Test 2

Question 1

Role of Community banks

Answer 1

• Small Business lending (small business loans) meaning they can include the character of the borrower and special features of the local market
• Personal relationship based meaning they are able to build a long-term relationship with their borrowers
• Farm Lending
• Retail Deposit Services, Providing personal service for depositors of low to moderate wealth (which large banks do not deal with)

Question 2

Applications of bond market model

Answer 2

1) Expected inflation rate (increase)
2) Expansionary phase of the economy (upswing of business cycle, example: 1990)
3) Historically low savings rate (rate of savings)

Question 3

Real interest rate

Answer 3

i_r=i_n- π^e

Question 4

Sources of financing for non-bank businesses

Answer 4

1) Loans (Banks : 18% non-bank intermediaries 38%)
2) Bonds (corporate 32%)
3) Stocks / Equity (11%)
4) Other (1%)

Question 5

Key problems encountered by financial institutions (businesses)

Answer 5

a) Asymmetric information (principal agent problem; info only people within the company know apposed to stock holders)
b) Adverse selection (hiding info, happens before contract happens)
c) Moral hazard (Happens after the contract happens; Bank using money on undesirable loans or instruments)

Question 6

Goals of banks

Answer 6

1) Liquidity / maintaining adequate liquidity
a) Meet withdrawal demands (1. Vault cash 2. Secondary money market papers[TBs, Banker’s acceptances] 3. Borrowing)
2) Profitability [ Profits (π) = Total revenue (payins) - Total cost (payouts)]
3) Solvency [Banks ability to meet all of its liabilities / obligations via the liquidation of its assets (assets = Liabilities + capital)]

Question 7

ROA

Answer 7

Return on assets = (Net profits after taxes) / (Dollar value of assets)
How well the bank is doing in terms of assets generated and as a proxy bank’s income generating capacity via it’s assets

Question 8

ROE

Answer 8

Return of Equity = (Net profits after taxes) / Equity

Net profits in relation to dollars worth of investment the owner of equity made

Question 9

EM

Answer 9

Equity Multiplier = Assets / Equity
Bank’s perspective
Lower ratio benefits depositors and higher ratio benefits owners

Question 10

Asset management theories

Answer 10

(Early era)

1) Commercial loan theory / Real Bill doctrine
2) Shiftability theory
3) Anticipated income theory

Question 11

Liability management theories

Answer 11

(Modern Era)

1) Liability management theory (modern)
2) Asset allocation theory

Question 12

Commercial Loan Theory

Answer 12

(‘Real Bill’ Doctrine) Attributes: Banks ought to emphasize short term loans.

Question 13

Shiftability theory

Answer 13

• key elements: Existence of active market and shiftability of an asset (tantamount to liquidity)
• Theory: Enabled the banks to create long term loans tending toward capital formation
• Limitations: What can be true for one or a few banks cannot be viable/true for the entire banking system

Question 14

Anticipated income theory

Answer 14

• Ability to pay of the borrower: depends on stability of future income of the borrower (Individual: length of employment. Firm: Revenue flow [debt/revenue ratio])

Question 15

Asset Allocation Theory

Answer 15

Adapt the Asset mix in view of changing liabilities mix. in example bulk of liabilities: trending toward short-term withdrawal the bank will have to maintain relatively more liquid assets (short term and secured)

Question 16

Liability management theory

Answer 16

control the amount of liabilities

Question 17

Banking/institutional structure

Answer 17

Domestic area and international area

Question 18

domestic area

Answer 18

Dual banking
unit banking (community)
Bank holding company
Correspondent banking

Question 19

International area

Answer 19

Edge Act corporation
International banking facilities in the U.S.
Foreign Banks in the U.S.

Question 20

Dual banking

Answer 20

State and federal chartered

Question 21

State chartered

Answer 21

• Chartered under state statutes
• Authority : state banking commissioner
• Banks: limited to certain delineated areas
• Generally smaller banks compared to federally chartered banks
• can opt to become members of the fed

Question 22

Fed Chartered

Answer 22

-Chartered under federal statues
- Authority: comptroller of currency (treasury)
- Branching: governed by state statues
- Generally larger banks tend to be fed chartered
(under the rubric of Bank holding companies)
- Mandatory members of the fed (which allows privileges of the fed and have responsibilities)

Question 23

Unit banking

Answer 23

• One bank serving a particular community
• Typically locally owned and locally administered
• Generally small banks
• Generally state chartered
• Decentralized mechanism / to preclude any outside control or monopolization

Question 24

Bank holding companies

Answer 24

• Umbrella of organization Having Bank and non-bank interests
• BHC can own banks and still have other business stakes
• After 1956: BHCs can have only bank-related other interests
• provide diversified services to various customers
• Provide diversified sources of funds

Question 25

Correspondent banking

Answer 25

Bank that collects deposits or transactions from foreign countries

Question 26

Edge Act Corporation

Answer 26

A special subsidiary engaged primarily in international banking. Their bank holding companies can also own a controlling interest in foreign banks and in foreign companies that provide financial services (such as finance companies)

Question 27

International banking facilities in the U.S. (IBFs)

Answer 27

• Can accept time deposits from foreigners but are not subject to either reserve requirements or restrictions on interest payments.
• Allowed to make loans to foreigners only

Question 28

Foreign Banks in the U.S.

Answer 28

Have to operate an agency office which means they can lend and transfer funds but they are not able to accept deposits from domestic residents.