Financial Institutions FIL 240 Dr. Keldon Bauer
Financial Markets • Direct financial flows • From those with surplus directly to those with deficits. • Indirect financial flows • From those with surplus to a financial intermediary. • From those with a deficit to a financial intermediary. • The intermediary supplies its own contract (security).
Financial Intermediation • Benefits of Intermediation • Denomination matching. • Aggregating small lenders with larger borrowers. • Maturity matching. • Taking shorter-term deposits and making longer-term loans. • Credit risk absorption. • Create information about credit worthiness, and putting your money where their mouth is.
Commercial Banks • The principal financial intermediary in most economies. • Seek to maximize owners’ wealth. • Therefore they seek to maximize interest rate spread. • Bank regulation: • Federal vs. state chartered. • Federal Reserve Bank. • Federal Deposit Insurance Corporation. • Office of the Comptroller of the Currency. • Required Reserve Ratio. • Primary reserves.
Federal Reserve System • Serves as Central Bank. • Organization: • 12 district banks. • Board of Governors. • Federal Open Market Committee. • 12 voting members (7 board members + 5 district bank presidents).
Controlling the Interest Rates • Open-market operations • Buying and selling t-bills to shift the supply curve and affect short-term interest rates. • Target interest rate and policy decided at FOMC meetings among voting members. • Minutes are posted on the Board of Governors website. • Discount window • Lends to member institutions at the “discount window.” • The rate is called the discount rate.
Savings and Loans (Thrifts) • Savings and Loans were established to take deposits and issue mortgages. • They could offer higher deposit rates. • They (originally) could only offer long-term mortgages. • When market forces moved faster than regulation, dis-intermediation occurred. • Many failures resulted.
Interest - Term Structure Yield Curve on Treasury Securities Maturity in Years
Thrift Regulation • Federal vs. state charter. • Office of Thrift Supervision (OTS). • Federal Deposit Insurance Corporation (FDIC). • Savings Association Insurance Fund (SAIF).
Thrift Ownership Structures • Stock ownership • Seek to maximize shareholder wealth. • Mutual ownership • Seek to maximize depositor/borrower wealth. • Typically have a weak governance structure. • Management appoint the board to oversee the management.
Credit Unions • Originated in Germany in the 1850s. • Offered credit to small business (Volksbanken) or farmers (Raiffeisenbanken). • The Schulze-Delitzsch type of cooperative bank was exported to Canada and the US in the early 20th century. • Member owned. • Board elected by members and serves on a voluntary basis. • Maximizes wealth to members. • Minimizes the interest rate spread.
Credit Union Regulation • Common bond • Originally used to overcome “information asymmetry.” • Restricts market size, and institution size. • Economies of scale. • Expanded and loosened. • Taxes • National Credit Union Administration (NCUA) • National Credit Union Share Insurance Fund (NCUSIF). • Central Liquidity Facility (CLF).
Finance Companies • Finance Companies • Consumer finance companies • Commercial finance companies • Sales finance companies • Insurance Companies • Life insurance companies • Property & casualty insurance companies • Pension Funds • Annuities