commercial banking (ch17, 18 & 19) – bus322 1 commercial banking banks’ balance sheet bank...
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Commercial Banking (ch17, 18 & 19) – BUS322 1
Commercial Banking
Banks’ Balance Sheet
Bank Management
Off-Balance-Sheet Activities
Banks’ Income Statement
Banks’ Regulations
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Uniform Bank Performance Report (UBPR)
• A comprehensive analytical too created by the FDIC on a quarterly report requirement
• Contain banks’ profitability and risk information in a consistent and uniformed basis
• To obtain information: http://www2.fdic.gov/ubpr and then follow instruction
Commercial Banking (ch17, 18 & 19) – BUS322 6
Assets – Uses of FundsReservesCash Items in Process of CollectionA check written on an account at another bank is deposited in bank A and the funds for this check have not yet been received from the other bank.
Deposits at Other BanksSecurities – debt securities only
– US government and agency securities– State and local gov. (municipal) securities– Others (investment-grade securities)
Bank Loans
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Alternative types of loansCommercial loans
– business borrowing — Temporary working capital need (prime rate) – credit line— Long-term uses, e.g., equipment purchases, plant expansion
Consumer Loans– Non-mortgage loans to consumers
— Installment loans (purchase of cars and household products)— Credit card loans (interest rate is quite high)
Real Estate LoansAgriculture Loans
– Short term
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Liabilities and Equity – Sources of Funds
Checkable Deposits non-interest-bearing checking accounts (demand deposits)
interest-bearing NOW (negotiable order of withdrawal)
money market deposit account (MMDAs)
Nontransaction Deposits Saving Accounts
Time Deposits: small-denomination & large-denomination
Borrowing discount loan and other borrowings
Bank Capital
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Bank Management
1. Liquidity management
2. Asset management
A. Managing credit risk
B. Managing interest-rate risk
3. Liability management
4. Managing capital adequacy
Commercial Banking (ch17, 18 & 19) – BUS322 10
Liquidity Management Reserve requirement = 10%, Excess reserves = $10 million
Assets Liabilities
Reserves $20 million Deposits $100 million
Loans $80 million Bank Capital $ 10 million
Securities $10 million
Commercial Banking (ch17, 18 & 19) – BUS322 11
Deposit outflow of $10 million
Assets Liabilities
Reserves $10 million Deposits $ 90 million
Loans $80 million Bank Capital $ 10 million
Securities $10 million
With 10% reserve requirement, bank still has excess reserves of $1 million: no changes needed in balance sheet
Liquidity Management
Commercial Banking (ch17, 18 & 19) – BUS322 12
Liquidity ManagementNo excess reserves
Assets Liabilities
Reserves $10 million Deposits $100 million
Loans $90 million Bank Capital $ 10 million
Securities $10 million
Deposit outflow of $ 10 million
Assets Liabilities
Reserves $ 0 million Deposits $ 90 million
Loans $90 million Bank Capital $ 10 million
Securities $10 million
With 10% reserve requirement, it has $9 million reserve shortfall
Commercial Banking (ch17, 18 & 19) – BUS322 13
1. Borrow from other banks or corporations
Assets Liabilities
Reserves $ 9 million Deposits $ 90 million
Loans $90 million Borrowings $ 9 million
Securities $10 million Bank Capital $ 10 million
2. Sell securities Assets Liabilities
Reserves $ 9 million Deposits $ 90 million
Loans $ 90 million Bank Capital $ 10 million
Securities $ 1 million
Liquidity Management
Commercial Banking (ch17, 18 & 19) – BUS322 14
Liquidity Management3. Borrow from Fed Assets Liabilities
Reserves $ 9 million Deposits $90 million
Loans $90 million Discount Loans $ 9 million
Securities $10 million Bank Capital $10 million
4. Call in or sell off loans Assets Liabilities
Reserves $ 9 million Deposits $ 90 million
Loans $81 million Bank Capital $ 10 million
Securities $10 million
Conclusion: excess reserves are insurance againstabove 4 costs from deposit outflows
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Asset and Liability ManagementAsset Management
1. Get borrowers with low default risk, paying high interest rates
2. Buy securities with high return, low risk
3. Diversify
4. Manage liquidity
Liability Management1. Important since 1960s
2. No longer primarily depend on checkable deposits, more on other borrowing
3. When see loan opportunities, borrow or issue CDs to acquire funds (first developed in 1961)
Commercial Banking (ch17, 18 & 19) – BUS322 16
Capital Adequacy Management1. Bank capital is a cushion that prevents bank failure2. Higher is bank capital, lower is return on equity
ROA = Net Profits/AssetsROE = Net Profits/Equity CapitalEM = Assets/Equity CapitalROE = ROA x EM (EM is equity multiplier)Capital , EM , ROE
3. Tradeoff between safety (high capital) and ROE4. Banks also hold capital to meet capital requirements5. Strategies for Managing Capital:
A. Sell or retire stockB. Change dividends to change retained earningsC. Change asset growth
Commercial Banking (ch17, 18 & 19) – BUS322 17
Off-Balance-Sheet Activities
Involve trading financial instruments and generating income from fees and loan sales, activities that affect bank profits but do not appear on bank balance sheet
For example, hedging with financial derivatives are off-balance-sheet activities. They are used to reduce Fis’ risk exposures, but they all involve risks.
