Académique Documents
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In this Chapter
Because banking system plays a major role in channeling funds
from the savers/lenders to investors/borrowers, it is important
to study:
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In this Chapter
• Basic Banking
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The Bank Balance Sheet
• The bank balance sheet is a list of the bank assets (what bank
owns) and liabilities (what it owes) where:
Total assets = total liabilities + bank’s capital (net worth).
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The Bank Balance Sheet –Liabilities
Liabilities:
• Liabilities are source of funds a bank uses to purchase assets.
• Banks obtain funds by borrowing and by issuing (selling) other
liabilities such as deposits.
• Liabilities include:
1. Checkable deposits
2. Non-transaction deposits
3. Borrowings
4. Bank capital
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The Bank Balance Sheet –Liabilities
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The Bank Balance Sheet –Liabilities
2. Non-transaction deposits.
– main source of bank funds.
– checks can’t be written on them.
– the interest rates paid are higher than those on checkable deposits.
• They include:
1. Saving accounts
2. Time deposits
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The Bank Balance Sheet –Liabilities
3. Borrowings, from:
– the central bank,
– other commercial banks,
– Corporations
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The Bank Balance Sheet –Assets
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The Bank Balance Sheet –Assets
1. Reserves include:
– what banks keep with central bank,
– currency (papers and coins) kept in the bank vaults
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The Bank Balance Sheet –Assets
2. Loans
– Banks make their profits primarily by issuing loans.
– Because of the lack of liquidity and higher default risk, the bank earns its
highest return on loans.
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The Bank Balance Sheet –Assets
4. Securities
– A bank’s holdings of securities are an important income-earning asset.
6. Other Assets
– The physical capital owned by the banks such as bank buildings, computer,
and other equipments.
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Table 1: Balance Sheet of All Commercial Banks (items as a
percentage of the total,
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Bank Management
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Bank Management
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Bank Management
• The bank now put your $100 bill into its vault so that the
bank’s assets rise by the $100 increase in vault cash.
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Basic Banking: Cash Deposit
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Basic Banking: Check Deposit
Alternatively, suppose you had opened the account with a
$100 check written on an account at another bank (the
Second Bank), we would get the same result.
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Basic Banking: Check Deposit
• If the central bank transfers the $100 of reserves from the Second
Bank to the First Bank and the final balance sheet position of the
two banks are as follows:
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Basic Banking: Making a Profit
• As we know, the bank obliged to keep a certain fraction of its checkable
deposits as required reserves.
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Basic Banking: Making a Profit
• To make a profit, the bank must put to productive use all or part
of the $90 of excess reserves it has available.
• If the bank decides not to hold any excess reserves but to make
loans instead. The T-account then looks like this:
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Basic Banking: Making a Profit
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Bank Management
• Asset Management
• Liability Management
• Interest-rate Risk
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Asset Management: 3 Goals
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Asset Management: 4 Tools
1. Find borrowers who will pay high interest rates and have low
possibility of defaulting.
– Loans officers engage in screening of the potential borrowers to reduce the
adverse selection process.
4. Balance need for liquidity against increased returns from less liquid
assets (such as loans) to avoid huge costs of deposit outflow.
– banks will hold securities that are more liquid even if they earn somewhat
lower return than other assets.
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Liability Management
• Banks aggressively set target goals for their asset growth and
tried to acquire funds by issuing liabilities as they were needed.
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Capital Adequacy Management
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Preventing Bank Failure
1. To learn that the bank is managed efficiently, its owners use the
return on assets (ROA) as a measure of bank profitability.
– ROA indicates how much profits are generated on average by each dollar
of assets.
ROA measures how efficiently the bank is run
• Given the return on assets, the lower the bank capital the higher the returns
for the owners of the bank.
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How much Capital a bank should hold?
Managers must decide how much higher safety they are willing
to trade off against the lower return on equity that comes with
higher capital.
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Credit Risk Management
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Credit Risk Management
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Credit Risk Management
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Credit Risk: Overcoming Adverse
Selection and Moral Hazard
• The attempts of financial institutions to solve these problems
help explain a number of principles for managing credit risk such
as:
(1) screening and monitoring,
– Screening
– Specialization in lending
– Monitoring and enforcement of restrictive covenants
(2) establishment of long-term customer relationships,
(3) loan commitments,
(4) collateral and compensating balance requirements,
(5) credit rationing.
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Credit Risk: Screening and Monitoring
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Credit Risk: Screening and Monitoring
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Credit Risk: Screening and Monitoring
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Credit Risk: Screening and Monitoring:
Specializing in lending
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Credit Risk: Screening and Monitoring: Monitoring &
Enforcement of Restrictive covenants
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Credit Risk: Long-Term Customer Relationship
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Credit Risk: Long-Term Customer Relationship
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Credit Risk: Loan Commitments
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Credit Risk: Loan Commitments
The advantage for the firm is that it has a source of credit when
it needs it.
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Credit Risk: Collateral & Compensating Balances
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Credit Risk: Collateral & Compensating Balances
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Managing Interest Rate Risk
• Interest-rate risk refers the risk of earnings and returns
that is associated with changes in interest rates.
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