Bank

• A financial intermediary accepting deposits and

granting loans; offers the widest menu of services
of any financial institution.
Banks and NBFIs
A nonbank financial institution (NBFI) is a financial
institution that does not have a full banking license and
cannot accept deposits from the public.
• FIs cannot issue cheques, pay-orders or demand drafts.
• FIs cannot receive demand deposits,
• FIs cannot be involved in foreign exchange financing,
• FIs can conduct their business operations with
diversified financing modes like syndicated financing,
bridge financing, lease financing, securitization
instruments, private placement of equity etc.
Roles Banks play in the economy
• Intermediation role
• Payments role
• Guarantor role
• Risk Management
• Investment Banking
• Saving/Investment advisor
• Safekeeping/Certification of value
• Agency role
• Policy role
Functions of a Bank
• The thrift function
• The payments function
• Credit Function
• Insurance Function
• Investment/Financial Planning Function
• Real Estate/Community Development Function
• Security Brokerage Function
• Investment Banking Function
• Merchant Banking Function
• Cash Management Function
Services Banks offer to the Public
• Currency exchanges
• Discounting notes and making loans
• Offering savings deposits
• Safekeeping of valuables and certification of value
• Supporting govt. activities
• Offering checking account (demand deposit)
• Offering trust services Equipment leasing
• Insurance service Retirement plans
• Venture capital loan Consumer loan
• Financial advising Cash management
Bank Financial Statements

• Report of Condition – Balance Sheet

• Report of Income – Income Statement
• Sources and Uses of Funds Statement
• Statement of Stockholders’ Equity
 Chapter
Measuring and Evaluating
Bank Performance 5

The purpose of this chapter is to discover what analytical tools can

be applied to a bank’s financial statements so that management and
the public can identify the most critical problems inside each bank
and develop ways to deal with those problems.
Value of a Bank’s Stock Rises
When:

• Expected Dividends Increase

• Risk of the Bank Falls
• Combination of Expected Dividend Increase and Risk
Decline
Key Profitability Ratios in
Banking Net Income After Taxes
Return on Equity Capital (ROE) 
Total Equity Capital

Net Income After Taxes

Return on Assets (ROA) 
Total Assets
Net Interest Income
Net Interest Margin 
Total Assets
Net Noninteres t Income
Net Noninteres t Margin 
Total Assets
 Key Profitability Ratios in
Banking (cont.)
Total Operating Revenues -
Total Operating Expenses
Net Bank Operating Margin 
Total Assets

Net Income After Taxes

Earnings Per Share (EPS) 
Common Equity Shares Outstandin g
Breaking Down ROE

x
ROE Depends On:

• Equity Multiplier
• Leverage or Financing Policies
• Net Profit Margin
• Effectiveness of Expense Management
• Asset Utilization
• Portfolio Management Policies
Bank Risks

• Credit Risk
• Liquidity Risk
• Market Risk
• Interest Rate Risk
• Earnings Risk
• Solvency Risk
 Asset-Liability Management

The purpose of asset-liability management

is to control a Bank’s Sensitivity to Changes
in Market Interest Rates and Limit its
Losses in its Net Income or Equity
Historical View of Asset-Liability
Management

• Asset Management Strategy

• Liability Management Strategy
• Funds Management Strategy
Goal of Interest Rate Hedging
One Important Goal of Interest Rate Hedging
is to Insulate the Bank from the Damaging
Effects of Fluctuating Interest Rates
One basic understanding is to stabilize the
net profit by neutralizing the impact of
changing interest rate.
Net Interest Margin

Interest Income - Interest Expenses

NIM 
Total Earnings Assets
Interest-Sensitive Gap
Measurements
Dollar Interest- Interest-Sensitive Assets –
=
Sensitive Gap Interest Sensitive Liabilities

Relative
Dollar IS Gap
Interest- 
Sensitive Gap Bank Size

Interest Interest Sensitive Assets

Sensitivity 
Interest Sensitive Liabilitie s
Ratio
Gap Positions and the Effect of Interest
Rate Changes on the Bank
• Asset-Sensitive Bank
• Interest Rates Rise
• NIM Rises
• Interest Rates Fall
• NIM Falls
• Liability-Sensitive Bank
• Interest Rates Rise
• NIM Falls
• Interest Rates Fall
• NIM Rises
Problems with Interest-Sensitive Gap
Management
• Interest Paid on Liabilities Tend to Move Faster than
Interest Rates Earned on Assets
• Interest Rate Attached to Bank Assets and Liabilities
Do Not Move at the Same Speed as Market Interest
Rates
• Point at Which Some Assets and Liabilities are
Repriced is Not Easy to Identify
• Interest-Sensitive Gap Does Not Consider the Impact
of Changing Interest Rates on Equity Position
 The Concept of Duration

Duration is the Weighted Average Maturity

of a Promised Stream of Future Cash Flows
Price Sensitivity of a Security

P i
 -D*
P (1  i)
Duration of an Asset portfolio

n
D A   w i * D Ai
i 1

Where:
wi = the dollar amount of the ith asset divided by total assets
DAi = the duration of the ith asset in the portfolio
Change in the Value of a Bank’s
Net Worth

 i   i 
NW  - D A * * A  - - D L * * L
 (1  i)   (1  i) 
Duration Gap

TL
D  DA - DL *
TA
Limitations of Duration Gap
Management
• Finding Assets and Liabilities of the Same Duration Can
be Difficult
• Some Assets and Liabilities May Have Patterns of Cash
Flows that are Not Well Defined
• Customer Prepayments May Distort the Expected Cash
Flows in Duration
• Customer Defaults May Distort the Expected Cash
Flows in Duration
• Convexity Can Cause Problems