Financial Liquidity and Cost Management Quiz

Funding Sources and Strategies

• Customer deposits are considered the most stable funding source for commercial banks due to their stickiness and low cost.
• Wholesale funding is considered less stable because it is more volatile and expensive.

Wholesale Funding Risks

• The main risk associated with wholesale funding is liquidity risk, which arises from the uncertainty of refinancing.

Funding Allocation

• Large banks buy funding at the margin to take advantage of cheaper funding opportunities and optimize their funding mix.

Investment Allocation

• Banks allocate their funds to investments in securities to diversify their portfolios and earn returns.

Money Market and Capital Market Instruments

• Money Market instruments are characterized by short-term maturity, high liquidity, and low risk.
• Capital Market instruments are characterized by long-term maturity, lower liquidity, and higher risk.

Investment Maturity Strategies

• The Ladder or Spaced Maturity Policy involves investing in a portfolio of securities with staggered maturities to manage interest rate risk and liquidity.

Deposit Types

• Transaction deposits are checking accounts used for daily transactions, whereas non-transaction savings deposits are used for storing value.
• Examples of transaction deposits include demand deposits, checking accounts, and Negotiable Order of Withdrawal (NOW) accounts.

Deposit Pricing

• Conditional pricing for deposits involves offering different interest rates to depositors based on their deposit volume and stability.

Liquidity Management

• The main strategy used by banks to find new money when deposit volume is inadequate is to attract new depositors or borrow from the market.
• Liquidity management involves storing liquidity in cash and marketable securities to meet unexpected withdrawals.
• The approach for estimating financial institutions' liquidity needs involves forecasting loans demand and deposits availability.

Financial Statement Analysis

• Bank regulators, investors, and creditors are interested in analyzing banks' financial statements to assess their financial health and risk.

Lending Programs

• The Federal Reserve's discount window offers lending programs, such as the secondary credit program, for institutions not qualifying for primary credit.

Capital Management

• Banks prefer to operate with lower levels of capital than socially optimal due to the high cost of capital.
• Tier 1 capital under the total risk-based capital ratio includes common equity, retained earnings, and disclosed reserves.

Credit Risk Management

• The internal ratings-based approach allows banks to assign a rating to each counterparty based on their internal credit assessment process.

Non-Performing Loans

• Selling non-performing loans from a bank's balance sheet can improve asset quality and reduce provisioning costs.

Capital Markets and Profitability

• The relationship between Return on Equity (ROE) and Price-to-Tangible Book Value (P/TBV) in the stock market is positive, indicating that higher ROE leads to higher P/TBV.
• The main factor that has affected the profitability of EU banks in recent years is the low-interest-rate environment.

Systemic Risk

• Systemic risk in the financial system refers to the risk of a collapse of the entire financial system.

Asset Classification and Funding

• Interest Earning Assets (IEA) for a bank include loans, securities, and other investments that generate income.
• The key indicator of a bank's funding strategy in terms of Interest Bearing Liabilities (IBL) is the Loan to Deposit Ratio (LD Ratio).
• The key method of reclassification for separating assets that generate income from other assets and liabilities that have a cost is the asset liability management (ALM) framework.
• The Loan to Deposit Ratio (LD Ratio) measures the bank's dependence on wholesale funding.
• Positive Yield on Assets (A) represents the net interest income earned by a bank.