1. Managing Nondeposit Liabilities
Chapter Thirteen
Managing Nondeposit Liabilities
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2. Key Topics Liability Management Customer Relationship Doctrine
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Key Topics
Liability Management
Customer Relationship Doctrine
Alternative Nondeposit Funds Sources
Measuring the Funds Gap
Choosing among Different Funds Sources
Determining the Overall Cost of Funds
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3. 13-3
Introduction
The traditional source of funds for most depository institutions is the deposit account
But what does management do to find new money when deposit volume is inadequate to support all loans and investments these institutions would like to make?
In this chapter we explore yet another important nondeposit source of funding – selling IOUs in the money and capital markets for periods of time that may stretch from overnight to several years
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4. Liability Management and the Customer Relationship Doctrine
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Liability Management and the Customer Relationship Doctrine
The Customer Relationship Doctrine
The first priority of a lending institution is to make loans to all those customers from whom the lender expects to receive positive net earnings
Thus, lending decisions often precede funding decisions
All loans and investments whose returns exceed their cost and whose quality meets the lending institution’s credit standards should be made
If enough deposits are not immediately available to cover these loans and investments, then management should seek out the lowest-cost source of borrowed funds available to meet its customers’ credit needs
During the collapse of the subprime mortgage market in the business recession, regulators found that many mortgage lenders went overboard in approving loans, falling well below normal industry standards with little or no documentation
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5. 13-5
Liability Management and the Customer Relationship Doctrine (continued)
Liability Management
During the 1960s and 1970s, the customer relationship doctrine spawned the liquidity management strategy known as liability management
The bank buys funds in order to satisfy loan requests and reserve requirements
It is an interest-sensitive approach to raising bank funds
It is flexible – The bank can decide exactly how much they need and for how long
The control mechanism to regulate incoming funds is the price of funds
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6. 13-6
TABLE 13–1 Sample Use of Nondeposit Funds Sources to Supplement Deposits and Make Loans
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7. Alternative Nondeposit Sources of Funds
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Alternative Nondeposit Sources of Funds
Federal Funds Market
Repurchase Agreements
Borrowing from Federal Reserve Banks
Advances from the Federal Home Loan Bank
Negotiable CDs
Eurocurrency Deposit Market
Commercial Paper
Long-Term Nondeposit Funds Sources
The usage of nondeposit sources of funds has risen
Larger institutions rely on the nondeposit funds market as a key source of short-term money to meet loan demand and unexpected cash emergencies
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8. 13-8
TABLE 13–2 Recent Growth in Nondeposit Sources of Borrowed Funds at FDIC-Insured Banks and Thrifts
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TABLE 13–3 The Relationship between the Size of Banks and Their Use of Nondeposit Borrowings (2007 figures for FDIC-insured banks)
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10. Alternative Nondeposit Sources of Funds (continued)
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Alternative Nondeposit Sources of Funds (continued)
Federal Funds Market
Borrowing from Federal Reserve Banks
Immediately available reserves are traded between financial institutions and usually returned within 24 hours
Deposits with correspondent banks and demand deposit balances of security dealers and governments can be used for loans to institutions
Types of Fed Funds Loan Agreements
Overnight Loans
Negotiated via wire or telephone, returned the next day
Normally not secured by specific collateral
Term Loans
Longer term Fed funds contracts (several days, weeks, or months)
Continuing Contracts
Automatically renewed each day
Normally between smaller respondent institutions and their larger correspondents
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