Financial Institutions Management

Cover
Financial Institutions Management: A Risk Management Approach
Dedication
About the Authors
Preface
Acknowledgments
Brief Contents
Contents
Part One: Introduction
	Chapter One: Why Are Financial Institutions Special?
		Introduction
		Financial Institutionsí Specialness
			FIs Function as Brokers
			FIs Function as Asset Transformers
			Information Costs
			Liquidity and Price Risk
			Other Special Services
		Other Aspects of Specialness
			The Transmission of Monetary Policy
			Credit Allocation
			Intergenerational Wealth Transfers or Time Intermediation
			Payment Services
			Denomination Intermediation
		Specialness and Regulation
			Safety and Soundness Regulation
			Monetary Policy Regulation
			Credit Allocation Regulation
			Consumer Protection Regulation
			Investor Protection Regulation
			Entry Regulation
		The Changing Dynamics of Specialness
			Trends in the United States
			Global Trends
		Summary
		Appendix 1A: The Financial Crisis: The Failure of Financial Services Institution Specialness
		Appendix 1B: Monetary Policy Tools
	Chapter Two: Financial Services: Depository Institutions
		Introduction
		Commercial Banks
			Size, Structure, and Composition of the Industry
			Balance Sheet and Recent Trends
			Other Fee-Generating Activities
			Regulation
			Industry Performance
		Savings Institutions
			Size, Structure, and Composition of the Industry
			Balance Sheet and Recent Trends
			Regulation
			Industry Performance
		Credit Unions
			Size, Structure, and Composition of the Industry
			Balance Sheet and Recent Trends
			Regulation
			Industry Performance
		Global Financial Performance
		Summary
		Appendix 2A: Financial Statement Analysis Using a Return on Equity (ROE) Framework
		Appendix 2B: Commercial Banks' Financial Statements and Analysis
	Chapter Three: Financial Services: Finance Companies
		Introduction
		Size, Structure, and Composition of the Industry
		Balance Sheet and Recent Trends
			Assets
			Liabilities and Equity
		Industry Performance
		Regulation
		Global Issues
		Summary
	Chapter Four: Financial Services: Securities Firms and Investment Banks
		Introduction
		Size, Structure, and Composition of the Industry
			Key Activities
		Balance Sheet and Recent Trends
			Recent Trends
			Balance Sheet
		Regulation
		Global Issues
		Summary
	Chapter Five: Financial Services: Mutual Fund and Hedge Fund Companies
		Introduction
		Size, Structure, and Composition of the Mutual Fund Industry
			Historical Trends
			Different Types of Mutual Funds
			Mutual Fund Objectives
			Investor Returns from Mutual Fund Ownership
			Mutual Fund Costs
		Balance Sheet and Recent Trends for the Mutual Fund Industry
			Money Market Funds
			Long-Term Funds
		Regulation of Mutual Funds
		Global Issues in the Mutual Fund Industry
		Hedge Funds
			Types of Hedge Funds
			Fees on Hedge Funds
			Offshore Hedge Funds
			Regulation of Hedge Funds
		Summary
	Chapter Six: Financial Services: Insurance Companies
		Introduction
		Life Insurance
			Size, Structure, and Composition of the Industry
			Balance Sheet and Recent Trends
			Regulation
		Property-Casualty Insurance
			Size, Structure, and Composition of the Industry
			Balance Sheet and Recent Trends
			Regulation
		Global Issues
		Summary
	Chapter Seven: Risks of Financial Institutions
		Introduction
		Interest Rate Risk
		Credit Risk
		Liquidity Risk
		Foreign Exchange Risk
		Country or Sovereign Risk
		Market Risk
		Off-Balance-Sheet Risk
		Technology and Operational Risks
		Risk of Digital Disruption and Fintech
		Insolvency Risk
		Other Risks and the Interaction of Risks
		Summary
Part Two: Measuring Risk
	Chapter Eight: Interest Rate Risk I
		Introduction
		The Level and Movement of Interest Rates
		The Repricing Model
			Rate-Sensitive Assets
			Rate-Sensitive Liabilities
			Equal Changes in Rates on RSAs and RSLs
			Unequal Changes in Rates on RSAs and RSLs
		Weaknesses of the Repricing Model
			Market Value Effects
			Overaggregation
			The Problem of Runoffs
			Cash Flows from Off-Balance-Sheet Activities
		Summary
		Appendix 8A: The Maturity Model
		Appendix 8B: Term Structure of Interest Rates
	Chapter Nine: Interest Rate Risk II
		Introduction
		Duration: A Simple Introduction
