FIN 350 Test 1

Interest Expense Sources:

-Deposit Interest Costs -Interest on Short-Term Debt -Interest on Long-Term Debt

Interest Income Sourses:

-Interest and Fees on Loans -Taxable Securities Revenue -Tax-Exempt Securities Revenue -Other Interest Income

What is a bank holding company?(Ch3)

A bank holding company is simply a corporation chartered for the purpose of holding the stock of at least one bank, often along with other businesses The growth of holding companies has been rapid in recent decades

Can you see any advantages to allowing interstate banking? What about potential disadvantages?(Ch3)

As far as problems are concerned, interstate banking threatens to increase the concentration of banking resources in the U.S., especially among larger banks in various regions of the nation. Increased concentration possibly could lead to higher prices and less service if the antitrust laws are not fully enforced. On the other hand, recent studies suggest that interstate mergers generate positive abnormal returns on bank stock. In addition, these banks are not tied to one local economic area and appear to be less subject to failure.

What are the key factors the organizers of a new financial firm should consider before deciding to seek a charter?(Ch4)

External Factors a. The level and growth of economic activity b. The need for a new financial firm c. The strength and character of competition in supplying financial services Internal Factors a. Qualifications and contacts of the organizers b. Management quality c. Pledging of capital to cover the cost of filing a charter application and begin operations

What relationship appears to exist between bank size, efficiency, and operating costs per unit of service produced and delivered? (CH3)

For banks and nonbank financial service providers alike, economies of scale and scope if achieved can lead to significant savings in operating costs with increases in service output.

How and why was the Dodd-Frank Regulatory Reform Act crafted to reduce systemic risk in the financial system, promote fair lending, protect consumers, and separate banks from key nonbank firms in an effort to restore public confidence(Ch2)

It emphasized providing consumers with more complete and understandable language to convey service prices and avoid misleading information

Why is the physical presence of a bank still important to many customers despite recent advances in long-distance communications technology?(Ch4)

Many customers still prefer the personal attention and personal service that contact with bank employees provides.

What are the most important components of ROA and what aspects of a financial institution's performance do they reflect? (Ch6)

ROA = NET INCOME / TOTAL ASSETS ROA is primarily an indicator of MANAGERIAL EFFICIENCY Indicates how capable management has been in converting ASSETS into NET EARNINGS

What are the principal components of ROE, and what does each of the these components measure?(Ch6)

ROE = NET INCOME / TOTAL EQUITY CAPITAL ROE is a measure of the rate of return flowing to shareholders Approximates the net benefit that the stockholders have received from investing their capital in the financial firm

Liquidity Risk

That bank customers will demand funds. On the liabilities side, the risk that depositors remove their funds. On the asset side, that borrowers will purchase things with their lines of credit.

What is the principal job performed by the FDIC?(Ch2)

The Federal Deposit Insurance Corporation (FDIC) insures the deposits of bank customers, up to a total of $250,000 per account owner, in banks that qualify for a certificate of federal insurance coverage. The FDIC is a primary federal regulator (examiner) of state-chartered, non-member banks. It is also responsible for liquidating the assets of banks declared insolvent by their federal or state chartering agency.

Why do the managers of financial firms often pay close attention today to the net interest margin and noninterest margin? To the earnings spread? (Ch6)

These 3 efficiency measures and profitability measures indicate how well mgmt have been able to keep the growth of revenues (loans, investments, service fees) ahead of rising costs (principal interest on deposits, other borrowings, employee salaries/benefits). Net Interest Margin = (Interest Income - Interest Expense) / Total Assets^2 (^II = loans & ^ IE = deposits) NET INTEREST MARGIN measures how large a spread between interest revenues and interest costs mgmt has been able to achieve by close control over earning assets and pursuit of the cheapest sources of funding. Net Non-interest Margin = (Non-interest revenue - provision for loan and lease losses - non-interest expenses) / Total Assets ^2 Measures the amount of non-interest revenues stemming from service fees the financial firm has been able to collect relative to the amount of non-interest costs incurred Earnings spread = (Total interest income/Total earnings assets) / (total interest expense/Total interest-bearing liabilities)

Liquidity Risk, Credit Risk, Interest-rate Risk, and Trading Risk

What are 4 risks that banks face?

