Mc Graw Hill Education

Transcription

1 Financial Institutions Management A Risk Management Approach Ninth Edition Anthony Saunders John M. Schiff Professor of Finance Solomon Center Stern School of Business New York University Marcia Millon Cornett Robert A. and Julia E. Doran Professor of Finance Bentiey University Mc Graw Hill Education

2 Contents PART ONE INTRODUCTION 1 Chapter One Why Are Financial Institutions Special! 2 Introduction 2 Financial Institutions' Specialness 4 FIs Function as Brokers 5 FIs Function as Asset Transformers 5 Information Costs 6 Liquidity and Price Risk 7 Other Special Services 8 Other Aspects of Specialness 8 The Transmission of Monetary Policy 9 Credit Allocation 9 Intergenerational Wealth Transfers or Time Intermediation 9 Payment Services 10 Denomination Intermediation 10 Specialness and Regulation 10 Safety and Soundness Regulation 11 Monetary Policy Regulation 13 Credit Allocation Regulation 13 Consumer Protection Regulation 14 Investor Protection Regulation 14 Entry Regulation 15 The Changing Dynamics of Specialness 15 Trends in the United States 15 Global Trends 21 Summary 22 Appendix 1A The Financial Crisis: The Failure of Financial Services Institution Specialness 25 Appendix 1B Monetary Policy Tools 25 Chapter Two Financial Services: Depository Institutions 26 Introduction 26 Commercial Banks 28 Size, Structure, and Composition ofthe Irtdustry 29 Balance Sheet and Recent Trends 33 Other Fee-Generating Activities 39 Regulation 40 Industry Performance 46 Savings Institutions 49 Size, Structure, and Composition of the Industry 49 Balance Sheet and Recent Trends 51 Regulation 53 Industry Performance 53 Credit Unions 55 Size, Structure, and Composition ofthe Industry 57 Balance Sheet and Recent Trends 58 Regulation 60 Industry Performance 60 Global Issues: The Financial Crisis 62 Summary 64 Appendix 2A Financial Statement Analysis Using a Return on Equity (ROE) Framework 69 Appendix 2B Commercial Banks' Financial Statements and Analysis 69 Appendix 2C Depository Institutions and Their Regulators 69 Appendix 2D Technology in Commercial Banking 69 Chapter Three Financial Services: Finance Companies 70 Introduction 70 Size, Structure, and Composition of the Industry 70 Balance Sheet and Recent Trends 74 Assets 74 Liabilities and Equity 79 Industry Performance 80 Regulation 82 Global Issues 84 Summary 84 XV

3 xvi Contents Chapter Four Financial Services: Securities Firnis and Investment Banks 86 Introduction 86 Size, Structure, and Composition of the Industry 88 Balance Sheet and Recent Trends 98 Recent Trends 98 Balance Sheet 102 Regulation 103 Global Issues 107 Summary 111 Chapter Five Financial Services: Mutual Fund and Hedge Fund Companies 114 Introduction 114 Size, Structure, and Composition of the Mutual Fund Industry 115 Historical Trends 115 Different Types of Mutual Funds 118 Mutual Fund Objectives 123 Investor Returns from Mutual Fund Ownership 125 Mutual Fund Costs 129 Balance Sheet and Recent Trends for the Mutual Fund Industry 132 Money Market Funds 132 Long-Term Funds 134 Regulation of Mutual Funds 135 Global Issues in the Mutual Fund Industry 138 Hedge Funds 140 Types of Hedge Funds 141 Fees on Hedge Funds 146 Offshore Hedge Funds 146 Regulation of Hedge Funds 147 Summary 148 Chapter Six Financial Services: Insurance Companies 151 Introduction 151 Life Insurance 152 Size, Structure, and Composition of the Industry 152 Balance Sheet and Recent Trends 156 Regulation 159 Property-Casualty Insurance 161 Size, Structure, and Composition of the Industry 161 Balance Sheet and Recent Trends 163 Regulation 172 Global Issues 172 Summary 174 Chapter Seven Risks of Financial Institutions 177 Introduction 177 Interest Rate Risk 178 Credit Risk 180 Liquidity Risk 182 Foreign Exchange Risk 184 Country or Sovereign Risk 186 Market Risk 187 Off Balance-Sheet Risk 188 Technology and Operational Risks 190 Insolvency Risk 192 Other Risks and the Interaction of Risks 193 Summary 194 PART TWO MEASURING RISK 199 Chapter Eight Interest Rate Risk I 200 Introduction 200 The Level and Movement of Interest Rates 201 The Repricing Model 203 Rate-Sensitive Assets 205 Rate-Sensitive Liabilities 206 Equal Changes in Rates on RSAs and RSLs 209 Unequal Changes in Rates on RSAs and RSLs 210 Weaknesses of the Repricing Model 213 Market Value Effects 213 Overaggregation 213 The Problem of Runoffs 214 Cash Flows from Off-Balance-Sheet Activities 214 Summary 215 Appendix 8A The Maturity Model 224 Appendix 8A Term Structure of Interest Rates 224 Chapter Nine Interest Rate Risk II 231 Introduction 231 Duration: A Simple Introduction 232 A General Formula for Duration 234 The Duration of Interest-Bearing Bonds 236