		A General Formula for Duration
			The Duration of Interest-Bearing Bonds
			The Duration of Zero-Coupon Bonds
			The Duration of Consol Bonds (Perpetuities)
		Features of Duration
			Duration and Maturity
			Duration and Yield
			Duration and Coupon Interest
		The Economic Meaning of Duration
			Semiannual Coupon Bonds
		Duration and Interest Rate Risk
			Duration and Interest Rate Risk Management on a Single Security
			Duration and Interest Rate Risk Management on the Whole Balance Sheet of an FI
		Immunization and Regulatory Considerations
		Difficulties in Applying the Duration Model
			Duration Matching Can Be Costly
			Immunization Is a Dynamic Problem
			Large Interest Rate Changes and Convexity
		Summary
		Appendix 9A: The Basics of Bond Valuation
		Appendix 9B: Incorporating Convexity into the Duration Model
	Chapter Ten: Credit Risk: Individual Loan Risk
		Introduction
		Credit Quality Problems
		Types of Loans
			Commercial and Industrial Loans
			Real Estate Loans
			Individual (Consumer) Loans
			Other Loans
		Calculating the Return on a Loan
			The Contractually Promised Return on a Loan
			The Expected Return on a Loan
		Retail versus Wholesale Credit Decisions
			Retail
			Wholesale
		Measurement of Credit Risk
		Default Risk Models
			Qualitative Models
			Quantitative Models
			Newer Models of Credit Risk Measurement and Pricing
		Summary
		Appendix 10A: Credit Analysis and Loan Underwriting
		Appendix 10B: BlackñScholes Option Pricing Model
	Chapter Eleven: Credit Risk: Loan Portfolio and Concentration Risk
		Introduction
		Simple Models of Loan Concentration Risk
		Loan Portfolio Diversification and Modern Portfolio Theory (MPT)
			Moodyís Analytics RiskFrontier Model
			Partial Applications of Portfolio Theory
			Regulatory Models
		Summary
		Appendix 11A: CreditMetrics
		Appendix 11B: CreditRisk+
	Chapter Twelve: Liquidity Risk
		Introduction
		Causes of Liquidity Risk
		Liquidity Risk at Depository Institutions
			Liability-Side Liquidity Risk
			Asset-Side Liquidity Risk
			Measuring a DI's Liquidity Risk Exposure
			Liquidity Risk Measures
			Liquidity Planning
			Liquidity Risk, Unexpected Deposit Drains, and Bank Runs
			Bank Runs, the Discount Window, and Deposit Insurance
		Liquidity Risk at Other Types of Financial Institutions
			Life Insurance Companies
			Property-Casualty Insurers
			Investment Funds
		Summary
	Chapter Thirteen: Foreign Exchange Risk
		Introduction
		Foreign Exchange Rates and Transactions
			Foreign Exchange Rates
			Foreign Exchange Transactions
		Sources of Foreign Exchange Risk Exposure
			Foreign Exchange Rate Volatility and FX Exposure
		Foreign Currency Trading
			FX Trading Activities
		Foreign Asset and Liability Positions
			The Return and Risk of Foreign Investments
			Risk and Hedging
			Multicurrency Foreign AssetñLiability Positions
		Interaction of Interest Rates, Inflation, and Exchange Rates
			Purchasing Power Parity
			Interest Rate Parity Theorem
		Summary
	Chapter Fourteen: Sovereign Risk
		Introduction
		Credit Risk versus Sovereign Risk
		Debt Repudiation versus Debt Restructuring
		Country Risk Evaluation
			Outside Evaluation Models
			OECD Country Risk Classifications
			Internal Evaluation Models
			Using Market Data to Measure Risk: The Secondary Market for LDC and Emerging Market Debt
		Summary
		Appendix 14A: Mechanisms for Dealing with Sovereign Risk Exposure
	Chapter Fifteen: Market Risk
		Introduction
		Calculating Market Risk Exposure
		The RiskMetrics Model
			The Market Risk of Fixed-Income Securities
			Foreign Exchange
			Equities
			Portfolio Aggregation
		Historic (Back Simulation) Approach
			The Historic (Back Simulation) Model versus RiskMetrics
			The Monte Carlo Simulation Approach
			Expected Shortfall
		Regulatory Models: The BIS Standardized Framework
		The BIS Regulations and Large-Bank Internal Models
		Summary
	Chapter Sixteen: Off-Balance-Sheet Risk
		Introduction
		Off-Balance-Sheet Activities and FI Solvency
		Returns and Risks of Off-Balance-Sheet Activities
			Loan Commitments
			Commercial Letters of Credit and Standby Letters of Credit
			Derivative Contracts: Futures, Forwards, Swaps, and Options
			Forward Purchases and Sales of When-Issued Securities
			Loans Sold
		Non-Schedule L Off-Balance-Sheet Risks
