Gillian Mae S.

Garcia
BSA 3A
December 3, 2021

Assignment 10: Commercial banking - Bank

management and bank performance

1. If a bank is very uncertain about future interest rates,

how might it insulate or protect its future performance
from future interest rate movements? (10 points)
- The bank can use the following methods to reduce interest rate risk if it
is very uncertain about future interest rates:
a) Maturity Matching, the coordination of a bank's cash inflows with cash
outflows by matching the maturity of income generating assets (such
as certificates of deposit) with the maturity of interest incurring
liabilities (debts). The deposit amounts are typically small relative to
the loan amounts. Therefore, a bank would have difficulty combining
deposits with a particular maturity to accommodate a loan request
with the same maturity.
b) Floating Rate Loan whose interest rate fluctuates according to the rise
or fall in the market interest rates. This method allow banks to
support long-term assets with short term deposits without overly
exposing themselves to interest rate risk. However, floating-rate loans
cannot completely eliminate the risk. If the cost of funds is changing
more frequently than the rate on assets, the bank’s net interest
margin is still affected by interest rate fluctuations.
c) Interest Rate Futures Contract by which lenders and borrowers
commit themselves to the interest rates at which they will lend or
borrow specified sums on a specified future date. Banks that may
suffer losses due to fluctuations in interest rates can use these
contracts to hedge (reduce risk).
d) Interest Rate Swap, an exchange of different cash flows, one
generated by a fixed interest rate on a sum, the other by a floating
interest rate on the same sum. A bank whose liabilities are more rate
sensitive than its assets can swap payments with a fixed interest rate
in exchange for payments with a variable interest rate over a
specified period of time. If interest rates rise, the bank benefits
because the payments to be received from the swap will increase
while its outflow payments are fixed. This can offset the adverse
impact of rising interest rates on the bank’s net interest margin.
e) Interest Rate Caps, a provision in adjustable rate mortgages that
limits how much an interest rate can increase. It is an agreement (for
a fee) to receive payments when the interest rate of a particular
security or index rises above a specified level during a specified time
period. Various financial intermediaries (such as commercial banks
and brokerage firms) offer interest rate caps. During periods of rising
interest rates, the cap provides compensation that can offset the
reduction in spread during such periods.
Gillian Mae S. Garcia
BSA 3A
December 3, 2021

2. Identify 3 bank policies and explain their influence on

the bank’s income statement. (15 points)
- Composition of liabilities influencing the gross interest expense. Gross
interest expenses represent interest paid on deposits and on other borrowed
funds. These expenses are affected by market rates and the composition of
the bank’s liabilities. Since income statements includes revenue and expenses,
the cash outflows or incurring of liabilities (such as deposits) affect the gross
interest expense of a bank.
Composition of assets influencing the loan losses. The loan loss provision
is a reserve account established by the bank in anticipation of loan losses in
the future. It should increase during periods when loan losses are more likely,
such as during a recessionary period. The amount of loan losses as a
percentage of assets is higher for banks that provide riskier loans, especially
when economic conditions weaken.
Nontraditional activities influencing noninterest income. Noninterest
income results from fees charged on services provided, such as lockbox
services, banker’s acceptances, cashier’s checks, and foreign exchange
transactions. Noninterest income is usually higher for money center, large,
and medium banks than for small banks. This difference occurs because the
larger banks tend to provide more services for which they can charge fees.