Chapter 9
Banking and the Management of Financial Institutions
Although this chapter performs the conventional function of outlining what banks (depository
institutions) do and what their balance sheets look like, it also emphasizes the economic way of
thinking about how banks manage their assets and liabilities to make a profit. Three tools are
used throughout this chapter and the rest of the book—the asymmetric information concepts of
adverse selection and moral hazard, introduced in Chapter 2, the theory of portfolio choice
developed in Chapter 5, and T-accounts, introduced in this chapter. In teaching this material, it is
worth emphasizing to the student that mastery of these tools will pay high dividends in helping
them to learn (and perform well on exams) in this course.
The subsection, “Capital Adequacy Management,” and the final three sections in the chapter,
“Managing Credit Risk,” “Managing Interest–Rate Risk,” and “Off-Balance-Sheet Activities,”
discuss issues that have become increasingly important in recent years. Many instructors may
therefore want to include this material in their courses, yet none of this material is essential to
understanding later chapters, so it can be skipped without any loss of continuity. The application
on how a capital crunch caused a credit crunch during the global financial crisis particularly
piques the interest of students because it shows how changes in banks’ behaviors can have major
effects on the economy.