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Commercial Banking

Commercial Banking. Banks’ Balance Sheet Bank Management Off-Balance-Sheet Activities Banks’ Income Statement Banks’ Regulations. Ten Largest U.S. Banks . Ten Largest Banks in the World. Uniform Bank Performance Report (UBPR).

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Commercial Banking

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  1. Commercial Banking • Banks’ Balance Sheet • Bank Management • Off-Balance-Sheet Activities • Banks’ Income Statement • Banks’ Regulations

  2. Ten Largest U.S. Banks

  3. Ten Largest Banks in the World

  4. Uniform Bank Performance Report (UBPR) • A comprehensive analytical too created by the FDIC on a quarterly report requirement • Contain banks’ profitability and risk information in a consistent and uniformed basis • To obtain information: http://www2.fdic.gov/ubpr and then follow instruction

  5. The Bank Balance Sheet

  6. Assets – Uses of Funds • Reserves • Cash Items in Process of Collection • A check written on an account at another bank is deposited in bank A and the funds for this check have not yet been received from the other bank. • Deposits at Other Banks • Securities – debt securities only • US government and agency securities • State and local gov. (municipal) securities • Others (investment-grade securities) • Bank Loans

  7. Alternative types of loans • Commercial loans • business borrowing • Temporary working capital need (prime rate) – credit line • Long-term uses, e.g., equipment purchases, plant expansion • Consumer Loans • Non-mortgage loans to consumers • Installment loans (purchase of cars and household products) • Credit card loans (interest rate is quite high) • Real Estate Loans • Agriculture Loans • Short term

  8. Liabilities and Equity – Sources of Funds • Checkable Deposits • non-interest-bearing checking accounts (demand deposits) • interest-bearing NOW (negotiable order of withdrawal) • money market deposit account (MMDAs) • Nontransaction Deposits • Saving Accounts • Time Deposits: small-denomination & large-denomination • Borrowing • discount loan and other borrowings • Bank Capital

  9. Bank Management 1. Liquidity management 2. Asset management A. Managing credit risk B. Managing interest-rate risk 3. Liability management 4. Managing capital adequacy

  10. Liquidity Management • Reserve requirement = 10%, Excess reserves = $10 million • Assets Liabilities • Reserves $20 million Deposits $100 million • Loans $80 million Bank Capital $ 10 million • Securities $10 million

  11. Liquidity Management • Deposit outflow of $10 million • Assets Liabilities • Reserves $10 million Deposits $ 90 million • Loans $80 million Bank Capital $ 10 million • Securities $10 million • With 10% reserve requirement, bank still has excess reserves of $1 million: no changesneeded in balance sheet

  12. Liquidity Management • No excess reserves • Assets Liabilities • Reserves $10 million Deposits $100 million • Loans $90 million Bank Capital $ 10 million • Securities $10 million • Deposit outflow of $ 10 million • Assets Liabilities • Reserves $ 0 million Deposits $ 90 million • Loans $90 million Bank Capital $ 10 million • Securities $10 million • With 10% reserve requirement, it has $9 million reserve shortfall

  13. Liquidity Management • 1. Borrow from other banks or corporations • Assets Liabilities • Reserves $ 9 million Deposits $ 90 million • Loans $90 million Borrowings $ 9 million • Securities $10 million Bank Capital $ 10 million • 2. Sell securities • Assets Liabilities • Reserves $ 9 million Deposits $ 90 million • Loans $ 90 million Bank Capital $ 10 million • Securities $ 1 million

  14. Liquidity Management • 3. Borrow from Fed Assets Liabilities Reserves $ 9 million Deposits $90 million Loans $90 million Discount Loans $ 9 million Securities $10 million Bank Capital $10 million • 4. Call in or sell off loans Assets Liabilities Reserves $ 9 million Deposits $ 90 million Loans $81 million Bank Capital $ 10 million Securities $10 million • Conclusion: excess reserves are insurance against • above 4 costs from deposit outflows

