BFF1001 Lecture Notes - Lecture 7: Interest Rate Risk, Asset Management, Liquidity Risk
Week 7: Financial Institutions
How do banks make money?
1. Chasing interest on assets (loans) – interest paid on liabilities
(deposits)
This difference between interested earned from loans and interest paid on
sources of funds is known as the interest rate margin (IRM)
IRM = (IR – IP)/ TA
Where IR = interest received,
IP = interest paid
TA = total assets
Size of the IRM is affected by…
1. Capital adequacy and reserve requirements
2. Product adequacy and reserve requirements
3. Product marginal costs
4. Demand elasticity
2. Fixed Fees and commissions
3. Returns on investments products
Document Summary
How do banks make money: chasing interest on assets (loans) interest paid on liabilities (deposits) This difference between interested earned from loans and interest paid on sources of funds is known as the interest rate margin (irm) Size of the irm is affected by : capital adequacy and reserve requirements, product adequacy and reserve requirements, product marginal costs, demand elasticity, fixed fees and commissions, returns on investments products. Bank risk can be defined as uncertainty arising from cash flows of the banks assets and liabilities. It is important to know the primary risks that commercial banks face : credit risk, interest rate risk, liquidity risk. Credit risk = arises from the possibility of default in the bank loan book; causing a loss of a portion of all loan principal and interest earnings. Interest rate = risk arises from unforeseen changes in the interest rate margin due to volatility in asset earnings and cost of funds.
