ANSWERS TO "DO YOU UNDERSTAND" TEXT QUESTIONS
1. When and why were the various types of thrift institutions started in the United States?
Solution: Thrifts trace their origins to the early-to-mid-19th century, when they originated as associations,
or clubs in “mutual” (depositor-owned) form to pool savings and make loans among ordinary individuals
overlooked or disregarded by the financial establishment of the era (particularly commercial banks).
2. Name the present federal regulators of savings institution institutions. Also, explain which ones no
longer exist and why.
Solution: The present deposit insurer is the FDIC. The present regulator of federally chartered savings
associations is the OTS, while the FDIC regulates most federally-insured and chartered savings banks.
State regulators regulate state-chartered savings banks and associations on a mostly OTS/FDIC model.
The FHLBB and FLSIC were closed in 1989 because they failed both to anticipate and to remediate the
thrift crisis. The RTC was chartered in 1989 to dispose of failed depository institutions, and disbanded in
1995 when its work was completed.
3. What are savings institutions’ most important assets and liabilities?
Solution: Commensurate with the industry’s traditional “franchise”, its most important assets are still 1–4
family home mortgage loans and its most important liabilities are still savings and time deposits. Relative
importance of other sources and uses of funds has, however, increased over the last 25 years.
4. What trends have recently occurred in savings associations’ capital adequacy, earnings, and numbers,
Solution: Capital adequacy has trended upward as weak thrifts have been liquidated or consolidated with
healthy ones and mutual form has largely given way to stock form. Interest rate spreads have widened
with low interest rates in the last decade or so. Loan losses have declined to nominal levels. Overall
earnings have thus improved. The number of charters has declined through merger, conversion to bank
charters, acquisitions of thrifts by banks, and disposition of failed institutions.
1. What are credit unions' most important assets and liabilities?
Solution: Credit unions’ most important assets are consumer loans (chiefly vehicle and real
estate), investment securities, and deposit holdings. Their most important liabilities are members’
share deposits, share-draft deposits, and certificates of deposit.
2. Why is the credit union common-bond requirement changing? How and why is it changing?
Solution: The requirement that all members of a credit union should share some common bond
(occupational, associational, or residential) is being applied under a broader definition. For
example, a teachers’ credit union might also admit spouses and relatives of teachers, and
allow members to remain after they retire or change to some other occupation. Credit
unions are often small and a restrictive interpretation of their common bond would limit their
potential growth. They cannot attain economies of scale or offer sophisticated services to their
members unless they find a way to grow.
3. How does the common-bond requirement affect credit unions’ credit risk?
Solution: Common-bond requirements potentially limit diversification of the loan portfolio.
1. What types of finance companies exist and what does each do?
Solution: Consumer finance companies primarily make loans to consumers. Sales finance companies
primarily finance sales made by retail dealers by buying the credit contracts (“ dealer paper”) generated
by those sales. Captive finance companies are sales finance companies that were started to finance the
sales of their parent companies’ goods and services. Factors finance business firms by buying and
collecting their accounts receivable. Business finance companies finance business loan needs in general.
Leasing companies purchase equipment needed by their customers and lease it to their customers.
2. How do finance companies fund their operations?
Solution: Most have lines of credit at commercial banks, and larger finance companies issue commercial
paper to obtain short-term funding. They also issue long-term debt. Captive finance companies can
borrow (obtain “transfer credit”) from their corporate parents.
3. Why are good credit ratings important to finance companies?
Solution: Because they generally do not issue insured liabilities. Thus, in order to reduce their funding
costs to the lowest possible level and to borrow loanable funds whenever needed, they must have the best
credit ratings possible.
4. What regulations have caused finance companies to de-emphasize their unsecured personal lending?
Solution: Consumer protection regulations have generally increased the cost of unsecured personal
lending. In particular, restrictions on collection practices and remedies have made it more difficult to
collect nonperforming or underperforming unsecured consumer loans. Proceedings under the Bankruptcy
Code also commonly involve the cancellation of unsecured debts. State interest rate ceilings have
sometimes made it difficult to make a profit on small consumer loans, which already embody just a
narrow margin of return over risk. Thus, finance companies have switched to making larger, better-
secured loans, such as second-mortgage home-equity lines.