THE UNIVERSITY OF SUSSEX

MSc EXAMINATION 2020/21

933N1 Bank Financial Management

Assessment Period: January 2021 A1

Duration: 24 hour Take-Away Paper

Candidates must attempt ALL questions

Each question carries 25 marks

Candidate Number: 234229

Word Count: 2050

Due Date: 9.30AM - 09/01/2021

933N1 Bank Financial Management

Question 1.

Barcs Bank reports the following figures in its Balance Sheet in 2019:

£ £
Assets million Liabilities and Equity million
Cash and inter-bank
deposits 51 Core deposits 486
Short-term security
investments 14 Large negotiable CDs 102
Total loans, gross 568 Deposits placed by brokers 20
Long-term securities 62 Other wholesale liabilities 113
Other assets 77 Equity capital 51
Total liabilities and Equity
Total assets 772 Capital 772

a. Evaluate the funding mix of deposits and non-deposit sources of funds employed by
Barcs.

(𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷)/(𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑎𝑎𝑎𝑎𝑎𝑎 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 ) = 486/772 = 𝟔𝟔𝟔𝟔. 𝟗𝟗𝟗𝟗%

(𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛 𝐶𝐶𝐶𝐶𝐶𝐶)/(𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑎𝑎𝑎𝑎𝑎𝑎 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 ) = 102/772 =

𝟏𝟏𝟏𝟏. 𝟐𝟐𝟐𝟐%

(𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑏𝑏𝑏𝑏 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵)/(𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑎𝑎𝑎𝑎𝑎𝑎 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 ) = 20/772 =

𝟐𝟐. 𝟓𝟓𝟓𝟓%

(𝑂𝑂𝑂𝑂ℎ𝑒𝑒𝑒𝑒 𝑤𝑤ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 )/(𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑎𝑎𝑎𝑎𝑎𝑎 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 ) = 113/772 =

𝟏𝟏𝟏𝟏. 𝟔𝟔𝟔𝟔%

(𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶)/(𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑎𝑎𝑎𝑎𝑎𝑎 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 ) = 51/772 = 6.61%

𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛 𝐶𝐶𝐶𝐶𝐶𝐶 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑏𝑏𝑏𝑏 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵

𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉 𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 = + +
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑎𝑎𝑎𝑎𝑎𝑎 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑎𝑎𝑎𝑎𝑎𝑎 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶
(𝑂𝑂𝑂𝑂ℎ𝑒𝑒𝑒𝑒 𝑤𝑤ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 )/( 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑎𝑎𝑎𝑎𝑎𝑎 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 ) = 𝟑𝟑𝟑𝟑. 𝟒𝟒𝟒𝟒%

The objective for Barcs is to have the appropriate funding mix to cover liquidity risk
and interest rate risk, having high core deposits, or increasing core deposits is one
strategy to do so. Barcs’s core deposits are 62.95% while wholesale funding (Volatile
funding) equals 30.44%. Therefore, Barc with this funding mix will be subject to low
liquidity risk and low-interest rate risk because the proportion of core deposits is
approximately double the proportion of wholesale funding. This funding mix is good
because if interest rates change wholesale depositors will be more likely to withdraw
funds and go somewhere else and affecting the bank's liquidity however Barcs should
not be affected that much as the proportion of their core deposits is high. 1 However,

1
High core deposits are needed for a good funding mix for a bank so they can sustain a period of interest rate changes and
liquidity problems. Core deposits are less sensitive to interest rate movements.
2
933N1 Bank Financial Management
Barcs can improve its funding mix by adding more stable funds sources that are less
sensitive to interest rate changes.

[10 marks]

b. Suppose that in the first half of 2020, due to the consequences of the Covid-19
outbreak, depositors had to withdraw their money at the bank, resulting in a reduction
of £150 million in core deposits. The bank then decided to issue new large negotiable
CDs to replace the outflows in core deposits. All other figures remain the same. Given
the mix of its assets, critically discuss the bank’s action, and suggest any relevant
strategies where appropriate.

