COMMERCIAL BANKS: FINANCIAL

MANAGEMENT

Chapter Five
 THE MEANING OF A COMMERCIAL BANK :

• Commercial banks are those banks responsible for

receiving deposits from savers and giving loans to
investors.
• Commercial banks perform this function with the aim of
achieving the profit represented by the Interest Rate Spread
(IRS).
 THE COMMERCIAL BANKS BALANCE SHEET :

• In the balance sheet of the commercial bank, any source of

fund would represent a liability while any uses of the fund
would represent an asset. In this regard, the liabilities
charges the bank with a cost while the assets would
generate return to the bank.
 LIABILITIES OF THE COMMERCIAL BANK:

Commercial banks could source their fund from:

• Deposits: which is a liability for the bank towards the
savers.
• Borrowings: When commercial banks borrow from either
other commercial banks or the central bank.
• Capital: Which is a liability on commercial banks towards
the owner of the bank (i.e: shareholders)
 ASSETS OF COMMERCIAL BANKS:

Commercial banks could use the fund available with them in

the following:
• Reserves: It represents the most liquid asset form where
the fund is kept in the treasury of the bank. In this regard, it
could be kept in either the reserves of the commercial
banks itself (i.e: vault cash).
• Although such reserves would not generate any return for
the bank, reserves must never be equals to zero. This is to
allow the commercial bank to meet any deposit outflow.
• To ensure that the reserves would never drop down to zero,
the central bank set a rule that any commercial bank must
keep a certain percent for the deposits in the form of a
liquid money. This latter is known as “required reserves:
RR” which are calculated as the required reserves ratio
determined by the central bank (rd) multiplied by the
demand deposits (D). That is to say:

RR = rd * D
• In addition to the RR, the manager of the commercial bank
might prefer to hold an additional percentage from the
deposits in the form of liquid money. This latter is referred to
as “excess reserves: ER” which are calculated as the excess
reserves ratio determined by the commercial bank manager
(re) multiplied by the demand deposits (D). That is to say:
ER = re * D
• Worth noting that; rd is obligatory and is the same for all
commercial banks while re is optional and can differ from
commercial bank to another. Also, worth noting that total
reserves in the commercial bank (R) could then be
calculates as: R = RR + ER
• Securities: In this case, the commercial bank could use
part of its sourced fund to trade in securities (mainly debt
instruments)
• In this regard, the return generated would be the yield
gained from such securities.
• Usually securities are considered the “secondary reserves”.
They are ranked the 2nd in terms of liquidity after reserves.
• Loans: As previously mentioned, the main function of the
bank is to give loans. Such loans could be consumer loans
(for buying consumer products) or business loans (to be
used in a business investment activity) or mortgage loans.
• In this regard, the bank would earn an interest rate on such
loans.
• Fixed Assets: Where the bank utilized part of the fund
collected to buy fixed assets such as buildings and lands.
• In this regard, the bank would earn capital gains in case of
having an increase in the price of such assets.
THE BALANCE SHEET FROM FOR
COMMERCIAL BANKS:
 MANAGING COMMERCIAL BANK:

To be an efficient bank manager, there are four types of bank

management (from the financial perspective) that should be
an issue of concern. These are:
Asset Management
Liability Management
Liquidity Management
Capital Adequacy Management
 1- ASSET MANAGEMENT:

• Since each of the assets items would result in generating

returns to the bank, the main aim of the bank manager here
is to set the optimal diversified portfolio of assets that
would maximize the return for the bank.
 2- LIABILITY MANAGEMENT:

• Since each of the liability items would result in charging

the bank with a cost, the main aim of the bank manager
here is to set the optimal diversified portfolio of liabilities
that would minimize the cost for the bank.
 3- LIQUIDITY MANAGEMENT

• It is very critical to concern about determining the optimal

amounts of reserves that would balance between not facing
a liquidity shortage (and thus not underestimating the
amount to be kept as reserves) and maximizing the
beneficial return-generating usage of the bank collected
fund (and thus not overestimating the reserves amount).
 MANAGING THE LIQUIDITY SHORTAGE:

This could be done through four methods as shown below:

• Borrow from the other commercial bank.
• Selling securities: in this case, the bank must accept the current
market price.
• Recalling loans: In this case, the bank would unfortunately lose the
customers.
• Borrowing from Central Bank: in this case, the bank would could be
pay the discount rate and if the scenario is repeated, the commercial
bank would be subject to the case of closing windows.
4-CAPITAL ADEQUACY MANAGEMENT:

• The aim concern in this aspect is to determine

reducing the profitability of the bank from a side
and to have the sufficient mine the optimal amount
of capital that would balance between the idea of
not reducing the profitability of the bank from a
side and to have the sufficient fund to cover any
asset destruction (written off loans) on the other
hand so as to avoid facing a bankrupt (insolvent).