Test 2 Flashcards
Role of Community banks
- Small Business lending (small business loans) meaning they can include the character of the borrower and special features of the local market
- Personal relationship based meaning they are able to build a long-term relationship with their borrowers
- Farm Lending
- Retail Deposit Services, Providing personal service for depositors of low to moderate wealth (which large banks do not deal with)
Applications of bond market model
1) Expected inflation rate (increase)
2) Expansionary phase of the economy (upswing of business cycle, example: 1990)
3) Historically low savings rate (rate of savings)
Real interest rate
i_r=i_n- π^e
Sources of financing for non-bank businesses
1) Loans (Banks : 18% non-bank intermediaries 38%)
2) Bonds (corporate 32%)
3) Stocks / Equity (11%)
4) Other (1%)
Key problems encountered by financial institutions (businesses)
a) Asymmetric information (principal agent problem; info only people within the company know apposed to stock holders)
b) Adverse selection (hiding info, happens before contract happens)
c) Moral hazard (Happens after the contract happens; Bank using money on undesirable loans or instruments)
Goals of banks
1) Liquidity / maintaining adequate liquidity
a) Meet withdrawal demands (1. Vault cash 2. Secondary money market papers[TBs, Banker’s acceptances] 3. Borrowing)
2) Profitability [ Profits (π) = Total revenue (payins) - Total cost (payouts)]
3) Solvency [Banks ability to meet all of its liabilities / obligations via the liquidation of its assets (assets = Liabilities + capital)]
ROA
Return on assets = (Net profits after taxes) / (Dollar value of assets)
How well the bank is doing in terms of assets generated and as a proxy bank’s income generating capacity via it’s assets
ROE
Return of Equity = (Net profits after taxes) / Equity
Net profits in relation to dollars worth of investment the owner of equity made
EM
Equity Multiplier = Assets / Equity
Bank’s perspective
Lower ratio benefits depositors and higher ratio benefits owners
Asset management theories
(Early era)
1) Commercial loan theory / Real Bill doctrine
2) Shiftability theory
3) Anticipated income theory
Liability management theories
(Modern Era)
1) Liability management theory (modern)
2) Asset allocation theory
Commercial Loan Theory
(‘Real Bill’ Doctrine) Attributes: Banks ought to emphasize short term loans.
Shiftability theory
- key elements: Existence of active market and shiftability of an asset (tantamount to liquidity)
- Theory: Enabled the banks to create long term loans tending toward capital formation
- Limitations: What can be true for one or a few banks cannot be viable/true for the entire banking system
Anticipated income theory
- Ability to pay of the borrower: depends on stability of future income of the borrower (Individual: length of employment. Firm: Revenue flow [debt/revenue ratio])
Asset Allocation Theory
Adapt the Asset mix in view of changing liabilities mix. in example bulk of liabilities: trending toward short-term withdrawal the bank will have to maintain relatively more liquid assets (short term and secured)
Liability management theory
control the amount of liabilities
Banking/institutional structure
Domestic area and international area
domestic area
Dual banking
unit banking (community)
Bank holding company
Correspondent banking
International area
Edge Act corporation
International banking facilities in the U.S.
Foreign Banks in the U.S.
Dual banking
State and federal chartered
State chartered
- Chartered under state statutes
- Authority : state banking commissioner
- Banks: limited to certain delineated areas
- Generally smaller banks compared to federally chartered banks
- can opt to become members of the fed
Fed Chartered
-Chartered under federal statues
- Authority: comptroller of currency (treasury)
- Branching: governed by state statues
- Generally larger banks tend to be fed chartered
(under the rubric of Bank holding companies)
- Mandatory members of the fed (which allows privileges of the fed and have responsibilities)
Unit banking
- One bank serving a particular community
- Typically locally owned and locally administered
- Generally small banks
- Generally state chartered
- Decentralized mechanism / to preclude any outside control or monopolization
Bank holding companies
- Umbrella of organization Having Bank and non-bank interests
- BHC can own banks and still have other business stakes
- After 1956: BHCs can have only bank-related other interests
- provide diversified services to various customers
- Provide diversified sources of funds