The mix of deposits and non-deposit:

(𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 )/(𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑎𝑎𝑎𝑎𝑎𝑎 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 ) = 336/772 = 𝟒𝟒𝟒𝟒. 𝟓𝟓𝟓𝟓%

(𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛 𝐶𝐶𝐶𝐶𝐶𝐶)/(𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑎𝑎𝑎𝑎𝑎𝑎 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶) = 252/772 =

𝟑𝟑𝟑𝟑. 𝟔𝟔𝟔𝟔%

(𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑏𝑏𝑏𝑏 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵)/(𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑎𝑎𝑎𝑎𝑎𝑎 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝑦𝑦 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶) = 20/772 =

𝟐𝟐. 𝟓𝟓𝟓𝟓%

(𝑂𝑂𝑂𝑂ℎ𝑒𝑒𝑒𝑒 𝑤𝑤ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 )/(𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑎𝑎𝑎𝑎𝑎𝑎 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶) = 113/772 =

𝟏𝟏𝟏𝟏. 𝟔𝟔𝟔𝟔%

(𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶)/(𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴) = 51/772 = 𝟔𝟔. 𝟔𝟔𝟏𝟏%

𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛 𝐶𝐶𝐶𝐶𝐶𝐶 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑏𝑏𝑏𝑏 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵

𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉 𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 = + +
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑎𝑎𝑎𝑎𝑎𝑎 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑎𝑎𝑎𝑎𝑎𝑎 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑡𝑡𝑎𝑎𝑎𝑎
(𝑂𝑂𝑂𝑂ℎ𝑒𝑒𝑒𝑒 𝑤𝑤ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 )/(𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑎𝑎𝑎𝑎𝑎𝑎 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶) = 𝟒𝟒𝟒𝟒. 𝟖𝟖𝟖𝟖%

The mix of Assets:

𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 51

= = 𝟔𝟔. 𝟔𝟔𝟔𝟔%
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 772

𝑆𝑆ℎ𝑜𝑜𝑜𝑜𝑜𝑜 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 14

= = 𝟏𝟏. 𝟖𝟖𝟖𝟖%
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 772

𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙,𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔 568

= = 𝟕𝟕𝟕𝟕. 𝟓𝟓𝟓𝟓%
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 772

𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 62

= = 𝟖𝟖. 𝟎𝟎𝟎𝟎%
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 772

𝑂𝑂𝑂𝑂ℎ𝑒𝑒𝑒𝑒 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 77
= = 𝟗𝟗. 𝟗𝟗𝟗𝟗%
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 772

If core deposits dropped to 336M and large CDs increased to 252M Barcs would have
approximately 43.52% in core deposits and 49.87% in wholesale liabilities (Volatile
funds). This will mean the bank is vulnerable to interest rate risk and therefore faces
high liquidity problems. To prevent this the bank needs to increase its core deposits
which are less sensitive to interest rate risk. For the mix of assets, Barcs has 8.41%
in short term investments/cash and 81.61% in gross and long-term loans. We assume
the long-term securities and gross loans are fixed, hence if interest rates increase the
bank will be not able to reprice their long-term securities (which make up 81.61%)
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933N1 Bank Financial Management
meaning Barcs will not be able to earn a higher yield on their assets. 2 However,
because Barcs now has wholesale deposits at 49.89% so they will need to reprice the
rates of these deposits and increasing interest costs. If interest costs increase and
Barcs cannot earn more on their assets it means Barcs faces interest rate risk and
liquidity risk and therefore earnings will decrease.

Barcs should focus on increasing its core deposits and increasing cash and short-term
securities. 3 To increase core deposits, Barcs should focus on increasing its non-
interest services such as ATMs, better customer services, and have helplines for
customers. These are fixed costs, so these costs will not increase as Barcs is attracting
more customers. Barcs should also offer more short-term loans as well as finding
borrowers who will pay a higher rate and good a good credit rating history however,
this will involve costs as the bank will have to spend time and money to find these
individuals.

[15 marks]

Question 2.

Consider the following summarised balance sheet of FSB Bank Ltd:

Assets Amount Rate Liabilities and Equity Amount Rate

Rate sensitive 5,000 6% Rate sensitive 6,000 2%
Fixed rate 3,500 9% Fixed rate 2,200 4%
Nonearning 1,500 Non-paying liabilities and equity 1,800
Total 10,000 Total 10,000
Unit: Thousand GBP.

a. Provide detailed definitions of rate-sensitive assets and rate-sensitive liabilities in GAP

analysis. Give examples where appropriate.

