Chap 9

• What is the equation for a bank's balance sheet?

  Total assets = Total liabilities + Bank capital

  
• What does a bank's balance sheet list?

  Sources of funds and uses of funds
• How do banks make profits?

  By earning higher interest on assets than liabilities
• What are checkable deposits?

  Bank accounts allowing checks to third parties
• Why has the share of checkable deposits shrunk?

  Due to more attractive financial instruments
• What are the costs of maintaining checkable deposits?

  Interest payments and servicing costs
• What are nontransaction deposits?

  Deposits that cannot be used for writing checks
• What are the two basic types of nontransaction deposits?

  Savings accounts and time deposits
• What are certificates of deposit (CDs)?

  Large denomination time deposits that are negotiable
• How do banks obtain funds through borrowings?

  By borrowing from the Federal Reserve System
• What is bank capital?

  The difference between total assets and liabilities
• How is bank capital raised?

  By selling new equity or retained earnings
• What happens when a bank has liabilities exceeding assets?

  The bank can be forced into liquidation
• What are reserves in banking?

  Funds held as deposits at the Fed and vault cash
• Why do banks hold reserves?

  To meet reserve requirements and for liquidity
• What is the required reserve ratio?

  The fraction of deposits that must be kept at the Fed
• What are excess reserves?

  Additional reserves held beyond required amounts
• What are cash items in process of collection?

  Deposits at other banks for services
• What types of securities do banks hold?

  Government, state, and local securities
• Why are short-term U.S. government securities called secondary reserves?

  Due to their high liquidity
• How do banks primarily make profits?

  By issuing loans
• Why are loans considered assets for banks?

  They provide income to the bank
• What are the largest categories of loans for commercial banks?

  Commercial, industrial, and real estate loans
• What are other assets for banks?

  Physical capital like buildings and equipment
• What is the basic banking process of asset transformation?

  • Savings deposit enables mortgage loans
  • Bank transforms depositor's asset into a bank asset
  • Example: "borrows short and lends long"
• What happens when a checking account is opened with a $100 bill?

  Bank reserves increase by $100

  
• What occurs when a check is written on another bank's account?

  Funds are collected from the other bank
• What is the required reserve if the required reserve ratio is 10% on $100?

  $10
• What does the bank do with excess reserves?

  It makes loans
• What are the "five C's" used to evaluate borrowers?

  Character, capacity, collateral, conditions, capital
• What are the general principles of bank management?

  • Liquidity Management: Acquire liquid assets
  • Asset Management: Low default rate and diversification
  • Liability Management: Low-cost fund acquisition
  • Capital Adequacy Management: Acquire needed capital
  • Credit Risk: Risk of borrower default
  • Interest-rate Risk: Risk from interest rate changes
• What happens if a bank has a deposit outflow of $10 million?

  Balance sheet changes to reflect new reserves

  
• What is the cost of borrowing from other banks in the federal funds market?

  The interest rate on these borrowings
• What is a second option for a bank to eliminate a reserve shortfall?

  Sell some of its securities
• What are the total reserves of the bank?

  $10M
• What is the total amount of deposits?

  $100M
• How much in loans does the bank have?

  $90M
• What is the bank capital amount?

  $10M
• What is the total amount of securities held by the bank?

  $10M
• What is the shortfall in reserves that must be eliminated?

  $9 million