Analysis of Commercial Bank Balance Sheet

CONTENTS INTRODUCTION DEFINITION_ OF COMMERCIAL BANK_ *Banks and another(prenominal) beat taking institutions argon financial intermediaries whose assets consist overwhelmingly of loans to a cudive variety of borrowers and whose liabilities consist overwhelmingly of gravels. THE ECONOMICS OF MONEY BANKING AND FINANCE tertiary* Edition PETER HOWELLS &038 KEITH BAIN Pg 32 A sound constitution of swearing is genuinely outstanding for all(prenominal) economy. mer rear endtile-grade cashboxs atomic number 18 directly related to the defrayal system of the economy. Generally most commercial curses argon controlled by the aboriginal bank of that particular country.The central bank arse never part with the banking system to fail beca manipulation if banks start to fail the payment system go out fail. They may allow or so banks to fail but the government pull up stakes never allow mammoth banks or the whole payment system to collapse. This is very evident from the upstart where government check pumped in huge amount of m unmatchabley to save the so called too big to fail banks. Banks helps in the payment go through various kinds of deposits, calculate cards and belief cards ANALYSIS OF COMMERCIAL BANK sleep SHEET For my assignment I clear picked up Lloyds TSB as my bank. Lloyds TSB is one of the four biggest bank in the UK.I have taken 2007 annual report as the class has published only the 2008 interim report. The blink of an eye item which we see in Lloyds TSB balance sheet is loan and advances to banks. It reflects the interbank relationship. This range of a function has fallen for most of the commercial bank and too for Lloyds TSB there is an decrement of 16. 50%. This is due(p) to the financial crisis which has hit banking sector very in earnest and m whatsoever banks have failed as a result. Llyods TSB gives loans to customer just same any other commercial bank and bank charge an pursuance for giving loans which is hig her than the amuse on deposit.But there is ceaselessly a default essay attached with the loan which the bank gives. Commercial Banks gives dissimilar kinds of loans starting from mortgage, education loan, overdraft facility etc. In encase of Lloyds TSB mortgage comes out to be 48. 4% of loans to customer. And thing we should bear in mind is that mortgage are long term loan and it can be for 30 years as well. Customer Accounts got an increase of 11% and there is an increase of 11% from 2006 to 2007. LIABILITIES OF LLOYDS TSB Lloyds TSB is also having some fixed deposit like Certificates of deposit.In these deposits customers cannot withdraw there money before a specified time and they also receive some divert as well. Second are the commercial papers which are unsecured promissory notes to meet short term obligations. Certificate of Deposit comes to around 14,995 one thousand thousand GBP and commercial paper is 17,388 one million million million GBP for Lloyds TSB. Lloyds TSB is also having reserves after remunerative reserves. This reserve can be used in case of soupcon or any unexpected essays The main lucks that commercial banks face due to their exposure to different kinds of assets and liabilities are liquidity risks, foodstuff risk and reference work risk.Lloyds TSB faces liquidity risk because of deposit in central bank. They have a deposit of 4330 million GBP. This means that they cannot give this amount as loans because its stuck with the central bank. This amount has increased considerably from 2006 to 2007. The bank faces liquidity risk because of their mismatch in assets and liabilities side. The conclave liquidity risk exposure is 33,185 million GBP. The main sources of liquidity risk for the bank are deposits from banks and customer accounts. As we seen above the assets of Lloyds TSB are long term whereas the liabilities are short term.The commercial bank is the main source of payment service in any economy. Whenever bank gives loan they are exposed to default risk. Default risk arises whenever a company or individual is unable to meets its obligation on enliven or principle payment of the loan. The bank faces asymmetric selective breeding paradox as well. though the bank does proper due effort before giving out any loans but asymmetric information problem cannot be ruled out with any banks at all. imputable to asymmetric information we have inauspicious selection and moral happening problem.Adverse selection problem comes to picture before entering into the transaction. In short the bank has to filter the good borrowers and the bad borrowers. Sometimes the bank may give loan to the bad borrowers and may suffer of this. Though banks have put checks like mention history before do out the loan but adverse selection problem cannot be neglected completely. The other problem which is created because of asymmetric information is moral speculate problem. The moral hazard problem starts after the bank has sa nctioned the loan. Borrowers may get into undesirable activities.The main objective for which the loan was sanctioned may never get fulfilled. The other side of moral hazard problem is the conflict of interest between the borrower and the bank. Borrowers may try to act on their interest rather than the interest of the bank. Banks like Lloyds TSB can overcome the problems of adverse selection and moral hazards if they have proper check and control on their customers but rarely any bank achieves 100% success in these problems. These are dickens most important risks which any financial mediator faces in order to serve their most important duty i. e. ayment services to the economy. Just like any other financial institution the group also faces commendation risk. textbookmark-start Credit risk textbookmark-end is risk due to uncertainty in a counterpartys (also called an textbookmark-start obligor textbookmark-end s or textbookmark-start reference books textbookmark-end ) ability to meet its obligations. Because there are many another(prenominal) types of counterpartiesfrom individuals to sovereign governmentsand many different types of obligationsfrom auto loans to differential coefficients transactions