GAP Analysis is a model to measure the amount of interest rate risk a bank is holding at
a fixed point in time, by comparing a banks RSA with its RSL as shown
𝐺𝐺𝐺𝐺𝐺𝐺𝑡𝑡 = 𝑅𝑅𝑅𝑅𝑅𝑅𝑡𝑡 − 𝑅𝑅𝑅𝑅𝑅𝑅𝑡𝑡 . GAP aims to measure expected net interest income and create
strategies to improve it or stabilizes it. The RSA’s and RSL’s will mature in a given time
(T) period however sometimes there will be differences in maturity and if so any asset or
liability that matures within the period (T) will have its principal amount repriced hence,
called rate sensitive. If an asset matures then the bank must reinvest the proceeds (I.e
the principal payment of a loan), if a depositor takes out his funds from the bank, the
bank needs to find that source of funds again from somewhere else. The Bank might
also receive a partial payment before maturity for assets and liabilities and therefore, for
example, any loan payment is called rate-sensitive if it is expected to be received within
time (T). Some assets and liabilities pay interest based on an index such as the FTSE100
(Base rate) and these base rates can change contractually, so we call these assets and
liabilities rate sensitive as they change when the base rate changes.

2
They will be able to reprice their short-term assets but that only adds up to 8.41%.
3
Core funding (deposits) is made up of current accounts, savings accounts, time deposits and transaction accounts
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933N1 Bank Financial Management
[10 marks]

b. Calculate the bank’s GAP. [2 marks]

𝐺𝐺𝐺𝐺𝐺𝐺𝑡𝑡 = 𝑅𝑅𝑅𝑅𝑅𝑅𝑡𝑡 − 𝑅𝑅𝑅𝑅𝑅𝑅𝑡𝑡 = 5000 − 6000 = £ − 1000 (Thousand)

c. Calculate the bank’s Net Interest Income. [2 marks]

𝑁𝑁𝑁𝑁𝑁𝑁 = [(6% × 5000) + (9% × 3500)] − [(2% × 6000) + (4% × 2200)]
𝑁𝑁𝑁𝑁𝑁𝑁 = 615 − 208
𝑁𝑁𝑁𝑁𝑁𝑁 = £407 (Thousand)
d. Calculate the bank’s Net Interest Margin. [2 marks]
𝑁𝑁𝑁𝑁𝑁𝑁 = 𝑁𝑁𝑁𝑁𝑁𝑁/𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴
𝑁𝑁𝑁𝑁𝑁𝑁 = 407/8500
𝑁𝑁𝑁𝑁𝑁𝑁 = 4.79%

e. Calculate the change in Net Interest Income and Net Interest Margin if there is a parallel
shift in the yield curve of 1 percentage point higher during the year. Comment on your
findings using the data and the implications of GAP analysis.

𝑁𝑁𝑁𝑁𝑁𝑁 = [(7% × 5000) + (9% × 3500)] − [(3% × 6000) + (4% × 2200)]

𝑁𝑁𝑁𝑁𝑁𝑁 = 665 − 268
𝑁𝑁𝑁𝑁𝑁𝑁 = £397 (Thousand)
𝑁𝑁𝑁𝑁𝑁𝑁 = 397/8500
𝑁𝑁𝑁𝑁𝑁𝑁 = 4.47%

As GAP Is negative a positive shift of 1 percent in the yield curve will cause net interest
income and net interest margin to decrease. If GAP is positive and interest rates
increase, then the NII and NIM will also increase. Banks would want a GAP of zero
however this is almost impossible to have. Static GAP is easy to understand and
indicates the amount and timing of interest rate risk. However, it does ignore a few
things such as the time value of money, the cumulative impact of changes in interest
rates, and ignores the embedded options in assets and liabilities.

[9 marks]

Question 3.

Critically discuss the importance of bank performance, using the different objectives of
different economic entities to support your discussion. Discuss the performance of UK banks
in light of the current economic and health circumstances. Refer to the bank performance
literature and use data to support your discussion where appropriate.

Ever since the 2008 banking financial crisis analysing the performance of a bank has been
a must for customers. We can use key bank performance ratios such as Efficiency ratio,
ROE, ROA, and AU however we can also use the CAMELS Ratings. Capital adequacy is a
measure of the ability to maintain capital relative to the risk level of the bank. Asset quality
is the credit risk associated with the loans, Management quality indicates the management's
ability to identify, measure, monitor, and control risk within the bank. Earnings reflex the
quality and trend of earnings; Liquidity measures the degree of liquidity and sensitivity
measures the sensitivity of changes in market rates on capital. The ratings go from 1 to 5
with 1 being “sound” and 4/5 means the banks have some problems. It is also key to look
out for the bank's efficiency, productivity, scale of economies, and economies of scope when
analysing performance.
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933N1 Bank Financial Management

