Ch 01 Forms and Functions

Question 1

bank (definition, functions, types)

Answer 1

There are many legal and working definitions of a bank. One definition is that a bank is an organization that makes loans, has FDIC-insured deposits, and has been granted banking powers either by the state or the federal government. The working definition used in this text is a for-profit stockholder owned financial institution that that makes loans.

Question 2

CHIPS (The Clearing House Interbank Payments System)

Answer 2

International funds transfers use CHIPS (Clearing House Interbank Payments System) operated by the New York Clearing House Association (NYCHA).

Question 3

commercial bank

Answer 3

A financial institution that is owned by stockholders, operates for a profit, and engages in lending activities. Legal definitions of a commercial bank depend on whose laws or rules are being used.

Question 4

commercial and industrial loans

Answer 4

C&I loans are loans made for business purposes, such as financing working capital and equipment.

Question 5

compliance risk

Answer 5

The risk to earnings or capital arising from a bank’s violations of laws, regulations, or rules.

Question 6

consolidation

Answer 6

Consolidation is the concentration of assets due to mergers and acquisitions.

Question 7

consumer or retail banks

Answer 7

Small- and medium-sized retail banks that serve the financial needs of their communities. These are the majority of banks in the U.S.

Question 8

correspondent banks

Answer 8

Banks that provide the gamut of banking products and services to other banks in exchange for fees and/or deposits.

Question 9

credit risk

Answer 9

The risk to earnings and capital that an obligor will fail to meet the terms of any contract with the bank, or otherwise fail to perform as agreed. It is usually associated with loans and investments, but it can also arise in connection with derivatives, foreign exchange, and other extensions of bank credit.

Question 10

deregulation

Answer 10

Deregulation in banking has three separate although closely related dimensions: price (e.g., deposit rate), product, and geographic deregulation. Price deregulation refers to the lifting of legal restrictions on the interest rates that depository institutions may pay to obtain funds. Product deregulation refers to the removal of the restrictions placed on banks and other depository institutions regarding the types of services offered, such as investment banking services or insurance underwriting. Geographic deregulation refers to the removal of limitations on the geographic extent over which banks (and other depository institutions) may operate deposit-taking facilities.

Question 11

economies of scale and scope

Answer 11

Economies of scale usually refer to a situation where a firm that has high volume of a commodity can produce it at low costs per unit. Economies of scope exist when two different products can be produced more cheaply at one firm than at two separate firms.

Question 12

efficiency ratio

Answer 12

Measures the proportion of operating income absorbed by overhead expenses. In its simplest form, it is computed by dividing noninterest expenses by total revenues. A lower value indicates a greater efficiency.

Question 13

Exportation Doctrine

Answer 13

A legal concept that allows corporations to establish nationwide consumer lending programs that are not affected by state consumer credit laws.

Question 14

Fedwire

Answer 14

Domestic interbank payments are transferred over the Fedwire, an electronic funds transfer system that is operated by the Federal Reserve.

Question 15

fee income

Answer 15

Banks charge fees for services that they provide to customers, such as loan commitment fees, ATM fees, and so on. These fees are becoming increasingly more important to banks as more liberal banking powers allow them to provide a wider range of financial services.

Question 16

foreign exchange risk

Answer 16

The risk to earnings or capital due to changes in foreign exchange rates.

Question 17

full-service banks, i.e., Wells Fargo

Answer 17

These banks provide a wide range of banking/financial services in contrast to banks that specialize in a narrow line of business such as credit cards.

Question 18

global, international or money center banks; i.e., Citibank or JPMorgan Chase

Answer 18

Large, internationally active banks. Also called international banks or money center banks.

Question 19

globalization

Answer 19

Globalization refers to the extent to which each country’s economy and financial markets becomes increasingly integrated resulting in development toward a single world market.

Question 20

interest rate risk

Answer 20

Interest rate risk is the risk to earnings and capital associated with changes in market rates of interest. This risk arises from differences in timing of rate changes and the timing of cash flows (repricing risk), from changes in the shape of the yield curve (yield curve risk), and from option values embedded in bank products (options risk).

Question 21

Internet banks

Answer 21

Banks that operate exclusively on the Internet.

Question 22

limited-purpose or monoline banks

Answer 22

Limited purpose banks that focus primarily on one line of business such as credit cards.

Question 23

liquidity risk

Answer 23

In the context of liquidity management, the risk that liquidity sources will fall short of liquidity needs. Also, the risk to earnings or capital arising from a bank’s ability to meet the needs of depositors and borrowers by turning assets into cash quickly with minimal loss, being unable to borrow funds when needed, or falling short of funds to execute profitable securities-trading activities. As applied to derivatives contracts, the risk that a counterparty will default and a liquidity shortfall will occur due to losses.

