SHSU Commercial Banking Exam 1
Why are banks regulated?
To prevent disruption of the economy, reduce risk, prevent large scale failures.
Loan Function of a Bank?
Transferring or allocating deposits and borrowed funds to most productive and profitable uses to provide growth and stability of the economy.
FHC
Financial Holding Companies authorized under GLBA to offer banking, securities, and insurance services
What is most important for banks?
Its customer base
Liquidity risk
Shows the relationship of a banks liquidity needs for meeting deposit outflows & loan increases vs. its actual sources of liquidity from either selling an asset it holds or acquiring additional liabilities
Good judgement for banking
Do not let greed put you at risk
What does the FDIC cover?
$250,000 for: 1. Checking accounts 2. NOW accounts 3. Savings accounts 4. Money market accounts 5. Certificates of deposits or time accounts Official checks of a Bank
What are the five ways banks can obtain funds?
- Transaction deposits - Short-term time & savings deposits - Long term time deposits (maturities over 180 days) - Money borrowed from other sources - Equity capital & retained earnings
Different types of risk? (8 types)
1. Credit risk 2. Interest rate risk 3. Liquidity risk 4. Price risk 5. Operational risk 6. Compliance risk 7. Strategic risk 8. Reputation risk
What are other significant financial service organizations?
1. Savings institutions 2. Money market funds 3. Mutual funds 4. Asset-backed security issuers
What does the FDIC do NOT cover?
1. Stock investments 2. Block investments 3. Mutual funds 4. Life insurance 5. Annuities 6. Municipal securities 7. Safe deposit boxes or 8. contents 9. Government securities
How do banks compare to other financial services?
1st Largest: Banks are the dominant financial institution in the U.S. based on the percentage of total assets (around 30%) 2nd Largest: Federally related mortgage pools (About 10%) 3rd Largest: Life Insurance Companies (About 10%)
Non-financial matters affecting mergers & acquisitions
Avoid post merger financial & operational complications Retain best employees of the acquired bank Keep the acquired banks best customers Maintain the beneficial aspects of the acquired banks culture
Presentation of bank financial statements
Balance sheet (report of condition) Assets: cash assets, loans, and securities Liabilities: deposit funds and non-deposit funds Capital: equity capital, subordinated notes, and debentures, and loan loss reserves Income Statement (report of income) -Interests income -Non-interest income -Interest expenses (including provision for loan losses) -Net profit
What is a legal and regulatory constraint?
Balance sheet: permissible assets, capital requirements Customer relationships: Consumer protection laws Protecting the safety and soundness of the banking industry
Evaluating banking performance (internally)
Bank planning (policy formulation): goals, budgets, strategic planning Technology: Computers, Communications, payments Personnel Development: Challenges (personal selling and geographic expansion) Job satisfaction (training and compensation)
What are wholesale banks?
Banks that focus on medium and large business firms (Which also includes limited purpose banks that are further specialized in terms of customer base)
Management risk responsibilities
Establish programs to measure on-going elements of risk Establish risk accountability
OCC
Charters national banks. States can issue state charters for banks.
Major factors that impact Banking and market shares?
Consumers have become more sophisticated Deregulation: Regulation limiting geographical locations increased bank mergers (14,400 banks 1985 to 5,500 in 2015) Competition among financial institutions with one-stop shopping centers Globalization of financial markets is increasing competition from foreign financial service firms Money and capital markets compete for banks' share of financial assets
What are limited purpose banks?
Credit cards
Why do banks fail?
Credit risk, interest rate risk, foreign exchange risk, bank runs, and fraud
What makes a merger unattractive?
Dilution of earnings (Dilution normally should not exceed 5%) As an investment it's failure to earn expected rate of return Payout takes in excess of 20 years
What will be approach to managing banks in this new environment?
Deal with difficult economic environment Face changing regulatory environment Overcome increasingly stiff competition Number of banks declined (37% since 2015) Deal with rapidly changing technology Alternative banking forms
Bank profitability
Economic growth affects credit risk (national, regional differences) Increased risk from more real estate loans than in the past. Fee income (non-interest income) increasing to about one-third of bank income Operation efficiency increasing (efficiency ratio equal to non-interest expenses to total revenues to manage overhead and personnel expenses)
Risk responsibilities of officers and staff
Evaluate risk in their are Look for/report exceptions to policy Prepare check-lists for monitoring risk Accept responsibilities for monitoring risk in their area Provide good data
What are over lapping regulatory authorities?
Fed, OCC, FDIC, OTS, and State banks
FIRREA 1989
Financial Institutions Reform, Recovery, and Enforcement Act Regulatory Structure: FHLBB closed and OTS established under FDIC to insure thrifts' deposits. Thrifts' asset powers reduced by focusing more on home lending Enforcement powers: "cease-and-desist" power of regulators Cross-bank guarantees in multi-bank holding companies Bank holding companies (BHCs) could acquire savings and loan associations
What do banks do for their customers?
Financial Intermediation: They offer deposits, loans, and other financial services which include: (securities investments, off-balance sheet risk taking, insurance, and trust services)
Areas of the bank subject to risk
General (competition, strategy, economy) Loan/credit Investment/securities Operations/computer systems Legal/regulatory Financial /accounting Internal/external crimes Other risks
How do mergers add value?
Generate increased earnings (cash flow) Entry into attractive new markets Stronger product lines Improved marketing/distribution of products Improved managerial capabilities Cost cutting Increasing market share
What is a market constraint?
