Overview of 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 2007: • Much greater distinction between types of FIs in terms of products in 1950 than in 2007 • 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. Specialness of Depository FIs • Products on both sides of the balance sheet • Loans • Business and Commercial • Deposits

5. Other outputs of depository FIs • Other products and services 1950: • Payment services, Savings products, Fiduciary services • By 2007, products and services further expanded to include: • Underwriting of debt and equity, Insurance and risk management products

6. 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

7. Largest US Depository Institutions Citigroup $1,746.2 Bank of America 1,451.6 J.P.Morgan Chase 1,338.0 Wachovia 559.9 Wells Fargo 483.4 HSBC North America 473.7 Taurus 430.4 Washington Mutual 348.9 U.S. Bancorp 216.9 Countrywide Financial 193.2 Total Assets ($Billions)

8. 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 • Mix of very large banks with very small banks

9. Functions & 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

10. Commercial Banks, December 2006 • Primary assets: • Real Estate Loans: $3,207.1 billion • C&I loans: $1,117.2 billion • Loans to individuals: $846.9 billion • Investment security portfolio: $1,632.9 billion • Of which, Treasury securities: $1,070.6 billion • Inference: Importance of Credit Risk

11. Commercial Banks • Primary liabilities: • Deposits: $6,426.5 billion • Borrowings: $2,020.7 billion • Other liabilities: $306.2 billion • Inference: • Highly leveraged

12. Small Banks, Nation

13. Large Banks, Nation

14. Structure and Composition • Shrinking number of banks: • 14,416 commercial banks in 1985 • 12,744 in 1989 • 7,450 in 2007 • Mostly the result of Mergers and Acquisitions • M&A prevented prior to 1980s, 1990s • Consolidation has reduced asset share of small banks

15. Structure & 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

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

17. 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 • Temporary effects: credit crunch during recessions of 1989-92 and 2001-02

18. 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.

19. Off-balance Sheet Activities • Heightened importance of off-balance sheet items • OBS assets • OBS liabilities • Large increase in derivatives positions is a major issue • Standby letters of credit • Loan commitments • When-issued securities

20. Trading and Other Risks • Allied Irish / Allfirst Bank • $750 million loss • National Australian Bank • $450 million loss

21. 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

22. Key Regulatory Agencies • FDIC • DIF • Role in preventing contagious runs or panics • 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.

23. Bank Regulators

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

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

26. Key Regulatory Legislation • 1927 McFadden Act: Controls branching of national banks. • 1933 Glass-Steagall: separates securities and banking activities, established FDIC, prohibited interest on demand deposits. • 1956 Bank Holding Company Act and subsequent amendments specifies permissible activities and regulation by FRS of BHCs.

27. Legislation (continued)... • 1970 Amendments to the Bank Holding Company Act: Extension to one-bank holding companies • 1978 International Banking Act: Regulated foreign bank branches and agencies in USA

28. Legislation (continued) • 1980 DIDMCA and 1982 DIA (Garn-St. Germain Depository Institutions Act) • Mainly deregulation acts. • Phased out Regulation Q. • Authorized NOW accounts nationwide • Increased deposit insurance from $40,000 to $100,000 • Reaffirmed limitations on bank powers to underwrite and distribute insurance products.

29. Legislation (continued) • 1987 Competitive Equality in Banking Act (CEBA) • Redefined bank to limit growth of nonbank banks. • 1989 FIRREA • Imposed restrictions on investment activities • Replaced FSLIC with FDIC-SAIF • Replaced FHLB with Office of Thrift Supervision • Created Resolution Trust Corporation

30. Legislation (continued) • 1991 FDIC Improvement Act • Introduced Prompt Corrective Action • Risk-based deposit insurance premiums • Limited “too big to fail” • Extended federal regulation over foreign bank branches and agencies

31. 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.

32. 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

33. Recent Legislative Changes • USA Patriot Act of 2001 • Sarbanes-Oxley Act of 2002

34. Industry Performance • Economic expansion and falling interest rates through 1990s • Brief downturn in early 2000 followed by strong performance improvements • Record earnings $106.3 billion 2003 • Only 2 failures in 2006 versus 206 in 1989 • Performance remained strong through mid 2000s as interest rates rose

35. Banking and Ethics • Bank of America and Fleet Boston Financial 2004 • J.P. Morgan Chase and Citigroup 2003 role in Enron • Riggs National Bank and money laundering concerns 2003, 2004 • Effects of entry into internet banking services

36. 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.

37. Savings Institutions: Recent Trends • Industry is smaller overall • Intense competition from other FIs • mortgages for example

38. Primary Regulators • Office of Thrift Supervision (OTS). • Charters and examines all federal S&Ls. • FDIC-DIF Fund. • FDIC Oversaw and managed Savings Association Insurance Fund (SAIF). • SAIF and BIF merged in January 2007 to form DIF • Same regulatory structure applied to commercial banks

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

40. 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

41. 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. • Claim of unfair advantage of CUs over small commercial banks • 2006: 66.4 percent of CUs federally chartered and regulated by NCUA

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

43. Global Issues • Narrowing margins and flattening yield curves • Mortgages dominating retail growth • Personal bankruptcies rising • Near crisis in Japanese Banking • China • Deterioration in early 2000s, NPLs at 50% levels • Opening to foreign banks (WTO entry) slow

44. Pertinent Websites American Bankers Association www.aba.com Federal Reserve www.federalreserve.gov Credit Union National Association www.cuna.org FDIC www.fdic.gov National Credit Union Administration www.ncua.gov Office of Comptroller of the Currency www.occ.treas.gov Office of Thrift Supervision www.ots.treas.gov

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