Business of Banking

1. Business of Banking Income from Loans and Securities Presented by S. Cox

2. Objectives • Describe four common ways banks generate revenue • Explain the connection between customer fees and bank profitability

3. Income from Traditional Bank Services • First look at their assets • Something owned by an individual or other entity • Two largest assets…loans and securities • How banks generate most of their income…also through the fees they charge

4. Income from Traditional Bank Services • Interest on Loans • Largest bank asset and produce the largest income • Interest is the fee charged for borrowing money…called interest income for a bank • Also charge interest on credit cards • How much interest? • Depends on competition, market rates, and the borrower’s creditworthiness • Every loan carries risk…if you have a poor credit rating, you may not be as likely to be able to pay back a loan and therefore the interest may be higher

5. Income from Traditional Bank Services • Interest on Securities • Typically bonds and treasury bills • Invest in long- and short-term securities • Long – matures in over one year…bonds • Short – matures in less than a year • Maturity – the date on which the investor can receive the initial investment

6. Treasury Securities

7. Treasury Securities • Banks balance interest income with liquidity by purchasing a mix of short and long term securities • Liquidity – the ability to quickly turn an asset into cash • Short term securities are more liquid than long term • Bank regulators restrict the types of securities banks can by…for example banks cannot invest in common stock

8. Gains on Securities • Selling a security for more than its purchase price = gain • Loans are bank’s primary asset, securities are the next most profitable • If giving loans is high and a bank needs money to make the loans, they may sell securities and if loan demands are low then they may buy securities

9. Income from Fees • Many bank fees relate to checking accounts • Often charge a monthly fee just for having a checking account • Insufficient funds fee – if there is not enough money in an account to cover a transaction • Overdraft program – provides funds to cover a check written on an account with insufficient funds • Overdraft – a negative balance

10. Income from Fees • Banks that offer credit cards may charge an annual fee just to have the card, late payment fees, and over the limit fees • ATMs may charge a surcharge…fee to withdraw cash, also called a convenience fee • Account inquiry fee – check the balance of your account • Safe deposit box rental fee – fee for individually secured containers, usually within a bank vault, used to store valuables • Money order fees – fee to purchase a money order in the exact amount payable to a specific party • Inactivity fee – if a customer doesn’t make a transaction within some specified period

11. Common Bank Service Fees

12. Business of Banking Income from Nontraditional Services

13. Objectives • Explain how banks earn income from insurance products • Describe types of operations and how they provide income • Explain how brokerage services operate and provide bank revenue • Describe how banks manage the financial assets of certain customers • Identify the major investment banking activities

14. Insurance Products • Yes, banks sell insurance!!! • The Glass-Steagall Act of 1933 prohibited banks from insurance activities, but under the Gramm-Leach-Bliley Act of 1999, banks can offer insurance • Insurance provides protection from risk • Risk – the chance that something unfavorable could happen to a person or property • Insurance – provides protection from certain risks that can cause a financial loss…death, illness, or accident • Many types of loss = many types of insurance

15. Insurance Products • Life insurance – protects people from a financial loss in the vent of a death…paid to a beneficiary • Credit Life – will pay off a loan if the insured dies • Mortgage Life – pays off the loan balance on your home on your death

16. Insurance Products • Property and Casualty Insurance and Liability Insurance – covers things rather than people • Property and Casualty…Houses and cars for example • Automobile insurance • Liability covers the medical and property expenses of somebody else if you cause an accident…required by all states • Collision pays for damage to your vehicle as the result of a vehicle on vehicle accident…no matter fault • Comprehensive covers other types of damage to your vehicle…if a tree falls on your car while parked on the street • Homeowner’s insurance – protection to your home and its contents…fire, theft, hail, and flood • Businesses…commercial insurance protects the physical assets of the business…buildings, equipment, and furniture

17. Insurance Products • Liability protects against the financial losses that may occur if the insured is found responsible for property loss or injuries to others…if someone falls on your front steps

18. Insurance Products

19. Trust Services • Since the early 1900s • Involve handling financial assets for a customer • The bank becomes the trustee, the person or institution that controls the financial assets for the customer • A legal document (trust) is drawn up to define the customer’s assets and how those assets should be handled

20. Trust Services • Individual Clients • Estate Planning – preparing for the transfer of assets after a client’s death • Business Clients • Relate to cash management • Accounting services – payroll • Capital services – expenditures…purchase of a new building • Collection services • Credit card services – processing, issuing, and credit analysis

21. Trust Services • Brokerage Services • Securities trading…buying and selling securities for a customer • Common stock, bonds, and treasury securities • Asset Management – for clients who don’t have the time or expert knowledge needed to handle their own investments • Fix income—mostly bonds, equities—mostly stocks, and cash equivalents

22. Investment Banking Services • Underwriting Securities – occurs when an investment bank buys a new stock directly from the company wanting to generate cash…the bank then sells the stock to the public • When investment banks underwrite a stock offering they make money through the underwriting spread which is the difference between the price paid and the price sold to the public

23. Investment Banking Services • Mergers and Acquisitions • Companies are often merging with and acquiring other companies • Merger takes place when two companies agree to combine • Acquisition happens when one company buys another company, setting itself up as the new owner

24. International Banking • Focuses on trade beyond the borders of the US • Types of financial institutions that offer international banking services • US based banks that do business internationally • Foreign banks doing business in the US • Other International banking entities

25. Business of Banking Banking Expenses

26. Objectives • Explain how deposits cause interest expense • Identify the major non-interest expense items for a bank

27. Interest Expense • Interest expense – when the bank pays interest to customers for using their money • Largest expense • Customers will shop around to get the highest interest rate(percentage paid for the use of borrowed money) • Not all deposit accounts pay interest • Many checking do not • If they do, they may have restrictions for example if you fall below a certain balance, no interest is paid

28. Operating Expenses • Operating expenses – costs that are incurred to keep the bank in business…utilities, rent, and employee wages and benefits • Employee wages and salaries are a major expense for banks • Often we only see the tellers and loan officers but there are many in other areas • Employee benefits such as health insurance and retirement plans as well as training employees use a considerable amount of money • Other operating expenses • Office equipment purchases and maintenance • Security expenses • Advertising and marketing costs