Liabilities-Deposits Assets- Loans

What are the biggest liabilities and Assets of a bank?

Money-center Banks

-Industry leaders -Cover whole regions, nations, and continents -Offer the widest possible menu of financial services -Acquire smaller businesses -Face tough global competition

Community Banks

-Much smaller -Service local communities and towns -Offer a narrower, but often more personalized, menu of financial services

What individuals or groups are likely to be interested in the banks' level of profitability and exposure to risk?(Ch6)

-owners, employees, depositors and creditors, and gov't regulators

-It brings added prestige due to stricter regulatory standards that may attract larger deposits -In times of trouble, the technical assistance supplied to a struggling institution by national authorities may be of better quality, giving the troubled bank a better chance to survive -Federal rules can pre-empt state laws

3 Benefits of Applying for a Federal (National) Charter

-It is generally easier and less costly to secure a state charter and supervisory fees are usually lower -The bank need not join the Federal Reserve System -Some states allow a bank to lend a higher percentage of its capital to a single borrower -State-chartered banks may be able to offer certain services that national banks may not be able to offer

4 Benefits of Applying for a State Charter

What is a bank? How does a bank differ from most other financial-service providers?(Ch1)

A bank can be defined by what economic function it performs, what services it offers its customers, or the legal basis for its existence. Historically, banks have been offering a great range of financial services such as checking and debit accounts, credit cards, and savings plans. However, banks today are rapidly expanding their service offerings to include investment banking (security underwriting), insurance protection, financial planning, advisory service for merging companies, risk-management services, and numerous other innovative financial products. O ther financial service providers offer some of the similar financial services offered by a bank but not all of them within one institution. Although, many financial-service institutions are trying to be as similar to banks as possible in the services they offer. Not only financial service industries but several industrial companies have stepped forward in recent decades to control a bank or a banklike firms.

What services do ATMs provide? What are the principal limitations of ATMs as a service provider? Should ATMs carry fees? Why?(Ch4)

ATMs frequently provide a wide menu of old and new services, including bill paying, transfer of funds between accounts, and the purchase of tickets for travel and entertainment. Most authorities expect ATM usage to grow rapidly as these machines offer more services and as bankers increasingly move to restrict customer access to more costly human tellers and other bank personnel, often by charging extra fees for personal service.

Which businesses are banking's closest and toughest competitors? What services do they offer that compete directly with banks' services?(CH1)

Among a bank's closest competitors are savings associations, credit unions, fringe banks, money market funds, mutual funds, hedge funds, security brokers and dealers, investment banks, finance companies, financial holding companies, and life and property/casualty insurance companies. All of these financial service providers are converging and embracing each other's innovations. The Financial Services Modernization Act has allowed many of these financial service providers to offer the public one-stop shopping for financial services.

How have banking and the financial-services market changed in recent years? What powerful forces are shaping financial markets and institutions today? (Ch1)

Banking is becoming a more volatile industry due, in part, to deregulation which has opened up individual banks to the full force of the financial marketplace. However, under the new regulatory trend-reregulation, the government tightened the financial-services sector due to crises and market collapse in the previous few years. At the same time, the number and variety of banking services has increased greatly due to the pressure of intensifying competition from nonbank financial-service providers and changing public demand for more conveniently and reliably provided services and increase in returns on their money invested. Adding to the intensity of competition, foreign banks have enjoyed success in their efforts to enter countries overseas and attract away profitable domestic business and household accounts. There has been service proliferation and greater competitive rivalry among financial firms that has led to a powerful trend— convergence. Convergence refers to the movement of businesses across industry lines so that a firm formerly offering perhaps one or two product line ventures into other product lines to broaden its sales base. Apart from these changes, there has also been a considerable improvement in the technological automation leading banking and financial services to comprise of a more capital-intensive, fixed-cost industry and a less labor-intensive, variable-cost industry than in the past. The trends of convergence, consolidation, geographic expansion, and technological change will continue to proliferate in the future years.

