2.  Learning Objectives 
Understand how important commercial banks are to the economy
Explore the structure of the United States’ banking industry
Examine bank financial statements and learn how to read them
Discover how banks create and destroy money and credit, and understand why this activity is vital

3. Introduction
Commercial banks are the dominant financial institution in most developed countries
These institutions offers the public a variety of services:
Deposit and credit services
Investment advice
Security underwriting
Insurance
Financial planning

4. The Structure of U.S. Commercial Banking
Banking structure:
The number and size of commercial banks:
In most nations the banking system consists of a few large banks
The U.S. system is dominated by small banks, but assets are concentrated in a small handful of banks
Trend toward consolidation:
Until recently, the trend has been for banks to merge in order to enjoy economies of scale
Recent events have raised public concern over this increasing consolidation:
Many banks are starting to reduce size

5. The Structure of U.S. Commercial Banking

6. Branch Banking Consolidation of banks into larger organizations:
Most evident in the long-term shift toward branch banking
Many of the nation’s largest banks have followed their customers to distant markets:
Branching
Mergers
To protect their sources of funds and their earnings

7. Bank Holding Companies
Growth of bank holding companies
A new type of financial-services holding company:
Created in 1999 from Gramm-Leach-Bliley
Brings together various financial institutions under the same holding company
Approaching structure of leading European banks
Corporations organized to acquire and hold the stock of one or more banks
Holding companies have become the predominant bank organizational form

8. International Banking
Bank expansion into international markets has taken place through a wide variety of organizational forms:
Representative offices
Branch offices
Acquisitions of existing overseas banks that then become subsidiaries of the international bank
Joint ventures with foreign firms

9. The Convergence Trend in Banking
Convergence in banking:
Banking organizations are looking more and more like other financial-service providers
Banks are offering many of the same services as security firms, insurance companies, etc.
Several banks in Canada, Great Britain, and Western Europe long ago became universal and merchant banks

10. Changing Technology
Banking today is also passing through a technological revolution
The most important pieces of technology include:
ATMs, POS, and internet banking
Benefits of this technological revolution:
Increased bank profitability
Increased speed of transactions for customers
Costs of this technological revolution:
Higher rates of identity theft
Short term pains as tellers are replaced with capital

11. Portfolio Characteristics of Commercial Banks
Primary reserves:
Consist of cash and deposits held with other banks
Reserves are the banker’s first line of defense against withdrawals
Commercial banks hold securities acquired in the open market
Loans are important to banks:
One of their highest yielding assets
Banks need funding to carry out lending and investing operations:
About two-thirds comes from deposits
14-11

12. Portfolio Characteristics of Commercial Banks
Moneys set aside in case a loan defaults is referred to as a loan loss allowance
Three types of deposits:
Demand deposits (checking accounts):
Important for transactions
Safer than cash
Savings:
Low interest rates
Low dollar amounts
Time deposits:
Fixed maturity
Highest rate of return offered

13. Portfolio Characteristics of Commercial Banks
Principal non-deposit sources of funds:
Purchases of reserves from other banks
Security repurchase agreements
Issuance of capital notes
Recently, banks have turned to new non-deposit funds sources:
Floating-rate CDs and notes sold in international markets
Sales of loans
Securitization of selected assets
Standby credit guarantees

14. Portfolio Characteristics of Commercial Banks

15. Portfolio Characteristics of Commercial Banks

16. Portfolio Characteristics of Commercial Banks
Equity capital supplied by a bank’s stockholders:
Provides a minor portion of total funds for banks
Revenues:
Interest and fees on loans
Interest and dividends on security holdings
Expenses:
Interest on deposits and other borrowed funds
Salaries and wages of employees

17. Portfolio Characteristics of Commercial Banks
Bank expenses have been rising:
Greater competition from bank and nonbank financial institutions increase the cost of raising funds
Expense of upgrading computers and automated equipment
The interest margin:
Net interest income less total interest paid
Non-interest margin:
Difference between banks non-interest income and their non-interest expenses

18. Portfolio Characteristics of Commercial Banks

19. Managing Commercial Bank Performance Today
Bank assets, liabilities, revenues, and expenses can be managed:
Written loan policies
The positioning of the bank's investment portfolio
Meeting the bank’s liquidity needs through asset conversion or liability management
Paying special attention to the largest depositors and to those customers with large outstanding credit lines

20. Managing Commercial Bank Performance Today
The performance of a bank:
Is evaluated relative to its own goals
Is also evaluated relative to the performance of its competitors
Four dimensions of bank performance tend to be the most closely followed:
The bank’s market value or stock price
The bank’s rate of return or profitability ratios
The bank’s risk exposure
The bank’s operating efficiency

21. Managing Commercial Bank Performance Today
Note that performance measurement should always take into account various differences:
Bank size
Location
Especially the product-line focus each bank adopts as its principal service mission
Another important dimension of bank performance is efficiency

22. Money Creation and Destruction by Banks and Bank Accounting
Banks have the power to create money:
Form of new checkable deposits, credit cards, debit cards, etc
The banking system can create a money:
Equal to a multiple of any excess reserves deposited
Simply by making loans and purchasing securities
By making loans with their excess reserves:
The banking system eventually creates total deposits and total loans
Several times larger than the original volume of new funds received

23. Money Creation and Destruction by Banks and Bank Accounting

24. Money Creation and Destruction by Banks and Bank Accounting

25. Money Creation and Destruction by Banks and Bank Accounting
Similarly, the money supply can contract by a multiple amount when legal reserves are withdrawn from the banking system

26. Money Creation and Destruction by Banks and Bank Accounting

27. Destruction of Deposits and Reserves

28. Implications of Money Creation and Destruction
Creation of money by banks is one of the most important sources of credit funds in the global economy
Money created by banks is instantly available for spending:
Need for monitoring by government
Creation of money can fuel inflation

29. Markets on the Net ABN AMRO at www.abnamro.com
American Bankers Association at
Bank of China Ltd. at
Bank Systems & Technology at
Bankrate.com at
Barclays at

30. Markets on the Net
Board of Governors of the Federal Reserve System at
CapitalOne at
China Construction Bank at
Citibank at
Consumer Action at
Federal Reserve Bank of Chicago at

31. Markets on the Net
Federal Deposit Insurance Corporation at
Federal Financial Institutions Examination Council at
Financial information for specific banks at
FYI Publications at

32. Markets on the Net IDC Financial Publishing at www.idcfp.com
Industrial and Commercial Bank of China at
ING Direct at
JPMorganChase at
Keybank at
MetLife Bank at

33. Markets on the Net
Office of the Comptroller of the Currency at
Sheshunoff at
Societe Generale at
UniCredit Group at
Veribanc at
Wells Fargo Bank at

34. Chapter Review Introduction to banking
The structure of U.S. commercial banking
A trend toward consolidation
Branch banking
Bank holding companies
International banking
The convergence trend in banking
Bank failures
Changing technology

35. Chapter Review Portfolio characteristics of commercial banks
Cash and due from banks (primary reserves)
Investment security holdings and secondary Reserves
Loans
Deposits
Nondeposit sources of funds
Equity capital
Revenues and expenses

36. Chapter Review Managing commercial bank performance
Managing bank assets, liabilities, revenue and expenses
Monitoring the performance of a bank
Money creation and destruction by banks and bank accounting
The creation of money and credit
Destruction of deposits and reserves
Implications of money creation and destruction