Tài chính doanh nghiệp - Chapter 19: Bank management

Chapter 19Bank ManagementFinancial Markets and Institutions, 7e, Jeff MaduraCopyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.1Chapter OutlineBank managementManaging liquidityManaging interest rate riskManaging credit riskManaging market riskOperating riskManaging risk of international operationsBank capital managementManagement based on forecastsBank restructuring to manage risksIntegrated bank management2Bank ManagementThe goal behind managerial policies of a bank is to maximize the wealth of the bank’s shareholdersManagers may be tempted to make decisions that are in their own best interestsBanks can incur agency costsBanks could provide stock as compensation to managers to maximize the bank’s stock priceBanks with a low stock price may become takeover targets3Bank Management (cont’d)Board of directorsThe board of directors oversees operations of the banks and attempts to ensure that managerial decisions are in the best interests of shareholdersBank boards tend to contain a higher percentage of outside members than boards of other types of firmsFunctions of bank directors are to:Determine a compensation system for bank executivesEnsure proper disclosure of the financial condition and performanceOversee growth strategies such as acquisitionsOversee policies for changing capital structureAssess performance and ensure that corrective action is taken if there is weak performance4Managing LiquidityBanks can experience illiquidity when cash outflows exceed cash inflowsIlliquidity can be resolved by creating additional liabilities or selling assetsBanks should maintain the level of liquid assets that will satisfy their liquidity needs but use their remaining funds to satisfy their other objectivesResearch has shown that high-performance banks are able to maintain relatively low liquidityUse of securitization to boost liquiditySecuritization commonly involves the sale of assets by the bank to a trustee who issues securities that are collateralized by the assetsSecuritization converts future cash flows into immediate cash5Managing Interest Rate RiskBank performance is influenced by the interest payments earned relative to the interest paid: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)6Managing Interest Rate Risk (cont’d)%%TimeTimeRate on LoansCost of FundsSpreadIncreasing Interest RatesDecreasing Interest RatesCost of FundsRate on Loans7Managing 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 riskMethods used to assess interest rate risk:Gap analysisDuration analysisRegression analysis8Managing Interest Rate Risk (cont’d)Methods used to assess interest rate risk (cont’d)Gap analysisGap is defined as:The gap ratio is the volume of rate-sensitive assets divided by rate-sensitive liabilities9Computing A Bank’s Gap and Gap RatioPhilly 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?10Managing Interest Rate Risk (cont’d)Methods used to assess interest rate risk (cont’d)Gap analysis (cont’d)Banks often classify assets and liabilities into categories based on the time of repricing and calculate a gap for each categoryBanks must decide how to classify their liabilities and assets as rate sensitive versus rate insensitiveEach bank may have its own classification system, because there is no perfect measurement of gap11Managing Interest Rate Risk (cont’d)Methods used to assess interest rate risk (cont’d)Duration measurementDuration can capture the different degrees of interest rate sensitivity:The duration of a bank’s asset portfolio is the weighted average of the durations of the individual assets12Managing Interest Rate Risk (cont’d)Methods used to assess interest rate risk (cont’d)Duration measurement (cont’d)The bank can also estimate the duration of its liability portfolio and then estimate the duration gap:A duration gap of zero means the bank is not exposed to interest rate riskBanks with positive duration gaps are adversely affected by rising interest rates and positively affected by declining interest rates13Managing Interest Rate Risk (cont’d)Methods used to assess interest rate risk (cont’d)Duration measurement (cont’d)Assets with shorter maturities have shorter durationsAssets that generate more frequent coupon payments have shorter durationsThe capabilities of duration are limited when applied to assets that can be terminated on a moment’s notice14Managing Interest Rate Risk (cont’d)Methods used to assess interest rate risk (cont’d)Regression analysisA bank can assess interest rate risk by determining how performance has historically been influenced by interest rate movementsA proxy must be chosen for bank performance and for prevailing interest rates and regression analysis can be applied:15Managing Interest Rate Risk (cont’d)Methods used to assess interest rate risk (cont’d)Regression analysis (cont’d)A positive (negative) coefficient suggests that performance is favorably (adversely) affected by rising interest ratesIf the interest rate coefficient is zero, the bank’s stock returns are insulated from interest rate movementsThe vast majority of research has found that bank stock levels are inversely related to interest rate movementsRegression analysis can be combined with the value-at-risk (VAR) method to determine how its market value would change in response to specific interest rate movements16Managing Interest Rate Risk (cont’d)Determining whether to hedge interest rate riskBanks should consider using their measurement of interest rate risk along with their forecast of interest rate movements to determine whether they should hedgeSince none of the measures is perfect for all situations, some banks measure interest rate risk using all three methodsIn general, the three methods should lead to a similar conclusion (see next slide)17Gap AnalysisIf the bank’s gap is:NegativePositiveIncreaseIncreaseDecreaseDecreaseand interest rates are expected to:the bank should:Consider hedgingRemain unhedgedRemain unhedgedConsider hedging18Duration Gap AnalysisIf the bank’s duration gap is:NegativePositiveIncreaseIncreaseDecreaseDecreaseand interest rates are expected to:the bank should:Remain unhedgedConsider hedgingConsider hedgingRemain unhedged19Regression AnalysisIf the bank’s Interest rate coefficient is:NegativePositiveIncreaseIncreaseDecreaseDecreaseand interest rates are expected to:the bank should:Consider hedgingRemain unhedgedRemain unhedgedConsider hedging20Managing Interest Rate Risk (cont’d)Methods used to reduce interest rate riskMaturity matchingThe bank can match each deposit’s maturity with an asset of the same maturityVery difficult to implement because deposits are short termUsing floating-rate loansFloating-rate loans allow banks to support long-term assets with short-term depositsIf the cost of funds is changing more frequently than the rate on assets, there is still interest rate riskCould result in increased exposure to credit risk21Managing Interest Rate Risk (cont’d)Methods used to reduce interest rate risk (cont’d)Using interest rate futures contractsThe sale of a futures contract on Treasury bonds prior to an increase in interest rates will result in a gainThe size of the bank’s position in Treasury bond futures is dependent on the size of its asset portfolio, the degree of its exposure to interest rate movements, and its forecast of future interest rate movements22Managing Interest Rate Risk (cont’d)Methods used to reduce interest rate risk (cont’d)Using interest rate swapsA bank whose liabilities are more rate sensitive than its asset can swap payments with a fixed interest rate in exchange for payments with a variable interest rate over a specified period of timeIf interest rates rise, the bank benefits because the payments to be received from the swap will increase while its outflow payments are fixedA bank whose assets are more rate sensitive than its liabilities can swap variable-rate payments in exchange for fixed-rate payments23Managing Interest Rate Risk (cont’d)Methods used to reduce interest rate risk (cont’d)Using interest rate capsAn agreement to receive payments when the interest rate of a particular security or index rises above a specified level during a specified time period can be used to hedge interest rate riskDuring periods of rising interest rates, the cap provides compensation which can offset the reduction in spread24Managing Interest Rate Risk (cont’d)International interest rate riskWith foreign currency balances, the strategy of matching asset and liability interest rate sensitivity will not automatically achieve a low degree of interest rate risk25Managing Credit RiskMost of a bank’s funds are used either to make loans or to purchase debt securities, which expose the bank to credit riskTradeoff between credit risk and expected returnBecause a bank cannot simultaneously maximize return and minimize credit risk, it must compromiseIt will select some assets that generate high returns but are subject to a high degree of credit riskIt will select some assets that are very safe but offer a lower rate of returnThe bank attempts to earn a reasonable return and maintain credit risk at a tolerable level26Managing Credit Risk (cont’d)Tradeoff between credit risk and expected return (cont’d)How the loan allocation decision affects return and riskCredit cards and consumer loans offer the highest margins above the bank’s cost of fundsCredit cards and consumer loans will experience more defaults than other types of loansMany banks have adopted more lenient credit standards to