CHAPTER 17

Banking and the

Management of
Financial Institutions

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All rights reserved.
 Chapter Preview

 Banks play an important role in channeling funds (about $6

trillion annually) to finance productive investment
opportunities.
 They provide loans to businesses, finance college
educations, and allow us to purchase homes with
mortgages.

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 Chapter Preview
 In this chapter, we examine how banking is conducted to earn the
highest profits possible. In the commercial banking setting, we look
at loans, balance sheet management, and income determinants.
Topics include:
─ The Bank Balance Sheet
─ Basics of Banking
─ General Principles of Bank Management
─ Off-Balance Sheet Activities
─ Measuring Bank Performance

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 The Bank Balance Sheet

 The Balance Sheet is a list of a bank’s assets and liabilities

 Total assets = total liabilities + capital

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 The Bank Balance Sheet

 A bank’s balance sheet lists sources of bank funds

(liabilities) and uses to which they are put (assets)
 Banks invest these liabilities (sources) into assets (uses) in
order to create value for their capital providers

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 The Bank Balance Sheet Lowest cost
source of
funds--
payable on
demand
Pay no
interest
Deposit
Secondary
with no
reserves
check
writing
Discount loans
74% of Fed Funds,
Assets
Corporate Loans
have grown by
factor of 10 since
1960 as % of Liab

Bank Equity = Assets - Liabilities,

listed as Liab because Bank owes this
to owners. Also includes Loan
Flow of funds (tab down to commercial banks)
http://www.federalreserve.gov/releases/z1/current/z1r-4.pdf
Loss Reserves

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 - Banks obtain funds by borrowing and by issuing other
liabilities (deposits).
- Banks use funds to acquire assets:
(securities, loans, ...)
- Banks make profits by: charging an interest rate on their
holdings (securities, loans, …) that is higher than the costs
of their liabilities (deposits,…).

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 Liabilities

Checkable Nontransaction
Borrowings Bank Capital
Deposits Deposits

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  - Liabilities: Sources of funds. These funds are obtained by
issuing (selling) liabilities:
 A. Checkable deposits:
 all bank accounts that allow the owner of the account to
write checks to third party.
 Checkable deposits are bank liabilities because the owner
of the deposit can withdraw from the account funds that the
bank is obligated to pay.
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 Checkable Deposits
 Checkable deposits are bank accounts that allow the owner of the account to write
checks to third parties. Checkable deposits include all accounts on which checks can
be drawn: non-interest-bearing checking accounts (demand deposits), interest-bearing
NOW (negotiable order of withdrawal) accounts, and money market deposit accounts
(MMDAs).
 A money market account is an interest-bearing account that typically pays a higher
interest rate than a savings account, and which provides the account holder with
limited check-writing ability.
 A money market fund (also called a money market mutual fund) is an open-ended
mutual fund that invests in short-term debt securities such as US Treasury bills and
commercial paper. Money market funds are widely (though not necessarily accurately)
regarded as being as safe as bank deposits yet providing a higher yield.

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 Nontransaction Deposits

 The primary source of bank funds, Owner cannot write

checks, but earn higher interest than those on checkable
deposits. This includes: savings accounts and times
deposits (small and large (CDs)).

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 Savings account Passbook

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 Difference between savings account and time
deposit
Savings Account Time Deposit
Liquidity more liquid and not accessible
can be accessible without prior
by the account notice by the
holder at any owner to the bank
given time
Interest Rate Lower interest rate Higher interest
rate
Time of Interest Paid annually Paid quarterly,
Payment half-annually, or
annually

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 Difference between Transaction and
Nontransaction Account
Transaction Account Nontransaction
Account
Flexibility More flexible and more Less flexible and less
liquid because it is liquid because it is
related to transactions related to savings
Interest Rate No interest Higher interest rate
Mechanism Offers checks Operations are written in
a Passbook
Examples Checking Account, Savings Account and
Demand Deposit, Time Deposit
Interest-bearing
Negotiable Order of
Withdrawal, and Money
Market Account

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 B. Nontransaction deposits:
C. Borrowings: from the central bank (discount loans) and
other commercial banks (overnight).
D. Bank Capital: the bank’s net worth: the difference
between total assets and liabilities.
 Funds are raised by: selling new equity (stock) or retained
earnings.
 Used against a drop in banks assets.
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 Assets

Cash Items
Deposits at
Reserves in Process Securities
Other Banks
of Collection

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  Assets: uses of funds, the bank acquired these funds by issuing liabilities in
order to purchase income earning assets.
 A. Reserves:
 Some of the funds that the bank acquire that are deposited at the central bank
+ Currency held by the bank (vault cash).

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  Reserves do not pay interest but the bank do hold them
because:
1- Reserve Requirements (required reserve ratio)
2- Excess Reserve
 Both can be used to meet obligations when funds are
withdrawn.

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 B. Cash items in process of collection
 C. Deposits at other banks
 D. Securities: an important income-earning asset: (securities: debt instruments
for commercial banks.
 E. Loans: a liability for second party (individual or firm) receiving it but
considered a bank’s asset.
 F. Other assets: Physical capital.

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  A security is a financial instrument that represents an
ownership position in a publicly-traded corporation
(stock), a creditor relationship with governmental body
or a corporation (bond).
 Securities are typically divided into debts and equities.
A debt security represents money that is borrowed and
must be repaid, with terms that define the amount
borrowed, interest rate and maturity/renewal date.
Debt securities include government and corporate
bonds, certificates of deposit (CDs).
 Equities represent ownership interest held by
shareholders in a corporation, such as a stock. Unlike
holders of debt securities who generally receive only
interest and the repayment of the principal, holders of
equity securities are able to profit from capital gains.

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 Panic Attacks
 Panic attacks are sudden periods of intense fear that may include
palpitations, sweating, shaking, shortness of breath, numbness, or a
feeling that something bad is going to happen.
 People with panic attacks often report a fear of dying or heart attack,
flashing vision, faintness or nausea, numbness throughout the body,
heavy breathing and hyperventilation, or loss of body control
 The maximum degree of symptoms occurs within minutes. Typically
they last for about 30 minutes but the duration can vary from seconds
to hours. There may be a fear of losing control or chest pain. Panic
attacks themselves are not dangerous physically.

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 Panic Attacks
 Panic attacks can occur due to number of disorders including panic
disorder, social anxiety disorder, post traumatic stress disorder, drug use
disorder, depression, and medical problems.
 Short-term triggering causes – Significant personal loss, including an
emotional attachment to a romantic partner, life transitions, significant life
change.
 Maintaining causes – Avoidance of panic-provoking situations or
environments, anxious/negative self-talk ("what-if" thinking), mistaken
beliefs ("these symptoms are harmful and/or dangerous"), withheld feelings.
 Diagnosis should involve ruling out other conditions that can produce similar
symptoms including heart disease, lung disease, and drug use

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 Panic Attacks

 Treatment of panic attacks should be directed at the

underlying cause.
 In those with frequent attacks, counselling or medications
may be used.
 Breathing training and muscle relaxation techniques may
also help.
 Those affected are at a higher risk of suicide.

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