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Chapter 12. Banks and Bank Mgmt.

Chapter 12. Banks and Bank Mgmt. Balance sheet Bank Risks. Bank Balance Sheet. Assets: Uses of funds 2007: $10.5 trillion Liabilities: Sources of funds $9.4 trillion. Assets. cash items (< $1 trillion) reserves -- required -- excess deposits at other banks

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Chapter 12. Banks and Bank Mgmt.

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  1. Chapter 12. Banks and Bank Mgmt. • Balance sheet • Bank Risks

  2. Bank Balance Sheet • Assets: Uses of funds • 2007: $10.5 trillion • Liabilities: Sources of funds • $9.4 trillion

  3. Assets • cash items (< $1 trillion) • reserves -- required -- excess • deposits at other banks • cash items in collection

  4. securities ($2.4 trillion) • debt securities • U.S. gov’t debt • municipal debt • loans ($6.9 trillion, 66% of assets) • commercial • real estate • consumer • interbank

  5. Liabilities • deposits ($6.4 trillion, 68%) • transaction deposits • Nontransaction deposits ($5.9 trillion) • Savings • CDs (large CDs, >$100,000 can be resold)

  6. borrowed funds • discount loans (Federal Reserve) • federal funds (other banks) • repos • eurodollar loans • commercial paper

  7. Bank capital • or net worth = assets – liabilities = $1.1 trillion 10 to 1 leverage! • banks have capital requirement • cushion against bad loan losses

  8. Bank capital and profits • ROE = net after tax profit bank capital • Higher bank capital lowers ROE

  9. Bank risks • Liquidity risk • Credit risk • Interest-rate risk • Other • Trading • Foreign currency • sovereignty • operational

  10. 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

  11. 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

  12. 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

  13. liabilities • cost of funds goes up with interest rates -- rates on CDs, money market accounts, savings, checking

  14. 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

  15. Other Risks • Trading risk • Securities fluctuate in values • Traders do not personally corver losses • Solution: monitoring, limits

  16. Foreign exchange risk • Currency fluctuations affect value of foreign assets • Use derivatives to manage • Sovereign risk • Governments interfere with currency transfers

  17. Operational risk • Damage to physical/computer infrastructure • Backup systems, geographically dispersed

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