Principle of Banking Managment - Banking - Lecture Slides, Slides of Banking and Finance

Download Principle of Banking Managment - Banking - Lecture Slides and more Slides Banking and Finance in PDF only on Docsity! Topic 3. PRINCIPLES OF BANK MANAGEMENT • The bank’s balance sheet • Managing the bank’s balance sheet: – 1. Liquidity management. – 2. Asset management. – 3. Liability management. – 4. Capital adequacy management. • Off-balance-sheet activities. Docsity.com The bank’s balance sheet Four core / traditional principles of bank management: Liquidity management. Asset management. Liability management (only to prominence since 1960s). Capital adequacy management. These four principles all concern management of the bank’s balance sheet. This has two columns; Assets and Liabilities: Liabilities – sources of the bank’s funds. Assets – uses to which the bank puts these funds. Docsity.com Reserves Deposits Assets Liabilities Bank I Reserves Deposits Assets Liabilities Bank II ‘T-accounts’: These are simplified balance sheets listing only the changes that occur in balance sheet items starting from an initial balance sheet position. Docsity.com Reserves Deposits Assets Liabilities Bank II Bank II has now gained £100 in reserves. Say it has a Required Reserve Ratio of 10%. It thus has an additional £ of Excess Reserves. Required Reserves Deposits Assets Liabilities Bank II Excess Reserves It can use these ER to invest in interest bearing assets (reserves earn no interest). Docsity.com Bank profit: Revenue from assets, e.g. • interest from loans, securities, etc. less Costs incurred on liabilities, e.g. Costs of servicing a deposit account: • keeping records • sending statements • paying cashiers • maintaining buildings/branches • returning cancelled cheques • cheque clearing charges • advertising and marketing costs • interest paid to depositor (if interest-bearing account). Docsity.com Bank Capital. The difference between a bank’s assets and liabilities. → alternatively defined as ‘net worth’. Included in the liabilities column of the balance sheet. Bank Capital TOTAL Reserves Loans TOTAL Deposits Assets Liabilities Securities Docsity.com Principal 1 Liquidity management. Sustain adequate liquidity to meet deposit outflow Deposit outflow means equivalent loss of reserves → Liquidity management is equivalent to Reserve adequacy management. Replenishing reserves Original / ‘traditional’ means: Adjust the balance sheet: Borrow from other banks or firms, or Central Bank (discount loans). Sell securities. Call in or sell off loans. Docsity.com BUT: Rearranging balance sheet is costly: Borrowings: Payment of interest. Sell securities: Loss of interest. Calling in loans: Loss of interest. BUT ALSO / most costly of all: Also damage to customer relationships. Probable ‘fire sale’ conditions → poor price: Loss of subjective / informational value. ER thus traditionally a form of insurance / ‘cushion’ against these costs. In fact largely superseded in recent decades: Other forms of insurance -- hedging / derivatives, etc. Docsity.com T-account after the deposit withdrawal: Bank Capital TOTAL Reserves Loans TOTAL Deposits Assets Liabilities Securities No action is needed to replenish reserves following this withdrawal: RRR of 10% → only m reserves required. There remain m ER. Docsity.com Bank Capital TOTAL Reserves Loans TOTAL Deposits Assets Liabilities Securities Now suppose that before the deposit withdrawal the bank had made an additional loan of £10m: Docsity.com