Banks are financial intermediaries with a traditional focus on taking deposits and lending money. As such, they are taxable investors with predominantly short- and intermediate-term liabilities.

Although we can view a bank's strategic asset allocation from the perspective of all bank assets including loans, real estate (including bank premises) and so forth, a bank's securities portfolio is subject to a distinct set of regulations and is traditionally treated separately.

Asset allocation for Banks

Bank's securities portfolio plays an important role in (1) managing the balance sheet's overall interest rate risk, (2) managing liquidity (assuring adequate cash is available to meet liabilities), (3) producing income, and (4) managing credit risk. The first concern is the most important and dictates an ALM approach to asset allocation. Banks' portfolios of loans and leases are generally not very liquid and may carry substantial credit risk. Therefore, a bank's securities portfolio plays a balancing role in providing a ready source of liquidity and in offsetting loan-portfolio credit risk.

As with the portfolios of insurers, public policy usually views bank portfolios as quasi- public trust funds. Thus banks typically face detailed regulatory restrictions on maximum holdings of asset types, often stated as a percentage of capital. In turn, the risk of assets affects banks' costs through the operation of risk-based capital rules ( types of reinsurance ).

EXAMPLE 5-20 An Asset Allocation for a Commercial Bank

William Bank is a hypothetical U.S. commercial bank. Although a more detailed breakdown of asset classes would be more realistic, the asset allocation presented below shows the typical emphasis on high-credit-quality debt instruments. The target percentages are stated as a percentage of the securities portfolio, for consistency with the presentation elsewhere, but regulatory guidelines are as a percentage of capital (capital stock and surplus plus undivided profits).

Investment Portfolio Asset Type


Regulatory Guideline

U.S. Treasury bonds


No limitation

Agency obligations


No limitation

Tax-exempt general obligations


No limitation

Tax-exempt other


<4% of capital, > Baa/BBB

Corporate bonds


< 10% of capital, > Baa/BBB

Money-market preferred stock


< 15% of capital


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