1. Banks and Bank Mgmt.
Balance sheet
Bank Risks

2. Bank Balance Sheet
Assets: Uses of funds
Liabilities: Sources of funds

3. Assets cash items reserves -- required -- excess
deposits at other banks
cash items in collection

4. securities
debt securities
U.S. gov’t debt
public debt
loans
commercial
real estate
consumer
interbank

5. Liabilities deposits transaction deposits Non-transaction deposits
Savings
CDs (large CDs, >$100,000 can be resold)

6. borrowed funds
discount loans (Federal Reserve)
federal funds (other banks)
commercial paper

7. Bank capital or net worth = assets – liabilities 10 to 1 leverage!
banks have capital requirement
cushion against bad loan losses

8. Bank capital and profits
ROE = net after tax profit
bank capital
Higher bank capital lowers ROE

9. Bank risks Liquidity risk Credit risk Interest-rate risk Other Trading
Foreign currency
sovereignty
operational

10. Liquidity Risks Risk of running short of cash
need cash to deal with deposit outflows
but holding cash drags down profits
Holding too little cash, bank incurs costs of raising additional funds

11. Credit risk Risk of unpaid loans How to minimize? Credit risk analysis
Credit history, scores
Monitoring, collateral
Diversification
Tradeoff with the gains of loan specialization

12. Interest-rate risk
changes in interest rates affect BOTH assets and liabilities
assets
changes VALUE
changes the amount of interest income
depends on whether LT or ST

13. liabilities
cost of funds goes up with interest rates
-- rates on CDs, money market accounts, savings, checking

14. banks typically borrow short-term
and lend long-term
so rate sensitive liabilities >
rate sensitive assets
so as interest rates rise
costs increase faster than income
bank profits fall
banks must manage interest rate risk
Floating rate loans, swaps

15. Other Risks Trading risk Securities fluctuate in values
Traders do not personally corver losses
Solution: monitoring, limits

16. Foreign exchange risk
Currency fluctuations affect value of foreign assets
Use derivatives to manage
Sovereign risk
Governments interfere with currency transfers

17. Operational risk
Damage to physical/computer infrastructure
Backup systems, geographically dispersed