Bank Management Chapter 5

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