Depository Institutions: Banks and Bank Management

These flashcards cover key concepts and terminology from Chapter 12 of 'Depository Institutions: Banks and Bank Management', focusing on the balance sheet of commercial banks, types of assets and liabilities, risk management, and profitability measures.

What are the three types of cash assets on a bank's balance sheet?

Reserves, cash items in the process of collections, and balances of accounts held at other banks.

What is considered the primary asset of modern commercial banks?

Loans, including business loans, real estate loans, consumer loans, and interbank loans.

What are checkable deposits?

They are a type of deposit account that banks offer, including various types of checking accounts.

What does the term 'non-transactions deposits' refer to?

Savings and time deposits that account for nearly two-thirds of all commercial bank liabilities.

What is a repurchase agreement (repo)?

A short-term collateralized loan where a security is exchanged for cash, with a promise to reverse the transaction later.

What is net interest income?

The difference between the interest a bank pays on its deposits and the interest it receives on loans.

How is credit risk managed in banks?

Through diversification and credit-risk analysis.

What is liquidity risk?

The risk of being unable to meet immediate financial obligations due to a sudden demand for funds.

What is net interest margin?

An indicator of future profitability calculated as net interest income expressed as a percentage of total assets.

What does the term 'trading risk' refer to?

The risk involved in actively buying and selling securities, loans, and derivatives, hoping to make profits.

How can banks manage interest-rate risk?

Through gap analysis, matching the sensitivity of assets and liabilities, and using interest-rate derivatives.

What are off-balance-sheet activities in banking?

Activities that generate fee income, including lines of credit and letters of credit.

What is operational risk in banks?

The risk that arises from failures in the computer systems or physical infrastructure, like buildings.

What is the importance of loan loss reserves?

They cover potential losses from defaulted loans, serving as part of a bank's capital.

What is the main source of funds for banks aside from deposits?

Borrowings from the Federal Reserve or other banks.

What are some typical liabilities found on a bank's balance sheet?

They include deposits (checkable, savings, time), borrowings (from the Fed, other banks), and bank capital.

What is the primary function of bank capital on a balance sheet?

It represents the owners' equity, provides a cushion against losses, and supports the bank's assets.

Besides loans and cash assets, what other significant assets do commercial banks commonly hold?

Securities, which banks actively buy and sell, and can also hold for investment.

What role do 'borrowings' play as a source of funds for banks?

They are a key liability when deposits are insufficient, often sourced from the Federal Reserve or other banks.

What are the four main categories of loans mentioned as primary assets for commercial banks?

Business loans, real estate loans, consumer loans, and interbank loans.

What are the key features of checkable deposit accounts?

They are deposit accounts that allow depositors to write checks and make payments easily, offering high liquidity.

Why are non-transactions deposits significant for commercial banks?

They account for nearly two-thirds of all commercial bank liabilities and typically have lower interest rates and less liquidity than checkable deposits.

How does 'diversification' help banks manage credit risk?

By lending to a wide variety of borrowers across different industries and regions, banks reduce the impact of a single loan default.

What is 'gap analysis' in the context of bank interest-rate risk management?

It involves measuring the difference between the interest-rate-sensitive assets and interest-rate-sensitive liabilities to assess exposure to interest rate changes.

Name two common types of off-balance-sheet activities mentioned in banking.

Lines of credit and letters of credit, which generate fee income for the bank.

Why are a bank's Securities sometimes called "Secondary Reserves"?

Because they are highly liquid and can be quickly converted to cash if the bank needs funds.

What specific components make up a bank's 'Reserves'?

Cash in the vault plus deposits held at the Federal Reserve.

What is 'correspondent banking' in the context of a bank's cash assets?

It refers to the balances of accounts that banks hold at other banks.

How does 'Bank Capital' provide a safety net against bank failure?

It acts as a cushion to absorb unexpected losses from a sudden drop in asset value or a surprise withdrawal of liabilities.

How is a bank's 'Return on Assets (ROA)' calculated?

Net profit after taxes divided by total assets (\frac{\text{Net Profit After Taxes}}{\text{Total Assets}}).

Explain how banks use 'Liability Management' to handle liquidity risk.

By borrowing funds (e.g., in the federal funds market) or actively attracting new deposits to cover shortfalls.

What is the underlying reason for 'Interest-Rate Risk' in banking?

It arises because a bank's short-term liabilities (like checking accounts) often do not match its long-term assets (like 30-year mortgages).

What specific financial metric does 'Gap Analysis' compare to assess interest-rate risk?

The difference (the "gap") between the yield on interest-sensitive assets and the yield on interest-sensitive liabilities.

What are the main strategies banks use to manage 'Trading Risk'?

Setting limits on the amount of risk individual traders can assume and holding more capital for portfolios with greater risk.

Define 'Sovereign Risk' in banking.

The risk that a foreign government will prohibit the repayment of loans made by the bank within that country.