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Depository Institutions: Types, Risks, and Services

This chapter explores the different types of depository institutions in the United States, including commercial banks, savings and loan associations, savings banks, and credit unions. It discusses the sources of income for these institutions, such as interest from loans and securities, as well as non-interest income. The chapter also delves into the asset/liability problem faced by depository institutions, including spread income, credit risk, regulatory risk, funding risk, and liquidity risk.

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Depository Institutions: Types, Risks, and Services

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  1. CHAPTER 3 DEPOSITORY INSTITUTIONS

  2. DEPOSITORY INSTITUTIONS • Depository Inst. in U.S.A • Commercial Banks • Savings and Loan Associations • Savings Banks • Credit Unions • Sources of income; • Interest from the loans made and securities invested in. • Non-Interest Income (Fees)

  3. THE ASSET/LIABILITY PROBLEM OF DEPOSITORY INSTITUTIONS • Spread income, margin. • The risks that a depository institution faces include: • Credit Risk (Default Risk) • Regulatory Risk • Funding (Interest rate) Risk • Liquidity Risk

  4. CREDIT RISK (DEFAULT RISK) The risk that a borrower may default on a loan abligation or that the issuer of a security that they held may default on its obligation.

  5. REGULATORY RISK Regulaters will change the rules and affect earnings of institutions unfavorably.

  6. FUNDING RISK Borrowing short-Lending long: This policy benefits from a decline in interest rates however if interest rates rise, it will loose.

  7. LIQUIDITY RISK • Com. Banks must be prepared to satisfy withdrawals and to provide loans. • Options available to manage the liquidity involve; • attracting additional deposits • using securities owned as collateral for borrowing from central bank and other financial institutions • liquidating securities that it currently holds in its portfolio • raising short-term funds in the money market (Repos). • Com. Banks hold liquid assets not only for operational purposes but also for regulatory requirements.

  8. COMMERCIAL BANKS The main role of the commercial banks is taking deposits and making loans. Others; Carrying out currency exchanges Providing credits by discounting commercial loans Safekeeping of customer valuables such as gold, securities etc. Supporting government activities with credit Purchasing government securities

  9. COMMERCIAL BANKS In today’s world, banks increase their services and activities, such as providing; financial advising to customers who use credits and have savings. equipment leasing services though which the bank buys the equipment and rent it to customers selling insurance policies such as life and non-life security brokerage services to their customers though buying bonds and other securities mutual funds, which usually provide higher returns than that on bank deposits.

  10. Commercial Banks in Turkey(Sep 2014) Commercial Banks........................34 State Owned......................3 Privately Owned................11 Foreign Banks...................19 Banks under DIF................1 Development and Inv. Banks ........13 State Owned......................3 Privately Owned.................7 Foreign Banks....................3 Sector Total...................................47

  11. THE NATURE OF BANKING SERVICES • Broad classification of services: • Individual banking • Institutional banking • Global banking

  12. INDIVIDUAL BANKING Consumer loans, mortgage loans, credit cards, brokerage services..etc.

  13. INSTITUTIONAL BANKING Loans to non-financial institutions, financial institutions, government entities. Commercial real estate financing, leasing, factoring. Management of assets (mutual funds), check clearing and electronic transfers.

  14. GLOBAL BANKING • Covers corporate finance, capital markets and foreign exchage services, investment banking firms. • Corporate financing; • Underwriting of securities, Banker’s acceptances, L/C. • Advices on obtaining funds, corp. restructuring, divestitures&acquisitions. • Interest rate swaps, currency swaps, forward contracts, interest rate options etc...

  15. BALANCE SHEET STRUCTURE OF COMMERCIAL BANKS

  16. ASSETS • Liquid Assets • Cash • Central Bank • Due from Banks • Investment Securities (T-bills, Repos, Debt ad Equity securites and etc) • Bank Loans (Working Cap. Loan- Term Loan) (Leases and Foctoring reveivables) • Commercial Loans • Consumer Loans • Real Estate Loans etc. • Fixed Assets

  17. LIABILITIES AND EQUITY CAPITAL • Deposits • Borrowed Funds • Equity Capital

  18. DEPOSITS • Deposits are the main source of funding. They can be categorized based on; • Maturity • Depositors • Negotiability

