Banking and the Management of

Financial Institutions

Kanjaraj Tangtatswas
1
Financial Institutions in Thailand

2
Assets, Liabilities, and Equities of Thai Commercial Banks
(December 2020)
include money that
bank deposit at bank of
Thailand

= govt . bond
Mr C corporate bond )

source of fun !
f majority
✓ = main act .
giving out loan
um MW
& take deposit

derivative contact
C- ✗ fy -14 te , forward !
.

Source: Bank of Thailand

3
Assets (Uses of Funds)

commercial bank are regulate by central bank

• Reserves *

=
central bank set
the amount of

keep at central
the amount to reserve
money that commercial
bank

Required reserve → maintain

certain amount !
,
Before = 6-1 .

y Now → = 7%

• Required reserve ratio = Required reserve

Deposit
Excess reserve = Reserves – Required
↳ left

reserves
Regulatory ratio

• LCR (Liquidity Coverage Ratio)

urn
* To
ensure that bank have sufficient liquidity asset to cover Net CF over 30 day

g) high quality liquid asset

low risk A bond ! ! ✓
} c- ✗ -904
=
.

w/ high liquid
bond
=
✗ corpora -1

5
 Average of Ratio of Thai Commercial Banks

7. Number of bank ( places I

2. Financial Ratio

3. Asset Quality & Capital Adequacy

Ratio (%)

4. Capital funds / Risk

assets

5. Tieri capital / Risk

assets

6. Off -
balance sheet Transactions / Assets
-

7. Non -

performing 109h / loans

8. Problem
assets / Asset plus
allowance

9. L 09h51 Deposits
around 700 Or above !

70 .

Liquidity coverage Ratio ( LCR ) 61

Source: www.bot.or.th
6
Basic Banking—Cash Deposit
Bank 1
Value cash
+ $100 Checkable deposits + $700

• Mr. A opens a checking account with a $100

bill.

7
Basic Banking—Check Deposit
Bank 1 Bank 2
Reserve
Cash items+$100
in Checkable Reserve -$100 Checkable
[ collection
process
cash

of
items
of
+
)
in process

$700
deposit +$100 deposit -$100
collection +$100

• Mr. A opens a checking account with a $100

check written on an account with Bank 2.
• When a bank receives additional deposits, it
gains an equal amount of reserves.
• When a bank loses deposits, it loses an equal
amount of reserves.
8
 Basic Banking – Making a Profit
Bank 1
keep ! !

Required
Reserves
reserves
+$100
+$10 Deposit +$100
/
Reserve
urn
+ $700

Excess reserves +$90

↳ amount that bank can use to lend out ! !

• Required reserves ratio = 10%

• Required reserves = 10% x $100 = $10

• Excess reserves = Total – Required
= $100 - $10 = $90
9
Basic Banking – Making a Profit
Bank 1

Required reserves +$10 Deposit +$100

Excess reserves
Loans +$90
+$90

• Assume that the bank hold loans instead of reserves.

• Interest rates
interest exp

Deposits: 5% p.a. $100 x 5% = $5

.

charge fee

Loans: 10% p.a. $90 x 10% = $9 from

customers

• Bank earns $4 p.a. ($9 - $5)

10
Bank Management

• Liquidity Management → ensure that

have
their
sufficient cash

• Asset Management
• Liability Management
• Capital Adequacy Management
• Credit Risk
• Interest-rate Risk

11
Liquidity Management:
Ample Excess Reserves
Require reserve -7040

Before After
maintain
Assets Liabilities + Capital Assetsits Liabilities + Capital
20%2 > not -
of minimum
reserve requirement
Reserves $20M Deposits $100M Reserves $10M Deposits d $90M
vww
urn

Loans $80M Bank $10M Loans $80M Bank $10M

Capital Capital
Securities $10M Securities $10M

• Donald Duck withdraw $10M from his account.

• A bank loses $10M of deposits.
• If a bank has ample excess reserves, a deposit
outflow does not necessitate changes in other parts of
its balance sheet.

