Session 5 · Banking
What banks do, how they make money, why they sometimes fail, and how we safeguard the system.
1) Intro Banks as “plumbing” for the economy
Banks move funds from savers to borrowers, run payments, and transform risk/maturity. When they work, they are invisible; when they don’t, everything else struggles.
Click to show more details (for FIN310)
- Three pillars: Intermediation • Payments • Safekeeping
- Three classic risks: Credit • Liquidity • Interest-Rate Risk
- Safety net: Capital, Liquidity buffers, Supervision, Deposit Insurance, Central-Bank backstops
🧾 Sample Bank Account Comparison (Fall 2025)
| Institution | Basic Checking | Savings APY | Notes |
|---|---|---|---|
| Chase | $12/mo (waived with $500 DD) | ≈0.01% | Huge ATM network, good app. |
| Bank of America | $12/mo (waived with $250 DD) | ≈0.01% | Preferred Rewards perks if balance >$20k. |
| Wells Fargo | $10/mo (waived with $500 DD) | ≈0.01% | Large branch network. |
| VyStar CU | $0 (no monthly fee) | ≈0.10% | Strong local presence, member-owned, good car loan rates. |
| Ally / SoFi (Online) | $0 | ≈4.25% | No branches, high-yield savings, ATM reimbursements. |
Rates are approximate and for education — check each bank’s site for current offers.
2) What Banks Do Transformations
Risk Transformation
Pool many risky loans ⇒ diversify idiosyncratic risk; screen/monitor borrowers.
Show simple example
Expected loss ≈ p(default) × exposure; diversification reduces variance; capital covers unexpected loss.
Maturity Transformation
Borrow short (deposits) and lend long (loans/securities).
Why it’s risky
Deposits can reprice/leave quickly while assets are fixed-rate and illiquid → duration gap. See IRR demo.
Liquidity Services
Checking/ATMs/wires/card rails keep payments flowing.
Student-life tie-in
- Direct deposit, debit cards, Zelle/ACH, ATM fees
- Overdraft vs. account alerts; fraud holds & provisional credit
3) Bank Balance Sheet (T-Accounts)
Assets
- Reserves at Fed / Cash
- Loans (retail, mortgage, commercial)
- Securities (Treasuries, MBS)
Liabilities & Equity
- Deposits (demand/time)
- Wholesale funding (repo, CP)
- Equity (capital)
Click to run a quick T-account shock
| Assets | Liabilities & Equity |
|---|---|
| Reserves: 100 | Deposits: 1000 |
| Loans: 900 | Equity: ≈0 |
| Total Assets: 1000 | Total Liabs+Eq: 1000 |
Explain it like I’m in FIN310
Make a $1000 loan → bank credits a deposit (liability +1,000) and splits assets: 100 to reserves and 900 to loans. Total assets now = 1,000, exactly matching total liabilities. Equity stays ~0 at origination.
4) Deposits, Reserves & Money Creation
When a bank makes a loan, it typically credits a deposit—creating money. Constraints: capital, liquidity, regulation, demand for loans, and the cost of funding.
Simple Multiplier (toy)
Why this equation?
- r = reserve ratio (decimal), e.g. 10% → 0.10
- l = leakage (share that leaves the banking system), e.g. 50% → 0.50
- The denominator is
r + l − r×l(equivalently1 − (1−r)(1−l)), and the multiplier is its reciprocal: Multiplier = 1 ÷ (denominator).
Geometric-series intuition:
1 + (1−r)(1−l) + [(1−r)(1−l)]² + … = 1 / [1 − (1−r)(1−l)].
Example: r = 0.10, l = 0.50 → denominator = 0.55 → Multiplier = 1 ÷ 0.55 ≈ 1.82.
Real-world multipliers are smaller due to capital & liquidity rules (LCR/NSFR), borrower demand, pricing, and extra “leakage” (cash withdrawals, debt paydowns).
Funding Cost vs. Lending Rate
📋 How to Play
- Raise the deposit rate — watch the spread shrink (margin pressure).
- Raise the loan rate — watch the spread widen (but demand may fall).
Explanation
Higher deposit rates without matching loan repricing will squeeze margins. See NIM below.
