week 3 Flashcards
(66 cards)
1
Q
what are deposits?
A
- money you put in a bank to be stored in exchange for potentially earning some interest on them.
- you put it in your savings account and the bank records it at the account balance
- used for giving loans
2
Q
what are loans?
A
- deposits given to people in need of money
- people need to have a good credit score so they can get approved for a loan
- the process allows the bank to earn interest on the loans they provide and they might share that interest with the initial depositors to incentivise their money back
3
Q
what is key for borrowing short-term?
A
- obtain funds in the short-term to meet their immediate finding needs
- these funds could come from customer deposits, interbank borrowing, short-term loans from other financial institutions
- provides banks with flexibility and liquidity since banks can respond to changing economic conditions and customer demands
4
Q
what is key for lending long-term?
A
- provide loans and credit to individuals, businesses and other entitites
- loans can have varying maturities, often extending over several years
- purpose: financial investment, real estate purchases, business expansions, consumer spending
5
Q
what is the rationale between short-time borrowing and long-term lending?
A
banks profit from the spread between the interest rates payed on their short-term liabilities (like deposits) and the interest rates they earn on their long-term assets like loans => this interest rate spread is often referred to as net interest margin; it is a primary source of reveneue for banks
6
Q
what is bank capital? and why is it classified as a liability?
A
- liabillities side of bank’s balance sheet => since it is a source of funds
- bank capital is the financial resources that the bank has raised from its shareholders and retained earnings (amount of profit remaining after a company has paid all cost, income taxes and dividends) = > it is a source of funds => liability just like deposits
7
Q
what is ownership stake?
A
- shareholder’s equity which includes common stock and retained earnings
- they represent the ownership stake in the bank
- shareholders provide capital to the bank in exchange for ownership stake
- it is still liabilities side but it does not constitute a debt obligation that must be repaid to external parties like
8
Q
what is bank insolvency ?
A
- it is a situation where a bank is unable to meet its financial obligations due to having liabilities exceeding assets => cannot repay its depositors or creditors
- represents significant financial distress
9
Q
what are the causes for insolvency?
A
- often results of persistent financial problems:
- substantial deterioration in asset quality,
- inadequate capital to cover losses
- mismanagment
10
Q
what does negative net worth signify?
A
- represents significant financial distress
- having negative net worth is a strong indicator of insolvency, but it doesn’t necessarily mean that the bank is autmatically and immediately declared insolvent. it just says it is at risk of becoming insolvent if corrective measures are not taken
- it is a serious concern, so it is constantly monitored by regulators
11
Q
when is a bank officially declared insolvent?
A
- depends on several factors:
– including specific regulatory framework in place
– extent of the bank’s financial distress
– actions taken to address the situation
12
Q
why are financial intermediaries important?
A
- , reduce information asymmetry, and provide various financial services.
13
Q
what are financial intermediaries?
A
Financial Intermediaries are institutions that play a crucial role in facilitating the transfer of funds from savers (those who have excess funds) to borrowers (those who need these funds) in the economy
14
Q
what is indirect finance?
A
refers to the process of facilitating funds from savers to borrowers through intermediaries, such as banks, mutual funds, insurance companies, and pension funds.
15
Q
what type of banks are considered financial intermediaries?
A
commercial banks + investment banks
commercial: accept deposits and provide loans
investment: assits in capital raising, mergers, acquisitions
16
Q
what are mutual funds:
A
- pool funds from mutliple investors to invest in a diversified portfolios
- provide access to a verity of assets
17
Q
what are insurance companies?
A
- provide risk protection throgh policies
18
Q
what are credit unions ?
A
- member-owned cooperatives providing financial services:
- focus is on specific companies
19
Q
Name the types of financial intermediaries.
A
- banks
- mutual funds
- insurance companies
- credit unoins
- pension funds
20
Q
What is the main function of financial intermediaries?
A
- risk transformation: Diversifying risk by pooling funds from multiple investors+Offering financial products that help individuals and institutions manage risk.
- economies of scale: reducing transaction costs
- information analysis: Reducing the information asymmetry between lenders and borrowers.
- maturity transformation: borrowing short-term and lend long-term
21
Q
How do financial intermediaries enhance efficiency?
A
By connecting those with excess funds to those in need of funds.
22
Q
What is capital allocation?
A
The process by which financial intermediaries allocate capital to productive projects, contributing to economic growth.
23
Q
What is liquidity provision?
A
Ensuring that funds are available for withdrawal while funding long-term investments.
24
Q
What are some pros of regulatory oversight in financial systems?
A
- Protecting consumers
- Maintaining market integrity
- Having regulatory bodies and agencies
- Ensuring financial stability
25
What are some cons of regulatory oversight in financial systems?
risk: risk of conflicts of interest and systemic risk
26
What are some cons of financial intermediaries?
Risk of conflicts of interest and systemic risk.
27
What are financial markets?
Platforms where various financial instruments, such as stocks, bonds, currencies, and commodities, are bought and sold.
28
What is the role of financial markets?
Providing a place for participants to trade financial assets and enabling the transfer of ownership.
29
What is the function of financial markets?
financial market allow borrowers (issuers) to raise funds directly from investors (savers) by issuing securities and investors can buy and sell these securities among themselves.
30
what are most popular examples of financial markets?
stock markets, bond markets, foreign exchange markets, commodity markets
31
What is the difference between financial intermediaries and financial markets?
* Intermediation vs. Direct Transactions: financial intermediaries facilitate transactions between savers and borrowers indirectly, while financial markets facilitate direct transactions between buyers and sellers
* Pooling of Funds:intermediaries pool funds from multliple sources to provide loans or investments, while financial markets allow individual investors to buy securities direclty from issuers
* Risk Management: intermediaries often manage risk through diversification, while risk managment in financal markets relies on individual investors'choice.