Question 24

national banks

Answer 24

Banks chartered by the Office of the Comptroller of the Currency are national banks, having the word “national” or N.A. (National Association) in their name.

Question 25

operational risk

Answer 25

The risk to earnings or capital arising from problems associated with the delivery or service of a product.

Question 26

payments systems (retail and large dollar)

Answer 26

The payments system refers to the means by which financial transactions are settled including checking accounts, coin and currency, credit cards, electronic payments, and wire transfers.

Question 27

preemption

Answer 27

A legal principle that states cannot limit the activities of national banks that they are authorized to conduct under federal law.

Question 28

price risk

Answer 28

This risk refers to the inverse relationship between changes in the level of interest rates and the price of securities.

Question 29

real bills doctrine

Answer 29

A 17th and 18th century concept that banks should only make short-term, self liquidating loans.

Question 30

reputation risk

Answer 30

The risk to earnings or capital from negative public opinion about a bank.

Question 31

securitization

Answer 31

Securitization is the issuance of a debt instrument in which the promised payments are derived from revenues generated by a defined pool of loans. The pools include mortgage loans, credit card loans, car loans, and loans to businesses.

Question 32

standby letter of credit

Answer 32

A letter of credit that is payable only in the event of a default, such as bond issuer failing to make interest payments.

Question 33

state bank

Answer 33

A bank chartered by a state.

Question 34

strategic risk

Answer 34

The risk to earnings or capital from making bad business decisions that adversely affect the value of the bank.

Question 35

SWIFT (the Society for Worldwide Interbank Financial Telecommunication)

Answer 35

The Society for Worldwide Interbank Financial Telecommunications is a cooperative owned by banks throughout the world to facilitate payments and financial messages among its members. SWIFT is used primarily for communications and the actual transfers of funds are done by the CHIPS and the Fedwire; domestic interbank payments are transferred over the Fedwire, an electronic funds transfer system that is operated by the Federal Reserve.

Question 36

Too-Big-to-Fail doctrine

Answer 36

The TBTF policy has been applied by governments when they believe that some event will result in severe economic distress. In the United States, the government has intervened on behalf of large banks, railroads (Reconstruction Finance Corporation), troubled government sponsored enterprises (The Farm Credit System), Chrysler Corporation, and labor strikes.

Question 37

trade credit

Answer 37

Credit granted by a selling firm to finance another firm’s purchase of the seller’s goods and services.

Question 38

transaction accounts

Answer 38

All deposits on which the account holder is permitted to make withdrawals by various means to make payments to third parties or others, including demand deposits, NOW accounts, and share draft accounts (offered by credit unions).

Question 39

trust services

Answer 39

Services provided by a trust company.

Question 40

wholesale banks

Answer 40

Specialized banks that deal almost exclusively with medium and large size businesses. They make corporate loans, interbank loans, commercial real estate and sovereign loans.

Question 41

wildcat banking

Answer 41

A term used in the 1800s to describe banks that could be organized with little or no capital or supervision.

Question 42

National Bank Act of 1864

Answer 42

Created the Office of the Comptroller of the Currency (OCC). Gave the OCC the power to (1) charter (2) regulate (3) supervise national banks. National banks have the word national or natural association in their names.

Question 43

Bank Holding Act of 1956

Answer 43

Changed the definition of a bank. Banks could accept deposits that could be withdrawn on demand and make commercial loans.

Question 44

What are the 3 main things banks offer their customers? (pg 9-11)

Answer 44

Payments (means by which financial transactions are settled), Intermediation, Other Financial Services (Off-balance sheet activities like standing letter of credit, Insurance and Securities related activities and trust services)

Question 45

What are the 9 risks associated with bank risk management according to the OCC? (pg 12)

Answer 45

Credit, Interest Rate, Operational, Liquidity, Price, Compliance, Foreign Exchange, Strategic and Reputation

Question 46

What are the 3 main contraints of risk for banks? (pg 13)

Answer 46

Market, Social and Legal/Regulatory

Question 47

Major factors affecting banking and market share?

Answer 47

Inflation, volitile interest rates, securitization, technology advances, consumers, deregulation, despecialization/competition, globalization and capital markets

Question 48

What are the assets of a commercial bank?

Answer 48

Loans, Investments, Cash, Other: buildings, equipment and some other odds and ends.

Question 49

What are the liabilties of a commercial bank?

Answer 49

Deposits, borrowings

Question 50

What is the primary determinant of bank profitability? (pg 24)

Answer 50

The state of the economy - including economic growth, the level of interest rates and other factors.