2. Overview of Depository Institutions
In this segment, we explore the depository FIs:
Size, structure and composition
Balance sheets and recent trends
Regulation of depository institutions
Depository institutions performance

3. Comparing the products of FIs in 1950, to products of FIs in 2007:
Products of U.S. FIs
Comparing the products of FIs in 1950, to products of FIs in 2007:
Much greater distinction between types of FIs in terms of products in 1950 than in 2007
Blurring of product lines and services over time
Wider array of services offered by all FI types
(Refer to Tables 2-1A and 2-1B in the text)

4. Specialness of Depository FIs
Products on both sides of the balance sheet
Loans
Business and Commercial
Deposits

5. Other outputs of depository FIs
Other products and services 1950:
Payment services, Savings products, Fiduciary services
By 2007, products and services further expanded to include:
Underwriting of debt and equity, Insurance and risk management products

6. Size of Depository FIs
Consolidation has created some very large FIs
Combined effects of disintermediation, global competition, regulatory changes, technological developments, competition across different types of FIs

7. Largest US Depository Institutions
Total Assets ($Billions)
Citigroup $1,746.2
Bank of America ,451.6
J.P.Morgan Chase ,338.0
Wachovia
Wells Fargo
HSBC North America
Taurus
Washington Mutual
U.S. Bancorp
Countrywide Financial

8. Depository Institutions
Commercial Banks
Largest depository institutions are commercial banks.
Differences in operating characteristics and profitability across size classes.
Notable differences in ROE and ROA as well as the spread
Thrifts
S&Ls
Savings Banks
Credit Unions
Mix of very large banks with very small banks

9. Functions & Structural Differences
Functions of depository institutions
Regulatory sources of differences across types of depository institutions.
Structural changes generally resulted from changes in regulatory policy.
Example: changes permitting interstate branching
Reigle-Neal Act

10. Commercial Banks, December 2006
Primary assets:
Real Estate Loans: $3,207.1 billion
C&I loans: $1,117.2 billion
Loans to individuals: $846.9 billion
Investment security portfolio: $1,632.9 billion
Of which, Treasury securities: $1,070.6 billion
Inference: Importance of Credit Risk

11. Commercial Banks Primary liabilities: Inference:
Deposits: $6,426.5 billion
Borrowings: $2,020.7 billion
Other liabilities: $306.2 billion
Inference:
Highly leveraged

12. Small Banks, Nation

13. Large Banks, Nation

14. Structure and Composition
Shrinking number of banks:
14,416 commercial banks in 1985
12,744 in 1989
7,450 in 2007
Mostly the result of Mergers and Acquisitions
M&A prevented prior to 1980s, 1990s
Consolidation has reduced asset share of small banks

15. Structure & Composition of Commercial Banks
Financial Services Modernization Act 1999
Allowed full authority to enter investment banking (and insurance)
Limited powers to underwrite corporate securities have existed only since 1987

16. Composition of Commercial Banking Sector
Community banks
Regional and Super-regional
Access to federal funds market to finance their lending and investment activities
Money Center banks
Bank of New York, Deutsche Bank (Bankers Trust), Citigroup, J.P. Morgan Chase, HSBC Bank USA
declining in number

17. Balance Sheet and Trends
Business loans have declined in importance
Offsetting increase in securities and mortgages
Increased importance of funding via commercial paper market
Securitization of mortgage loans
Temporary effects: credit crunch during recessions of and

18. Some Terminology
Transaction accounts
Negotiable Order of Withdrawal (NOW) accounts
Money Market Mutual Fund
Negotiable CDs: Fixed-maturity interest bearing deposits with face values over $100,000 that can be resold in the secondary market.

