USA bank risk and return

The ability of commercial bank in the united states to engage in securities activities. It either directly or indirectly through affiliates of parent holding companies. It has been restricted through much of U.S. history but the boundaries of the restrictions have varied both through time and according to regulatory jurisdiction.

Restriction were imposed by some reasons.

->Fears of potential conflict of interest.

->Fear that commercial banks would have excessive economic power.

->Assume adverse effect on bank safety.

->A desire to protect non bank dealers.

Commercial bank or commercial bank holding companies or their risk and return moderate increase in private securities activities have not increased either the riskiness or the failure rate of commercial bank in the past, nor do, they promise to do so in the future.

The area of discussion.

The Nature of bank risks

Financial risk may be defined as the probability(uncertainty) of realizing a (outcome) an investment. It is lower than the investor expected at the time the investment was made. As losses net of gains must be charged against an institution’s capital (net worth). Sufficiently large losses can drive it into economic insolvency.Thus excessively risk activities relative to an institution’s capital to assets ratio can have an adverse impact on its safety and soundness.

The riskiness of a bank’s  activities depends both on the riskiness of all of the individual activities conducted in its asset, liability and off-balance sheet.

Portfolio and on the interaction or covariance of the returns on these activities through time.That is the riskiness of the over all bank can not be determine by simply summing the risk of its individual activities.

Bank would never want to eliminate all risks

They could do so only at the expense of lower return rather, well managed bank seek to control their risk exposure through risk management.

Risk management involves selecting individual activities with know risk and return portfolio. Combining them through diversification so as to obtain the highest overall net income gains.

Possible while exposing the bank to an aggregate risk exposure  that is consistent with the banks capital position.

The risk that banks generally assume are follows.

1)Credit risk

2)Interest risk

3)Liquidity risk

4)Foreign risk

5)Operation risk

6)Regulatory risk

7)Legal risk

8)Black box risk

Evaluation of the riskiness of securities activities

In theory,securities activities can increase,decrease,or not change the risk exposure of commercial banks. Bank holding companies.The potential impact be measured in two basic ways.

Change in volatility and return

A number of studies seek to measures the impact risk if banks were permitted to engage. In addition securities activities.Either through hypothetical acquisitions of existing investment firms or through expansion of the same activities as under taken by existing securities dealer.

Basically, these studies  the change in measures of volatility and return. It would occur if banks generally would hypothetically acquire different percentage of investment banking activities.

Most of the studies estimate the total risk by calculating the covariance of returns.Banking and other activities that might be combined with banking.Some studies also estimate the additional revenue earned by summing the revenue from the activities.

Several of the papers that use market return on the share of commercial  banks and securities companies do not include measures of capital available to absorb losses.They provide useful information only if the correlation of return implies smaller risk.Other studies relate risk to capital by calculating “Z” score,which measures the probability that a reduction in return might exceed a firm’s capital.

All the studies suffer from an additional serious shortcoming.They fail account for the fact that both commercial banks and investment bank hold, underwriter and trade U.S. government and municipal general obligation bond.

Change in the failure puts of banks engaging in securities

Thought history,few if any U.S. commercial bank  have failed because their involvement in securities activities before or after glass-stegall.J.F.I.O connor.Connor is the comptroller of the currency from 1933 to 1938 cut to  give the reason for the failure of call 2955 national banks that failed from 1865 through 1936, including the depression years 1929 to 1933.

Securities were not a sufficiently frequent reason to be classified separately the among the seven categories of the reason listed for the reason listed for these failure.

->It was strongly asserted at the time that banks involvement in securities understanding and trading was an important case of the great number of banks failures, experienced during the great depression.

->Securities purchased by smaller banks from banks that dealt in securities was a cause of the smaller banks’failures.

->Major cause of bank failures of commercial bank in easy 1930 had been the extensive investment of bank assets in long-term securities.

Three risk need to be considered

>Underwriting risk-Securities underwriting is riskless when the issue is underwritten on a “best offers”basis.In these situation, the underwriter contracts to market the issue and is not liable if the amount obtained is less than the amount expected.

When underwriters purchase and then sell the issue they may incurr risk.

->Dealing risk-Securities hold for trade could pose additional risk to the extent that the market values of the securities might decline.These potential costs are offset by gains in these values.

Both stock  and bond price are volatile and dealers at times have experienced large losses an net.

Banks already can assume as much interest risk as they wish through dealing and investing in government securities and colaterlized mortgage obligation.

->Brokerage risk– Securities brokerage activity at banks is likely to increase were commercial banks permitted to underwrite and sell securities without limit however, this activity involves to price risk.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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