Presentation on theme: "Functions and Forms of Banking Outline –What is a bank? –What do banks do for their customers? –Why do banks perform those services? –How do banks compare."— Presentation transcript:
Functions and Forms of Banking Outline –What is a bank? –What do banks do for their customers? –Why do banks perform those services? –How do banks compare to other financial service organizations? –What factors have affected the operations of commercial banks and other financial service organizations? –What are the principal sources and uses of funds for banks?
What is a bank? In the U.S. a “bank” is defined by federal and state laws and by bank regulators. –National Currency Act of 1863 created the OCC and said a national bank will carry out the “… business of banking.” –Bank Holding Company Act of 1956 changed the definition to accepting deposits that can be withdrawn on demand and making commercial loans. –Competitive Equality Banking Act of 1987 broadened definition to accepting deposits and making loans. –Today a legal definition is that a bank makes loans, has insured FDIC deposits, and has banking powers under state and federal government laws.
What is a bank? Types of banks: –Global, international banks or money center banks –Medium and large size banks that are full-service banks (but not universal banks as in Europe and some other foreign countries) –Small and medium size banks that are retail or consumer banks (which use correspondent banks and outsourcing) –Banks that focus on medium and large business firms or wholesale banks (which also includes limited purpose banks that are further specialized in terms of customer base)
What do banks do for their customers? Payments –These services include coin and currency and financial transactions, including checking accounts, credit cards, electronic banking (CHIPS or Clearing House Interbank Payments System), wire transfers (Fedwire), international payments (SWIFT or Society for Worldwide Interbank Financial Telecommunication), etc. –Retail payments system and large-dollar payments system for business and government
What do banks do for their customers? Financial intermediation: –Deposit function of offering savers a wide variety of denominations, interest rates, and maturities, as well as risk-free (FDIC insured) deposits and a high degree of liquidity. –Loan function of transferring or allocating savings to most productive and profitable uses to provide growth and stability of the economy. –Other financial services include off-balance sheet risk taking (from financial derivatives and guarantees), insurance-related activities, securities-related services, and trust services.
Why do banks perform those services? Banks are private firms with a public purpose. They seek to maximize shareholder wealth (represented by the market value of bank stock and dividends paid). Banking is the management of risk. By taking risks, they earn a profit. -- Credit risk-- Foreign exchange risk -- Interest rate risk-- Compliance risk -- Liquidity risk-- Strategic risk -- Price risk-- Reputation risk Various factors that affect banks include include market, social, and legal and regulatory constraints.
How do banks compare to other financial service organizations? Banks are the dominant financial institution in the U.S. based on the percentage of total assets (24%). Federally related mortgage pools are second largest (12%). Life insurance are third largest (11%). Other significant organizations include savings institutions, money market funds, mutual funds, and asset-backed security issuers. However, commercial banks shrank from 34% in 1980 to 24% in 1997.
What factors have affected the operations of commercial banks and other financial service organizations? Inflation and volatile interest rates: –Rising interest rates caused shorter-term deposit costs to rise faster than longer-term loans. Also, as rates rose, the market value of their assets declined and borrowers defaulted on loans with greater frequency than normal. Securitization: –Banks are pooling loans for various kinds and selling securities with claims on these loans. Technological advances: –Telecommunications and computers are increasing economies of scale and economies of scope for banks.
What factors have affected the operations of commercial banks and other financial service organizations? Consumers have become more sophisticated. Capital markets have increased their competition with banks in attracting firms seeking debt funds. Deregulation: –The elimination of laws that placed geographic limits on banks, their products and services, and the rates they can pay has stimulated bank mergers and consolidation in the banking industry (e.g., 14,400 banks in 1985 compared to 8,500 banks in 2000). Despecialization and competition among financial institutions with one-stop shopping centers. Global integration of financial markets is increasing competition from foreign financial service firms.
What are the principal sources and uses of funds for banks? Assets –Loans commercial and industrial (C&I) loans real estate loans consumer loans –Investments short-term, liquid securities (e.g., U.S. Treasury securities) long-term securities –Cash –Other assets buildings, equipment, etc.
What are the principal sources and uses of funds for banks? Liabilities –Deposits transactions deposits nontransactions deposits –Nondeposit sources of funds Equity –Relatively small compared to debt sources of funds. Highly leveraged compared to nonfinancial firms.