Why are some banks reaching out to become one-stop financial-service conglomerates? Is this a good idea?(CH1)

Banks and various financial institutions are converging in terms of the services they offer and embracing each other's innovations. There are two reasons that banks are increasingly becoming one-stop financial service conglomerates. The first reason is the increased competition from other types of financial institutions and the second reason is the erosion of the bank's market share for providing traditional services. Due to these reasons, the banks demanded for a relief from traditional rules and lobbying for an expanded authority to reach new markets around globe. This has led the United States Congress to pass the Financial Services Modernization Act which has allowed banks to expand their role to be full service providers. It is a beneficial step as it has led the U.S. banks to stay in the competition and increase the market share by entering into various new industries like the securities and insurance industries.

What trend in branch banking has been prominent in the United States in recent years?(Ch3)

Branch banking has become increasingly important with the great majority of states now allowing statewide branching. Today, more states permit statewide branching and only a minority restrict branching in some way. There was an increase in the number of branches in the 60's, 70's and 80's as the population fled cities to suburban areas. However, in recent years the growth in full-service branches has slowed because of the sky-rocketing costs of land and building office facilities. In addition, ATM's and electronic networks have taken over much of the routine banking transactions. There is not as much need for full service branches as before.

What trends are affecting the way banks and their competitors are organized today?(Ch3)

Deregulation and service (technological) innovation have accelerated this trend as intense competition at home and abroad has encouraged banks to become larger organizations, serving broader and more diversified market areas. Even small banks are reorganizing to meet these challenges by being more efficient in meeting their broader-based customer needs.

Yes, It repealed part of the Glass-Steagal act, removing barriers in the market among banking companies, securities companies and insurance companies that prohibited any one institution from acting as any combination of an investment bank, a commercial bank, and an insurance company. Furthermore, it failed to give to the SEC or any other financial regulatory agency the authority to regulate large investment bank holding companies.

Did Gram-Leach-Bliley contribute to the credit crisis?

What is the relationship between the provision for loan losses on a bank's Report of Income and the allowance for loan losses on its Report of Condition?(Ch5)

Gross loans equal the total of all loans currently outstanding that are recorded on the bank's books. Net loans are equal to gross loans less any interest income on loans already collected by the bank but not yet earned and also less the allowance for loan-loss account (or bad-debt reserve). The allowance for loan losses is built up gradually over time by an annual noncash expense item that is charged against the bank's current income, known as the Provision for Loan Losses. The dollar amount of the annual loan-loss provision plus the amount of recovered funds from any loans previously declared worthless (charged off) less any loans charged off as worthless in the current period is added to the allowance-for-loan-losses account. If current charge-offs of worthless loans exceed the annual loan-loss provision plus any recoveries on previously charged-off loans the annual net figure becomes negative and is subtracted from the allowance-for-loan-losses account.

Equal Credit Opportunity Act

Individuals and families could not be denied a loan merely because of their age, sex, race, national origin, or religious affiliation, or because they were recipients of public welfare

Net Interest Income =

Interest Income - Interest Expenses

What services does the Federal Reserve provide to depository institutions?(Ch2)

Many services needed by banks are provided by the Federal Reserve banks. Among the most important services provided by the Fed are checking clearing, the wiring of funds, shipments of currency and coin, safekeeping securities of depository institutions and their customers, issuing new securities from the U.S. Treasury and selected other federal agencies, loans from the Reserve banks to qualified depository institutions, and the supplying of information concerning economic and financial trends and issues. The Fed began charging for its services in order to help recover the added costs of deregulation which made more institutions eligible for Federal Reserve services and also to encourage the private marketplace to develop and offer similar services (such as check clearing and wire transfers).

What is monetary policy?(CH2)

Monetary policy consists of regulation and control over the growth of money and credit in an attempt to pursue broad economic goals such as full employment, reduction of inflation, and sustainable economic growth. Its principal tools are open market operations, changes in the discount (lending) rate, and changes in reserve requirements behind deposits.

