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
cash items in collection

 securities ($2.4 trillion)

debt securities
U.S. govt debt
municipal debt

loans ($6.9 trillion, 66% of assets)

commercial
real estate
consumer
interbank

Liabilities

deposits ($6.4 trillion, 68%)

transaction deposits
Nontransaction deposits ($5.9
trillion)
Savings
CDs (large CDs, >$100,000 can be
resold)

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

Bank capital

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

Bank capital and profits

ROE = net after tax profit

bank capital
Higher bank capital lowers ROE

Bank risks

Liquidity risk
Credit risk
Interest-rate risk
Other
Trading
Foreign currency
sovereignty
operational

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

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

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

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

 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

Other Risks

Trading risk
Securities fluctuate in values
Traders do not personally corver
losses
Solution: monitoring, limits

 Foreign exchange risk

Currency fluctuations affect value

of foreign assets
Use derivatives to manage
Sovereign risk
Governments interfere with
currency transfers

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