4 Contents xvii The Duration of Zero-Coupon Bonds 238 The Duration ofconsol Bonds (Perpetuities) 238 Features of Duration 239 Duration and Maturity 239 Duration and Yield 240 Duration and Coupon Interest 240 The Economic Meaning of Duration 241 Semiannual Coupon Bonds 245 Duration and Interest Rate Risk 246 Duration and Interest Rate Risk Management on a Single Security 246 Duration and Interest Rate Risk Management on the Whole Balance Sheet of an FI 249 Immunization and Regulatory Considerations 256 DifFiculties in Applying the Duration Model 257 Duration Matching Can Be Costly 257 Immunization Is a Dynamic Problem 257 Large Interest Rate Changes and Convexity 258 Summary 260 Appendix 9A The Basics of Bond Valuation 269 Appendix 9B Incorporating Convexity into the Duration Model 269 Chapter Ten Credit Risk: Individual Loan Risk 279 Introduction 279 Credit Quality Problems 281 Types of Loans 283 Commercial and Industrial Loans 283 Real Bstate Loans 286 Indiuidual (Consumer) Loans 287 Olher Loans 289 Calculating the Return on a Loan 289 The Contractually Promised Return on a Loan 290 The Expected Return on a Loan 293 Retail Versus Wholesale Credit Decisions 294 Retail 294 Wholesale 295 Measurement of Credit Risk 296 Default Risk Models 297 Qualitative Models 297 Quantitative Models 300 Newer Models of Credit Risk Measurement and Pricing 304 Summary 321 Appendix 10A Credit Analysis and Loan Underwriting 330 Appendix 10B Black Scholes Option Pricing Model 330 Chapter Eleven Credit Risk: Loan Portfolio and Concentration Risk 331 Introduction 331 Simple Models of Loan Concentration Risk 332 Loan Portfolio Diversification and Modern Portfolio Theory (MPT) 334 Moody's Analytics Portfolio Manager Model 337 Partial Applications of Portfolio Theory 340 Regulatory Models 344 Summary 345 Appendix IIA CreditMetrics 350 Appendix IIB CreditRisk+ 354 Chapter Twelve Liquidity Risk 357 Introduction 357 Causes of Liquidity Risk 358 Liquidity Risk at Depository Institutions 359 Liability-Side Liquidity Risk 359 Asset-Side Liquidity Risk 363 Measuring a DI's Liquidity Risk Exposure 365 New Liquidity Risk Measures Implemented by the Bank for International Settlements 369 Liquidity Planning 375 Liquidity Risk, Unexpected Deposit Drains, and Bank Runs 376 Bank Runs, the Discount Window, and Deposit Insurance 377 Liquidity Risk at Other Types of Financial Institutions 378 Life Insurance Companies 378 Property-Casualty Insurers 379 Investment Funds 379 Summary 381 Appendix 12A Sources and Uses of Funds Statement, J. P. Morgan Chase, March Appendix 12B Illustrative Template for the LCR 388

