1. Chapter Thirteen Managing Non-deposit Liabilities Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

2. Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Key Topics Customer Relationship Doctrine Liability Management Alternative Non-deposit Funds Sources Measuring the Funds Gap Choosing Among Different Funds Sources Determining the Overall Cost of Funds 13-2

3. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Customer Relationship Doctrine The first priority of the bank is to make loans to all qualified customers and if funds are not available the bank should seek out the lowest cost source of funding to meet customers’ needs. 13-3

4. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Liability Management The bank buys funds in order to satisfy loan requests and reserve requirements An interest-sensitive approach to raising bank funds The bank can decide exactly how much they need and for how long The control mechanism to regulate incoming funds is the price of funds 13-4

5. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Non-deposit Sources of Funds Federal Funds Market Repurchase Agreements Federal Reserve Bank Negotiable CDs Eurocurrency Deposit Market Commercial Paper Long Term Sources 13-5

6. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Recent Growth in Non-deposit Sources of Borrowed Funds at FDIC-Insured Institutions What are the trends? 13-6

7. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Alternative Non-deposit Sources of Funds The usage of non-deposit sources of funds has risen Larger institutions rely on the non-deposit funds market as a key source of short-term money to meet loan demand and unexpected cash emergencies 13-7

8. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Federal Funds Market Immediately Available Reserves Are Traded Between Financial Institution and Usually Returned Within 24 hours. Deposits with Correspondent Banks and Demand Deposit Balances of Security Dealers and Governments Can Be Used For Loans to Institutions. 13-8

9. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Repurchase Agreements Can be thought of as collateralized fed funds transactions; more complex; less exposure to credit risk Involves the temporary sale of high-quality assets (usually government securities) accompanied by an agreement to buy back those assets on a specific future date at a predetermined price or yield 13-9

10. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Borrowing from the Fed: The Three Types of Loans at the Discount Window Primary Credit – This Loan is Available for Short Terms and to Institutions in Sound Financial Condition. Rate is Slightly Higher than the Federal Funds Rate. Secondary Credit – These Loans are Available at a Higher Interest Rate to Institutions not Qualifying for Primary Credit. Monitored by the Federal Reserve to Control Excess Risk Seasonal Credit - These loans Cover Longer Periods Than Primary Credit for Small and Medium Institutions Experiencing Seasonal Swings in Deposits and Loans 13-10

11. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Negotiable CD An interest-bearing receipt evidencing the deposit of funds in the bank for a specified period of time for a specified interest rate. It is considered a hybrid account since it is legally a deposit 13-11

12. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Eurocurrency Deposit Market Eurodollars are dollar-denominated deposits Placed in Banks Outside the U.S. Eurocurrency Deposits Originally Were Developed in Western Europe to Provide Liquid Funds to Swap Among Institutions or Lend to Customers Labeled ‘Liabilities to Foreign Branches’ When a Foreign Branch Lends Euro-deposits to its Home Office 13-12

13. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Commercial Paper Short-Term Notes With Maturities from 3 or 4 Days to 9 Months Issued By Well-Known Companies. Two Types ▫ Industrial Paper- -Purchase Inventories ▫ Finance Paper – Issued by Finance Companies and Financial Holding Companies Banks Cannot Issue These Directly But Affiliated Companies Can Issue Them. 13-13

14. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Long-Term Non-deposit Sources of Funds Capital Notes and Debentures are Examples of Long Term Sources of Funds 13-14

15. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. The Funds Gap Gap is Based on: ▫ Current and Projected Demand and Investments the Bank Desires to Make ▫ Current and Expected Deposit Inflows and Other Available Funds Size of This Gap Determines Need for Nondeposit Funds 13-15

16. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Non-deposit Funding Sources: Factors to Consider The Relative Costs of Raising Funds From Each Source The Risk of Each Funding Source The Length of Time for Which Funds are Needed The Size of the Institution Regulations Limiting the Use of Various Funding Sources 13-16