Transcript Document

17
Commercial
Bank
Operations
© 2003 South-Western/Thomson Learning
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Chapter Objectives
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Describe the most common sources of funds
for commercial banks
Describe the most common uses of funds for
commercial banks
Describe typical off-balance sheet activities
for commercial banks
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Bank Participation in Financial
Conglomerates
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Impact of the Financial Services
Modernization Act (1999)
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Banks and other financial service firms were
given more freedom to merge and offer a range of
financial services
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Insurance
Securities services
Banks now a subsidiary of financial
conglomerates
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Bank Participation in Financial
Conglomerates
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Benefits of diversified services to individuals and
firms
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Individuals can obtain all their financial services at a
single financial conglomerate
 Deposits
 Loans
 Investing
(brokerage)
 Insurance
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Businesses can obtain loans, issue stocks and bonds,
and have their pension fund managed by the same
institution
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Bank Participation in Financial
Conglomerates
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Benefits of diversified services to the
financial institution
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Reduce reliance on demand for single service
Economies of scale and scope
Diversification (service and geographical) may
result in less risk
Generate new business
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Bank Sources of Funds
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Transaction deposits
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Demand deposit account (checking)
Savings Deposits
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Passbook savings
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Bank Sources of Funds
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Time Deposits
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Certificate of deposit (CD)
 No
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secondary market
Negotiable CD
 Short-term,
minimum $100,000
 Can trade among investors via dealer
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Money Market Deposit Accounts (MMDAs)
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More liquid than CDs : no specified maturity
Limited check writing
Created in 1982
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Bank Sources of Funds
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Federal Funds Purchased
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Short-term loans between banks
Allows banks to meet reserve requirement or
funding needs
Interest rate charged is the federal funds rate
Borrowing from the Federal Reserve Banks
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Borrowing at the discount window
Discount rate
Intended for meeting temporary short-term reserve
requirement needs
Must get Fed approval
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Bank Sources of Funds
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Repurchase agreements
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Sale of securities by one party to another with an
agreement to repurchase the securities at a
specified date and price
Banks may sell T-bills to a corporation with
temporary excess cash (bank demand deposit)
and then buy them back later
Source of funds for a few days
Collateralized by the treasury bills
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Bank Sources of Funds
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Eurodollar borrowings
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Banks outside the United States make dollardenominated loans
Eurodollar market is very large
Bonds issued by the bank
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Like other businesses, banks issue bonds to
finance long-term fixed assets
Usually subordinated to deposits
Part of secondary regulatory capital
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Bank Sources of Funds
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Bank capital
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Obtained from issuing stock or retaining earnings
No obligation to pay out funds in the future
Must be sufficient to absorb operating losses
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Uses of Funds by Banks
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Loans make up about 64 percent of bank assets,
while all securities make up about 22 percent of
assets. Cash represents 6 percent of bank assets.
Cash and “due from” balances at institutions
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Currency/coin provided via banks
Reserve requirements imposed by Fed
 Tool
for controlling the money supply
 Due from Fed and vault cash count as reserves
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Also hold cash and due from balances to maintain
liquidity and accommodate withdrawal requests by
depositors
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Uses of Funds by Banks
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Bank Loans
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Types of business loans
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Working capital loans
Term loans
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Purchasing fixed assets
Protective covenants
Informal line of credit
Revolving credit loan
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Uses of Funds by Banks
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Bank Loans
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Loan participations
 Sometimes
large firms seek to borrow more money than
an individual bank can provide
 Lead bank
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Loans supporting leveraged buyouts
 Banks
charge a high loan rate
 Monitored by bank regulators
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Uses of Funds by Banks
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Bank Loans
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Collateral requirements on business loans
 Increasingly
accepting intangible assets
 Important to service-oriented firms
 Increased lending risk with service businesses--telecomm
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Types of consumer loans
 Installment
loans
 Credit cards
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Real estate loans
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Uses of Funds by Banks
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Investment securities (bank income and
liquidity)
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Treasury securities
Government agency securities
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Corporate and municipal securities
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Freddie Mac
Fannie Mae
Investment grade only
Federal funds sold
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Lending funds in the federal funds market
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Uses of Funds by Banks
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Repurchase agreements
Eurodollar loans
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Branches of U.S. banks located outside of the
U.S.
Foreign-owned banks
Fixed assets
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Office buildings
Land
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Off-Balance Sheet Activities
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Loan commitments
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Obligation of bank to provide a specified loan
amount to a particular business upon request
Note issuance facility (NIF)
Banks earn fee income for risk assumed
Standby letters of credit (SLC)
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Backs a customer’s obligation to a third party
Banks earn fee income
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Off-Balance Sheet Activities
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Forward contracts
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Agreement between a customer and bank to
exchange one currency for another on a particular
future date at a specified exchange rate
Allows customers to hedge their exchange-rate
risk
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Off-Balance Sheet Activities
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Swap contracts
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Two parties agree to periodically exchange
interest payments on a specified notional amount
of principal
Banks serve as intermediaries or dealer and/or
guarantor for a fee
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