Chapter 2: An Overview of the Financial System Flashcards
What is a bank failure?
tangible equity/assets < 2%
what is tangible equity?
money put up to start bank
what makes up tangible equity?
tier 1 capital + cumulative perpetual preferred stock - intangible assets
what makes up tier 1 capital?
equity + retained earnings
equity
money from common stockholders
retained earnings
kept earnings not given out as dividends
what makes up assets?
investments, loans, and fixed assets
what is an asset on a bank balance sheet?
something you own
what is a liability/capital on a bank balance sheet?
what a bank owes
what makes up liabilities and capital?
deposits, borrowings, total capital (tier 2, tier1)
what does the bank invest in?
treasury bonds, corporate bonds, mortgage backed securities
what makes up the loans banks give out?
commercial, auto, home, student, credit card
what makes up a bank’s fixed assets?
land, building, equipment
what makes up a bank’s deposits?
checking accounts, savings, money market deposits, CDs
House hold nudge constraint
income = consumption + tax + savings
What are the 10 characteristics of failed banks?
- pursued aggressive growth strategies
- chartered for less than 10 years
- rapid growth of commercial real estate loan portfolio
- had out of territory CRE loans
- large credit losses on CRE loans
- used nontraditional funding sources
- exhibit weak underwriting standards
- exhibit weak credit administration practices
- did not maintain enough for loan loss allowance account
- located in fast growing housing market areas
underwriting
approve or denying loans
asymmetric information
one party does not know enough about the other party to make accurate decisions
adverse selection
people who apply loans for that will likely default on them (before transaction)
moral hazard problem
not making sure borrower isn’t taking excessive risk
maturity
of years until debt instrument’s expiration
short term maturity
less than a year
intermediate maturity
between 1 and 10 years
long term maturity
ten years or longer
primary market
financial market that sells new issues of a security to initial buyers by the or government agency borrowing the funds
secondary market
financial market in which securities that have been previously issues are resold
two ways secondary markets are organized
- exchanges
- over the counter market
exchanges
where buyers and sellers meet to conduct trade
over the counter market
dealers at different locations who have an inventory of securities stand ready to buy and sell securities to anyone who comes and is willing to accept their prices
money market
short term debt instruments are sold
capital market
longer term debt and equity instruments are traded
money market instruments
short-term debt securities issued by governments, financial institutions, and corporations; least risky
federal funds rate
interest rate on federal funds
default
when people don’t pay backs their loans
commercial paper
short term debt instruments issued by large banks and well known corporations
repurchase agreements (repos)
effectively short term loans for which treasury bills serve as collateral
federal funds
interbank loans
capital market instruments
debt and equity instruments with maturities of greater than one year
US government securities
long-term debt instruments issued by the US treasury to finance the deficits of the federal government
economies of scale
as transaction costs decreases, the size of transactions increase
risk sharing
assets with risk characteristics that people are comfortable with
economies of scope
a saving gained by producing multiple goods as the cost of producing each individual thing decreases
allowance for loan loss
an estimate of uncollectible amounts used to reduce the book value of loans and leases to the amount that a bank expects to collect (money for defaults)
provision for loan loss
an income statement expense set aside as an allowance for uncollected loans and loan payments
3 major goals of banking
- safe and sound (capital ratio)
- competitiveness (asset growth rate)
- economic viability (ROA)
Who were bailed out by the Federal Housing Finance Administration during the financial crisis of 2008?
Fannie Mae
