Week 6 Flashcards
What are a bank’s key financial statements?
- Balance sheet (stocks)
- Income / P/L statement (flows)
Why are retail banks exposed to liquidity risk?
Because their liabilities are more liquid than their assets
What characterises an investment bank’s balance sheet?
Securities make up most assets and liabilities
What is the difference between revenues & costs?
- Revenues generated by assets
- Costs generated by liabilities
What are the main costs for a bank?
- Interest paid on deposits & debts
- Provision for loan losses & taxes
- Dividends to shareholders
- Staffing & operating costs
What is ‘reclassifying’ an income statement?
Scaling / adjusting it for the size of the bank
How do you reclassify an income statement?
- Subtract PLL to get net interest income after PLL
- Calculate net non-interest income
- Combine to get pre-tax net operating profit
- Add/subtract securities gains/losses to get profit before taxes
- Account for extraordinary items e.g. M&As
- After tax you get net profit
- After dividends you get retained prodit
What is PLL?
Provision for loan losses
What are the categories of financial ratios?
- Profitability
- Asset quality
- Liquidity
- Solvency
- Efficiency
What ratios measure profitability?
- ROE
- ROA
- NIM
What ratios measure asset quality?
NPL
What ratios measure liquidity?
Liquidity ratio
What ratios measure solvency?
Capital ratio / EM
What ratios measure efficiency?
C/I
What is ROE?
- Return on equity
- Profitability measure for shareholders
- ROE = net income/total equity
What is ROA?
- Return on assets
- General profitability measure
- ROA = net income/total assets
What is EM?
- Equity multiplier/capital ratio
- Solvency/leverage measure
- EM = total assets/total equity
What is NIM?
- Net interest margin
- Profitability ratio
- NIM = net interest income/earning assets
Should NIM ideally be high or low?
High
What is C/I?
- Cost to income ratio
- Efficiency measure
- C/I = non-interest expenses/total income
What is the liquidity ratio?
core deposits/total assets
What is NPL?
- Non-performing loans
- Not yet written off
- But in doubt/problematic
What is capital adequacy?
- Total risk-based capital ratio
- Measures soundness
What is the difference between liquidity & solvency?
- Liquidity = cash flow
- Solvency = stock
What is ALM?
Asset & liability management
What is the purpose of ALM?
Maximise profits & shareholder value
What is included in ALM?
- Investment (asset) decisions
- Financing (liability) decisions
- Monitoring performance
Why is ALM different for banks than other companies?
Loans & deposits are more complex than other assets & liabilities
When is shareholder value created?
When ROC > cost of capital
What is one measure of shareholder value?
EVA (economic value added)
How is EVA calculated?
NOPAT - (CI x K)
- net op profit after tax
- capital invested
- cost of capital
In ALM, what is included under asset management?
- Maximise loan/security returns
- Minimise risks
- Adequate liquidity
In ALM, what is included under liability management?
- Maximise interbank market returns
- Minimise cost of deposits
What must be balanced in ALM?
- Long-run (2-5yr) strategic objectives
- Flexibility to respond to shocks
Why is flexibility especially important for global banks?
Shocks could come from anywhere in the world
What are the types of reserves?
- Required reserves
- Excess reserves
If banks are illiquid, what steps do they take, in order?
- Borrow from other banks
- Sell securities
- Sell loans
- Borrow from central bank (if solvent)
Why was Northern Rock nationalised?
It was still solvent despite liquidity crisis
Why do shareholders prefer low capital?
high leverage = low capital = high ROE
What are the advantages of holding capital?
- ex ante - can loan when demand is high
- es post - protects bank when it incurs losses
