FIN 2024 Financial Institutions and Markets

Tutorial 4 Bank Management

Discussion Questions:
As at 1st March, Starbright Bank has RM1.5 billion worth of deposits from customers, has
loans from the central bank of RM260 million. The bank’s equity stands at RM280 million.
a) If the bank plans to keep 10% of their assets in financial securities and rest into
providing loans, create a simple balance sheet for Starbright Bank by utilizing the
information above. Assume that the Statutory Reserve Requirement (SRR) at 9% of
deposits.
Assets Liabilities
Reserves $135.0 million Deposits $1,500.0 million
Loans $1,701.0 million Loans fr. Central $260.0 million
Bank
Securities $204.0 million Equities
Bank Capital $280.0 million
$2,040.0 million $ 2,040.0 million

b) If there was a sudden deposit outflow of RM200 million from depositors due to
financial distress, what problems might the bank face in terms of their balance
sheet?
Assets Liabilities
Reserves $0 million Deposits $1,300.0 million
Loans $1,701.0 million Loans fr. Central Bank $260.0 million
Securities $139.0 million Equities
Bank Capital $280 million
$1,840.0 million $1,840 million
SRR cannot meet the 9% anymore. In fact, it will deplete reserves to zero and the bank has
no choice but to liquidate an additional $65 million of securities to meet deposit outflow.

c) How could they solve it? How much must they maintain the reserve now?
Borrow from other banks. Borrowings will increase by $117 million, reserves
increase by $117 million.
Assets Liabilities
Reserves $117 million Deposits $1,300.0 million
Bank Borrowings $117.0 million
Loans $1,701.0 million Loans fr. Central Bank $260.0 million
Securities $139.0 million Equities
Bank Capital $280 million
$1,957.0 million $1,957 million

Sell Securities. Reserves up by $117 million, securities down by $117 million to $22
million
Assets Liabilities
Reserves $117.0 million Deposits $1,300.0 million
Loans $1,701.0 million Loans fr. Central Bank $260.0 million
Securities $22.0 million Equities
Bank Capital $280 million
$1,840.0 million $1,840 million

Borrow from the central bank. Loans from. Central Bank will increase by $117
million to $377 million, reserves increase by $117 million.
Assets Liabilities

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 Reserves $117 million Deposits $1,300.0 million
Loans $1,701.0 million Loans fr. Central Bank $377.0 million
Securities $139.0 million Equities
Bank Capital $280 million
$1,957.0 million $1,957 million

Sell off loans. Loans assets reduce by $117 million to $1584 million, reserves
increase by $117 million.
Assets Liabilities
Reserves $117 million Deposits $1,300.0 million
Loans $1,584.0 million Loans fr. Central Bank $260.0 million
Securities $139.0 million Equities
Bank Capital $280 million
$1,840.0 million $1,840 million

Short Discussions
1. The purpose of liquidity management is to make sure they do not lend out too much
money that it will deplete their reserves to a dangerous level. This means that they
would have to monitor their reserves constantly to make sure they have sufficient
liquidity. However, we see that the behaviour of banks is at the opposite, where
they would lend as much money as they possibly can, and then look at the
sufficiency of reserves by the end of the day. If they are insufficient, they would use
liquidity measures in order to have short term liquidity solutions. Explain why does
this happen, and the risks that might occur.
Your answers may be based on opinion so there are no real fixed answers to this.
However, this is my opinion and may be used as a guide to yours.
 Banks are primarily profiting making companies and providing loans are their
bread and butter from earning interest income.
 Banks are comfortable and confident to source for cash and reserves in a
short period of time if needed.
 Even though accumulating deposits are not a short term solution, but
borrowing funds from other banks and central banks, selling off financial
securities are almost instant solutions.
 Because of this confidence, banks usually sell now (loans), and buy supplies
(source for funding) later.
Risks that might occur:
 Unexpectedly higher than normal D/E ratio.
 Too much emphasis on lending to profit may loosen the screening process and
higher bad loans may occur, increasing the credit risk of the bank.

For bank is private entity , make profit is need to give out the loan

Your answer may be based on opinion, so there is no real fixed answer to this. However, this
is my opinion and can be used as your guide.
• Banks mainly make money in profitable companies, and loans are the basis for earning
interest income.
• If needed, banks will feel comfortable and confident to obtain cash and reserves in a short
time.
• Although accumulating deposits is not a short-term solution, borrowing money from other
banks and central banks and selling financial securities is an almost instant solution.
• Because of this confidence, banks usually sell immediately (loan) and then purchase
supplies (source of funding).
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Possible risks:
• Unexpectedly higher than normal D/E ratio.
• Excessive emphasis on profit loans may relax the screening process and may generate
more non-performing loans, thereby increasing the bank's credit risk.

