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LESSON 1 MANAGEMENT OF FINANCIAL INSTITUTION The banking business is made by= Funding by deposits and other “non-funding borrowing” (when needed) Lending by “loans” core business Providing financial/banking services Holding stakes in other financial/non-financial entities investments in “participations” Carrying out other financial activities, to be referred to as “securities investments” (investments done in securities “fixed income securities” investments bonds & notes) and “liquidity management” (management of the CF in-out of the bank) Security Investments: Main Objectives and Factors Affecting The Related Decisions Bank invest in “securities” when it has “excess cash” (not enough for making new loans) the return on “cash” =0 while the return in “securities”>0 Bank sell “securities” when it has “cash needs” selling securities for raising $ used for making new loans or for facing “cash needs” Securities can be used as “pledge” (= guaranty on a financial asset) for raising funds from depositors [ex= getting $ from ECB in the “discount window” securities must be pledged for raising funds from the ECB at the “official ECB interest rate” the same “amount borrowed” must be pledged, for the time of the lending, in the form of “securities” you remain the “owner of the pledged securities”, but you cannot use them in the way wanted during the period in which they are pledged ] 5 main objectives in making “security investments” = 1. Offset credit risk in the portfolio of loans (if too high loans are risky assets higher credit risk) high quality (low credit risk) securities can be purchased and can be held to balance the risk from loans (securities are less risky assets) by buying securities you would reduce the overall “credit risk” exposure of the assets held by the bank 2. Buying securities by also making loans you would provide a higher “geographic diversification” of the assets hold by banks indeed, the issuer of securities are often based in different economic regions than the debtors of loans [banks size is classified depending on the amount of Total assets the banks hold there are, on average, a high # of small banks and few # of big banks smaller banks with few employees and branches are “locally oriented” and makes loans mainly to local customers so it does not have a good level of geographical diversification on their “loan portfolio” so they do buy securities from “issuers” coming from a different geographical area] “securities” are used for diversifying the “portfolio of financial investments” you own (securities+ loans) 3.
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