19. Off-balance Sheet Activities
Heightened importance of off-balance sheet items
OBS assets
OBS liabilities
Large increase in derivatives positions is a major issue
Standby letters of credit
Loan commitments
When-issued securities

20. Trading and Other Risks
Allied Irish / Allfirst Bank
$750 million loss
National Australian Bank
$450 million loss

21. Other Fee-generating Activities
Trust services
Correspondent banking
Check clearing
Foreign exchange trading
Hedging
Participation in large loan and security issuances
Payment usually in terms of noninterest bearing deposits
Interbank markets trade currencies b/t each other: foreign exchange trading. Foreign currencies are ordered through banks or a correspondent bank (20-30 banks world-wide that enter into the interbank market.
-hedging-offer to smaller banks for a fee
-syndicates-banks grouping together in order oto make a loan to another bank -

22. Key Regulatory Agencies
FDIC
DIF
Role in preventing contagious runs or panics
OCC: Primary function is to charter national banks.
FRS: monetary policy, lender of last resort.
National banks are automatically members of the FRS. State-chartered banks can elect to become members.
State bank regulators
Dual Banking System: Coexistence of nationally and state-chartered banks.
-FDIC used to be split, bank insurance fund and savings association insurance fund and formed into DIF. Through one single fund now. ( only recently)
-OCC- and primary regulators for nat’l banks.
-three fed regulators: state banks have a choice, most are not members, but all have FDIC insurance (99.8% insured)
-FRC-main function is to inc/dec money supply, just recently. Monetary policy is what they evolved into in order to help prevent bank-runs, originally only meant to be lender of last resort. -12 fed banks, in d.c., 7 governors appointed by pres and confirmed by senate term of 14 years, chairman of board (ben bernanke) is elected among their peers for 4 years as long as their term of governorship is not passed. Can stay in longer for 14 years if played out right (alan greenspan)
-timothy geither? Bank president of new york bank, now sec of treasury

23. Bank Regulators -members are typically larger
-reason to not be a member would be high costs and too much regulation

24. Web Resources
For more detailed information on the regulators, visit:

25. Other Regulatory Issues
Importance of Bank Holding Companies is increasing.
BHCs regulated by FRS.
-bhc’s-shell org: holds at least one commercial bank: fed regulates bhcs: other types of org’s that are not investment, insurance co. relationship has to be approved by the fed.
-glamm-leach bliley- new bhc=financial services holding companies wh/ can hold any type of financial instituion and non-bank entities (i.e. mortage co. or loan co.)
Ex: citi bank is a fshc
-goldmansachs turned themselves into a bank holding company in oct 08 wh/ is held by fshc

26. Key Regulatory Legislation
1927 McFadden Act: Controls branching of national banks.
1933 Glass-Steagall: separates securities and banking activities, established FDIC, prohibited interest on demand deposits.
1956 Bank Holding Company Act and subsequent amendments specifies permissible activities and regulation by FRS of BHCs.
-M.A.-gave states the rights to say whether a bank can branch and if so, how far and where. In affect until 1997, reagle-neil act repealed it and allowed banks to branch independently. Fed tried to entice banks to branch across state lines. Also wanted them to acquire banks that were failing. This has all made banks larger and fewer in number.
-G.S.- today up to $250,000 in insurance.
-BHCA-less stringent rules than today.

27. Legislation (continued)...
1970 Amendments to the Bank Holding Company Act: Extension to one-bank holding companies
1978 International Banking Act: Regulated foreign bank branches and agencies in USA

28. Legislation (continued)
1980 DIDMCA and 1982 DIA (Garn-St. Germain Depository Institutions Act)
Mainly deregulation acts.
Phased out Regulation Q.
Authorized NOW accounts nationwide
Increased deposit insurance from $40,000 to $100,000
Reaffirmed limitations on bank powers to underwrite and distribute insurance products.
-ggdia- big thing it did was phase out regulation q: capped i. rates earned on deposits, wh/ created disardmediation; forced people into short term securities, wh/ was stopped by putting a cap of $10000 on treasuries wh/ forced people to hold money outside the U.S. wh/ created the euro-dollar market accounts.
-Negotiable Order of withdraw (NOW)= demand deposit account, earns interest, can be restrictions on with withdraws
-Money market demand accounts- more considered savings accounts: no more than 6 transactions per month
-banks can not act as investment bank

