Principles of Commercial and Investment Banking - Essay Example

A bank needs to hold enough excess reserves that can be able to meet all depositor's needs. This shields the bank from additional costs in meeting the depositor's needs. Such additional costs include the cost of borrowing from other banks, the sale of securities, calling in loans, and resulting borrowing from a federal bank.

Asset management; a bank needs to manage its asset effectively to maximize its profits. This can mainly be done through, acquiring liquid assets that have an acceptable low level of risk such as government securities, diversifying its asset holding portfolio as a risk asset management strategy, issuing loans yielding higher interest to borrowers who are deemed safe, last the bank s meet to maintain enough reserve to meet its depositors need without resulting to borrowing to save on the cost of borrowing.

Liability management with the increased innovation and changes in the operation of banks operation banks needs to ensure the cost of funds is minimized. This ensures a bank will be able to meet its obligation as they fall due.

The capital adequacy management-the manager must decide the amount of capital the bank should maintain and then acquire the needed capital in consideration of the regulation existing in the market. Capital is essential in the bank as it prevents failures and also influences returns on common stockholders.

There are various techniques used by banks to manage credit risk they include:

Prescreening and loan monitoring. Banks usually collect information about their prospective clients. The information collects helps to evaluate the borrowers and classify the borrower either as a safe borrower or a risky borrower in this event the bank can manage the credit risk.

Another way is continuously monitor the borrower after the lender has issued a loan, this help to solve the problem of moral hazard where the borrower undertakes a more risky venture than the one the money was borrowed for.

The second manages credit risk by establishing a long customer relationship this helps the banks to collect information about the borrower and asses the overall creditworthiness of the borrower.

Third, the bank can manage credit risk by placing stringent conditions on the use of borrowed funds. In this case, the bank issues restrictive covenants that restrict the borrower from engaging in risky activities.

Fourth a bank needs to ask for collateral, in which it would recover the money in the event the borrower fails to repay the amount borrowed.

Fifth another credit management tool is credit rationing. In this case, the bank refuses to lend the borrower funds even if they are willing and able to pay a high level of interest rates.

 Now let us turn our interest to measure to manage the interest rate risk, interest rates are very volatile therefore the bank needs to appropriately hedge against loss emanating from the changes in interest rates. Therefore, the bank needs to undertake a gap and duration analysis, in this case, the sensitivity of profits to interests, where the liabilities which are sensitive to changes in the rate of interest are subtracted to from assets that are responsive to changes in the rate of interest in gap analysis.