Who charters new banks in the United States?

New banks are chartered by the banking commissions of the individual states or, at the federal level, by the Office of the Comptroller of the Currency (OCC)

What are POS terminals, and where are they usually located?(CH4)

Point-of-sale terminals are set up to accommodate customer purchases of goods and services. These computer terminals normally are located in supermarkets, gasoline stations, and similar places with a link to the banks' own computer records

What are primary reserves and secondary reserves, and what are they supposed to do?(Ch5)

Primary reserves consist of cash, including a bank's vault cash and checkable deposits held with other banks or any other funds such as reserves with the Federal Reserve that are accessible immediately to meet demands for liquidity made against the bank. Secondary reserves consist of assets that pay some interest (though usually pay returns that are much lower than earned on other assets, such as loans) but their principal feature is ready marketability. Most Secondary reserves are marketable securities such as short term government securities and private securities such as commercial paper. Both primary and secondary reserves are held to keep the bank in readiness to meet demands for cash (liquidity) from whatever source those demands may arise.

Which accounts are most important and which are least important on the asset side of a bank's balance sheet? What accounts are most important on the liability side of a balance sheet?(Ch5)

Rank Order Assets 1 Cash 2 Investment Securities 3 Loans 4 Miscellaneous Assets Rank Order Liabilities and Equity Capital 1 Deposits 2 Nondeposit Borrowings 3 Equity Capital 4 Miscellaneous Liabilities

To what different kinds of risk are banks and their financial-service competitors subjected today? (Ch6)

Risk to the manager of a financial institution or to a regulator supervising financial institutions means the perceived uncertainty associated with a particular event. -Credit Risk -Liquidity Risk -Market Risk -Interest Rate Risk -Operational Risk -Legal and Compliance Risk -Reputation Risk -Strategic Risk -Capital Risk

What items on a bank's balance sheet and income statement can be used to measure its risk exposure? To what other financial institutions do these risk measures seem to apply? (Ch6)

Standard dev Variance of net income Variance of ROE or ROA Ratios: 1. Must be looked at in specific industries 2. Ratio analysis does not always give every detail 3. Cross sectional time series 4. Size of ratios need to be taken into account

What kinds of information must the organizers of new national banks provide the Comptroller of the Currency in order to get a charter?(Ch4)

The Comptroller of the Currency asks for information on the number of competing banks and bank-like institutions in the service area of the proposed bank. More competitive market situations limit the profit potential and perhaps the growth potential of a new bank. Also requested is information about shopping centers, retail and wholesale business activity, recent population growth, traffic counts, and personal income levels - all viewed as indicators of potential demand for banking services in the service area of the proposed new bank. Applicants must also provide background information on the organizers and proposed management of a new bank so the Comptroller can decide if these people are qualified, law-abiding, and trustworthy to manage the public's funds as well as their own. They are usually expected to put together and submit to the chartering authority a detailed business plan , including marketing, management, and financial components.

What key roles does the Federal Reserve System perform in the banking and financial system?(Ch2)

The Federal Reserve System supervises and examines the activities of state-chartered banks that choose to become members of its system and qualify for Federal Reserve membership and regulates the acquisitions and activities of bank holding companies. However, the Fed's principal responsibility is monetary policy -- the control of money and credit growth in order to achieve broad economic goals.- It also Imposes reserve requirements

What is happening to banking's share of the financial marketplace and why? (Ch1)

The Financial Services Modernization Act of 1999 allowed many of the banks' closest competitors to offer a wide array of financial services thereby taking away market share from "traditional" banks. Because of the relatively liberal government regulations, banks with quality management and adequate capital can become conglomerate financial-service providers. The same will become true for security firms, insurers, and other financially oriented companies that wish to acquire bank affiliates. Hence, the banks and their closest competitors are converging into one-stop shopping for financial services and this trend should continue in the future.

