Banking Industry Number of banks ~7,000 decreasing (result of consolidation, deregulation and failures) Number of branches ~90,000 (result of relaxed geographical restrictions, but now peaking out) About 4,000 are small banks (< $100 million in assets) The large banks in our economy have gotten that way by mergers and acquisitions.

Banks vs. Branches (1920-2010)

Commercial Bank Sector Balance Sheet Uses of Funds Sources of Funds (Assets) (Liabilities + Capital) Cash Assets (8%) Deposit Liabilities (69%) FF sold/Rev repos (4%) Borrowed Funds (16%) Investments (19%) Other Liabilities (3%) Loans & Leases (55%) Subordinated Notes & Deben (1%) Premises (1%) Capital Accounts (11%) Other (13%) (See pp. 411 & 417)

First Three Items on Left Cash Assets (8%): Vault cash (physical currency) Reserves at the Fed Fed Funds Sold/Rev repos (4%): Fed Funds sold Reverse Repurchase Agreements Investments (19%): cushion in case need more liquidity U.S. Treasury securities Agency securities Municipal bonds

Fourth Item on Left Loans and Leases (55%): where banks make their money Loans commercial and industrial real estate agricultural consumer Leases fast-growing line of business for the big banks fleet assets (aircraft, ships,..), rolling stock (railroad cars, trucks,..), equipment (cranes, generators,..)

First Two Items on Right Deposit Liabilities (69%): Transaction Deposits Savings Deposits Time Deposits (retail and negotiable CDs) Borrowed Funds (16%): Fed Funds purchased Repurchase Agreements Eurodollars (dollars borrowed abroad) Discount Window loans

Last Two Items on Right Subordinated Notes and Debentures (1%) Subordinated to claims of depositors Capital Accounts (11%) Paid-in capital (from sale of stock) Retained earnings

Capital Adequacy Capital adequacy ratio: Numerator is Subordinated Notes & Debentures + Paid-in capital + Retained earnings Denominator is a weighted average of assets Riskfree, weight of 0.0 Very risky assets like CDOs, weight of 1.0 Everything else, weight in between

Five ‘C’s of Credit Five “C”s of Credit: Character (willingness to pay) Capacity (cash flow) Capital (wealth or net worth) Collateral (security for the loan) Conditions (economic conditions)

Base Rate Pricing Markups to base rate include adjustments for default risk, term-to-maturity, and competitive factors. rL = BR + DR + TM + CF In this way, business loans can vary from customer to customer. BR could be prime rate, Libor, or a T-bill rate. Loan pricing is one of most important managerial decisions in banking.

Things for Final Last third of course: 5 Cs 3 base rate adjustments What TIPS stands for 6 types of MM instruments Names of 3 ratings agencies Latest National Debt and Social Security Trust fund figures 14 + 5 trillion = 19 trillion 2.8 trillion Other numbers: 3.8 trillion 500 billion (approx) Know meaning of the word “notional” as regards CDSs Know about Commodity Futures Modernization Act (2000) Questions end Dec 7 midnight.