Mcf 304 bank management
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MCF 304: Bank Management. Lecture 2.2 Asset Management. Asset Management. How to distribute bank funds among different categories of assets so as to maximize profits Different assets have different level of liquidity and profitability

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MCF 304: Bank Management

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Mcf 304 bank management

MCF 304: Bank Management

Lecture 2.2

Asset Management


Asset management

Asset Management

How to distribute bank funds among different categories of assets so as to maximize profits

Different assets have different level of liquidity and profitability

The LP dilemma: If bank emphasize on liquidity, profitability will be sacrifice


Bank financial statements balance sheet

Bank Financial Statements:Balance Sheet

Fixed Assets

Current Assets

-Cash and short term funds

-Securities purchased under resale agreement (REPO)

-Deposits and placements with banks and other financial institutions

Securities held for trading

Investment securities

Loans, advances and financing

Other assets

Investment in subsidiary companies

Investment in associate companies


Bank financial statements income statement

Bank Financial Statements:Income Statement

Interest Income

(-) Interest Expense

(=)Net Interest Income

(-) Allowance for losses on loans, advances and financing

(+)Non-Interest Income

(=)Net Income

Net Income

(-) Overhead Expenses

(=) Profit Before Tax

(-) Tax

(=) Net Profit After Tax

(-) Transfer to Statutory Reserves

(=) Net Profit After Transfer to Statutory Reserves


Bank financial statements income statement1

Bank Financial Statements:Income Statement

Net Profit After Transfer to Statutory Reserves

(+) Retained Profit Brought Forward

(+) Distributable Profit

(-) Proposed Dividend

(=) Retained Profit Carried Forward

Earnings Per Share


Asset management1

Asset Management

How the bank invest its assets / funds to maximize its shareholders wealth

As the liquidity and profitability differ from one assets to another, banks must take into consideration the liquidity-profitability (LP) Dilemma


Lp dilemma

LP Dilemma

Exist because the degrees of liquidity and profitability are different across different assets

Attributed by conflicting goals among depositors, shareholders and controlling party

Shareholders expect high return, depositors desire maximum liquidity


Lp dilemma1

LP Dilemma

LP Dilemma = to find a method that can strike a balance between risk & return, liquidity & profitability

Three methods;

Fund pool method

Assets allocation method

Management science method


Fund pool method

Fund Pool Method

Fund from all sources are pooled together to create a single source of funds

The funds are distributed to the various predetermined categories of assets based of their degree of importance


Fund pool method1

Fund Pool Method

Example

Current deposits200

Savings deposits100

Fixed deposits100

REPO50

NCD’s50

Debentures 100

Total600

Reserve based 20%

Statutory reserves 10%

Secondary reserves 20%

Loan portfolio 30%

Allocation by sectors;

Agriculture 10%

Manufacturing 50%

Real estate 20%

Service 20%


Disadvantaged of fund pool method

Disadvantaged of Fund Pool Method

Over emphasize on liquidity at the expense of profitability

Does not provide any specific basis for purpose of estimating liquidity standards

does not take into consideration the volatility of deposits accounts

Does not recognized source of liquidity


Assets allocation method

Assets Allocation Method

Banks are forced to utilize deposits more efficiently and effectively as a result of competition from non-bank financial institutions in terms of deposits acquisitions and use funds in a more profitable way

Assets allocation method treats each source of fund individually in view of the different degrees of volatility among them. Each source of funds is treated as a profit centre

Short (long) term assets should be financed by short (long) term financing


Disadvantages of assets allocation method

Disadvantages of Assets Allocation Method

May overestimate the liquidity of deposits accounts

Does not recognized loan portfolio as a source of liquidity

Asset & liability management decisions are made separately

does not provide specific guidelines on the allocation of funds among different categories of bank assets


Management science method

Management Science Method

a.k.a Linear programming method

A mathematical procedure to choose variable values for purpose of maximizing (minimizing) an objective, subject to certain restrictions

Helps to determine the required balance sheet quantity set in order to maximize bank profitability subjects to restrictions in trems of liquidity and other fixed rules


Management science method1

Management Science Method

Example

Bank A has funds totaling RM25 million which can be invested in loan assets (X1) and secondary reserves (X2). The funds made up of current deposits and fixed deposits. The rate of return is estimated at 12% while short term securities 8%. Let’s assume that the bank income is net income after deducting the cost of deposits. The management bank of bank A has stipulated the bank’s liquidity standard of RM2 in short term securities for every RM10 investment in fixed assets


Bank liquidity

Bank Liquidity

5 factors why banks must have adequate liquidity;

Confidence

Relationship

Force sale

Risk premium

Last chance


Bank liquidity theory

Bank Liquidity Theory

Commercial Financing

A bank is considered liquid if its loan portfolio consist of short term financing only

Maturity dates of financing coincides with maturity dates of deposits

Stability

Bank invest part of their funds in loan portfolio & secondary markets

This theory prolongs the average maturity period of loans portfolios


Bank liquidity theory1

Bank Liquidity Theory

Expected Income

Bank liquidity can be acquired through loan repayments

Loan repayment should be match with loan income

Acknowledges that loan portfolio is a source of liquidity

Liability Management

Banks can fulfill liquidity requirements by borrowing from the money and capital markets

Borrowed funds acquired for the purpose of bank liquidity are sometimes called purchased funds


Liquidity measurement

Liquidity Measurement

No one single specific measurement standards

However loan to deposit ratio is used widely to measure liquidity

As the ratio increases, bank liquidity decreases

Loan interest increase in tandem with the increase in loan to deposit ratio since the demand for credit exceeds supply


Disadvantages of loan to deposits ratio

Disadvantages of Loan to Deposits Ratio

Does not show the maturity or quality of loan portfolio

Does not provide any truth about bank liquidity needs. Banks that provides more for speculative loans are more likely to face liquidity problems

Does not provide any information on other assets of a bank other than its loan portfolio


Other liquidity measurement

Other Liquidity Measurement

1. Cash Assets / Total Assets

2. (Cash Assets – Statutory Reserve + Marketable Government Securities of Less than One year Maturity) / Total Deposits

3. (Cash Assets – Reserve + Government Securities) / Total Deposits

4. (Cash Assets + Government Securities) / Total Deposits


Estimating credit requirement

Estimating Credit Requirement

Please refer to worksheet


Thank you

Thank You!

Izdihar Baharin @ Md Daud

Post Graduate Centre

HP: 006019-5170817

Email: [email protected]


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