5) How Banks Earn Money (Net Interest Margin & fees)
Quick NIM Calculator
What this mini-game shows
- NIM (Net Interest Margin):
(Interest income − Interest expense) ÷ Earning assets. - Pre-tax ROA (toy):
(Interest income − Interest expense + Non-interest income) ÷ Earning assets. - Teaching toy: ignores provisions, taxes, and operating costs to focus on margin intuition.
How to play
- Change Interest income to simulate loan yields/mix.
- Change Interest expense to simulate deposit/wholesale costs.
- Scale Earning assets to see size effects (ratios may stay the same).
- Tweak Non-interest income to see fees cushioning NIM pressure.
What the results say
- NIM = 3.30% means 3.30¢ of net interest per $1 of earning assets.
- Pre-tax ROA (toy) = 4.10% means fees lift returns to 4.10¢ per $1 (before costs we ignore here).
- If expense rises faster than income, NIM compresses → profitability falls unless pricing/fees adjust.
What this ignores (on purpose)
- Credit costs (provision for loan losses)
- Operating expenses & taxes
- Capital & liquidity requirements (CET1, LCR/NSFR)
Use this to build intuition; real banks must also cover losses/overhead and meet regs.
Fee Examples
- Payments/Interchange, Wealth/Advisory, Service fees
- Mortgage origination/servicing, Investment banking
Student-life tie-in
ATM fees, overdraft, statement fees; avoid with alerts, autopay, and maintaining minimums.
5A) National vs Regional Banks Scale, funding, geography & risk
What typically differs?
- Scale: Nationals are very large; regionals smaller/local.
- Funding mix: Nationals more wholesale/markets; regionals more core deposits.
- Geography: Nationals diversify widely; regionals more concentrated.
- Reg burden: Nationals face more complex oversight.
- Income mix: Nationals more fee diversity; regionals more NIM-heavy.
Snapshot (toy metrics)
Translate each row
- Assets: Size ⇒ scale & complexity.
- Footprint: Diversification vs local risk.
- Funding: Core deposits cheaper/stable; wholesale flexible/volatile.
- Uninsured %: Higher ⇒ faster runs if confidence breaks.
- NIM: Spread earnings (may be thinner at huge scale).
- Fee share: More business lines diversify revenue.
Mini stress hint (uninsured vs HQLA)
What is HQLA?
HQLA = High-Quality Liquid Assets. These are assets that can be quickly sold or pledged to raise cash without major losses. Under the Liquidity Coverage Ratio (LCR), banks must hold enough HQLA to survive 30 days of severe outflows.
- Level 1: Most liquid, no haircut — cash, Fed reserves, U.S. Treasuries.
- Level 2A: Slight haircut — GSE securities (agency MBS), some sovereign bonds.
- Level 2B: Higher haircut — high-quality corporates, equities (up to 15% of HQLA).
A higher % of HQLA means the bank can handle more withdrawals before it must sell illiquid assets at fire-sale prices. Pair this with the uninsured deposit % to see stress vulnerability.
Quick quiz: which is more exposed to a local downturn?
5B) Which Bank Should You Choose? Life + Features
Check all that apply, then click See My Bank Match to get a suggestion and feature checklist.
Life Stage & Plans
Feature Priorities
Recommendation
Choose options and click below to see your result.
Bank Type Glossary (with Examples)
-
National bank: Nationwide reach, big ATM network, premium cards, mortgages.
Examples: JPMorgan Chase, Bank of America, Wells Fargo, Citibank. -
Regional bank: Regional footprint, strong for mortgages, local feel.
Examples: PNC Bank, Truist, Fifth Third, Regions Bank. -
Credit union / community bank: Low fees, personal service, car loan specialists.
Examples: VyStar Credit Union (FL), Navy Federal CU, local community banks. -
Online bank / fintech: Highest APYs, lowest fees, no branches.
Examples: Ally Bank, SoFi, Chime, Discover Bank, Capital One 360.
Examples are for teaching only — check current offers and availability where you live.
