1. Copyright © 2002 Pearson Education, Inc. Slide 13-1

2. Copyright © 2002 Pearson Education, Inc. Slide 13-2 Chapter 13 The Business of Banking

3. Copyright © 2002 Pearson Education, Inc. Slide 13-3 How Banks Earn Profits A balance sheet lists assets, liabilities, and net worth. Bank liabilities are the funds the bank acquires from savers. Bank assets are the uses of acquired funds. Bank net worth is the difference between assets and liabilities.

4. Copyright © 2002 Pearson Education, Inc. Slide 13-4 Table 13.1 Balance Sheet of U.S. Commercial Banks, 2000

5. Copyright © 2002 Pearson Education, Inc. Slide 13-5 Bank Liabilities and Net Worth Checkable deposits Nontransaction deposits Borrowings Net worth

6. Copyright © 2002 Pearson Education, Inc. Slide 13-6 Bank Assets Cash Items Securities Loans Other Assets

7. Copyright © 2002 Pearson Education, Inc. Slide 13-7 Bank Failure Bank failure occurs when a bank cannot pay its depositors and meet its reserve requirements.

8. Copyright © 2002 Pearson Education, Inc. Slide 13-8 The Relationship Between Banks and Savers Banks provide risk-sharing, liquidity, and information services to depositors. Banks must manage both moral hazard and liquidity problems. Bankers reduce moral hazard by putting capital at risk and threat of withdrawals. Banks use asset and liability management to offset liquidity risk.

9. Copyright © 2002 Pearson Education, Inc. Slide 13-9 Figure 13.1 Bank Intermediary Services

10. Copyright © 2002 Pearson Education, Inc. Slide 13-10 Relationship Between Banks and Borrowers Banks are concerned about credit risk, the risk that borrowers might default. Banks suffer interest rate risk if market interest rate changes cause profits to fluctuate.

11. Copyright © 2002 Pearson Education, Inc. Slide 13-11 Methods to Reduce Credit Risk Diversification of loans Credit-risk analysis Requiring collateral Credit rationing Restrictive covenants in loan agreements Long-term relationship with the borrower

12. Copyright © 2002 Pearson Education, Inc. Slide 13-12 Methods to Reduce Interest Rate Risk Floating-rate debt Interest rate swap Futures and options contracts

13. Copyright © 2002 Pearson Education, Inc. Slide 13-13 Table 13.2 Exposure to Risk in Banking Contracts

14. Copyright © 2002 Pearson Education, Inc. Slide 13-14 Causes of Recent Shifts in Sources and Uses of Funds Interest rates increased, becoming volatile during the 1980s. Prohibitions on the payment of interest on checkable deposits were relaxed. By the 1990s, the interest rates banks could pay depositors were fully deregulated.

15. Copyright © 2002 Pearson Education, Inc. Slide 13-15 Off-Balance-Sheet Lending Off-balance-sheet lending: banks do not hold as assets the loans they make. Examples: standby letter of credit, loan commitment, and loan sale Off-balance-sheet activities have become important in generating banks’ profits. Off-balance-sheet activities have expanded in the United Kingdom and Japan.