1. Copyright © 2000 Addison Wesley Longman Slide #15-1 Chapter Fifteen THE BANKING FIRM AND BANK MANAGEMENT

2. Copyright © 2000 Addison Wesley Longman Slide #15-2 The Bank Balance Sheet 有利息或不付息 包括銀行持有之 currency 及存在央行的存款 Secondary reserve  FF market Discount loan FF market RP agreement Loans from BHC Eurodollar  Loan loss reserve 為 bank capital 之重要組成 Negotiable CD 有次級市場 流動性高，安全性高 通常買者為大企業或其他銀行 Cash items

3. Copyright © 2000 Addison Wesley Longman Slide #15-3 Bank Operation T-account Analysis: Deposit of $100 cash into First National Bank Assets Liabilities Vault Cash $100 Checkable Deposits + $100 (=Reserves)

4. Copyright © 2000 Addison Wesley Longman Slide #15-4 Bank Operation Deposit of $100 check First National Bank Assets Liabilities Cash items in + $100 Checkable Deposits + $100 process of collection First National Bank Second National Bank Assets Liabilities Reserves Deposits + $100 + $100 - $100 - $100 Conclusion: When bank receives deposits, reserves  by equal amount; when bank loses deposits, reserves  by equal amount First National 會將 check 轉存到它在 Fed 開的存款帳戶∴ Fed 會從 Second National 收到現金 此時 First National Bank 應只會保留 $10 作 required reserve ，其餘 $90 作 Loan 出去，以賺取 較高利潤

5. Copyright © 2000 Addison Wesley Longman Slide #15-5 Principles of Bank Management 1. Liquidity management 2. Asset management A. Managing credit risk B. Managing interest-rate risk 3. Liability management 4. Managing capital adequacy Liquidity Management Reserve requirement = 10%, Excess reserves = $10 million Assets Liabilities Reserves $20 million Deposits $100 million Loans $80 million Bank Capital $ 10 million Securities $10 million Deposit outflow

6. Copyright © 2000 Addison Wesley Longman Slide #15-6 Deposit outflow of $10 million Assets Liabilities Reserves $10 million Deposits $ 90 million Loans $80 million Bank Capital $ 10 million Securities $10 million With 10% reserve requirement, bank still has excess reserves of $1 million: no changes needed in balance sheet Principles of Bank Management

7. Copyright © 2000 Addison Wesley Longman Slide #15-7 Liquidity Management No excess reserves Assets Liabilities Reserves $10 million Deposits $100 million Loans $90 million Bank Capital $ 10 million Securities $10 million Deposit outflow of $ 10 million Assets Liabilities Reserves $ 0 million Deposits $ 90 million Loans $90 million Bank Capital $ 10 million Securities $10 million With 10% reserve requirement, bank has $9 million reserve shortfall

8. Copyright © 2000 Addison Wesley Longman Slide #15-8 1. Borrow from other banks or corporations Assets Liabilities Reserves $ 9 million Deposits $ 90 million Loans $90 million Borrowings $ 9 million Securities $10 million Bank Capital $ 10 million 2. Sell securities Assets Liabilities Reserves $ 9 million Deposits $ 90 million Loans $ 90 million Bank Capital $ 10 million Securities $ 1 million Liquidity Management Federal Fund Market or issue negotiable CD, or Eurodollar Deposit or RP agreement

9. Copyright © 2000 Addison Wesley Longman Slide #15-9 Liquidity Management 3. Borrow from Fed Assets Liabilities Reserves $ 9 million Deposits $90 million Loans $90 million Discount Loans $ 9 million Securities $10 million Bank Capital $10 million 4. Call in or sell off loans Assets Liabilities Reserves $ 9 million Deposits $ 90 million Loans $81 million Bank Capital $ 10 million Securities $10 million Conclusion: excess reserves are insurance against above 4 costs from deposit outflows

