1. PowerPoint Presentation by Charlie Cook Copyright © 2004 South-Western. All rights reserved. Chapter 11 Depository Financial Institutions

2. Copyright © 2004 South-Western. All rights reserved.11–2 Fundamental Issues 1.What are the historical origins of modern banking institutions? 2.How did today’s segmented groupings of depository institutions arise? 3.What are the key assets of commercial banks? 4.What are the key liabilities of commercial banks? 5.How do savings institutions differ from commercial banks?

3. Copyright © 2004 South-Western. All rights reserved.11–3 Fundamental Issues (cont’d) 6.How do credit unions raise and allocate their funds?

4. Copyright © 2004 South-Western. All rights reserved.11–4 Goldsmith Bankers Bullion:  Uncoined gold or silver used as money. Fractional-reserve banking:  A system in which banks hold reserves equal to less than the amount of total deposits.

5. Copyright © 2004 South-Western. All rights reserved.11–5 The Roots of Modern Banking Merchant bankers:  Merchants who, after receiving payment from the purchasers of their goods, would then repay those who had provided loan financing. The Italian merchant bankers:  The term bank derives from the merchants’ bench, or banco, on which money changed hands in the marketplaces of medieval Italy.  The term bankruptcy refers to the “breaking of the bench” that occurred when a merchant banker became overextended and failed.

6. Copyright © 2004 South-Western. All rights reserved.11–6 Banking Three key features of the banking business:  Banks take deposits from customers and maintain accounts on customers’ behalf.  Banks manage payments on behalf of customers by collecting and paying checks, notes, and other “banking currency.”  Banks provided advances to customers in the form of loans. The interest on these loans and the fees that banks charge for accounting and deposit services are the banks’ sources of revenues and, ultimately, profits.

7. Copyright © 2004 South-Western. All rights reserved.11–7 Early American Banking Bank of North America:  Founded by Robert Morris, a Philadelphia financier.  Chartered in 1871 by the Continental Congress. Dual banking system:  A regulatory structure in which either states or the federal government can grant bank charters. The Free-Banking Period (1837 until 1863):  Two types of banks  Banks operated by state governments.  Private banks incorporated under state free-banking laws.

8. Copyright © 2004 South-Western. All rights reserved.11–8 The Two-Tiered Banking System National Banking Act of 1863  Granted federal charters to a number of banks (all within the Union states).  Imposed a federal tax on all notes issued by state banks (mostly based in Confederate states).  Imposed reserve requirements on the deposits of banks and prohibited branch banking by state- chartered banks.  Required national banks to back their notes by posting government bonds.

9. Copyright © 2004 South-Western. All rights reserved.11–9 The Rise of Thrift Institutions Mutual ownership:  A depository institution organizational structure in which depositors own the institution. Types of mutual ownership  Savings banks (thrift institutions)  Savings and loan institutions  Credit unions

10. Copyright © 2004 South-Western. All rights reserved.11–10 Segmented Banking in the Twentieth Century Bank run:  An unexpected series of cash withdrawals at a depository institution that can induce its failure. Extensive federal regulation:  Home Owners Loan Act of 1933  National Housing Act of 1934  Federal Credit Union Act

11. Copyright © 2004 South-Western. All rights reserved.11–11 Commercial Banks Commercial bank:  A depository institution that faces few legal restrictions on its powers to lend to businesses and can legally issue checking deposits from which holders may write unlimited numbers of checks. Asset:  Anything owned by a person or business that has a market value. Collateral:  Assets that a borrower pledges as security in case it should fail to repay a loan.

12. Copyright © 2004 South-Western. All rights reserved.11–12 Commercial Bank Assets: Loans Commercial and industrial (C&I) loans:  Loans that commercial banks and other depository institutions make to businesses. Consumer Loans  Credit extended to individuals.

13. Copyright © 2004 South-Western. All rights reserved.11–13 Commercial Bank Assets ($ Billions), July 31,2002 Table 11–1 Commercial and industrial loans990.214.8% Consumer loans568.78.5% Real estate loans1,878.728.0% Interbank loans305.94.6% Other loans284.14.2% Total loans$4,027.660.1% U.S.government securities932.213.9% Other securities683.910.2% Total securities$1,616.124.1% Cash assets304.74.5% Other assets755.011.3% Total assets$6,703.4100.0% SOURCE: Board of Governors of the Federal Reserve System, H.8 (510) Statistical Release.

14. Copyright © 2004 South-Western. All rights reserved.11–14 Consumer Loans Installment credit:  Loans to individual consumers that entail periodic repayments of principal and interest. Revolving credit:  Loans to individuals that permit them to borrow automatically up to specified limits and to repay the balance of the loan at any time.

15. Copyright © 2004 South-Western. All rights reserved.11–15 Commercial Bank Assets (cont’d) Term federal funds:  Interbank loans with maturities exceeding one day. Cash assets:  Depository institution assets that function as media of exchange.  Vault cash that a depository institution holds on location to honor cash withdrawals by depositors.  Reserve deposit accounts that depository institutions maintain at Federal Reserve banks.

