Financial Institution Chapter 14

Front 1

what are the main source of bank revenue?

Back 1

Loan interest and fees represent the main source of bank revenue, followed by interest on investment securities.

Front 2

what is the largest source of bank expense?

Back 2

Interest paid on deposits is the largest expense, followed by interest on other borrowings.

Front 3

what is net interest income?

Back 3

Net interest income is the difference between gross interest income and gross interest expense. This margin is relatively stable because the interest rates banks earn and pay are largely set by the market

Front 4

what is provison for loan losses?

Back 4

Provision for loan losses is an expense item that adds to a bank’s loan loss reserve (a contra-asset account).

Front 5

why is provision for loan losses needed?

Back 5

because they anticipate that a certain amount of people are going to default on thier loans. and leave room in thier budget for it.

Front 6

what are included in non interests income

Back 6

Noninterest income includes fees and service charges. This source of revenue has grown significantly in importance.

Front 7

what is included in non interest expense?

Back 7

Noninterest expense includes personnel, occupancy, technology, and administration. These expenses have also grown in recent years.

Front 8

what are two measures of profitability?

Back 8

return on average assets
(net income / average total assets)

return on average equity.
net income / average total equity)

Front 9

A bank must balance the demands of what three constituencies?

Back 9

shareholders—mainly interested in profitability
depositors—mainly interested in safety
Regulators—mainly interested in safety

Front 10

how can bank make more profits?

Back 10

by taking on more risks. this is not very healthy sometimes because it make bankrupt the bank

Front 11

liquidity

Back 11

the ability to fund deposit withdrawals, loan requests, and other promised disbursements when due.

Front 12

is it possible for a profitable bank to fail

Back 12

yes. A bank can be profitable and still fail because of illiquidity.

Front 13

insolvency

Back 13

A firm is insolvent when the value of its liabilities exceeds the value of its assets.
Banks have relatively low capital/asset ratios but generally high-quality assets.

Front 14

what three things must the bank keep balanced?

Back 14

A bank must balance profitability, liquidity, and solvency

Front 15

what are some of teh demands on liquidity?

Back 15

The demands for liquidity include accommodating deposit withdrawals, paying other liabilities as they come due, and accommodating loan requests.

Front 16

what are primary reserves?

Back 16

Primary Reserves are noninterest bearing, extremely liquid bank assets ie. vault cash, balances they maintain at other banks and excess reserves at the bank.

Front 17

what secondary reserves?

Back 17

short-term assets easily converted to cash at a price near their purchase price. Highly marketable with low default risk or price risk but they yield low interests return.

Front 18

what are some examples of secondary returns?

Back 18

treasuries, agencies and reverse repos

Front 19

Loans and leases

Back 19

generally less liquid and riskier than other bank assets and thus represent the most potentially profitable use of bank funds

Front 20

Liability Management Theory

Back 20

assumes certain types of bank liabilities are very sensitive to interest rate changes.

Front 21

what kind of tools can be used in liability management?

Back 21

negotiable c.d, fed funds, repurchase agreements, commercial paper, deposit etc

what happens is that these are liabilities that bakd has to pay but by offering a different rate a higher rate on c.d for example more people will deposit in the bank increasing thier liabilities yet but also increasing the liquidity of the company.

Front 22

what are repurchase agreements?

Back 22

the borrower agrees to sell immediately a security to a lender and also agrees to buy the same security from the lender at a fixed price at some later date.

done to get cash now and buy back when more cash is available.

Front 23

roles of Bank capital

Back 23

1. Financial cushion that enables banks to absorb temporary operating losses.

2.Helps maintain public confidence in soundness banks and banking system.

3.Provides some protection for uninsured depositors.

4.Source of funds for growth (new products, services, or facilities).

Front 24

Tier one bank capital
"Core" Capital

Back 24

“core” capital includes common stock, common surplus, retained earnings, non-cumulative perpetual preferred stock, minority interest in consolidated subsidiaries, minus goodwill and other intangible assets.

Front 25

Tier 2 capital
"supplementary capital"

Back 25

capital includes cumulative perpetual preferred stock, loan loss reserves, mandatory convertible debt, and subordinated notes and debentures.

Front 26

risk-weighting

Back 26

when higher risks assets recieve higher rates than lower risked assets

The purpose is to require high-risk banks to hold more capital than low-risk banks.

Front 27

what is the minimum percentage of risk weighted assets to capital

Back 27

Tier one =4%
Tier two + tier one must be 8%

Front 28

what happens if a bank is undercapitalized?

Back 28

Undercapitalized banks receive extra regulatory scrutiny; regulators may limit activities, intervene in management, or even revoke charter.

Front 29

what is loan portfolio analysis?

Back 29

a process used to ensure that banks are well diversified.

Front 30

to what does the term rate sensitive applies?

Back 30

Assets and liabilities which “reprice” (change interest rate in a specified period of time) are identified as “rate- sensitive”.

Front 31

how do you compute a bank GAP

Back 31

A bank's Maturity GAP is computed by subtracting rate sensitive liabilities (RSL) from rate sensitive assets (RSA).

Front 32

What is a positive bank gap

Back 32

rate sensitive assets are greater than rate sensitive liabilities
RSA > RSL

Front 33

what happens in a positive GAP

Back 33

Net interest income will decline if interest rates fall
More assets than liabilities reprice downward if interest rates decline, thus reducing net interest income

Front 34

what is a negative GAP?

Back 34

rate sensitive assets are less that rate sensitive liabilities
RSA< RSL

Front 35

what happens in a negative GAP?

Back 35

Net interest income will decline if interest rates increase
More liabilities than assets reprice upward if interest rates increase, thus reducing net interest income.

Front 36

duration of GAP?

Back 36

The percentage change in the value of a portfolio, given a change in interest rates, is proportional to the duration of the portfolio multiplied by the change in interest rates

Front 37

what is the purpose of duration GAP analysis?

Back 37

Duration GAP analysis matches cash flows and their repricing capabilities over a period of time.

Front 38

Assets have longer duration than liabilities.
what happens If interest rates rise

Back 38

More assets than liabilities will lose value,
Thus reducing the value of the bank’s equity

Front 39

Assets have longer duration than liabilities.
what happens If interest rates fall?

Back 39

More assets than liabilities will gain value,Thus increasing the value of the bank’s equity

Front 40

Assets have shorter duration than liabilities.
what happens If interest rates rise

Back 40

More liabilities than assets will lose value,
Thus increasing the value of the bank’s equity