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41 Cards in this Set

  • Front
  • Back


  • Cash and deposits
  • Securities
  • Loans and leases
  • Miscellaneous assets


  • Deposits (demand, NOWs, money market, savings, and time)
  • Non-deposit borrowings
  • Equity capital from shareholders (stock, surplus, retained earnings.

Basic Equation

C+ S + L + MA = D + NDB + EC

C =Cash AssetsS =Security HoldingsL =LoansMA =Miscellaneous Assets

D =DepositsNDB =Nondeposit Borrowings EC =Equity Capital

*Cash assets = primary reserves

*Securities = secondary reserves


Liquid Securities (secondary reserves):

  • Short-term Govt. securities (T-bills)
  • Other money market securities, e.g. Commerical Paper (CP).

Investment Securities

  • US Govt. Notes (T-bills), Corporate Bonds & Municipal Bonds.

Trading Account Assets

  • Securitiespurchased to Provide Short-Term Profits from Short-Term Price Movements.

Loan Accounts

Themajor Asset category: many types:

  • Commercialand Industrial Loans
  • ConsumerLoans (Loans to Individuals)
  • RealEstate Loans
  • FinancialInstitution Loans, Leases etc

Federal Funds Sold and Reverse Repurchase Agreements

  • AType of Loan Account covering interbank lending
  • GenerallyOvernight Loans
  • FederalFunds Sold - Funds Come from the
  • Deposits at the Federal Reserve


Non Deposit Borrowings

  • Fed Funds Purchased
  • Other Borrowed funds
  • Subordinated Debt
  • Limited Life Preferred Stock
  • Other Liabilities (e.g. Deferred tax)

Equity Capital:

•Perpetual Preferred Stock

–perpetual (as opposed to preferred stockwith a given maturity which would be treated as a liability)

Equity Capital:


  • Common Stock
  • Capital surplus
  • Retained earnings
  • Treasury stock
  • Contingency reserve

Banks value assets and liabilities at original (historical, book-value) cost. Problem?

Assumed A or L held to maturity and ignores changing risk and therefore valuation.

“Gains trading” sellassets that appreciate, hang on to those that deprecate = accumulation of risk

Off-Balance Sheet Items

  • Unused commitments
  • Standby credit agreements
  • Derivative contracts:

- Future contracts

- Options

- Swaps

OBStransactions expose a firm to counterparty risks.

OBSitems have grown so rapidly that, for the banking industry as a whole, theyexceed total bank assets many times over.

Secondary Mortgage Market:

FinancialInstitutions remove mortgages from their balance sheets through one of twomechanisms:

Pooling recently originated mortgages togetherand selling them in the secondary market.

Securitizing mortgages (i.e. by issuing securities backed bynewly originated mortgages)

Advantagesof securitization

  • Financial Institutions can reduce theliquidity risk, interest rate risk, and credit risk of their loan portfolios.

  • Institutions generate income fromorigination and service fees.

Income Statement

Net Interest Income

- Provision for Loan Loss

Net Income After PLL

+/- Net Non-interest Income

Net Income Before Taxes


Net Income

- Dividends

Undivided profits

Net Interest Income=

Interest Income - Interest Expenses

Interest Income

  • Interest and Fees on Loans
  • Taxable Securities Revenue
  • Tax-Exempt Securities Revenue
  • Other Interest Income

Interest Expenses

  • Deposit Interest Costs
  • Interest on Short-Term Debt
  • Interest on Long-Term Debt

Net Non-Interest Income=

Non-interest Income - Non-interest Expenses

Non-Interest Income

  • Feeds Earned from Fiduciary Activities fees for managing or protecting a customer's property/ pension/ retirement.
  • Service Charges on Deposit Accounts
  • Trading Account Gains and Fees
  • Additional Non-interest Income

Non-Interest Expense

  • Salaries and Employee benefits
  • Premises and equipment expenses
  • Other operating expenses

Commercial vs. Investment Banks:

Balance Sheet

Liabilities: Investment banks have Less deposits evident & more wholesale funding of the business (Eurodollar,interbank market, repo market)

Assets: Fewerloans and more securities as assets.