12
Liquidity Management:
Shortfall in Reserves Reserves must be at least
Trade -
Off btw safety &
opportunity $90 M x 10% = $9M

Before After
Assets Liabilities + Capital Assets Liabilities + Capital
* **

Reserves $10M Deposits $100M Reserves $0 Deposits $90M

Bank need to find $9M

Loans $90M Bank $10M Loans $90M Bank $10M

Capital Capital
Securities $10M Securities $10M

• Reserves are a legal requirement and the

shortfall must be eliminated
• Excess reserves are insurance against the
costs associated with deposit outflows

13
Liquidity Management: Borrowing

Assets Liabilities + Capital

Reserves r $9M r Deposits $90M
Loans $90M Borrowing
www
9 $9M
Securities $10M Bank Capital $10M

• Cost incurred is the interest rate paid on the

borrowed funds

14
What happened in mid September 2007
… * Notice ! !
borrowing from another bank become more riskies
-

Caz interest can double / triple

• The rates on loans that banks charge

each other rapidly rose in the turmoil.
The London interbank overnight dollar
offered rate (LIBOR) jumped by 3.33%, after crisis
nfdollble
its biggest increase ever, to nun
6.44%.
Source: Economist

15
Liquidity Management:
Securities Sale

Assets Liabilities + Capital

Reserves ^
$9M Deposits $90M
Loans $90M Bank Capital $10M
Securities
www.w
bank can sell securities
from $70M to $1M ! !
v $1M
* when u sell bond sell at discount
,
↳ If
No-one want yr bond 1 bad : low quality , low liquidity )

• The cost of selling securities is the brokerage

and other transaction costs
7. borrow from
other banks
2. borrow central
banks
3. sell
security

16
Liquidity Management:
Central Bank
* Rate from borrow central bank is higher than borrow other banks
* Need colas 1-etat ! !
* it sent bad signal → as they can't borrow from other commercial banks
ww

Assets Liabilities + Capital

Reserves $9M Deposits $90M
Loans $90M Borrow from $9M
central bannk
Securities $10M Bank Capital $10M

• Borrowing from the central bank also incurs

interest payments based on the discount rate

17
Thai Financial Institutions’ Average Current
Account Balances over Fortnight Period

!!

significantly
increase
-

keep more excess reserve

Not good
lending activity
-

* Tradeoff risk & return

Source: www.bot.or.th 18
Large and increasing deposits at Federal Reserve show that banks
rather park the money with Federal Reserve than lending it out, i.e.
the market is not functioning.

Reserve than
f back maintain

After crisis ! !
✓ Keep more reserve

19
Source: https://www.federalreserve.gov/
Liquidity Management:
Reduce Loans

Assets Liabilities +Capital

Reserves $9M Deposits $90M
(
last option to do ! !
* call 109ns ( decrease loans

Loans ✗ hurt relationships toward client

/
. $81M Bank Capital $10M
* or can sell 109h at discount to
another bank

Securities $10M

• Reduction of loans is the most costly way of

acquiring reserves
• Calling in loans antagonizes customers
• Other banks may only agree to purchase loans at a
substantial discount
20
Asset Management:
Three Goals

• Seek the highest possible returns on

loans and securities
• Reduce risk
• Have adequate liquidity

21
Asset Management: Four Tools

• Find borrowers who will pay high

interest rates and have low possibility
of defaulting
• Purchase securities with high returns
and low risk
• Lower risk through diversification
• Balance need for liquidity against
increased returns from less liquid assets
22
Liability Management
* Bank recieve deposite CST funding )

• After the recent financial crisis, banks

are encourage to seek longer term
c- × U keep money at the bank means 4 have to hold some of WIN
}
.

money in the account ! !

funding and reduce the mismatch of

↳ use part of it pay utility bill

www

funds.

23
Regulatory ratio

• NSFR (Net Stable Funding Ratio)

* Not effective in Thai

Source of funds ( where bank

67 must find I

↳u ri skies asset that bank lend money out ! !

