1. Chapter Eleven
Commercial Banks

2. Chapter Outline Depository Institutions Definition
Typical Characteristics of Commercial Banks
Trends in Commercial Banks
Bank Size and Activities
Regulation

3. 1. Depository Institutions
Financial Institutions that:
Accept deposits (Insured by government)
Make loans
Have access to payment system
Are heavily regulated
Three major groups
Commercial banks
Savings institutions
Credit Unions

4. 2. Commercial Banks Largest group of depository institutions
Major liability includes deposits; nondeposit sources of funds include subordinated notes and debentures
Loans are broader in range than savings and credit unions: commercial, real estate, consumer, etc.
Deposits insured by FDIC
Regulated separately from savings institutions and credit unions: Federal Reserve, Office of the Comptroller of the Currency (OCC), FDIC

5. 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

6. Commercial Bank Balance Sheet (b$, 2004)
Assets
Total cash assets……………… $
U.S. gov securities…………… $
Fed Funds/Repurchase………
Other…………………………
Investment securities………… ,879.3
Interbank loans………………
Loans exc. Interbank…………
Comm. and Indust…………..$
Real estate…………………… 2,544.9
Individual……………………
All other………………………
Less: Reserve for losses………
Total loans……………………… $4,739.8
Other assets…………………… ,208.4
Total assets…………………… $8,244.4

7. Commercial Bank Balance Sheet (b$, 2004)
Liabilities and Equity
Transaction accounts…………… $
Nontransaction accounts……… ,689.1
Total deposits…………………… $5,406.0
Borrowings……………………… ,769.6
Other liabilities…………………
Total liabilities………………… $7,423.4
Equity……………………………

8. Commercial Bank Balance Sheet (2004)
Assets
Total cash assets……………… %
U.S. gov securities…………… %
Fed Funds/Repurchase……… %
Other………………………… %
Investment securities………… %
Interbank loans……………… %
Loans exc. Interbank………… %
Comm. and Indust………… %
Real estate…………………… %
Individual…………………… %
All other……………………… %
Less: Reserve for losses……… %
Total loans……………………… %
Other assets…………………… %
Total assets…………………… %

9. Commercial Bank Balance Sheet (2004)
Liabilities and Equity
Transaction accounts…………… %
Nontransaction accounts……… %
Total deposits…………………… %
Borrowings……………………… %
Other liabilities………………… %
Total liabilities………………… %
Equity…………………………… %

10. Industry Performance A well run bank usually has an ROA of 0.5% to 3%.
To get an acceptable ROE, banks must resort to using a very high amount of leverage; the debt/asset ratio at a bank is usually over 90%.
The average ROA and ROE for commercial banks in 2003 is 1.40% and 15.31%, respectively, compared to 1989 when ROA and ROE averaged 0.49% and 7.71%.

11. 2.1 Trends in Commercial Banks
Portfolio Shift
As a percentage of the typical bank’s balance sheet, over the last 50 years, mortgages have risen and securities have fallen
Loss of Market Share
20 years ago banks had 40% share
10 years ago banks had 26% share
Today banks have 19% share

12. 2.2 Trends in Commercial Banks
Movement toward off-balance sheet activities
Movement away from net spread income (interest income minus interest expense)
Movement toward fee income

13. 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

14. Examples of Off-Balance Sheet Activities
Loan commitments
promises to make loans in return for fees
Trust services
generates fees by holding and managing individuals or corporations assets
Correspondent banking
generates fees by provision of banking services to other banks

15. 2.3 Trends in Commercial Banks
Consolidation
Number of Banks
,709
,958
,579
,080
,660

16. Economies of Scale and Scope
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
X efficiencies
cost savings due to the greater managerial efficiency of the acquiring firm

17. 4. Commercial Banks by Asset Size (2004)
Size Range
Number %
Assets
< $100 million
3,755
49.0%
$194.6
2.4%
$100 million - $1 billion
3,458
45.2%
$927.8
11.2%
$1 billion - $10 billion
360
4.7%
$971.3
11.8%
> $10 billion 87
1.1%
$6,150.7
74.6%
Total Industry
7,660
100.0%
$8244.4

18. Bank Size Classifications
Community bank - a small bank that frequently specializes in retail or consumer banking
Regional bank - a mid-sized bank that engages in a complete array of wholesale commercial banking activities
Super regional bank – a large regional bank – usually does business in more than one state
Money center bank - a bank that relies heavily on nondeposit or borrowed sources of funds
Financial conglomerate – a large bank that does a lot of other financial activities – investment banking, insurance etc.

19. 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 have fewer core deposits
Large banks lend to larger corporations which means that their interest rate spread is narrower
Large banks are more diversified, have more off-balance-sheet activities and generate more noninterest income

20. Bank Size and Concentration
Wholesale banking
provide commercial and industrial loans funded with purchased funds
Retail banking
provide residential and consumer loans and accepting small deposits

21. Wholesale Banking Services
Controlled disbursement accounts
Account reconciliation
Lockbox services
Electronic lockbox
Funds concentration
Electronic funds transfer
Check deposit services

22. Wholesale Banking Services (cont..)
Electronic initiation of letters of credit
Treasury management software
Electronic data interchange
Facilitate business-to-business e-commerce
Electronic billing
Verifying identities
Assist small business entry in e-commerce

23. Retail Banking Services
Automated teller machines (ATMs)
Point-of-sale debit (POS) cards
Preauthorized debits/credits
Paying bills via telephone
On-line banking
Smart cards (stored-value cards)

24. 5. 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