Payment System and Banking Relationships1 U.S. Banking System Financial Institutions  Commercial Banks Focus: corporate services: lending, cash management  Savings and Loans Focus: real estate mortgages  Credit Unions Focus: Consumer loans and accounts

Payment System and Banking Relationships2 U.S. Banking System Regulation of Banking System  Most foreign countries Few, large banks  Canada: Bank of Nova Scotia, TDB, CIBC, Bank of Canada, etc., found all across country

Payment System and Banking Relationships3 U.S. Banking System Regulation of Banking System  United States Numerous, small banks  Depression era legislation limited bank branches  Why?  In the 1980s, many Texas banks were in trouble  Legislation permitted out of state banks to acquire “troubled banks”  1995: legislation passed permitting interstate banking  Many predicted only a few, large banks would remain at this point  With some banks increasing in size, such as Bank of America  Banks can provide cash collection and concentration for operations across country  But, personal touch was often lost: loan officers moved; phone trees

Payment System and Banking Relationships4 U.S. Banking System Regulation Q  Corporations can not receive interest income on checking account balances Sole proprietorships can have interest earning accounts Alternative strategies:  Sweep accounts: excess balances into overnight loans  Firms with large cash balances  Money market mutual funds:  Minimum check amount generally $500  Uninsured  Minimal risk as generally invested in government securities

Payment System and Banking Relationships5 U.S. Banking System FDIC Insurance  $250,000 per account through 2009 Married couple Multiple banks Capital requirements  Tier 1: $3 of common stock for $100 of assets  Tier 2: $8 of common, preferred stock for $100 of risk weighted assets 100% risk factor: business loans 50% risk factor: real estate loans 0% risk factor: T bills 150% risk factor: past due loans

Payment System and Banking Relationships6 U.S. Banking System Fed  Structure 12 district banks 25 regional branches 6 regional check processing centers  Impact on payment system Assists in processing checks Provides wire transfer system for large payments Provides ACH for small dollar electronic payments Regulates availability schedules

Payment System and Banking Relationships7 U.S. Banking System Check clearing  Fed credits collecting bank’s account and debits drawee bank’s account Collecting bank records deposit; drawee bank records check  MICR line: Fed Reserve Bank Code Bank ID Number Account Number Check Number

Payment System and Banking Relationships8 U.S. Banking System Check clearing  On Us: written on bank where check is deposited (30% checks)  Local: process by: Courier presenting, clear through correspondent, local clearing house  Availability: max two business days  Out of Town: process by: Courier presenting, presenting image, correspondent, Fed  Availability: max five business days

Payment System and Banking Relationships9 U.S. Banking System Check clearing  Float Collection: Day check written – Day funds available Disbursement: Day check written – Day funds taken from account  Component Mail Processing Clearing  Based on bank’s availability schedule

Payment System and Banking Relationships10 U.S. Banking System Availability schedule: Fifth Third Bank, pages  Eastwood Bank, Rochester, MN First $100 next day Local checks: two days Out of town checks: five days Longer availability:  Deposit more than $5,000  Redepositing NSF check  Account has been overdrawn New accounts: first 30 days  Electronic deposit: immediately  Cash, wire transfer, cashier checks up to $5,000: next day  Other checking deposits: 10 days

Payment System and Banking Relationships11 Electronic Payments Wire Transfers: entry increasing one bank’s account and decreasing the other  Immediate access for large dollar amounts ($30,000 average) Overnight loans of repo agreements More expensive than other forms of moving funds ACH: automatic deposit of payroll checks; government checks  One or two day availability  Cheaper to process than checks $5 per ACH; 10 cents per item in ACH at First-Mid Illinois  Payor knows when funds will be withdrawn May reduce float Incentives to adopt ACH

Payment System and Banking Relationships12 Debit Cards Processed locally or through ACH  Vendor: Immediate availability for local accounts Two business day availability if out of town  Customer: Local checks: immediate withdrawal of funds ACH: two days withdrawal

Payment System and Banking Relationships13 International Payments Giro system  Payment made by customers; often at post office Not sent to creditor  Funds are transferred between accounts based on account number Bank then notifies company funds are available  Used for regular periodic payments  Can be made automatically Value dating  Delays availability of deposits  Moves debit date for checks  To compensate for payment of interest

Payment System and Banking Relationships14 Managing Bank Relationships Reliable services with reasonable costs  Services Collection services: availability; concentration; lockbox Payment services: wires; ach; letters of credit Information services: advisory services on collection and disbursement Credit services: line of credit; factoring; medium-term loans Investment services: money market funds; repos

Payment System and Banking Relationships15 Managing Bank Relationships Reliable services with reasonable costs  Reasonable costs Account analysis statement  Benefit from company’s deposits exceed cost of bank providing services to company  I.E., is this company a profitable customer for bank?  Earnings Credit Allowance = Average collected balance x Earnings credit rate  Average collected balance = Ledger balance (amount in account) – Float (deposits not collected) – Required Reserves (Funds which can not be loaned)  Earnings credit rate = Based on T-bill rates; less than money market rates  Cost of providing services  Processing on us, local, out of town checks  Processing returned; redeposited checks  Fund transfers  Deposits  FDIC Insurance  If benefit > cost; excess benefit carried to next period  If cost > benefit; service charge or required balances increased next period