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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
Chapter 4. Depository Institutions“Banks”
  • Asset/Liability problem
  • Commercial Banks
  • Savings and Loans
  • Credit Unions
i asset liability problem
I. Asset/Liability Problem
  • Assets
    • how banks USE their funds
    • loans, cash reserves, securities
  • Liabilities
    • how banks GET their funds
    • deposits, borrowing, commercial paper
interest rate risk
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
slide4
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
liquidity
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
ii commercial banks
II. Commercial Banks
  • state or federal charter
    • dual banking system
    • 75% state chartered
  • consolidation
    • 1988: 13,137, 2000: 8,375
  • all insured by FDIC
regulators
Regulators
  • Federal Reserve System
    • member banks

-- all federal & some state banks

  • Comptroller of the Currency
    • federal banks
  • FDIC
    • nonmember state banks
  • state agencies
bank services
Bank services
  • individual
    • consumer loans, mortgages, credit cards, student loans, accounts
  • institutions
    • commercial lending/leasing
    • pension, cash management
slide9
global
    • corporate financing
    • currency exchange
    • bank acceptances
  • interest and fee income
    • banks increasingly rely on fee income
balance sheet 2003
Balance Sheet (2003)
  • Assets
    • loans (64%)
    • securities (25%)
    • cash (5%)
    • other (6%)
slide11
Liabilities
    • deposits (65%)
    • other borrowing (28%)

-- the Federal Reserve

(discount loans)

-- other banks (federal funds)

-- financial markets (commercial paper)

    • Equity capital (7%)
slide12
money center banks
    • rely on money market to raise funds
  • regional banks
    • rely on deposits to raise funds
regulation
Regulation
  • much of it due to Great Depression

& resulting bank failures

    • some of this has been repealed,

but still affects banks today

repealed regulations
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
slide15
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

slide16
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

other regulations
Other Regulations
  • FDIC (1933)
    • deposit insurance ($100,000)
    • prevents bank panics

-- depositors won’t withdraw $

    • creates moral hazard

-- banks, depositors less careful

slide18
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.

iii savings loans
III. Savings & Loans
  • state or federal charter
    • 1988 3500; 1998 1700
  • created in 1933 to give mortgages
regulators20
Regulators
  • FSLIC 1933-89, FDIC since 1989
  • Office Thrift Supervision since 1989
    • federal
  • state agencies
  • Federal Reserve
balance sheet
Balance Sheet
  • assets (traditional)
    • mortgages
    • U.S. government securities
  • asset choices expanded 1982
    • Garn-St. Germain Act
slide22
Liabilities (traditional)
    • savings accounts, CDs
    • higher Regulation Q ceilings
  • liabilities expanded 1980
s l crisis
S&L Crisis
  • massive S&L failures in 1980s
  • required taxpayer bailout to deposit insurance fund
  • led to reform of industry regulation
origins of problem
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
deregulation
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
continuing problems
Continuing problems
  • does not solve interest rate problem
  • regulators do not close insolvent S&Ls
    • increase in fraud, risk taking
s l bailout 1989 1991
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
iv credit unions
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
balance sheet29
Balance Sheet
  • assets
    • consumer loans
    • mortgages
    • U.S. gov’t securities
  • liabilities
    • member deposits
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