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Major Items of the Banks Balance Sheet
The balance sheets from financial institutions vary from those of other organizations. This is because there are no inventories or accounts payable and accounts receivable as one would expect. Their assets consist of investments and loans while liabilities consist of deposits and borrowings. Cash is one of the items present in such statements, and it represents 2% of their assets. Financial institutions earn their returns from keeping people’s money. This is achieved by lending that money to people who pay back at an interest.
Additionally, they invest that money in other areas to generate revenue for themselves. In banking language, these assets are called earning assets. Financial institutions invest a commendable amount of the money they get in securities because there is a wide pool of alternative counters to invest in, hence increasing the chances of earning huge returns. Besides, loans are the major source of revenue for financial institutions depending on the interest rates attached to those loans. This explains why most assets fall under this category. Furthermore, banks have very little hard assets such as buildings and equipment and they do not need them to remain operational.
Key Risk Factors in the Banking Industry
The first risk factor is strategic risk, and it comes in when executing plans. This means that banks have to look ahead to identify possible barriers that could halt the progress of their operations. The evaluation process entails looking into future changes that could favor banks, such as speculated rise in interest rates. In such a case, strategic risk management ensures that challenges are foreseen before they actually occur.
Credit risk is another factor that revolves around borrowers who may fail to repay the amount of money they borrowed. The financial institutions use mechanisms to ensure they are shielded from such losses. They do this by assessing the borrowers to determine their ability to repay the loan before giving them loans.
Market risk is another crucial factor because if banks do not keep an eye on the market trends they could find themselves between the rock and a hard place, especially if the interest rates go down. This would have a negative impact on their assets in form of loans because the borrowers would pay little money than expected. Additionally, they have to watch how the various currencies appreciate and depreciate in value to be prepared in facing the volatility that comes along with such trends.
The last major risk is liquidity risk, which is closely associated with market risk. This is because the changing trends in markets could hinder a financial institution from transforming its cash from liquid assets into cash probably because the economy has declined.
Measuring the Performance of Financial Institution
When gauging the performance of a financial institution there are various areas that have to be looked into before concluding whether the bank is on the right track or not. More importantly, one has to look at the output obtained from investments in securities and the profits earned from the repayment of loans. This is done by identifying the initial value of the bank’s investment and the accumulated value.
Principle Tools for Monetary Policy
The central bank uses the tools of monetary policy. They include the open market operations that are meant to regulate the amount of money in the reserve. This is achieved by purchasing the treasury bills to raise the reserve amounts. Additionally, the central bank can sell the government securities to slash the bank reserve. This is important because it influences the transactions in the other parts of the economy, such as the lending rates.
Similarly, a discount loan is a utility used to regulate other banks. When the central bank issues money to the banks at a higher discount, the banks extend this rate to their borrowers, which discourages them from taking the loans. This causes people to withdraw their funds and if the central bank does not come in, the banks could run out of reserves, hence the central bank acts as the back up plan for other banks. On the other hand, low discounts cause borrowers to flood the banks.
Changes in reserve requirements are the last alternative tool used by the central bank. It dictates the minimum amount that must be kept as reserve. This implies that there is a set limit of supply that the central bank cannot exceed without authority from the legislators. Conferring the powers to legislators complicates the matter because it takes more time to make such decisions.
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