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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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Chapter 4 depository institutions banks l.jpg
Chapter 4. Depository Institutions“Banks”

  • Asset/Liability problem

  • Commercial Banks

  • Savings and Loans

  • Credit Unions


I asset liability problem l.jpg
I. Asset/Liability Problem

  • Assets

    • how banks USE their funds

    • loans, cash reserves, securities

  • Liabilities

    • how banks GET their funds

    • deposits, borrowing, commercial paper


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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


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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


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II. Commercial Banks

  • state or federal charter

    • dual banking system

    • 75% state chartered

  • consolidation

    • 1988: 13,137, 2000: 8,375

  • all insured by FDIC


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Regulators

  • Federal Reserve System

    • member banks

      -- all federal & some state banks

  • Comptroller of the Currency

    • federal banks

  • FDIC

    • nonmember state banks

  • state agencies


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Bank services

  • individual

    • consumer loans, mortgages, credit cards, student loans, accounts

  • institutions

    • commercial lending/leasing

    • pension, cash management


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  • global

    • corporate financing

    • currency exchange

    • bank acceptances

  • interest and fee income

    • banks increasingly rely on fee income


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Balance Sheet (2003)

  • Assets

    • loans (64%)

    • securities (25%)

    • cash (5%)

    • other (6%)


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  • Liabilities

    • deposits (65%)

    • other borrowing (28%)

      -- the Federal Reserve

      (discount loans)

      -- other banks (federal funds)

      -- financial markets (commercial paper)

    • Equity capital (7%)


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  • money center banks

    • rely on money market to raise funds

  • regional banks

    • rely on deposits to raise funds


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Regulation

  • much of it due to Great Depression

    & resulting bank failures

    • some of this has been repealed,

      but still affects banks today


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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


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  • 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


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  • 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


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Other Regulations

  • FDIC (1933)

    • deposit insurance ($100,000)

    • prevents bank panics

      -- depositors won’t withdraw $

    • creates moral hazard

      -- banks, depositors less careful


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  • 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.


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III. Savings & Loans

  • state or federal charter

    • 1988 3500; 1998 1700

  • created in 1933 to give mortgages


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Regulators

  • FSLIC 1933-89, FDIC since 1989

  • Office Thrift Supervision since 1989

    • federal

  • state agencies

  • Federal Reserve


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Balance Sheet

  • assets (traditional)

    • mortgages

    • U.S. government securities

  • asset choices expanded 1982

    • Garn-St. Germain Act


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S&L Crisis

  • massive S&L failures in 1980s

  • required taxpayer bailout to deposit insurance fund

  • led to reform of industry regulation


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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


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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


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Continuing problems

  • does not solve interest rate problem

  • regulators do not close insolvent S&Ls

    • increase in fraud, risk taking


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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


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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


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Balance Sheet

  • assets

    • consumer loans

    • mortgages

    • U.S. gov’t securities

  • liabilities

    • member deposits


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