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FMI Spring 2021 Lecture 5 Handout
FMI Spring 2021 Lecture 5 Handout
FMI Spring 2021 Lecture 5 Handout
Anurag Singh
Spring 2021
Managing Risk
Depository Institutions
Finance Companies
Insurance Companies
Managing Risk
Balance Sheet
Income Statements
Regulation
Industry Performance
Their models of finance and investing were risky and they needed the
cushion of bank deposits (faced significantly tighter regulations and
much closer supervision by bank examiners at the same time)
Depository Institutions
Change in the size, structure, and composition of this industry is the result
of mergers and acquisitions - Regulation required?
Only after 1980s and 1990s, bank mergers with other banks across state
lines (interstate mergers) were allowed
The Riegle-Neal Act 1994 eased branching by banks across state lines
(number of branches increased from 43,293 in 1985 to 82,613 in 2015)
Anurag Singh (ITAM) Financial Markets and Institutions Spring 2021 9 / 25
Overview Commercial Bank Industry CB Balance Sheets
The bigger banks tend to fund themselves in national markets and lend to
larger corporations
Their spreads (i.e., the difference between lending and deposit rates) in the
past (the 1990s and early 2000s) often were narrower than those of smaller
regional banks
She smaller banks were more sheltered from competition in highly localized
markets
Small banks have been able to control credit risk more efficiently
Balance Sheets
How to access them?
3
https://finance.yahoo.com/quote/BAC/
4
https://finance.yahoo.com/quote/BAC/financials?p=BAC
5
https://finance.yahoo.com/quote/BAC/balance-sheet?p=BAC
6
Download call reports of citibank from 2007Q1 to 2008Q1 https://cdr.ffiec.gov/public/ManageFacsimiles.aspx
Anurag Singh (ITAM) Financial Markets and Institutions Spring 2021 13 / 25
Overview Commercial Bank Industry CB Balance Sheets
Balance Sheets
Balance Sheet Structure
Assets
Cash and Due from Depository Institutions
Investment Securities
Loans and Leases
Other Assets
Investment Securities
Generate some income, also used for liquidity risk management
purposes
Highly liquid, have low default risk, and can usually be traded in
secondary markets
Banks generally maintain significant amounts of these securities to
ensure that they can easily meet liquidity needs that arise unexpectedly
Since the revenue generated from investment securities is low compared
to that from loans and leases, many (particularly larger) banks attempt
to minimize the amount of investment securities they hold
Anurag Singh (ITAM) Financial Markets and Institutions Spring 2021 17 / 25
Overview Commercial Bank Industry CB Balance Sheets
Investment Securities
Federal funds sold and RPs: Short maturity (generally 1 day)
Lend for short intervals to other banks seeking short-term funding
(interbank market for excess reserves is called the federal funds market
and the interest charged is the fed funds rate)
Repurchase agreements (RPs or repos) can be viewed as collateralized
federal funds transactions (due to credit risk exposure, sellers may seek
collateral backing for the one-day fed funds loan and the interest
charged is the RP rate)7
7
Collateral remains on the balance sheet of the seller (even though he has sold legal title to the collateral to the buyer).
Cash received is added as an asset while it is balanced on the liability side by the repayment due to the buyer at maturity. The
idea is to show that leverage has gone up and the balance sheet is expanded.
Anurag Singh (ITAM) Financial Markets and Institutions Spring 2021 18 / 25
Overview Commercial Bank Industry CB Balance Sheets
Investment Securities
U.S. Treasury and agency securities: Longer maturity, higher
returns. Fully backed by the U.S. government, carry no default risk.8
Securities issued by states and political subdivisions: Longer
maturity, higher returns. Carry some default risk.9
8
agency securities can be backed by Government National Mortgage Association carry no default risk
9
backed by Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, and not directly by
the full faith and credit of the U.S. government
Anurag Singh (ITAM) Financial Markets and Institutions Spring 2021 19 / 25
Overview Commercial Bank Industry CB Balance Sheets
Investment Securities
Mortgage-backed securities: Collateralized mortgage obligations and
mortgage-backed bonds
Other debt and equity securities: Investment-grade corporate bonds,
foreign debt securities, and securities such as U.S. Treasury securities
and municipals held for short-term trading purposes
Other Assets
Physical assets and real estate
Intangible assets can be goodwill and mortgage servicing rights10
Deferred taxes, prepaid expenses, and mortgage servicing fees
receivable
10
MSRs have ongoing administrative duties that are regularly processed for the entire length of a mortgage. Common rights
included are the right to collect mortgage payments monthly, to set aside taxes and insurance premiums in escrow, and to
forward the interest and principal portions to the mortgage lender.
Anurag Singh (ITAM) Financial Markets and Institutions Spring 2021 25 / 25