After studying this chapter you will be able to understand: Basic lending principles, what is asset management banking? asset management banking, what is liability management banking? Profitability, profitability management.
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Trang 4- Asset management
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Asset management banking
- One of the main challenges to a bank Is ensuring its own liquidity under all
reasonable conditions
- Commercial banks differ widely in how they manage liquidity
* Asmall bank derives Its funds primarily from customer deposits Its assets are
mostly loans to small firms and
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Asset management banking
- Excess funds are typically invested In assets that will provide it with liquidity
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Liability management banking
- In contrast, large banks generally lack Sufficient deposits to fund their main
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Liability management banking
- Most of these banks borrow the funds they need from other major lenders in the form of short-term liabilities which must be
continually rolled over
- This is known as liability management,
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Liability management banking
- Asmall bank will lose potential income If It gets its asset management wrong
* Alarge bank may fail if it gets its liability
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Liability management banking
- The key to liability management is the ability to borrow always
‘ Therefore, a bank’s most vital asset Is Its creditworthiness If there is any doubt
about Its credit, lenders can easily switch to another bank
‘ The rate a bank must pay to borrow will go up rapidly with the slightest suspicion of
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Liability management banking
- In recent years, large banks have been making increasing use of asset
management in order to enhance liquidity, holding a larger part of their assets as
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Liability management banking
* A‘bank run’ is an overwhelming demand for cash by a bank’s depositors
- Alarge depositor assumes a risk and
needs to know something about the bank’s own balance sheet
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Liability management banking
- Even if the depositor Knows the bank has adequate liquidity
‘ Large depositors must, therefore, be
concerned about what others are likely to believe Arumour a bank, even though
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Trang 17* Q: What Is profitability and profitability
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Profitability
- A bank generates profit from the
differential between the level of interest it pays for deposits and other sources of
funds and the level of interest it changes In its lending activities
- This difference ts referred to as the
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Profitability
* Historically Profitability from lending
activities has been cyclic and dependent on the needs and strengths of loan
customers
- In recent history, investors have
demanded a more stable revenue stream and banks have therefore, placed more emphasis on transaction fees, primarily
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Profitability
- However, lending activities still provide the
bulk of a commercial or retail bank’s income
- In the past few decades, banks have taken many measures to ensure that they
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Profitability
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Profitability Management
- Profitability management Is a total
management process, rather than just an accounting or analysis procedure
- In contrast to asset and liability
management, it places primary emphasis on the profit and loss account and
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Profitability Management
* With profitability management, profitability is not merely reported; it is planned,
measured and interpreted
- Planning ensures that efforts are directed toward the achievement of corporate
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Profitability Management
- Measurement checks and adjusts progress against plan by matching
revenue received with related expense - Interpretation develops a valid picture of
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Profitability Management
* Profitability management involves the monitoring of three distinct types of
profitability statistics The profits of bank can be measured in three ways;
- By organization - By product
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Profitability Management
* Organizational profitability is the most familiar type since all banks have some system for reporting the performance of their major organizational units
‘ However, an effective profitability
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Safety Issues
- The persistent failures of banks to lend sensibly in Pakistan and in many other countries have brought the question of Safety In lending to the fore;
- Why do banks persistently lend so
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Safety Issues
‘ One essential problem is the human and managerial challenge of motivating
employees of banks to cater to the interest of the owners (Shareholders) of the bank - The history of banking Is replete with
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Safety Issues
- In some countries, there are well-defined
market rates for bribes for obtaining loans
from banks
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Safety Issues
* Another aspect of the problems of banks concerns prudent levels of leverage
- A bank ts a financial intermediary with
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Safety Issues
- Leverage, at the level of the bank, is dangerous regardless of the quality of
credit analysis which has gone into each loan
- High leverage generates high risk and
high returns If high returns are obtained, the bank takes the profits but it Is
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Safety Issues
- Regulators have tried many policy
Initiatives aimed at obtaining a banking system which has controlled leverage,
high quality lending and thus, a reduced risk of failure
- These include capital adequacy requirements based on clumsy
measurement of risk, prohibition of lending
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Safety Issues
* Ariskless loan Is one that Is fully
collateralised using actively traded assets ‘ These assets should be traded objects so
that a ‘market to market’ can be done
daily, to ensure that the collateral is always larger than the outstanding loan
- The value of the asset that is measured
when marking to market should be the
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Diversification of Risk
‘ Diversification in banking has been a topic of discussion in the literature for decades - |t effects on performance, risk, efficiency
and firm value have been examined extensively
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Benefits of Diversification
- One of the most common benefits
associated with respect to diversification Is a lower cost of capital
- Banks, with some level of global
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Benefits of Diversification
- Furthermore, the potential for more
efficient internal capital markets Is another of cited benefit to diversification
- Another benefit associated with activity diversification is the ability to gain
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Benefits of Diversification
- An example might be bank which collects Information credit information on potential borrowers With this information, the bank may be able to offer these potential clients Insurance products or underwriting
services at a lower cost because much of the information needed has already been collected when evaluating the loan
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Benefits of Diversification
- Benefits associated with market power
have also been advanced The argument Suggests that banks may diversify their
activities or their operations geographically to gain or maintain market share
* Finally, an important benefit that has been proposed by some Is the ability for