1. Financial Markets and Institutions 6th Edition
PowerPoint Slides for:
Financial Markets and Institutions 6th Edition
By Jeff Madura
Prepared by
David R. Durst
The University of Akron

2. Commercial Bank Operations17

3. Chapter Objectives
Describe the most common sources of funds for commercial banks
Describe the most common uses of funds for commercial banks
Describe typical off-balance sheet activities for commercial banks

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

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

6. Bank Participation in Financial Conglomerates
Benefits of diversified services to the financial institution
Reduce reliance on demand for single service
Economies of scale and scope
Diversification (service and geographical) may result in less risk
Generate new business

7. Bank Sources of Funds Transaction deposits Savings Deposits
Demand deposit account (checking)
Negotiable order of withdrawal (NOW) account
1981
Requires larger minimum balance
Savings Deposits
Passbook savings
Regulation Q until 1986

8. Bank Sources of Funds Time Deposits
Certificate of deposit (CD)
No secondary market
Negotiable CD
Short-term, minimum $100,000
Can trade among investors via dealer
Money Market Deposit Accounts (MMDAs)
More liquid than CDs : no specified maturity
Limited check writing
Created in 1982

9. Bank Sources of Funds Federal Funds Purchased
Short-term loans between banks
Allows banks to meet reserve requirement or funding needs
Interest rate charged is the federal funds rate
Borrowing from the Federal Reserve Banks
Borrowing at the discount window
Discount rate
Intended for meeting temporary short-term reserve requirement needs
Must get Fed approval

10. Bank Sources of Funds Repurchase agreements
Sale of securities by one party to another with an agreement to repurchase the securities at a specified date and price
Banks may sell T-bills to a corporation with temporary excess cash (bank demand deposit) and then buy them back later
Source of funds for a few days
Collateralized by the treasury bills
Form of paying interest on large customer checking balances

11. Bank Sources of Funds Eurodollar borrowings Bonds issued by the bank
Banks outside the United States make dollar-denominated loans
Eurodollar market is very large
Bonds issued by the bank
Like other businesses, banks issue bonds to finance long-term fixed assets
Usually subordinated to deposits
Part of secondary regulatory capital

12. Bank Sources of Funds Bank capital
Obtained from issuing stock or retaining earnings
No obligation to pay out funds in the future
Primary vs. secondary
Must be sufficient to absorb operating losses
As of 1992: risk-based capital requirement

13. Uses of Funds by Banks
Loans 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.
Cash and “due from” balances at institutions
Currency/coin provided via banks
Reserve requirements imposed by Fed
Tool for controlling the money supply
Due from Fed and vault cash count as reserves
Also hold cash and due from balances to maintain liquidity and accommodate withdrawal requests by depositors

14. Uses of Funds by Banks Bank Loans Types of business loans
Working capital loans
Term loans
Purchasing fixed assets
Protective covenants
Informal line of credit
Revolving credit loan

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

16. Uses of Funds by Banks Bank Loans
Collateral requirements on business loans
Increasingly accepting intangible assets
Important to service-oriented firms
Increased lending risk with service businesses--telecomm
Lender liability on business loans
Lender liability lawsuits—toxic dump under corner business
Types of consumer loans
Installment loans
Credit cards
Real estate loans

17. Uses of Funds by Banks
Investment securities (bank income and liquidity)
Treasury securities
Government agency securities
Freddie Mac
Fannie Mae
Corporate and municipal securities
Investment grade only
Federal funds sold
Lending funds in the federal funds market

18. Uses of Funds by Banks Repurchase agreements Eurodollar loans
Branches of U.S. banks located outside of the U.S.
Foreign-owned banks
Fixed assets
Office buildings
Land

19. Off-Balance Sheet Activities
Loan commitments
Obligation of bank to provide a specified loan amount to a particular business upon request
Note issuance facility (NIF)
Banks earn fee income for risk assumed
Standby letters of credit (SLC)
Backs a customer’s obligation to a third party
Banks earn fee income

20. Off-Balance Sheet Activities
Forward contracts
Agreement between a customer and bank to exchange one currency for another on a particular future date at a specified exchange rate
Allows customers to hedge their exchange-rate risk

21. Off-Balance Sheet Activities
Swap contracts
Two parties agree to periodically exchange interest payments on a specified notional amount of principal
Banks serve as intermediaries or dealer and/or guarantor for a fee