2. Capital adequacy is an essential issue in bank management. Discuss the factors that
a bank manager needs to consider in determining the amount of bank capital.
In determining the amount of bank capital, bank managers must decide how much of
the increased safety that comes with higher capital they are willing to trade off against
the lower return on equity that comes with higher capital.
In more uncertain times, when the possibility of large losses on loans increases, bank
managers might want to hold more capital to protect equity holders. Conversely, if they
have confidence that loan losses won’t occur, they might want to reduce the amount of
bank capital, have a higher equity multiplier, and thereby increase the return on equity.
ROA = Net Profits/Assets
ROE = Net Profits/Equity Capital
EM = Assets/Equity Capital
ROE = ROA x EM
Equity Capital ↑ EM ↓ ROE ↓
Equity Capital ↓, EM ↑ROE ↑
Liabilities ↑ EM ↑ ROE↑

When determining the amount of bank capital, the bank manager must decide to
balance the higher security that high capital brings with the lower return on equity.
In more uncertain times, when the possibility of large loan losses increases, bank
managers may wish to hold more capital to protect equity holders. Conversely, if they
are confident that loan losses will not occur, then they may wish to reduce bank capital
and increase the equity multiplier, thereby increasing the return on equity.
ROA = net profit/assets
ROE = net profit/equity
EM = assets/equity
ROE = ROA x EM
Equity ↑EM↓ROE↓
Equity ↓, EM↑ROE↑
Liabilities↑EM↑ROE↑

For bank manager, there always should be balance increase safety and increase ROE.

3. If the president of a bank told you that the bank was so well run that it has never
had to call in loans, sell securities, or borrow as a result of a deposit outflow, would
you be willing to buy stock in that bank? Why or why not?
What’s the question asking? If the bank does not need to use tools for reserve
insufficiency when they lend too much or outflow of deposits, meaning they have
excess reserves. Is that good? Bad?
Good?
 Ready for Opportunity.
 Good liquidity.
 Cost of funds fluctuates less.
Bad?
 Because the bank president is not managing the bank well.

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  The fact that the bank has never incurred costs as a result of a deposit
outflow means that the bank is holding a lot of reserves that do not earn any
interest.

what? If banks do not need to use tools to make up for insufficient reserves when they lend
too much or when deposits flow out, it means that they have excess reserves. Is this good or
bad?
it is good?
• Be prepared for the opportunity.
• Good liquidity.
• The cost of funds fluctuates less.
Bad?
• Because the bank president is not doing well.
• The bank has never incurred costs due to the outflow of deposits, which means that the
bank holds many reserves that have not earned any interest.

4. Explain why do banks have to be concerned about diversifying their loan assets as
well as in their deposit liabilities.
Diversification is a risk management technique used by businesses and finance to
allocate assets (or sources of funds) to multiple allocations in order to reduce
concentration risk. For loan assets, banks may diversify in terms of maturity, types of
loans, interest rates, industries or even currency. Sources of deposits may be
sourced from multiple sources such as current, savings, fixed deposits, multiple
currencies, or from the public, financial institutions or the central banks.
They have to concerned about diversification in order to reduce concentration risk
so that factors such as interest rate fluctuation, economic cycle, specific industry
volatility and liquidity will not impact their ability to generate revenue overall. In
terms of deposits, diversifying their sources of debt allows them to manage liquidity
risk better, as well as the cost of funds. Diversifying their maturities of the liabilities
is also crucial, from short term deposits to long term deposits.
Diversification is a risk management technique used by enterprises and the
financial industry to allocate assets (or sources of funds) to multiple distributions
to reduce concentration risks. For loan assets, banks may diversify in terms of
maturity, loan type, interest rate, industry and even currency. Deposit sources may
come from multiple sources, such as demand deposits, savings, fixed deposits,
multiple currencies, or from public, financial institutions or central banks.

They must focus on diversification to reduce concentration risks so that factors

such as interest rate fluctuations, economic cycles, industry-specific volatility and
liquidity will not affect their overall income-generating capabilities. In terms of
deposits, diversification of debt sources enables them to better manage liquidity
risks and capital costs. From short-term deposits to long-term deposits,
diversifying its debt maturity is also crucial.

Diversification is important , ensure that your risk is diversified, you only can reduce
the risk over time.