Chapter 4. Depository Institutions Banks Asset/Liability problem Commercial Banks Savings and Loans Credit Unions 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 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 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: yr. loan 9.1%, 6 mo. CD 8% mo. CD 18.27% derivatives help banks manage this risk changes in interest rates will change profits rising short-term rates reduce the spread income example: yr. loan 9.1%, 6 mo. CD 8% mo. CD 18.27% derivatives help banks manage this risk

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

RegulatorsRegulators Federal Reserve System member banks -- all federal & some state banks Comptroller of the Currency federal banks FDIC nonmember state banks state agencies 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 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 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%) 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%) 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 money center banks rely on money market to raise funds regional banks rely on deposits to raise funds

RegulationRegulation much of it due to Great Depression & resulting bank failures some of this has been repealed, but still affects banks today 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 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 a lot of merger activity since McFadden Act (1927) restricted interstate bank branching designed to protect small banks -- U.S. has many smaller banks inefficient -- no economies of scale repealed 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 advantages for global banking, economies of scale Glass-Steagall Act (1933) separation of commercial banking, securities firms, & insurance -- belief that abuses led to 1929 market crash weakened in 1980s, 1990s repealed advantages for global banking, economies of scale

Other Regulations FDIC (1933) deposit insurance ($100,000) prevents bank panics -- depositors wont withdraw $ creates moral hazard -- banks, depositors less careful FDIC (1933) deposit insurance ($100,000) prevents bank panics -- depositors wont 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. 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 ; created in 1933 to give mortgages state or federal charter ; created in 1933 to give mortgages

RegulatorsRegulators FSLIC , FDIC since 1989 Office Thrift Supervision since 1989 federal state agencies Federal Reserve FSLIC , 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 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 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 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 1970s rising inflation leads to rising interest rates spread income disappears market interest rates rise above Reg. Q ceilings loss of deposits

DeregulationDeregulation 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 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 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 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 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. govt securities liabilities member deposits assets consumer loans mortgages U.S. govt securities liabilities member deposits