Week 2 Business of Banking and Bank performance Flashcards
Name and explain the assets on a banks balance sheet
• Cash and due from banks
– Vault cash, balances with Reserve Bank, balances at other financial institutions (e.g. receivables, collateral paid, other financial assets)
• Investment securities
– To earn interest and meet liquidity needs.
– Highly liquid, low default risk, traded in the secondary market.
– E.g. securities purchased under agreement to resell,
certificate of deposit, promissory notes, government securities
• Loans
– The major assets, generating the greatest amount of income.
– The highest default risk and relatively illiquid.
– Commercial and industrial loans (e.g. business loans), real
estate loans (e.g. housing loans), consumer loans (e.g.
personal loans and cards)
• Other assets
– E.g. property and equipment, intangible assets, goodwill,
etc.
name and explain the banks liabilities on the ba]alance sheet
• Payable due to other financial institutions (e.g.
interbank borrowing, securities sold under
agreements for repurchase, collateral received)
• Deposits
– E.g. certificate of deposit, at-call (non-interest bearing
or interest bearing) and term deposits, etc.
• Borrowed funds (e.g. debt issues)
– Short-term or long-term; unsecured or secured.
– E.g. commercial papers, covered bonds, securitisation, etc.
• Loan capital
– Instruments issued by a bank with terms and conditions that qualify for inclusion as regulatory
capital
name and explain the banks equity on the ba]alance sheet
• Shareholders’ equity
– Share capital (ordinary shares, preference shares) and retained earnings (accumulated net income not paid out as cash dividends).
– Represents ownership interest in the bank.
explain off balance sheet (OBS) activities
• OBS items are contingent asset and liabilities that may
affect the future status of balance sheet. Some
common items are:
– Loan commitments
– Commercial letters of credit
– Standby letters of credit
– Loan sales with recourse
– Derivatives
– Other fee-generating activities: e.g. trust services, proceeding
services, correspondent banking.
Explain interest income on a banks income statement
• Interest income
– Interest and fees earned on a bank’s assets, such as loans and leases, deposits held at other institutions,
investment and other securities
– Vary between institutions due to:
• Rate effect: rate earned on assets with different risk and maturity.
• Composition (mix) effect: the mix of assets may differ.
• Volume effect: all else equal, a larger volume of assets would
increase interest income
Explain interest expense on a banks income statement
– Interest paid on interest-bearing liabilities.
– May vary between institutions due to:
• Rate effect: interest cost per liability may differ between
banks because of differences in risk premiums, timing,
and maturity of the borrowing.
• Composition (mix) effect: the mix of liabilities may differ.
• Volume effect: banks operate with different amount of
interest-bearing debt.
Explain noninterest income on a banks income statement
– Income received as a result of its on- and off-balancesheet activities, such as:
• Fiduciary activities: trust department.
• Service charges: e.g. account fees.
• Trading gains (or losses): from securities, derivatives, foreign
exchange, securitisation, etc.
• Investment banking activities: e.g. advisory, brokerage,
underwriting fees and commissions, etc.
• Insurance commission fees and income
Explain noninterest expense on a banks income statement
• Noninterest expense (e.g. operating
expenses)
– Generally large relative to noninterest income.
– It is primarily composed of:
• Personnel expense: salary and employee benefits,
etc.
• Occupancy expense: depreciation of premises and
equipment, utilities, etc.
• Other operating expense: technology, advertising,
one-time transaction, etc.
Explain loan loss expense on a banks income statement
• Loan loss expenses (e.g. impairment charges)
– Current period’s allocation to the allowance for loan
losses listed on the balance sheet, representing
management’s prediction of loans at risk of default for
the period.
– Noncash, tax-deductible expense.vn
What is net interest income?
• Net interest income = interest income –
interest expense
– Measures bank’s ability to generate profits and control interest rate risk.
what is total operating income?
• Total operating income = interest income +
noninterest income
– It represents bank’s income from all sources
What are the last two things on the income statement?
• Income taxes expense
• Net income/net profit (e.g. profit after income
taxes)
Explain Profit Margin (PM)
DuPont analysis
- PM = net income / total operating income
- Bank’s ability to control
- Lower the above ratios, higher the profit margin.
• A breakdown of PM can isolate the various expense, such as:
– Interest expenses ratio = interest expense / total operating income ect.
Explain Asset utilisation (AU)
DuPont analysis
- AU = total operating income / average total assets
- The extent to which a bank’s assets generate revenue.
• A breakdown of AU can separate two sources of revenue:
– Interest income ratio = interest income / average total assets
– Noninterest income ratio = noninterest income / average total asset
• A high value of this ratio signifies the efficient use of bank
resources to generate income, but may indicate underlying
problems
Explain Equity multiplier
DuPont analysis
– EM = average total assets / average total equity capital
– Represents the degree of financial leverage employed by the
bank.
