Question

Bank A is a retail universal bank operating in a fast changing interest rate environment. The bank’s balance sheet has the following features:

Deposits: TL 12.0bn 3 months of average maturity average deposit interest rate: 6%

Borrowings: TL 8.0bn 12 months of average maturity average borrowing interest rate: 8%

Loans: TL 15.0bn 16 months of average maturity average loan interest rate: 12%

Securities: TL 10.0bn 24 months of average maturity average securities interest rate: 10%

Capital: TL 2.0bn

Reserve requirements: 10% of the total of deposit and borrowing base (reserves do not yield any interest rate)

The Bank uses its securities portfolio for repo transactions with an average maturity of 1 month to make up for the funding gap to carry its assets. Average repo interest rate is equal to that of its borrowing rate, and repo transactions have been realized with a 50% haircut.

Please assume other assets and liabilities being negligible.

NPL ratio for the bank is 4%, and have been 100% provisioned.

Net fee income of the bank is equal to 80% of its total operating expenses which is equal to TL 0.5bn

Corporate tax rate: 25%

Base rate quoted by the Central Bank: 4%

a. Please calculate the Bank’s ROE and ROA, if above mentioned figures have been sustained for the whole year.

b. As economy grows faster, the central bank decides to increase its reserve requirements instead of increasing its base rate. Therefore reserve requirements have been increased to 20%. Please comment on Bank A’s balance sheet strategies following to such a decision. And comment on its new liquidity and capital position.

c. As the economy grows even faster, finally Central Bank has to increase the interest rates… New base rate becomes 10%. Traditionally the Bank’s borrowing and deposit costs is based on a fix differential on the CB base rate. (ie 2% over base rate for deposits and 4% for borrowings). And the Bank’s NPL increases to 6%. Keeping other balance sheet items fix, please calculate the Bank’s new expected yearly ROE… Keep the reserve requirements at 20%. Please comment on potential strategies for the Bank.

Answer 1