How have bank failures influenced recent legislation?(CH2)

The Glass-Steagall Act, passed by the U.S. Congress in 1933, was one of the most comprehensive pieces of banking legislation in American history. It created the Federal Deposit Insurance Corporation to insure smaller-size bank deposits, imposed interest-rate ceilings on bank deposits, and separated commercial banking from investment banking, thereby removing commercial banks from underwriting the issue and sale of corporate stocks and bonds in the public market.

What is the Glass-Steagall Act, and why was it important in banking history?(Ch2)

The Glass-Steagall Act, passed by the U.S. Congress in 1933, was one of the most comprehensive pieces of banking legislation in American history. It created the Federal Deposit Insurance Corporation to insure smaller-size bank deposits, imposed interest-rate ceilings on bank deposits, broadened the branching powers of national banks to include statewide branching if state banks possessed similar powers, and separated commercial banking from investment banking, thereby removing commercial banks from underwriting the issue and sale of corporate stocks and bonds in the public market.

What accounts make up the Report of Income (income statement of a bank)?(Ch5)

The Report of Income includes all sources of bank revenue (loan income, investment security income, revenue from deposit service fees, trust fees, and miscellaneous service income) and all bank expenses (including interest on all borrowed funds, salaries, wages, and employee benefits, overhead costs, loan loss expense, taxes, and miscellaneous operating costs.) The difference between operating revenues and expenses (including tax obligations) is referred to as net income.

Glass Steagall Act 1933

The ____ defined the boundaries of commercial banking by providing constraints that were effective for more than 60 years -This legislation separated commercial banking from investment banking and insurance -The Federal Deposit Insurance Corporation (FDIC) was created to guarantee the public's deposits up to a stipulated maximum amount in order to enhance public confidence in the banking system

Are there any significant advantages or disadvantages for holding companies or the public if these companies acquire banks or nonbank business ventures?(Ch3)

The ability of holding companies to acquire nonbank businesses has given them the capacity to cross state lines even where state law prohibited entry by out-of-state banking firms. It also allows a holding company to diversify across many different product lines to help stabilize the company's net earnings. However, launching nonbank businesses can stretch holding-company management too far and make it ineffective, resulting in damage to the performance of banks belonging to the same holding company. The public may gain if holding companies are less subject to failure than other types of financial service firms and are more efficient to operate. However, the public may lose if the concentration of services in bank holding companies causes the prices of those services to rise or if resources are drained away from local communities causing slower growth of those communities.

What are the principal accounts that appear on a bank's balance sheet (Report of Condition)?(Ch5)What individuals or groups are likely to be interested in the banks' level of profitability and exposure to risk?

The principal asset items on a bank's Report of Condition are loans, investments in marketable securities, cash, and miscellaneous assets. The principal liability items are deposits and nondeposit borrowings in the money market. Equity capital supplied by the stockholders rounds out the total sources of funds for a bank.

Trading Risk

The risk that bank trader's will take excess risks and make losses. Traders are paid bonuses to make a lot of money. However, if they lose the bank's money they don't have to pay it back. This makes for a moral hazard problem.

Credit Risk

The risk that customers don't repay loans issued by the bank. Banks try solve this by diversification and credit risk analysis

Interest-rate risk

The risk that the interest rate on the bank's liabilities will rise.

ROE = NET INCOME / TOTAL EQUITY CAPITAL ROE is a measure of the rate of return flowing to shareholders Approximates the net benefit that the stockholders have received from investing their capital in the financial firm

What are the principal components of ROE?

What are the advantages of having a national bank charter? A state bank charter?(Ch4)

a)It brings prestige due to stricter regulations and may help attract more customers b.) In times of trouble the technical assistance given may be better ensuring a better chance of long run survival c.) OCC fights for preemption of state laws and regulations The benefits of a state charter are: a.) It may be easier and less costly to get a state charter b.) The bank does not have to join the Federal Reserve and therefore avoids buying and holding low yield stock of the Federal Reserve c.) Many states let a bank lend more to one borrower d.) State chartered banks may be able to make types of loans that a nationally chartered bank cannot