Transcript Slide 1
Depository Institutions Depository Institutions Include: Institutions which take deposits Deposits represent Liabilities (debt) for DI’s Include: Banks Savings & Loan institutions Savings Banks Credit Unions Asset/liability problem of Depository institutions A depository institution seeks to earn a positive spread between the assets it in invests in (loans and securities) and the costs of funds(deposits and other sources) How do DI’s make money? 3 ways: Loans Make direct loans to entities Securities investments Investing in securities & holding portfolios Fees Charged to their customers Asset/liability problem of Depository institutions Risks faced by the depository institutions Credit risk-default risk that the borrower will default on his loan obligation or that the issuer of the security that the depository institution holds defaults on its obligation. Regulatory risk-regulators will change the rules so as to impact the earnings of the institution unfavorably Asset/liability problem of Depository institutions Funding risk Illustration Suppose that the depository institution raises $100 million by issuing a deposit account that has a maturity of one year and by agreeing to pay 7% interest Suppose that $100 million is invested in a government security that matures in 15 years , paying an interest rate of 9% Asset/liability problem of Depository institutions If interest rates declines, the spread will increase If Interest rates rise What position should you have? If interest rates fall What position should you have? Asset/liability problem of Depository institutions When interest rates are expected to decline, depository institutions borrow short and lent long When interest rates are expected to rise, depository institutions borrow long and lent short Asset-Liability Problem of DI’s? Threats of positioning: Adverse financial consequences If expectations are not realized, Huge losses can occur No one can predict interest rates consistently Highly risky? Becomes same as gambling Long run losses highly likely? Liquidity concerns A depository institution must be prepared to satisfy withdrawals of funds by depositors and to provide loans to customers 4 ways to solve liquidity issues? Attract additional deposits Borrowing from the federal agency or other financial institutions Sell securities that it owns Raise short term funds in the money market Commercial Banks 5 largest banks of Pakistan Commercial Banks Bank services: Individual banking Institutional banking Global banking Corporate financing Capital market products Foreign exchange products and services Bank Funding Three sources of funds for banks: Deposits Non deposit borrowing Common stocks and retained earnings Bank Funding Deposits Demand deposits Savings deposits Time deposits Bank Funding Reserve requirements and borrowing in the federal funds market All banks must maintain a specified percentage of their deposits in a noninterest bearing account at the State bank. Reserve ratio Required reserve Bank Funding Excess reserves- when actual reserves exceed required reserves. Banks temporarily short of funds can borrow reserves from banks that have excess reserves. The market where banks can borrow or lend reserves is called the federal funds market. The interest rate that is charged to borrow funds in this market is called the federal funds rate. Bank Funding Borrowing at the Fed discount window: Banks temporarily short of funds can borrow from the Fed at its discount window Collateral is necessary to borrow Discount rate- the interest rate that the Fed charges to borrow funds at the discount window Borrowing from the Fed is done basically to meet short term liquidity needs Bank Funding Other non deposit borrowing Issuing obligations in the money market, or intermediate to long term in the form of issuing securities in the bond market. Regulation Ceilings imposed on the interest rates that can be paid on deposit accounts Geographical restrictions on branch banking Permissible activities for commercial banks Capital requirements for commercial banks Savings and loan Associations Provision of funds for financing of a home. The collateral for the loans would be the home being financed Mutually owned or corporate stock ownership Savings and loan Associations Assets: Traditionally, the only assets in which S&L’s were allowed to invest have been mortgages, and government securities. Problem: Maturity matching problem Savings and loan Associations Other investments: Consumer loans( loans for home improvement , automobiles, education , business or credit cards) Non consumer loans ( commercial , corporate , business or agriculture loans) Junk bonds Investment in short term assets for operational or regulatory purposes. Savings and loan Associations Funding: Savings and time deposits Negotiable order of withdrawal (NOW) accounts Money market deposit accounts (MMDA) The S&L Crisis Credit unions “Common bond” requirement for credit union membership No corporate ownership Purpose: Serve member’s saving and borrowing needs Credit unions are owned by their members, member deposits are called shares.