1. Chapter Eleven
Commercial Banks

2. Definition of a Commercial Bank
Represent the largest group of depository institutions measured by asset size.
Perform functions similar to those of savings institutions and credit unions - they accept deposits (liabilities) and make loans (assets)
Liabilities include nondeposit sources of funds such as subordinated notes and debentures
Loans are broader in range, including consumer, commercial, international, and real estate
Regulated separately from savings institutions and credit unions

3. Differences in Balance Sheets
Depository Institutions Nonfinancial Firms
Assets Liabilities Assets Liabilities
Loans Deposits Deposits Loans
Other Other
financial financial
assets assets
Other Other Other Other
non liabilities non liabilities
financial and financial and
assets equity assets equity

4. Commercial Bank Balance Sheet
Assets
Total cash assets……………… $
U.S. gov securities…………… $
Fed Funds/Repurchase………
Other…………………………
Investment securities………… ,497.2
Interbank loans………………
Loans exc. Interbank………… ,778.1
Comm. and Indust…………..$
Real estate…………………… 1,803.6
Individual……………………
All other………………………
Less: Reserve for losses………
Total loans……………………… $3,823.2
Other assets……………………
Total assets…………………… $6,569.2

5. Commercial Bank Balance Sheet
Liabilities and Equity
Transaction accounts…………… $1,376.5
Nontransaction accounts……… ,015.5
Total deposits…………………… $4,391.6
Borrowings……………………… ,348.6
Other liabilities…………………
Total liabilities………………… $5,971.8
Equity……………………………

6. Balance Sheet Items Assets Liabilities Equity
loans and investment securities
Liabilities
transaction accounts - the sum of noninterest-bearing demand deposits and interest-bearing checking accounts
NOW account - an interest-bearing checking account
negotiable CDs - fixed-maturity interest-bearing deposits with face values of $100,000 or more that can be resold in the secondary market
Equity
common and preferred stock, surplus or additional paid-in capital, and retained earnings (continued)

7. Balance Sheet Items Off-Balance-Sheet activities Trust services
off-balance-sheet asset - when an event occurs, this item moves onto the asset side of the balance sheet or income is realized on the income statement
off-balance-sheet liability - when an event occurs, this item moves onto the liability side of the balance sheet or an expense is realized on the income statement
Trust services
generates fees by holding and managing individuals or corporations assets
Correspondent banking
generates fees by provision of banking services to other banks

8. Economies of Scale and Scope
Economies of scale - the degree to which a firm’s average unit costs of producing financial services fall as its output of services increase
Economies of scope - the degree to which a firm can generate cost synergies by producing multiple financial service products
Megamerger - the merger of banks with assets of $1 billion or more
X efficiencies - cost savings due to the greater managerial efficiency of the acquiring firm

9. Measuring Economies of Scale
ACi = TC i Si
Where:
ACi = Average costs of the ith bank
TCi = Total costs of the ith bank
Si = Size of the bank measured by assets, deposits
or loans

10. Economies of Scale and the Effect of Technology Improvement
Average
Cost
Old Technology
AC1
New Technology
AC2
Size

11. By offering more services to a given customer:
Economies of Scope
By offering more services to a given customer:
revenue can be enhanced
costs can be reduced
Cost economies of scope
investments in one financial service (such as lending) may reduce costs to produce financial services in other areas (such as securities underwriting or brokerage)
Revenue economies of scope

12. Bank Size and Concentration
Community bank - a bank that specializes in retail or consumer banking
Regional or superregional bank - a bank that engages in a complete array of wholesale commercial banking activities
Federal funds market - an interbank market for short-term borrowing and lending of bank reserves
Money center bank - a bank that relies heavily on nondeposit or borrowed sources of funds

13. Bank Size and Activities
Large banks have easier access to capital markets and can operate with lower amounts of equity capital
Large banks tend to use more purchased funds (such as fed funds) and have fewer core deposits
Large banks lend to larger corporations which means that their interest rate spread is narrower
the difference between lending and deposit rates
Large banks are more diversified and generate more noninterest income

14. Industry Performance
Provision for loan losses - bank management’s recognition of expected bad loans for the period
Net charge-offs - actual losses on loans and leases
Net operating income - income before taxes and extraordinary items
Noncurrent loans - loans past due 90 days or more and loans not accruing interest

15. Regulators Federal Deposit Insurance Corporation (FDIC)
insures the deposits of commercial banks
Office of the Comptroller of the Currency (OCC)
function is to charter national banks as well as close them
has the power to approve/disapprove of mergers
Federal Reserve System
requires all banks to meet the same noninterest-bearing reserve requirements
State Authorities
performs for state chartered banks similar functions as the OCC does for national banks