Question 12.P.1: Rhinestone National Bank reports the following figures in it...

a. Evaluate the funding mix of deposits and nondeposit sources of funds employed by Rhinestone. Given the mix of its assets, do you see any potential problems? What changes would you like to see management of this bank make? Why?

Core deposits/Assets = 8.00%

Large Negotiable CDs/Assets = 24.00%

Brokered Deposits/Assets = 10.40%

Other Deposits/Assets = 7.2%

Money Market Liabilities/Assets = 31.2%

Other Liabilities/Assets = 10.40%

Equity Capital/Assets = 8.80%

The proportion of core deposits at Rhinestone is exceptionally low, while large CDs and other money-market borrowings make up more than 54 percent of the bank’s total funding sources. This funding mix tends to subject the bank to excessive vulnerability to quick withdrawal of funds and high interest-rate risk exposure. Rhinestone also appears to be excessively dependent on brokered deposits which are highly volatile and interest-sensitive. Adding in these brokered deposits, more than half of Rhinestone’s assets are funded with highly interest-sensitive deposits and money-market borrowings. Management needs to expand the bank’s core deposits and other more stable funds sources.

b. Suppose market interest rates are projected to rise significantly. Does Rhinestone appear to face significant losses due to liquidity risk? Due to interest rate risk? Please be as specific as possible.

If interest rates rise, Rhinestone will experience higher interest costs immediately or within hours or a few days on at least 50 percent of its funding sources. Unfortunately all but $65 million of its $625 million in total assets are longer-term, inflexible assets whose interest yields cannot be adjusted as rapidly as the interest rates to be paid out on the bank’s liabilities. Other factors held equal, the bank’s earnings will be squeezed. Management needs to do some serious restructuring work on both sides of the bank’s balance sheet in moving toward more flexible-return assets and more flexible-cost liabilities, and to move toward greater use of interest-rate hedging techniques.