Commercial Bank Operations - Commercial Bank Operations 1 What is the primary goal of a commercial bank Why may this goal be translated into maximising

Commercial Bank Operations - Commercial Bank Operations 1...

  • University of Wollongong
  • FIN 111
  • Notes
  • Colonel_Willpower_Kingfisher
  • 6
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Commercial Bank Operations 1) What is the primary goal of a commercial bank? Why may this goal be translated into maximising the firm’s stock share price? The primary goal of a bank is profit maximisation. Stock prices provide continuous monitoring of how well management is doing on behalf of stockholders, and reflect shareholder’s expectations about the firm’s future performance. For firms not widely traded, this type of continuous review is not available. 2) Why are demand deposits a more important source of funds for small banks than for large banks? Why are demand deposits considered to be a more stable source of funds for small banks than for large banks? Small banks rely more heavily on demand deposits for liquidity purposes as small banks do not have the ability to tap into money markets that large banks can. Also demand deposits are FDIC insured so individuals’ deposits are safe and easily accessed. Large banks however use more repos and other sources of borrowing for liquidity reasons. 3) What are borrowed funds? Give some specific examples. Have borrowed funds become more or less important as a source of funds for banks? Borrowed funds include federal funds which is the act of either buying or selling of funds from the Federal Reserve. Repurchase agreements are a form of loan in which the bank sells securities (usually government securities) to the lender but simultaneously contracts to repurchase the same securities either on call or on a specified date at a price that produces an agreed-on yield. A banker’s acceptance is a draft drawn on a bank by a corporation to pay for merchandise. The draft promises payment of a certain sum of money to its holder at some future date. In effect, the bank substitutes its credit standing for that of the issuing corporation. Borrowed funds have become more important as a source of funds because they are used for liquidity purposes and for large banks they are used to generate revenue (financial leverage). 4) Describe the impact that the GFC had on the balance sheets of financial institutions in Australia. The first signs of distress in financial markets emerged around the middle of 2007 when two funds related to US financial company Bear Stearns announced serious problems with their holdings of mortgage-backed securities (MBS). The problems were particularly acute in the case of securities containing sub-prime mortgages, which are mortgages to individuals with a non-standard credit history or on lower incomes. The dislocation spread through credit markets over the second half of 2007 as concerns intensified about the value of mortgage-backed securities and other asset-backed securities. Securities which had been thought by investors to be low- risk were downgraded sharply as assets underlying those securities suffered very sharp losses. These concerns caused banks to become considerably less willing to lend to each other and to hoard their cash holdings. As a result, interest rates in money and credit markets rose and parts of credit markets started to malfunction.

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