Chapter 19 Bank Management Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning All rights reserved Chapter Outline            Bank management Managing liquidity Managing interest rate risk Managing credit risk Managing market risk Operating risk Managing risk of international operations Bank capital management Management based on forecasts Bank restructuring to manage risks Integrated bank management Bank Management   The goal behind managerial policies of a bank is to maximize the wealth of the bank’s shareholders Managers may be tempted to make decisions that are in their own best interests  Banks   can incur agency costs Banks could provide stock as compensation to managers to maximize the bank’s stock price Banks with a low stock price may become takeover targets Bank Management (cont’d)  Board of directors  The board of directors oversees operations of the banks and attempts to ensure that managerial decisions are in the best interests of shareholders  Bank boards tend to contain a higher percentage of outside members than boards of other types of firms  Functions of bank directors are to:      Determine a compensation system for bank executives Ensure proper disclosure of the financial condition and performance Oversee growth strategies such as acquisitions Oversee policies for changing capital structure Assess performance and ensure that corrective action is taken if there is weak performance Managing Liquidity  Banks can experience illiquidity when cash outflows exceed cash inflows   Banks should maintain the level of liquid assets that will satisfy their liquidity needs but use their remaining funds to satisfy their other objectives   Illiquidity can be resolved by creating additional liabilities or selling assets Research has shown that high-performance banks are able to maintain relatively low liquidity Use of securitization to boost liquidity   Securitization commonly involves the sale of assets by the bank to a trustee who issues securities that are collateralized by the assets Securitization converts future cash flows into immediate cash Managing Interest Rate Risk  Bank performance is influenced by the interest payments earned relative to the interest paid: Net interest margin    Interest revenues - Interest expenses Assets During a period of rising interest rates, a bank’s net interest margin will likely decrease if its liabilities are more rate sensitive than its assets (see next slide) During a period of decreasing interest rates, a bank’s net interest margin will likely increase if its liabilities are more rate sensitive than its assets (see next slide) Managing Interest Rate Risk (cont’d) Increasing Interest Rates Decreasing Interest Rates % % Rate on Loans Rate on Loans Spread Cost of Funds Cost of Funds Time Time Managing Interest Rate Risk (cont’d)   To measure interest rate risk, a bank measures the risk and then uses its assessment of future interest rates to decide whether and how to hedge the risk Methods used to assess interest rate risk:  Gap analysis  Duration analysis  Regression analysis Managing Interest Rate Risk (cont’d)  Methods used to assess interest rate risk (cont’d)  Gap  analysis Gap is defined as: Gap Rate sensitive assets - Rate sensitive liabilities  The gap ratio is the volume of rate-sensitive assets divided by rate-sensitive liabilities Computing A Bank’s Gap and Gap Ratio Philly Bank generated interest revenues of $100 million last year and $45 million in interest expenses Philly bank has $2 billion in assets, of which $800 million are rate-sensitive Philly also has $700 million in rate-sensitive liabilities What are Philly Bank’s gap ?and gap ratio Gap Rate sensitive assets - Rate sensitive liabilities $800,000,000  $700,000,000 $100,000,000 Gap ratio  $800,000,0 00 114 29% $700,000,000 10 .. .Chapter Outline            Bank management Managing liquidity Managing interest rate... Decrease Consider hedging Increase Consider hedging Decrease Remain unhedged Negative Positive 19 Regression Analysis If the bank’s Interest rate coefficient is: …and interest rates are expected