1. Chapter 12 - Bank Management
Money and Banking – Michael Brandl ©2017 Cengage Learning

2. 12-1a Asset Transformation
Commercial Banks have two basic functions:
Accept deposits of money
Make loans
Asset Transformation: banks transform the assets of savers into assets for borrowers.
Money and Banking – Michael Brandl ©2017 Cengage Learning

3. 12-1b Bank Management: The Big Picture State Security Bank vs
12-1b Bank Management: The Big Picture State Security Bank vs. Commercial Banks
Community Banks are characterized as having assets < 1 billion
Commercial Banks “Money Centers” spread across the country and typically around the world.
Regardless of what size and form a bank is, they all operate under the same accounting rules and regulations.
Money and Banking – Michael Brandl ©2017 Cengage Learning

4. 12-1b Bank Management: The Big Picture Statement of Assets: Things owned by the bank or owed to the bank
A bank balance sheet summarizes the financial position of the bank at a certain time.
Every balance sheet must balance; this means that the value of assets must equal the amount of claims against those assets.
Liabilities are things owed by the bank to depositors or others. A balanced sheet is balanced because
Assets = liabilities + net worth
Money and Banking – Michael Brandl ©2017 Cengage Learning

5. 12-2a Transaction Deposits
Commercial banks accept the deposits of households and businesses, keep the money safe until it is demanded via checks.
Checkable Deposits of banks are known variously as demand deposits, NOW (negotiable order of withdrawal) accounts, ATS (automatic transfer service) accounts and share draft accounts.
The commonality is that depositors can write checks on them whenever, and in whatever amount, they choose.
Money and Banking – Michael Brandl ©2017 Cengage Learning

6. 12-2a Transaction Deposits: Demand Deposits and NOW Accounts
Characteristics of a demand deposit.
No maturity period, or an original maturity period of <7 days.
Payable on Demand
No limit on the number of withdrawals or transfers
No eligibility requirements
Money and Banking – Michael Brandl ©2017 Cengage Learning

7. 12-2a Transaction Deposits: The Invention of NOW accounts
Regulation Q – Banking Act of 1933 forbade banks to pay interest on checking accounts or demand deposits.
Ronald Haselton: created the “savings account”.
Withdrawal of funds at anytime by writing a check
1980 – Congress passed legislation to allow all depository institutions to offer NOW accounts.
Checking accounts that pay interest.
Money and Banking – Michael Brandl ©2017 Cengage Learning

8. 12-2a Transaction Deposits: Money Market Deposit Accounts
MMDA
An interest-bearing account containing a variety of interest-bearing short-term securities.
Have a minimum-balance requirement
A limit on how often a person can withdraw funds
Money and Banking – Michael Brandl ©2017 Cengage Learning

9. 12-2b Nontransaction Accounts
Near Monies: highly liquid financial assets that do not function directly or fully as a medium of exchange but can be readily converted into currency or checkable deposit.
Certificates of Deposit – illiquid savings accounts for a stated length of time or term.
They range from 91 days to 10 years. The longer the term, the higher the annual interest rate paid.
Money and Banking – Michael Brandl ©2017 Cengage Learning

10. 12-2bNontransaction Accounts: Certificates of Deposits
Illiquid savings accounts for a stated length of time or term.
There are usually substantial penalties for early withdrawals
CDs require $1, to open
JUMBO CD – “large time deposit”
Major difference between CDs and JUMBO CDs:
Interest paid on JUMBO is negotiable instead of a stated rate
JUMBO CDs – secondary market, banks buy and sell JUMBO CDs among each other.
Money and Banking – Michael Brandl ©2017 Cengage Learning

11. 12-2c Other Liabilities
Deposits constitute claims that the depositors have against the assets of the bank and thus are a new liability account.
Banks can also raise fuds via other methods.
Federal Funds purchases
Repurchase agreements
Subordinated debt
Eurodollar accounts
Other borrowing and other liabilities
Money and Banking – Michael Brandl ©2017 Cengage Learning

12. 12-3: Bank Loans and Other Assets 12-3a Cash
Vault Cash: Counted as reserves; banks keep a significant portion of their own reserves in their vaults.
Banks hold a small portion of their assets in the form of cash, around 2% or 3% of assets.
US banks do not want to lend the cash they are holding
It does not pay high returns to the banks that hold the cash
Hold assets that pay a higher rate of return.
Money and Banking – Michael Brandl ©2017 Cengage Learning

