Overview of Depository Institutions

Overview of Depository Institutions

Size, Structure and Composition of Depository FIs

Þ  Definition of Commercial Bank

ü  Accept demand deposits and make commercial loans.

Þ  Consolidation has created some very large depository FIs

Þ  Depository institutions

ü  Commercial Banks

è  Specialize in short-term business credit

è  Largest depository institutions are commercial banks

è  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

è  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

è  Financial Services Modernization Act 1999: Allowed full authority to enter investment banking (and insurance)

ü  Thrifts

è  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

è  Savings Banks:

•  Founded in early 1800s

•  Provided savings accounts for individuals

•  Existed then and now only in New England

ü  Credit Unions

è  Fields of membership requirements: employee groups, associations, religious affiliations and residential areas

è  Not- for-profit organization

è  Offers lower average fees and more competitive rates than banks do

Understanding Commercial Bank’s Balance Sheets

Þ  Balance Sheet

ü  Assets = Liabilities + Equity

ü  Bank assets

è  Cash and due from banks: vault cash, deposits held at the Fed and other financial institutions, and cash items in the process of collection

è  Investment Securities: assets held to earn interest and help meet liquidity needs

è  Loans: the major asset, generate the greatest amount of income, exhibit the highest default risk and are relatively illiquid

è  Other assets: bank premises and equipment, interest receivable, prepaid expenses, other real estate owned, and customers' liability to the bank

ü  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

Þ  Bank liabilities and equity

ü  Assets = Liabilities + Equity

ü  Bank liabilities

è  Demand deposits: transactions accounts that pay no interest

è  Negotiable orders of withdrawal (NOWs) and automatic transfers from savings (ATS) accounts: pay interest set by each bank without federal restrictions

è  Money market deposit accounts (MMDAs): pay market rates, but a customer is limited to no more than six checks or automatic transfers each month

è  Savings and time deposits represent the bulk of interest-bearing liabilities at banks:

è  Deposits held in foreign offices: balances issued by a bank subsidiary located outside the U.S.

è  Rate-sensitive borrowings: Federal Funds purchased and Repos

ü  Core vs. volatile funds

è  Core deposits include: demand deposits, NOW accounts, MMDAs, and small time deposits

è  Core deposits are stable deposits that are not highly interest rate-sensitive

è  Core deposits are more sensitive to the fees charged, services rendered, and location of the bank

è  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

è  Large, or volatile, borrowings are liabilities that are highly rate-sensitive

ü  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

ü  Stockholders equity

è  Subordinated notes and debentures: notes and bonds with maturities in excess of one year

è  Ownership interest in the bank: common and preferred stock and retained earnings

Þ  The income statement

ü  Interest income (II): the sum of interest and fees earned on all of a bank's assets, interest income includes interest from:

è  Loans

è  Deposits held at other institutions

è  Municipal and taxable securities, and

è  Investment and trading account securities

ü  Interest expense (IE) is the sum of interest paid on all interest-bearing liabilities

ü  Interest income less interest expense is net interest income (NII)

ü  Loan-loss provisions (PLL): represent management's estimate of potential lost revenue from bad loans

ü  Noninterest income (OI)

ü  Noninterest expense (OE)

è  Personnel expense: salaries and fringe benefits paid to bank employees

è  Occupancy expense : rent and depreciation on equipment and premises, and

è  Other operating expenses: utilities and deposit insurance premiums

Þ  Evaluating bank performance

ü  Return on equity (ROE)

ü  Return on assets (ROA)

Þ  Trends of bank’ balance sheets

ü  Business loans have declined in importance

ü  Offsetting increase in securities and mortgages

ü  Increased importance of funding via commercial paper market

ü  Securitization of mortgage loans

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