5 xviii Contents Chapter Thirteen Foreign Exchange Risk 391 Introduction 391 Foreign Exchange Rates and Transactions 391 Foreign Exchange Rates 391 Foreign Exchange Transactions 392 Sources of Foreign Exchange Risk Exposure 395 Foreign Exchange Rate Volatility and FX Exposure 399 Foreign Currency Trading 400 FX Trading Activities 401 Foreign Asset and Liability Positions 403 The Return and Risk of Foreign Investments 403 Risk and Hedging 405 Multicurrency Foreign Asset-Liability Positions 409 Interaction of Interest Rates, Inflation, And Exchange Rates 410 Purchasing Power Parity 411 Interest Rate Parity Theorem 412 Summary 414 Chapter Fourteen Sovereign Risk 422 Introduction 422 Credit Risk Versus Sovereign Risk 426 Debt Repudiation Versus Debt Rescheduling 428 Country Risk Evaluation 429 Outside Evaluation Models 430 OECD Country Risk Classifications 431 Internal Evaluation Models 433 Using Market Data to Measure Risk: The Secondary Market for LDC and Emerging Market Debt 442 Summary 444 Appendix 14A Mechanisms for Dealing with Sovereign Risk Exposure 448 Chapter Fifteen Market Risk 449 Introduction 449 Calculating Market Risk Exposure 453 The RiskMetrics Model 453 The Market Risk of Fixed-lncome Securities 454 Foreign Exchange 457 Equities 458 Portfolio Aggregation 459 Historie (Back Simulation) Approach 462 The Historie (Back Simulation) Model versus RiskMetrics 465 The Monte Carlo Simulation Approach 466 Expected Shortfall 470 Regulatory Models: The BIS Standardized Framework 473 Partial Risk Factor Approach 474 The BIS Regulations and Large-Bank Internal Models 477 Summary 479 Chapter Sixteen Off Balance Sheet Risk 485 Introduction 485 Off-Balance-Sheet Activities and FI Solvency 486 Returns and Risks of Off-Balance-Sheet Activities 490 Loan Commitments 493 Commercial Letters of Credit and Standby Letters of Credit 496 Derivative Contracts: Futures, Forwards, Swaps, and Options 499 Forward Purchases and Sales of When-Issued Securities 502 Loans Sold 503 Non-Schedule L Off-Balance-Sheet Risks 504 Settlement Risk 504 Affüiate Risk 505 The Role of OBS Activities in Reducing Risk 506 Summary 508 Appendix 16A A Letter of Credit Transaction 512 Chapter Seventeen Technology and Other Operational Risks 513 Introduction 513 What Are the Sources of Operational Risk? 516 Technological Innovation and Profitabiiity 516 The Impact of Technology on Wholesale and Retail Financial Service Production 519 Wholesale Financial Services 519 Retail Financial Services 520 Advanced Technology Requirements 522 The Effect of Technology on Revenues and Costs 523 Technology and Revenues 525 Technology and Costs 525 Technology and the Evolution of the Payments System 530 Risks That Arise in an Electronic Transfer Payment System 533 Other Operational Risks 538 Regulatory Issues and Technology and Operational Risks 540 Summary 542

