Chapter 3 – Depository Institutions BA 543 Financial Markets and Institutions

Chapter 3 – Depository Institutions Types Commercial Banks (Check-writing Institutions) Savings and Loans (NOW accounts) Savings Banks (NOW accounts) Credit Units (Share Draft accounts) Basic Business Receive Deposits (Funds Borrowed from Customers) – Demand Deposits Charge Fees for Services Invest: Loans to Customers or Securities Provide Conveniences (Checking or NOW Accounts)

Chapter 3 – Depository Institutions Commercial Banks Two major Types Banking Act of 1863 established National Banks Office of the Comptroller of Currency Regulation Authority National Banks – Federal Charter and must be insured by Bank Insurance Fund or BIF (administered by FDIC) State Banks – State Chartered each State Regulates State Banks may elect to join Federal System and if they do must insure with BIF (about 15% elect to join) Federal Reserve Act of 1913 - Established Federal Reserve System Today about 7,100 FDIC insured or supervised http://www.federalreserve.gov/releases/lbr/current/default.htm http://www.fdic.gov/bank/statistical

Chapter 3 – Depository Institutions Savings and Loan Association Assets – Traditionally Mortgages and Mortgage Backed Securities Liabilities (Funding) – Passbook Savings Today NOW accounts Regulation Originally - Home Owners Loan Act of 1933 Now – Federal S&Ls by Office of Thrift Supervisor S&L Crisis of the 1980s - Disintermediation

Chapter 3 – Depository Institutions Savings Banks Similar to S&Ls Broader Assets and so they weathered the interest changes of the 80s Credit Unions Common Bond among members Cooperative or Mutual – No Corporate Stock Numbers bigger than commercial banks but total assets very small compared to commercial banks Typically strong local player in banking

Chapter 3 – Depository Institutions Bank Funding Demand Deposits – Checking and Savings Regional Banks rely primarily on demand deposits Time Deposits – Certificates of Deposit Borrowed Funds – Fed Window (Bank of last resort) Selling of Securities Short Term Notes, Bonds, Repos, etc. Money Center Banks rely on this form of funding Reserve Requirement – More Later

Chapter 3 – Depository Institutions Income Generation Individual Banking – charges for services Fees for checking, mortgage origination, credit cards, trusts, etc. Spread on consumer loans Institutional Banking –charges for services Commercial and Real Estate Financing, Leasing, Factoring Accounts Receivable, etc. Global Banking Bond Dealers, Currency Dealers, Banker’s Acceptance, Letters of Credit, etc. Financial Products such as SWAPS

Chapter 3 – Depository Institutions Asset/Liability Problem Credit (Default) Risk Loans are not fully backed by assets Defaults on personal loans Regulatory Risk Rule changes adversely impact income of bank Interest Rate Risk – Example Borrow $1 million for 1 year at 5% Buy $1 million Five year Zero Coupon Bond at 7% Interest rates raise to 8% in year two Liquidity Issues Ways to pay off demand deposits

Chapter 3 – Depository Institutions Capital Requirements Very Low Equity Stake Equity Stake is the “risk” position of owners Tier One and Tier Two Different types of Equity Holdings Risk Weights of Assets TABLE 3-3 Page 50 Arrived at on no particular scientific basis Basle Committee on Banking Regulations and Supervisory Practices 1988 (G-10 Countries)

Chapter 3 – Depository Institutions Regulations McFadden Act 1927 – States Right to Set Rules for Banking – Unit Banking States, Branches Allowed or Not Allowed Banking Act 1933 - Glass-Steagall (Sections 16, 20, 21, and 32) Separate Investment Banking and Commercial Banking - WHY? Garn-St. Germain Act 1982 – NOW Accounts Interstate Banking and Branching Act – 1994 Gramm-Leach-Bliley Act 1999