assets that are in the funds with the index assets that should be in the funds if need be. That does not make a difference when everything is going well, but if the derivatives counterparty defaults and the portfolio assets are illiquid—which they often are—this can lead to substantial losses by the time the collateral assets have been sold.

Investment certificates, finally, are exchange‐listed securities whose payoff structure is linked to the performance of one or more financial indicators. Technically, it is a package of a bond and a derivative. Usually, no meaningful arm's‐length secondary market exists, but issuers are prepared to purchase their certificate back at current fair value, minus a discount. A popular structure in the certificate space is a call option payoff with capped upside based on a major index like the S&P 500. In this case the certificate returns increase in line with the index returns, but there is a minimum repayment amount, and often a maximum also. A related product is structured deposits, which have a similar risk profile, but where the investment is not in form of a security, but in form of a deposit, and where the principal amount—but not interest—is covered by deposit insurance.

5.5.1 Property and Casualty Insurance

Property and casualty insurance deals with specific event risks. To give a few examples, in the retail market there is home insurance, which insures home owners or tenants against break‐in and things like water damage etc, and there is car insurance, which deals with at least damage done to others as a consequence of the insured person driving a car, and possibly with damages to the insured person's car. In the professional space there are all kinds of indemnities, eg against malpractice, and in the company space those can insure themselves against a number of risks, eg fire on their premises. Smaller companies will usually only have access to off‐the‐shelf insurance contracts, but larger ones, as well as very wealthy individuals, might be able to negotiate highly personalised insurance contracts with the underwriters of specialist insurance syndicates.

5.5.2 Health Insurance

The underlying aim of health insurance is to insure individuals against the cost associated with major illness. Most health insurance contracts also deal with more regular occurrences, eg annual check‐ups, or recurrent doctor visits due to minor illnesses like colds, and therefore health insurance has a strong health management component. It also lowers the cost of treatment because insurance companies have a large purchasing power in the health market, and are therefore able to obtain substantially better prices than individuals seeking treatment.

5.5.3 Life Insurance

Life insurance products broadly cover two risks: first, the risk of dying too early, leaving one's dependents without sufficient funds to support themselves, and second, the risk of dying too late, and therefore outliving one's resources in retirement.

The first one is a straightforward insurance product: especially at the age where it matters most—beginning of career, family with young children—mortality is low, so the risk can be insured on an annual basis against a reasonably modest premium, with current premiums being in line with current pool pay‐outs.

The second risk is more complex. Premiums received today relate to an insurable event many decades out, so there is an investment risk, and also there is very limited feedback early on if underwriting standards are inadequate. Also, the sums involved are very large: people pay into insurance contracts for up to four decades, to receive funds for a period of typically at least two decades. Multiplying this by the number of people who take out life insurance, it is clear that insurers must hold asset portfolios that are substantial on the scale of the overall economy to back those claims.

5.5.4 Reinsurance

Reinsurance is the insurer's insurance, ie insurance companies protecting themselves against the overall amount of claims they have to pay out becoming too high. This allows insurers to take on risks that would not normally be insurable. For example, because of distribution advantages and regulations many insurance companies' presences are local, eg at a country level, or even at state level in the US. Some claims exhibit a high local correlation, eg damages to property by weather events. Local insurers on their own cannot insure those because of the correlation of losses. However, in the presence of reinsurance, an insurer can lay off the extreme part of the risk to a reinsurer who can in turn pool it over a much larger region, and those risks therefore become insurable.