Money and Banking chapter 10

bank capital

Banks can also raise funds by selling equity (stock) or from retained earnings

primary concerns that a bank manager/president has to worry about

1. deposit outflows 2. keeping an acceptable level of risk for assets 3. Aquire funds at a low cost 4. Determine the optimal level of capital

ROE

ROA x EM Net profit/ equity = net profit/assets x assets/equity

Earning interest on asset holdings that exceed interest paid on liabilities

How do banks earn profit?

Liability management

acquiring funds at a low cost

net worth of the bank

assets-liabilites

Reserves/Reserve Requirements

banks are required by law to hold a certain fraction of deposits in reserves (Vault cash)

capital adequacy management

It is important because 1.helps prevent bank failure 2. return for owners 3. meeting regulatory requirements

return on assets Shows how efficiently a bank is being run

Net Profit after tax/assets

Return on Equity (ROE) Or Return on capital bc EQUITY AND CAPITAL ARE THE SAME THING This tells equity holders how much the bank is earning on their equity investments

Net profit after tax/Equity (or capital)

Non-transaction deposits

customers cannot write checks for these accounts. (examples include savings accounts and CDs)

Duration analysis

examines the sensitivity of the market value of the banks total assets and liabilities to changes in interest rates *Essentially something with a long term maturity will suffer a larger loss in market value than something with a short maturity when interest rates rise

%change in market value of security

percentage point change in interest rates X duration in years

They suffer capital losses. Same idea can be applied to banks & their balance sheet

what happens to long term bond holders when interest rates rise?

lost earnings on loans or securities

what is the opportunity cost of holding excess reserves?

calling in or selling loans.

what is the worst way for a bank to deal with deposit outflows?

to provide some wiggle room when deposit outflows occur

why would a bank want to hold excess reserves?

Checkable deposits

"Demand deposits" customers have access to their funds on demand. Most do not pay interest, but there are some interest bearing checking accounts and money market deposit accounts

asset management

Acceptable level of risk on asset holdings

Securities

An important part of the income earning process for banks *Most commonly held bonds are US treasuries and municipal bonds*

Equity Multiplier (EM)

Assets/Equity (or capital)

Gap analysis

The amount of rate-sensitive liabilities is subtracted from the amount of rate-sensitive assets

Loans

The real *primary* money making engine for banks. They have a much higher default risk than securities, so banks earn higher returns. Common examples = mortgage, business, and consumer.

Maximize profits

What is the goal of any business?