FIN310 — Midterm 2 Study Guide

Core topics: Bank Basics, Regulation, Fractional Reserve Banking, Credit Unions, Bank Failures.

1) Bank Basics Foundations

What banks actually do
Intermediation & risk transformation
Banks pool loans and monitor borrowers to reduce idiosyncratic risk and information problems.
Money creation
New loans typically create new deposits (they don’t “use up” existing deposits).
Balance sheet (memorize):
Assets = loans, securities, reserves; Liabilities = deposits, borrowings; Equity = capital.
Net Interest Margin (NIM) = (interest income − interest expense) / average earning assets.
Rate risk: mismatched repricing/duration of assets vs. liabilities.
Liquidity risk: forced sales during withdrawals → realized losses.
Deposit insurance reduces, but does not eliminate, run risk (coverage limits, confidence).
Quick checklist — can you…?

2) Bank Regulation Safety & Soundness

Key laws & structures
  • Federal Reserve Act (1913) — created the Fed; lender of last resort.
  • Glass–Steagall (1933) — separated commercial & investment banking (major parts repealed in 1999 via GLBA).
  • Dodd–Frank (2010) — stress testing, enhanced oversight, “Too Big To Fail” reforms.
Capital & liquidity ratios (what they measure)
CET1 ratio = CET1 capital / risk-weighted assets (RWA). Capital absorbs losses; it doesn’t prevent them.
Leverage ratio uses total exposures (not RWA). Backstop to risk-based capital.
LCR — High-Quality Liquid Assets (HQLA) must projected 30-day net outflows (≥100%).
NSFR — stable funding over ~1 year must required stable funding (≥100%).
Checklist — regulation fluency

3) Fractional Reserve Banking Mechanics

How the system multiplies deposits
  • Banks keep only a fraction of deposits as reserves; the rest can be lent out.
  • More excess reserves held voluntarily → smaller effective deposit multiplier.
  • Central bank reserves support payments & liquidity needs.
Checklist — fractional logic

4) Credit Unions Compare & Contrast

Banks vs. credit unions
Banks: for-profit, shareholder-owned. Insured by FDIC.
Credit Unions: not-for-profit, member-owned. Insured by NCUA.
Checklist — CU essentials

5) Bank Failures Risk in Practice

Why banks fail
Common causes: capital erosion, liquidity runs, poor risk management, concentration risk.
Uninsured deposits flee faster in stress → higher run vulnerability.
Duration mismatch: rising rates ↓ long-bond prices → AOCI hits; if forced to sell, losses become realized.
Resolution tools: receivership, bridge bank to maintain critical functions during sale/transition.
Case example — SVB 2023 (what to remember)
Concentrated uninsured deposits + large, unhedged long-duration securities → rapid digital outflows and failure.
Checklist — failure literacy

6) Extras & Exam Tips Good to Know

Stablecoins & custody (quick parallels)
Private keys: loss can mean permanent loss of access (self-custody).
Not FDIC insured: crypto exchange balances ≠ insured bank deposits.
Segregation of assets is critical (avoids commingling risk).
Exam strategies
  • Memorize the bank balance sheet layout and what drives NIM.
  • Be able to define and contrast CET1, leverage ratio, LCR, NSFR.
  • Explain how fractional reserve banking and excess reserves affect money creation.
  • Know the differences between banks vs. credit unions (ownership, insurer, mission).
  • Use SVB 2023 as a compact narrative for liquidity + duration + deposits.