generate credit card businessFor banks that were too lenient, the wide spread between the return on credit card loans and the cost of funds has been offset by a high level of bad debt expenses27Managing Credit Risk (cont’d)Tradeoff between credit risk and expected return (cont’d)Changes in expected return and riskBanks adjust their asset portfolio according to changes in economic conditionsBanks generally reduce loans and increase purchases of low-risk securities when the economy is weakWhen economy conditions began to improve in 2003, banks were more willing to provide more loans subject to more risk28Managing Credit Risk (cont’d)Measuring credit riskBanks employ credit analysts who review the financial information of corporations applying for loans and evaluate their creditworthinessDetermining the collateralThe bank must decide whether to require collateral than can back the loanDetermining the loan rateRatings are used to determine the premium to be added to the base rate according to credit riskSome loans to high-quality customers are commonly offered at rates below the prime rate29Managing Credit Risk (cont’d)Diversifying credit riskBanks should diversify their loans to make sure their customers are not dependent on a common source of incomeApplying portfolio theory to loan portfoliosThe variance of an asset portfolio’s return is:The covariance measures the degree to which asset returns move in tandem30Managing Credit Risk (cont’d)Diversifying credit risk (cont’d)The covariance is equal to the correlation coefficient between asset returns times the standard deviation of each asset’s return, so:The portfolio variance is positively related to the correlations between asset returnsIf a bank’s loans are driven by one particular economic factor, the returns will be highly correlated31Managing Credit Risk (cont’d)Diversifying credit risk (cont’d)Industry diversification of loansIf one particular industry experiences weakness, loans to other industries will be insulatedDiversifying loans across industries has limited effectiveness when economic conditions are weakGeographic diversification of loansDiversification of loans across districts could achieve significant risk reduction in loan portfolios because of low correlations32Managing Credit Risk (cont’d)Diversifying credit risk (cont’d)International diversification of loansDiversification of loans across countries can reduce exposure to any one countryBanks should assess a country’s risk and focus on countries with a high country risk ratingThe international debt crisis in the 1980s and the Asian Crisis of 1997 dampened the desire by banks to diversify loans internationally33Managing Credit Risk (cont’d)Diversifying credit risk (cont’d)Selling loansBanks can eliminate loans that are causing excessive risk in their portfolios by selling them in the secondary marketLoan sales often enable the bank originating the loan to continue servicing the loanRevising the loan portfolio in response to economic conditionsWhen economic conditions deteriorate, a bank’s loan portfolio may be heavily exposed to economic conditions even if it has purchased additional Treasury securities34Managing Market RiskMarket risk results from changes in the value of securities due to changes in financial market conditions such as interest rate movements, exchange rate movements, and equity pricesAs banks pursue new services related to the trading of securities, their exposure to market risk has increasedBanks face increased market risk because of their increased involvement in the trading of derivatives35Managing Market Risk (cont’d)Measuring market riskBanks commonly use value-at-risk to measure their exposure to market riskInvolves determining the largest possible loss that would occur as a result of changes in market prices based on a specified confidence levelThe bank estimates the impact of an adverse scenario on its positions based on the sensitivity of the values of its positions to the scenarioUsing the VAR method, the bank can ensure that it has sufficient capital to cushion against the adverse effects of the scenarios36Managing Market Risk (cont’d)Measuring market risk (cont’d)Bank revisions of market risk measurementsBanks continually revise their estimate of market risk in response to changes in their investment and credit positions and to changes in market conditionsHow J.P. Morgan assesses market riskUses a 95 percent confidence level to determine the maximum expected one-day loss on its investments and credit instruments due to changes in interest rates, foreign exchange rates, equity prices, and commodity prices37Managing Market Risk (cont’d)Measuring market risk (cont’d)Relationship between a bank’s market risk and interest rate riskA bank’s market risk is partially dependent on its exposure to interest rate riskBanks give special attention to interest rate risk because it is the most important component of market riskMethods used to reduce market riskA bank could reduce its involvement in the activities that cause the high exposuree.g., reduce the amount of transactions in which it serves as a guarantor for its clients or reduce its investment in foreign debt securities38Operating RiskOperating risk is the risk resulting from a bank’s general business operations related to:InformationExecution of transactionsDamaged relationships with clientsLegal issuesRegulatory issues39Managing Risk of International OperationsExchange rate riskSome international loans contain a clause that allows repayment in a foreign currency, allowing the borrower to avoid exchange rate riskOften, banks convert available funds to whatever currency corporations want to borrowCreates an asset denominated in a foreign currency and a liability denominated in a different currencyThe bank’s profit margin is reduced if the liability currency appreciates against the asset currencyBanks typically hedge net exposure to exchange rate risk40Managing Risk of International Operations (cont’d)Settlement risk:Is the risk of loss due to settling bank transactionse.g., a bank may send its currency to another bank, but that bank may not send anything backCan create systemic risk, which is the risk that many participants will be unable to meet their obligations because they did not receive payments on obligations due to them41Bank Capital ManagementBank operations are different from other types of firms because the majority of their assets generate more predictable cash flowsBanks can use a much higher degree of leverage than other types of firmsBanks must meet the minimum capital ratio required by regulatorsIf a bank has too much capital, each shareholder will receive a smaller proportion of any distributed earnings42Bank Capital Management (cont’d)A common measure of the return to shareholders is return on equity (ROE):The greater the leverage measure, the greater the amount of assets per dollar of equity43Computing Banks’ ROEsHidebt Bank and Lodebt Bank each have an ROA of 2 percent. Hidebt Bank has a leverage measure of 13, while Lodebt Bank has a leverage measure of 9. What is the ROE for each bank?44Bank Capital Management (cont’d)Banks can reduce the required level of capital by selling some loans in the secondary marketBanks’ required capital is specified as a proportion of loansBanks can reduce excessive capital by distributing a high percentage of their earnings to shareholdersCapital management is related to dividend policy45Management Based on ForecastsEconomic Forecast Adjustment to Liability StructureAdjustment to Asset StructureAssessment of Bank’s Adjusted StructureStrong economyConcentrate more heavily on loans; reduce holdings of low-risk securitiesIncreased potential for stronger earnings; increased exposure of bank earnings to credit riskWeak economyConcentrate more heavily on risk-free low-risk loans; reduce holdings of risky loansReduced credit risk; reduced potential for stronger earnings if the economy does not weakenIncreasing interest ratesAttempt to attract CDs with long-term maturitiesApply floating interest rates to loans whenever possible; avoid long-term securitiesReduced interest rate risk; reduced potential for stronger earnings if interest rates decreaseDecreasing interest ratesAttempt to attract CDs with short-term maturitiesApply fixed interest rates to loans whenever possible; concentrate on long-term securities or loansIncreased potential for stronger earnings; increased interest rate risk46Bank Restructuring to Manage RisksBank operations change in response to changing regulations and economic conditions and to managerial policies designed to hedge riskDecisions to restructure are complex because of their effects on customers, shareholders, and employeesA strategic plan to satisfy customers and shareholders may not satisfy employeese.g., many banks downsized in the early 1990s47Bank Restructuring to Manage Risks (cont’d)Bank acquisitionsBanks can restructure by growing through acquisitions of other banksAcquisitions offer advantages:Economies of scaleDiversification of loansAcquisitions have disadvantages:Optimistic projections of cost efficienciesEmployee morale problems and high employee turnover48Integrated Bank ManagementBank management of assets, liabilities, and capital is integratedAsset growth can be achieved only if a bank obtains the necessary fundsGrowth may require an investment in fixed assets that will require an accumulation of bank capitalAn integrated management approach is necessary to manage liquidity risk, interest rate risk, and credit risk49