What Items Or Variables Are Determined By Liability Manageme

1what Items Or Variables Are Determined By Liability Management Dec

What items or variables are determined by liability management decisions? What items or liabilities are included in borrowed funds? Provide a brief description of each. What affects the size and cost of core deposits? Explain how are Time CDs not considered "hot money." What are transaction accounts? What is their cost to the bank? How do they compare with other liabilities in terms of being a source of funds? What are NOW accounts? How do they differ from regular checking accounts? Part (a), Describe the least expensive source of funds for a typical bank. Part (b), explain why interest costs do not equal the effective cost of bank liabilities.

Paper For Above instruction

The management of a bank's liabilities is crucial in maintaining profitability, liquidity, and stability. Liability management involves strategic decisions regarding the composition, cost, and maturity structure of the bank's liabilities. These decisions influence various items and variables, including the types and amounts of liabilities, cost of funds, and the bank's ability to meet cash flow needs. Among the key items determined by liability management are demand deposits, savings accounts, time deposits, borrowed funds, and capital.

Borrowed funds primarily encompass various forms of debt that the bank raises externally to support asset expansion or liquidity needs. These include Federal funds purchased, repurchase agreements, Federal Home Loan Bank borrowings, and other interbank borrowings. Federal funds purchased are short-term unsecured loans between banks for reserve management purposes. Repurchase agreements are short-term sales of securities with an agreement to repurchase them at a higher price, effectively serving as a secured loan. Federal Home Loan Bank borrowings are longer-term funds obtained through borrowing from the FHLB system, often used for mortgage lending. Each of these instruments provides the bank with liquidity but also entails costs and risk considerations.

The size and cost of core deposits are primarily influenced by factors such as the bank's reputation, customer loyalty, interest rate environment, and competitive positioning. Core deposits include transaction accounts and savings accounts that tend to be more stable and less sensitive to interest rate changes. The stability of core deposits reduces funding costs and helps mitigate liquidity risks. Variations in market interest rates affect the attractiveness of deposits and can alter the bank's ability to maintain low-cost funding sources.

Time Certificates of Deposit (Time CDs) are generally not considered "hot money" because they are less sensitive to short-term interest rate changes and are not typically withdrawn on short notice. Time CDs usually have fixed terms and interest rates, and there are penalties for early withdrawal, which discourages sudden outflows. This characteristic makes them more stable and less likely to be withdrawn abruptly compared to more volatile forms of funds.

Transaction accounts are deposit accounts used for day-to-day banking activities such as deposits, withdrawals, and payments. Examples include checking accounts. Their primary advantage to banks lies in their stability and cost-effectiveness as a source of funds. Transaction accounts often have lower interest rates or sometimes no interest at all, but they provide a reliable and inexpensive source of funds, given their large volume and low risk profile. Compared to other liabilities, transaction accounts are a significant stable source of funds, although they may be less lucrative than higher-interest deposits or borrowed funds.

Negotiable Order of Withdrawal (NOW) accounts are interest-earning checking accounts offered by banks. They differ from regular checking accounts in that they typically offer interest payments to the account holder, providing an additional incentive for customers to maintain higher balances. Unlike regular checking accounts, which generally do not pay interest, NOW accounts are considered a hybrid, combining features of checking and savings accounts, thus improving the bank's ability to attract funds at competitive rates.

Part (a) of the question prompts a description of the least expensive source of funds for a typical bank. Generally, demand deposits, especially core transaction accounts, represent the least costly source of funds because they are stable and do not typically incur significant interest expenses. Moreover, they are less sensitive to short-term interest rate fluctuations, making them an essential component of low-cost funding strategies.

Part (b) addresses why the interest cost of liabilities does not necessarily equate to their true or effective cost. While the interest rate paid on liabilities reflects the nominal cost, the actual cost can be different when considering factors such as associated administrative costs, reserve requirements, and the opportunity costs of funds. For example, a liability with a low-interest rate might still entail significant operational expenses or regulatory costs that increase its true cost. Additionally, the bank's interest expense does not include implicit costs like the opportunity cost of not using the funds elsewhere or the costs associated with maintaining liquidity or managing risk.

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