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Banks and Bank Mgmt. Balance sheet Bank Risks
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Bank Balance Sheet Assets: Uses of funds Liabilities: Sources of funds
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Assets cash items reserves -- required -- excess
deposits at other banks cash items in collection
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securities debt securities U.S. gov’t debt public debt loans commercial real estate consumer interbank
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Liabilities deposits transaction deposits Non-transaction deposits
Savings CDs (large CDs, >$100,000 can be resold)
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borrowed funds discount loans (Federal Reserve) federal funds (other banks) commercial paper
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Bank capital or net worth = assets – liabilities 10 to 1 leverage!
banks have capital requirement cushion against bad loan losses
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Bank capital and profits
ROE = net after tax profit bank capital Higher bank capital lowers ROE
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Bank risks Liquidity risk Credit risk Interest-rate risk Other Trading
Foreign currency sovereignty operational
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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
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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
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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
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liabilities cost of funds goes up with interest rates -- rates on CDs, money market accounts, savings, checking
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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
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Other Risks Trading risk Securities fluctuate in values
Traders do not personally corver losses Solution: monitoring, limits
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Foreign exchange risk Currency fluctuations affect value of foreign assets Use derivatives to manage Sovereign risk Governments interfere with currency transfers
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Operational risk Damage to physical/computer infrastructure Backup systems, geographically dispersed
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