Banking in the U. S. I. Structures II. Management ECO 473 Dr. D. Foster

I. Banking Structure in the U. S.

Institutions . . . Commercial Banks Savings Institutions Credit Unions “Money Center” banks Regional (& Super-) banks Community Banks Savings Institutions Lost 50% of deposits 1989 - 2001 1980s - Congress relaxes lending rules Credit Unions 1934-strict member rules; relaxed since. no fed’l tax -  deposit rates &  loan rates

Commercial Bank Assets ($ Billions), June 2008 Dec. 2014 Commercial & industrial loans 1,507 13.5% Consumer loans 831 7.5% Real estate loans 3,645 32.7% Interbank loans 454 4.1% Other loans (net) 918 8.2% Total loans 7,355 66.1% U.S. government securities 1,113 10.0% Other securities 1,358 12.2% Total securities 2,471 22.2% Cash assets 300 2.7% Other assets 1,004 9.0% Total assets 11,130 100.0% 1,784 11.9% 1,198 8.0% 3,629 24.2% 86 0.6% 1,195 8.0% 7,892 52.6% 2,045 13.6% 884 5.9% 2,929* 19.5% 2,821 18.8% 1,363 9.1% 15,005 100.0% * $1,393 bill. is in mortgaged-backed securities (MBS)

Commercial Bank Liabilities and Equity Capital ($ Billions), June 2008 Dec. 2014 Transactions deposits 603 Small time and savings deposits 4,180 Large time deposits 2,126 Total deposits 6,909 Borrowings from banks 480 Other borrowings 1,829 Total borrowings 2,309 Trading liabilities --- Other liabilities 674 Net due to foreign offices -18 Equity capital 1,155 Total liabilities & equity 11,029 5.5% 37.9% 19.3% 62.6% 4.4% 16.6% 20.9% --- 6.1% -0.2% 10.5% 100.0% --- --- 8,736 58.2% 1,700 11.3% 10,436 69.5% 118 0.8% 1,663 11.1% 1,781 11.9% 226 1.5% 423 2.8% 505 3.4% 1,642 10.9% 15,013 100.0%

Commercial Bank Asset Allocations Dec. 2014 60% 20%

Commercial Bank Liabilities and Equity Capital Dec. 2014 70% 19% 11%

Misc. Data on Banks & Savings Institutions (FDIC) 1990 to 2010: Bank offices: 63,200 to 94,300 --main offices: 12,300 to 6,700 --branches: 51,000 to 88,000

Misc. Data on Credit Unions (FDIC) 2010: Fed’l CU: 4,600 State CU: 2,750 Tot. Assets: $914 billion

The Top Twenty Banks* [based on assets] in the U. S. *As of March, 2016

Sources of Commercial Bank Revenues Commercial Bank Expenses

Equity as a Percentage of Bank Assets in the United States, 1840–Present

II. Banking Management in the U. S.

Evolution of theories of bank management & risk. Real bills doctrine Shiftability theory Anticipated income Conversion of funds Gap management Duration gap management

Real bills doctrine – managing liquidity risk Shiftability theory Anticipated income Conversion of funds Gap management Duration gap management Make low-risk loans with high liquidity… Lend to finance shipment of goods: -- paid off quickly to known buyer. -- earns low return. Lend for production… -- “self-liquidating” loans; repaid as sold. -- relatively low risk.

Real bills doctrine – managing liquidity risk Shiftability theory Anticipated income Conversion of funds Gap management Duration gap management Assets Liabilities Cash Reserves $5,000 Equity $50,000 Shipping Loans $35,000 [payable in 30-120 days] Production Loans $10,000 [payable in 30-60 days] $50,000

Shiftability theory – managing credit risk Real bills doctrine Shiftability theory – managing credit risk Anticipated income Conversion of funds Gap management Duration gap management  Return with longer-term loans… -- adds to the default risk. -- offset with purchases of gov’t. securities. - “Secondary reserves” add liquidity. Popular until the Crash of 1929: -- Margin calls & loan defaults  deposit withdrawals -- Liquidate UST  falling prices & capital loss -- Calling in loans exacerbates circumstances.