13. 12-3b Securities US Treasury securities have the lowest default risk.
Securities issued by US government agencies.
These two classes of assets provide a large and active secondary Market and a high level of liquidity
These are important characteristics to banks
US government debt is very safe and very liquid but have relatively low yields
Money and Banking – Michael Brandl ©2017 Cengage Learning

14. 12-3c Bank Loans: Different types of bank loans
Short-term Business Loans:
Self- liquidating inventory loans.
Seasonal borrowing
Interim construction loans
Securities dealer financing
Retail and equipment financing
Money and Banking – Michael Brandl ©2017 Cengage Learning

15. 12-3c Bank Loans: Long –term Business Loans
Term asset-based: fixed asset or blind-spot loans.
Project loans: More than one bank participates, or lends a portion of the total loan. Created for financing large, long-term projects
Leveraged Buyouts (LBOs) – investor or private equity fund, borrows funds to buy all of the outstanding shares of a corporation.
Company becomes privately held. During which, it can be improved and the shares can then be sold at a higher price.
Repayment of the loan occurs when the shares are sold.
Agricultural loans. Subsidized by the federal government. Include loans for equipment, feed, seed and even things such as water.
Money and Banking – Michael Brandl ©2017 Cengage Learning

16. 12-3c Bank Loans: Short-term Consumer Loans
Credit Cards. Unsecured revolving credit agreements. Borrowers do not have to pledge assets as collateral. Borrower can borrow any amount up to the maximum allowed.
Unsecured personal loans. Sometimes called signature loans, the borrower offers no collateral, only their signature, to get the loan
Unsecured personal lines of credit. Similar to a credit card, there is a maximum amount the borrower may borrow, but they typically do not borrow the entire amount at once.
Money and Banking – Michael Brandl ©2017 Cengage Learning

17. 12-3c Bank Loans: Long-term Consumer Loans
Home Mortgages: first mortgages, used by the borrower to obtain funds to purchase the real estate. Mortgages can be amortized over 15 or 30 years and may have a fixed or adjustable interest rate.
Home Mortgages: second mortgages and equity lines of credit. The difference between the market value of asset, a house, and the amount owned on the asset is called equity. These home loans were called second mortgages.
Automobile loans. Consumers must get a loan and pledge the auto as collateral. Payback periods generally depending on new vs. used autos can be longer for new car purchases.
Other vehicle loans. Motorcycle loans, boat loans, among others. Interest rates on these vehicle loans tend to be higher than those on auto loans.
Money and Banking – Michael Brandl ©2017 Cengage Learning

18. 12-4 Off Balance Sheet Activities
Due to fierce competition over borrowers increasing, savers discovered alternative places to save their funds.
Bank fees replaced the shrinking interest rate spread.
Fee-generating activities involve transactions that take place off the bank’s balance sheet.
Off balance sheet activities have become a way for banks to get around legal capital requirements.
Money and Banking – Michael Brandl ©2017 Cengage Learning

19. 12-4a Commercial Letters of Credit
A letter explaining if a “buyer” does not pay a “seller” for a good or service, the bank will pay.
If the buyer and seller agree upon payment and a loan was not made, there is nothing to put on the bank’s balance sheet.
A bank does not extend this service to the “buyer” for free.
The bank will charge a fee.
Money and Banking – Michael Brandl ©2017 Cengage Learning

20. 12-4b Standby Letters of Credit
A bank promises to pay a third party if the bank’s customer does not repay as promised.
A much more general commitment than a commercial letter of credit. It is not tied to a specific transaction.
Banks viewed standby letters as a risk free way to generate fee income.
Money and Banking – Michael Brandl ©2017 Cengage Learning

21. 12-4c Financial Derivatives: Currency and Interest Rate Forward, Futures, Options, and Swap Contracts
Financial derivatives: an agreement between a bank to exchange currencies or interest payments at an agree- upon price at some date in the future, or the right to do so.
Credit Default Swap Contracts: the bank that issues the CDS is insuring repayment to the issuer of the financial contract.
Money and Banking – Michael Brandl ©2017 Cengage Learning