Bank One / Rabobank Essay
1. What is the problem? Why might investors be so concerned about the bank’s derivative use?
The problem is that Banc One’s stock price has gone down nearly 25% due to analyst and investor concern that increased derivative use has inflated key accounting margins and ratios. The derivatives (interest-rate swaps) do not show up on the balance sheet as assets/liabilities, but do show up on the income statement. Therefore, metrics such as ReturnOnAssets may not accurately reflect the underlying business.
Derivative use was concerning to investors mainly because they did not fully understand the complex swaps, and saw them as risky. Banks had not typically invested so heavily in swaps, so investors felt that Banc …show more content…
Using only the asset side, I would invest in more municipal bonds and treasuries at a fixed-rate. These would pay out a more favorable interest rate (wrt prime) as interest rates fell, making the portfolio less asset-sensitive.
Using only the liability side, I would offer more floating-rate securities to the public. These would pay out a less favorable rate as interest rates rose.
6. Why use derivatives instead of investments for asset and liability management?
First, it allows for more liquidity in the bank. They would be essentially investing in the equivalent of long-term securities without tying up their cash in the assets. Second, the derivatives create a better ReturnOnAssets metric. Since the derivatives do not appear as assets on the balance sheet, gains from the investments will appear on the income statement without the accompanying increase in asset size, like an equivalent balance asset instruments. Third, the derivatives reduce the need to hold capital. Regulations stipulate that a bank needs to hold a certain percentage of risk-based assets in cash. Without these appearing as assets, no capital needs to be held against them.
7. What should the executives of Banc One do? What did they do?
They should lower their portfolio of derivatives. The bank was still at risk to large interest rate swings, so