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Chapter 19
Bank Management
Financial Markets and Institutions, 7e, Jeff Madura
Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.
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Chapter Outline

Bank management

Managing liquidity

Managing interest rate risk

Managing credit risk

Managing market risk

Operating risk

Managing risk of international operations

Bank capital management

Management based on forecasts

Bank restructuring to manage risks

Integrated bank management
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
Ensure proper disclosure of the financial condition and
performance

Oversee growth strategies such as acquisitions

Oversee policies for changing capital structure

Assess performance and ensure that corrective action is
taken if there is weak performance
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Managing Liquidity

Banks can experience illiquidity when cash outflows
exceed cash inflows

Illiquidity can be resolved by creating additional liabilities or
selling assets

Banks should maintain the level of liquid assets that will
satisfy their liquidity needs but use their remaining funds
to satisfy their other objectives

Research has shown that high-performance banks are able to
maintain relatively low liquidity

Use of securitization to boost liquidity

Securitization commonly involves the sale of assets by the bank
to a trustee who issues securities that are collateralized by the

Rate on Loans
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Managing Interest Rate Risk
(cont’d)

To measure interest rate risk, a bank measures
the risk and then uses its assessment of future
interest rates to decide whether and how to
hedge the risk

Methods used to assess interest rate risk:

Gap analysis

Duration analysis

Regression analysis
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Managing Interest Rate Risk
(cont’d)

Methods used to assess interest rate risk
(cont’d)

Gap analysis

Gap is defined as:

The gap ratio is the volume of rate-sensitive assets divided
by rate-sensitive liabilities

Banks often classify assets and liabilities into categories
based on the time of repricing and calculate a gap for each
category

Banks must decide how to classify their liabilities and assets
as rate sensitive versus rate insensitive

Each bank may have its own classification system, because
there is no perfect measurement of gap
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Managing Interest Rate Risk
(cont’d)

Methods used to assess interest rate risk
(cont’d)

Duration measurement

Duration can capture the different degrees of interest rate
sensitivity:

The duration of a bank’s asset portfolio is the weighted
average of the durations of the individual assets
∑
∑
=
=
+
+
=

rate risk

Banks with positive duration gaps are adversely affected by rising
interest rates and positively affected by declining interest rates
( )
[ ]
LIAB/ASDURLIAB-DURASDURGAP ×=
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Managing Interest Rate Risk
(cont’d)

Methods used to assess interest rate risk
(cont’d)

Duration measurement (cont’d)

Assets with shorter maturities have shorter durations

Assets that generate more frequent coupon payments have
shorter durations

The capabilities of duration are limited when applied to
assets that can be terminated on a moment’s notice
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Managing Interest Rate Risk
(cont’d)

Methods used to assess interest rate risk
(cont’d)


Regression analysis can be combined with the value-at-risk
(VAR) method to determine how its market value would change in
response to specific interest rate movements
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Managing Interest Rate Risk
(cont’d)

Determining whether to hedge interest rate risk

Banks should consider using their measurement of
interest rate risk along with their forecast of interest
rate movements to determine whether they should
hedge

Since none of the measures is perfect for all
situations, some banks measure interest rate risk
using all three methods

In general, the three methods should lead to a similar
conclusion (see next slide)
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Gap Analysis
If the bank’s gap is:
Negative
Positive
Increase
Increase
Decrease
Decrease
…and interest rates