Depository Institutions

1. Depository Institutions

2. Depository Institutions Include: • Institutions which take deposits • Deposits represent Liabilities (debt) for DI’s Include: • Banks • Savings & Loan institutions • Savings Banks • Credit Unions

3. Asset/liability problem of Depository institutions • A depository institution seeks to earn a positive spread between the assets it in invests in (loans and securities) and the costs of funds(deposits and other sources)

4. How do DI’s make money? • 3 ways: • Loans • Make direct loans to entities • Securities investments • Investing in securities & holding portfolios • Fees • Charged to their customers

5. Asset/liability problem of Depository institutions • Risks faced by the depository institutions • Credit risk-default risk that the borrower will default on his loan obligation or that the issuer of the security that the depository institution holds defaults on its obligation. • Regulatory risk-regulators will change the rules so as to impact the earnings of the institution unfavorably

6. Asset/liability problem of Depository institutions • Funding risk • Illustration • Suppose that the depository institution raises $100 million by issuing a deposit account that has a maturity of one year and by agreeing to pay 7% interest • Suppose that $100 million is invested in a government security that matures in 15 years , paying an interest rate of 9%

7. Asset/liability problem of Depository institutions • If interest rates declines, the spread will increase • If Interest rates rise What position should you have? • If interest rates fall What position should you have?

8. Asset/liability problem of Depository institutions • When interest rates are expected to decline, depository institutions borrow short and lent long • When interest rates are expected to rise, depository institutions borrow long and lent short

9. Asset-Liability Problem of DI’s? • Threats of positioning: • Adverse financial consequences • If expectations are not realized, Huge losses can occur • No one can predict interest rates consistently • Highly risky? • Becomes same as gambling • Long run losses highly likely?

10. Liquidity concerns • A depository institution must be prepared to satisfy withdrawals of funds by depositors and to provide loans to customers • 4 ways to solve liquidity issues? • Attract additional deposits • Borrowing from the federal agency or other financial institutions • Sell securities that it owns • Raise short term funds in the money market

11. Commercial Banks • 5 largest banks of Pakistan

12. Commercial Banks • Bank services: • Individual banking • Institutional banking • Global banking- • Corporate financing • Capital market products • Foreign exchange products and services

13. Bank Funding • Three sources of funds for banks: • Deposits • Non deposit borrowing • Common stocks and retained earnings

14. Bank Funding • Deposits • Demand deposits • Savings deposits • Time deposits

15. Bank Funding • Reserve requirements and borrowing in the federal funds market • All banks must maintain a specified percentage of their deposits in a non- interest bearing account at the State bank. • Reserve ratio • Required reserve

16. Bank Funding • Excess reserves- when actual reserves exceed required reserves. • Banks temporarily short of funds can borrow reserves from banks that have excess reserves. • The market where banks can borrow or lend reserves is called the federal funds market. • The interest rate that is charged to borrow funds in this market is called the federal funds rate.

17. Bank Funding • Borrowing at the Fed discount window: • Banks temporarily short of funds can borrow from the Fed at its discount window • Collateral is necessary to borrow • Discount rate- the interest rate that the Fed charges to borrow funds at the discount window • Borrowing from the Fed is done basically to meet short term liquidity needs

18. Bank Funding • Other non deposit borrowing • Issuing obligations in the money market, or intermediate to long term in the form of issuing securities in the bond market.

19. Regulation • Ceilings imposed on the interest rates that can be paid on deposit accounts • Geographical restrictions on branch banking • Permissible activities for commercial banks • Capital requirements for commercial banks

20. Savings and loan Associations • Provision of funds for financing of a home. • The collateral for the loans would be the home being financed • Mutually owned or corporate stock ownership

21. Savings and loan Associations • Assets: • Traditionally, the only assets in which S&L’s were allowed to invest have been mortgages, and government securities. • Problem: • Maturity matching problem

22. Savings and loan Associations • Other investments: • Consumer loans( loans for home improvement , automobiles, education , business or credit cards) • Non consumer loans ( commercial , corporate , business or agriculture loans) • Junk bonds • Investment in short term assets for operational or regulatory purposes.

23. Savings and loan Associations • Funding: • Savings and time deposits • Negotiable order of withdrawal (NOW) accounts • Money market deposit accounts (MMDA)

24. The S&L Crisis

25. Credit unions • “Common bond” requirement for credit union membership • No corporate ownership • Purpose: • Serve member’s saving and borrowing needs • Credit unions are owned by their members, member deposits are called shares.