5C) Jargon Decoder Plain-English + where it shows up
Terms & Why Students Care
| Term | Meaning | Why Students Care |
|---|---|---|
| NIM | Net Interest Margin | Earnings on loans/securities after paying for deposits/funding. |
| HQLA | High-Quality Liquid Assets | Cash/Treasuries to meet outflows. |
| LCR | Liquidity Coverage Ratio | Enough HQLA for 30-day stress? ≥100% goal. |
| TCE | Tangible Common Equity | Core loss-absorbing capital. |
| AOCI/OCI | Accumulated Other Comprehensive Income | Unrealized gains/losses (esp. AFS) in equity. |
| HTM vs AFS | Held-to-Maturity vs Available-for-Sale | HTM shields P&L; AFS marks hit AOCI. |
| IOR | Interest on Reserves | Fed rate on reserves; policy floor. |
Where to Find in Filings
- NIM: Income Statement + average earning assets.
- HQLA: Liquidity section/HQLA table.
- LCR: Liquidity/Reg capital section.
- TCE/CET1: Regulatory capital tables.
- AOCI: Balance Sheet (AOCI line).
- HTM/AFS: Investment securities note.
- IOR: Federal Reserve H.15 / FOMC.
5D) Jargon Snapshot by Bank Use latest 10-Q/Annual/NCUA
Tip: Hover the ℹ️ to see where to click in filings. Values change each quarter; update often.
| Metric | JPMorgan Chase | Bank of America | Wells Fargo | VyStar CU |
|---|---|---|---|---|
| NIM ℹ️ | ||||
| HQLA (amt or % assets) ℹ️ | ||||
| LCR ℹ️ | N/A (CU) | |||
| TCE (or CET1 proxy) ℹ️ | ||||
| AOCI (OCI) ℹ️ | ||||
| HTM vs AFS mix ℹ️ | ||||
| IOR (reference) ℹ️ | ||||
Where to click (shortcuts)
- JPMorgan Chase — IR ▶ Quarterly Results ▶ 10-Q PDF + Pillar 3.
- Bank of America — IR ▶ Quarterly Results ▶ 10-Q + “Regulatory Capital”.
- Wells Fargo — IR ▶ Quarterly Supplement (NII/NIM) + 10-Q Liquidity section.
- VyStar CU — NCUA FPR (“Financial Performance Report”) ▶ NIM/Net Worth/Investments.
Research Links
6) Core Risks
Credit Risk
Borrower defaults or deteriorates.
Simple credit math
Expected loss ≈ PD × LGD × EAD. Capital covers unexpected loss.
Liquidity Risk
Need cash now; assets not liquid or too costly to sell/pledge.
Funding mix matters
Stable core deposits vs. volatile wholesale funding changes outflow rates.
Interest-Rate Risk
Duration mismatch: deposits reprice fast, assets slow.
Hedge idea
Use swaps to pay fixed/receive floating to reduce positive duration gap.
Mini duration gap demo
Why students should care
The duration gap measures how sensitive a bank’s net worth is to interest-rate changes.
Example: A gap of 4.2 years means roughly:
+1% rate shock → ≈ −4.2% drop in asset value (net of liabilities).
- ≤ 1 yr: Low interest-rate risk — bank is nearly hedged.
- 1–3 yrs: Moderate risk — NIM and capital may swing with rates.
- > 3 yrs: High risk — rapid hikes can wipe out equity if unhedged.
Real-world example — SVB (2023):
Silicon Valley Bank had very long-duration securities funded by short-term, uninsured deposits.
When the Fed hiked rates, asset values plunged. To meet withdrawals, SVB sold bonds at losses,
triggering panic and accelerating the run.
Conclusion: Manage duration gap with swaps, floating-rate loans, or shorter securities. Too much duration = dangerous for capital when rates rise.
7) Capital & Liquidity Ratios
Capital (toy leverage)
What this tells us
Leverage ratio = TCE ÷ Total Assets. Here:
60 ÷ 1000 = 6%. That means shareholders are funding 6¢ per $1 of assets — the rest is deposits & debt.
- Higher (8–10%): More loss-absorbing cushion — safer bank.
- Lower (≤5%): Thin capital — small asset losses can wipe out equity.
Real regulators use CET1/RWA (risk-weighted assets) and require buffers ≥4.5% + add-ons.
Liquidity (LCR-style intuition)
What is LCR?
LCR = Liquidity Coverage Ratio, a Basel III requirement that large banks must hold enough High-Quality Liquid Assets (HQLA) to cover their projected net cash outflows for a 30-day severe stress scenario.
