Chapter 4. Depository InstitutionsChapter 4. Depository Institutions“Banks”“Banks”

Chapter 4. Depository InstitutionsChapter 4. Depository Institutions“Banks”“Banks”

• Asset/Liability problem

• Commercial Banks

• Savings and Loans

• Credit Unions

• Asset/Liability problem

• Commercial Banks

• Savings and Loans

• Credit Unions

I. Asset/Liability Problem I. Asset/Liability Problem I. Asset/Liability Problem I. Asset/Liability Problem

• Assets how banks USE their funds loans, cash reserves, securities

• Liabilities how banks GET their funds deposits, borrowing, commercial

paper

• Assets how banks USE their funds loans, cash reserves, securities

• Liabilities how banks GET their funds deposits, borrowing, commercial

paper

Interest Rate RiskInterest Rate RiskInterest Rate RiskInterest Rate Risk

• banks tend to borrow short and lend long maturity intermediation

• banks depend on spread income interest received on assets minus

interest paid on deposits

• banks tend to borrow short and lend long maturity intermediation

• banks depend on spread income interest received on assets minus

interest paid on deposits

• changes in interest rates will change profits rising short-term rates reduce the

spread income

example:

1970 30 yr. loan 9.1%, 6 mo. CD 8%

1981 6 mo. CD 18.27%

• derivatives help banks manage this risk

• changes in interest rates will change profits rising short-term rates reduce the

spread income

example:

1970 30 yr. loan 9.1%, 6 mo. CD 8%

1981 6 mo. CD 18.27%

• derivatives help banks manage this risk

LiquidityLiquidityLiquidityLiquidity

• banks must hold some cash, near cash

• if fall short, must pay to borrow funds or sell assets

• tradeoffs between liquidity and interest rate earned

• banks must hold some cash, near cash

• if fall short, must pay to borrow funds or sell assets

• tradeoffs between liquidity and interest rate earned

II. Commercial BanksII. Commercial BanksII. Commercial BanksII. Commercial Banks

• state or federal charter dual banking system 75% state chartered

• consolidation 1988: 13,137, 2000: 8,375

• all insured by FDIC

• state or federal charter dual banking system 75% state chartered

• consolidation 1988: 13,137, 2000: 8,375

• all insured by FDIC

RegulatorsRegulatorsRegulatorsRegulators

• Federal Reserve System member banks

-- all federal & some state banks

• Comptroller of the Currency federal banks

• FDIC nonmember state banks

• state agencies

• Federal Reserve System member banks

-- all federal & some state banks

• Comptroller of the Currency federal banks

• FDIC nonmember state banks

• state agencies

Bank servicesBank servicesBank servicesBank services

• individual consumer loans, mortgages, credit

cards, student loans, accounts

• institutions commercial lending/leasing pension, cash management

• individual consumer loans, mortgages, credit

cards, student loans, accounts

• institutions commercial lending/leasing pension, cash management

• global corporate financing currency exchange bank acceptances

• interest and fee income banks increasingly rely on fee

income

• global corporate financing currency exchange bank acceptances

• interest and fee income banks increasingly rely on fee

income

Balance Sheet (2003)Balance Sheet (2003)Balance Sheet (2003)Balance Sheet (2003)

• Assets loans (64%) securities (25%) cash (5%) other (6%)

• Assets loans (64%) securities (25%) cash (5%) other (6%)

• Liabilities deposits (65%) other borrowing (28%)

-- the Federal Reserve

(discount loans)

-- other banks (federal funds)

-- financial markets (commercial paper) Equity capital (7%)

• Liabilities deposits (65%) other borrowing (28%)

-- the Federal Reserve

(discount loans)

-- other banks (federal funds)

-- financial markets (commercial paper) Equity capital (7%)

• money center banks rely on money market to raise

funds

• regional banks rely on deposits to raise funds

• money center banks rely on money market to raise

funds

• regional banks rely on deposits to raise funds

RegulationRegulationRegulationRegulation

• much of it due to Great Depression

& resulting bank failures some of this has been repealed,

but still affects banks today

• much of it due to Great Depression

& resulting bank failures some of this has been repealed,

but still affects banks today

Repealed regulationsRepealed regulationsRepealed regulationsRepealed regulations

• Regulation Q (1933) interest rate ceilings on bank

deposits problems in 1970s as market

interest rates rose above ceilings phased out in 1980

• Regulation Q (1933) interest rate ceilings on bank

deposits problems in 1970s as market

interest rates rose above ceilings phased out in 1980

• McFadden Act (1927) restricted interstate bank branching designed to protect small banks

-- U.S. has many smaller banks inefficient

-- no economies of scale repealed 1994

-- a lot of merger activity since

• McFadden Act (1927) restricted interstate bank branching designed to protect small banks

