FISV 2012 Introduction to Financial Institutions Studt Guide 2: Bank Management & Operations Chapters 17,18,19,20 & class notes Instructions Part 1: Measuring BaDon't forget about the age old question of opre 3360 exam 1
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nk Performance 40 Points 1. Write the formula to calculate the following and describe how the ratio is used to measure performance a. Return on Assets Formula: Net Income After Taxes / Total Assets Description (from class notes): ROA is the primary indicator of managerial efficiency. It indicates how capably the management of the bank has been converting the institutions assets into net earnings (Note: Loan losses from nonpreforming loans show up here) b. Return on Equity Formula: Net Profit after tax / Equity capital (Total equity) Description (from class notes): ∙ Bank owners (shareholders) care about how much the bank is earning on their equity investments ∙ Direct relationships between ROA (which measures how efficiently the bank is running) and ROE (how well owners are ding on investment) c. Net Interest Margin Formula: Interest Income – Interest expense / Total Assets Description (from class notes):NIM measures the profitability and efficiency, how well management has kept the growth of revenues (from loans, investments) ahead of rising cost of deposits and money market borrowing. d. Net NonInterest Margin Formula: Non interest revenue – Non interest expense / Total assets Description (from class notes: NonInterest Margin measures the amount of noninterest revenues steaming from deposit service charges and other service fees the bank has been able to collect relative to the amount of noninterest cost incurred (including salaries + wages + maintenance and repairs on bank facilities + loans loss expense) For most banks the NNIM is negative. 2. As presented in class, write the formula for a bank’s net liquidity position (+ sources for liquidity) ( demands for liquidity). Explain what each category means and how bank management uses the information to adjust their bank’s product/pricing strategy. Formula: Income deposits + Revenues from sale of nondeposit services + Customer Loan payments + Sale of Bank Assets + Borrowing from Money Market – deposit withdrawals + volume of accepted loan payments + Repayment of bank borrowing + Other operating expenses + dividend payments to shareholders Sources for liquidity Income deposits This is money that the customer has earned and has decided to put the money in the bank for safe keeping instead of leaving it in their personal possession. Revenues from sale of non deposit services This can vary from ATM fees to other services that are provided by the bank that have a small nominal fee for their services. Customer Loan payments This is the money that the loan payer makes back to the bank for the current loan that they have with the bank to help pay back the agreed borrowing that they made at the time of the loan acceptance. Sale of bank assets This is assets that the bank has for reserves such as stocks and bonds and treasury notes that the bank has that will guarantee instant money in case of emergency. Borrowing from money market This is money that the bank collects or borrows from the money market or the federal reserve in order to have more cash for potential investments or lending out of the money for loans. Demands for liquidity Deposit withdrawals This is money that depositors have invested in the banks in forms of checking or savings account and when the customers go to withdraw money from the bank whether from the ATM or from making payments for bills and etc. Volume of accepted loan payments This is money that must be given out immediately so a large investment can be made by the borrower that is applying for the loan. Meaning that the more loans that are accepted, the more money the bank must have to be able to give that amount of money to the borrower. Repayment of bank borrowing This is money that the bank borrowed from the money market or federal reserve and after a period of time must pay back the money they initially borrowed meaning that it comes out of their cash reserves. Other operating expenses This money goes towards salaries and wages and maintenance to the machines with the building and other such things that allow the bank to run and operate properly on a daily basis. Dividend payments to shareholders These are corporate earnings that the bank decides to pass onto its shareholders for investing their money in the bank operations and stock. This comes directly from the overall amount of money that the company earns so it is an instant loss of liquidity. Description: Banks take all of this current info that is provided to them that they use on a daily basis to run their bank and properly make adjustments to the interest rates among loan accounts and savings accounts will adequately make it so they can make a profit and not a loss from month to month. If a loss is incurred, then something needs to change because overtime the bank will go out of business or have to file for bankruptcy. Due to the amount of money loss that they received because of much higher spending and lending out then initial money coming in. 3. If a bank earns $169 million net profit after tax and has $17 billion invested in assets, what is its return on assets? Calculations: ∙ 169,000,000/17,000,000,000 Answer: ROA is ________0.0099%_________ 4. If a bank earns $75 million net profits after tax and has $7.5 billion invested in assets and $600 million equity investment, what is its return on equity? Calculations: ∙ 75,000,000/8,100,000,000 Answer: ROE is _______0.00926%__________ Part 2: Bank Management/Short Essay 60 points/ 10 pts each 5. As presented in class, what are the two most important performance decisions? ∙ The two most important performance decisions are sources of its funds and the uses of its funds or liabilities and assets. 6. What is accomplished when a bank integrates its liability management with its asset management? ∙ Integration of liability management and asset management ensures that all policies will be consistent with a cohesive set of economic forecast. Meaning that the bank is not lending out more money for liability then it is taking in from assets. Also meaning that a bank is capitalizing on all potential money that they are earning from assets by lending them out for liabilities and not just having it sit in accounts and collect no interest or profit. 7. As economic conditions change, how do banks adjust their portfolios? ∙ As economic conditions change the banks adjust their portfolios to make sure that they have an even amount of assets and liabilities. This prevents the banks from having to many liabilities and if the time comes for people to pay their liabilities and they simply cannot afford to they may default. This causing the bank to have a loss in revenue and over time can cause the bank to go out of business due to the fact that it cannot support itself because they are not getting enough funds to support their liability and operations. 8. If a bank shifts its loan policy to pursue more credit card loans, how will its net interest margin be affected? ∙ The bank’s net interest margins will rise potentially substantially do to the fact that credit cards are a high risk high reward entity meaning that credit cards are one of the heist rates of interest charged for money used. Forcing the net interest margin to rise due to the use of more credit card use meaning that more interest will be collected. 9. What are likely reasons for weak bank performance? ∙ The likely reasons for a weak bank performance is a poor performance job on their comparisons for figures such as amount of money invested in their assets and liabilities compared to their regional competitors. This effectively making them obsolete because programs and offerings are not matching those of other banks meaning that less and less investors are choosing their bank and a loss in total revenue for the bank is occurring. Causing them to underperform compared to the regional completion based on the current economy. 10. Why do banks invest in securities, even though loans typically generate a higher return? ∙ Banks invest in securities because they are a solid or safe way to make sure when the time is needed for more money to be needed for use that they can effectively cash those securities in and not lose any value of the security. Unlike loans that may get a bank a larger return but they always have the fear and the potential for the borrower to default on his loan meaning that the bank may never get its borrowed money back.