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Chapter Twenty Two

Part IV The Management of Financial Institutions. Chapter Twenty Two. RISK MANAGEMENT IN FINANCIAL INSTITUTIONS. Managing Credit Risk. Solving Asymmetric Information Problems 1. Screening 2. Monitoring and Enforcement of Restrictive Covenants 3. Specialize / Diversify in Lending

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Chapter Twenty Two

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  1. Part IV The Management of Financial Institutions Chapter Twenty Two RISK MANAGEMENT IN FINANCIAL INSTITUTIONS

  2. Managing Credit Risk • Solving Asymmetric Information Problems • 1. Screening • 2. Monitoring and Enforcement of Restrictive Covenants • 3. Specialize / Diversify in Lending • 4. Establish Long-Term Customer Relationships • 5. Loan Commitment Arrangements • 6. Collateral and Compensating Balances • 7. Credit Rationing promote長期關係 and information flow

  3. Managing Interest-Rate Risk 15x0.1 • First National Bank • Assets Liabilities • --------------------------------------------------------------------------------------------------------------------- • Reserves and cash items $ 5 m | Checkable deposits $ 15 m • | • Securities | Money market deposit accounts $ 5 m • less than 1 year $ 5 m | • 1 to 2 year $ 5 m | Savings deposits $ 15 m • greater than 2 year $ 10 m | • | CDs: Variable-rate $10 m • Residential mortgages | less than 1 year $ 15 m • Variable rate $ 10 m | 1 to 2 year $ 5 m • Fixed rate (30 year) $ 10 m | greater than 2 year $ 5 m • | • Commercial Loans | Fed funds $ 5 m • less than 1 year $ 15 m | • 1 to 2 year $ 10 m | Borrowings: less than 1 year $10 m • greater than 2 year $ 25 m | 1 to 2 year $ 5 m • | greater than 2 year $ 5 m • Physical capital $ 5 m | • | Bank capital $ 5 m 15×0.2 10×0.2

  4. Income Gap Analysis • RSA, which has interest rate that will be reset (repriced) within one year • Rate-Sensitive Assets = $5m + $ 10m + $15m + 20% x $10m • RSA = $32 m • Rate-Sensitive Liabs = $5m + $25m + $5m+ $10m + 10% x $15m • + 20%x$15m • RSL = $49.5 m • If i  5% in one year  • increase Asset Income = + 5% x $32.0m = + $ 1.6m • increase Liability Costs = + 5% x $49.5m = + $ 2.5m • increase Income = $ 1.6m - $ 2.5 = - $0.9m • If RSL > RSA, iNIM, Income • GAP = RSA - RSL • = $32.0m - $49.5m = -$17.5m • ΔIncome = GAP x Δi • = - $17.5m x 5% = -$0.9m 改進：maturity bucket approach

  5. Duration of First National Bank's Assets and Liabilities 100 95

  6. Duration Gap Analysis • %ΔP - DUR x Δi/(1+i) • i 5%, from 10% to 15%  • ΔAsset Value = %ΔP x Assets • = -2.7 x .05/(1+.10) x $100m • = -$12.3m • ΔLiability Value = %ΔP x Liabilities • = -1.03 x .05/(1+.10) x $95m • = -$4.5m • ΔNW = -$12.3m - (-$4.5m) = -$7.8m • Alternatively, • DURgap = DURA - [L/A x DURL] • = 2.7 - [(95/100) x 1.03] • = 1.72 • %ΔNW = - DURgap x Δi/(1+i) • = - 1.72 x .05/(1+.10) • = -.078 = -7.8% • ΔNW = -.078 x $100m • = -$7.8m

  7. Example of Finance Company • Friendly Finance Company • Assets Liabilities • ------------------------------------------------------------------------------------------------- • Cash and Deposits $ 3 m | Commercial Paper $ 40 m • | • Securities | Bank Loans • less than 1 year $ 5 m | less than 1 year $ 3 m • 1 to 2 year $ 1 m | 1 to 2 year $ 2 m • greater than 2 year $ 1 m | greater than 2 year $ 5 m • | • Consumer Loans | Long-Term Bonds • less than 1 year $ 50 m | and other long-term • 1 to 2 year $ 20 m | debt $ 40 m • greater than 2 year $ 15 m | • | Capital $ 10 m • Physical capital $ 5 m | 90 100

  8. Duration of Finance Company's Assets and Liabilities

  9. Gap and Duration Analysis Finance company RSA>RSL.∴income gap>0 DURgap< 0∴ DURA<(L/A)DURL ∴利率上升較有利income, MW • If i 5% • Gap Analysis • GAP = RSA - RSL = $55 m - $43 m = $12 million • ΔIncome = GAP x Δi = $12 m x 5% = $0.6 million • Duration Gap Analysis • DURgap = DURA - [L/A x DURL ] • = 1.16 - [90/100 x 2.77] = -1.33 years • %ΔNW = - DURgap X Δi /(1+i) • = -(-1.33) x .05/(1+.10) • = .061 = 6.1% Commercial bank RSA<RSL.∴income gap<0 DURgap> 0∴ DURA>(L/A)DURL ∴利率上升較不利income, MW  ∴ΔNW=0.061×100m=6.1m

  10. Managing Interest-Rate Risk • Problems with GAP Analysis • 1. Assumes slope of yield curve unchanged and flat • 2. Manager estimates % of fixed rate assets and liabilities that are rate sensitive Income gap假設利率改變時，yield curve斜率不變 Duration gap更進一步假設yield curve斜率=0

  11. Managing Interest-Rate Risk DURGAP=DURA-(L/A)DURL =2.7-(95/100)×1.03=1.72>0 • Strategies for Managing Interest-Rate Risk • In example above, shorten duration of bank assets or lengthen duration of bank liabilities • To completely immunize net worth from interest-rate risk, set DURgap = 0 1. Reduce DURa = 0.98 DURgap = 0.98 - [(95/100) x 1.03] = 0 2. Raise DURl = 2.80 DURgap = 2.7 - [(95/100) x 2.80] = 0

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