Chapter 9: Banking and Management of Financial Institutions

Question 1

what is the equation of balance sheets?

Answer 1

total assets = total liabilities + capital

Question 2

non-transaction deposits

Answer 2

the primary source of bank funds
- savings and CDs

Question 3

Bank capital

Answer 3

the bank’s net worth (total assets - liabilities = net worth)

Question 4

correspondent banking

Answer 4

small banks with deposits at larger banks

Question 5

secondary reserves

Answer 5

high liquidity, short term US government securities

Question 6

deposit outflows

Answer 6

when deposits are lost
because depositors make withdrawals and demand payment

Question 7

liquidity management

Answer 7

keep enough cash to meet obligations to depositors

Question 8

asset management

Answer 8

purchase assets to maximize profits while managing credit and interest risk

Question 9

liability management/liquidity risk

Answer 9

acquiring funds at low cost

Question 10

capital adequacy management

Answer 10

maintain sufficient capital to prevent bank failure

Question 11

credit risk

Answer 11

the risk arising because borrowers may default

Question 12

interest rate risk

Answer 12

the riskiness of earnings and returns on bank assets caused by interest-rate changes

Question 13

return on assets (ROA)

Answer 13

the net profit after taxes per dollar of assets
- ROA = net profit after tax/assets

Question 14

return on equity (ROE)

Answer 14

the net profit after taxes per dollar of equity (bank) capital
- net profit after taxes/equity

Question 15

equity multiplier (EM)

Answer 15

the amount of assets per dollar of equity capital
- assets/equity

Question 16

loan commitment

Answer 16

a bank’s commitment to provide a firm with loans up to a given amount at an interest rate that is tied to some market interest rate

Question 17

compensating balances

Answer 17

A firm receiving a loan must keep a required minimum amount of funds in a checking account at the bank

Question 18

credit rationing

Answer 18

refusing to make loans even though borrowers are willing
to pay the stated interest rate, or even a higher rate

Question 19

basic gap analysis

Answer 19

gap = RSA - RSL
change in net worth = gap * change in interest

Question 20

duration analysis

Answer 20

-(duration A x A - duration L x L) change in interest

Question 21

Off-balance-sheet activities

Answer 21

activities that affect bank profits but do not appear on bank balance sheets

Question 22

loan sale

Answer 22

a secondary loan participation

Question 23

screening process

Answer 23

underwriting, checking credit score

Question 24

monitoring process

Answer 24

checking that loan is not being used for high risk things

Question 25

loan department

Answer 25

stopping bad credit risks from becoming borrowers

Question 26

collections department

Answer 26

stopping borrowers from becoming bad credit risks

Question 27

type I error

Answer 27

denying a good CR "framing an innocent man"

Question 28

type II error

Answer 28

approving a bad CR "freeing a guilty man"

Question 29

underwriting standards check...?

Answer 29

loan-to-value ratios, credit scores, and income ratios

Question 30

loan-to-value ratios

Answer 30

physical security

Question 31

income ratios

Answer 31

financial capabilities

Question 32

3 Cs of lending

Answer 32

collateral, capacity, character

Question 33

housing expense

Answer 33

(principle + interest + property tax + insurance)/gross income

Question 34

total debt expense

Answer 34

auto loans + credit loans + student loans

Question 35

what happens in the housing market when people are denied loans?

Answer 35

housing prices fall because demand for houses fall

Question 36

mortgage crisis

Answer 36

- lending to high risk borrowers - large amounts of money that they could not afford - inflated appraisals - inflated non-verified income

Question 37

FICO

Answer 37

fair Isaac corporation - credit score model to measure risk of default creditworthiness (range of 300-850)

Question 38

What makes up a credit score

Answer 38

payment history 35, credit utilization 30, length of credit history 15, types of credit used 10, credit inquiries 10

Question 39

what are the 3 factors of why real interest rates are low?

Answer 39

1. rising propensity to save 2. slowing investment demand 3. central bank actions

Question 40

factors of why there is a rise in propensity to save

Answer 40

- aging population saving for retirement - China increasing world's pool of saving

Question 41

factors of why there is slow investment demands

Answer 41

- slowing economic trend growth - falling real cost of plant and equipment - value of firms shifting to intangible assets

Question 42

why has the central banks' actions affected interest rates?

Answer 42

- low short term interest rates for 8 years cause low long-term rates - quantitative easing - buying long term bonds causes low long-term rates

Question 43

3 reasons why banks manage capital levels

Answer 43

- prevent bank failure - adjust ROE - regulatory requirements

Question 44

3 ways to raise capital-to-assets

Answer 44

- increase capital by issuing equities (more shares) - increase capital by decreasing dividends - reduce assets by selling loans/securities and paying off liabilities

Question 45

what is the problem with issuing more equity?

Answer 45

reduces current equity

Question 46

3 ways to lower capital-to-asset

Answer 46

- buy back bank stocks - increase dividend payout - increase assets by issuing CDs and acquiring loans/investments (increasing liabilities)

Question 47

how does increasing/decreasing dividends affect capital?

Answer 47

changes retained earnings

Question 48

capital-to-assets growth rate analysis

Answer 48

the growth rate of a ratio is the difference between numerator and denominator growth rates, (for small growth rate) - %Change(C/A) = change C/C - change A/A

Question 49

If change C/C = change A/A, what is the % change C/A?

Answer 49

0

Question 50

If change C/C = change A/A, what is the return on assets?

Answer 50

ROA = Change A/A * Change C/A

Question 51

Equation for finding max withdrawal from bank

Answer 51

(Total Reserve - Outflow)/(Deposit - Outflow) >= Required reserve ratio

Question 52

when a bank has insufficient reserves it may:

Answer 52

1. borrow from other banks or corporations 2. sell securities 3. reduce loans 4. borrow from Fed (discount loan)

Question 53

maturity bucket approach to gap analysis

Answer 53

measure the gap for several maturity subintervals

Question 54

standardized gap analysis

Answer 54

accounts for the differing degrees of rate sensitivity among rate-sensitive assets and liabilities

Question 55

total reserves

Answer 55

required reserves + excess reserves = deposits at the Fed + vault cash

Question 56

net interest margin

Answer 56

ROA - COF

Question 57

shadow banking

Answer 57

another way to get funds from savers to borrowers

Question 58

Term asset back security loan facility (TALF)

Answer 58

restore credit flows to HHs and firms through the securitization market

Question 59

disintermediation

Answer 59

reducing use of intermediaries

Question 60

Repos are made up of two transactions

Answer 60

cash transaction and forward contract

Question 61

Repos

Answer 61

when Bank A gives Bank B bonds and agrees to buy back at a later date

Question 62

Reverse repos

Answer 62

when Bank A buys back their bonds from Bank B