Chapter 16 Commercial Bank Operations © 2001 South-Western College Publishing Company

2 Chapter Objectives nDescribe the most common sources of funds for commercial banks nDescribe the most common uses of funds for commercial banks

3 Bank Participation in Financial Conglomerates nImpact of the Financial Services Modernization Act (1999) 4Prompted by the Citicorp-Traveler’s merger 4Banks and other financial service firms were given more freedom to merge and offer a range of financial services Insurance Securities services

4 Bank Participation in Financial Conglomerates nBenefits of diversified services to individuals and firms 4Individuals can obtain all their financial services at a single financial conglomerate Deposits Loans Investing (brokerage) Insurance 4Businesses can obtain loans, issue stocks and bonds, and have their pension fund managed by the same institution

5 Bank Participation in Financial Conglomerates nBenefits of diversified services to the financial institution 4Reduce reliance on demand for single services 4Diversification may result in less risk 4Generate new business

6 Bank Sources of Funds 4Deposit accounts Transaction deposits Savings deposits Time deposits Money market deposit accounts 4Borrowed funds Federal funds purchased Borrowing from the Federal Reserve banks Repurchase agreements Eurodollar borrowings

7 Bank Sources of Funds 4Long-term sources of funds Bonds issued by the bank Bank capital

8 Bank Sources of Funds nTransaction deposits 4Demand deposit account (checking) 4Negotiable order of withdrawal (NOW) account 1981 Requires larger minimum balance nSavings Deposits 4Passbook savings 4Regulation Q until 1986

9 Bank Sources of Funds nTime Deposits 4Certificate of deposit (CD) No secondary market 4Negotiable CD Short-term, minimum $100,000 Can trade among investors nMoney Market Deposit Accounts (MMDAs) 4More liquid than CDs : no specified maturity 4Limited checkwriting 4Created in 1982

10 Bank Sources of Funds nFederal Funds Purchased 4Short-term loans between banks One to seven days 4Allows banks to meet reserve requirement 4Interest rate charged is the federal funds rate nBorrowing from the Federal Reserve Banks 4Borrowing at the discount window 4Discount rate 4Intended for meeting temporary short-term needs 4Must get Fed approval

11 Bank Sources of Funds nBank capital 4Obtained from issuing stock or retaining earnings 4No obligation to pay out funds in the future 4Must be sufficient to absorb operating losses

12 Uses of Funds by Banks nLoans 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. nCash 4Required to hold some cash as reserves 4Reserve requirements imposed by Fed Tool for controlling the money supply 4Also hold cash to maintain liquidity and accommodate withdrawal requests by depositors

13 Uses of Funds by Banks nBank Loans 4Types of business loans Working capital loans Term loans –Purchasing fixed assets –Protective covenants Informal line of credit Revolving credit loan

14 Uses of Funds by Banks nBank Loans 4Loan participations Sometimes large firms seek to borrow more money than an individual bank can provide Lead bank 4Loans supporting leveraged buyouts Banks charge a high loan rate Monitored by bank regulators

15 Uses of Funds by Banks nBank Loans 4Collateral requirements on business loans Increasingly accepting intangible assets Important to service-oriented firms 4Lender liability on business loans Lender liability lawsuits 4Types of consumer loans Installment loans Credit cards 4Real estate loans

16 Uses of Funds by Banks nInvestment in securities 4Treasury securities 4Government agency securities Freddie Mac and Fannie Mae 4Corporate and municipal securities Investment grade only nFederal funds sold 4Lending funds in the federal funds market