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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 2005

bank balance sheet
Bank Balance Sheet

Money & Banking Maclachlan, Spring 2005

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 2005

general principles of bank management
General Principles of Bank Management
  • Liquidity Management
  • Asset Management
  • Liabilitity Management
  • Capital Adequacy Management

Money & Banking Maclachlan, Spring 2005

two types of risk
Two Types of Risk
  • Credit Risk
  • Interest Rate Risk

Money & Banking Maclachlan, Spring 2005

managing risk
Managing Risk

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

-- Walter Wriston, former head of Citicorp

Money & Banking Maclachlan, Spring 2005

credit risk
Credit Risk

Asymmetric information.

Before transaction: adverse selection.

After transaction: moral hazard.

Money & Banking Maclachlan, Spring 2005

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 2005

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 2005

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 2005

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 2005

banking industry structure and competition
Banking Industry Structure and Competition

Chapter 10

Money & Banking Maclachlan, Spring 2005

historical development of the banking industry
Historical Development of the Banking Industry

Outcome: Multiple Regulatory Agencies

1. Federal Reserve

2. FDIC

3. Office of the Comptroller of the Currency

4. State Banking Authorities

Money & Banking Maclachlan, Spring 2005

improvements in it gave rise to
Improvements in IT gave rise to

Electronic banking

Credit & debit cards

ATM’s, ABM’s

Commercial paper

Securitization

Junk bonds

Money & Banking Maclachlan, Spring 2005

avoidance of regulations gave rise to
Avoidance of regulations gave rise to

Money market mutual funds

Sweep accounts

Money & Banking Maclachlan, Spring 2005

interest rate volatility gave rise to
Interest rate volatility gave rise to

Securitization

MMMF, Commercial Paper

ARM’s

Derivatives

Money & Banking Maclachlan, Spring 2005

fee based banking
Fee Based Banking

Less reliance on revenue from the spread between interest received on assets and interest paid on liabilities.

Fees earned through off-balance sheet activities, e.g., loan origination and servicing, loan commitments, bankers’ acceptances, derivatives, underwriting commercial paper.

Money & Banking Maclachlan, Spring 2005

dual banking system
Dual Banking System

State chartered banks operating along side nationally chartered banks.

Money & Banking Maclachlan, Spring 2005

the decline in banks as a source of finance
The Decline in Banks as a Source of Finance

Money & Banking Maclachlan, Spring 2005

8 000 commercial banks in u s vs a handful in other countries
8,000 commercial banks in U.S. vs. a handful in other countries.

Why?

McFadden Act (1927)

Money & Banking Maclachlan, Spring 2005

reasons for consolidation
Reasons for consolidation
  • IT
  • Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994

Money & Banking Maclachlan, Spring 2005

bank consolidation and number of banks
Bank Consolidation and Number of Banks

Money & Banking Maclachlan, Spring 2005

separation of banking from other financial services industries
Separation of Banking from other Financial Services Industries
  • Glass-Steagall Act 1933
  • Gramm-Leach-Bliley Financial Services Modernization Act of 1999

Money & Banking Maclachlan, Spring 2005