BanksChapter 2RiskManagementandFinanciallnstitutions3e,Chapter2,CopyrightJohnC.Hull2012
Banks Chapter 2 Risk Management and Financial Institutions 3e, Chapter 2, Copyright © John C. Hull 2012 1
Nature of Banking Commercial bankingTaking deposits, making loansWholesale vs retailMoney center banksInvestment bankingRaising debt and equity for companies; adviceon mergers and acquisitions, restructurings,etc2RiskManagementandFinancialInstitutions3e,Chapter2CopyrightJohnC.Hull2012
Nature of Banking ⚫ Commercial banking ⚫ Taking deposits, making loans ⚫ Wholesale vs retail ⚫ Money center banks ⚫ Investment banking ⚫ Raising debt and equity for companies; advice on mergers and acquisitions, restructurings, etc Risk Management and Financial Institutions 3e, Chapter 2, Copyright © John C. Hull 2012 2
Structure of Banking in the US Large international banks (small number)Regional banks (several hundred)Small community banks (severalthousand)3RiskManagementandFinancialInstitutions3e,Chapter2,CopyrightJohnC.Hull2012
Structure of Banking in the US ⚫ Large international banks (small number) ⚫ Regional banks (several hundred) ⚫ Small community banks (several thousand) Risk Management and Financial Institutions 3e, Chapter 2, Copyright © John C. Hull 2012 3
History of Bank Regulation in US(page 23)McFadden Act (1927, 1933)Douglas Amendment (1956)Bank Holding Companies Act (1970)Riegel-Neal Interstate Banking andBranching Efficiency Act (1994)RiskManagementandFinancialInstitutions3e,Chapter2,CopyrightJohnC.Hull20124
History of Bank Regulation in US (page 23) ⚫ McFadden Act (1927, 1933) ⚫ Douglas Amendment (1956) ⚫ Bank Holding Companies Act (1970) ⚫ Riegel-Neal Interstate Banking and Branching Efficiency Act (1994) Risk Management and Financial Institutions 3e, Chapter 2, Copyright © John C. Hull 2012 4
ExampleofSimpleBankBalanceSheet: End 2012 (Table 2.2, page 24)AssetsLiabilities590CashDeposits5MarketableSecurities10Subord L.T. Debt580LoansEquity Capital5Fixed Assets100100TotalTotal5RiskManagementandFinancialInstitutions3e,Chapter2,CopyrightJohnC.Hull2012
Example of Simple Bank Balance Sheet: End 2012 (Table 2.2, page 24) Risk Management and Financial Institutions 3e, Chapter 2, Copyright © John C. Hull 2012 5 Assets Cash 5 Marketable Securities 10 Loans 80 Fixed Assets 5 Total 100 Liabilities Deposits 90 Subord L.T. Debt 5 Equity Capital 5 Total 100
Income Statement: 2012 (Table 2.3, page25)3.00Net Interest Income(0.80)Provisionfor Loan Losses0.90Non-Interest IncomeNon-lnterest Expense(2.50)0.60Pre-Tax Operating Income6RiskManagementandFinancialInstitutions3e,Chapter2,CopyrightJohnC.Hull2012
Income Statement: 2012 (Table 2.3, page 25) Net Interest Income 3.00 Provision for Loan Losses (0.80) Non-Interest Income 0.90 Non-Interest Expense (2.50) Pre-Tax Operating Income 0.60 Risk Management and Financial Institutions 3e, Chapter 2, Copyright © John C. Hull 2012 6
Year2013 What happens in year 2013 if it is thesame as year2012 exceptthat provisionfor loan losses is 4.0 instead of 0.8?7RiskManagementandFinancialInstitutions3e,Chapter2,CopyrightJohnC.Hull2012
Year 2013 ⚫ What happens in year 2013 if it is the same as year 2012 except that provision for loan losses is 4.0 instead of 0.8? Risk Management and Financial Institutions 3e, Chapter 2, Copyright © John C. Hull 2012 7
Whatif Balance SheetHad BeenMoreAggressive?AssetsLiabilities594CashDeposits5MarketableSecurities10Subord L.T. Debt180LoansEquity Capital5Fixed Assets100100TotalTotal8RiskManagementandFinancialInstitutions3e,Chapter2,CopyrightJohnC.Hull2012
What if Balance Sheet Had Been More Aggressive? Risk Management and Financial Institutions 3e, Chapter 2, Copyright © John C. Hull 2012 8 Assets Cash 5 Marketable Securities 10 Loans 80 Fixed Assets 5 Total 100 Liabilities Deposits 94 Subord L.T. Debt 5 Equity Capital 1 Total 100
RegulationRegulators set minimum levels for thecapital a bank is required to keepEquity is an example of Tier 1 capitalSubordinated long term debt is anexample of Tier 2 capital9RiskManagementandFinancialInstitutions3e,Chapter2,CopyrightJohnC.Hull2012
Regulation ⚫ Regulators set minimum levels for the capital a bank is required to keep ⚫ Equity is an example of Tier 1 capital ⚫ Subordinated long term debt is an example of Tier 2 capital Risk Management and Financial Institutions 3e, Chapter 2, Copyright © John C. Hull 2012 9
Deposit Insurance (pages 26-27)Most countries have deposit insurance programs thatinsure depositors against losses up to a certain levelIn the US the FDiC has provided protection fordepositors since 1933Theamountinsuredwas $2.500in1933Ithasbeenincreased several timesFollowing thecredit crisis itwas increased from$100,000 to $250,000 in October 2008.Why might deposit insurance encourage a bank totake risks?RiskManagementandFinancialInstitutions3e,Chapter2,CopyrightJohnC.Hull 201210
Deposit Insurance (pages 26-27) ⚫ Most countries have deposit insurance programs that insure depositors against losses up to a certain level ⚫ In the US the FDIC has provided protection for depositors since 1933 ⚫ The amount insured was $2,500 in 1933 ⚫ It has been increased several times ⚫ Following the credit crisis it was increased from $100,000 to $250,000 in October 2008. ⚫ Why might deposit insurance encourage a bank to take risks? Risk Management and Financial Institutions 3e, Chapter 2, Copyright © John C. Hull 2012 10