  19. DEPOSITS Accoring to maturity, bank deposits are categorized as; • Demand deposits (Checking Account): • Time deposits • One month • Three-month • Six-month • One year

  20. DEPOSITS According to depositors; Saving deposits Commercial deposits Interbank deposits Official deposits

  21. DEPOSITS • According to negotiability; • Negotiable deposits (Certificate of Deposits, CDs) • Non-negotiable deposits (All others)

  22. BORROWED FUNDS • Borrowed Funds(Non Depository Funds ): • Interbank funds borrowed • Borrowing from; • Central bank • Other banks • Abroad. • Debentures

  23. EQUITY CAPITAL • Common stock • Paid in Capital • Retained Earnings

  24. B/S OF TURKISH BANKS • Assets • Liquid Assets • Cash and Central Bank • Due from banks • Receivables from money market • Financial assets ready to sell • Bank Loans • Loan Reveivables • Factoring receivables • Assets holding up-to maturity • Subsidiaries • Leasing receivables • Derivatives for hedging • Fixed Assets

  25. Liabilities • Deposits • Financial derivative liab. for buying and selling purposes • Issued securities • Funds • Foreign liabilities • Financial derivative liab. for hedging • Reserves • Tax liabilies • Loans on fixed assets for buying and selling purposes

  26. Shareholders’ Equity - paid-in capital, - reserves, - net current year income.

  27. OFF B/S ASSETS AND LIABILITIES Off- Balance-Sheet Items Guarantee letters Loan Commitments (Taahhütler): Contractural commitment by a bank to loan to a customer a certain maximum amount at given interest rate terms Financial Derivatives Custody accounts (securities) (emenat kıymetler)

  28. Structure of Off-Balance Sheet Items(Safe-custody and Pledged Securities are excluded)

  29. Distribution of Off- Balance Sheet Items

  30. Structure of Derivative Instruments

  31. Distribution of the Derivative Instruments

  32. INCOME STATEMENT • Interest Income • Interest Income on Loans • Interest on Leases • Interest on Deposits at other Institutions • Interest on Investment Securities • Interest Expenses • Interest on Deposits • Interest on Borrowed Funds • Interest on debentures

  33. INCOME STATEMENT • Non-Interest Income • Income from fiduaciary activities • Service charges on deposit accounts • Gains from trading assets and liabilities • Non-Interest Expenses • Salaries and Employee Benefits • Expenses on fixed assets • Total Operating Income (Total Revenue) = Interest Income +Non-Interest Income

  34. Commercial Banks in Turkey

  35. FINANCIAL STATEMENT ANALYSIS • Financial statement analysis is based on accounting ratios • Time series analysis is the analysis of financial statements over a period of time • Cross-sectional analysis is the analysis of financial statements comparing one firm with others • Most financial statement analyses is a combination of time series analysis and cross-sectional analysis

  36. RETURN ON EQUITY (ROE) FRAMEWORK • Return on Equity (ROE) analysis begins with ROE and then breaks it down into its components • ROE measures the overall profitability of the bank per dollar of equity • ROE can be broken down into its components

  37. Return on Equity (ROE) Framework • Return on Assets (ROA) measures profit generated relative the banks assets • Equity Multiplier (EM) measures the extent to which assets are funded with equity relative to debt (i.e., it is a measure of leverage) • ROA can also be broken down into its components McGraw-Hill/Irwin

  38. Return on Equity (ROE) Framework • Profit Margin (PM) measures the ability to pay expenses and generate net income from interest and noninterest income and is composed of • interest expense ratio • provision for loan loss ratio • noninterest expense ratio • tax ratio • Asset Utilization (AU) measures the amount of interest and noninterest income generated per dollar of total assets and is composed of • interest income ratio • noninterest income ratio McGraw-Hill/Irwin

  39. Other Ratios • The net interest margin (NIM) measures the net return on a bank’s earning assets • The spread measures the difference between the average yield on earning assets and average cost on interest-bearing liabilities McGraw-Hill/Irwin

  40. Other Ratios • Overhead efficiency measures a bank’s ability to generate noninterest income to cover noninterest expenses • Many additional ratios are commonly used to analyze commercial banks by breaking down the components of ROE even further. McGraw-Hill/Irwin

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