Noninterest income includes fees and service charges.
This source of revenue has grown significantly in importance.
Noninterest expense includes salary expenditures. These expenses have also grown in recent years. Because of lower interest rates, Wachovia reported for 2004 that Salaries and Employee Benefits alone were $8.7 billion, while total interest expense was $5.3 billion.
A bank must successfully balance profitability on one hand and liquidity and solvency on the other.
Bank failure can result from the depletion of capital caused by losses on loans or securities -- from over-aggressive profit seeking. But a bank that only invests in high-quality assets may not be profitable.
Failure can also occur if a bank cannot meet the liquidity demands of its depositors -- a run on the bank occurs. If assets are profitable, but illiquid, the bank also has a problem.
Bank insolvency very often leads to bank illiquidity.
Profitability Goal Versus Liquidity and Solvency
The current standards define two forms of capital:
Tier 1 capital includes common stock, common surplus, retained earnings, noncumulative perpetual preferred stock, minority interest in consolidated subsidiaries, minus goodwill and other intangible assets.
Tier 2 capital includes cumulative perpetual preferred stock, loan loss reserves, mandatory convertible debt, and subordinated notes and debentures.
The Value at Risk methodology uses recent market volatility to estimate within a given level of confidence the maximum trading loss that would be expected for the bank to incur from an adverse movement in market rates and prices over the period.
VAR evaluates overall riskiness for banks. VAR measure the loss potential up to a certain probability within a given time period.
Value at Risk - continued V = - D r ( 1 + r) X P V / r = the sensitivity of changes in asset values to changes in the risk factor D = Duration P = Probability Desired using a Normal Distribution
Matched hedging is a form of microhedging, which is hedging a specific transaction.
Macrohedging, on the other hand, involves using instruments of risk management, such as financial futures, options on financial futures, and interest rate swaps to reduce the interest rate risk of the bank’s entire balance sheet.
Interest rate swaps are privately negotiated agreements than can be tailor made to fit the circumstances of particular counterparties.
Swaps can be made for more varied maturities than is possible with futures, tailored to particular interest rates, and the settlement dates can be designed to fit the cash flow pattern of the counterparties.
Swaps are less marketable and carry more default risk than financial futures.