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CH5 - Chapter 12 Depository Institutions Banks and Bank...

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Chapter 12 Depository Institutions: Banks and Bank Management Chapter Overview This chapter examines the business of banking, looking at where depository institutions get their funds and what they do with them. It also examines the sources of banks’ liabilities and the ways that they manage their assets. The sources of risk that banks face are also considered, as well as how that risk can be managed. Reading this chapter will prepare students to: Understand banks’ balance sheets and how they make profit. Explain the risks in the day-to-day business of banks. Assess the degree to which banks can manage the risks they face. Important Points of the Chapter Banks are the most visible financial intermediaries in the economy. These depository institutions accept deposits from savers and make loans to borrowers. They include commercial banks, savings and loans, and credit unions. Banks seek to profit from their various lines of business; they provide accounting and record keeping services, provide access to the payments system, pool the savings of small depositors and use the funds to make loans to borrowers, and they offer customers risk-sharing services. Banks are important, and when they are poorly managed the entire economy suffers. Application of Core Principles Principle #1: Time (page 274) Banks hold only 3% of their assets as cash because holding cash is expensive; it earns no interest. Principle #3: Information (page 283) Among a bank’s off-balance sheet activities is the provision of a line of credit to a trusted customer. Since the bank usually knows the customer to whom it grants the line of credit, the cost of establishing creditworthiness (an information cost) is negligible. Principle #2: Risk (page 284) Banks are exposed to a host of risks, including liquidity risk, credit risk, interest-rate risk, trading risk, and operational risk. Principle #1: Time (page 285) Holding excess reserves is expensive, since it means forgoing the interest that could be earned on loans or securities. Principle #3: Information (page 288) Since banks specialize in information gathering, they attempt to gain a competitive advantage in a narrow line of business. The problem is that doing so exposes the bank to added risks. 165 Instructor’s Manual t/a Cecchetti: Money, Banking, and Financial Markets
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Chapter 12 Depository Institutions: Banks and Bank Management Teaching Tips/Student Stumbling Blocks Here’s a great introduction to the topic of this chapter. Start with the section Your Financial World : Choosing the Right Bank for You (page 291) and follow up with this very short (maybe 5 questions) quiz (by Holden Lewis) on the website of Bankrate.com. Designed to help people decide if a virtual bank is right for them, respondents click on the answers to the questions, and then submit the responses and see the feedback. The site can be found at: http://www.bankrate.com/brm/news/emoney/equiz1.asp Chapter 12 builds on students’ understanding of Core Principles 1, 2 and 3, as
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