Question

What affects the book value of bank equity? What affects its market value?

What is the reason that banks are exposed to liquidity risk more so than most non-financial firms?

Who, if anyone, pays for bank deposit insurance? Why is it called “government” deposit insurance?

What types of firms would generally consider both bond issues and bank loans as potential forms of debt?

Answer 1

a. Book Value of a Bank Equity is the stock's intrinsic value, that means all the assets minus liabilities or debts of the company. Hence, actual reduction in the book value of assets, such as depreciation on assets, reduction in loans given, high provision for non-performing assets, can affect the book value of a bank stock.

b. A number of factors affect the market value of a bank stock, such as income from and growth of the bank's deposit base, interest rate considerations, quality of the loan portfolio and etc.

c. Banks are exposed to liquidity risk so more-than non-financial firms due to following reasons:

i. Banks borrow large amount of short term deposits and reserves from individuals and businesses and from other lending institutions and then turn around and make long term credit available to their liabilities. Thus, banks must always stand ready to meet immediate cash demands that can be substantial at times, especially near the end of the week, the first of each month, during certain seasons of the year.

ii. One more reason is banks sensitivity to change in interest rate raises. Depositors will withdraw their funds and invest elsewhere for higher returns.Many loan customers will look for alternatives that carry lower interest rates. Thus, changing interest rates affects both customers demand for deposits and customers demand for loans, each of which has a potent impact on a bank liquidity position.

d. The central banking authority of any country, Federal Deposit Insurance Corporation (FIDC) in case of USA pays for the bank deposit insurance, to every depositor in case of any defaults on deposits by the member banks.

e. It is called Government deposit insurance, because FIDC is a United States Government Corporation which was created by the 1933 Banking Act.

f. All Non-Financial Firms, that is other than Banks and Finance companies, will consider bond issues and bank loans as potential forms of debts.