-- U.S. has many smaller banks inefficient

-- no economies of scale repealed 1994

-- a lot of merger activity since

• Glass-Steagall Act (1933) separation of commercial banking,

securities firms, & insurance

-- belief that abuses led to 1929 market crash

weakened in 1980s, 1990s repealed 1999

-- advantages for global banking,

economies of scale

• Glass-Steagall Act (1933) separation of commercial banking,

securities firms, & insurance

-- belief that abuses led to 1929 market crash

weakened in 1980s, 1990s repealed 1999

-- advantages for global banking,

economies of scale

Other RegulationsOther RegulationsOther RegulationsOther Regulations

• FDIC (1933) deposit insurance ($100,000) prevents bank panics

-- depositors won’t withdraw $ creates moral hazard

-- banks, depositors less careful

• FDIC (1933) deposit insurance ($100,000) prevents bank panics

-- depositors won’t withdraw $ creates moral hazard

-- banks, depositors less careful

• Capital Requirements ratio capital to assets cushion against investment losses since 1989, assets risk-wt.

-- low risk, low wt

-- Tbills, 0% wt.

-- high risk, high wt.

-- commercial loan, 100% wt.

• Capital Requirements ratio capital to assets cushion against investment losses since 1989, assets risk-wt.

-- low risk, low wt

-- Tbills, 0% wt.

-- high risk, high wt.

-- commercial loan, 100% wt.

III. Savings & LoansIII. Savings & LoansIII. Savings & LoansIII. Savings & Loans

• state or federal charter 1988 3500; 1998 1700

• created in 1933 to give mortgages

• state or federal charter 1988 3500; 1998 1700

• created in 1933 to give mortgages

RegulatorsRegulatorsRegulatorsRegulators

• FSLIC 1933-89, FDIC since 1989

• Office Thrift Supervision since 1989 federal

• state agencies

• Federal Reserve

• FSLIC 1933-89, FDIC since 1989

• Office Thrift Supervision since 1989 federal

• state agencies

• Federal Reserve

Balance SheetBalance SheetBalance SheetBalance Sheet

• assets (traditional) mortgages U.S. government securities

• asset choices expanded 1982 Garn-St. Germain Act

• assets (traditional) mortgages U.S. government securities

• asset choices expanded 1982 Garn-St. Germain Act

• Liabilities (traditional) savings accounts, CDs higher Regulation Q ceilings

• liabilities expanded 1980

• Liabilities (traditional) savings accounts, CDs higher Regulation Q ceilings

• liabilities expanded 1980

S&L CrisisS&L CrisisS&L CrisisS&L Crisis

• massive S&L failures in 1980s

• required taxpayer bailout to deposit insurance fund

• led to reform of industry regulation

• massive S&L failures in 1980s

• required taxpayer bailout to deposit insurance fund

• led to reform of industry regulation

Origins of problemOrigins of problemOrigins of problemOrigins of problem

• 1970s

• rising inflation leads to rising interest rates spread income disappears

• market interest rates rise above Reg. Q ceilings loss of deposits

• 1970s

• rising inflation leads to rising interest rates spread income disappears

• market interest rates rise above Reg. Q ceilings loss of deposits

DeregulationDeregulationDeregulationDeregulation

• DIDMCA 1980, Garn-St. Germain 1982

• expanded assets choices of S&Ls consumer, commercial loans corporate securities

• expanded liability choices NOW accounts, money market

accounts

• phased out Regulation Q

• DIDMCA 1980, Garn-St. Germain 1982

• expanded assets choices of S&Ls consumer, commercial loans corporate securities

• expanded liability choices NOW accounts, money market

accounts

• phased out Regulation Q

Continuing problemsContinuing problemsContinuing problemsContinuing problems

• does not solve interest rate problem

• regulators do not close insolvent S&Ls increase in fraud, risk taking

• does not solve interest rate problem

• regulators do not close insolvent S&Ls increase in fraud, risk taking

S&L Bailout 1989, 1991S&L Bailout 1989, 1991S&L Bailout 1989, 1991S&L Bailout 1989, 1991

• federal money to liquidate failed S&Ls and pay depositors

• created OTS

• FDIC takes over FSLIC risk-based FDIC premiums more power to close banks

• re-restricted S&L assets choices

• federal money to liquidate failed S&Ls and pay depositors

• created OTS

• FDIC takes over FSLIC risk-based FDIC premiums more power to close banks

• re-restricted S&L assets choices

IV. Credit UnionsIV. Credit UnionsIV. Credit UnionsIV. Credit Unions

• members must have “common bond”

• nonprofit, member owned

• 10,000 (but small in total assets)

• federal or state charter

• own deposit insurance fund

• members must have “common bond”

• nonprofit, member owned

• 10,000 (but small in total assets)

• federal or state charter

• own deposit insurance fund

Balance SheetBalance SheetBalance SheetBalance Sheet

• assets consumer loans mortgages U.S. gov’t securities

• liabilities member deposits

• assets consumer loans mortgages U.S. gov’t securities

• liabilities member deposits