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Chapter. 2. The Financial Services Industry: Depository Institutions. Overview of Depository Institutions. In this segment, we explore the depository FIs: Size, structure and composition Balance sheets and recent trends Regulation of depository institutions

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  1. Chapter 2 The Financial Services Industry: Depository Institutions

  2. Overview of Depository Institutions • In this segment, we explore the depository FIs: • Size, structure and composition • Balance sheets and recent trends • Regulation of depository institutions • Depository institutions performance

  3. Products of U.S. FIs • Comparing the products of FIs in 1950, to products of FIs in 2000: • Much greater distinction between types of FIs in terms of products in 1950 than in 2000 • Blurring of product lines and services over time • Wider array of services offered by all FI types • Refer to Tables 2-1A and 2-1B in the text

  4. Size of Depository FIs • Consolidation has created some very large FIs • Combined effects of disintermediation, global competition, regulatory changes, technological developments, competition across different types of FIs

  5. Largest Depository Institutions, 2000 by total assets (billions) Citigroup $804.3 J.P. Morgan Chase 707.5 BankAmerica 671.7 Banc One 283.4 First Union 246.6 Wells Fargo 241.1 Washington Mutual 190.8 Fleet Boston 179.1 SunTrust Banks 100.6 HSBC 87.1

  6. Depository Institutions • Commercial Banks • Largest depository institutions are commercial banks. • Differences in operating characteristics and profitability across size classes. • Notable differences in ROE and ROA as well as the spread • Thrifts • S&Ls • Savings Banks • Credit Unions

  7. Functions and Structural Differences • Functions of depository institutions • Regulatory sources of differences across types of depository institutions. • Structural changes generally resulted from changes in regulatory policy. • Example: changes permitting interstate branching • Reigle-Neal Act

  8. Commercial Banks • Primary assets: • Real Estate Loans: $1,670.3 billion • C&I loans: $1,048.2 billion • Loans to individuals: $609.7 billion • Other loans: $367.5 billion • Investment security portfolio: $1,662.0 billion • Of which, Treasury bonds: $710.0 billion • Inference: Importance of Credit Risk

  9. Commercial Banks • Primary liabilities: • Deposits: $4,176.6 billion • Borrowings: $1,532.5 billion • Other liabilities: $401.0 billion • Inference: • Highly leveraged

  10. Small Banks, Nation

  11. Large Banks, Nation

  12. Structure and Composition • Shrinking number of banks: • 14,416 commercial banks in 1985 • 12,744 in 1989 • 8,315 in 2000 • Mostly the result of Mergers and Acquisitions • M&A prevented prior to 1980s, 1990s • Consolidation has reduced asset share of small banks

  13. Structure and Composition of Commercial Banks • Financial Services Modernization Act 1999 • Allowed full authority to enter investment banking (and insurance) • Limited powers to underwrite corporate securities have existed only since 1987

  14. Composition of Commercial Banking Sector • Community banks • Regional and Super-regional • Access to federal funds market to finance their lending activities • Money Center banks • Bank of New York, Bank One, Bankers Trust, Citigroup, J.P. Morgan/Chase, HSBC Bank USA • declining in number

  15. Balance Sheet and Trends • Business loans have declined in importance • Offsetting increase in securities and mortgages • Increased importance of funding via commercial paper market • Securitization of mortgage loans

  16. Some Terminology • Transaction accounts • Negotiable Order of Withdrawal (NOW) accounts • Money Market Mutual Fund • Negotiable CDs: Fixed-maturity interest bearing deposits with face values over $100,000 that can be resold in the secondary market.

  17. Off-balance sheet activities • Heightened importance of off-balance sheet items • Large increase in derivatives positions is a major issue • Standby letters of credit • Loan commitments • When-issued securities • Loans sold

  18. Other Fee-generating Activities • Trust services • Correspondent banking • Check clearing • Foreign exchange trading • Hedging • Participation in large loan and security issuances • Payment usually in terms of noninterest bearing deposits

  19. Key Regulatory Agencies • FDIC (BIF and SAIF) • OCC: Primary function is to charter national banks. • FRS: monetary policy, lender of last resort. • National banks are automatically members of the FRS. State-chartered banks can elect to become members. • State bank regulators • Dual Banking System: Coexistence of nationally and state-chartered banks.