29. Legislation (continued)
1987 Competitive Equality in Banking Act (CEBA)
Redefined bank to limit growth of nonbank banks.
1989 FIRREA
Imposed restrictions on investment activities
Replaced FSLIC with FDIC-SAIF
Replaced FHLB with Office of Thrift Supervision
Created Resolution Trust Corporation
-financial institution reform and recovery act (FIRREA)-Today: resolution Trust Corp. (no longer exists) was created to take over assets of failed savings and loans and figure out what to do with them, argument is that we should reinstate this RTC.
-RTC- what it actually did; savings and loan banks were failing ( zombie bank (Thomas Meyer- when banks are becoming completely insolvent- equity falling to 0 and are left alive), and they were allowed to continuing to function, and once they began starting to close, assets are taken over by the primary regulator and rtc is created to manage them and sell them off. Different today b/c banks were given the TARP money to buy assets in a kind of auction and the fed gov’t bought preferred shares, increasing the equity in the banks and presumably increase their cushions, and it was forced on all the banks b/c the gov’t didn’t want the public to know which bank really needed it and cause a bank-run. If a bank like Citibank failed it would wipe out the FDIC overnight, and possibly leave a lot of people unpaid, as well as banks with a vested interest in Citibank, almost like a domino effect.
-REO acct.= real-estate owned acct (where foreclosures go in a banks accounting records)
-RTC entered into private equity partnerships to liquidate the assets from failed savings and loans (80-90’s)
-problem today has one more player, the banks, than it did when we had the RTC wh/ complicates things further which is why we can’t have a RTC b/c the banks that hold these assets have not failed and they are having a hard time coming to an agreement b/t them to solve these problems, i.e. no pricing schemes for these assets that appeal to all three groups (equity partners, banks, tax payers/gov’t)
-equity is repelling off these assets right now
-silent partner=have money invested but have no say
-private equity groups-the ones that are involved

30. Legislation (continued)
1991 FDIC Improvement Act
Introduced Prompt Corrective Action
Risk-based deposit insurance premiums
Limited “too big to fail”
Extended federal regulation over foreign bank branches and agencies
-regulators were practicing forbearance (deferment, i.e. looking away) and allowed these banks to turn into “zombie banks”: this brought us to the 1991 prompt corrective action which was to close them down and put them into receivership
-2 funds created: BIF (bank insurance fund) and SAIF (savings association and insurance funds)
-”too big to fail” : today it is Fannie, Freddie (Lehman Brothers was)
-JP Morgan Chase has the Washington Mutual subsidiaries but nothing else
-Now only one pool of insurance funds=depository insurance fund (BIF and SAIF together)

31. Legislation (continued)
1994 Riegle-Neal Interstate Banking and Branching Efficiency Act
Permits BHCs to acquire banks in other states.
Invalidates some restrictive state laws.
Permits BHCs to convert out-of-state subsidiary banks to branches of single interstate bank.
Newly chartered branches permitted interstate if allowed by state law.
-every state has now signed it :single interstate banks have made the banking systems very efficient: now regulated under a single charter not their own
-DeNovo-brand new branches: allowed in every state, how will it be created?

32. 1999 Financial Services Modernization Act
Allowed banks, insurance companies, and securities firms to enter each others’ business areas
Provided for state regulation of insurance
Streamlined regulation of BHCs
Prohibited FDIC assistance to affiliates and subsidiaries of banks and savings institutions
Provided for national treatment of foreign banks
(Gramm-Leach-Bliley Act)
-Insurance company in louisiana are regulated by louisiana
-foreign banks are now regulated as a nat’l bank

33. Recent Legislative Changes
USA Patriot Act of 2001
Sarbanes-Oxley Act of 2002
-SOX- held accountable for financial issues within their companies
-USA Patriot Act-allows fed gov’t to freeze accounts (particularly when investigating terrorists)

34. Economic expansion and falling interest rates through 1990s
Industry Performance
Economic expansion and falling interest rates through 1990s
Brief downturn in early 2000 followed by strong performance improvements
Record earnings $106.3 billion 2003
Only 2 failures in 2006 versus 206 in 1989
Performance remained strong through mid 2000s as interest rates rose
-Banks like lower i. rates and steep ( like right now)
-1989-peak of savings and loans crisis

