Banks
1. The Banking business model is simple. Banks receive money form depositors and the capital markets and lend to borrowers, profiting from the spread, which is called net interest income.
2. Most banks banks also make money from basic fees and other service, which is usually referred to as noninterest income.
3. Combine net interest income and and noninterest to get net revenues, a view of the bank's top line. This is the banking model.
4. Federal government guarantees well over half of the banking industry's liabilities (via FDIC insurance), and banks can turn to Federal Reserve as lender of last resort if they are caught in a short-term liquidity crunch.
5. This implicit subsidy ( FDIC insurance), which other corporations don't have, allows banks to effectively borrow at below-market rates. This makes the banking industry the lowest cost, safest producer of liquidity in the world.
It's All about Risk
6. The heart and soul of banking is centered on one thing: risk management.
7. Banks accept three types of risk: (1) credit, (2) liquidity, and (3) interest rate and they get paid to take on this risk.
8. Banks ability to earn a premium for managing credit and interest rate risk can - quickly become their greatest weakness if, for example, loan losses grow faster tan expected.
Managing Credit Risk
9. Investors can get a sense of a bank's credit quality by examining its balance sheet, loan categories, trends in nonperforming loans and charge-off rates, as well as management's lending philosophy.
10. The problem is that these measures are historical - everything we know about the credit quality of a lending institution is learned after the fact.
11. Banks' giant balance sheets shield - Portfolio Diversity, Conservative underwriting and account management and Aggressive collections procedures
Selling Liquidity
12. Banks offer liquidity management services in many forms - back-up line of credit, banks buy firms receivables at a discount known as factoring, because business wants cash as soon as possible
13. There is no other business in the world where you can take money from people and effectively charge them to take if off their hands.
Managing Interest Rate Risk
Investor's Checklist Banks
The business model of banks can be summed up as the management of three types of risks: credit, liquidity, and interest rate.
Investors should focus on conservatively run institutions. They should seek out firms that hold large equity bases relative to competitors and provision conservatively for future loan losses.
Different components of banks' income statements can show volatile swings depending on a number of factors such as interest rate and credit environment. However, well-run banks should generally show steady net income growth through varying environments. Investors are well served to seek out firms with a good track record.
Well-run banks focus heavily on matching the duration of assets with the duration of liabilities. For instance, banks should fund long-term loans with liabilities such as long-term debt or deposits, not short-term funding. Avoid lenders that don't.
Banks have numerous competitive advantages. They can borrow money at rates lower than even the federal government. They are large economies of scale on this business derived from having an established distribution network. The capital-intensive nature of banking deters new competitors. Consumer-switching costs are high, and there are limited barriers to exit money losing endeavors.
Investors should seek out banks with a strong equity base, consistently solid ROEs and ROAs, and an ability to grow revenues at a steady pace.
Comparing similar banks on a price-to-book measure can be a good way to make sure you're not overpaying for a bank stock.
1. The Banking business model is simple. Banks receive money form depositors and the capital markets and lend to borrowers, profiting from the spread, which is called net interest income.
2. Most banks banks also make money from basic fees and other service, which is usually referred to as noninterest income.
3. Combine net interest income and and noninterest to get net revenues, a view of the bank's top line. This is the banking model.
4. Federal government guarantees well over half of the banking industry's liabilities (via FDIC insurance), and banks can turn to Federal Reserve as lender of last resort if they are caught in a short-term liquidity crunch.
5. This implicit subsidy ( FDIC insurance), which other corporations don't have, allows banks to effectively borrow at below-market rates. This makes the banking industry the lowest cost, safest producer of liquidity in the world.
It's All about Risk
6. The heart and soul of banking is centered on one thing: risk management.
7. Banks accept three types of risk: (1) credit, (2) liquidity, and (3) interest rate and they get paid to take on this risk.
8. Banks ability to earn a premium for managing credit and interest rate risk can - quickly become their greatest weakness if, for example, loan losses grow faster tan expected.
Managing Credit Risk
9. Investors can get a sense of a bank's credit quality by examining its balance sheet, loan categories, trends in nonperforming loans and charge-off rates, as well as management's lending philosophy.
10. The problem is that these measures are historical - everything we know about the credit quality of a lending institution is learned after the fact.
11. Banks' giant balance sheets shield - Portfolio Diversity, Conservative underwriting and account management and Aggressive collections procedures
Selling Liquidity
12. Banks offer liquidity management services in many forms - back-up line of credit, banks buy firms receivables at a discount known as factoring, because business wants cash as soon as possible
13. There is no other business in the world where you can take money from people and effectively charge them to take if off their hands.
Managing Interest Rate Risk
Investor's Checklist Banks
The business model of banks can be summed up as the management of three types of risks: credit, liquidity, and interest rate.
Investors should focus on conservatively run institutions. They should seek out firms that hold large equity bases relative to competitors and provision conservatively for future loan losses.
Different components of banks' income statements can show volatile swings depending on a number of factors such as interest rate and credit environment. However, well-run banks should generally show steady net income growth through varying environments. Investors are well served to seek out firms with a good track record.
Well-run banks focus heavily on matching the duration of assets with the duration of liabilities. For instance, banks should fund long-term loans with liabilities such as long-term debt or deposits, not short-term funding. Avoid lenders that don't.
Banks have numerous competitive advantages. They can borrow money at rates lower than even the federal government. They are large economies of scale on this business derived from having an established distribution network. The capital-intensive nature of banking deters new competitors. Consumer-switching costs are high, and there are limited barriers to exit money losing endeavors.
Investors should seek out banks with a strong equity base, consistently solid ROEs and ROAs, and an ability to grow revenues at a steady pace.
Comparing similar banks on a price-to-book measure can be a good way to make sure you're not overpaying for a bank stock.