Overview of Depository Institutions
Overview of Depository Institutions
Size, Structure and Composition of Depository FIs
Definition of Commercial Bank
✓ Accept demand deposits and make commercial loans.
Consolidation has created some very large depository FIs
Depository institutions
Commercial Banks
Specialize in short-term business credit
Largest depository institutions are commercial banks
← Shrinking number of banks: 14,416 commercial banks in 1985, 12,744 in 1989, 8,315 in 2000 and 5,328 in 2015. Mostly the result of mergers and acquisitions
← Commercial banks are also classified as
• Community banks
• Regional and Super-regional: Access to federal funds market to finance their lending activities
• Money Center banks: Bank of New York, Citigroup, J.P. Morgan/Chase, HSBC Bank USA
← Financial Services Modernization Act 1999: Allowed full authority to enter investment banking (and insurance)
✓ Thrifts
← Savings & loan associations (S&Ls):
• Founded in mid-1800s
Specialize in real estate loans
• Members pooled funds to loan to members to buy houses
• Originally all were mutual associations, the board elected by members; now some are stock-issuing corporations
← Savings Banks:
• Founded in early 1800s
• Provided savings accounts for individuals
• Existed then and now only in New England
✓ Credit Unions
← Fields of membership requirements: employee groups, associations, religious affiliations and residential areas
← Not- for-profit organization
← Offers lower average fees and more competitive rates than banks do
Understanding Commercial Bank’s Balance Sheets
Balance Sheet
Assets = Liabilities + Equity
Bank assets
← Cash and due from banks: vault cash, deposits held at the Fed and other financial institutions, and cash items in the process of collection
← Investment Securities: assets held to earn interest and help meet liquidity needs
← Loans: the major asset, generate the greatest amount of income, exhibit the highest default risk and are relatively illiquid
← Other assets: bank premises and equipment, interest receivable, prepaid expenses, other real estate owned, and customers' liability to the bank
✓ Commercial banks primary assets:
2000 2015
Real Estate Loans: $1,670.3 billion $3,921.4 billion
C&I loans: $1,048.2 billion $1,779.3 billion
Loans to individuals: $609.7 billion $1,362.6 billion
Other loans: $367.5 billion $669.4 billion
Investment security portfolio: $1,662.0 billion $3,052.1 billion
Of which, Treasury bonds: $710.0 billion $406.6 billion
8 Bank liabilities and equity
Assets = Liabilities + Equity
✓ Bank liabilities
← Demand deposits: transactions accounts that pay no interest
← Negotiable orders of withdrawal (NOWs) and automatic transfers from savings (ATS) accounts: pay interest set by each bank without federal restrictions
← Money market deposit accounts (MMDAs): pay market rates, but a customer is limited to no more than six checks or automatic transfers each month
← Savings and time deposits represent the bulk of interest-bearing liabilities at banks:
← Deposits held in foreign offices: balances issued by a bank subsidiary located outside the U.S.
← Rate-sensitive borrowings: Federal Funds purchased and Repos
Core vs. volatile funds
← Core deposits include: demand deposits, NOW accounts, MMDAs, and small time deposits
← Core deposits are stable deposits that are not highly interest rate-sensitive
← Core deposits are more sensitive to the fees charged, services rendered, and location of the bank
← Volatile liabilities or net non-core liabilities include: large CDs (over 100,000), deposits in foreign offices, federal funds purchased, repurchase agreements, and other borrowings with maturities less than one year
← Large, or volatile, borrowings are liabilities that are highly rate-sensitive
✓ Commercial banks’ primary liabilities:
2000 2015
Deposits: $4,176.6 billion $11,349.5 billion
Borrowings: $1,532.5 billion $1,297.5 billion
Other liabilities: $401.0 billion $563.8 billion
Stockholders equity
← Subordinated notes and debentures: notes and bonds with maturities in excess of one year
← Ownership interest in the bank: common and preferred stock and retained earnings
11 The income statement
✓ Interest income (II): the sum of interest and fees earned on all of a bank's assets, interest income includes interest from:
← Loans
← Deposits held at other institutions
← Municipal and taxable securities, and
← Investment and trading account securities
Interest expense (IE) is the sum of interest paid on all interest-bearing liabilities
Interest income less interest expense is net interest income (NII)
Loan-loss provisions (PLL): represent management's estimate of potential lost revenue from bad loans
Noninterest income (OI)
Noninterest expense (OE)
← Personnel expense: salaries and fringe benefits paid to bank employees
← Occupancy expense : rent and depreciation on equipment and premises, and
← Other operating expenses: utilities and deposit insurance premiums
Evaluating bank performance
13 Return on equity (ROE)
Return on assets (ROA)
15 Trends of bank’ balance sheets
✓ Business loans have declined in importance
✓ Offsetting increase in securities and mortgages
✓ Increased importance of funding via commercial paper market
✓ Securitization of mortgage loans
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