  20. Web Resources • For more detailed information on the regulators, visit: http://www.fdic.gov http://www.occ.treas.gov http://federalreserve.gov Web Surf

  21. Other Regulatory Issues • Importance of Bank Holding Companies is increasing. • BHCs regulated by FRS.

  22. Key Regulatory Legislation • 1927 McFadden Act: Controls branching of national banks. • 1933 Glass-Steagall: separates securities and banking activities. • 1956 Bank Holding Company Act and subsequent amendments specifies permissible activities and regulation by FRS of BHCs.

  23. Legislation (continued)... • 1970 Amendments to the Bank Holding Company Act: Extension to one-bank holding companies • 1970 International Banking Act: Regulated foreign bank branches and agencies in USA

  24. Legislation (continued) • 1980 DIDMCA and 1982 DIA (Garn-St. Germain Depository Institutions Act) • Mainly deregulation acts. • Phased out Regulation Q. • 1987 Competitive Equality in Banking Act (CEBA) • Redefined bank to limit growth of nonbank banks.

  25. Legislation (continued) • 1989 FIRREA • Imposed restrictions on investment activities • Replaced FSLIC with FDIC-SAIF • Replaced FHLB with Office of Thrift Supervision • Created Resolution Trust Corporation

  26. Legislation (continued) • 1991 FDIC Improvement Act • Introduced Prompt Corrective Action • Risk-based deposit insurance premiums • Limited “too big to fail”

  27. Legislation (continued) • 1994 Riegle-Neal Interstate Banking and Branching Efficiency Act • Permits BHCs to acquire banks in other states. • Invalidates some restrictive state laws. • Permits BHCs to convert out-of-state subsidiary banks to branches of single interstate bank. • Newly chartered branches permitted interstate if allowed by state law.

  28. 1999 Financial Services Modernization Act • Financial Services Modernization Act • Allowed banks, insurance companies, and securities firms to enter each others’ business areas • Provided for state regulation of insurance • Streamlined regulation of BHCs • Prohibited FDIC assistance to affiliates and subsidiaries of banks and savings institutions • Provided for national treatment of foreign banks

  29. Industry Performance • Economic expansion and falling interest rates through 1990s • Commercial banks record earnings of $71.6 billion • Downturn in early 2000s • Reduction in performance • Increased provision for loan losses • Only 6 failures in 2000 versus 206 in 1989 • Technology risks remain

  30. Savings Institutions • Comprised of: • Savings and Loans Associations • Savings Banks • Effects of changes in Federal Reserve’s policy of interest rate targeting combined with Regulation Q and disintermediation. • Effects of moral hazard and regulator forbearance. • Qualified Thrift Lender (QTL) test.

  31. Savings Institutions: Recent Trends • Industry is smaller overall • Intense competition from other FIs • mortgages for example • Concern for future viability

  32. Primary Regulators • Office of Thrift Supervision (OTS). • Charters and examines all federal S&Ls. • FDIC-SAIF Fund. • Oversees and manages Savings Association Insurance Fund (SAIF).

  33. Web Resources • For more information on the regulation of savings institutions, visit: Treasury www.ots.treas.gov FDIC www.fdic.gov Web Surf

  34. Savings Banks • Mutual organizations • Primarily East Coast • Not exposed to the oil-based shocks of 1980s • Real estate price exposure • Demutualization • May be regulated at both state and federal level

  35. Credit Unions • Nonprofit depository institutions owned by member-depositors with a common bond. • Exempt from taxes and Community Reinvestment Act (CRA). • Expansion of services offered in order to compete with other FIs. • Approximately 2/3 federally chartered and subject to NCUA regulation.

  36. Web Resources • For information on credit unions visit: American Bankers Association www.aba.com Web Surf

  37. Global Issues • Near crisis in Japanese Banking • 19 of the biggest Japanese banks on credit watch list • European banks continued to perform well • Implications for future competitiveness

  38. Other Trends • Number of banks continues to decline. • Increase in off-balance-sheet activities. • Increase in income derived from fees-for-service rather than spread income. • Increased competition between banks and across financial services sectors. • Increased competition from foreign FIs.

  39. Pertinent Websites www.federalreserve.gov www.cuna.org www.fdic.gov www.occ.treas.gov www.ots.treas.gov www.us-banker.com Web Surf

  40. *Financial Statement Analysis • Time series analysis of key ratios • ROE framework • ROE = ROA × EM • ROA = PM × AU

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