1.The profitability of a bank depends on several different factors. a. Why is “G
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Question
1.The profitability of a bank depends on several different factors.
a. Why is “Gap Analysis” so important to a bank?
b. What should a bank do if inflation increases? Explain with examples.
c. What should a bank do if inflation decreases? Explain with examples.
2. Banks manage their assets in a variety of ways.
a. Explain the importance of “liquidity management”?
b. What is the concern of the bank in regard to the liquidity of its assets?
c. What can banks do to management liquidity risk?
3. Bank Management is becoming increasingly complicated.
a. What are the Four Major concerns of bank managers in ensuring the profitability of their operations?
b. Explain three with examples.
c. Which one do you believe is most important? Explain with examples.
4. The management of bank risk is a crucial function of management.
a. What are the most important risk management principles that involve approving loans?
b. Why do Adverse Selection and Moral Hazards make the underwriting process more complicated.
c. Is the loan approval process different in Western/International banks in comparison to Islamic banks? Explain with examples.
Explanation / Answer
Answer to Question 1(a):
GAP Analysis is the analysis of the assets and liabilities of a bank in order to maintain a strong cash flow and avoid a situation of liquidity crunch. GAP analysis helps the bank in taking major lending decisions also set targets for deposits. GAP analysis technique was used since 1980s to analyse the interest rate risks for a bank. In order to analyse the interest rate or credit risk, interest rate sensitive liabilities are subtracted from correspinding interest rate sensitive assets. The resulting gap is then multiplied by the changes in the interest rates for that particular period. GAP analysis is one of the first methods used to analyse a bank's risk exposure.
Answer to Question 1(b):
Inflation refers to a situation where there is a general increase in the price level of all goods and services in an economy. Banks can try to control the inflation rate through a sharp increase in real interest rates, more than proportionally reflected in nominal interest rates.This move usually provokes a fall in investment and a revaluation of currency. The first effect brakes domestic demand, the second the foreign one. Example: If inflation rises it will lead to rise in prices and thus rise in business income of the manufacturer. Better salaries to employees and expansion of business. If a man earning $200 per month now earns $350 per month his buying capacity increases and thus the circle continues. Availability of more currency in the market and cheap, easy and affordable credit options might fuel to the inflation. Hence in order to reduce the supoly of credit the banks follow a tight lending policy by increasing the interest rates.
Answer to Question 1(c):
When inflation reduces, the banks follow an easy lendibg policy. The approach of the country's Central Bank in changing the 'repo' rate determines the actions by commercial banks.
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