1. MCF 304: Bank Management
Lecture 2.2
Asset Management

2. Asset Management
How to distribute bank funds among different categories of assets so as to maximize profits
Different assets have different level of liquidity and profitability
The LP dilemma: If bank emphasize on liquidity, profitability will be sacrifice

3. Bank Financial Statements: Balance Sheet
Fixed Assets
Current Assets
- Cash and short term funds
- Securities purchased under resale agreement (REPO)
- Deposits and placements with banks and other financial institutions
Securities held for trading
Investment securities
Loans, advances and financing
Other assets
Investment in subsidiary companies
Investment in associate companies

4. Bank Financial Statements: Income Statement
Interest Income
(-) Interest Expense
(=)Net Interest Income
(-) Allowance for losses on loans, advances and financing
(+)Non-Interest Income
(=)Net Income
Net Income
(-) Overhead Expenses
(=) Profit Before Tax
(-) Tax
(=) Net Profit After Tax
(-) Transfer to Statutory Reserves
(=) Net Profit After Transfer to Statutory Reserves

5. Bank Financial Statements: Income Statement
Net Profit After Transfer to Statutory Reserves
(+) Retained Profit Brought Forward
(+) Distributable Profit
(-) Proposed Dividend
(=) Retained Profit Carried Forward
Earnings Per Share

6. Asset Management
How the bank invest its assets / funds to maximize its shareholders wealth
As the liquidity and profitability differ from one assets to another, banks must take into consideration the liquidity-profitability (LP) Dilemma

7. LP Dilemma
Exist because the degrees of liquidity and profitability are different across different assets
Attributed by conflicting goals among depositors, shareholders and controlling party
Shareholders expect high return, depositors desire maximum liquidity

8. LP Dilemma
LP Dilemma = to find a method that can strike a balance between risk & return, liquidity & profitability
Three methods;
Fund pool method
Assets allocation method
Management science method

9. Fund Pool Method
Fund from all sources are pooled together to create a single source of funds
The funds are distributed to the various predetermined categories of assets based of their degree of importance

10. Fund Pool Method Example Current deposits 200 Savings deposits 100
Fixed deposits 100
REPO 50
NCD’s 50
Debentures 100
Total 600
Reserve based 20%
Statutory reserves 10%
Secondary reserves 20%
Loan portfolio 30%
Allocation by sectors;
Agriculture 10%
Manufacturing 50%
Real estate 20%
Service 20%

11. Disadvantaged of Fund Pool Method
Over emphasize on liquidity at the expense of profitability
Does not provide any specific basis for purpose of estimating liquidity standards
does not take into consideration the volatility of deposits accounts
Does not recognized source of liquidity

12. Assets Allocation Method
Banks are forced to utilize deposits more efficiently and effectively as a result of competition from non-bank financial institutions in terms of deposits acquisitions and use funds in a more profitable way
Assets allocation method treats each source of fund individually in view of the different degrees of volatility among them. Each source of funds is treated as a profit centre
Short (long) term assets should be financed by short (long) term financing

13. Disadvantages of Assets Allocation Method
May overestimate the liquidity of deposits accounts
Does not recognized loan portfolio as a source of liquidity
Asset & liability management decisions are made separately
does not provide specific guidelines on the allocation of funds among different categories of bank assets

14. Management Science Method
a.k.a Linear programming method
A mathematical procedure to choose variable values for purpose of maximizing (minimizing) an objective, subject to certain restrictions
Helps to determine the required balance sheet quantity set in order to maximize bank profitability subjects to restrictions in trems of liquidity and other fixed rules

15. Management Science Method
Example
Bank A has funds totaling RM25 million which can be invested in loan assets (X1) and secondary reserves (X2). The funds made up of current deposits and fixed deposits. The rate of return is estimated at 12% while short term securities 8%. Let’s assume that the bank income is net income after deducting the cost of deposits. The management bank of bank A has stipulated the bank’s liquidity standard of RM2 in short term securities for every RM10 investment in fixed assets

16. Bank Liquidity 5 factors why banks must have adequate liquidity;
Confidence
Relationship
Force sale
Risk premium
Last chance

17. Bank Liquidity Theory Commercial Financing
A bank is considered liquid if its loan portfolio consist of short term financing only
Maturity dates of financing coincides with maturity dates of deposits
Stability
Bank invest part of their funds in loan portfolio & secondary markets
This theory prolongs the average maturity period of loans portfolios

18. Bank Liquidity Theory Expected Income
Bank liquidity can be acquired through loan repayments
Loan repayment should be match with loan income
Acknowledges that loan portfolio is a source of liquidity
Liability Management
Banks can fulfill liquidity requirements by borrowing from the money and capital markets
Borrowed funds acquired for the purpose of bank liquidity are sometimes called purchased funds

19. Liquidity Measurement
No one single specific measurement standards
However loan to deposit ratio is used widely to measure liquidity
As the ratio increases, bank liquidity decreases
Loan interest increase in tandem with the increase in loan to deposit ratio since the demand for credit exceeds supply

20. Disadvantages of Loan to Deposits Ratio
Does not show the maturity or quality of loan portfolio
Does not provide any truth about bank liquidity needs. Banks that provides more for speculative loans are more likely to face liquidity problems
Does not provide any information on other assets of a bank other than its loan portfolio

21. Other Liquidity Measurement
1. Cash Assets / Total Assets
2. (Cash Assets – Statutory Reserve + Marketable Government Securities of Less than One year Maturity) / Total Deposits
3. (Cash Assets – Reserve + Government Securities) / Total Deposits
4. (Cash Assets + Government Securities) / Total Deposits

22. Estimating Credit Requirement
Please refer to worksheet

23. Izdihar Baharin @ Md Daud
Thank You!
Izdihar Md Daud
Post Graduate Centre
HP: