Topic 2 Flashcards
What is a balance sheet?
List of a banks assets and liabilities
What do banks do with their money?
They invest their liabilities (sources) into assets (uses) in order to create value for their capital providers.
What is net worth?
Difference between a banks assets and liabilities.
What are the four categories of assets?
Cash
Securities
Loans
All other assets
Total bank assets = ?
Total bank liabilities + bank capital
Three types of cash items?
Reserves (vault cash and banks deposits at the central bank)
Cash items in process of collection (uncollected funds from checks)
Balances of the accounts that banks hold at other banks (usually deposits from small banks at larger banks (correspondent bank deposits))
3 types of securities?
Government/agency debt
Municipal debt
Other (non-equity) securities
What are secondary reserves? Why are they called this?
Securities - because a sizeable portion of them will be very liquid
5 types of loans?
Commercial and industrial loans Real estate loans Consumer loans Interbank loans Other loans (eg. For the purchase of securities)
3 types of bank and who they lend to?
Commercial banks loan to businesses mainly
Savings banks provide mortgages
Credit unions specialise in consumer loans
What has allowed commercial banks to become more involved in real estate?
The creation of MBS (mortgage backed securities) means banks can sell the mortgage loans they made, which reduces the risk of illiquid assets
3 sources of funds for banks?
Checkable deposits
Nontransaction deposits
Borrowings
Difference between checkable and nontransaction deposits?
Checkable deposits includes all accounts that allow the depositor to write checks to third parties.
Nontransaction deposits are accounts which the depositor cannot write checks.
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5 types of banking risks?
Liquidity Credit Interest-rate Trading Other
What is liquidity risk?
The risk of sudden demand for liquid funds
How can banks manage liquidity risk? (2)
Holding excess reserves
Adjusting its assets or its liabilities
How can a bank reduce its liquidity risk via asset management? (3)
Sell a portion of its securities portfolio
Sell some of its loans to other banks
Refuse to renew a customer loan that has come due
How can a bank reduce its liquidity risk via liability management? (2)
They can borrow from another bank or the central bank
They can attract additional deposits
What is credit risk?
The risk that banks won’t be repaid
Two ways and explained of how banks manage credit risk?
Diversification - banks make a variety of different loans to spread the risk (can be difficult to do if a bank specialises in certain loans)
Credit risk analysis - bank examines the borrowers credit history to determine an appropriate interest rate to charge
When can diversification be difficult for banks?
When they specialise in certain loan types
What creates interest rate risk?
Since liabilities are shorter term and assets are longer term, the mismatch creates interest rate risk
Example of how interest rate risk might create an issue?
If interest rates rise, this can cause the value of assets to fall by more than their liabilities
Eg. If they borrow money by issuing floating interest rate bonds, but lend money with fixed-rate mortgages, then an increase in the interest rate will decrease their profits since they must increase payments to bondholders but receive no increase on the interest on their mortgages
How can interest rate risk be managed?
By using short term deposits to finance short term loans tf eradicate mismatch
Define net interest margin?
The difference between the interest rate on liabilities and assets
What is trading (/market) risk?
Trading risk is the risk an asset may fall in value
Traders work for banks buying and selling securities etc
Why is there moral hazard in trading?
Traders share in profits but don’t share in the losses tf they sometimes take too much risk
How is trading risk managed?
A risk manager computes risk and only allows each trader a maximum amount of risk
What is foreign exchange risk?
Risk that comes from holding assets denominated in one currency and liabilities denominated in another
What is sovereign risk?
Some foreign borrowers may not repay their loans if their government prohibits them from doing so (eg. Argentina 2002)
What is operational risk?
When computers fails or buildings burn down
What is redenomination risk?
Risk a country may switch back to an old currency
