1. 1 Banking Industry Number of banks ~7,000 decreasing (result of consolidation, deregulation and failures) Number of branches ~90,000 increasing (result of relaxed geographical restrictions) About 4,000 are small banks (< $100 million in assets) Banks most commonly ranked by total assets. The large banks in our economy have mostly gotten there by means of mergers and acquisitions.

2. 2 Banks vs. Branches

3. 3 Balance Sheet for a Commercial Bank Uses of Funds Sources of Funds (Assets) (Liabilities + Capital) Cash Assets (8%) Deposit Liabilities (69%) FF sold/Rev repos (4%) Borrowed Funds (16%) Investments (19%) Other Liabilities (3%) Loans & Leases (55%) Subordinated Notes & Deben (1%) Premises (1%) Capital Accounts (11%) Other (13%) (See pp. 417 & 411)

4. 4 First Three Items on Left Cash Assets (8%): Vault cash (physical currency and coin) Reserves at the Fed Fed Funds Sold/Rev repos (4%): Fed Funds sold Reverse Repurchase Agreements Investments (19%): cushion in case need more liquidity U.S. Treasury securities Agency securities Municipal bonds

5. 5 Fourth Item on Left Loans  commercial and industrial  real estate  agricultural  consumer Leases  fast-growing line of business for the big banks  fleet assets (aircraft, ships,..), rolling stock (railroad cars, trucks,..), equipment (cranes, generators,..) Loans and Leases (55%)

6. 6 First Two Items on Right Deposit Liabilities (69%): Transaction Deposits Savings Deposits Time Deposits (retail and negotiable CDs) Borrowed Funds (16%): Fed Funds purchased Repurchase Agreements Eurodollars (dollars borrowed abroad) Discount Window loans

7. 7 Last Two Items on Right Subordinated Notes and Debentures (1%) Subordinated to claims of depositors Capital Accounts (11%) Paid-in capital (from sale of stock) Retained earnings

8. 8 Capital Adequacy Capital adequacy ratio: Numerator is subordinated notes & bonds + capital stock + retained earnings Denominator is a weighted average of assets Riskfree, weight of 0 Very risky assets like CDOs, weight of 1 Everything else, weight in between

9. 9 Base Rate Pricing Markups to base rate include adjustments for default risk, term-to-maturity, and competitive factors. r L = BR + DR + TM + CF In this way, business loans can vary from customer to customer. BR could be prime rate, Libor, or a T-bill rate. Loan pricing is one of most important managerial decisions is banking.

10. 10 Five ‘C’s of Credit Five “C”s of Credit:  Character (willingness to pay)  Capacity (cash flow)  Capital (wealth or net worth)  Collateral (security for the loan)  Conditions (economic conditions)