Presentation on theme: "BuffDaniel Presents Money and Banking Chapter 7 Bank Management."— Presentation transcript:
1 BuffDaniel PresentsMoney and BankingChapter 7Bank Management
2 Balance Sheet: A balance sheet lists the uses of acquired funds, assets; the source of acquired funds, liabilities; and the difference between the two, net worth.Assets = Liabilities + Capital
3 Assets – use of funds: Bank assets include cash items and funds used in securities investments, loans, and other asset holdings.The most liquid asset held by banks is reserves, which consist of vault cash—cash on hand in the bank or in deposits at other banks—and deposits with the Federal Reserve SystemRequiredExcessThe Fed requires banks to hold some of their deposits as required reserves in the form of vault cash or in reserve accounts at a Federal Reserve bank.Marketable securities are liquid assets that banks trade in securities markets.U.S. GovtState and LocalTwo-thirds of bank assets are loansBusinessConsumerMortgagesOther bank assets include the equipment and buildings the bank owns and collateral received from borrowers in default.Cash items in processingDeposits in other banks
4 Liabilities – Sources of funds: Bank liabilities are the funds the bank acquires from savers. Demand deposits: Banks offer savers checkable deposits, accounts that grant a depositor the right to write checks.Savings Deposits: To attract funds from depositors who want to earn interest on their funds, banks offer nontransactions deposits, such as savings accounts, money market deposit accounts, and certificates of deposit.In the United States federal deposit insurance provides government guarantees for account balances up to $100,000.Borrowings, or nondeposit liabilities, include short-term loans in the federal funds market, loans from a bank’s foreign branches or other subsidiaries or affiliates, repurchase agreements, and loans from the Federal Reserve System (known as discount loans).
5 Bank net worth, or equity capital, is the difference between the value of assets and the value of liabilities.A bank failure occurs when a bank cannot repay its depositors with enough reserves left to meet its reserve requirements.To analyze movements in bank profits, use is made of an accounting tool called a T-account, which lists change in balance sheet items from an initial position as they occur.
6 Starting a Bank Why start a bank? Obtain a charter Raise Funds (200) To make profits for the ownersMake profits by loaningObtain a charterRaise Funds (200)Building = 100Cash = 100Reserve Requirement of 10%Percentage of Deposits that must be held in the FEDAccept DepositsMake Loans
7 Revenues Costs Profits Basic Operation Interest income Noninterest incomeTrading income – derivates (options and futures)Customer feesCostsInterest ExpenseLoan LossesResource ExpenseProfitsRevenues - CostsBasic OperationT – accountsSomeone opens a checking accountBank makes a loanBank borrows from the FEDWhat if reserves fall below required amount
8 Services Traditional Modern Checking Savings Loans Bill paying Retirement accountsMoney market accountsInvestmentsCredit and Debit CardsInsuranceTax helpOnline banking
9 Types of Bank Management Asset management – maximize profits by loaning, maintaining liquidity, and meeting reserve requirementsLiability management – borrowing from other banks, the FED and corporations and issuing CD’sCapital Management – prevent bank failure, meet requirements, maintain returns to owners
10 Types of Bank RiskLeverage Risk – Extent to which a bank’s assets are purchased with debtCredit Risk – Extent to which a bank’s borrowers will defaultCredit or default risk—the risk that the borrower is unwilling or unable to live up to the terms of the liability it has soldInterest Rate Risk – Extent to which assets and liabilities are subject to interest rate changesInterest Rate Risk—the risk that the interest rate will unexpectedly change so that the costs of an FI’s liabilities exceed the earnings on its assets or that the value of long-term fixed rate assets has fallen as interest rates rise.Trading Risk – Extent to which a banks financial instruments are subject to losses caused by the marketLiquidity Risk – Extent to which banks are subject to unexpected withdrawals or unexpected loan demandLiquidity Risk—the risk that the FI will be required to make a payment when the intermediary has only long-term assets that cannot be converted to liquid funds quickly without a capital loss.Exchange Rate Risk—the risk that changes in the exchange rate can adversely affect the value of foreign exchange or foreign financial assets.