Commercial vs. Investment Banks:

Income statement

Non-interest income would be moreprominent due to: Tradingactivities and the offering of Investment and Financial services

The costs of investment banks are alsodistinct. Investmentbanks have high technology, communications and physical capital costs. Alsohigh staff costs which can include some very large bonus payments.

The value of the financial firm’s stockwill tend to rise if:

  1. Dividends are expected to increase
  2. The financial organization’sperceived level of risk falls.
  3. Market interest rates decrease, reducing shareholders’ acceptablerates of return via the risk-free rate of interest component of all marketinterest rates

Dividend Discount Model

Return On Equity (ROE)

Net Income

Total Equity Capital

Return on Assets (ROA)

Net Income

Total Assets

Net Interest Margin

Interest Income - Interest Expense

Total Assets

Net Non-interest Margin

Net Non-interest Income

Total Assets

Earnings Spread

Total Interest Income - Total Interest Expense

Total Earning Assets Total Interest Bearing L

Measures the effectiveness of a financial firm's intermediation function in borrowing and lending money andalso the intensity of competition in the firm’s market area.

Ifother factors are held constant, the spread will decline as competitionincreases.

Net Bank Operating Margin

Operating Revenues - Operating Expenses

Total Assets

Earnings per share (EPS)

Net Income After Taxes

Number of common shares outstanding


Net Profit Margin (NPM) =

Net Income

Net Operating Revenue

* Effectiveness of Expense Management (cost control)

Asset Utilization Ratio (AU) =

Total Operating Revenue

Total Assets

* Portfolio Management Policies (the mix and yield of assets).

The Equity Multiplier (EM) =

Total Assets

Total Equity Capital

* Leverage of Financing Policies: the choice of sources of funds (debt or equity).

Interest Rate Risk

Danger that shifting interest rates may adversely affect a bank's net income or value of its assets or equity.

Credit Risk

The probability that some of the financial firm's assets will decline in value or become worthless, because a debtor defaults

Liquidity Risk

Probability the Firm will not have sufficient cash and borrowing capacity to meet withdrawals and other cash needs.

Insolvency/ Capital Risk

Probability of the value of the bank's assets declining below it's level of total liabilities.

when A < L

(often subject to regulation)

Market Risks

Market risk considers movement in the market prices of the banks assets and liabilities.

Price movements arise due to changes in supply, demand, interest rates, exchange rates and other asst prices and other factors.

Becoming increasingly important as banks continue to trade more.

Foreign Exchange Risks

Foreign exchange risks arise from changes in the exchange rate between two currencies.

This may adversely affect the value of the banks assets and liabilities and its profits (value of income from subsidiaries).

- Could diversify

- Use derivatives to hedge against exchange rate movements.

Off-balance sheet (OBS) risk

•TheVolatility in Income and Market Value of Bank Equity that May Arise fromUnanticipated Losses due to OBS Activities (activities that do not have abalance sheet impact until a transaction is affected)

Operational Risk

UncertaintyRegarding a Financial Firm’s Earnings Due to Failures in Computer Systems,
Errors, Misconduct by Employees, Floods, Lightening Strikes and Similar Eventsor Risk of Loss Due to Unexpected Operating Expenses.

Reputation Risk

Legal and Compliance Risk

1. Risk associated with Public Opinion.

2. Risks to Earnings resulting from actions taken by the legal system.

Country or Sovereign risk

Risk that repayments from foreign borrowers may be interrupted because of interference from foreign governments.

Two Ratios to measure operating efficiency:

Operating efficiency ratio =Total Operating Expenses / Total Operating Revenues

lower ratio is better

Employee productivity ratio = Net Operating income / Number of employees