Chapter 9, goals

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Chapter 9, goals

• Understand the 4 different goals of bank
  management
• Liquidity management
• Asset management
• Liability management
• Capital adequacy management

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Basic BankingCash Deposit

• Opening of a checking account leads to an
  increase in the banks reserves equal to the
  increase in checkable deposits

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Basic BankingCheck Deposit
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Basic BankingMaking a Profit

• Asset transformation-selling liabilities with one
  set of characteristics and using the proceeds to
  buy assets with a different set of
  characteristics
• The bank borrows short and lends long

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Bank Management

• Liquidity Management
• Asset Management
• Credit Risk
• Liability Management
• Capital Adequacy Management
• Interest-rate Risk

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Liquidity Management Ample Excess Reserves,
rrr10

• Enough reserves and liquid assets to meet reserve
  requirements and net deposit outflows
• If a bank has ample excess reserves, a deposit
  outflow does not necessitate changes in other
  parts of its balance sheet

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Liquidity Management Shortfall in Reserves

• Reserves are a legal requirement and the
  shortfall must be eliminated
• Excess reserves are insurance against the costs
  associated with deposit outflows

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Liquidity Management Borrowing, federal funds
for example

• Cost incurred is the interest rate paid on the
  borrowed funds

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Liquidity Management Securities Sale

• The cost of selling securities is the brokerage
  and other transaction costs

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Liquidity Management Federal Reserve, discount
window

• Borrowing from the Fed also incurs interest
  payments based on the discount rate

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Asset Management Three Goals

• Seek the highest possible returns on loans and
  securities
• Reduce risk
• Have adequate liquidity

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Asset Management Four Tools

• Find borrowers who will pay high interest rates
  and have low possibility of defaulting
• Purchase securities with high returns and low
  risk
• Lower risk by diversifying
• Balance need for liquidity against increased
  returns from less liquid assets

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Liability Management

• Recent phenomenon due to rise of money center
  banks
• Expansion of overnight loan markets and new
  financial instruments (such as negotiable CDs)
• Checkable deposits have decreased in importance
  as source of bank funds

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Capital Adequacy Management

• Bank capital helps prevent bank failure
• The amount of capital affects return for the
  owners (equity holders) of the bank
• Regulatory requirement

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Capital Adequacy Management Preventing Bank
Failure When Assets Decline
gtcalculate the change in net worth for the 2 banks
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Capital Adequacy Management Returns to Equity
Holders
gtmeasure the EM for the 2 different banks before
the decline in assets
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Capital Adequacy Management Safety

• Benefits the owners of a bank by making their
  investment safe
• Costly to owners of a bank because the higher the
  bank capital, the lower the return on equity
• Choice depends on the state of the economy and
  levels of confidence

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Credit Risk Overcoming Adverse Selection and
Moral Hazard

• Screening and information collection
• Specialization in lending
• Monitoring and enforcement of restrictive
  covenants
• Long-term customer relationships
• Loan commitments
• Collateral and compensating balances
• Credit rationing

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Interest-Rate Risk

• If a bank has more rate-sensitive liabilities
  than assets, a rise in interest rates will reduce
  bank profits and a decline in interest rates will
  raise bank profits

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Interest Rate Risk Gap Analysis
gtIf interest sensitive liabilities are 30million
more than interest sensitive assets, calculate
the change in profits resulting from a 2 change
in interest rates
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Interest Rate Risk Duration Analysis
gtIf a bank has 100million in assets with an
average 3 year duration and 96million in
liabilities with an average 2 year duration,
calculate the change in net worth resulting from
a 2 change in interest rates
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Chapter 1011

• Understanding the regulation of banking in the US
• Banks motivations
• Regulators role
• Asymmetric information
• Changes in laws
• Bank responses

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Evolution of the Banking Industry

• Financial innovation is driven by the desire to
  earn profits
• A change in the financial environment will
  stimulate a search by financial institutions for
  innovations that are likely to be profitable
• Responses to change in demand conditions
• Responses to changes in supply conditions
• Avoidance of regulations