- Formula:
LCR = HQLA ÷ 30-day net outflows. - Goal: ≥100% (1.0x) so the bank can survive 30 days without outside help.
- Examples of HQLA: cash, reserves at the Fed, U.S. Treasuries, agency MBS (Level 1 assets).
If LCR < 100%, the bank may be forced to borrow emergency funds or sell illiquid assets quickly — which can cause losses and panic. This was one reason SVB ran into trouble: it didn’t have enough immediately-available HQLA compared with its large uninsured deposit base.
Real-world lesson — SVB 2023
Silicon Valley Bank’s capital looked fine at book value (≈8% leverage ratio), but much of its equity was tied up in long-dated securities that had large unrealized losses. When those losses were recognized, real capital dropped sharply.
On liquidity, SVB had a relatively low HQLA % vs. its very concentrated uninsured deposits. When outflows started, it didn’t have enough quick cash and had to sell bonds at losses — which spooked depositors and caused a classic run.
Takeaway: strong capital and liquidity coverage are both needed. A bank can look solvent on paper but still fail if it can’t meet withdrawals in real time.
8) Bank Runs & Backstops
- Run mechanics: concerns → withdrawals → asset sales (losses) → more concerns.
- Fire sale risk: long-duration assets sold into rising-rate markets ⇒ realized losses.
- Backstops: Deposit insurance, discount window, emergency facilities, communications.
Run stress toy
Explain the hint
Higher uninsured + lower liquidity = faster runs historically; communication and pledging collateral can help.
9) 2023 Lessons (SVB-style profile)
- Concentration: client base with correlated cash-flow cycles.
- High share of uninsured deposits ⇒ fast, digital outflows.
- Large fixed-rate securities at low yields ⇒ big unrealized losses when rates rose.
- Communication & risk governance gaps.
- Backstop design matters (collateral valuation, term, stigma).
Click for a 5-bullet student takeaway
- Don’t fund long fixed assets with hot money.
- Know your uninsured %, and pre-position collateral.
- Hedge duration when rates can rise.
- Explain your balance sheet clearly to depositors.
- Practice drills for outflow days.
9A) Media Gallery Banking Concepts in Action
📺 Why the U.S. Has 4,500 Banks (vs. Canada’s 79)
Watch this short video for insight into why the U.S. banking landscape has thousands of banks while Canada has only a few dozen — a mix of history, regulation, and geography.
Source: YouTube – “Why the U.S. Has 4,500 Banks and Canada Has 79”
10) Mini Tools
11) Quiz – Session 5
Quick 3-question check on balance sheets, liquidity coverage, and NIM. Answers appear immediately.
Q1. A bank funds long-term fixed-rate mortgages mostly with demand deposits. Which risk is primary?
Q2. If HQLA = $200 and 30-day net outflows = $150, the coverage ratio (toy) is closest to:
Q3. Raising deposit rates quickly while loan rates reprice slowly will most directly squeeze:
Opens in a new tab — great prep for midterm: T/F on balance sheets, money creation, NIM, capital & liquidity.
12) Homework — Which Bank Fits You? Due: Midterm 2
- Run the tools: Use Which Bank Should You Choose? and skim National vs Regional. Note your selected checkboxes and the recommendation you received.
- Your pick (150–250 words): State your recommended bank type and explain why using at least 3–5 criteria.
- Reality check (100–200 words): Which institution do you currently bank with? Compare features you have vs. need.
-
Feature checklist:
Feature Must-Have Nice-to-Have My Current Bank My Recommended Type Monthly/overdraft fees & minimums ATM/branch access where I’ll live Payments (Zelle/ACH/wires), app quality International usage/FX & ATM fees Savings/APY & goals (emergency fund) Upcoming loans (auto/mortgage) Perks (cash-back/travel/student) - Action plan (100–150 words): Will you stay or switch? If switching, list the top 3 features and how you’ll do it. If staying, what would make you reconsider.
- Attach evidence (optional): Screenshot your selections and any fee/APY pages you consulted.
Grading rubric (10 pts)
- Tools used & noted (2)
- Justification quality (3)
- Feature checklist (3)
- Action plan (2)
Note: Educational exercise, not financial advice. Verify fees/APYs on official sites.
Note: All calculators here are simplified to teach intuition (not regulatory calculations).