6 Contents xix PART THREE MANAGING RISK 545 Chapter Eighteen Liability and Liquidity Management 546 Introduction 546 Liquid Asset Management 546 Monetary Policy Implementation Reasons 547 Taxation Reasons 547 The Compositum of the Liquid Asset Portfolio 548 Return-Risk Trade-Off for Liquid Assets 549 The Liquid Asset Reserve Management Problem for U.S. Depository Institutions 549 Undershooting/Overshooting of the Reserve Target 554 Managing Liquid Assets Other than Cash 558 Liability Management 559 Funding Risk and Cost 559 Choice of Liability Structure 560 Demand Deposits 560 Interest-Bearing Checking (NOW) Accounts 561 Passbook Savings 563 Money Market Deposit Accounts (MMDAs) 563 Retail Time Deposits and CDs 564 Wholesale CDs 564 Federal Funds 565 Repurchase Agreements (RPs) 566 Other Borrowings 567 Liquidity and Liability Structures for U.S. Depository Institutions 568 Liability and Liquidity Risk Management In Insurance Companies 570 Liability and Liquidity Risk Management In Other Financial Institutions 571 Summary 571 Appendix IBA Federal Reserve Requirement Accounting 575 Appendix 18B Bankers' Acceptances and Commercial Paper as Sources of Financing 575 Chapter Nineteen Deposit Insurance and Other Liability Guarantees 576 Introduction 576 Bank and Thrift Guaranty Funds 577 The Ganses of the Depository Fund Insolvencies 579 The Financial Environment 579 Moral Hazard 580 Panic Prevention Versus Moral Hazard 581 Controlling Depository Institution Risk Taking 581 Stockholder Discipline 582 Depositor Discipline 587 Regulatory Discipline 592 Non-U.S. Deposit Insurance Systems 593 The Discount Window 594 Deposit Insurance versus the Discount Window 594 The Discount Window 594 Other Guaranty Programs 597 National Credit Union Administration 597 Property-Casualty and Life Insurance Companies 597 The Securities Investor Protection Corporation 598 The Pension Benefit Guaranty Corporation 599 Summary 601 Appendix 19A Calculation of Deposit Insurance Premiums 606 Appendix 19B FDIC Press Release of Bank Failures 611 Appendix 19C Deposit Insurance Coverage for Commercial Banks in Various Countries 611 Chapter Twenty Capital Adequacy 612 Introduction 612 Capital and Insolvency Risk 613 Capital 613 The Market Value of Capital 615 The Book Value of Capital 616 The Discrepancy between the Market and Book Values ofequity 616 Arguments against Market Value Accounting 617 Capital Adequacy in the Commercial Banking And Thrift Industry 619 Capital 624 Credit Risk-Adjusted Assets 624 Calculating Risk-Based Capital Ratios 625 Capital Requirements for Other Financial Institutions 643 Securities Firms 643 Life Insurance 644 Property-Casualty Insurance 646 Summary 648

7 xx Contents Appendix 20A Internal Ratings-Based Approach to Measuring Credit Risk Adjusted Assets 656 Appendix 2 OB Methodology Used to Determine G-SIBs' Capital Surcharge 658 Chapter Twenty-One Product and Geographie Expansion 659 Introduction 659 Product Diversification 660 Segmentation in the U.S. Financial Services Industry 661 Commercial and Investment Banking Activities 661 Banking and Insurance 664 Commercial Banking and Commerce 665 Nonbank Financial Service Firms and Banking 665 Nonbank Financial Service Firms and Commerce 667 Activity Restrictions in the United States Versus Other Countries 668 Issues Involved in the Diversification of Product Offerings 668 Safety and Soundness Concems 669 Economies of Scale and Scope 671 Conflicts of Interest 671 Deposit Insurance 673 Regulatorg Oversight 673 Competition 674 Domestic Geographie Expansion 675 Regulatory Factors Affecting Geographie Expansion 676 Insurance Companies 676 Thri/ts 677 Commercial Banks 677 Cost and Revenue Synergies Affecting Domestic Geographie Expansion by Merger and Acquisition 680 Cost Synergies 680 Revenue Synergies 681 Merger Guidelines for Acceptability 682 Other Market- and Firm-Specific Factors Affecting Domestic Geographie Expansion Decisions 685 Global and International Expansions 685 U.S. Banks Abroad 686 Foreign Banks in the United States 690 Advantages and Disadvantages of International Expansion 692 Advantages 692 Disadvantages 693 Summary 694 Chapter Twenty-Two Futures and Forwards 698 Introduction 698 Forward and Futures Contracts 700 Spot Contracts 700 Forward Contracts 700 Futures Contracts 702 Forward Contracts and Hedging Interest Rate Risk 703 Hedging Interest Rate Risk with Futures Contracts 704 Microhedging 704 Macrohedging 705 Routine Hedging versus Selective Hedging 705 Macrohedging with Futures 706 The Problem of Basis Risk 713 Hedging Foreign Exchange Risk 715 Forwards 715 Futures 716 Estimating the Hedge Ratio 719 Hedging Credit Risk with Futures and Forwards 722 Credit Forward Contracts and Credit Risk Hedging 723 Futures Contracts and Catastrophe Risk 725 Regulation of Derivative Securities 725 Summary 727 Appendix 22A Microhedging with Futures 734 Chapter Twenty-Three Options, Caps, Floors, and Collars 735 Introduction 735 Basic Features of Options 735 Buying a Call Option on a Bond 736 Writing a Call Option on a Bond 737 Buying a Put Option on a Bond 738 Writing a Put Option on a Bond 738 Writing Versus Buying Options 739 Economic Reasons for Not Writing Options 739 Regulatory Reasons 741 Futures versus Options Hedging 741 The Mechanics of Hedging a Bond or Bond Portfolio 742 Hedging with Bond Options Using the Binomial Model 743 Actual Bond Options 747 Using Options to Hedge Interest Rate Risk On The Balance Sheet 749 Using Options to Hedge Foreign Exchange Risk 754