11 Managing Credit Risk: Banks are concerned about credit risk, the risk that borrowers might default on their loans, which arises because of problems of adverse selection and moral hazard.DiversificationBanks can reduce credit risk by holding a diversified portfolio of loans.Banks can also reduce credit risk by performing credit-risk analysis, in which the bank examines the borrower’s likelihood of repayment and general business conditions that might influence the borrower’s ability to repay the loan.Banks require collateral, or assets pledged to the bank in the event that the borrower defaults.Collateral requirementsCompensating balances – minimum balance in an accountTo reduce adverse selection and moral hazard problems banks sometimes practice credit rationing, in which case the size of a borrower’s loan is limited or the borrower is simply not allowed to borrow any amount at the going interest rate.Credit rationing – restricting who gets the loan and the amountTo reduce the costs of moral hazard banks monitor borrowers and place restrictive covenants in loan agreements
12 Screening applicants – applying for a loan One of the best ways for a bank to gather information about a borrower’s prospects or to monitor a borrower’s activities is for the bank to have a long-term relationship with the borrower.Screening applicants – applying for a loanBeacon Scores to 850775+ Preferred725 – 774 Platinum700 – 724 Gold680 – 699 Standard 1640 – 679 Standard 2620 – 639 Standard 3Forget itDeterminants of your credit scorePayment History 35%Credit cards, retail accounts, carloans, and mortgagesAmount owed 30%Number of accounts with balancesThe amount you owe vs amount of credit availableCredit History 15%The amount of time you’ve had each accountThe longer the betterNew credit 10%Number of accounts opened recentlyNumber of recent inquiriesOpening accounts in a short period is not goodTypes of credit used 10%Number of credit cards, retail accounts, consumer finance accounts, and mortgagesLess credit cards is better
13 5 C’s of Credit Character – financial integrity and management skills Clean credit history and reportCapacity – ability to repay a loanIncomeProfits from businessRatio of debt to incomeCapital – additional funds available or resourcesAssets such as SavingsLiabilities such as mortgage or credit card balanceConditions – external economic and noneconomic influencesIs your job subject to the state of the economy?Collateral – guarantee or security for a loanCar or home
14 Maintaining good credit Bankruptcy Types of Loans Lines of Credit RatingsPassSubstandardDoubtfulLoss – will not be paid backMaintaining good creditBankruptcyTypes of LoansLines of CreditExternal influencesWarElections
15 Specializing in the types of loans they provide Monitoring the covenants of a loan agreementEnforcing those agreementsEstablish long term relationships with customersLoan commitments to commercial customers for a long period of time (line of credit)
16 Managing Bank Risk: Banks experience interest rate risk if changes in market interest rates cause bank profits to fluctuateTo evaluate their exposure to interest rate risk, banks measure the duration of their assets and liabilities, which is the responsiveness of the assets’ or liabilities’ market value to a change in the market interest rate.Duration analysis – measures value of assets and liabilities to interest ratesBanks can reduce the risk of interest rate fluctuations through the use of floating-rate debt, with the loan interest rate being variable.Banks can also reduce their exposure to interest rate (and exchange rate) risk by using swaps, such as an interest rate swap that exchanges the expected future return on one financial instrument for the expected future return on another.Gap analysis – measures bank profits sensitivity to interest rates
17 Off-Balance Sheet Activities Letters of Credit and Loan CommitmentsLoan Sales – selling a debtGeneration of fee incomeATM fees and over draftsTrading in other markets
18 Financial innovation: Financial innovation is the creation of new financial instruments, markets, and institutions, new ways for people to spend, save, and borrow funds, and changes in the operation and scope of activities by financial intermediaries.Financial engineering – coming up with new products and services to meet the needs of the customersDemand condition changesAdjustable rate mortgages in Chicago in 1975Supply condition changes1960’s with computers came credit cards and debit cardsElectronic bankingCyber banksElectronic moneyAvoiding Existing Regulations by creating new types of accounts (NOW) that are specified in the requirements
19 Bank Supervision Focus on safety and soundness CAMELS Bank performance Financial conditionCompliance with regulationsCAMELSCapital AdequacyAsset QualityManagementEarningsLiquiditySensitivity to market risk