24
Capital Adequacy Management

• Bank capital helps prevent bank failure

f) loss → can cause bank to go bankrupt

• The amount of capital affects return for

ummm

the owners (equity holders) of the bank

• Regulatory requirement

25
Capital Adequacy Management:
Preventing Bank Failure When
Assets Decline
High Bank Capital Low Bank Capital

Assets Liabilities + Capital Assets Liabilities + Capital

Reserves $10M Deposits $90M Reserves $10M Deposits $96M

Loans $90M Bank Capital $10M Loans $90M Bank Capital $4M

$5M loans are www

written-off. g) Dr loss
.

cr . loan
$5M
$5M

=
bank lend money out
& don't get it back ! !

High Bank Capital Low Bank Capital

Assets Liabilities + Capital Assets Liabilities + Capital

Reserves $10M Deposits $90M Reserves $10M Deposits $96M

Go bankrupt
j

Loans $85M Bank Capital $5M Loans $85M Bank Capital -$1M
26
Capital Adequacy Management:
Returns to Equity Holders

• Return on Equity (ROE)

ROE = Net Profit * Trade
-
Off btw

Equity ( ]
-
Equity more E. more return

frisk & more risk

= Net Profit x Assets

Assets Equity g) larger
Go
equity ,
bankrupt !
www

= ROA x Equity Multiplier

Given the ROA the lower the bank capital, the higher the ROE.

27
Capital Adequacy Management:
Safety

• Benefits the owners of a bank by making

their investment safe
• Costly to owners of a bank because the
higher the bank capital, the lower the
return on equity
• Choice depends on the state of the
economy and levels of confidence

28
Credit Risk and Asymmetric
Information
• Adverse Selection (Lemon Problem)
p can't repay bank ! !

Those with bad credit are the ones who most actively seek financing.
ummm

Adverse selection increases the chances that a loan might not be

repaid, lenders might decide not to make any loans, even though
there are good credit risk in the market place.
Occurs before the transaction.
• Moral Hazard
Once borrowers have obtained a loan, they may take on big risk
because they’re playing with someone’s else money.
Because moral hazard increases the probability of default, lenders
may decide that they would rather not make a loan.
Arises after the transaction.

29
Credit Risk: Overcoming Adverse
Selection and Moral Hazard
Bank go through all of this ! !

• Screening and information collection

• Specialization in lending
• Monitoring and enforcement of
restrictive covenants
• Long-term customer relationships
• Loan commitments
• Collateral and compensating balances
• Credit rationing
Refuse to make a loan
Grant a smaller loan than what the borrower wants
30
Interest-Rate Risk
client deposit : pay interest !

Assets Liabilities + Capital

✓

Rate-sensitive assets $20M Rate-sensitive liabilities $50M

Variable-rate and short-term loans Variable-rate CDs
*
lending out loans : earn interest

Short-term securities Money market deposit accounts

* If rate 9g
u can earn more too !!

Fixed-rate assets lend money

at .
or

rate 6 ! :(fixed
month
- rate I
$80M Fixed-rate liabilities $50M
Reserves Checkable deposits
Long-term loans Savings deposits
Long-term securities Long-term CDs
/

• If a bank has more rate-sensitive liabilities than assets, a rise in

⑦
interest rates will reduce ummm
bank profits and a decline in interest
rates will raise bank profits liability -

as the cost from

gonna increase
( $50M 91 > asset /
$20M I

31
Interest-Rate Risk

• Suppose that interest rates rise by 5%

on average, from 10% to 15%.
• Incomes on assets increases by $1M
($20M x 5%)
• Expenses on liabilities increases by
$2.5M ($50M x 5%)
• Profit falls by $1.5M ($1M - $2.5M)
Notice that rate will increase in the future !
the rate
sensitive asset
-

-
Increase
-

reduce the rate

-
sensitive liability

32
Interest Rate Risk: Gap
Analysis
Basic Gap Analysis:

(rate-sensitive assets this → so ,

rate sensitive liabilities)
when in sit not effect much !
*To minimize the gab btw 2 Of

interest rates = in bank profits

= ($20M - $50M) x 5%
= -$30M x 5%
= -$1.5M

33