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Chapter Fifteen

Chapter Fifteen. The Banking Firm and Bank Management. The Bank Balance Sheet. Flow of funds (tab down to commercial banks) http://www.federalreserve.gov/releases/z1/current/z1r-4.pdf. Bank Operation. T-account Analysis: Deposit of $100 cash into First National Bank. Bank Operation.

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Chapter Fifteen

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  1. Chapter Fifteen The Banking Firm and Bank Management

  2. The Bank Balance Sheet Flow of funds (tab down to commercial banks)http://www.federalreserve.gov/releases/z1/current/z1r-4.pdf

  3. Bank Operation • T-account Analysis: • Deposit of $100 cash into First National Bank

  4. Bank Operation • Deposit of $100 check • Conclusion: When bank receives deposits, reserves  by equal amount; when bank loses deposits, reserves by equal amount

  5. Principles of Bank Management • Liquidity management • Asset management • Managing credit risk • Managing interest-rate risk • Liability management • Managing capital adequacy

  6. Principles of Bank Management

  7. Principles of Bank Management • With 10% reserve requirement, bank still has excess reserves of $1 million: no changes needed in balance sheet

  8. Liquidity Management • With 10% reserve requirement, bank has $9 million reserve shortfall

  9. Liquidity Management

  10. Liquidity Management • Conclusion: Excess reserves are insurance against above 4 costs from deposit outflows

  11. Asset and Liability Management • Asset Management • Get borrowers with low default risk, paying high interest rates • Buy securities with high return, low risk • Diversify • Manage liquidity • Liability Management • Important since 1960s • No longer primarily depend on deposits • When see loan opportunities, borrow or issue CDs to acquire funds

  12. Capital Adequacy Management • Bank capital is a cushion that prevents bank failure • Higher is bank capital, lower is return on equity • ROA = Net Profits/Assets • ROE = Net Profits/Equity Capital • EM = Assets/Equity Capital • ROE = ROAEM • Capital , EM, ROE

  13. Capital Adequacy Management (cont.) • Tradeoff between safety (high capital) and ROE • Banks also hold capital to meet capital requirements • Strategies for Managing Capital • Sell or retire stock • Change dividends to change retained earnings • Change asset growth

  14. Off-Balance-Sheet Activities • Fee income from • Foreign exchange trades for customers • Servicing mortgage-backed securities • Guarantees of debt • Backup lines of credit • Financial futures and options • Foreign exchange trading • Interest rate swaps • Loan sales • All these activities involve risk

  15. Banks' Income Statement

  16. Measures of Bank Performance • ROA = Net Profits/ Assets • ROE = Net Profits/ Equity Capital • NIM = [Interest Income - Interest Expenses]/ Assets

  17. Financial Innovation • Innovation is result of search for profits • Response to Changes in Demand • Major change is huge increase in interest-rate risk starting in 1960s • Example: Adjustable-Rate Mortgages • Response to Changes in Supply • Major change is improvement in computer technology • Increases ability to collect information • Lowers transactions costs • Examples • Bank Credit Cards • Electronic Banking Facilities

  18. Avoidance of Existing Regulations • Regulations Behind Financial Innovation • Reserve requirements • Tax on deposits = IrD • Deposit-rate ceilings (Reg Q) • As i, loophole mine to escape reserve requirement tax and deposit-rate ceilings

  19. Avoidance of Existing Regulations • Examples • Eurodollars • Bank Commercial Paper • NOW Accounts • ATS Accounts • Sweep Accounts and Overnight RPs • Money Market Mutual Funds

  20. Profiting from Treasury Strips

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