Chapter 9 Slideshow Flashcards
Balance sheet equation
Total assets = total liabilities + capital
assets - uses of funds, securities and loans
liabilities - sources of funds, borrowing
Assets include
- Reserves
– Cash items in the process
of collection
– Deposits at other
banks
– Securities
– Loans
– Other assets
Liabilities Include
- checkable deposits
- non-transaction deposits (time dep. savings dep. CDs)
- borrowings
- bank capital
Asset transformation
selling liabilities with one set of characteristics and using the proceeds to buy assets w/ diff characteristics
the bank borrows _____ and lends _____
short, long
Principles of Bank management to maximize profit
- liquidity
- asset
- liability
- capital adequacy
- credit risk
- int rate risk
“mgmt”
liquidity management
to ensure
that the bank
has enough
cash on hand
to pay its
depositors
when there
are deposit
outflows.
asset management
to ensure
that assets
have low
level of risk
and rate of
default.
liability management
to acquire funds w/ low cost
capital adequacy management
to ensure
that bank
maintain
adequate
capital
credit risk management
the
probability
that
borrowers
default.
interest rate risk management
the riskiness of
returns on assets
because of changes
in interest rates.
4 options to meet deposit outflows:
- borrowing
- securities sales
- Federal reserve in discount loans
- Reduce loans
Purpose of excess reserves
insurance against the costs associated with deposit outflows
3 goals to maximize profit
- seek highest possible returns on loans and securities
- reduce risk
- have adequate liquidity
4 tools to maximize profits
- find borrowings that pay high int with low default
- purchase securities with high returns and low risk
- lower risk by diversifying assets, loans, and customers
- balance need for liquidity against increased returns from less liquid assets
main trade-off in liability management
higher returns vs lower risk
How has liability management changed since 1960s
before 1960s, checkable deposits were major source of funds
after 1960s, large banks sold CDs, engaged in borrowing, used overnight loans
why is capital adequacy important? (3)
- bank capital helps prevent bank failure
- amt of capital affects return for owners of the bank
- a minimum amt is required by regulatory authority
ROA formula
net profit after taxes / assets
ROE formula
net profit after taxes / equity capital
Equity multiplier, definition and formula
amt of assets per dollar of equity capital
EM = assets / equity capital
Relationship between ROE, EM, and ROA
ROE = ROA * EM
trade offs concerning bank capital
benefit: safer investments and reduces chances of bankruptcy
cost: higher bank capital, lower ROE
How to manage interest rate risk
rearrange balance sheet using duration, develop financial instruments w/o rearranging balance sheets
5 steps to managing credit risk
- screening and monitoring
- LT customer relation
- loan commitments
- collateral and compensating
- credit rationing
Off balance sheet activities
loan sales, generation of fee income, trading activites and risk mgmt techniques
When is a bank failure less likely to occur?
when it has more bank capital
