Commercial Bank Management Test 1

-FINA401

Who can Issue a charter for a new bank? 

The OCC: issues charter for national banks. Supervises the activities of national banks. 

The State Board Commissions issue charters for state specific depository institutions. 

What is ALL? 

Stands for Allowance for Loan Leases (Balance Sheet). Banks are allowed to build up a reserve for future loan losses from their flow of income based on their recent loan-loss experience. ALL is a contra-asset account representing an accumulated reserve against which loans declared to be uncollectible can be charged off. 

What is PLL?

Stands for Provision for Loan and Lease Losses (Income Statement). Is a non-cash item. It’s built up gradually over time by accumulated deductions from current income. It represents management’s estimate of future loans and lease losses.

What does a bank have to offer in order to be qualified as a bank?

A bank needs to offer

1) Demand (Checkable) Deposits

2) Grant Commercial Loans

What is an indispensable task offered by banks?

Their role is to serve as financial intermediaries between savers and borrowers. Banks will safeguard depositors’ assets.

Who is the office of the Comptroller of the Currency

It’s the oldest federal agency and they supervise the activities of national banks. It’s a division of the Treasury Department. Issues charters for new national banks. Supervises and regularly examines all national banks. Must approve all national banks for branch offices, trust powers, and acquisitions. 

What is a bank? 

Any institution that can qualify for deposit insurance administered by the Federal Deposit Insurance Corporation.

What are the primary and secondary reserves on a bank’s balance sheet?

Primary: Cash

Secondary: Investment Securities Available for Sale are the liquid portion of the bank’s securities.

What does it mean to say that Banks are Delegated Monitors? 

Banks are regarded as Delegated Monitors. Banks evaluate borrower on behalf of their depositors and earn fees for supplying monitoring services. It has a duty to underwrite loans properly and ensure the loan is repaid. Banks are suppliers of liquidity and transaction services. 

What was one of the first services offered by banks?

Currency exchange: they would want to trade their goods but they needed the local currency to do that. Others: Discounting Commercial Notes, Savings Deposits, Safekeeping of valuables/Certification of Valuables.

What Law Prevented Banks from Offering Investment Banking Services? 

Law that Prevented: Glass Steagall Act of 1933

Law that Granted: 1999 Gram Beech Bliley Act.

What is the Interchange fees charged for use of ATMs

Automated Teller Machines. Are shared by several financial firms to lower costs, are centered around the globe. If you use another institution’s ATM, they’ll charge interchange fees that are passed to customers.

What has happened in the past ten years regarding the number of banks and branches?

There are fewer banks, less branching, more technology efficiency uses, less in person. 

Bank Consolidation: Financial Institutions merging or acquiring other financial institutions resulting in a decreased number of independent financial institutions in existence. Has produced a decline in employment in the financial services sector, it opens up possibilities of economies of scale. 

Bank convergence: Banks expanding their array of services, results from consolidation. 

Service Proliferation, Competition, Regulation/Deregulation, Technological Change/Innovation. 

What role do banks play with regard to analyzing prospective borrowers?

Banks want to make sure they will pay out the loan. Gatekeeper, risk management is very important. Credit management is very important. The loans they make need a high degree of certainty that they’ll pay back.

Net Interest Income

Total Interest Income - Total Interest Expense = Net Interest Income

Federal Reserve Act: (1913) ?

A series of financial panics in the 19th and 20th centuries led to the creation of the Federal Reserve (FED). It’s principal role is to serve as a lender of last resort to help stabilize financial markets and the economy. They control the supply of money to promote economic stabilitiy. 

Glass Steagall Act (1933) ? 

Defined the boundaries of commercial banking by providing constraints that were effective for more than 60 years. Separated commercial banking from investment banking and insurance. The FDIC was created. It defined what a bank can and can’t do.

Reagle Neal Act (1994) ? 

Repealed  previous provisions by now allowing Inter-estate Banking. Adequately capitalized and managed holding companies can acquire banks across state lines. No single banking company can control more than 10% of nationwide deposits or more than 30% of deposits in a single state (unless a state waives this latter restriction). For the first time in U.S. history, American banks could accept deposits and follow their customers across state lines. 

Gramm-Leach Bliley Act (1999) ?

