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Management of Financial Institutions

Management of Financial Institutions. Chapter 9. Bank Balance Sheet. Commercial banks Commercial banks make profits through asset transformation (borrow short, lend long). Investment Banks Investment banks make profits through acting as brokers of securities.

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Management of Financial Institutions

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  1. Management of Financial Institutions Chapter 9 Money & Banking Maclachlan, Spring 2006

  2. Bank Balance Sheet Money & Banking Maclachlan, Spring 2006

  3. Commercial banks Commercial banks make profits through asset transformation (borrow short, lend long). Investment Banks Investment banks make profits through acting as brokers of securities. Indirect Finance vs. Direct Finance Money & Banking Maclachlan, Spring 2006

  4. General Principles of Bank Management • Liquidity Management • Asset Management • Liabilitity Management • Capital Adequacy Management Money & Banking Maclachlan, Spring 2006

  5. Two Types of Risk • Credit Risk • Interest Rate Risk Money & Banking Maclachlan, Spring 2006

  6. Managing Risk “The business of banking is the production of information.” -- Walter Wriston, former head of Citicorp Money & Banking Maclachlan, Spring 2006

  7. Credit Risk Asymmetric information. Before transaction: adverse selection. After transaction: moral hazard. Money & Banking Maclachlan, Spring 2006

  8. Methods to deal with Credit Risk • Screening • Monitoring • Relationship banking • Loan commitments • Collateral • Credit rationing Money & Banking Maclachlan, Spring 2006

  9. Interest Rate Risk Risk associated with borrowing short and lending long. If interest rates rise, liabilities will be turned over at new higher rates while the bank is still earning low rates on assets. Money & Banking Maclachlan, Spring 2006

  10. Managing Interest Rate Risk Keep track of the gap = rate sensitive assets – rate sensitive liabilities Loan sales Fee income Derivatives (financial contracts as insurance) Money & Banking Maclachlan, Spring 2006

  11. Calculate the 1-year GAP (RSA-RSL) (300+100)-(10+90+160+200+200) = -260 Money & Banking Maclachlan, Spring 2006

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