Money and Banking Final Review

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Chapter 10
Banking and the Management of Financial Institutions
• Financial institution
• Financial intermediary
o Take deposits, make loans
• Banks make money on the spread between what they take in from loans and what they pay out on interest on deposits o (minus their expenses)
• Government licensed institutions
o Can be licensed by the federal government or the state government o Federally chartered or state chartered
• Receiving, keeping, lending, money with interest
o "Banco" ( bench or desk
• Borrow short lend long
o Borrow money short term, and lend in the long term
o Take deposits, lend money with long term loans
• Holding company
o Citi bank ( citi group
o Citi group owns citi bank and prime America, among others o Own other financial entities
• Banks cannot own real estate in America

Types of banking activities
• Retail banking
o Deals directly with individuals and small businesses
• Business banking
o Provides banking services to midsize businesses
• Corporate banking
o Deals with large businesses (Fortune 100 and 500, etc.) • Private banking
o Deals with high net worth individuals
• Investment banking
o Deals with financial markets
*Citi, Bank of America, and JP Morgan Chase does all of the above • Islamic banking
o Interest free
o Under law you aren't allowed to give or charge interest o They do charge it but don't call it interest, they've worked around it o Don't believe in usury
What do banks do?
• Banks act as a payment agent
o Take checks (cleared through Federal Reserve and take deposits • Enable customer payments through electronic systems
o ACH automatic clearing house
o ATM transactions
• Borrow money (by accepting deposits)
• Lend (loans)
• Provide all types of payment services
Banks are faced with a number of risks
• 3 primary risks
1. Liquidity
▪ Pay deposits
2. Credit
▪ Risk of defaults
3. Interest rate
▪ Need to make sure there is a sufficient spread between what comes in and what is paid out  
Banks are faced with a number of challenges
1. Highly regulated
o By the FDIC, the OCC, FRB, etc.
2. Each regulator has own regulations
3. Struggle to effectively manage interest rate spread
4. Managing their asset portfolio
5. Pressures from shareholders
o Shareholders want to get paid
6. Increased competition
Chapter 11
 The Bank Balance Sheet

Assets (something that is owed to you)
• Reserves
• Cash items in process of collection
• Deposits at other banks
• Securities
o Government securities
▪ US government has never defaulted on anything
▪ Banks are not permitted to buy stocks; too risky
• Loans
o Considered assets on a bank's balance sheet
• Other assets
Liabilities (what is owed by you)
• Checkable deposits
o Accounts that allow owners to write checks
• Nontransaction deposits
• Borrowings
o Borrow from other banks, any borrowings
• Bank capital
o Assets-Liabilities=Bank Capital
o i.e. net worth
• Banks make profit by selling liabilities and buying assets o Borrow short lend long
Bank Management
• Liquidity Management
o If banks don't have enough liquidity they may:
▪ borrow from Fed, borrow from other banks,  sell securities (stocks), reduce lending • Asset Management
o Diversify
o Adequately underwrite or review loans (adverse selection) ▪ Due diligence before lending
• Liability Management
• Capital Adequacy Management
o Return on assets (ROA)
▪ Determines profitability
▪ Net profit after taxes/assets
o Return on equity (ROE)
▪ Net profit after taxes/equity
o Negative...
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