			Settlement Risk
			Affiliate Risk
		The Role of OBS Activities in Reducing Risk
		Summary
		Appendix 16A: A Letter of Credit Transaction
	Chapter Seventeen: Technology and Other Operational Risks
		Introduction
		Sources of Operational Risk
		Information Technology (IT) Risks
			Strategic Risk of IT
			Cybersecurity Risk
			Technology Vendor and Third-Party Risk
			Data Management Risk
			Risk of Ineffective Risk Management
		The Effect of Technology on Revenues and Costs
			Technology and Revenues
			Technology and Costs
		Technology and the Evolution of the Payments System
			Risks That Arise in an Electronic Transfer Payment System
		Regulatory Issues and Technology and Operational Risks
		Summary
	Chapter Eighteen: Risk of Digital Disruption and Fintech
		Introduction
		The Evolution of Fintech
		Changing Relationship Between Banks and Fintechs
		How Big Tech Is Transforming Fintech
		The Types of Fintech Innovations
			Payments, Clearing, and Settlement Services
			Market Support Services
			Credit, Deposit, and Capital-Raising Services
			Investment Management Services
		Regulatory Approaches to Fintech
			Fintech Charters and Other Licenses
			Regulating Big Techs
			International Regulations
		Summary
Part Three: Managing Risk
	Chapter Nineteen: Liability and Liquidity Management
		Introduction
		Liquid Asset Management
			Monetary Policy Implementation Reasons
			Taxation Reasons
		The Composition of the Liquid Asset Portfolio
			Managing Liquid Assets Other than Cash
		Liability Management
			Funding Risk and Cost
		Choice of Liability Structure
			Demand Deposits
			Interest-Bearing Checking (NOW) Accounts
			Passbook Savings
			Money Market Deposit Accounts (MMDAs)
			Retail Time Deposits and CDs
			Wholesale CDs
			Federal Funds
			Repurchase Agreements (RPs)
			Other Borrowings
		Liquidity and Liability Structures for U.S. Depository Institutions
		Liability and Liquidity Risk Management in Insurance Companies
		Liability and Liquidity Risk Management in Other Financial Institutions
		Summary
		Appendix 19A: Minimum Reserve Requirements
		Appendix 19B: Bankersí Acceptances and Commercial Paper as Sources of Financing
	Chapter Twenty: Deposit Insurance and Other Liability Guarantees
		Introduction
		Bank and Thrift Guaranty Funds
		The Causes of the Depository Fund Insolvencies
			The Financial Environment
			Moral Hazard
		Panic Prevention versus Moral Hazard
		Controlling Depository Institution Risk Taking
			Stockholder Discipline
			Depositor Discipline
			Regulatory Discipline
		Non-U.S. Deposit Insurance Systems
		The Discount Window
			Deposit Insurance versus the Discount Window
			The Discount Window
		Other Guaranty Programs
			National Credit Union Administration
			PropertyñCasualty and Life Insurance Companies
			The Securities Investor Protection Corporation
			The Pension Benefit Guaranty Corporation
		Summary
		Appendix 20A: Calculation of Deposit Insurance Premiums
		Appendix 20B: FDIC Press Release of Bank Failures
		Appendix 20C: Deposit Insurance Coverage for Commercial Banks in Various Countries
	Chapter Twenty-One: Capital Adequacy
		Introduction
		Capital and Insolvency Risk
			Capital
			The Market Value of Capital
			The Book Value of Capital
			The Discrepancy between the Market and Book Values of Equity
			Arguments against Market Value Accounting
		Capital Adequacy in the Commercial Banking and Thrift Industry
			Credit Risk and Risk-Based Capital
			Risk-Weighted Assets for Credit Risk
			Interest Rate Risk, Market Risk, and Risk-Based Capital
			Operational Risk and Risk-Based Capital
		Summary
		Appendix 21A: Internal Ratings-Based Approach to Measuring Risk-Weighted Assets
		Appendix 21B: Methodology Used to Determine G-SIBs' Capital Surcharge
		Appendix 21C: Capital Requirements for Other Financial Institutions
	Chapter Twenty-Two: Product and Geographic Expansion
		Introduction
		Product Diversification
		Segmentation in the U.S. Financial Services Industry
			Commercial and Investment Banking Activities
			Banking and Insurance
			Commercial Banking and Commerce
			Nonbank Financial Service Firms and Banking
			Nonbank Financial Service Firms and Commerce
		Activity Restrictions in the United States versus Other Countries
