Chapter 13

How does a bank make profit or revenue

- Fill the market by providing service

- Earn profit by charging customers with that service
- Banks need to payless for the fund it receives from depositors than it earns from the loans it
makes

A banks sources and uses of funds are summarized on ots BALANCE SHEET

Asset – is something of value that an individual or firm owns

Liability – is something that an individual or firm owes

Bank capital – also called shareholders equity is the difference between the value of the bank’s assets
and value of its liabilities

BANK ASSETS

- Banks acquire bank assets from the funds they receive from depositors

The following are the most important bank assets

1. Reserves and other cash assets

- The most liquid asset that a bank holds is reserves

Required reserve – BSP mandates that bank holds a percentage of their demand deposits

Excess reserves – Reserves that bank holds over and above those that are required

2. Marketable securities
- Are liquid assets that banks trade in financial markets

Secondary reserve – bank holding of government treasury securities

3. Loans receivable
- Largest category of bank assets
a. Loans to business – C&I loan
b. Consumer loans – made to households primarily to buy automobiles
c. Real estate loans –
- Residential mortgages – loans made to purchase home
- Commercial mortagaes – loans made to purchase stores, offices, and other commercial buildings
4. Other assets

BANK LIABILITIES

- The most important liabilities are the funds a bank acquires from savers
Main types of deposit accounts

1. Demand or current account deposit

- Which are accounts against which depositors can write checks
2. Nondemand deposit
- Sacrifice immediate access to funds for higher interest payments.
3. Borrowings

BANK CAPITAL

- Also called “Shareholders equity” or “bank net-worth” is the difference between the value of a
bank's assets and the value of its liabilities

BASIC OPERATION OF COMERCIAL BANK

- Borrow short (accept deposits) and lend long (make loans)

- PCB EXAMPLE
- Spread – the difference between the average interest rate banks receive on their asserts and the
average interest they pay on their liabilities

Bank leverage

- The ratio of assets to capital

Leverage ratio

- The inverse of which (ratio of assets to capital)

Leverage

- is measure of how much debt an investor assumes in making an investment

MANAGING BANK RISK

Three types of risk

A. Liquidity risk
- Is the possibility that a bank may not be able to meet its cash needs by selling assets or raising
funds at a reasonable cost
B. Credit risk
- Is the risk that the borrowers might default on their loans
- Asymmetric information – adverse selection and moral hazzard
Different methods banks can use to manage credit risk

1. Diversification Investors – Diversifying their holdings

2. Credit risk analysis – bank loan officers screen loan applicants to eliminate potentially bad risks
3. Collateral – to reduce problems of adverse selection, banks generally requires that a borrower
put up a collateral
4. Credit rationing – limits the size of the loan
5. Monitoring and restrictive covenant – bank monitor borrowers
6. Long-term business relationship

C. Interest rate risk

- If changes in market interest rates cause a bank’s profit to fluctuate
- Make more adjustable rate of floating rate
CHAPTER 14

OFF-BALANCE SHEET ACTIVITIES

- Off-balance sheet activities do not affect the banks balance sheet because they do not increase
either the bank’s asset or its liabilities
1. Loan commitments
- Bank agrees to provide a borrower to a stated amount of funds during a specified period of time
a. Upfront fee – when the commitment is written
b. Non-usage fee on the unused portion of the loan
2. Standby letters of credit
- The banks commit to lend funds to the borrower-the seller of the commercial paper- to pay off
its maturing commercial paper
3. Loan sales
- Is a financial contract in which bank agress to sell the expected future returns from an
underlying bank loans to a third party.
- Secondary loan participation – involve sale of loan contract without recourse, which means the
the bank does not provide any guarantee about the loan
4. Trading activities
- Futures
- Options
- Interest swaps

INVESTMENT BANKS

- Offer distinct financial services, dealing with larger and more complicated financial deals than
retail banks

Role of investment banks

1. Corporate advising – M&A’s, financial product to sell

2. Brokerage division – trading and market making, intermediaries

Typical divisions within investment banks include

1. Industry coverage groups

- Are established to have separate groups within the bank each having expertise in specific
industries
2. Financial product groups
- IPO’s and M&A’s
TYPES OF FIRMS ENGAGED IN INVESTMENT BANKING

1. Bulge Bracket Banks

2. Middle-Market Banks
3. Boutique Banks

BULGE BRACKET BANKS

- Major international investment banking firms

Provide clients

1. Trading of all types of asset management services

2. Equity research and issuance
3. M&A services

MIDDLE MARKET BANKS

- Occupy middle position between smaller regional investment banking firms

BOUTIQUE BANKS

1. Regional boutique banks – smallest of investment banks

2. Elite boutique banks - Often like regional boutique banks, for prestigious clients

AREAS OF BUSINESS

A. Brokerage
1. Proprietary trading – investment banks have their own funds that they can both invest and trade
2. Acting as a broker – can match investors
3. Research – economic market trends
B. Corporate advising
1. Brining companies to market - IPO
2. Bringing companies together
3. Structuring products –

HOW INVESTMENT BANKS MAKE OR LOSE MONEY

Making money

- Bank receive fees in return for providing advice

- Underwriting services
- Loans and guarantees
 - Brokerage services

Losing money

- Holding unwanted shares

- Create financial products which they fail to sell
Chapter 16

OBJECTIVES OF FUBABCUAK REGULATION

a. TO ensure the soundness of the financial system

b. TO increase the information available to investors
c. TO improve control of financial system

ENSURING SOUNDNESS OF THE FINANCIAL SYSTEM

Types of regulation

1. Restriction entry
- Very tight regualations as to who is allowed to set up a financial intermediary and institution
2. Stringent reporting requirements
- MUS FOLLOW PFRS
3. Restrictions on asset and activities
4. Deposit insurance
- Maximum of 500,000 can be recovered if bankrupt
5. Limits on Competition
- Restriction of opening additional branches in the same location
- Restriction of opening branches in another location
6. Restriction on interest rate

THE ROLE OF BSP

- Maintain price stability

- Preserve monetary stability

RESPONSIBILITY

- Policy directions in the areas of money, banking and credit

BSP FUNCTION

Liquidity management

Currency issue

Lender of last resort

Financial Supervision

Management of foreign currency reserves

Monetary and economic sector

- Mainly responsible for the operation activities related to monetary policy

Financial supervision sector

- Mainly responsible for the regulation of banks and other BSP-supervised

Currency management sector

- Mainly responsible for the forecasting, production, distribution, and retirement of Philippine
currency

Corporate services sector

- Mainly responsible for the effective management of corporate strategy

Devices that may be used by BSP

1. Control of legal reserve requirement

2. Control of discount and rediscount
3. Open market operation
4. Control of collateral required on bank loans
5. Imposition of portfolio ceiling
6. Minimum capital ratio
7. Margin requirement for L/C
8. Moral suasion
9. Purchase and sale of government securities

FUNCTIONS OF PDIC

1. Deposit insurance
2. Risk mitigation
3. Receivership and liquidation

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