1 / 56

CAPITAL MARKETS

CAPITAL MARKETS. BSC/BBA III Winter Semester 2010 Lahore School of Economics. Chapter 3 Depository Institutions. Depository Institutions Learning Objectives. What is a depository institution? How a DI generates income? What is the Asset/Liability problem for DI’s? What is Funding Risk?

lalo
Télécharger la présentation

CAPITAL MARKETS

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. CAPITAL MARKETS BSC/BBA III Winter Semester 2010 Lahore School of Economics

  2. Chapter 3Depository Institutions

  3. Depository InstitutionsLearning Objectives • What is a depository institution? • How a DI generates income? • What is the Asset/Liability problem for DI’s? • What is Funding Risk? • What are DI’s funding sources? • What are Reserve Requirements?

  4. Depository Institutions? Include:

  5. Depository Institutions? Include: • Institutions that take deposits Deposits represent Liabilities (debt) for DI’s Include: • Banks • Savings & Loan institutions • Credit Unions

  6. How do DI’s make money? 3 ways:

  7. How do DI’s make money? 3 ways: • Loans Make direct loans to entities • Securities investments Investing in securities & holding portfolios • Fees Charged to their customers

  8. Importance of DI’s? Heavily regulated because:

  9. Importance of DI’s? Heavily regulated because: • Their role in financial system a) Creating the financial playing field • Principal means of making payments a) Individuals & Businesses use for payments • Vehicle for Govt monetary policy a) MP implemented through banking system

  10. Special Privileges • Access to Federal Deposit Insurance • Provision of liquidity in emergencies • Govt has interest in DI’s stability & survival…

  11. Asset-Liability Management 2 Main problems: • Funding Risk • Liquidity Risk

  12. Asset-Liability Management Funding Risk: Illustrate using 100MM, 7% 1 & 10 yrs • Use of Spreads(DI’s make money) Difference between bid/ask or charging premiums • Gaps Open positions created due to duration differences • Interest rate exposure Funding activity resulting in interest rate risk

  13. Asset-Liability Management Opportunities:

  14. Asset-Liability Management Opportunities: • Interest Rate view Managers who have expectations of interest rate changes will seek to profit from funding! • If Interest rates rise What position should you have? • If interest rates fall What position should you have?

  15. Asset-Liability Management Opportunities: • Interest Rate view Managers who have expectations of interest rate changes will seek to profit from funding! • If Interest rates rise DI will benefit if it has borrowed long & lent short because when interest rates will rise its cost will remain unchanged but will be able to lend at a higher rate! • If interest rates fall DI will benefit if it has borrowed short & lent long!

  16. Asset-Liability Management Threats of positioning:

  17. Asset-Liability Management Threats of positioning: • Adverse financial consequences If expectations are not realized, Huge losses can occur • No one can predict interest rates consistently Highly risky • Becomes same as gambling Long run losses highly likely

  18. Asset-Liability Management Main goal of Mgmt:

  19. Asset-Liability Management Main goal of Mgmt: • Try Locking in the spread • Minimize interest rate exposure • Various financial instruments used to manage risk

  20. Asset-Liability Management Main goal of Mgmt: • Try Locking in the spread (By not trying to bet on interest rate movements, focus should solely be on earning from the spread not on interest rate movements) • Minimize interest rate exposure (By investing in assets & Liabilities of similar maturity ranges) • Various financial instruments used to manage risk (Examples include interest rate options, swaps & forwards)

  21. Liquidity Concerns of DI’s? Balancing two activities?

  22. Liquidity Concerns of DI’s? Balancing two activities: • Satisfy Withdrawals of customers (Liquidity Concerns) Liquidity required • Provide Loans to customers (Earnings)

  23. Liquidity Concerns of DI’s? 4 ways to solve liquidity issues?

  24. Liquidity Concerns of DI’s? 4 ways to solve liquidity issues: • Attract deposits • Borrowing from Federal Agency or other Financial Institutions (using security collateral) • Sell Securities on hand • Raise Funds in Money Markets

  25. Liquidity Concerns of DI’s? Increase Borrowing using securities: • Discount window borrowing at Fed

  26. Liquidity Concerns of DI’s? Sell securities it owns: • DI must invest in ST, liquid securities with little Price Risk and keep these in its inventory • E.g: stocks?... No, Bonds? …. No • Solution: ?

