IFM - Chapter 17 - Banking and the management of financial institutions

What are checkable deposits?

Accounts that allow the depositor to write checks to third parties, including:

• Non-interest earning checking accounts

• Interest earning NOW accounts

• Money-market deposit accounts
  They are safe, liquid, low-cost, and make up ~10% of bank liabilities.

What are nontransaction deposits?

Primary source of bank liabilities (50%). These include:

• Savings accounts

• Time deposits (CDs)
  They have high funding cost but are most stable.

What are bank borrowings?

Funds from the Fed, other banks, or corporations. Types include:

• Discount loans

• Fed funds

• Offshore deposits

• Repos

• Commercial paper
  They are volatile and make up ~19% of liabilities.

What is bank capital?

Funds supplied by the bank owners; constitutes about 11% of total assets.

What are bank reserves?

Funds held at the Fed (including vault cash).

• Required reserves: Legally mandated.

• Excess reserves: Beyond required minimum.

What are cash items in process of collection?

Deposited checks not yet cleared or transferred from other banks.

what are deposits at other banks?

Usually from smaller banks placed at larger ones (correspondent banking).
Together with reserves and collection items, they make up Cash Items (16% of assets).

What are securities in a bank’s balance sheet?

• Securities on a bank’s balance sheet are financial assets that the bank invests in, such as bonds, treasury bills, or other marketable instruments.

  👉 The bank holds these securities mainly to:

  • Earn income (interest)

  • Manage liquidity

  • Comply with regulations
    

    Make up ~20% of assets.
    

What are loans in a bank’s balance sheet?

Income-generating assets (e.g., business, auto, mortgage loans).
Not very liquid.
Make up ~53% of assets.
Includes Other Assets like buildings and equipment.

What is asset transformation?

The process where banks take short-term deposits to make long-term loans.
Example: Savings deposits used for mortgage loans.
Banks “borrow short and lend long.”

What are the four primary concerns of bank management?

1. Liquidity management

2. Asset management

3. Liability management

4. Managing capital adequacy
   Also includes managing credit and interest-rate risks.

What happens when there’s a $10 million deposit outflow and no excess reserves?

• The bank faces a shortfall (insufficient required reserves).

• Balance sheet example:

  • Assets: $0M reserves, $90M loans, $10M securities

  • Liabilities: $90M checkable deposits, $10M bank capital

How can a bank recover from a reserve shortfall?

• Borrow from other banks

• Sell securities

• Borrow from the Federal Reserve

• Reduce the loan portfolio

What is asset management in banking?

Maximizing return on assets while minimizing risk by:

1. Lending to low-default, high-interest borrowers

2. Buying high-return, low-risk securities

3. Diversifying

4. Managing liquidity

What is liability management?

Liability management is how banks manage their sources of funding (their liabilities), such as deposits, borrowed funds, or issued bonds, to ensure they have enough money to operate and meet obligations.

👉 In other words: it’s how banks decide where to get the money they use to make loans and buy assets.

Managing the source of funds (deposits, CDs, debt):

1. Important since the 1960s

2. Banks no longer rely solely on deposits

3. Use CDs/borrowing when loan opportunities arise

What is the role of asset-liability management (ALM) in banks?

• balancing the structure of a bank’s assets and liabilities to manage liquidity, interest rate, and other financial risks, ensuring the bank remains stable and profitable.

• Banks now manage both sides of the balance sheet together

• Most use an ALM committee

• Explains rise in CDs/loans vs. checkable deposits

What is capital adequacy management?

• Balancing safety (high capital) vs. return on equity (ROE)

• Banks hold capital to meet regulatory requirements

it’s about making sure the bank is financially strong enough to survive bad times.

How can banks manage excess capital?

• Increase assets (keep capital constant)

• Reduce capital by increasing payouts:

  • Stock repurchases

  • Dividends

How can banks manage too little capital?

• Reduce assets (sell securities or reduce lending)

• Raise capital (issue stock or cut payouts)

What are off-balance-sheet activities?

1. Loan sales (secondary market)

2. Fee income from:

   • FX trades, MBS servicing, debt guarantees, credit lines

3. Trading & risk management (futures, FX, swaps)
   ➡ These involve risk and potential conflicts

banking activities that generate income or involve risk, but do not appear as assets or liabilities on the balance sheet.

How is bank performance measured?

Via the income statement:

• Operating income

• Operating expenses

• Net operating income
  ✅ Different from a manufacturing firm