FINE 442 - Commercial Banks (7)

What is a (commercial) bank?

Institution that takes deposits and makes loans, channeling funds from savers to borrowers and reducing asymmetric information.

How does a bank make profits in simple terms?

It pays a lower interest rate on deposits than the rate it earns on loans and securities, earning a spread.

What are checkable deposits (demand deposits)?

Deposits that can be withdrawn on demand (chequing accounts); very liquid and low-cost funding but with servicing costs.

What are non-transaction deposits?

Deposits not used for payments: savings accounts and time deposits (small time deposits and large negotiable CDs).

What are the main types of bank borrowings?

Borrowing in interbank markets (fed funds, repos, other loans), issuing bonds, and taking discount loans from the central bank.

What are reserves and cash items on a bank's balance sheet?

Reserves held at the central bank plus vault cash, and cash items in process of collection (e.g. cheques being cleared).

What securities do banks typically hold?

Short- and long-term government securities and other safe securities such as municipal or agency bonds.

What are the main loan categories for banks?

Business (commercial & industrial) loans, real estate/mortgage loans, and consumer loans such as auto or personal loans.

What are "other assets" for a bank?

Physical capital such as buildings, computers, equipment, and other fixed assets.

What is asset transformation (intermediation) for a bank?

Selling liquid, low-risk, short-term liabilities (deposits) and using the funds to buy illiquid, risky, long-term assets (loans and securities).

What are off-balance-sheet (OBS) items?

Contingent claims whose size and timing of cash flows are uncertain, so they do not appear directly on the balance sheet.

Give two examples of off-balance-sheet items.

Loan commitments (credit lines that can be drawn later) and derivative contracts such as futures, forwards, or swaps.

How can a bank handle a deposit outflow (liquidity management)?

It can borrow reserves, sell securities, borrow from the central bank, or reduce loans; excess reserves act as liquidity insurance.

Why is bank capital important?

Capital absorbs losses and reduces insolvency risk; with more capital, a given loan loss is less likely to wipe out equity.

What are the two main components of operating income for a bank?

Interest income from loans and securities, and non-interest income from fees and other services.

What are the three main components of operating expenses?

Interest expenses on deposits and borrowings, non-interest expenses (wages, premises, overhead), and provisions for loan losses.

What is net operating income vs net income for a bank?

Net operating income = operating income − operating expenses; net income also includes gains/losses on securities, extraordinary items, and taxes.

What is Return on Assets (ROA) and its formula?

ROA = Net income / Total assets; it measures how efficiently the bank uses its assets to generate profit.

What is Return on Equity (ROE) and its link to ROA?

ROE = Net income / Bank capital, and ROE = ROA × (Assets / Capital); higher leverage raises ROE but also risk.

What is Net Interest Margin (NIM) and its formula?

NIM = (Interest income − Interest expenses) / Assets; it measures net interest spread relative to the size of the balance sheet.

How do ROA and ROE behave around crises?

They usually drop sharply during financial crises and recover afterward, showing that bank profitability is highly cyclical.

What happens on the balance sheet when a bank receives a new $100 deposit (simple example)?

Assets: +$100 reserves (of which part are required reserves and part can later be lent out); Liabilities: +$100 checkable deposits.

In the sample data, roughly what share of operating income is interest income vs non-interest income?

About 65% of operating income is interest income and about 35% is non-interest income (fees and other).

In the sample data, what is the main component of non-interest expenses?

Salaries and employee benefits, which account for about half of non-interest expenses.