Transcript Document

Where are we going in this course?
• FINA 441, Part I, Financial Markets (done!)
• FINA 441, Part II, Financial Institutions or
Intermediaries
• DEPOSITORY (Commercial Banks, S&Ls, Savings
Banks, Credit Unions)
• CONTRACTUAL (Life Insurance Co, Fire/Casualty
Insurance Co, Pension Funds)
• INVESTMENT (Finance Co., Investment Co./Mutual
Funds, Money Market Funds)
• OTHER (Investment Bankers, Mortgage Bankers,
Security Dealers/Brokers)
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FINANCIAL INTERMEDIARIES
DIRECT
- involves only one contract between lender & borrower
- called dis-intermediation
- E.g. you loan money to your neighbor
SEMI-DIRECT
- Involves essentially one contract but . . .
- A middle party is needed to execute it
- E.g. you buy Intel stock through Charles Schwab from your neighbor
INDIRECT
- Involves two contracts
- Financial intermediary is in the middle
- E.g. you deposit money in the bank which loans it to your neighbor
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FUNCTIONS OF FIN. INTERMEDIARIES
Maturity & Liquidity Intermediation
E.g. You deposit $ in savings account, which is loaned out in a 30-yr fixed-rate mortgage to your neighbor;
even though the loan won’t be paid off for many years, yet you can get your money at any time. Financial
intermediaries absorb liquidity risk!
Interest-rate and Inflation Risk Intermediation
E.g. Bank absorbs risk from borrower locking into fixed rate for 30 years.
Repackaging Size
E.g. Bank can re-package the size of a security to the level desired. Most of us don’t have $100,000 sitting
around to lend to our neighbor, so many of us poor investors can pool our $.
Diversification & Default Risk
E.g. You deposit $ in savings account, pooled together with other investors, so that no one investor is
lending to only one borrower. Depository institutions also offer government deposit insurance. In short,
financial intermediaries absorb default risk.
Efficiencies & Specialization
E.g. Bank is better able to invest in mortgages (legal issues, credit approval, etc.). Since the bank has
specialized in this, it has economies of scale (full-time lawyers, appraisers, credit specialists, etc.)
Clearing House for Payments
E.g. financial intermediaries make possible EFT, credit/debit cards, checks, etc. which wouldn’t exist
otherwise
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Types of Financial Intermediaries
Assets of Financial Institutions (in $ billions)
1970
Type
$
%
Depository
Commercial Banks
517 39%
S&Ls & Savings Banks
250 19%
Credit Unions
18
1%
Contractual
Life Insurance Co.
201 15%
Fire & Casualty Insurance Co.
50
4%
Pensions (private)
112
8%
Pensions (gov't)
60
5%
Investment
Finance Companies
64
5%
Mutual Funds (Invest. Co.)
47
4%
Money Mkt Mutual Funds
0
0%
Total
1319 100%
GDP
GDP as % of total assets
1980
$
1990
%
$
2010
%
$
%
40 year
Growth%
20 year
Growth%
10 year
Growth%
1481
792
67
37%
20%
2%
3334
1365
215
30%
12%
2%
14133
1254
883
33%
3%
2%
2733
501
4905
953
157
1317
423
91
410
464
182
504
197
11%
5%
12%
5%
1367
533
1629
737
12%
5%
15%
7%
4826
1369
5471
2686
11%
3%
13%
6%
2400
2737
4884
4476
1039
751
1085
1362
352
256
335
363
1663
4%
6962 16%
3259
8%
42506 100%
14256
34%
2597
14812
n/a
3222
810
9945
4287
1052
272
1064
653
387
205
5%
70
2%
76
2%
4038 100%
2788
69%
610
6%
654
6%
498
5%
10942 100%
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Role of Financial Institutions
Types of Depository Financial Institutions
Commercial
Banks
Total Assets
$15.2T
(2014)
Savings
Institutions
Total Assets
$1.1 T
(2014)
Credit Unions
Total Assets
$1.05 T
(2014)
https://www2.fdic.gov/hsob/HSOBRpt.asp
Copyright© 2002 Thomson Publishing. All rights reserved.
Copyright© 2002 Thomson Publishing. All rights reserved.
CHAPTER
17
Commercial
Bank
Operations
Commercial Bank Consolidations
Today there are half as many banks as there were in
1985. Today, the largest 5 banks control half of bank
assets vs. 30% in 2001.
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Largest U.S. Banks
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Bank Participation in Financial Conglomerates