35. Banking and Ethics
Bank of America and Fleet Boston Financial 2004
J.P. Morgan Chase and Citigroup 2003 role in Enron
Riggs National Bank and money laundering concerns 2003, 2004
Effects of entry into internet banking services

36. Savings Institutions Comprised of:
Savings and Loans Associations
Savings Banks
Effects of changes in Federal Reserve’s policy of interest rate targeting combined with Regulation Q and disintermediation.
Effects of moral hazard and regulator forbearance.
Qualified Thrift Lender (QTL) test.
-Washington Mutual (savings institutions)
-deposit institution deregualtion and monetary control act
-savings and loans and savings banks were treated the same
-commercial bank deposits can not pay interest under regulation Q
-moral hazard- investing in Freddie Mac when they went down b/c you thought they would not be nationalized which would pay out to shareholders larger returns- overall taking more risk b/c you think you are covered enough
-this was huge in the savings in loans crisis with the zombie banks ( bank managers taking risky actions because it really didn’t matter)
-QTL- if the bank has 65% or more of the assets held in mortgages, they are considered a qualified thrift lender (thrift is a savings and loans, savings bank, or credit unions)

37. Savings Institutions: Recent Trends
Industry is smaller overall
Intense competition from other FIs
mortgages for example
-far fewer because many have been acquired by others
-savings and loans were charged a higher rate so they tried to change their charters into a commercial bank

38. Office of Thrift Supervision (OTS). FDIC-DIF Fund.
Primary Regulators
Office of Thrift Supervision (OTS).
Charters and examines all federal S&Ls.
FDIC-DIF Fund.
FDIC Oversaw and managed Savings Association Insurance Fund (SAIF).
SAIF and BIF merged in January 2007 to form DIF
Same regulatory structure applied to commercial banks

39. Web Resources
For more information on the regulation of savings institutions, visit:
Treasury
FDIC

40. May be regulated at both state and federal level
Savings Banks
Mutual organizations
Primarily East Coast
Not exposed to the oil-based shocks of 1980s
Real estate price exposure
Demutualization
May be regulated at both state and federal level
-almost all are in the northeast
-mutual-means depositors own the company
-demutualized- ex: Washington Mutual in the 80’s became a stockholder owned company

41. Exempt from taxes and Community Reinvestment Act (CRA).
Credit Unions
Nonprofit depository institutions owned by member-depositors with a common bond.
Exempt from taxes and Community Reinvestment Act (CRA).
Expansion of services offered in order to compete with other FIs.
Claim of unfair advantage of CUs over small commercial banks
2006: 66.4 percent of CUs federally chartered and regulated by NCUA
-not-for profit so they don’t pay tax: a lot of credit unions are run by retired commercial bankers
-CRA (helped prevent red-lining)- don’t have to make loans to their community ( which is harder for banks that are nation-wide)
-common bond today is now “do you breathe air?” i.e. very loose common bond
-NCUA-national credit union association- insures all the depositors

42. Web Resources
For information on credit unions visit:
American Bankers Association

43. Narrowing margins and flattening yield curves
Global Issues
Narrowing margins and flattening yield curves
Mortgages dominating retail growth
Personal bankruptcies rising
Near crisis in Japanese Banking
China
Deterioration in early 2000s, NPLs at 50% levels
Opening to foreign banks (WTO entry) slow
-narrowing margins- net interest income= interest income- interest expense, this decreases
-banks borrow from the short-end of yield curve and assets are at the long-end
-Wachovia- made a decision to enter the mortgage business by purchasing a mortgage company in 2006 for a very high price and almost immediately, borrowers began defaulting and it is now the only commercial bank that has failed.

44. Pertinent Websites
American Bankers Association Federal Reserve
Credit Union National Association
FDIC
National Credit Union Administration
Office of Comptroller of the Currency
Office of Thrift Supervision

45. *Financial Statement Analysis
Time series analysis of key ratios
ROE framework
ROE = ROA × EM
ROA = PM × AU