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Management of Financial Institutions

Management of Financial Institutions Chapter 9 Bank Balance Sheet Commercial banks Commercial banks make profits through asset transformation (borrow short, lend long). Investment Banks Investment banks make profits through acting as brokers of securities.

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Management of Financial Institutions

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  1. Management of Financial Institutions Chapter 9 Money & Banking Maclachlan, Spring 2005

  2. Bank Balance Sheet Money & Banking Maclachlan, Spring 2005

  3. Commercial banks Commercial banks make profits through asset transformation (borrow short, lend long). Investment Banks Investment banks make profits through acting as brokers of securities. Indirect Finance vs. Direct Finance Money & Banking Maclachlan, Spring 2005

  4. General Principles of Bank Management • Liquidity Management • Asset Management • Liabilitity Management • Capital Adequacy Management Money & Banking Maclachlan, Spring 2005

  5. Two Types of Risk • Credit Risk • Interest Rate Risk Money & Banking Maclachlan, Spring 2005

  6. Managing Risk “The business of banking is the production of information.” -- Walter Wriston, former head of Citicorp Money & Banking Maclachlan, Spring 2005

  7. Credit Risk Asymmetric information. Before transaction: adverse selection. After transaction: moral hazard. Money & Banking Maclachlan, Spring 2005

  8. Methods to deal with Credit Risk • Screening • Monitoring • Relationship banking • Loan commitments • Collateral • Credit rationing Money & Banking Maclachlan, Spring 2005

  9. Interest Rate Risk Risk associated with borrowing short and lending long. If interest rates rise, liabilities will be turned over at new higher rates while the bank is still earning low rates on assets. Money & Banking Maclachlan, Spring 2005

  10. Managing Interest Rate Risk Keep track of the gap = rate sensitive assets – rate sensitive liabilities Loan sales Fee income Derivatives (financial contracts as insurance) Money & Banking Maclachlan, Spring 2005

  11. Calculate the 1-year GAP (RSA-RSL) (300+100)-(10+90+160+200+200) = -260 Money & Banking Maclachlan, Spring 2005

  12. Banking Industry Structure and Competition Chapter 10 Money & Banking Maclachlan, Spring 2005

  13. Historical Development of the Banking Industry Outcome: Multiple Regulatory Agencies 1. Federal Reserve 2. FDIC 3. Office of the Comptroller of the Currency 4. State Banking Authorities Money & Banking Maclachlan, Spring 2005

  14. Improvements in IT gave rise to Electronic banking Credit & debit cards ATM’s, ABM’s Commercial paper Securitization Junk bonds Money & Banking Maclachlan, Spring 2005

  15. Avoidance of regulations gave rise to Money market mutual funds Sweep accounts Money & Banking Maclachlan, Spring 2005

  16. Interest rate volatility gave rise to Securitization MMMF, Commercial Paper ARM’s Derivatives Money & Banking Maclachlan, Spring 2005

  17. Fee Based Banking Less reliance on revenue from the spread between interest received on assets and interest paid on liabilities. Fees earned through off-balance sheet activities, e.g., loan origination and servicing, loan commitments, bankers’ acceptances, derivatives, underwriting commercial paper. Money & Banking Maclachlan, Spring 2005

  18. Dual Banking System State chartered banks operating along side nationally chartered banks. Money & Banking Maclachlan, Spring 2005

  19. The Decline in Banks as a Source of Finance Money & Banking Maclachlan, Spring 2005

  20. 8,000 commercial banks in U.S. vs. a handful in other countries. Why? McFadden Act (1927) Money & Banking Maclachlan, Spring 2005

  21. Reasons for consolidation • IT • Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 Money & Banking Maclachlan, Spring 2005

  22. Bank Consolidation and Number of Banks Money & Banking Maclachlan, Spring 2005

  23. Separation of Banking from other Financial Services Industries • Glass-Steagall Act 1933 • Gramm-Leach-Bliley Financial Services Modernization Act of 1999 Money & Banking Maclachlan, Spring 2005

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