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Finance Exam Essay

967 words - 4 pages

1. Explain in general terms how savings institutions differ from commercial banks with respect to their sources of funds and uses of funds. Discuss each source of funds for savings institutions. Identify and discuss the main uses of funds for savings institutions.

Savings institutions obtain a large portion of their funds from savings deposits, more than large commercial banks. While savings institutions can offer NOW accounts, they cannot offer the traditional demand deposits. Savings institutions concentrate on mortgages as their main use of funds. Commercial banks concentrate on commercial loans and some consumer loans.

The major sources of funds for savings institutions
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3. What criteria are used by regulators to examine a thrift institution?

Capital, asset quality, management ability, earnings potential, liquidity, and sensitivity to risk factors.

4. Discuss the entrance of savings institutions into consumer and commercial lending. What are the potential risks and rewards of this strategy? Discuss the conflict between diversification and specialization of savings institutions.

Savings institutions that diversify their business may become less reliant on mortgage lending and therefore may be able to stabilize their earnings. However, by diversifying, they forgo their specialization in their area of expertise. There is a cost to learning other businesses, such as commercial lending. The costs may be worthwhile in the long run, as diversification of services may be a necessary goal for survival.
Regulatory restrictions have been loosened, allowing savings institutions to offer commercial loans and consumer loans. The potential risk to savings institutions that now provide such loans is that they improperly assess creditworthiness due to inexperience.

5. Describe the liquidity and credit risk of savings institutions, and discuss how each is managed.

Savings institutions experience liquidity risk since they commonly use short-term liabilities to finance long-term assets. They commonly increase their liabilities rather than reduce their assets in order to increase liquidity. Mortgages are the main reason for default risk. Insurance is available for the many types of mortgages issued.

6. Explain why many savings institutions experience financial problems at the same time.

Savings institutions are exposed to credit risk as a result of their heavy concentration in mortgages, mortgage-backed securities, and other securities. They attempt to diversify their investments to reduce credit risk. Savings institutions are highly susceptible to interest rate risk because their asset portfolios are typically less rate sensitive than their liability portfolios to interest rate movements

7. What were some of the more obvious reasons for the SI crisis?

1. Rising interest rates in the late 1980s, which reduced the spread between interest earned on loans and interest paid...

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