In the 1960s some of the large money center banks

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In the 1960s, some of the large money center banks such as Citibank began to look for ways to make liabilities more flexible. Liabilities could provide liquidity, through overnight markets such as the federal funds market, or through new financial instruments such as negotiable CDs. Such innovations made liability management much more dynamic, and led to the development of the asset-liability management model that most banks follow today. Over time, demand deposits have declined in importance, while borrowings and negotiable CDs have increased. At the credit union, we are also continually seeking ways to provide checking and savings accounts to our members and the community as a whole. We have accounts known as Individual Development Accounts, that encourage eligible low-income people to save in an IDA account, and at the end of the year their savings are matched 3 to 1 by community groups. Annual savings of $500 could become $2000 with the match. We also have starter accounts, which are small checking accounts for people who need to repair their credit and have access to basic financial services. All of these programs increase the diversity of our liabilities and help the community at the same time. Capital Adequacy Management Remember that Bank Capital = Assets - Liabilities. The important issue to address here is how much capital should the bank hold? High amounts of capital enable the bank to have a cushion for deposit outflows and a way to 97
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Econ 350 U.S. Financial Systems, Markets and Institutions Class 10 cover losses caused by bad loans. High capital levels are also looked upon favorably by regulators. On the other hand, high capital levels reduce the return to equity holders of the bank, as we will see. Bank stockholders would, ceteris paribus, prefer low levels of capital and a higher return on equity. The capital adequacy decision has several consequences: -- Bank capital helps to prevent bank failure, especially in times of recession when many loans may be failing at once. Bank capital reduces the chance of bank insolvency. -- Regulators care about capital and capitalization rates. Since 1991, low levels of capital signal “prompt corrective action” among regulators. -- The level of capital affects the return on equity. Measures of bank profitability Two measures of bank profitability are known as the Return on Assets and the Return on Equity. They are defined and measured as follows. Return on assets (ROA): is a measure of the amount of profit generated by each dollar of assets held by the bank. It is measured as ROA = net profit after taxes . assets Return on equity (ROE): is a measure of the amount of profit generated by each dollar of equity capital. It is measured as ROE = net profit after taxes equity capital The ROE and ROA are linked through something known as the equity multiplier.
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