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Chapter++9+Banking+and+the+Management+of+Financial+Institutions (1)

Chapter++9+Banking+and+the+Management+of+Financial+Institutions (1)

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Chapter 9 Banking and the Management of Financial Institutions - The Bank Balance Sheet -Basic Banking - General Principles of Bank Management - Managing Credit Risk - Managing Interest-Rate Risk - Off-Balance-Sheet Activities Motivation : In this chapter, we examine how banking is conducted to earn the highest profits possible: how and why banks make loans, how they acquire funds and manage their assets and liabilities (debts), and how they earn income. The Bank Balance Sheet Total assets = total liabilities + capital Liabilities Checkable Deposits Checkable deposits are bank accounts that allow the owner of the account to write checks to third parties. Checkable deposits include all accounts on which checks can be drawn: non-interest-bearing checking accounts (demand deposits), interest-bearing NOW (negotiable order of withdrawal) accounts, and money market deposit accounts (MMDAs). Checkable deposits is an important source of bank funds, making up 7% of bank liabilities. Once checkable deposits were the most important source of bank funds (over 60% of bank liabilities in 1960), but with the appearance of new, more attractive 1
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financial instruments, such as money market mutual funds, the share of checkable deposits in total bank liabilities has shrunk over time. Nontransaction Deposits Nontransaction deposits are the primary source of bank funds (59% of bank liabilities in Table 1). Owners cannot write checks on nontransaction deposits, but the interest rates are usually higher than those on checkable deposits. There are two basic types of nontransaction deposits: savings accounts and time deposits (also called certificates of deposit, or CDs). Small-denomination time deposits (deposits of less than $100,000) are less liquid for the depositor than passbook savings, earn higher interest rates, and are a more costly source of funds for the banks. Large-denomination time deposits (CDs) are available in denominations of $100,000 or over and are typically bought by corporations or other banks. Borrowings Banks obtain funds by borrowing from the Federal Reserve System, the Federal Home Loan banks, other banks, and corporations. Borrowings from the Fed are called discount loans (also known as advances). Banks also borrow reserves overnight in the federal (fed) funds market from other U.S. banks and financial institutions. Borrowings have become a more important source of bank funds over time: In 1960, they made up only 2% of bank liabilities; currently, they are 26% of bank liabilities. Bank Capital The final category on the liabilities side of the balance sheet is bank capital, the bank’s net worth, which equals the difference between total assets and liabilities (8% of total bank assets in Table 1). The funds are raised by selling new equity (stock) or from retained earnings.
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