Commercial Banking Flashcards
Primary source of income for commercial banks
Interest earned on loans and investment securities
Primary expenses for commercial banks
Interest paid on deposits and borrowed funds. Also salaries
Principle source of funds for commercial banks
Deposit accounts
For large banks, what is more important: Borrowed funds or deposits?
Borrowed Funds
List a banks liabilities
Deposit accounts: Transactional and Non-Transactional
Deposits
Borrowed funds
List a banks assets
Reserves: Deposits at central bank
Securities: Income earning assets
Loans
List a banks capital
Share capital
Retained Earnings
Reserve accounts
Name 2 off-balance-sheet banking activities
Trading financial instruments
Loan brokerage
Three loan commitments
- Line of credit
- Term loans
- Resolving credit facilities
Three measures of bank performance
- Rate of return on average assets (ROAA)
- Rate of return on average equity (ROAE)
- Net Interest Margin
Name and define the two types of liquidity management
- Asset management: Maintaining sufficient cash and non-cash that can be quickly converted
- Liability management: Acquiring liquidity for the liability side of the balance sheet
Four elements of asset management
- Primary reserves: Immediately available to cover liquidity demands (Vault cash, deposits at CB)
- Secondary reserves: Provide added liquidity while earning interest (T-Bills, short-term government securities)
- Bank Loans: Undertaken once bank has satisfied liquidity needs (loans to business)
- Investments: Undertaken once loan demand has been satisfied (long term t-securities)
What is liability management
Attracting additional funds by increasing the interest rate on interest sensitive funds
What are the typical securities used for liability management (4)
- Negotiable CDs,
- repos,
- commercial papers
- eurodollars
What is the primary risk a bank can have
Credit risk (risk of a loan default)
Components of CAMELS
Capital adequacy
Asset quality
Management
Earnings
Liquidity
Sensitivity to market risk
Why do banks want to manage interest rate risk?
To ensure that they spread between its borrowing rates and rates they can earn on investments
General aspects of managing interest rate risk (3)
- Shorter term deposits fund longer term loans
- Term structure usually upward sloping
- When rates rise the deposits reprice before the loan, exposing banks to decreased earnings
Three ways to measure interest rate risk
- Maturity gap analysis (used to ensure banks have maturities similar to their liabilities)
- Duration gap analysis: (more precise and used by large organisations)
- Value at Risk (VaR)
Maturity Gap = ? - ?
Rate sensitive assets (RSA) - Rate sensitive liabilities (RSL)
What does a duration gap analysis measure
The difference between the duration of a banks assets and liabilities
What does a VaR measure
The maximum potential gains and losses by a portfolio within a period
Critiques of VaR (2)
- Future may differ from the past - VaR does not report the max potential loss
- Different portfolios may have the same VaR but different expected levels of loss
Define Micro Hedging
- Hedging a specific transaction
- Matched funding (fixed rate loans are funded with deposits or borrowed funds of the same maturity)
Define Macro Hedging
Through the use of derivatives (financial futures, options on futures and interest rate swaps)
Why do banks participate in the markets for interest rate and currency forwards, futures, options and swaps
to speculate on the direction of changes in IRs or XRs
