COMMERCIAL BANKS

QUIZZ
1. Rank the following bank assets from most liquid (Rank: 1) to least liquid (Rank: 4)
a. Commercial Loans
b. Securities
c. Reserves
d. Physical Capital

2. If the president of a bank told you that the bank was so well run that it never had to
call in loans, sell securities or borrow as a result of a deposit outflow, would you be
willing to buy stock in that bank? Why or why not?
3. If the bank you own has no excess reserves and a sound customer comes in asking
for a loan, should you automatically turn the customer down, explaining that you
don’t have any excess reserves to loan out? Why or why not? What options are
available for you to provide the funds your customer needs?
4. Why has the development of overnight loan markets made it more likely that banks
will hold fewer reserves?
5. If you are a banker and expect interest rates to rise in the future, would you want to
make short-term or long-term loans?
6. “Bank managers should always seek the highest return possible on their assets.” Is
this statement true, false or uncertain? Explain your answer.
7. “Banking has become a more dynamic industry because of more active liability
management.” Is this statement true, false or uncertain?
8. Why has noninterest income been growing as a source of bank operating income?
9. Which components of operating expenses experience the greatest fluctuations?
Why?
10. Why do equity holders care more about ROE than ROA?
11. What does the net interest margin measure and why is it important to bank
managers?
12. If a bank doubles the amount of its capital and ROA stays constant, what will happen
to ROE?
13. If a bank finds its ROE is too low because it has too much bank capital, what can it
do to raise its ROE?
 14. What are the benefits and costs for a bank when it decides to increase the amount of
its bank capital?
15. If a bank is falling shore of meeting its capital requirements by $1m, what three
things can it do to rectify the situation?

EXCERCISES
1. The balance sheet of TriBank starts with an allowance for loan losses of $1.33m.
During the year, TriBank charges off worthless loans of $0.84m, recovers $0.22m on
loans previously charged off, and charges current income for a $1.48m provision for
loan losses. Calculate the end-of-year allowance for loan losses.

2. Wiggley S&L issues a standard 30-year fixed rate mortgage at 7.8% for $150,000.
Thirty-six months later mortgage rates jump to 13%. If the S&L sells the mortgage
at this point how much of a loss is incurred?
3. Refer to the previous question. In 1981 Congress allowed S&Ls to sell mortgages at
a loss and amortize the loss over the remaining life of the mortgage. If this were
used for the previous question, how would the transaction have been recorded? What
would be the annual adjustment? When would that end?

4. For the upcoming week, Nobel National Bank plans to issue $25m in mortgages and
purchase $100m in T-bills. New deposits of $35m are expected and other sources
will generate $15m in cash. What is Nobel’s estimate of funds needed?

5. A bank estimates that demand deposits are, on average, $100m with a standard
deviation of $5m. The bank wants to maintain a minimum of 8% of deposits in
reserves at all times. What is the highest expected level of deposits during the
month? What reserves to they need to maintain? Use a 99% confidence level.

The remaining questions (6 to 16) relate to the first month’s operation of

NewBank.
6. NewBank started its first day of operations with $6m in capital. $100m in checkable
deposits is received. The bank issues a $25m commercial loan and another $25m in
mortgages, with the following terms.
  Mortgages: 100 standard 30-year fixed-rate mortgages with a nominal annual rate
of 5.25% each for $250,000.
 Commercial loan: 3-year loan, simple interest paid monthly at 0.75% per month.
If required reserves are 8%, what does the bank’s balance sheet look like? Ignore
any loan loss reserves.

7. NewBank decides to invest $45m in 30-day T-bills. The T-bills are currently trading
at $4986.70 (including commissions) for a $5,000 face value instrument. How many
do they purchase? What does the balance sheet look like?
8. On the third day of operations, deposits fall by $5m. What does the balance sheet
look like? Are there any problems?
9. To meet any shortfall in the previous question, NewBank will borrow the cash in the
federal funds market. Management decides to borrow the needed funds for the
remainder of the month (now 29 days). The required yield on a discount basis is
2.9%. What does the balance sheet look like after this transaction?
10. The end of the month finally arrives for NewBank, and it receives all of the required
payments from its mortgages, commercial loans and T-bills. How much cash is
received? How are these transactions recorded?
11. NewBank also pays off its federal funds borrowed. How much cash is owed? How
is this recorded?

12. What does the month-end balance sheet for NewBank look like? Calculate this
before any income tax consideration.

13. Calculate NewBank’s ROA and NIM for its first month. Assume that net interest
equals EBT, and that NewBank is in the 34% tax bracket.

14. Calculate NewBank’s ROE and final balance sheet including its tax liabilities.\

15. If NewBank’s target ROE is 4.5%, how much net fee income must it generate to
meet this target?
16. After making payments for three years, one of the mortgage borrowers defaults on
the mortgage. NewBank immediately takes possession of the house and sells it at
auction for $175,000. Legal fees amount to $25,000. If no loan loss reserve was
established for the mortgage loans, how is this event recorded.