Permitted banking companies to affiliate with insurance and securities firms under common ownership. Diversified service offerings and reduced their overall business risk exposure.

What is a standby letter of credit? 

Guarantee by the bank to pay an obligation on behalf of one of their customers in case the business defaults. Beneficiary landlord, bank pays rent behalf of the customer. The Bank issues a guarantee that in the event of a default, the bank will repay a borrower’s obligation.

Why are banks regulated?

Prevent money laundering, maintain financial stability, protect depositors. Banks will want to keep honesty, integrity, and structure.

What are some key trends when looking at consolidation and geographic expansion of banks?

Banks are expanding and merging. Regulation allowed banks to expand branch operations across state lines: Riegle-Neal Act. Allowed interstate banking. Service Proliferation, Competition, Regulation/Deregulation, Technological Change and Innovation, Consolidation, Convergence. 
-Population and geographic area of the primary serviced by the bank. 

-Competition in the area. 

-Number and type of business in the area

-Traffic patterns and adequacy of roads

-Financial history of area to be served- 

-Who are the stockholders

-What is the experience of the organizers and management? 

-Projections for loans and deposits. 

What is the largest item on a bank's Income Statement?

Interest Income: Comes from loans.

What are the trust services provided by banks?

Trust department manage assets for you. Can act as third party comptroller of your assets. A trust department generates fee income. Record keeping for corporate security transactions and dispensing interest and dividend payments, Managing corporate and individual pension and retirement plans

Define a money center bank

Largest commercial banks based in leading financial center. Have more than $125BB in assets. Are considered too big to fail. Are chartered and supervised by the federal government. Usually located in a large city. Profit centered approach Better diversified, ability to raise large amounts of capital, they attract top managerial talent.

Define a community bank

Smaller, locally focused commercial and savings banks. Typically have less than $1BB in assets. Do business in the local area. Also known as retail banks. To market smaller, locally based deposits and loans. Significantly impacted by changes in the health of the local economy and keeping up with new regulations. These institutions have been losing ground both in numbers of institutions and in industry shares. 

Define a Retail Bank

Community bank, more local exposure, will offer business, consumer banking services.

Money Market Account:

Interest is paid on these accounts, limited check-writing is permitted, no minimum balance requirement and no maturity.

Savings Account

offer low interest rates.

CDs

Certificate of Deposits: fixed maturity with a stipulated interest rate. Can be of any denomination, maturity and yield as determined by the bank and agreed upon by the depositor. 

Checking

interest can be paid on these accounts.

What is a financial holding company ?

BHC: Umbrella corporation where there are multiple banks underneath it. Zions. 

FHC: Will have multiple banks, also multiple insurance companies, investment companies, has more financial services.

Benefits of a State Charter

Lower expenses and increased earnings. Improved regulatory access and relationships. Dilution of national bank powers. Monitoring by regulators is easy. State charters may be able to offer certain services that national banks may not offer. Some states allow banks to lend to a higher percentage of its capital to a single borrower. 

Benefits of a national charter 

Added prestige due to stricter regulations. Federal rules can pre-empt laws. The OCC offers to banks highly expert credit examinations and risk management capabilities that benefit all sizes and types of banks in the national system. The OCC has a nationwide reach which enables it to take actions to protect national bank customers regardless of the state in which they reside. In this regard, pioneering steps taken by the OCC to combat unfair deceptive practices, and the OCC’s progressive approach to customer privacy issues. Have had nationwide customer benefits. 

Internal Rate of Return

Formula.. Discount rate that makes NPV = 0. Take the project if the IRR is greater than the required return. NCF = Future Cash Inflows. 

(NCF/(1+Er))1 + (NCF2) … = 0 

Bank’s balance sheet

Balance Sheet = Report of Condition

Shows the amount and composition of funds sources (financial inputs) drawn upon to finance lending and investing activities and how much has been allocated to loans, securities, and other funds used (financial outputs at any given point in time).

Assets: Cash + Deposits in other banks, Securities, Loans, and Miscellaneous Assets.

Liabilities. + Equity = Deposits (D) + Nondeposit borrowings (NDB) + Equity Capital (EC).

Advantages of Large Banks over Community Banks

Better diversified (Both geographically and product line). 

Better withstand fluctuating economy 

Able to raise large amounts of capital 

Attract top managerial talent