Bank Management Chapter 5

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Questions and Answers

What is one strategy to improve financial performance?

Decrease funding sources

Increase employee expenses

Reduce interest income

Increase fees associated with various services (correct)

What is the main component of an income statement that represents financial inflows?

Loan Loss Expense

Interest Expenses

Revenues (correct)

Noninterest Expenses

What is Net Interest Income also referred to as?

Interest Rate

Interest Margin (correct)

Loan Loss Provision

Net Operating Income

What is the purpose of Loan Loss Expense?

To deduct from current revenues before taxes Signup and view all the answers

What is the formula to calculate Net Interest Income?

Interest Income - Interest Expenses Signup and view all the answers

What is the primary source of revenue for most depository institutions?

Interest earned from loans and security investments Signup and view all the answers

What is the purpose of reducing employee, overhead, loan-loss, and miscellaneous operating expenses?

To improve financial performance Signup and view all the answers

What is an income statement a record of?

Financial flows over time Signup and view all the answers

What is the primary source of funding for banks?

Deposits Signup and view all the answers

What is the purpose of non-deposit borrowings?

To supplement deposits and provide additional liquidity Signup and view all the answers

What does equity capital provide to a financial firm?

A long-term stable base of financial support Signup and view all the answers

What do liabilities and equity capital represent on a balance sheet?

Accumulated sources of funds Signup and view all the answers

What is the purpose of a bank's assets?

To generate income for stockholders Signup and view all the answers

What is included in the 'Cash Assets' category?

Vault Cash, Deposits with Other Banks, and Cash Items in Process of Collection Signup and view all the answers

What is the purpose of 'Cash Items in Process of Collection'?

To serve as a defense against customer deposit withdrawals Signup and view all the answers

What is the term for 'Vault Cash, Deposits with Other Banks, and Reserve Account with the Federal Reserve'?

Primary Reserves Signup and view all the answers

What does noninterest income include?

Fees earned from fiduciary activities and service charges on deposit accounts Signup and view all the answers

What is the key component of noninterest expenses?

Wages, salaries, and employee benefits Signup and view all the answers

What is the result of subtracting noninterest expenses and provision for loan losses from noninterest income?

Net noninterest income Signup and view all the answers

What is the sum of interest income and net noninterest income?

Net operating income Signup and view all the answers

What are the two categories of net income?

Cash dividends and retained earnings Signup and view all the answers

What is the purpose of an income statement in a financial firm?

To report income and expenses Signup and view all the answers

What does the report of income for a bank typically include?

Income and expenses data Signup and view all the answers

What is the importance of financial statements in banks and similar financial firms?

To report income and expenses, and to analyze the performance of the firm Signup and view all the answers

What is the primary purpose of a bank's cash balance?

To meet demands for cash from customers Signup and view all the answers

What is the second line of defense to meet demands for cash?

Liquid portion of investment securities Signup and view all the answers

What type of securities are held for their rate of return?

Income-generating securities Signup and view all the answers

How are income-generating securities recorded on the books of a banking firm?

At their original cost or market value, whichever is lower Signup and view all the answers

What type of securities are not included in 'Securities' on the Report of Condition?

Trading account assets Signup and view all the answers

What is the primary source of funds for temporary loans made to other depository institutions?

Reserves a bank has on deposit with the Federal Reserve Bank Signup and view all the answers

What is the largest asset item on a bank's balance sheet?

Loan accounts Signup and view all the answers

What is the primary purpose of a bank's trading account assets?

To provide short-term profits from short-term price movements Signup and view all the answers

What percentage of the total value of all bank assets do loans usually account for?

Half to three-quarters Signup and view all the answers

What is one way to categorize loans?

By the purpose for borrowing money Signup and view all the answers

What type of loan is given to a farmer to purchase seeds?

Agricultural production loan Signup and view all the answers

What is the difference between short-term loans and long-term loans?

The maturity of the loan Signup and view all the answers

What is the purpose of the allowance for loan losses?

To build up a reserve for future loan losses Signup and view all the answers

What is the difference between specific reserves and general reserves?

Specific reserves are for specific loans, while general reserves are for general loans Signup and view all the answers

What is unearned income?

Interest income on loans received from customers Signup and view all the answers

What is deducted from the amount of gross loans?

Loan losses, both current and projected Signup and view all the answers

Study Notes

Bank Management and Financial Strategies

Ways to increase profitability:
- Increase the volume of services that provide fee income
- Increase fees associated with various services
- Shift funding sources toward less-costly borrowings
- Reduce employee, overhead, loan-loss, and miscellaneous operating expenses
- Reduce owed tax through improved tax management practices

Income Statement

Components of income statement:
- Interest income
- Interest expenses
- Net interest income
- Loan loss expense
- Noninterest income
- Noninterest expenses
- Net operating income and net income
Interest income:
- Earned from loans and security investments
- Majority of revenues for most depository institutions
Interest expenses:
- Interest on deposits
Net interest income:
- Total interest expenses subtracted from total interest income
- Often referred to as the interest margin
- The gap between interest income and interest cost
- Key determinant of profitability
Loan loss expense:
- Annual loan loss provision deducted from current revenues before taxes
Noninterest income:
- Sources of income other than revenues from loans and investment securities
- Fees earned from fiduciary activities
- Service charges on deposit accounts
- Trading account gains and fees
- Additional noninterest income (including revenues from investment banking, security brokerage, and insurance services)
Noninterest expenses:
- Wages, salaries, and employee benefits
- Costs of maintaining, rental fees, and costs of furniture
- Legal fees, office supplies expenses, and repaid costs
Net operating income and net income:
- Sum of interest income and net noninterest income
- Pretax net operating income
- Net income divided into two categories: cash dividends and retained earnings

Balance Sheet

Components of balance sheet:
- Assets
- Liabilities
- Equity capital
Assets:
- Cash assets
- Investment securities
- Trading account assets
- Federal funds
- Loan accounts
Cash assets:
- Account called Cash and Deposits Due from Bank
- Includes vault cash, deposits with other banks, cash items in process of collection, and reserve account with the Federal Reserve
- First line of defense against customer deposits withdrawal
- First source of fund when a customer comes with a loan request
Investment securities:
- Divided into:
  - Liquid portion (short-term government securities, privately issued money market securities, interest-bearing time deposits, and commercial paper)
  - Income-generating portion (held-to-maturity securities)
Trading account assets:
- Securities purchased to provide short-term profits from short-term price movements
- Reported as trading account assets
Federal funds:
- Includes mainly temporary loans made to other depository institutions
- Funds for these temporary loans often come from the reserves a bank has on deposit with the Federal Reserve Bank
Loan accounts:
- Major asset item
- Divided into several groups:
  - By purpose (commercial and industrial, consumer, real estate, financial institutions, foreign, agricultural production, security, and leases)
  - By maturity (short-term and long-term)
  - By collateral (secured and unsecured)
  - By pricing terms (floating-rate and fixed-rate)
Loan losses:
- Loan losses, both current and projected, are deducted from the amount of gross loans
- By law, banks are allowed to build up a reserve for future loan losses, called allowance for loan losses (ALL)
- ALL represents an accumulated reserve against uncollectable loans
Unearned income:
- Interest income on loans received from customer but not earned under the accrual method of accounting banks use today

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Description

This quiz covers strategies for increasing fee income, reducing expenses, and improving tax management practices in bank management. Topics include reducing operating expenses, shifting funding sources, and improving tax management practices.