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Off-Balance-Sheet Activities1. Loan Sales
2. Fee income fromA. Foreign exchange trades for customers
B. Servicing mortgage-backed securities
C. Guarantees of debt
D. Backup lines of credit
2. Financial futures and options
3. Foreign exchange trading
4. Interest rate swaps
Commercial Banking (ch17, 18 & 19) – BUS322 20
Banks’ Income StatementOperating Income
interest income
non-interest income
Operating Expenses
interest expenses
non-interest expenses
provisions for loan losses
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Income Statement
Net Operating Income: Difference between Operating Income and Operating Expenses
Gains/losses on Securities
Gains/lossesExtraordinary Items: events or transactions that are unusual and infrequent
Income taxes: profit after tax
Commercial Banking (ch17, 18 & 19) – BUS322 22
Measures of Bank Performance
ROA = Net Profits/ AssetsROE = Net Profits/ Equity CapitalNIM = [Interest Income - Interest Expenses]/ Assets
Commercial Banking (ch17, 18 & 19) – BUS322 23
Bank RegulationRegulatory Structure• A charter from state/federal gov is needed for
open a commercial bank– State bank – having state charter, regulated by state
agency
– National bank – having federal charter—Regulated by the office of Comptroller of Currency (issue
charter)—FDIC—Federal Reserve
Commercial Banking (ch17, 18 & 19) – BUS322 24
Branching RegulationsBranching Restrictions:
Anticompetitive
Response to Branching Restrictions
1. Bank Holding CompaniesA. Allowed purchases of banks outside state
B. BHCs allowed wider scope of activities by Fed
C. BHCs dominant form of corporate structure for banks
2. Nonbank BanksNot subject to branching regulations, but loophole closed in 1987
3. Automated Teller MachinesNot considered to be branch of bank, so networks allowed
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Nationwide Banking and Bank Consolidation
Bank Consolidation: Why? 1. Branching restrictions weakened2. Development of superregional banks
Riegle-Neal Act of 19941. Allows full interstate branching2. Promotes further consolidation
Future of Industry StructureWill become more like other countries, but not quite:
Several thousand, not several hundred
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Separation of Banking and Securities
Industries: Glass-Steagall Case for Glass-Steagall
1. FDIC gives unfair advantage to banks2. Allowing banks into underwriting is dangerous because FDIC promotes
too much risk taking3. Potential conflicts of interest
Case Against Glass-Steagall1. Decreases competition2. Unfair to banks3. Hinders diversification
Will Separation Continue?No, Gramm-Leach-Bliley Financial Service Modernization Act of 1999 1) allow banks to underwrite insurance and securities and engage in real estate 2) allows securities firms and insurance companies to purchase banks
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Separation in Other Countries1. Universal banking: Germany
2. British-style universal banking
3. U.S./Japan separation
Separation of Banking and Securities Industries: Glass-Steagall
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Other Depositary InstitutionsThrifts (or thrift institutions)1. Mutual saving banks: depositors are owners of
firms
2. S&Ls (saving and loan Associations): getting deposits and make long-term mortgage loans
3. Credit unions: financial institutions that focus on servicing the banking and lending needs of its members
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