Chapter 9: Banking and Management of Financial Institutions Flashcards
what is the equation of balance sheets?
total assets = total liabilities + capital
non-transaction deposits
the primary source of bank funds
- savings and CDs
Bank capital
the bank’s net worth (total assets - liabilities = net worth)
correspondent banking
small banks with deposits at larger banks
secondary reserves
high liquidity, short term US government securities
deposit outflows
when deposits are lost
because depositors make withdrawals and demand payment
liquidity management
keep enough cash to meet obligations to depositors
asset management
purchase assets to maximize profits while managing credit and interest risk
liability management/liquidity risk
acquiring funds at low cost
capital adequacy management
maintain sufficient capital to prevent bank failure
credit risk
the risk arising because borrowers may default
interest rate risk
the riskiness of earnings and returns on bank assets caused by interest-rate changes
return on assets (ROA)
the net profit after taxes per dollar of assets
- ROA = net profit after tax/assets
return on equity (ROE)
the net profit after taxes per dollar of equity (bank) capital
- net profit after taxes/equity
equity multiplier (EM)
the amount of assets per dollar of equity capital
- assets/equity
loan commitment
a bank’s commitment to provide a firm with loans up to a given amount at an interest rate that is tied to some market interest rate
compensating balances
A firm receiving a loan must keep a required minimum amount of funds in a checking account at the bank
credit rationing
refusing to make loans even though borrowers are willing
to pay the stated interest rate, or even a higher rate
basic gap analysis
gap = RSA - RSL
change in net worth = gap * change in interest
duration analysis
-(duration A x A - duration L x L) change in interest
Off-balance-sheet activities
activities that affect bank profits but do not appear on bank balance sheets
loan sale
a secondary loan participation
screening process
underwriting, checking credit score
monitoring process
checking that loan is not being used for high risk things
loan department
stopping bad credit risks from becoming borrowers
collections department
stopping borrowers from becoming bad credit risks
type I error
denying a good CR “framing an innocent man”
type II error
approving a bad CR “freeing a guilty man”
underwriting standards check…?
loan-to-value ratios, credit scores, and income ratios
loan-to-value ratios
physical security
income ratios
financial capabilities
3 Cs of lending
collateral, capacity, character
housing expense
(principle + interest + property tax + insurance)/gross income
total debt expense
auto loans + credit loans + student loans
what happens in the housing market when people are denied loans?
housing prices fall because demand for houses fall
mortgage crisis
- lending to high risk borrowers
- large amounts of money that they could not afford
- inflated appraisals
- inflated non-verified income
FICO
fair Isaac corporation
- credit score model to measure risk of default creditworthiness (range of 300-850)
What makes up a credit score
payment history 35, credit utilization 30, length of credit history 15, types of credit used 10, credit inquiries 10
what are the 3 factors of why real interest rates are low?
- rising propensity to save
- slowing investment demand
- central bank actions
factors of why there is a rise in propensity to save
- aging population saving for retirement
- China increasing world’s pool of saving
factors of why there is slow investment demands
- slowing economic trend growth
- falling real cost of plant and equipment
- value of firms shifting to intangible assets
why has the central banks’ actions affected interest rates?
- low short term interest rates for 8 years cause low long-term rates
- quantitative easing - buying long term bonds causes low long-term rates
3 reasons why banks manage capital levels
- prevent bank failure
- adjust ROE
- regulatory requirements
3 ways to raise capital-to-assets
- increase capital by issuing equities (more shares)
- increase capital by decreasing dividends
- reduce assets by selling loans/securities and paying off liabilities
what is the problem with issuing more equity?
reduces current equity
3 ways to lower capital-to-asset
- buy back bank stocks
- increase dividend payout
- increase assets by issuing CDs and acquiring loans/investments (increasing liabilities)
how does increasing/decreasing dividends affect capital?
changes retained earnings
capital-to-assets growth rate analysis
the growth rate of a ratio is the difference between numerator and denominator growth rates, (for small growth rate)
- %Change(C/A) = change C/C - change A/A
If change C/C = change A/A, what is the % change C/A?
0
If change C/C = change A/A, what is the return on assets?
ROA = Change A/A * Change C/A
Equation for finding max withdrawal from bank
(Total Reserve - Outflow)/(Deposit - Outflow) >= Required reserve ratio
when a bank has insufficient reserves it may:
- borrow from other banks or corporations
- sell securities
- reduce loans
- borrow from Fed (discount loan)
maturity bucket approach to gap analysis
measure the gap for several maturity subintervals
standardized gap analysis
accounts for the differing degrees of rate sensitivity among rate-sensitive assets and liabilities
total reserves
required reserves + excess reserves = deposits at the Fed + vault cash
net interest margin
ROA - COF
shadow banking
another way to get funds from savers to borrowers
Term asset back security loan facility (TALF)
restore credit flows to HHs and firms through the securitization market
disintermediation
reducing use of intermediaries
Repos are made up of two transactions
cash transaction and forward contract
Repos
when Bank A gives Bank B bonds and agrees to buy back at a later date
Reverse repos
when Bank A buys back their bonds from Bank B
