Chapter 10 The Bank Balance Sheet I The Bank Balance Sheet a Total Assets Liabilites Capital i Uses loans Sources deposits Capital b Liabilities i Checkable Deposits 1 Payable On Demand 2 Low interests due to high liquidity of Money ii NonTransaction Deposits 1 Savings Accounts 2 CDs 3 Have higher Intersts rates due to less liquidity iii Borrowing 1 Discount Loans the FED to met the overnight requirement rate banks borrow from other banks through iv Bank Capital 1 c Assets Use of Funds banks vault cash i Reserves 1 reasons for holding raised by selling new stock or keeping retained earnings deposits plus currency that is typically held by a Reserve Requirement regulation that for every dollar of checkable deposits at a bank a certain fraction 10 must be kept on hand additional reserves b Excess reserves i Most liquid of all bank assets and a bank can use them to meet obligations ii Cash Item in Process of Collection 1 check that is processed but the funds have yet to be received iii Deposits at Other Banks 1 many small banks hold deposits at larger banks in exchange a Made up of debt instruments because banks cannot for a variety of services a FOREX b Check Processing 2 Securities hold stock 3 Loans a Primary source of revenue 4 Other Assets a Physical seets i Building ii Computers II Basic Banking a When a bank receives additional deposits it gains an equal amount of reserves when it looses deposits it loses an equal amount of reserves b borrow short and Lend Long III General Principles of Bank Management a 4 Concerns i Deposit Outflows make withdraws on demand deposits 1 Liquidity Management when depositors are lost because depositors assets to meet banks obligations to creditors the acquisition of sufficiently liquid ii Asset Management manage the risk level of assets that are being acquired with low default rates and by diversifying holdings iii Liability Managemnet iv Capital Adequacy amount of capital the bank should maintain acquire funds at low costs b Liquidity Management and the Role of the FED i Bank Reserve Requirment Shortfall Action Steps 1 Borrow from other banks from Federal funds Market or a Can have high transaction costs and can eat into ramount of securities to be sold from Corporations 2 Sell securities 3 Borrwoing from the FED a At Discount Rate 4 Reduce loans a Can call in loans when the mature i Not re issue them 1 loose customers doing this b Sell them at a discount on the secondary market c Capital Adequacy Management i Bank Capital 1 2 ii Equity Holders If bank writes of loans then it can use capital to absorb blow if vapital is whipped out then bank is insolvent 1 Return on Assets ROA Profit after Tax Assets a How efficiently the bank is being run given its assets 2 Return on Equity ROE Profit After tax Equity Capital a How much bank earning on equity investment 3 Equity Multiplier EM Assets Equity Capital 4 ROE ROA EM a Given the ROA the lower the bank capital the higher the Return for the owners of the bank b Raising Bank Capital i Sell Common Stock ii Reducing dividends iii Reduce assets and make fewer loans iv Sell off securities c Lowering Bank Capital i Buying back stock ii iii Acquiring new funds Increasing stock dividends IV Managing Credit Risk a Screening and Monitoring i Screening screen out bad credit risk to good ones so loans are mor profotiable to them 1 gain info on client or loan 2 Speciliaze in lending in a certain geographic area or industry to gain insight in niche market 3 don t let borrowers engage in risky activity b Long Term Customer relationships i Reduces the cost of info collecting and makes it easier to screen out bad debt ii Customers more likely to NOT engage in risky behavior because customer wants to keep long term CRM c Loan Commitments a given amount at an interest rate that is tied to ome market interest rate banks commitment to provide a firm with loans up to i Source of Credit Line that can be tapped d Collateral and Compensating Balances i Compensating Balance required minimum amount of funds in a checking account at a bank a firm receiving a loan must keep a ii Having a lean on assets as collateral e Credit Rationing willing to pay the stated interest rate or even a higher rate refusing to make loans even though borrowers are i Lender refuses to make a loan of any amount to the borrower even if borrower is wiloling to pay higher rate ii Willing to make loan but borrower restricts size of loan 1 the larger the loan the more likely you are to engage in activities that will result in you not being able to pay back laon a If a bank has a more rate sensitive liabilities than assets a rise in interests rates will reduce bank profits and a decline in interests rates will raise bank profits b Gap Analysis from the amount of rate sensitive assets in which the amount of rate sensitve liabilities is subtracted i Multiplying GAP by the change in interests rates we can immediately obtain the effect on bank profits c Duration Analysis banks total assets and liabilities to change in interests rates examines the sensitivity of the market value if the V Managing Interests Rate Risks a celebration i change in market value of security change in interest duration in years VI Off Balance Sheets Transactions generating income from fees and loan sales activities that affect bank profits but do not appear on bank balance sheets involves trading financial instruments and a Loan Sales contracts that sell all or part of the cash stream from a specific loan and thereby removes the loan so that it no longer is an asset on the banks balance sheet b Generation of Fee Income i FOREX trades ii Packaging MBS c Trading Practices and Risk Management Practices i