BUSINESS OF BANKING Income from Loans and Securities Presented by S. Cox

Objectives  Describe four common ways banks generate revenue  Explain the connection between customer fees and bank profitability

Income from Traditional Bank Services  First look at their assets  Something owned by an individual or other entity  Two largest assets…loans and securities How banks generate most of their income…also through the fees they charge

Income from Traditional Bank Services  Interest on Loans  Largest bank asset and produce the largest income  Interest is the fee charged for borrowing money…called interest income for a bank  Also charge interest on credit cards  How much interest?  Depends on competition, market rates, and the borrower’s creditworthiness  Every loan carries risk…if you have a poor credit rating, you may not be as likely to be able to pay back a loan and therefore the interest may be higher

Income from Traditional Bank Services  Interest on Securities  Typically bonds and treasury bills  Invest in long- and short-term securities Long – matures in over one year…bonds Short – matures in less than a year Maturity – the date on which the investor can receive the initial investment

Treasury Securities Short-Term Security Treasury Bills Also Called T-bills May be purchased from the Treasury or banks Yield is what the market will pay on maturity May be resold Issued in terms of 4, 13, 26, and 52 weeks Considered risk free because they are issued by the US government Short-to- Medium Term Security Treasury Notes Also called T-notes Fixed interest rate Sold at auction May be resold Long-Term Security Savings Bonds Series EE Fixed interest rate Available in paper or electronically Earn interest for up to 30 years Nontransferrable Series I Two methods for paying interest—one is fixed, the other is tied to inflation rate Earn interest for up to 30 years Nontransferrable Treasury Bonds Also Called T-bonds Fixed interest rate Pays interest every six months (up to 30 years) May be resold Considered risk free because they are issued by the US government

Treasury Securities  Banks balance interest income with liquidity by purchasing a mix of short and long term securities  Liquidity – the ability to quickly turn an asset into cash  Short term securities are more liquid than long term  Bank regulators restrict the types of securities banks can by…for example banks cannot invest in common stock

Gains on Securities  Selling a security for more than its purchase price = gain  Loans are bank’s primary asset, securities are the next most profitable  If giving loans is high and a bank needs money to make the loans, they may sell securities and if loan demands are low then they may buy securities

Income from Fees  Many bank fees relate to checking accounts  Often charge a monthly fee just for having a checking account  Insufficient funds fee – if there is not enough money in an account to cover a transaction  Overdraft program – provides funds to cover a check written on an account with insufficient funds Overdraft – a negative balance

Income from Fees  Banks that offer credit cards may charge an annual fee just to have the card, late payment fees, and over the limit fees  ATMs may charge a surcharge…fee to withdraw cash, also called a convenience fee  Account inquiry fee – check the balance of your account  Safe deposit box rental fee – fee for individually secured containers, usually within a bank vault, used to store valuables  Money order fees – fee to purchase a money order in the exact amount payable to a specific party  Inactivity fee – if a customer doesn’t make a transaction within some specified period

Common Bank Service Fees Checking AccountsATM Insufficient funds fees Overdraft fees Service fees Stop payment fees Account balance fees Transaction fees—using another bank Transaction fees—using ATM internationally Credit CardsSafe Deposit Boxes Annual fees Over-the-limit fees Late payment fees Rental fees Late rental payment fees Lost key replacement fees Miscellaneous Money order fees Inactivity fees Electronic funds transfer fees

BUSINESS OF BANKING Income from Nontraditional Services

Objectives  Explain how banks earn income from insurance products  Describe types of operations and how they provide income  Explain how brokerage services operate and provide bank revenue  Describe how banks manage the financial assets of certain customers  Identify the major investment banking activities

Insurance Products  Yes, banks sell insurance!!!  The Glass-Steagall Act of 1933 prohibited banks from insurance activities, but under the Gramm- Leach-Bliley Act of 1999, banks can offer insurance  Insurance provides protection from risk  Risk – the chance that something unfavorable could happen to a person or property  Insurance – provides protection from certain risks that can cause a financial loss…death, illness, or accident  Many types of loss = many types of insurance

