Depository Institutions Banks

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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
     deposits, borrowing, commercial
      paper
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
• 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
• 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

• state or federal charter
     dual banking system
     75% state chartered
•   consolidation
     1988: 13,137, 2000: 8,375
•   all insured by FDIC
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

• individual
      consumer loans, mortgages, credit
       cards, student loans, accounts
•   institutions
      commercial lending/leasing
      pension, cash management
• global
      corporate financing
      currency exchange
      bank acceptances
•   interest and fee income
      banks increasingly rely on fee
       income
Balance Sheet (2003)

• Assets
   loans (64%)
   securities (25%)
   cash (5%)
   other (6%)
• Liabilities
   deposits (65%)
   other borrowing (28%)
    -- the Federal Reserve
      (discount loans)
    -- other banks (federal funds)
    -- financial markets (commercial
    paper)
   Equity capital (7%)
• money center banks
      rely on money market to raise
       funds
•   regional banks
      rely on deposits to raise funds
Regulation

• much of it due to Great Depression
     & resulting bank failures
   some of this has been repealed,
    but still affects banks today
Repealed regulations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
• 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
• 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

• FDIC (1933)
   deposit insurance ($100,000)
   prevents bank panics
    -- depositors won’t withdraw $
   creates moral hazard
    -- banks, depositors less careful
• 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

• state or federal charter
     1988 3500; 1998 1700
•   created in 1933 to give mortgages
Regulators

• FSLIC 1933-89, FDIC since 1989
• Office Thrift Supervision since 1989
     federal
•   state agencies
•   Federal Reserve
Balance Sheet

• assets (traditional)
     mortgages
     U.S. government securities
•   asset choices expanded 1982
     Garn-St. Germain Act
• Liabilities (traditional)
      savings accounts, CDs
      higher Regulation Q ceilings
•   liabilities expanded 1980
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

• 1970s
• rising inflation leads to rising
    interest rates
      spread income disappears
•   market interest rates rise above Reg.
    Q ceilings
      loss of deposits
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

• does not solve interest rate problem
• regulators do not close insolvent
 S&Ls
  increase in fraud, risk taking
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

• members must have “common
    bond”
•   nonprofit, member owned
•   10,000 (but small in total assets)
•   federal or state charter
•   own deposit insurance fund
Balance Sheet

• assets
      consumer loans
      mortgages
      U.S. gov’t securities
•   liabilities
      member deposits

				
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