BANKING

Liabilities

  • Banks acquire funds by issuing liabilities (e.g., deposits), which are sources of funds used to purchase income-earning assets.

Checkable Deposits

  • Bank accounts allowing checks to third parties. Types include:

    • Non-interest-bearing (demand deposits)

    • Interest-bearing NOW accounts

    • Money market deposit accounts (MMDAs).

  • Considered an asset for depositors and a liability for banks. Typically the lowest-cost source of funds.

Nontransaction Deposits

  • A primary source of bank funds with higher interest than checkable deposits.

  • Includes:

    1. Savings Accounts (withdrawable anytime)

    2. Time Deposits (fixed maturity).

Borrowings

  • Banks borrow from other banks/central banks to meet required deposits.

Bank Capital

  • Calculated as total assets - total liabilities. Represents the bank's net worth.

Assets

  • Banks use acquired funds to purchase income-earning assets.

Reserves

  • Comprise deposits + currency. Banks hold some funds in reserves for liquidity.

  • Two Reasons for Reserves:

    1. Required Reserves: Held due to reserve requirements (e.g., 10%).

    2. Excess Reserves: Held for liquidity to meet obligations.

Cash Items in Process of Collection

  • Claims on other banks for funds payable soon.

Deposits at Other Banks

  • Small banks hold deposits in larger banks.

Securities

  • Comprised of debt instruments (e.g., US government securities).

Loans

  • Assets for banks, liabilities for borrowers, cannot be cashed before maturity, and have a default risk.

Asset Transformation

  • Process where banks sell liabilities to buy assets with different liquidity, risk, size, and return characteristics.

Required Reserves

  • Essential for banks to maintain to handle withdrawal demands.

Ways to Combat Reserve Shortages:

  1. Borrowing from the federal funds market.

  2. Selling securities.

  3. Discount loans from the Fed (most costly).

  4. Calling in loans.

Asset Management

  1. Target high-interest borrowers with low default risk.

  2. Invest in high-return, low-risk securities.

  3. Diversify asset types to manage risk.

  4. Ensure liquidity to meet reserve requirements.

Capital Management

  • Capital protects against failure and affects returns for equity holders.

  • Return on Assets (ROA): Measures profitability. Formula: ROA = net profit after taxes / assets.

  • Return on Equity (ROE): Important for equity holders. Formula: ROE = net profit after tax / equity capital.