		Issues Involved in the Diversification of Product Offerings
			Safety and Soundness Concerns
			Economies of Scale and Scope
			Conflicts of Interest
			Deposit Insurance
			Regulatory Oversight
			Competition
		Domestic Geographic Expansion
		Regulatory Factors Affecting Geographic Expansion
			Insurance Companies
			Thrifts
			Commercial Banks
		Cost and Revenue Synergies Affecting Domestic Geographic Expansion by Merger and Acquisition
			Cost Synergies
			Revenue Synergies
			Merger Guidelines for Acceptability
		Other Market- and Firm-Specific Factors Affecting Domestic Geographic Expansion Decisions
		Global and International Expansions
			U.S. Banks Abroad
			Foreign Banks in the United States
		Advantages and Disadvantages of International Expansion
			Advantages
			Disadvantages
		Summary
	Chapter Twenty-Three: Futures and Forwards
		Introduction
		Forward and Futures Contracts
			Spot Contracts
			Forward Contracts
			Futures Contracts
		Forward Contracts and Hedging Interest Rate Risk
		Hedging Interest Rate Risk with Futures Contracts
			Microhedging
			Macrohedging
			Routine Hedging versus Selective Hedging
			Macrohedging with Futures
			The Problem of Basis Risk
		Hedging Foreign Exchange Risk
			Forwards
			Futures
			Estimating the Hedge Ratio
		Hedging Credit Risk with Futures and Forwards
			Credit Forward Contracts and Credit Risk Hedging
			Futures Contracts and Catastrophe Risk
		Regulation of Derivative Securities
		Summary
		Appendix 23A: Microhedging with Futures
	Chapter Twenty-Four: Options, Caps, Floors, and Collars
		Introduction
		Basic Features of Options
			Buying a Call Option on a Bond
			Writing a Call Option on a Bond
			Buying a Put Option on a Bond
			Writing a Put Option on a Bond
		Writing versus Buying Options
			Economic Reasons for Not Writing Options
			Regulatory Reasons
			Futures versus Options Hedging
		The Mechanics of Hedging a Bond or Bond Portfolio
			Hedging with Bond Options Using the Binomial Model
		Actual Bond Options
		Using Options to Hedge Interest Rate Risk on the Balance Sheet
		Using Options to Hedge Foreign Exchange Risk
		Hedging Credit Risk with Options
		Hedging Catastrophe Risk with Call Spread Options
		Caps, Floors, and Collars
			Caps
			Floors
			Collars
			Caps, Floors, Collars, and Credit Risk
		Summary
		Appendix 24A: Microhedging with Options
	Chapter Twenty-Five: Swaps
		Introduction
		Swap Markets
		Interest Rate Swaps
			Realized Cash Flows on an Interest Rate Swap
			Macrohedging with Swaps
		Currency Swaps
			Fixed-Fixed Currency Swaps
			Fixed-Floating Currency Swaps
		Credit Swaps
			Total Return Swaps
			Pure Credit Swaps
			CDS Indexes
		Swaps and Credit Risk Concerns
			Netting and Swaps
			Payment Flows Are Interest, Not Principal
			Standby Letters of Credit
		LIBOR Transition
		Summary
		Appendix 25A: Setting Rates on an Interest Rate Swap
	Chapter Twenty-Six: Loan Sales
		Introduction
		The Bank Loan Sales Market
			Definition of a Loan Sale
			Types of Loan Sales
			Types of Loan Sales Contracts
			Trends in Loan Sales
			The Buyers and the Sellers
		Why Banks and Other FIs Sell Loans
			Reserve Requirements
			Fee Income
			Capital Costs
			Liquidity Risk
		Factors Affecting Loan Sales Growth
			Access to the Commercial Paper Market
			Customer Relationship Effects
			Legal Concerns
			BIS Capital Requirements
			Market Value Accounting
			Asset Brokerage and Loan Trading
			Government Loan Sales
			Credit Ratings
			Purchase and Sale of Foreign Bank Loans
		Summary
	Chapter Twenty-Seven: Securitization
		Introduction
		Mechanisms Used to Convert On-Balance-Sheet Assets to a Securitized Asset
		The Pass-Through Security
			GNMA
			FNMA
			FHLMC
			The Incentives and Mechanics of Pass-Through Security Creation
			Prepayment Risk on Pass-Through Securities
			Prepayment Models
			Government Sponsorship and Oversight of FNMA and Freddie Mac
		The Collateralized Mortgage Obligation (CMO)
			Creation of CMOs
			Class A, B, and C Bond Buyers
			Other CMO Classes
		The Mortgage-Backed Bond (MBB) or Covered Bond
		Innovations in Securitization
			Mortgage Pass-Through Strips
			Securitization of Other Assets
		Can All Assets Be Securitized?
		Summary
		Appendix 27A: Fannie Mae and Freddie Mac Balance Sheets
Index