Using examples, explain why having a high ROE may be problematic for a bank. (7 marks)

Section A

Banco Santander
In thousand USD (‘000 $)
Income statement
Net interest revenue 41,131,178
Interest Income 67,209,947
Interest Expense 26,078,769
Other operating income 19,218,776
Net gains (losses) on trading and derivatives 1,488,331
Net gains (losses) on assets at FV through income statement -101,940
Net fees and commissions 10,441,102
Remaining operating income 7,391,283
Overheads 33,600,776
Loan loss provisions 11,082,727
Other -1,165,719
Profit before tax 14,500,731
Tax 4,658,080
Net income 9,842,652
Operating income 60,349,954
Common and Preferred dividends declared n.a.
Loans 1,007,531,572
Gross loans 1,036,235,608
Less: Reserves for impaired loans / NPLs 28,704,036
Other earning assets 434,804,861
Loans and advances to banks 47,452,686
    of which Reverse Repos, Securities Borrowed and Cash Collaterals     n.a.
Derivatives 80,433,425
Other securities 303,435,984
Remaining earning assets 3,482,766
Total earning assets 1,442,336,433
Fixed assets 24,765,536
Non-earning assets 265,052,402
Cash& Balances at Central Bank 164,631,450
Goodwill 30,904,751
Other Intangible Assets 3,494,759
Total assets 1,732,154,371
Liabilities & equity
Deposits & short term funding 1,122,875,408
Total customer deposits 864,222,469
Deposits from banks 195,142,831
of which Reverse Repos, Securities Borrowed and Cash Collaterals n.a.
Other deposits and short-term borrowings 63,510,108
Other interest bearing liabilities 464,029,393
Derivatives 79,472,786
Trading liabilities 131,141,010
Long term funding 253,415,598
Other (non-interest bearing) -251,853
Reserves 17,376,652
Equity 128,124,771
Total liabilities & equity 1,732,154,371

Table 1: Consolidated Statements Banco Santander 2017 (Source: Orbis Bank Focus)

Section A

Answer ALL questions.

  1. The balance sheet for Bank of Santander SA is given in Table 1.
  1. Using the information provided calculate the following ratios:
    1. Return on assets (ROA)                                                        (3 marks)
    1. Return on equity (ROE)                                                        (3 marks)
    1. Net interest margin (NIM)                                                              (3 marks)
  • Using examples, explain why having a high ROE may be problematic for a bank.                                                                                      (7 marks)
  • Using examples, explain why the three core functions of banks are important for a well-functioning economy.                                                             (9 marks)
  • As an employee of Lemon Brothers Bank you are asked to create term loans that might appeal to potential customers. You are working on different structures for a 3 years loan of £5,000 at an interest rate of 4%. The Bullet loan structure consist of zero payments at the end of the first and second year and a final payment of £5,624.32 at the end of the third year.  
  1. Calculate the payments for a loan structure that includes interest only paid at the end of each year and a final repayment at the end of the third year.

                                                                                                     (5 marks)

  • Show one example of a Balloon-style repayment structure for the loan mentioned above.                                                                                (10 marks)
  • Calculate the payments for a mortgage style repayment loan.     (10 marks)

(please turn page)

Section B

Answer TW0 questions

    • Examine the three functions of money and why each of them are important for   a smooth functioning of an economy.                                    (15 marks)
  • “A pound today is worth more than a pound next year.” Discuss this concept using relevant theory.                                                                 (10 marks)
    • Explain why investment banks may experience conflicts of interest when undertaking their business operations.                                                   (12 marks)
  • Examine the reasons why investment banks are able to make large profits.

     (5 marks)

  • Discuss why investment banks pay large bonuses to their employees and why this is controversial?                                                                       (8 marks)
    • Explain how a central bank can engage in expansionary monetary policy using open market operations.                                                             (15 marks)
  • Analyse how ‘quantitative easing’ is intended to influence the market for lending, and therefore, the level of economic activity.                   (10 marks)

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