Objectives of Commercial Banks Flashcards
What is the main objective of commercial banks and why?
Their objective is profit maximisation.
This is so they can keep shareholders happy, where more profits means higher dividends for them. This can also benefit managers or executives who can get perks from this.
How will commercial banks achieve this objective?
They will borrow short term which is low interest and lend long term which is high interest. This can give great profit margins.
Banks can also take more risks, where they can offer loans to those on low incomes or bad financial history.
What is the problem with this objective?
It could lead to bank failure, which is not in the best interest of the bank.
What are the consequences of bank failure?
Systemic risk.
If a bank fails then other banks may be harmed and they may fail as well. This weakens the whole financial system.
Financial system outcomes.
This system is the back bone of the economy so if its weak theres a risk of recession, lost incomes, lost jobs, and lost outputs.
Bank bailouts.
Taxpayers may be effected where the gov may need to prevent the bank from failing in order to protect from much worse consequences. This is not in the best interest of the shareholders as it may lead to harsh regulations after. Also, since the taxpayers basically funded the bank, their power reduces.
What does this potential risk mean for banks?
It means they must balance their objectives with liquidity in mind and security.
They must sacrifice some profits and hold a balance portfolio of assets.
How will banks balance the objective with liquidity and security?
Which is also considered an objective.
Liquidity.
They will need to hold more liquid forms of money like cash. They may even engage in interbank markets. These help avoid bank run, but the bank wont be as profitiable.
Security.
They will need to manage risk and avoid insolvency. This can be done by offering safe loans and charging lower interest rates. This also reduces profitability but its safer.
What are the 2 ways a bank may fail?
Liquidity crisis.
This is where they dont have enough short term liquid assets to cover or meet short term liabilities.
Insolvency crisis.
This is where the bank dosent have enough capital to offset any loses in assets. EG: Loans which go bad.
