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Management of Financial Institutions. Chapter 9. Bank Balance Sheet. Commercial banks Commercial banks make profits through asset transformation (borrow short, lend long). Investment Banks Investment banks make profits through acting as brokers of securities.

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Management of financial institutions

Management of Financial Institutions

Chapter 9

Money & Banking Maclachlan, Spring 2006


Bank balance sheet
Bank Balance Sheet

Money & Banking Maclachlan, Spring 2006


Indirect finance vs direct finance

Commercial banks

Commercial banks make profits through asset transformation (borrow short, lend long).

Investment Banks

Investment banks make profits through acting as brokers of securities.

Indirect Finance vs. Direct Finance

Money & Banking Maclachlan, Spring 2006


General principles of bank management
General Principles of Bank Management

  • Liquidity Management

  • Asset Management

  • Liabilitity Management

  • Capital Adequacy Management

Money & Banking Maclachlan, Spring 2006


Two types of risk
Two Types of Risk

  • Credit Risk

  • Interest Rate Risk

Money & Banking Maclachlan, Spring 2006


Managing risk
Managing Risk

“The business of banking is the production of information.”

-- Walter Wriston, former head of Citicorp

Money & Banking Maclachlan, Spring 2006


Credit risk
Credit Risk

Asymmetric information.

Before transaction: adverse selection.

After transaction: moral hazard.

Money & Banking Maclachlan, Spring 2006


Methods to deal with credit risk
Methods to deal with Credit Risk

  • Screening

  • Monitoring

  • Relationship banking

  • Loan commitments

  • Collateral

  • Credit rationing

Money & Banking Maclachlan, Spring 2006


Interest rate risk
Interest Rate Risk

Risk associated with borrowing short and lending long.

If interest rates rise, liabilities will be turned over at new higher rates while the bank is still earning low rates on assets.

Money & Banking Maclachlan, Spring 2006


Managing interest rate risk
Managing Interest Rate Risk

Keep track of the gap

= rate sensitive assets – rate sensitive liabilities

Loan sales

Fee income

Derivatives (financial contracts as insurance)

Money & Banking Maclachlan, Spring 2006


Calculate the 1 year gap rsa rsl
Calculate the 1-year GAP (RSA-RSL)

(300+100)-(10+90+160+200+200)

= -260

Money & Banking Maclachlan, Spring 2006


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