creed risk takes many forms. (www. riskglossary. om). After the groups acquisition of Halifax of Scotland, the credit pass judgment of the bank has come down. In order to counter credit risk credit rating plays a very important role. The group exposure to credit risk is 356,860 million GBP. PART 2 asset Liability Management The ALM group within a bank has been touch with control of interest rate risk on the balance sheet. For some bank it may be equally important to manage interest rate risk arising from off balance sheet, but it is instructive to depend at the traditional methods and progress to the relatively new procedures. (HEFFERNAN, SHELAGH A. 2005) Moreover banks have mismatch in maturity of their asset and obligation. Banks use asset liability m anagement to manage interest rate risk, mart risk and credit risk. Lets take an example where all deposits are on fixed rate of interest but all loans are make on floating rate of interest. Commercial banks mainly use trine types of markets to cover these risks. These are money market, capital market and derived function market. jacket crown Market is generally used by large companies or governments to tolerate funds for the long period.Capital market can be of two types like primary market, securities are traded for the first time and secondary market, and in this securities are traded after they are traded in the primary market. Another discussion section of capital market is bond market and stock market. There are various stock market around the world like capital of the United Kingdom Stock Exchange, whereas bond market includes different kinds of bonds like government bonds (US treasury bills), foreign bonds etc. One of the most important changes in this market is the dev elopment of asset approve securities. textbookmark-start Securitization textbookmark-end is a financial transaction in which assets are pooled and securities representing interests in the pool are issued. (http//www. riskglossary. com/) When securitization is support by any assets such as student loan, mortgages this starts asset backed security. Lloyds TSB also securitizes its assets in order to overcome its liquidity problem. The process of securitization has become quite abstruse with the introduction of Collateralized Debt Obligation, Collateralized Loan Obligation etc.And these difficult securities are the heart of the financial crisis. Lloyds TSB is not having much exposure to these complex securities. Banks get into off balance sheet activities to get more profit. It helps the bank to get fee income. One more advantage of off balance sheet activity is that it does not appear into the balance sheet of the bank. The derivative market is also used by the bank to hedge their risks. By their nature, derivatives instruments can be used for hedging different types of risks.Owing to this, banks and amends companies use derivatives in the management of their Asset Liability Management (Cornelius Nandyal, 2001). The derivative market is going through dish out of new changes. Regulators are exhausting to put mess hall of new regulations in order to bring transparency. Banks use interest rate swaps, credit default swaps, total return swap, credit linked notes etc. But different people have different views on derivatives. According to Warren Buffet derivatives are weapon of mass destruction and can act as time bombs in the future.Whereas Alan Greenspan says Derivatives have permitted the unbundling of financial risks. Because risks can be unbundled, individual financial instruments now can be analyzed in terms of their common underlying risk factors, and risks can be managed on a portfolio basis. Banks have also used money market for asset liability managem ent. The most important organ of the money market is the interbank market. In interbank market banks with surplus take to bank with deficit. This market is severely hit by the recent financial crisis.Banks dont know about the financial soundness of the bank to which they are change. This has increased the liquidity problem of the bank. Other types of market are the gilt repo, commercial paper market and the corroboration of deposit market. As we have seen above Lloyds TSB invest in commercial paper and certificate of deposit. Securitization and the Global Financial Crisis DIAGRAMATIC EXPLANATION OF SECURITIZATION drawframe Source http//www. usbancortrusteeservices. com/images/ygpa7_chart_offering_structure_ptnm. pg The recent crisis started because of the sub prime mortgage loans that originated in the USA. But these loans were repackaged and sold all round the world, so this crisis which began in USA became a worldwide crisis. Securitization gives banks lot more leverage. The se eds of the recent crisis were sown in when the Federal Reserve make interest rates around 1% and the economy was pumped with lot of cash. Banks started giving these loans as mortgage to the sub prime customers, without any credit check and at very easy terms and condition.Once interest rate started to increase in 2004, borrowers started to default on their loans. With the increase of interest rates house prices started to come down. Credit rating agencies who gave these securities AAA rating made these securities junk. The assumption on which these rating agencies were working was that house prices entrust keep raisingin the future as well. The combination of low capital requirements oblige on AAA-rated assets and a commonly held perception that they were safe, allowed banks to hold on to any senior tranches that were not sold to investors.But when the structured finance market collapsed in late 2007, the investment banks found themselves holding hundreds of billions of dollars of low-quality asset pools, many of which consisted of leveraged buy-outs loans, subprime mortgages, and bonds from CDOs in process-that is, where the tranches had not yet been sold to other investors. (Coval et al, 2008) No one knows the worth of these complex securities which the banks are holding. Banks have stopped lending to each other because no one is sure of how much the other bank is holding. So interbank market is almost closed.