10. Copyright © 2000 Addison Wesley Longman Slide #15-10 Asset and Liability Management Asset Management 1. Get borrowers with low default risk, paying high interest rates 2. Buy securities with high return, low risk 3. Diversify 4. Manage liquidity to satisfy reserve requirement Liability Management 1. Important since 1960s, 由 money center bank 開始靈活的隨時找到 資金 2. No longer primarily depend on deposits 3. When see loan opportunities, borrow or issue CDs to acquire funds

11. Copyright © 2000 Addison Wesley Longman Slide #15-11 Capital Adequacy Management 1. Bank capital is a cushion that prevents bank failure 2. Higher is bank capital, lower is return on equity ROA = Net Profits/Assets ROE = Net Profits/Equity Capital EM = Assets/Equity Capital ROE = ROA x EM Equity Capital , EM , ROE  3. Tradeoff between safety (high capital) and ROE 4. Banks also hold capital to meet capital requirements 5. Strategies for Managing Capital: A. Sell or retire stock B. Change dividends to change retained earnings C. Change asset growth 1980 年代不動產不景氣，導致銀行 承受大量之呆帳損失，∴ equity capital  又加上新的自有資本管制 ，強制銀行要提高自有資本比率。 導致 “credit crunch” Make more (fewer) loans Buy (Sell) securities and increase (reduce) liabilities

12. Copyright © 2000 Addison Wesley Longman Slide #15-12 Off-Balance-Sheet Activities 1. Fee income from A. Foreign exchange trades for customers B. Servicing mortgage-backed securities C. Guarantees of debt ，如 banker’s acceptance D. Backup lines of credit ，如 loan commitment, depositor overdraft, privilege, NIF or RUF 2. Financial futures and options 3. Foreign exchange trading 4. Interest rate swaps 5. Loan sales  將 loan 的 cash stream 賣給別人 All these activities involve risk For hedging and speculation 如 1995 Barings trader Leeson Agency problem Asymmetric information  moral hazard  Loss $1.3billion It’s not the only case!! 解決之道為 monitoring, internal control, risk assessment 如 VAR

13. Copyright © 2000 Addison Wesley Longman Slide #15-13 Banks' Income Statement  Off balance sheet activities

14. Copyright © 2000 Addison Wesley Longman Slide #15-14 Measures of Bank Performance ROA = Net Profits/ Assets ROE = Net Profits/ Equity Capital NIM = [Interest Income - Interest Expenses]/ Assets Why? Bad loans

15. Copyright © 2000 Addison Wesley Longman Slide #15-15 Financial Innovation Innovation is result of search for profits 1.Response to Changes in Demand Major change is huge increase in interest-rate risk starting in 1960s Example: Adjustable-Rate Mortgages 2.Response to Changes in Supply Major change is improvement in computer technology 1. Increases ability to collect information 2. Lowers transactions costs Examples: 1. Bank Credit Cards 2. Electronic Banking Facilities

16. Copyright © 2000 Addison Wesley Longman Slide #15-16 3.Avoidance of Existing Regulations Regulations Behind Financial Innovation 1.Reserve requirements Tax on deposits = i x r D 2.Deposit-rate ceilings (Reg Q) As i , loophole mine to escape reserve requirement tax and deposit-rate ceilings i 為若將準備金 loan 出去所能賺的利率 r D 為存款準備率  disintermediation

17. Copyright © 2000 Addison Wesley Longman Slide #15-17 Avoidance of Existing Regulations Examples: 1. Eurodollars 2. Bank Commercial Paper 3. NOW Accounts 4. ATS Accounts 5. Sweep Accounts and Overnight RPs 6. Money Market Mutual Funds 為了規避支 票存款帳戶 不得支付利 息的規定 BHC 1960 年代 inflation  i  disintermediation 為了規避 deposit rate ceiling 及 reserve requirement  by calling a check a “ negotiable order of withdrawal”

18. Copyright © 2000 Addison Wesley Longman Slide #15-18 Profiting from Treasury Strips YTM=10% <10% why? Reinvestment risk