Chapter 12. Banks and Bank Mgmt.

Balance sheet Bank Risks

Bank Balance Sheet

Assets:

Uses of funds 2007: $10.5 trillion Liabilities: Sources of funds $9.4 trillion

Assets

cash items (< $1 trillion)

reserves -- required -- excess deposits at other banks cash items in collection

 securities ($2.4 trillion)

debt securities U.S. govt debt municipal debt loans ($6.9 trillion, 66% of assets) commercial real estate consumer interbank

Liabilities

deposits ($6.4 trillion, 68%)

transaction deposits Nontransaction deposits ($5.9 trillion)
Savings CDs (large CDs, >$100,000 can be resold)

 borrowed funds
discount loans (Federal Reserve) federal funds (other banks) repos eurodollar loans commercial paper

Bank capital

or net worth
= assets liabilities = $1.1 trillion 10 to 1 leverage! banks have capital requirement cushion against bad loan losses

Bank capital and profits

ROE = net after tax profit

bank capital Higher bank capital lowers ROE

Bank risks

Liquidity risk Credit risk Interest-rate risk Other Trading Foreign currency sovereignty operational

Liquidity Risks

Risk of running short of cash

need cash to deal with deposit outflows but holding cash drags down profits Holding too little cash, bank incurs costs of raising additional funds

Credit risk

Risk of unpaid loans How to minimize?

Credit risk analysis
Credit history, scores

Monitoring, collateral Diversification

Tradeoff with the gains of loan specialization

Interest-rate risk

changes in interest rates affect

BOTH assets and liabilities assets changes VALUE changes the amount of interest income depends on whether LT or ST

 liabilities
cost of funds goes up with interest rates -- rates on CDs, money market accounts, savings, checking

 banks typically borrow short-term

and lend long-term so rate sensitive liabilities > rate sensitive assets so as interest rates rise costs increase faster than income bank profits fall banks must manage interest rate risk Floating rate loans, swaps

Other Risks

Trading risk
Securities fluctuate in values Traders do not personally corver losses Solution: monitoring, limits

 Foreign exchange risk

Currency fluctuations affect value of foreign assets Use derivatives to manage Sovereign risk Governments interfere with currency transfers

 Operational risk
Damage to physical/computer infrastructure Backup systems, geographically dispersed