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Chapter 4. Depository Institutions “Banks”

Chapter 4. Depository Institutions “Banks”. Asset/Liability problem Commercial Banks Savings and Loans Credit Unions. I. Asset/Liability Problem . Assets how banks USE their funds loans, cash reserves, securities Liabilities how banks GET their funds

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Chapter 4. Depository Institutions “Banks”

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  1. Chapter 4. Depository Institutions“Banks” • Asset/Liability problem • Commercial Banks • Savings and Loans • Credit Unions

  2. I. Asset/Liability Problem • Assets • how banks USE their funds • loans, cash reserves, securities • Liabilities • how banks GET their funds • deposits, borrowing, commercial paper

  3. Interest Rate Risk • banks tend to borrow short and lend long • maturity intermediation • banks depend on spread income • interest received on assets minus interest paid on deposits

  4. changes in interest rates will change profits • rising short-term rates reduce the spread income example: 1970 30 yr. loan 9.1%, 6 mo. CD 8% 1981 6 mo. CD 18.27% • derivatives help banks manage this risk

  5. Liquidity • banks must hold some cash, near cash • if fall short, • must pay to borrow funds or • sell assets • tradeoffs between liquidity and interest rate earned

  6. II. Commercial Banks • state or federal charter • dual banking system • 75% state chartered • consolidation • 1988: 13,137, 2000: 8,375 • all insured by FDIC

  7. Regulators • Federal Reserve System • member banks -- all federal & some state banks • Comptroller of the Currency • federal banks • FDIC • nonmember state banks • state agencies

  8. Bank services • individual • consumer loans, mortgages, credit cards, student loans, accounts • institutions • commercial lending/leasing • pension, cash management

  9. global • corporate financing • currency exchange • bank acceptances • interest and fee income • banks increasingly rely on fee income

  10. Balance Sheet (2003) • Assets • loans (64%) • securities (25%) • cash (5%) • other (6%)

  11. Liabilities • deposits (65%) • other borrowing (28%) -- the Federal Reserve (discount loans) -- other banks (federal funds) -- financial markets (commercial paper) • Equity capital (7%)

  12. money center banks • rely on money market to raise funds • regional banks • rely on deposits to raise funds

  13. Regulation • much of it due to Great Depression & resulting bank failures • some of this has been repealed, but still affects banks today

  14. Repealed regulations • Regulation Q (1933) • interest rate ceilings on bank deposits • problems in 1970s as market interest rates rose above ceilings • phased out in 1980

  15. McFadden Act (1927) • restricted interstate bank branching • designed to protect small banks -- U.S. has many smaller banks • inefficient -- no economies of scale • repealed 1994 -- a lot of merger activity since

  16. Glass-Steagall Act (1933) • separation of commercial banking, securities firms, & insurance -- belief that abuses led to 1929 market crash • weakened in 1980s, 1990s • repealed 1999 -- advantages for global banking, economies of scale

  17. Other Regulations • FDIC (1933) • deposit insurance ($100,000) • prevents bank panics -- depositors won’t withdraw $ • creates moral hazard -- banks, depositors less careful

  18. Capital Requirements • ratio capital to assets • cushion against investment losses • since 1989, assets risk-wt. -- low risk, low wt -- Tbills, 0% wt. -- high risk, high wt. -- commercial loan, 100% wt.

  19. III. Savings & Loans • state or federal charter • 1988 3500; 1998 1700 • created in 1933 to give mortgages

  20. Regulators • FSLIC 1933-89, FDIC since 1989 • Office Thrift Supervision since 1989 • federal • state agencies • Federal Reserve

  21. Balance Sheet • assets (traditional) • mortgages • U.S. government securities • asset choices expanded 1982 • Garn-St. Germain Act

  22. Liabilities (traditional) • savings accounts, CDs • higher Regulation Q ceilings • liabilities expanded 1980

  23. S&L Crisis • massive S&L failures in 1980s • required taxpayer bailout to deposit insurance fund • led to reform of industry regulation

  24. Origins of problem • 1970s • rising inflation leads to rising interest rates • spread income disappears • market interest rates rise above Reg. Q ceilings • loss of deposits

  25. Deregulation • DIDMCA 1980, Garn-St. Germain 1982 • expanded assets choices of S&Ls • consumer, commercial loans • corporate securities • expanded liability choices • NOW accounts, money market accounts • phased out Regulation Q

  26. Continuing problems • does not solve interest rate problem • regulators do not close insolvent S&Ls • increase in fraud, risk taking

  27. S&L Bailout 1989, 1991 • federal money to liquidate failed S&Ls and pay depositors • created OTS • FDIC takes over FSLIC • risk-based FDIC premiums • more power to close banks • re-restricted S&L assets choices

  28. IV. Credit Unions • members must have “common bond” • nonprofit, member owned • 10,000 (but small in total assets) • federal or state charter • own deposit insurance fund

  29. Balance Sheet • assets • consumer loans • mortgages • U.S. gov’t securities • liabilities • member deposits

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