UK banks have been Europe’s best performing financial firms (Casu, Girardone, Molyneux,
2006). However, due to the recent pandemic, UK banks have been faced with a hard time.
The main aim for banks in this current moment is to maintain or increase their net interest
income while having enough reserves in the bank for depositors. Due to Covid-19 banks
were facing a high number of depositors withdrawing their funds and to do so UK banks had
to ensure they had enough reserves to handle this or sell off short-term assets to raise
funds. With interest rates near to 0% as set by the Bank of England customers would rather
invest in fixed income such as bonds where they can earn a higher amount. This means
banks would be able to issue fewer loans to individuals as fewer people are depositing. UK
banks would also be spending high amounts on moral hazard costs as some people’s
incentives would change after receiving a loan at such time. A bank's RSA may also be
acted by changes from high volatility levels and higher counterparty risk. Bank losses and
lower capital will lead to negative spillovers resulting in banks having to sell bonds to
increase their liquidity. From this pandemic is it evident that banks must set a high reserve
ratio just in case of emergencies, so they have enough liquidity.

[25 marks]

Question 4.

Critically discuss the relationship between bank competition and financial stability. Use the
related banking literature to support your discussion where appropriate.

Bank competition provides customers with a greater choice of options and in theory
improves access to finance. Competition will mean banks need to be more efficient than
each other and provide greater quality products and services. This will result in lower costs
for the banks and potentiality better rates for customers. This was tested in 2008 by Schaeck
and Cihak and they found a direct link between market competition causing bank stability to
rise and stated that financial stability benefits the more concentrated markets (Schaeck,
Cihak, 2008). Earlier Boyd and De Nicolo (2005) also identified competition reduces
monopoly power for loan funding, as banks provide lower interest rates the borrowers are
more likely to reply their loans rather than take risky projects, causing the moral hazard
problem and bankruptcy risk to slowly diminish. Competition will also reduce the too big to
fail problem as banks will have to always be on top of their game to be more efficient. This
is also proved in Boots and Greenbaum (1993) study where they suggested that lower
competition for larger banks is more beneficial for them as it is easier for them to collect
information on their borrowers, which decreases their information rent and improves the
effectiveness of monitoring activities, hence competition gets rid of the too big to fail
problem. Studies from Boyd and Prescott (1986), and Rmakrisman and Thakor (1984),
Diamond (1984) also found that large (“big-sized”) banks would want high monopoly power
with low competition to “reap” the benefits of economies of scope and scale. The larger
banks will also have more advanced technology to screen applications and help them avoid
adverse selection. However, with many banks competing for the same customers the banks
will have to continually work hard to offer competitive rates, this may also encourage banks
to take on more risky projects and give out more loans to high-risk individuals, therefore
increasing moral hazard and adverse selection. Banks with high marginal costs will struggle
to keep up with high competition and will be forced to reduce their costs.

To conclude an increase for competition among banks is highly beneficial for customers as
it lowers borrowing rates while giving customers more flexibility with their banking choices.
Competition also encourages banks to become more efficient and keep evolving while

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933N1 Bank Financial Management
providing the best services for customers. It helps banks eliminate the moral hazard problem
and removes the too big to fail problem for banks which is a disadvantage for monopoly size
banks but a huge benefit for smaller banks.

[25 marks]

Biography

Boot, A.W., Greenbaum, S.I. and Thakor, A.V., 1993. Reputation and discretion in
financial contracting. The American economic review, pp.1165-1183.

Boyd, J.H. and De Nicolo, G., 2005. The theory of bank risk taking and competition
revisited. The Journal of finance, 60(3), pp.1329-1343.

Boyd, J.H. and Prescott, E.C., 1986. Financial intermediary-coalitions. Journal of

Economic theory, 38(2), pp.211-232.

Casu, B., Girardone, C. and Molyneux, P., 2006. Introduction to banking (Vol. 10).
Pearson education.

Diamond, D.W., 1984. Financial intermediation and delegated monitoring. The review of
economic studies, 51(3), pp.393-414.

Ramakrishnan, R.T. and Thakor, A.V., 1984. Information reliability and a theory of
financial intermediation. The Review of Economic Studies, 51(3), pp.415-432.

Schaeck K, Cihak M. How does Competition affect Efficiency and Soundness in Banking?
New Perspectives and Empirical Evidence European Central Bank. 2008;Working paper
No. 932.

END OF PAPER