  27. Liquidity Concerns of DI’s? Sell securities it owns: • DI must invest in ST, liquid securities with little price risk and keep these in its inventory • E.g stocks?... No, Bonds? …. No • Solution: Short term, Money Market instruments like Treasury Bills, Commercial Papers etc

  28. Liquidity Concerns of DI’s? SECONDARY RESERVES? • Securities held by a DI for the purpose of satisfying withdrawals or loans. • Disadvantage? Lower yield % of assets as secondary reserves depends on DI’s risk/return appetite

  29. Liquidity Concerns of DI’s? One more reason for holding liquid assets?

  30. Liquidity Concerns of DI’s? One more reason for holding liquid assets? • To fulfill Govt regulation! • In form of Reserve Requirements (discussed later)

  31. Commercial Banks 3 Main Types of services:

  32. Commercial Banks 3 Main Types of services: • Individual Banking • Institutional Banking • Global Banking

  33. Commercial Banks Individual Banking • Consumer Lending • Residential Mortgage • Credit Card financing • Car & Boat Financing • Brokerage services • Student Loans

  34. Commercial Banks Institutional Banking: • Loans to Corporations • Loans to Insurance companies • Loans to Government • Commercial Financing & Leasing

  35. Commercial Banks Global Banking: • Foreign Exchange products • Capital Markets products • Corporate financing products

  36. Commercial Banks How do Banks raise Funds?

  37. Commercial Banks How do Banks raise Funds? 3 Main Sources of Funds • Deposits • Non-Deposit Borrowing • Common Stock & Retained Earnings

  38. Commercial Banks How do Banks raise Funds? 3 Main Sources of Funds • Deposits (Demand Deposit, Savings Deposit, Time Deposits) • Non-Deposit Borrowing (Borrowing from Federal Reserve through Discount window, Repurchase Agreements, borrowing by the issuance of instruments in the money & bond market) • Common Stock & Retained Earnings

  39. Commercial Banks Reserve Requirement & Borrowing at the Fed Funds Market? • Banks must maintain a %age of deposits with Federal Reserve called Reserve Ratio. • The cash kept with Fed is called Required Reserve.

  40. Reserve Requirement Type of Deposits: • Transaction Deposits • Non-transactions Deposits Reserve Ratios are higher for transaction Deposits relative to non transaction deposits!

  41. Reserve Requirements • Reserve maintenance period 2 Week period where the average of the daily total of each type of deposit is taken to get RR (THR-WED) • Actual Reserves Average Amount of Reserves held at the close of business at the Federal Reserve Bank during each day of a two week reserve maintenance period. • Excess Reserves If bank reserves exceed the RR at the Fed • Fed Funds Market & Fed Funds Banks short of RR borrow from Excess Reserves of other Banks at Fed Funds rate.

  42. Reserve Requirements Fed Discount Window: • Fed is the Banker’s Bank – last resort • Charges DISCOUNT RATE • Collateral Treasury securities, Govt securities etc. • Heavily Discourages its use Will investigate if use becomes frequent

  43. Regulations • Regulation of Interest rates • Geographical Restrictions • Permissible Activities for Commercial Banks • Capital Requirements for Commercial banks

  44. Regulations • Regulation of Interest rates Ceilings imposed on the interest rate that can be paid on Deposit Accounts. • Geographical Restrictions This legislation was intended to prevent large banks from expanding geographically & thereby taking over smaller banking entities, threatening competition. • Permissible Activities for Commercial Banks • Capital Requirements for Commercial banks

  45. Permissible Activities for Commercial Banks • The permissible activities of banks are limited to those that are viewed by the Fed as closely “related to banking”. • Banks can neither underwrite securities & stocks, nor can act as dealers in the secondary market. • Banking act of 1933 Prohibits any depository institution from engaging in the securities business.

  46. Capital Requirements for Commercial Banks • The ratio of equity Capital to total assets is low, typically less than 8% in case of banks. • “Off Balance Sheet Obligations” • Risk Based Capital Requirements

  47. Risk Based Capital Requirements Types of Capital • Tier 1 Capital (Core Capital) It consists basically of common Stockholder’s Equity, Preferred Stock & minority interest in subsidiaries. It is based on book Value of Total Assets. • Tier 2 Capital(Supplemental Capital) It includes loan loss Reserves, Perpetual Debt & hybrid Capital Instruments. It is based on Risk Weighted Assets.

  48. Risk Based Capital Requirements

  49. Risk Based Capital Requirements- Example

  50. Risk Based Capital Requirements- Example

More Related