8 Contents xxi Hedging Credit Risk with Options 755 Hedging Catastrophe Risk with Call Spread Options 756 Caps, Floors, and Collars 757 Caps 758 Floors 761 Collars 762 Caps, Floors, Collars, and Credit Risk 765 Summary 765 Appendix 23A Microhedging with Options 772 Chapter Twenty-Four Swaps 773 Introduction 773 Swap Markets 774 Interest Rate Swaps 775 Realized Cash Flows on an Interest Rate Swap 779 Macrohedging with Swaps 780 Currency Swaps 783 Fixed-Fixed Currency Swaps 783 Fixed-Floating Currency Swaps 785 Credit Swaps 786 Total Return Swaps 788 Pure Credit Swaps 790 CDS Indexes 790 Swaps and Credit Risk Concerns 791 Netting and Swaps 792 Payment Flows Are Interest, Not Principal 793 Standby Letters of Credit 793 Summary 793 Appendix 24A Setting Rates on an Interest Rate Swap 799 Chapter Twenty-Five Loan Sales 803 Introduction 803 The Bank Loan Sales Market 804 Definition of a Loan Sale 804 Types of Loan Sales 804 Types of Loan Sales Contracts 806 Trends in Loan Sales 807 The Buyers and the Seilers 808 Why Banks and Other FIs Seil Loans 813 Reserve Requirements 813 Fee Income 814 Capital Costs 814 Liquidity Risk 814 Factors Affecting Loan Sales Growth 814 Access to the Commercial Paper Market 814 Customer Relationship Effects 815 Legal Concerns 815 BIS Capital Requirements 815 Market Value Accounting 815 Asset Brokerage and Loan Trading 816 Government Loan Sales 816 Credit Ratings 816 Purchase and Sale of Foreign Bank Loans 816 Summary 817 Chapter Twenty-Six Securitization 819 Introduction 819 Mechanisms Used to Convert On-Balance-Sheet Assets to a Securitized Asset 820 The Pass-Through Security 823 GNMA 824 FNMA 824 FHLMC 825 The Incentives and Mechanics of Pass-Through Security Creation 825 Prepayment Risk on Pass-Through Securities 831 Prepayment Models 835 Government Sponsorship and Oversight of FNMA and Freddie Mac 843 The Collateralized Mortgage Obligation (CMO) 845 Creation of CMOs 846 Class A, B, and C Bond Buyers 848 Other CMO Classes 848 The Mortgage-Backed Bond (MBB) or Covered Bond 849 Innovations in Securitization 851 Mortgage Pass-Through Strips 851 Securitization of Other Assets 854 Can All Assets Be Securitized? 855 Summary 857 Appendix 26A Fannie Mae and Freddie Mac Balance Sheets 862 INDEX 863