Chapter 3 – Depository Institutions

1. Chapter 3 – Depository Institutions BA 543 Financial Markets and Institutions

2. Chapter 3 – Depository Institutions • Types • Commercial Banks (Check-writing Institutions) • Savings and Loans (NOW accounts) • Savings Banks (NOW accounts) • Credit Units (Share Draft accounts) • Basic Business • Receive Deposits (Funds Borrowed from Customers) – Demand Deposits • Charge Fees for Services • Invest: Loans to Customers or Securities • Provide Conveniences (Checking or NOW Accounts)

3. Chapter 3 – Depository Institutions • Commercial Banks • Two major Types • Banking Act of 1863 established National Banks • Office of the Comptroller of Currency Regulation Authority • National Banks – Federal Charter and must be insured by Bank Insurance Fund or BIF (administered by FDIC) • State Banks – State Chartered each State Regulates • State Banks may elect to join Federal System and if they do must insure with BIF (about 15% elect to join) • Federal Reserve Act of 1913 - Established Federal Reserve System • Today about 7,100 FDIC insured or supervised • http://www.federalreserve.gov/releases/lbr/current/default.htm • http://www.fdic.gov/bank/statistical

4. Chapter 3 – Depository Institutions • Savings and Loan Association • Assets – Traditionally Mortgages and Mortgage Backed Securities • Liabilities (Funding) – Passbook Savings • Today NOW accounts • Regulation • Originally - Home Owners Loan Act of 1933 • Now – Federal S&Ls by Office of Thrift Supervisor • S&L Crisis of the 1980s - Disintermediation

5. Chapter 3 – Depository Institutions • Savings Banks • Similar to S&Ls • Broader Assets and so they weathered the interest changes of the 80s • Credit Unions • Common Bond among members • Cooperative or Mutual – No Corporate Stock • Numbers bigger than commercial banks but total assets very small compared to commercial banks • Typically strong local player in banking

6. Chapter 3 – Depository Institutions • Bank Funding • Demand Deposits – Checking and Savings • Regional Banks rely primarily on demand deposits • Time Deposits – Certificates of Deposit • Borrowed Funds – Fed Window (Bank of last resort) • Selling of Securities • Short Term Notes, Bonds, Repos, etc. • Money Center Banks rely on this form of funding • Reserve Requirement – More Later

7. Chapter 3 – Depository Institutions • Income Generation • Individual Banking – charges for services • Fees for checking, mortgage origination, credit cards, trusts, etc. • Spread on consumer loans • Institutional Banking –charges for services • Commercial and Real Estate Financing, Leasing, Factoring Accounts Receivable, etc. • Global Banking • Bond Dealers, Currency Dealers, Banker’s Acceptance, Letters of Credit, etc. • Financial Products such as SWAPS

8. Chapter 3 – Depository Institutions • Asset/Liability Problem • Credit (Default) Risk • Loans are not fully backed by assets • Defaults on personal loans • Regulatory Risk • Rule changes adversely impact income of bank • Interest Rate Risk – Example • Borrow $1 million for 1 year at 5% • Buy $1 million Five year Zero Coupon Bond at 7% • Interest rates raise to 8% in year two • Liquidity Issues • Ways to pay off demand deposits

9. Chapter 3 – Depository Institutions • Capital Requirements • Very Low Equity Stake • Equity Stake is the “risk” position of owners • Tier One and Tier Two • Different types of Equity Holdings • Risk Weights of Assets • TABLE 3-3 Page 50 • Arrived at on no particular scientific basis • Basle Committee on Banking Regulations and Supervisory Practices 1988 (G-10 Countries)

10. Chapter 3 – Depository Institutions • Regulations • McFadden Act 1927 – States Right to Set Rules for Banking – Unit Banking States, Branches Allowed or Not Allowed • Banking Act 1933 - Glass-Steagall (Sections 16, 20, 21, and 32) Separate Investment Banking and Commercial Banking - WHY? • Garn-St. Germain Act 1982 – NOW Accounts • Interstate Banking and Branching Act – 1994 • Gramm-Leach-Bliley Act 1999