Transcript MCF 304: Bank Management Lecture 2.2 Asset Management Asset Management • • • How to distribute bank funds among different categories of assets so as to maximize.

MCF 304: Bank Management
Lecture 2.2
Asset Management
1
Asset Management
•
•
•
How to distribute bank funds among different
categories of assets so as to maximize profits
Different assets have different level of
liquidity and profitability
The LP dilemma: If bank emphasize on
liquidity, profitability will be sacrifice
2
Bank Financial Statements:
Balance Sheet
Fixed Assets
Current Assets
- Cash and short term funds
- Securities purchased under
resale agreement (REPO)
- Deposits and placements
with banks and other
financial institutions
- Securities held for trading
- Investment securities
- Loans, advances and
financing
- Other assets
- Investment in subsidiary
companies
- Investment in associate
companies
3
Bank Financial Statements:
Income Statement
Interest Income
(-) Interest Expense
(=)Net Interest Income
(-) Allowance for losses on
loans, advances and
financing
(+)Non-Interest Income
(=)Net Income
Net Income
(-) Overhead Expenses
(=) Profit Before Tax
(-) Tax
(=) Net Profit After Tax
(-) Transfer to Statutory
Reserves
(=) Net Profit After Transfer to
Statutory Reserves
4
Bank Financial Statements:
Income Statement
Net Profit After Transfer
to Statutory Reserves
(+) Retained Profit
Brought Forward
(+) Distributable Profit
(-) Proposed Dividend
(=) Retained Profit Carried
Forward
Earnings Per Share
5
Asset Management
• How the bank invest its assets / funds to
maximize its shareholders wealth
• As the liquidity and profitability differ from
one assets to another, banks must take into
consideration the liquidity-profitability (LP)
Dilemma
6
LP Dilemma
• Exist because the degrees of liquidity and
profitability are different across different assets
• Attributed by conflicting goals among
depositors, shareholders and controlling party
• Shareholders expect high return, depositors
desire maximum liquidity
7
LP Dilemma
•
LP Dilemma = to find a method that can
strike a balance between risk & return,
liquidity & profitability
• Three methods;
i. Fund pool method
ii. Assets allocation method
iii. Management science method
8
Fund Pool Method
• Fund from all sources are pooled together to
create a single source of funds
• The funds are distributed to the various
predetermined categories of assets based of
their degree of importance
9
Fund Pool Method
Example
Current deposits
Savings deposits
Fixed deposits 100
REPO
NCD’s
50
Debentures
Total
200
100
50
100
600
Reserve based 20%
Statutory reserves 10%
Secondary reserves 20%
Loan portfolio 30%
Allocation by sectors;
Agriculture 10%
Manufacturing 50%
Real estate 20%
Service 20%
10
Disadvantaged of Fund Pool Method
• Over emphasize on liquidity at the expense of
profitability
• Does not provide any specific basis for purpose
of estimating liquidity standards
• does not take into consideration the volatility
of deposits accounts
• Does not recognized source of liquidity
11
Assets Allocation Method
• Banks are forced to utilize deposits more efficiently
and effectively as a result of competition from nonbank financial institutions in terms of deposits
acquisitions and use funds in a more profitable way
• Assets allocation method treats each source of fund
individually in view of the different degrees of
volatility among them. Each source of funds is treated
as a profit centre
• Short (long) term assets should be financed by short
(long) term financing
12
Disadvantages of
Assets Allocation Method
• May overestimate the liquidity of deposits accounts
• Does not recognized loan portfolio as a source of
liquidity
• Asset & liability management decisions are made
separately
• does not provide specific guidelines on the allocation
of funds among different categories of bank assets
13
Management Science Method
• a.k.a Linear programming method
• A mathematical procedure to choose variable
values for purpose of maximizing (minimizing)
an objective, subject to certain restrictions
• Helps to determine the required balance sheet
quantity set in order to maximize bank
profitability subjects to restrictions in trems of
liquidity and other fixed rules
14
Management Science Method
Example
Bank A has funds totaling RM25 million which can
be invested in loan assets (X1) and secondary reserves
(X2). The funds made up of current deposits and fixed
deposits. The rate of return is estimated at 12% while
short term securities 8%. Let’s assume that the bank
income is net income after deducting the cost of
deposits. The management bank of bank A has
stipulated the bank’s liquidity standard of RM2 in
short term securities for every RM10 investment in
fixed assets
15
Bank Liquidity
•
i.
ii.
iii.
iv.
v.
5 factors why banks must have adequate
liquidity;
Confidence
Relationship
Force sale
Risk premium
Last chance
16
Bank Liquidity Theory
Commercial Financing
- A bank is considered
liquid if its loan
portfolio consist of short
term financing only
- Maturity dates of
financing coincides with
maturity dates of
deposits
Stability
- Bank invest part of their
funds in loan portfolio
& secondary markets
- This theory prolongs the
average maturity period
of loans portfolios
17
Bank Liquidity Theory
Expected Income
- Bank liquidity can be
acquired through loan
repayments
- Loan repayment should be
match with loan income
- Acknowledges that loan
portfolio is a source of
liquidity
Liability Management
- Banks can fulfill liquidity
requirements by borrowing
from the money and capital
markets
- Borrowed funds acquired for
the purpose of bank liquidity
are sometimes called
purchased funds
18
Liquidity Measurement
• No one single specific measurement standards
• However loan to deposit ratio is used widely to
measure liquidity
• As the ratio increases, bank liquidity decreases
• Loan interest increase in tandem with the
increase in loan to deposit ratio since the
demand for credit exceeds supply
19
Disadvantages of
Loan to Deposits Ratio
• Does not show the maturity or quality of loan
portfolio
• Does not provide any truth about bank liquidity
needs. Banks that provides more for
speculative loans are more likely to face
liquidity problems
• Does not provide any information on other
assets of a bank other than its loan portfolio
20
Other Liquidity Measurement
1. Cash Assets / Total Assets
2. (Cash Assets – Statutory
Reserve + Marketable
Government Securities of
Less than One year
Maturity) / Total Deposits
3. (Cash Assets – Reserve +
Government Securities) / Total
Deposits
4. (Cash Assets + Government
Securities) / Total Deposits
21
Estimating Credit Requirement
Please refer to worksheet
22
Thank You!
Izdihar Baharin @ Md Daud
Post Graduate Centre
HP: 006019-5170817
Email: [email protected]
23