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Financial Markets and Institutions 6th Edition PowerPoint Slides for: By Jeff Madura Prepared by David R. Durst The University of Akron.

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Presentation on theme: "Financial Markets and Institutions 6th Edition PowerPoint Slides for: By Jeff Madura Prepared by David R. Durst The University of Akron."— Presentation transcript:

1 Financial Markets and Institutions 6th Edition PowerPoint Slides for: By Jeff Madura Prepared by David R. Durst The University of Akron

2 CHAPTER 17 Commercial Bank Operations

3 Copyright© 2002 Thomson Publishing. All rights reserved. Chapter Objectives n Describe the most common sources of funds for commercial banks n Describe the most common uses of funds for commercial banks n Describe typical off-balance sheet activities for commercial banks

4 Copyright© 2002 Thomson Publishing. All rights reserved. Bank Participation in Financial Conglomerates n Impact of the Financial Services Modernization Act (1999) l Prompted by the Citicorp-Travelers merger l Banks and other financial service firms were given more freedom to merge and offer a range of financial services u Insurance u Securities services n Banks now a subsidiary of financial conglomerates

5 Copyright© 2002 Thomson Publishing. All rights reserved. Bank Participation in Financial Conglomerates n Benefits of diversified services to individuals and firms l Individuals can obtain all their financial services at a single financial conglomerate u Deposits u Loans u Investing (brokerage) u Insurance l Businesses can obtain loans, issue stocks and bonds, and have their pension fund managed by the same institution

6 Copyright© 2002 Thomson Publishing. All rights reserved. Bank Participation in Financial Conglomerates n Benefits of diversified services to the financial institution l Reduce reliance on demand for single service l Economies of scale and scope l Diversification (service and geographical) may result in less risk l Generate new business

7 Copyright© 2002 Thomson Publishing. All rights reserved. Bank Sources of Funds n Transaction deposits l Demand deposit account (checking) l Negotiable order of withdrawal (NOW) account u 1981 u Requires larger minimum balance n Savings Deposits l Passbook savings l Regulation Q until 1986

8 Copyright© 2002 Thomson Publishing. All rights reserved. Bank Sources of Funds n Time Deposits l Certificate of deposit (CD) u No secondary market l Negotiable CD u Short-term, minimum $100,000 u Can trade among investors via dealer n Money Market Deposit Accounts (MMDAs) l More liquid than CDs : no specified maturity l Limited check writing l Created in 1982

9 Copyright© 2002 Thomson Publishing. All rights reserved. Bank Sources of Funds n Federal Funds Purchased l Short-term loans between banks l Allows banks to meet reserve requirement or funding needs l Interest rate charged is the federal funds rate n Borrowing from the Federal Reserve Banks l Borrowing at the discount window l Discount rate l Intended for meeting temporary short-term reserve requirement needs l Must get Fed approval

10 Copyright© 2002 Thomson Publishing. All rights reserved. Bank Sources of Funds n Repurchase agreements l Sale of securities by one party to another with an agreement to repurchase the securities at a specified date and price l Banks may sell T-bills to a corporation with temporary excess cash (bank demand deposit) and then buy them back later l Source of funds for a few days l Collateralized by the treasury bills l Form of paying interest on large customer checking balances

11 Copyright© 2002 Thomson Publishing. All rights reserved. Bank Sources of Funds n Eurodollar borrowings l Banks outside the United States make dollar- denominated loans l Eurodollar market is very large n Bonds issued by the bank l Like other businesses, banks issue bonds to finance long-term fixed assets l Usually subordinated to deposits l Part of secondary regulatory capital

12 Copyright© 2002 Thomson Publishing. All rights reserved. Bank Sources of Funds n Bank capital l Obtained from issuing stock or retaining earnings l No obligation to pay out funds in the future l Primary vs. secondary l Must be sufficient to absorb operating losses l As of 1992: risk-based capital requirement

13 Copyright© 2002 Thomson Publishing. All rights reserved. Uses of Funds by Banks n Loans make up about 64 percent of bank assets, while all securities make up about 22 percent of assets. Cash represents 6 percent of bank assets. n Cash and due from balances at institutions l Currency/coin provided via banks l Reserve requirements imposed by Fed u Tool for controlling the money supply u Due from Fed and vault cash count as reserves l Also hold cash and due from balances to maintain liquidity and accommodate withdrawal requests by depositors

14 Copyright© 2002 Thomson Publishing. All rights reserved. Uses of Funds by Banks n Bank Loans l Types of business loans u Working capital loans u Term loans n Purchasing fixed assets n Protective covenants u Informal line of credit u Revolving credit loan

15 Copyright© 2002 Thomson Publishing. All rights reserved. Uses of Funds by Banks n Bank Loans l Loan participations u Sometimes large firms seek to borrow more money than an individual bank can provide u Lead bank l Loans supporting leveraged buyouts u Banks charge a high loan rate u Monitored by bank regulators

16 Copyright© 2002 Thomson Publishing. All rights reserved. Uses of Funds by Banks n Bank Loans l Collateral requirements on business loans u Increasingly accepting intangible assets u Important to service-oriented firms u Increased lending risk with service businesses--telecomm l Lender liability on business loans u Lender liability lawsuitstoxic dump under corner business l Types of consumer loans u Installment loans u Credit cards l Real estate loans

17 Copyright© 2002 Thomson Publishing. All rights reserved. Uses of Funds by Banks n Investment securities (bank income and liquidity) l Treasury securities l Government agency securities u Freddie Mac u Fannie Mae l Corporate and municipal securities u Investment grade only n Federal funds sold l Lending funds in the federal funds market

18 Copyright© 2002 Thomson Publishing. All rights reserved. Uses of Funds by Banks n Repurchase agreements n Eurodollar loans l Branches of U.S. banks located outside of the U.S. l Foreign-owned banks n Fixed assets l Office buildings l Land

19 Copyright© 2002 Thomson Publishing. All rights reserved. Off-Balance Sheet Activities n Loan commitments l Obligation of bank to provide a specified loan amount to a particular business upon request l Note issuance facility (NIF) l Banks earn fee income for risk assumed n Standby letters of credit (SLC) l Backs a customers obligation to a third party l Banks earn fee income

20 Copyright© 2002 Thomson Publishing. All rights reserved. Off-Balance Sheet Activities n Forward contracts l Agreement between a customer and bank to exchange one currency for another on a particular future date at a specified exchange rate l Allows customers to hedge their exchange-rate risk

21 Copyright© 2002 Thomson Publishing. All rights reserved. Off-Balance Sheet Activities n Swap contracts l Two parties agree to periodically exchange interest payments on a specified notional amount of principal l Banks serve as intermediaries or dealer and/or guarantor for a fee


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