A bank has long-term non-investment assets (i.e. loans it issues and debt securities it invests in)? What about debt securities that a bank issues, would these be a liability?
A bank also has investment assets (AKA an investment portfolio)? This helps account for the duration mismatch between a bank’s assets (long-term in nature) and a bank’s liabilities (short-term) in nature?
CFAI says that the long-term horizon of a bank is evidenced by : (1) cutting
back new lending, (2) selling part of its existing loan portfolio, (3) increasing allocations to short-maturity, liquid securities, and (4) decreasing leverage through fewer
large wholesale time deposits.
Wouldn’t a bank increasing its lending mean that it is increasing its long-term assets and would therefore have a more long-term horizon? Thank you in advance for any clarification you can provide!
Banks as a business have a long term horizon “perpetual” planning horizon the mix of assets and liabilities they own at any one point in time will reflect their view on current economic conditions - this is done to protect the vakue of equity.
A supermarket does nor change (at lieast very significantly) the assets it owns and liabilities depending on economic decisions.
The points above you highlight are considered evidence of tactical changes due to economic conditions low spreads with recession coming) the back tactically reduces leverage and reduces the duration of its assets protecting equity so it can expand more rapidly when the situation allows.
This ability to radically alter the make up of risk profile and duration of assets and liabilities is key feature of managing a bank.
Thank you, that makes sense. Regarding debt securities, CFAI says The largest component of bank assets is loans, typically comprising up to 50% or more of the assets of the large, international banks that dominate the sector. The next largest component of assets is debt securities, typically accounting for 25% or more of total assets. Would debt securities that a bank issues be considered a liability? What does a bank do more of, issue or invest in debt securities?
They obviously need to be concerned about credit risk on loans made .
But also about liquidity and duration of assets and liabilities.
The more mis-match risk theoretically higher ROE but more problems if things go wrong.
You give out long term loans or hold illiquid risky assets and finance with short term commerical paper. Any hint of a credit risk in your asset portfolio your depositers walk away and you are bust.
Safer banks will to try and hold a mixture of assets and liabilites such they have the flexibility to change the asset/liability credit/duration risk as times change. You don’t need to change everything just around the edges to change the risk profile of the bank.