1. The Financial Services Industry: Depository Institutions
Chapter 2
The Financial Services Industry: Depository Institutions

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. Products of U.S. FIs
Comparing the products of FIs in 1950, to products of FIs in 2000:
Much greater distinction between types of FIs in terms of products in 1950 than in 2000
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. 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

5. Largest Depository Institutions, 2000 by total assets (billions)
Citigroup $804.3
J.P. Morgan Chase
BankAmerica
Banc One
First Union
Wells Fargo
Washington Mutual
Fleet Boston
SunTrust Banks
HSBC

6. 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

7. Functions and 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

8. Commercial Banks Primary assets: Inference: Importance of Credit Risk
Real Estate Loans: $1,670.3 billion
C&I loans: $1,048.2 billion
Loans to individuals: $609.7 billion
Other loans: $367.5 billion
Investment security portfolio: $1,662.0 billion
Of which, Treasury bonds: $710.0 billion
Inference: Importance of Credit Risk

9. Commercial Banks Primary liabilities: Inference:
Deposits: $4,176.6 billion
Borrowings: $1,532.5 billion
Other liabilities: $401.0 billion
Inference:
Highly leveraged

10. Small Banks, Nation

11. Large Banks, Nation

12. Structure and Composition
Shrinking number of banks:
14,416 commercial banks in 1985
12,744 in 1989
8,315 in 2000
Mostly the result of Mergers and Acquisitions
M&A prevented prior to 1980s, 1990s
Consolidation has reduced asset share of small banks

13. Structure and 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

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

15. 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

16. 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.

17. Off-balance sheet activities
Heightened importance of off-balance sheet items
Large increase in derivatives positions is a major issue
Standby letters of credit
Loan commitments
When-issued securities
Loans sold

18. 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

19. Key Regulatory Agencies
FDIC (BIF and SAIF)
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.

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

21. Other Regulatory Issues
Importance of Bank Holding Companies is increasing.
BHCs regulated by FRS.

22. Key Regulatory Legislation
1927 McFadden Act: Controls branching of national banks.
1933 Glass-Steagall: separates securities and banking activities.
1956 Bank Holding Company Act and subsequent amendments specifies permissible activities and regulation by FRS of BHCs.

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

24. Legislation (continued)
1980 DIDMCA and 1982 DIA (Garn-St. Germain Depository Institutions Act)
Mainly deregulation acts.
Phased out Regulation Q.
1987 Competitive Equality in Banking Act (CEBA)
Redefined bank to limit growth of nonbank banks.

25. Legislation (continued)
1989 FIRREA
Imposed restrictions on investment activities
Replaced FSLIC with FDIC-SAIF
Replaced FHLB with Office of Thrift Supervision
Created Resolution Trust Corporation

26. Legislation (continued)
1991 FDIC Improvement Act
Introduced Prompt Corrective Action
Risk-based deposit insurance premiums
Limited “too big to fail”

27. 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.

28. 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

29. Industry Performance
Economic expansion and falling interest rates through 1990s
Commercial banks record earnings of $71.6 billion
Downturn in early 2000s
Reduction in performance
Increased provision for loan losses
Only 6 failures in 2000 versus 206 in 1989
Technology risks remain

30. 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.

31. Savings Institutions: Recent Trends
Industry is smaller overall
Intense competition from other FIs
mortgages for example
Concern for future viability

32. Primary Regulators Office of Thrift Supervision (OTS). FDIC-SAIF Fund.
Charters and examines all federal S&Ls.
FDIC-SAIF Fund.
Oversees and manages Savings Association Insurance Fund (SAIF).

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

34. 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

35. 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.
Approximately 2/3 federally chartered and subject to NCUA regulation.

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

37. Global Issues Near crisis in Japanese Banking
19 of the biggest Japanese banks on credit watch list
European banks continued to perform well
Implications for future competitiveness

38. Other Trends Number of banks continues to decline.
Increase in off-balance-sheet activities.
Increase in income derived from fees-for-service rather than spread income.
Increased competition between banks and across financial services sectors.
Increased competition from foreign FIs.

39. Pertinent Websites www.federalreserve.gov www.cuna.org www.fdic.gov
Web Surf

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