Impact of the Financial Services
Modernization Act (1999)
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Prompted by the Citicorp-Traveler’s merger
Gave more freedom to merge and offer a range of
financial services

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Insurance
Securities services
Many banks are now subsidiaries of a
financial conglomerate
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Bank Participation in Financial Conglomerates

Benefits of diversified services

To Individuals: they can obtain all their
financial services at a single place (one stop
shop)

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Deposits
Loans
Investing (brokerage)
Insurance
To Businesses: they 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

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
Risks of conglomerates: too big to fail
NOTE: there are bills currently before Congress
now that would split big banks and their
diversified services. This is an attempt to prevent
the “too-big-to-fail” syndrome.
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Sources of Funds (right hand of Balance Sheet)
Source: Federal Reserve
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Bank Sources of Funds

Transaction deposits
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Demand deposit account
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Negotiable order of withdrawal (NOW) account

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Interest-bearing checking account
Requires larger minimum balance
Savings Deposits



Checking account that does not pay interest
Passbook savings
Regulation Q until 1986 – max. interest rate
Auto Transfer Service (ATS) created in 1978 allows
ZBA accounts and overdraft protection.
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Bank Sources of Funds

Time Deposits (have specific maturity)
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Retail certificate of deposit (CD)
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
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Negotiable CD

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
No secondary market
Early withdrawal penalty
New: Bull-market, bear-market and callable CDs
Short-term, minimum $100,000, usually $1m, no
FDIC insurance
Marketable -- can trade among investors via dealer
Money Market Deposit Accts (MMDAs)



More liquid than CDs with no maturity
Limited check writing (e.g. 5 per month)
Created in 1982 with Garn St. Germain Act
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Bank Sources of Funds

Federal Funds Purchased

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Short-term loans between banks (usually 1-7 days), often to meet reserve
requirements (most report weekly on Wed.)
Allows banks to borrow S/T (seasonal, etc.) or may provide a S/T
investment
Interest rate is the Federal Funds Rate, typically above the T-bill rate since
small amounts of liquidity and default risk may exist.
Borrowing from the Federal Reserve Banks
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Borrowing at the discount window, which is discouraged
Discount Rate (usually 1% higher than Fed Fds Rate)
Intended for meeting temporary short-term reserve requirement needs
Must get Fed approval, Fed may frown at you
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Bank Sources of Funds

Repurchase agreements

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Sale of T-bills (usually) by bank to a business with
excess cash and an agreement to repurchase the
securities at a later date and higher price
Source of funds for a few days for the bank
Collateralized by the Treasury bills
Form of paying interest on large customer
checking balances (Rogers Elementary!)
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Bank Sources of Funds

Eurodollar borrowings

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
Banks outside the United States make dollardenominated loans (maybe even to US banks)
Eurodollar market is very large (Saddam Hussein
was caught with a briefcase full of what?)
Bonds issued by the bank


Like other businesses, banks issue bonds to
finance long-term fixed assets
Usually subordinated to deposits
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Bank Sources of Funds

Bank capital

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Represents amount of equity stockholders have
Obtained from issuing stock and retaining earnings
The more capital, the more “safe” the bank is because
capital is a buffer to absorb future losses
Banks often resist building up too much capital because it
lowers the return on equity (ROE). Stated another way,
the more leverage the bank, the more ROE is magnified.
Capital is usually approx. 6-12% of assets but it really
depends on risk-based capital requirement and size of bank
Primary capital (stock & RE) is of higher quality than
secondary capital (subordinated notes & bonds)
Copyright© 2002 Thomson Publishing. All rights reserved.
Bank Capital Regulation
A major reason banks failed during the financial
crisis because of inadequate capital.
Basel III (or the Third Basel Accord) is a global
regulatory standard on bank capital adequacy, stress
testing, and market liquidity risk agreed upon by the
members of the Basel Committee on Banking
Supervision in 2010–11, and scheduled to be
introduced from 2013 until 2018. (Basel is a town in
Switzerland where they meet.) Basel III strengthens
bank capital and introduces new regs on liquidity and
leverage.
Copyright© 2002 Thomson Publishing. All rights reserved.
Uses of Funds
(left hand side of balance sheet)
Source: Federal Reserve
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Uses of Funds by Banks