* Expertise: intermediaries possess expertise in evaluating risk and managing financial products, while in financial markets investors rely on their own reserach and analysis
32
what are the key commerial banking activities:
- taking in deposits and making loans to hoiseholds and firms
33
What is a bank balance sheet?
A statement that shows a bank's financial position on a particular day, summarizing assets and liabilities.
34
What are assets in a bank balance sheet?
- What the bank owns or financial claims it holds.
- what other people owe to the banks
- something of value that an individual or a firm owns. in particular a financial claim
35
What are liabilities in a bank balance sheet?
- What others owe to the bank or financial claims against the bank.
- whatever is left for the shareholders
something that an individual or a firm owes, particularly a financial claim on an individual or a firm
36
What is bank capital?
The difference between the value of a bank's assets and its liabilities; also known as shareholders' equity.
- total assets = total liabilities + shareholders equity.
- shareholder's equity = bank net worth = bank capital
37
What does it mean for a bank to be solvent?
The bank has enough assets to pay off all its liabilities, with something left for shareholders.
total assets > total liabilities, shareholder's equity >0
- it allows for banks to handle extreme events - when all deposits are withdrawn, all borrowed funds became due, can't borrow more funds
38
What does it mean for a bank to face insolvency?
The bank cannot repay its depositors because its liabilities exceed its assets.
39
What does it mean for a bank to be facing insolvency?
A bank is facing insolvency when it cannot repay its depositors because its liabilities are greater than its assets.
total assets < total liabilities, shareholder's equity <0, results in bank failure
- of companies have negative shareholder's equity it is a sign for insolvency
## Footnote
Total Assets < Total Liabilities; Shareholder’s Equity < 0 results in bank failure.
40
What condition characterizes bank insolvency?
- A bank is unable to meet its long-term financial obligations and cannot pay its debts as they become due.
- it is more severe and long-lasting financial condition
41
What are the components of a bank's liabilities?
Currency in circulation
Reserves (deposits held by commercial banks at the central bank)
## Footnote
Reserves include deposits at the Fed and vault cash.
42
What are the primary assets of a bank?
Government securities (holding by fed that affects money supply and earn interest such as gov bonds)
Discount loans (provide loans to banks and earn the discount rate)
Loans to financial institutions.
43
Why do banks deposit money at the Federal Reserve?
- To satisfy legal reserve requirements.
- the fed in turn uses these deposits to buy gov securities that provide the bulk of its earnings
44
What is the purpose of reserve requirements set by the Federal Reserve?
Control money supply - ( by adjusting reserve requirement, they can control the amount of money that banks can lend, impacting the growth of the money supply)
Promote banking system stability - ensures liquidity for meeting customer needs preventing bank runs and supporting financial stability
Influence interest rates - change in money suppky impacts short-term interest rates
ex: When the Fed increases reserve requirements, banks have fewer funds available to lend, leading
to higher interest rates.
Conversely, lowering reserve requirements can lead to lower interest rates as banks have more
funds to lend.
45
What formula is used to calculate the reserve requirement ratio?
Reserve Ratio = Percentage of deposits that must be kept on hand at a central bank.
reserve requirement = reserve requirement ratio (%) x Bank Deposits
46
how to banks maintain sufficient reserves to meet requirements
- deposits with central banks
- cash in their vaults
47
What is considered excess reserves?
Any cash over the required minimum that the bank is holding in its vault.
- they are used to meet unexpected liquidity needs and can also be loaned to otehr banks in the interbank liquidity market
48
What are the main categories of bank loans?
* Non-mortgage loans
* Consumer loans
* Mortgage loans/Real estate
49
What do bank assets include?
- Funds received from depositors
- borrowed funds
- initial shareholder contributions
- retained profits.
50
what is vault cash?
it is cash on hand in a bank including currency in ATMs and deposits with other banks
51
What are demand deposits?
Checkable deposits on which banks do not pay interest.
52
What are fixed-term deposits also known as?
Certificates of deposit (CDs).
53
What are borrowings considered in the context of a bank's balance sheet?
A liability.
54
What is collateral in banking?
Assets or property offered by a borrower as security for a loan.
55
True or False: Checkable deposits are assets to banks.
False.
56
How has the importance of checking accounts changed over time?
Households hold less in checking accounts relative to other financial assets.
57
What is the liquidity preference theory?
A theory that explains how individuals prefer to hold cash rather than other forms of wealth.
58
What are borrowings considered on the bank balance sheet?
A liability
## Footnote
Borrowings represent obligations that the company must fulfill in the future.
59
What forms can borrowings take?
Loans, bonds, or lines of credit
## Footnote
These are various instruments through which a bank can raise funds.
60
What are borrowings from the central bank called?
Advances from Bank of Canada
## Footnote
This refers to funds borrowed from the central bank by commercial banks.
61
What is bank capital?
A cushion against a drop in the value of its assets
## Footnote
It protects the bank from insolvency.
62
What is required of depository institutions regarding their deposits?
To keep a certain fraction in accounts with the Fed
## Footnote
This is a regulatory requirement for maintaining liquidity.
63
what are pension funds?
- investment portfolios managed by professionals to provide retirement income
64
what is risk managment:
- the act of providing tools for managing finanical risk
65
what are securities?
- liquid assets that banks trade in financial markets
- banks are allowed to hold securities issued by the US treasury and other gov agencies and corporate bonds
66
what type of loans are there??
- non-mortgage loans to firms => commercial + industrial
- non-mortagge loans to consumers => households for cars and other goods
- mortgage loasn / Real Estate => residential and commercial mortgages
- illiquid !