Growth of economy and local markets Competition from nonbank lenders and financial service firms
Capital risk
How much asset values may decline before the position of its depositors (or the depositor insurer such as the FDIC) and other creditors are jeopardized
Major factors have been affecting banking and market shares?
Inflation and variable interest rates: - rising interest rates caused short-term deposit costs to rise faster than long-term loans. - also, while rates increased, the market value of their assets declined and borrowers defaulted on loans with greater frequency than normal Securitization: -banks are pooling loans for various kinds and selling securities with claims on these loans Technological advances: - Telecom and computers are increasing Econ of scale and Econ of scope for banks.
What are global banks?
International banks or money center banks
What is Banking?
Is the management of risk. By taking risk, they earn profit.
Risk Ratios
Leverage Ratio: Total equity/total assets Total Capital Ratio: (Total equity + long-term debt + reserve for loan losses)/ total assets
Examples of Business Finance Parallel with Banking
Like non-financial firms, financial firms obtain funds from creditors and owners to obtain raw materials, labor & capital Financial firms purchase funds instead of raw materials such as iron ore. The product sold is loans instead of steel Financial firms seeks to maximize value much like a manufacturing or other type firm
How do banks balance risk & returns?
Many banks have to take higher risks to get acceptable returns. A Banks performance will affect its value in the market place Modeling provides an excellent planning tool. A Bank should compare its performance with its peers in order to measure success
Discount rates differ due to?
Market liquidity Default risk Taxability Call risk Yield curve plots current yields on either US Treasury coupon or strip securities against their maturities
Evaluating bank performance (external)
Market share: Earnings effects Role of technology Regulatory compliance: Capital Lending Securities Other Public confidence: (Critical) Deposit insurance Public image
Factors that affect banks?
Market, Social, Regulatory Constraints
What is the primary objective of finance?
Maximize value by seeking highest returns for risk level deemed appropriate by the owners.
What is a Bank holding company?
Multi-bank Holding Company has two or more banks as subsidiaries One-bank holding company has only one bank as a subsidiary Autonomy varies with strategy
Directors risk responsibilities
Need to have general knowledge of bank activities Established review & implement policies Review overall risk management program with management
Pressure on bank profits
New competition for banks have developed from financial and non-financial firms Banks & thrift institutions have lost the legal protection of their funds & their monopoly on offering consumer savings accounts Banks' position as credit-granting intermediaries has been eroded by alternative lower cost forms of credit extension
Deposit Function of a Bank?
Offer savers a wide variety of denominations, interest rates, and maturities. As well as risk-free (FDIC Insured) deposits and a high degree of liquidity. Deposits up to $250,000 insured by FDIC.
What are Banks?
Private firms with a public purpose. They seek to maximize shareholder wealth. (This is represented by the market value of bank stock and dividends paid.)
Bank employ funds in what five ways?
Short-term, high quality debt securities (under 180 days) Long-term, high quality debt securities (over 180 days) Good quality loans with rates varying with market rates Medium-quality loans with rates varying market Good-quality fixed rate loans
Profitability Ratios
ROE=NI/TE (Rate of return on equity= Net income after taxes/total equity) ROA=NI/TA (Rate of Return on assets = net income after taxes/total assets) NIM Net interest margin = (total interest income - total interest expense)/total assets
Interest risk
Related to the changes in asset & liability returns and values caused by movements in interest rates. (Goal is to have a Ratio close to 1.0)
1980s banking problem
Relaxed credit standards led to many failures Money market funds, debt & equity mutual funds, and annuities were popular.
What is the Banking & Branching Efficiency Act of 1994?
Removed barriers to interstate expansion
Keys to risk management
Risk identification Risk measurements Risk control
Don't over react to risk
Risk is like dynamite, it is an occupational hazard. Do not let risk manage you Much of risk entails the obvious Good data is best projection
Credit risk
Risk that the interest or principal, or both, on securities and loans will not be paid as promised
Current Bank Structure
State Banks may elect to become members of the federal reserve All banks may normally choose to be a member of a holding company there are 5,500 commercial banks currently, the trend towards multiple offices is growing. National banks must be members of the federal reserve Nearly all banks are privately owned
Deregulation of interstate banking
States passed legislation after Supreme Court in northeast Bancorp v. Board of governors FRB ruled in favor of regional reciprocal laws
What is a social constraint?
Supporting local communities Charitable contributions
What does the FFIEC do?
The Federal Financial Institution Examination Council coordinates joint regulatory efforts.
What role does Commercial Banking have in the U.S. Economy?
To accomplish everything below we need Intermediaries: Taxes paid to governments are spent Funds spent by unit earning, find their way back into the stream Funds saved by unit earning, loaned to others & put back in the stream New reserves from the federal reserve find their way into the stream
What are medium and large banks?
They are fully service banks (but not universal banks as in Europe and some other foreign countries)
What are Small and medium sized community banks?
They are retail or consumer banks (which use correspondent banks and outsourcing)
How many central banks were formed for the US?
Three, the last being the Federal Reserve
Two specific types of Banks?
Unit banks: single offices, serving their communities from one office Branch banks: More than one or multiple offices that can be in one community or spread through several cities and/or states
Dodd-Frank 2010
Wall Street Reform and customer protection act passed after 2008 financial crisis CFPB was created to protect consumers Systematically Important Financial Institutions designated to prevent TBTF bailouts "Volcker Rule" limits proprietary trading Emergency lending to banks allowed by Fed with approval of secretary of the treasury
Problem asset Category
When it is criticized but not classified - it is watched When it is classified as problem - it is a substandard Doubtful And is written off as a loss Non-accrual assets can accrue interest