Insurance Products  Life insurance – protects people from a financial loss in the vent of a death…paid to a beneficiary  Credit Life – will pay off a loan if the insured dies  Mortgage Life – pays off the loan balance on your home on your death

Insurance Products  Property and Casualty Insurance and Liability Insurance – covers things rather than people  Property and Casualty…Houses and cars for example Automobile insurance Liability covers the medical and property expenses of somebody else if you cause an accident…required by all states Collision pays for damage to your vehicle as the result of a vehicle on vehicle accident…no matter fault Comprehensive covers other types of damage to your vehicle…if a tree falls on your car while parked on the street Homeowner’s insurance – protection to your home and its contents…fire, theft, hail, and flood Businesses…commercial insurance protects the physical assets of the business…buildings, equipment, and furniture

Insurance Products  Liability protects against the financial losses that may occur if the insured is found responsible for property loss or injuries to others…if someone falls on your front steps

Insurance Products Types of Health Insurance Indemnity Health Known as a fee-for-service plan. Lets the insured go to any doctor he or she chooses The insurance pays a portion of covered healthcare costs Health Maintenance Organization (HMO) An association of doctors, hospitals, and other healthcare providers that provides comprehensive medical services. The insurance pays part or all of the healthcare costs only if the insured uses a doctor that is part of the HMO. Preferred Provider Organziation (PPO) An association of providers that offers services at a lower cost to subscribers. Gives the insured more choice than an HML The insurance pays part or all of the healthcare costs only if the insured uses a doctor that is part of the PPO.

Trust Services  Since the early 1900s  Involve handling financial assets for a customer  The bank becomes the trustee, the person or institution that controls the financial assets for the customer  A legal document (trust) is drawn up to define the customer’s assets and how those assets should be handled

Trust Services  Individual Clients  Estate Planning – preparing for the transfer of assets after a client’s death  Business Clients  Relate to cash management Accounting services – payroll Capital services – expenditures…purchase of a new building Collection services Credit card services – processing, issuing, and credit analysis

Trust Services  Brokerage Services  Securities trading…buying and selling securities for a customer Common stock, bonds, and treasury securities  Asset Management – for clients who don’t have the time or expert knowledge needed to handle their own investments  Fix income—mostly bonds, equities—mostly stocks, and cash equivalents

Investment Banking Services  Underwriting Securities – occurs when an investment bank buys a new stock directly from the company wanting to generate cash…the bank then sells the stock to the public  When investment banks underwrite a stock offering they make money through the underwriting spread which is the difference between the price paid and the price sold to the public

Investment Banking Services  Mergers and Acquisitions  Companies are often merging with and acquiring other companies  Merger takes place when two companies agree to combine  Acquisition happens when one company buys another company, setting itself up as the new owner

International Banking  Focuses on trade beyond the borders of the US  Types of financial institutions that offer international banking services  US based banks that do business internationally  Foreign banks doing business in the US  Other International banking entities

BUSINESS OF BANKING Banking Expenses

Objectives  Explain how deposits cause interest expense  Identify the major non-interest expense items for a bank

Interest Expense  Interest expense – when the bank pays interest to customers for using their money  Largest expense  Customers will shop around to get the highest interest rate (percentage paid for the use of borrowed money)  Not all deposit accounts pay interest Many checking do not If they do, they may have restrictions for example if you fall below a certain balance, no interest is paid

Operating Expenses  Operating expenses – costs that are incurred to keep the bank in business…utilities, rent, and employee wages and benefits  Employee wages and salaries are a major expense for banks Often we only see the tellers and loan officers but there are many in other areas  Employee benefits such as health insurance and retirement plans as well as training employees use a considerable amount of money  Other operating expenses Office equipment purchases and maintenance Security expenses Advertising and marketing costs