Cash and “due from” balances at institutions


Currency/coin provided via banks
Reserve requirements imposed by Fed


Due from Fed and vault cash count as reserves
Hold cash and due from balances to maintain
liquidity and accommodate withdrawal requests by
depositors
Copyright© 2002 Thomson Publishing. All rights reserved.
Uses of Funds by Banks

Bank Loans (59% of assets)

Types of business loans


Working capital loans (business operating cycle)
Term loans




Purchasing fixed assets
Protective covenants & conditions
Informal line of credit (bank not obligated to lend)
Revolving credit loan (bank obligated)
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Uses of Funds by Banks: Volume of
Small Business Loans
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Uses of Funds by Banks

Bank Loans

Loan participations (syndicates)

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
Sometimes large firms seek to borrow more money
than an individual bank can provide
Lead bank will organize the syndicate
Loans supporting leveraged buyouts



Banks charge a high loan rate
Monitored by bank regulators
Highly-leveraged transactions (HLTs) where debt ratio
> 75%.
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Uses of Funds by Banks

Bank Loans

Collateral requirements on business loans


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Types of consumer loans

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
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Increasingly accepting intangible assets
Important to service-oriented firms which have few hard assets
Increased lending risk with service businesses--telecomm
Installment loans (cars, furniture, etc.)
Credit cards
Usury laws
Real estate loans
Copyright© 2002 Thomson Publishing. All rights reserved.
Bank Prime Rate Over Time
Theoretically, the prime rate is the rate charged to most creditworthy
customers – moves in tandem with Fed funds rate, often 3% above.
http://research.stlouisfed.org/fred2/series/MPRIME?cid=117
Copyright© 2002 Thomson Publishing. All rights reserved.
Uses of Funds by Banks

Investment securities (bank income and
liquidity)



Treasury securities
Government agency securities
Corporate and municipal securities


Investment grade only
Federal funds sold
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Uses of Funds by Banks


Repurchase agreements
Eurodollar loans



Branches of U.S. banks located outside of the U.S.
Foreign-owned banks
Fixed assets


Office buildings
Land
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How Banks Finance Economic Growth
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Off-Balance Sheet Activities

Loan commitments



Obligation of bank to provide a specified loan
amount to a particular business upon request
Banks earn fee income for risk assumed
Standby letters of credit (SLC)


Backs a customer’s obligation to a third party
Banks earn fee income
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Off-Balance Sheet Activities

Forward contracts in foreign currency


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

Interest rate swap contracts



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
Credit default swap contacts

Privately negotiated contracts to protect investors
against the risk of default on debt securities
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Baker Boyer Bank



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

In the 1800s, Walla Walla was the largest city in the Northwest
and the financial and cultural center of the NW region (and it
almost became the state capitol).
Baker Boyer Bank (BBB) was founded in 1869, twenty years
before Washington became a state. The bank really started as a
mercantile store where gold miners would keep their gold in the
store’s safe. As much as $40,000 in gold would be left in the
safe for more than a year, and though it wasn't common to give
or ask for receipts, no losses were ever suffered.
At one point in 1911, the BBB building was the tallest building
west of the Mississippi River.
During the banking crisis of the 1930s, most banks were forced
to close, at least temporarily. But BBB was determined to
remain open, even though it had been ordered closed. BBB
allowed customers to use the back door of the bank until banks
were allowed to reopen.
BBB is still partly owned by the families of the original
founders, Dorsey Baker and John Boyer. Today the CEO is the
great-great-granddaughter of Dorsey Baker.
BBB remains a community bank with 8 branches in WW, TriCities, Milton-Freewater, and Yakima
1911, tallest building west of the
Miss. River
Megan Clubb,
CEO
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Banner Bank



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

Banner Bank (BB) started in the 1890 (one year
after Washington gained statehood and two years
before the founding of WWU).
For most of its history, it was known as First
Washington Bank and remained a small,
community-based bank in Eastern Washington.
In 1995, the bank did an IPO and become a public
company traded on the Nasdaq (ticker of BANR).
Since then, the bank has pursued a path of
tremendous growth through mergers/acquisitions.
Today it has expanded to 93 branches in 31
counties throughout WA, OR and ID.
In 2000, the bank changed its name to Banner
Bank.
WW Headquarters
Bank in Boise
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