Commercial Banking

Question 1

Primary source of income for commercial banks

Answer 1

Interest earned on loans and investment securities

Question 2

Primary expenses for commercial banks

Answer 2

Interest paid on deposits and borrowed funds. Also salaries

Question 3

Principle source of funds for commercial banks

Answer 3

Deposit accounts

Question 4

For large banks, what is more important: Borrowed funds or deposits?

Answer 4

Borrowed Funds

Question 5

List a banks liabilities

Answer 5

Deposit accounts: Transactional and Non-Transactional
Deposits
Borrowed funds

Question 6

List a banks assets

Answer 6

Reserves: Deposits at central bank
Securities: Income earning assets
Loans

Question 7

List a banks capital

Answer 7

Share capital
Retained Earnings
Reserve accounts

Question 8

Name 2 off-balance-sheet banking activities

Answer 8

Trading financial instruments
Loan brokerage

Question 9

Three loan commitments

Answer 9

1. Line of credit
2. Term loans
3. Resolving credit facilities

Question 10

Three measures of bank performance

Answer 10

1. Rate of return on average assets (ROAA)
2. Rate of return on average equity (ROAE)
3. Net Interest Margin

Question 11

Name and define the two types of liquidity management

Answer 11

1. Asset management: Maintaining sufficient cash and non-cash that can be quickly converted
2. Liability management: Acquiring liquidity for the liability side of the balance sheet

Question 12

Four elements of asset management

Answer 12

1. Primary reserves: Immediately available to cover liquidity demands (Vault cash, deposits at CB)
2. Secondary reserves: Provide added liquidity while earning interest (T-Bills, short-term government securities)
3. Bank Loans: Undertaken once bank has satisfied liquidity needs (loans to business)
4. Investments: Undertaken once loan demand has been satisfied (long term t-securities)

Question 13

What is liability management

Answer 13

Attracting additional funds by increasing the interest rate on interest sensitive funds

Question 14

What are the typical securities used for liability management (4)

Answer 14

1. Negotiable CDs,
2. repos,
3. commercial papers
4. eurodollars

Question 15

What is the primary risk a bank can have

Answer 15

Credit risk (risk of a loan default)

Question 16

Components of CAMELS

Answer 16

Capital adequacy
Asset quality
Management
Earnings
Liquidity
Sensitivity to market risk

Question 17

Why do banks want to manage interest rate risk?

Answer 17

To ensure that they spread between its borrowing rates and rates they can earn on investments

Question 18

General aspects of managing interest rate risk (3)

Answer 18

1. Shorter term deposits fund longer term loans
2. Term structure usually upward sloping
3. When rates rise the deposits reprice before the loan, exposing banks to decreased earnings

Question 19

Three ways to measure interest rate risk

Answer 19

1. Maturity gap analysis (used to ensure banks have maturities similar to their liabilities)
2. Duration gap analysis: (more precise and used by large organisations)
3. Value at Risk (VaR)

Question 20

Maturity Gap = ? - ?

Answer 20

Rate sensitive assets (RSA) - Rate sensitive liabilities (RSL)

Question 21

What does a duration gap analysis measure

Answer 21

The difference between the duration of a banks assets and liabilities

Question 22

What does a VaR measure

Answer 22

The maximum potential gains and losses by a portfolio within a period

Question 23

Critiques of VaR (2)

Answer 23

1. Future may differ from the past - VaR does not report the max potential loss
2. Different portfolios may have the same VaR but different expected levels of loss

Question 24

Define Micro Hedging

Answer 24

1. Hedging a specific transaction
2. Matched funding (fixed rate loans are funded with deposits or borrowed funds of the same maturity)

Question 25

Define Macro Hedging

Answer 25

Through the use of derivatives (financial futures, options on futures and interest rate swaps)

Question 26

Why do banks participate in the markets for interest rate and currency forwards, futures, options and swaps

Answer 26

to speculate on the direction of changes in IRs or XRs