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Chapter 24
Risk Management in Financial Institutions
Chapter Preview
Managing financial institutions has never been an easy task. But, uncertainty in the economic environment has increased, making the job of the financial institution manager that much harder.
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Chapter Preview
In this chapter, we examine how financial institutions manage credit risk, default risk, etc. We explore the tools available to managers to measure these risks and strategies to reduce them. Topics include:
Managing Credit Risk
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Moral hazard plays as role as well. Once a borrower has a loan, she has an incentive to engage in risky projects to produce the highest payoffs, especially if the project is financed mostly with debt.
Copyright 2009 Pearson Prentice Hall. All rights reserved.
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4. Collateral: a pledge of property or other assets that must be surrendered if the terms of the loan are not met ( the loans are called secured loans).
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Income Gap Analysis: Determining Rate Sensitive Items for First National Bank
Assets
assets with maturity less than one year
variable-rate mortgages short-term commercial loans portion of fixed-rate mortgages (say 20%)
Liabilities
money market deposits
variable-rate CDs short-term CDs federal funds short-term borrowings portion of checkable deposits (10%) portion of savings (20%)
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Income Gap Analysis: Determining Rate Sensitive Items for First National Bank
Rate-Sensitive Assets = $5m + $ 10m + $15m + 20% $20m
RSA
= $32m
= $5m + $25m + $5m+ $10m + 10% $15m
Rate-Sensitive Liabs
+ 20% $15m
RSL
= $49.5m
if i 5% Asset Income = +5% $32.0m = +$ 1.6m Liability Costs = +5% $49.5m = +$ 2.5m Income = $1.6m $ 2.5 = $0.9m
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GAP
Income
This is essentially a short-term focus on interest-rate risk exposure. A longer-term focus uses duration gap analysis.
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or
Change in Value = DUR x [i / (1 + i)] x Original Value
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Net Worth:
NW = Assets Liabilities
NW
Recall from the balance sheet that First National Bank has Bank capital totaling $5m. Following such a dramatic change in rate, the capital would fall to $2.8m.
Copyright 2009 Pearson Prentice Hall. All rights reserved.
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Income Gap Analysis: Determining Rate Sensitive Items for Friendly Finance Co. Assets
securities with a maturity less than one year
Liabilities
commercial paper bank loans with a maturity less than one year
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=
% NW = = =
1.33 years
DURgap X i /(1 + i) (1.33) .05/(1 + .10) .061, or 6.1%
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Chapter Summary
Managing Credit Risk: basic techniques for managing relationships and rationing credit were reviewed. Managing Interest-Rate Risk: the essential techniques of measuring interest-rate risk for both income and capital affects were presented.
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