Financial Markets and Institutions (2-downloads)

421

TA B L E   1 7 . 3

Measures of Bank Performance, 1980–2009

Year

Return on Assets 

(ROA) (%)

Return on Equity 

(ROE) (%)

Net Interest 

Margin (NIM)(%)

1980

0.77

13.38

3.33

1981

0.79

13.68

3.31

1982

0.73

12.55

3.39

1983

0.68

11.60

3.34

1984

0.66

11.04

3.47

1985

0.72

11.67

3.62

1986

0.64

10.30

3.48

1987

0.09

1.54

3.40

1988

0.82

13.74

3.57

1989

0.50

7.92

3.58

1990

0.49

7.81

3.50

1991

0.53

8.25

3.60

1992

0.94

13.86

3.89

1993

1.23

16.30

3.97

1994

1.20

15.00

3.95

1995

1.17

14.66

4.29

1996

1.19

14.45

4.27

1997

1.23

14.69

4.21

1998

1.18

13.30

3.47

1999

1.31

15.31

4.07

2000

1.19

14.02

3.95

2001

1.15

13.09

3.90

2002

1.30

14.08

3.96

2003

1.38

15.05

3.73

2004

1.28

13.20

3.54

2005

1.30

12.73

3.50

2006

1.28

12.31

3.31

2007

0.81

7.75

3.29

2008

0.03

0.35

3.16

2009

0.05

0.7

2.03

Source:

http://www2.fdic.gov/qbp/2010mar/all1a.html.

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422

Part 6 The Financial Institutions Industry

S U M M A R Y

1. The balance sheet of commercial banks can be

thought of as a list of the sources and uses of bank

funds. The bank’s liabilities are its sources of funds,

which include checkable deposits, time deposits, dis-

count loans from the Fed, borrowings from other

banks and corporations, and bank capital. The bank’s

assets are its uses of funds, which include reserves,

cash items in process of collection, deposits at other

banks, securities, loans, and other assets (mostly

physical capital).

2. Banks make profits through the process of asset

transformation: They borrow short (accept deposits)

and lend long (make loans). When a bank takes in

additional deposits, it gains an equal amount of

reserves; when it pays out deposits, it loses an equal

amount of reserves.

3. Although more liquid assets tend to earn lower

returns, banks still desire to hold them. Specifically,

banks hold excess and secondary reserves because

they provide insurance against the costs of a deposit

outflow. Banks manage their assets to maximize prof-

its by seeking the highest returns possible on loans

and securities while at the same time trying to lower

risk and making adequate provisions for liquidity.

Although liability management was once a staid affair,

large (money center) banks now actively seek out

sources of funds by issuing liabilities such as nego-

tiable CDs or by actively borrowing from other banks

and corporations. Banks manage the amount of cap-

ital they hold to prevent bank failure and to meet

bank capital requirements set by the regulatory

authorities. However, they do not want to hold too

much capital because by so doing they will lower the

returns to equity holders.

4. Off-balance-sheet activities consist of trading finan-

cial instruments and generating income from fees and

loan sales, all of which affect bank profits but are not

visible on bank balance sheets. Because these off-

balance-sheet activities expose banks to increased

risk, bank management must pay particular attention

to risk assessment procedures and internal controls

to restrict employees from taking on too much risk.

5. A bank’s net operating income equals operating

income minus operating expenses. Adding gains (or

losses) on securities and net extraordinary items to

net operating income and then subtracting taxes

yields net income (profits after taxes). Additional

measures of bank performance include the return on

assets (ROA), the return on equity (ROE), and the

net interest margin (NIM).

K E Y   T E R M S

asset management, p. 405

balance sheet, p. 399

capital adequacy management, 

p. 405

credit risk, p. 405

deposit outflows, p. 405

discount loans, p. 401

discount rate, p. 407

equity multiplier (EM), p. 411

excess reserves, p. 401

interest-rate risk, p. 405

liability management, p. 405

liquidity management, p. 405

loan commitment, p. 414

loan sale, p. 414

money center banks, p. 409

net interest margin (NIM), p. 420

off-balance-sheet activities, p. 414

operating expenses, p. 417

operating income, p. 417

required reserve ratio, p. 401

required reserves, p. 401

reserve requirement, p. 401

reserves, p. 401

return on assets (ROA), p. 411

return on equity (ROE), p. 411

secondary reserves, p. 402

vault cash, p. 401

Q U E S T I O N S

1. Rank the following bank assets from most to least liquid: