1. Alternative Nondeposit Sources of Funds (continued)
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Alternative Nondeposit Sources of Funds (continued)
Borrowing from Federal Reserve Banks
The Fed will make the loan through its discount window by crediting the borrowing institution’s reserve account
Each loan made by the Federal Reserve banks must be backed by collateral acceptable to the Fed
Several types of loans are available from the Fed’s discount window
Primary Credit
This loan is available for short terms and to institutions in sound financial condition
Rate is slightly higher than the federal funds rate
Secondary Credit
These loans are available at a higher interest rate to institutions not qualifying for primary credit
Seasonal Credit
These loans cover longer periods than primary credit for small and medium institutions experiencing seasonal swings in deposits and loans
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2. Alternative Nondeposit Sources of Funds (continued)
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Alternative Nondeposit Sources of Funds (continued)
Advances from Federal Home Loan Banks
Allows institutions (home mortgage lenders) to use home mortgages as collateral for advances
A way to improve the liquidity of home mortgages and encourage more lenders to provide credit
Number of loans has increased dramatically in recent years
Maturities range from overnight to more than 20 years
Federal Home Loan Bank (FHLB) System has 12 regional banks
Has federal charter and can borrow cheaply and pass savings on to institutions
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3. Alternative Nondeposit Sources of Funds (continued)
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Alternative Nondeposit Sources of Funds (continued)
Development and Sale of Large Negotiable CDs
An interest-bearing receipt evidencing the deposit of funds in the bank for a specified period of time for a specified interest rate
It is considered a hybrid account since it is legally a deposit
Types of Negotiable CDs
Domestic CDs.
Euro CDs
Yankee CDs
Thrift CDs
Fixed-rate CDs
Variable-rate CDs
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4. Alternative Nondeposit Sources of Funds (continued)
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Alternative Nondeposit Sources of Funds (continued)
Development and Sale of Large Negotiable CDs
Interest rates on fixed-rate CDs are quoted on an interest- bearing basis and the rate is computed assuming a 360-day year
Represent the majority of all large negotiable CDs issued
Example
Suppose a depository institution promises an 8 percent annual interest rate to the buyer of a $100,000 six-month (180-day) CD
The depositor will have the following at the end of six months
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5. Alternative Nondeposit Sources of Funds (continued)
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Alternative Nondeposit Sources of Funds (continued)
The Eurocurrency Deposit Market
Eurocurrency deposits were developed originally in Western Europe to provide liquid funds that could be swapped among multinational banks or loaned to the banks’ largest customers
Eurodollars are dollar-denominated deposits placed in bank offices outside the United States
Because they are denominated on the receiving banks’ books in dollars rather than in the currency of the home country and consist of accounting entries in the form of time deposits, they are not spendable on the street like currency
Most Eurodollar deposits are fixed-rate time deposits
Floating-rate CDs (FRCDs) and floating-rate notes (FRNs) were introduced in an effort to protect banks and their Eurodepositors from the risk of fluctuating interest rates
The Eurocurrency market is the largest unregulated financial marketplace in the world
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6. Alternative Nondeposit Sources of Funds (continued)
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Alternative Nondeposit Sources of Funds (continued)
Commercial Paper Market
Commercial paper consists of short-term notes, with maturities normally ranging from three or four days to nine months, issued by well-known companies to raise working capital
Industrial Paper – purchase inventories
Finance Paper – Issued by finance companies and financial holding companies
The notes are generally sold at a discount from face value through security dealers or through direct contact with the issuing company
This funds source tends to be high in volume and moderate in cost but also volatile in available capacity and subject to credit risk
Recently foreign banks have accelerated their mining of both European and American paper markets despite the pressures of the Great Recession
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7. Alternative Nondeposit Sources of Funds (continued)
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Alternative Nondeposit Sources of Funds (continued)
Long-Term Nondeposit Funds Sources
The nondeposit sources of funds discussed to this point are mainly short-term borrowings
However, many financial firms also tap longer-term nondeposit funds stretching well beyond one year
Examples include mortgages issued to fund the construction of buildings and capital notes and debentures
These longer-term nondeposit funds sources have remained relatively modest over the years due to regulatory restrictions and the augmented risks associated with long-term borrowing
Also, because most assets and liabilities held by depository institutions are short- to medium-term, issuing long-term indebtedness creates a significant maturity mismatch
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8. Choosing among Alternative Nondeposit Sources
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Choosing among Alternative Nondeposit Sources
The demand for nondeposit funds is determined basically by the size of the gap between the institution’s total credit demands and its deposits and other available monies
Gap is based on:
Current and projected demand and investments the bank desires to make
Current and expected deposit inflows and other available funds
Size of this gap determines the need for nondeposit funds
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9. Choosing among Alternative Nondeposit Sources (continued)
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Choosing among Alternative Nondeposit Sources (continued)
Nondeposit Funding Sources: Factors to Consider
The relative costs of raising funds from each source
The risk (volatility and dependability) of each funding source
The length of time (maturity or term) for which funds are needed
The size of the institution that requires more funds
Regulations limiting the use of alternative funds sources
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10. Choosing among Alternative Nondeposit Sources (continued)
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Choosing among Alternative Nondeposit Sources (continued)
A good formula for doing cost comparisons among alternative sources of funds
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11. Quick Quiz What is liability management?
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Quick Quiz
What is liability management?
What advantages and risks does the pursuit of liability management bring to a borrowing institution?
What is the customer relationship doctrine, and what are its implications for fund-raising by lending institutions?
What are the principal advantages to the borrower of funds under an RP agreement?
What are the advantages of borrowing from the Federal Reserve banks or other central bank? Are there any disadvantages?
How is a discount window loan from the Federal Reserve secured? Is collateral really necessary for these kinds of loans?
Why were negotiable CDs developed?
What is the available funds gap?
What factors must the manager of a financial institution weigh in choosing among the various nondeposit sources of funding available today?
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