  15. Asset and Liability Management • Asset Management 1. Get borrowers with low default risk, paying high interest rates 2. Buy securities with high return, low risk 3. Diversify 4. Manage liquidity • Liability Management 1. Important since 1960s 2. No longer primarily depend on checkable deposits, more on other borrowing 3. When see loan opportunities, borrow or issue CDs to acquire funds (first developed in 1961)

  16. Capital Adequacy Management 1. Bank capital is a cushion that prevents bank failure 2. Higher is bank capital, lower is return on equity ROA = Net Profits/Assets ROE = Net Profits/Equity Capital EM = Assets/Equity Capital ROE = ROA x EM (EM is equity multiplier) Capital , EM, ROE 3. Tradeoff between safety (high capital) and ROE 4. Banks also hold capital to meet capital requirements 5. Strategies for Managing Capital: A. Sell or retire stock B. Change dividends to change retained earnings C. Change asset growth

  17. Off-Balance-Sheet Activities • Involve trading financial instruments and generating income from fees and loan sales, activities that affect bank profits but do not appear on bank balance sheet • For example, hedging with financial derivatives are off-balance-sheet activities. They are used to reduce Fis’ risk exposures, but they all involve risks.

  18. Off-Balance-Sheet Activities • Loan Sales • Fee income from A. Foreign exchange trades for customers B. Servicing mortgage-backed securities C. Guarantees of debt D. Backup lines of credit • 2. Financial futures and options • 3. Foreign exchange trading • 4. Interest rate swaps

  19. Banks' Income Statement

  20. Banks’ Income Statement • Operating Income • interest income • non-interest income • Operating Expenses • interest expenses • non-interest expenses • provisions for loan losses

  21. Income Statement • Net Operating Income: Difference between Operating Income and Operating Expenses • Gains/losses on Securities • Gains/lossesExtraordinary Items: events or transactions that are unusual and infrequent • Income taxes: profit after tax

  22. Measures of Bank Performance • ROA = Net Profits/ Assets • ROE = Net Profits/ Equity Capital • NIM = [Interest Income - Interest Expenses]/ Assets

  23. Bank Regulation • Regulatory Structure • A charter from state/federal gov is needed for open a commercial bank • State bank – having state charter, regulated by state agency • National bank – having federal charter • Regulated by the office of Comptroller of Currency (issue charter) • FDIC • Federal Reserve

  24. Branching Regulations • Branching Restrictions: • Anticompetitive • Response to Branching Restrictions • 1. Bank Holding Companies A. Allowed purchases of banks outside state B. BHCs allowed wider scope of activities by Fed C. BHCs dominant form of corporate structure for banks • 2. Nonbank Banks Not subject to branching regulations, but loophole closed in 1987 • 3. Automated Teller Machines Not considered to be branch of bank, so networks allowed

  25. Bank Consolidation and Number of Banks

  26. Nationwide Banking and Bank Consolidation • Bank Consolidation: Why? • 1. Branching restrictions weakened • 2. Development of superregional banks • Riegle-Neal Act of 1994 • 1. Allows full interstate branching • 2. Promotes further consolidation • Future of Industry Structure • Will become more like other countries, but not quite: • Several thousand, not several hundred

  27. Separation of Banking and Securities Industries: Glass-Steagall • Case for Glass-Steagall • 1. FDIC gives unfair advantage to banks • 2. Allowing banks into underwriting is dangerous because FDIC promotes too much risk taking • 3. Potential conflicts of interest • Case Against Glass-Steagall • 1. Decreases competition • 2. Unfair to banks • 3. Hinders diversification • Will Separation Continue? • No, Gramm-Leach-Bliley Financial Service Modernization Act of 1999 • 1) allow banks to underwrite insurance and securities and engage in real estate • 2) allows securities firms and insurance companies to purchase banks

  28. Separation of Banking and Securities Industries: Glass-Steagall • Separation in Other Countries 1. Universal banking: Germany 2. British-style universal banking 3. U.S./Japan separation

  29. Other Depositary Institutions • Thrifts (or thrift institutions) • Mutual saving banks: depositors are owners of firms • S&Ls (saving and loan Associations): getting deposits and make long-term mortgage loans • Credit unions: financial institutions that focus on servicing the banking and lending needs of its members

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