Bank Balance Sheet
gap analysis
measures mismatches between rate sensitive liabilities and assets
capacity ratio
net loans and leases/total assets (-); loans are among least liquid assets.
Return on Assets (ROA)
net profit after tax / assets
Return on Equity (ROE)
net profit after tax / equity capital Net Income/Total Equity
Equity Multiplier (EM)
the amount of assets per dollar of equity capital assets / equity capital
Cash position indicator
(cash and deposits due from depository institutions)/total assets. (+)
creditworthiness 6Cs
- cash (ability to generate cash flow) - capacity (legal and financial capacity) - collateral (possessione of adequate collateral) - conditions (effect of change in economic conditions of borrowers ability to pay) - character (responsibility, truthfulness, serious purpose and intention to pay) - capital
responsibilities of credit department
- check creditworthiness of borrower - check on the loan agreement to be properly structured and documented - check if lender can make claims on assets and earnings of the customer in case of his default
What is included in liabilities?
- checkable deposits - non transaction deposits (small denomination time deposits, savings deposits) - borrowings - bank capital
Sources of demand for liquidity (L^D)
- customers withdrawing money from accounts - credit request from customers (new loan requests or existing credit lines)
What are the sources of IRR?
- gap risk - basis risk - embedded option risk - reinvestment risk
reasons for taking collateral
- guarantee of loan to be paid back - gives psychological advantage over the borrower
Asset and Liabilities Management (ALM)
- mechanism to address the risk faced by a bank because of mismatch between assets and liabilities - ALM policy framework focuses on bank profitability and long term viability - aims at managing volume, mix, maturity, rate sensitivity, quality and liquidity of assets and liabilities as a whole to attain predetermined acceptable risk / reward ratio
sources of supply of liquidity (LS)
- new customer deposit inflows - customers repaying their loans - revenues (fee income) - borrowings from the money market
Factors that affect liquidity risk
- over extension of credit - high level of non-performing assets - poor asset quality - mismanagement - reliance on a few wholesale depositors - large undrawn loan commitments - lack of appropriate liquidity policy and contingent plan
types of loan collateral
- real property - personal property - personal guarantee - inventory - factoring - accounts receivable
what is included in assets?
- reserves - cash items in process of collection - deposits at other banks - securities (gov and state) - loans - other assets
negative effects of liquidity crunch
- risk to bank's earnings - repetitional risk - contagion effect - liquidity crisis can lead to runs on institutions
how to banks manage credit risk?
- screening - specialization in lending - monitoring and enforcement of restrictive covenants
ALM Goals
- seek highest possible returns on loans and securities - reduce risk - have adequate liquidity
deposit composition ratio
demand deposits/time deposits (-); demand deposits are more likely to be withdrawn than time deposits.
managing interest rate risk
If a bank has more rate-sensitive liabilities than assets, a rise in interest rates will reduce bank profits and a decline in interest rates will raise bank profits
Liquidity Deficit
LD> LS - tradeoff btwn liquidity and profitability - rarely are D and S equal
liquidity excess
Ld<Ls
ROE =
ROA * EM
check deposit
When a bank receives additional deposits, it gains an equal amount of reserves; when it loses deposits, it loses an equal amount of reserves.
What are checkable deposits?
deposits in bank accounts from which depositors may make withdrawals by writing checks to third parties - makes up 11% of bank liabilities - payable on demand - lower interest rate
Capital Adequacy Management
a bank's decision about the amount of capital it should maintain and then acquisition of the needed capital - amt of capital affects return for the equity holders of bank - tradeoff between safety and returns to equity holders (choice depends on state of the economy and levels of confidence)
excess reserves
a bank's reserves over and above its required reserves, insurance against costs associated with
hot money ratio
a ratio that reflects whether the institution has roughly balanced the volatile liabilities it has issued with the money market assets it holds that could be sold quickly to cover those liabilites money market (short term) assets / volatile liabilities = (cash and due from deposits held at other depository institutions + holdings of short term securities + federal funds loans + reverse repurchase agreements) / (large CDs + Euro-currency deposits + federal funds borrowings + repurchase agreements)
what is a bank loan?
about 53% of bank assets and more than 50% of bank revenues - less liquid than other assets - largest categories are commercial and industrial loans
what is a security at a bank?
account for 19% of assets, produce more than 10% of revenues - secondary reserves = US gov and agency securities - state and local gov securities are less marketable
What is capital?
bank's net worth - difference between total assets and liabilities - cushion against a decline in value of assets
Basic banking
banks make profits by asset transformation, borrow short and lend long
core deposit ratio
core deposits / total assets, where core deposits include total deposits less all deposits over $100,000. Core deposits are primarily small-denomination checking and savings accounts that are considered unlikely to be withdrawn on short notice and so carry lower liquidity requirements
What are borrowings?
from the Fed (discount loans) - the federal home loan banks - borrowings from other banks (federal funds) - corporations
GAP approach
gap = inflow of funds - outflow of funds liquidity deficit gap <0 liquidity excess gap>0 mismatch = (negative gap / outflow) x100
liquidity securities indicator
gov securities / total assets
Net Interest Income (NII)
interest income - interest expense
Net Interest Margin (NIM)
interest income minus interest expense divided by earning assets
liabilities-sensitive gap =
interest sensitive assets - interest sensitive liabilities < 0
interest-sensitive gap=
interest-sensitive assets - interest sensitive liabilities based on : - analysis of maturities and repricing opportunities
asset-sensitive positive gap =
interest-sensitive assets - interest-sensitive liabilities >0
assets mismatch
occurs when inflows more than outflows, excess money should be deployed in profit generating avenues such as: - gov bonds and securities - shares of good companies - any other legal investments
liability mismatch
outflows more than inflows, managing the situation based on time availability - short term borrowing - availing finances and discounting facilities from other banks - sell securities, shares, etc
how can you increase capital?
sell new equity (stock) or from retained earnings
Asset transformation
selling liabilities with one set of characteristics and using the proceeds to buy assets with a different set of characteristics
what are non transaction deposits?
the primary source of bank funds, - the interest rates paid on these are usually higher than checkable deposits - main types: savings accounts & time deposits
Interest rate risk
the risk arising from changes in market interest rates that might adversely affect a bank's financial condition characteristics: - excessive IRR can pose significant threat to bank's earnings and capital base - int rate risk refers to volatility in Net Interest Income or variations of net interest margin and in net worth
credit risk
the risk that borrowers might default on their loans/ fail to make required payments
Liquidity risk
the risk that the institution might not be able to generate sufficient cash flow to meet its financial obligations
Total Assets =
total liabilities + capital liabilities, capital are sources of bank funds assets are uses of the funds