Shiftability theory – managing credit risk Real bills doctrine Shiftability theory – managing credit risk Anticipated income Conversion of funds Gap management Duration gap management Assets Liabilities Cash Reserves $50,000 Demand Deposits $250,000 US Treasuries $200,000 Savings Deposits $500,000 Short Term Loans $200,000 Long Term Loans $325,000 Equity $25,000 $775,000 During a panic, depositors withdraw funds. Cash reserves are quickly depleted but US Treasuries can be liquidated to cover what is needed … up to a point. In the GD, failing loans encouraged withdrawals and flooding the market with UST depressed prices.

Anticipated income - managing interest rate risk Real bills doctrine Shiftability theory Anticipated income - managing interest rate risk Conversion of funds Gap management Duration gap management Initiation of the “installment loan”… -- mitigates default risk through ongoing payments. -- gives the bank a highly predictable stream of income. -- has features that make it a “super- liquidating” loan.

Anticipated income - managing interest rate risk Real bills doctrine Shiftability theory Anticipated income - managing interest rate risk Conversion of funds Gap management Duration gap management Assets Liabilities Cash Reserves $50,000 Demand Deposits $250,000 US Treasuries $200,000 Savings Deposits $500,000 Short Term Installment Loans $200,000 Long Term Installment Loans $325,000 Equity $25,000 $775,000 A panic will have less of an impact in that the loans now generate predictable income and defaulting loans are less likely to burden the bank.

Conversion of funds - managing interest rate risk Real bills doctrine Shiftability theory Anticipated income Conversion of funds - managing interest rate risk Gap management Duration gap management Match asset & liability maturities… -- long-term loans with CDs. -- short-term loans with deposits. Events that change interest rates will be neutralized.

Conversion of funds - managing interest rate risk Real bills doctrine Shiftability theory Anticipated income Conversion of funds - managing interest rate risk Gap management Duration gap management Assets Liabilities Cash Reserves $50,000 Demand Deposits $300,000 US Treasuries $150,000 Credit Card loans $400,000 Savings Deposits $575,000 Short Term Consumer Loans $200,000 Long Term Business Loans $250,000 Certificates of Dep. $950,000 Mortgage Loans $825,000 Equity $50,000 $1,875,000 As interest rates rise and fall both sides of the balance sheet are approximately equally affected.

Gap Management – managing profit Real bills doctrine Shiftability theory Anticipated income Conversion of funds Gap Management – managing profit Relate assets & liabilities by interest… -- manage the “gap” to bank’s advantage. -- if interest rates are expected to rise … make gap positive. -- if interest rates are expected to fall … make gap negative. Assets Liabilities Cash Reserves $50,000 Demand Deposits $300,000 US Treasuries $150,000 Credit Card loans $400,000 Savings Deposits $575,000 Short Term Consumer Loans $200,000 Long Term Business Loans $250,000 Certificates of Dep. $950,000 Mortgage Loans $825,000 Equity $50,000 $1,875,000

Duration gap management Real bills doctrine Shiftability theory Anticipated income Conversion of funds Gap Management – managing profit Duration gap management Measure ave. time for payments (in or out)… -- if positive and interest rates fall, bank profits rise. -- if positive and interest rates rise, bank profits fall. Assets Liabilities … Auto Loans (5 yr.) $400,000 3-5 yr. CDs $575,000 Portfolio average payoff = 36 months Portfolio average payout = 32 mo.

Does Bank Size Matter? Economies of scale -- Efficient structure theory. -- Cost savings seem minor; mgt. savings. Concentration will . . . -- raise costs? -- lower costs? Consolidation stats: Community bank % of all banks: 96% (ICBA, 2015) Community bank % of total bank assets: 14% (FDIC, 2011)

Universal Banking Banks own firms -- Better informed about financial condition. -- Conflict of interest? Firms own banks -- Does the FED regulate the firm as well? Banks do . . . Whatever (economies of scope): -- Insurance. -- Real estate. -- Stock brokers.

Banking in the U. S. I. Structures II. Management ECO 473 Dr. D. Foster