16. Copyright © 2004 South-Western. All rights reserved.11–16 Commercial Bank Assets (cont’d) Correspondent balances:  Deposit accounts that banks hold with other banks. Cash items in process of collection:  Checks deposited with a bank for immediate credit but not yet cleared for final payment to the bank; usually referred to simply as “cash items.”

17. Copyright © 2004 South-Western. All rights reserved.11–17 Commercial Bank Liabilities and Equity Capital Liability:  A legally enforceable claim on the assets of a business or individual. Net worth:  The excess of assets over liabilities, or equity capital. Equity capital:  The excess of assets over liabilities, or net worth.

18. Copyright © 2004 South-Western. All rights reserved.11–18 Commercial Bank Asset Allocations Figure 11–1 SOURCE: Board of Governors of the Federal Reserve System, H.8 (510) Statistical Release.

19. Copyright © 2004 South-Western. All rights reserved.11–19 Commercial Bank Liabilities Noncontrollable liabilities:  Liabilities whose dollar amounts bank customers largely determine once banks have issued the liabilities to them.  Transactions deposits  Savings deposits  Small-denomination time deposits.  Deferred availability cash items.

20. Copyright © 2004 South-Western. All rights reserved.11–20 Commercial Bank Liabilities and Equity Capital ($ Billions), July 31, 2002 Table 11–2 Transactions deposits$ 635.89.5% Small time and savings deposits2,765.941.3% Large time deposits1,051.115.6% Total deposits$4,452.866.4% Borrowings from banks$ 393.55.9% Other borrowings897.213.4% Total borrowings$1,290.719.3% Other liabilities$ 423.66.3% Equity capital*$ 536.38.0%* Total liabilities and equity$6,703.4100.0% *Authors’ estimate. SOURCE: Board of Governors of the Federal Reserve System, H.8 (510) Statistical Release.

21. Copyright © 2004 South-Western. All rights reserved.11–21 Controllable Liabilities And Equity Capital Controllable liabilities:  Liabilities whose dollar amounts banks can directly manage.  Large-denomination time deposits  Purchased funds (very short-term bank borrowings in the money market)  Other borrowings –Sales of repurchase agreements, borrowings from the Federal Reserve, and Eurodollar liabilities.  Subordinated notes and debentures

22. Copyright © 2004 South-Western. All rights reserved.11–22 Brokered Deposits at Small U.S.Commercial Banks Figure 11–2 SOURCES: : Federal Deposit Insurance Corporation, Statistics on Banking, various issues; authors’ estimates.

23. Copyright © 2004 South-Western. All rights reserved.11–23 Commercial Bank Liabilities and Equity Capital Figure 11–3 SOURCES: Federal Reserve Bulletin, Board of Governors of the Federal Reserve System; and Quarterly Financial Results and Conditions of the Thrift Industry, Office of Thrift Supervision, various issues.

24. Copyright © 2004 South-Western. All rights reserved.11–24 Deposits at Federally Insured Savings Institutions Figure 11–4 SOURCES: Federal Reserve Bulletin, Board of Governors of the Federal Reserve System; and Quarterly Financial Results and Conditions of the Thrift Industry, Office of Thrift Supervision, various issues.

25. Copyright © 2004 South-Western. All rights reserved.11–25 Assets of Credit Unions as a Percentage of Assets at Commercial Banks Figure 11–4 SOURCES: National Credit Union Administration; and Federal Deposit Insurance Corporation, Statistics on Banking, various issues; authors’ estimates.

26. Copyright © 2004 South-Western. All rights reserved.11–26 Assets and Liabilities of Savings Institutions ($ Billions) Table 11–3 SOURCE: : Quarterly Financial Results and Conditions of the Thrift Industry, Office of Thrift Supervision, May 2002. Cash and securities$173.817.4% Mortgage loans540.354.2% Mortgage-backed securities89.69.0% Commercial loans31.03.1% Consumer loans66.26.6% Other assets 96.8 9.7% Total assets$997.7100.0% Total deposits$582.558.4% Government borrowings193.719.4% Other borrowings101.310.2% Other liabilities33.23.3% Equity capital 87.0 8.7% Total equity and liabilities$997.7100.0%

27. Copyright © 2004 South-Western. All rights reserved.11–27 Assets and Liabilities and Equity at Federally Insured Credit Unions ($ Billions) Table 11–4 SOURCE: Statistics for Federally Insured Credit Unions, National Credit Union Administration, March 2002. Loans$271.566.0%Share deposits$356.986.8% Securities100.724.5%Other liabilities & equity54.513.2% Cash assets25.86.3% Other assets 13.4 3.2% Total assets$411.4100.0%Total liabilities & equity$411.4100.0%

28. Copyright © 2004 South-Western. All rights reserved.11–28 Defining the Limits of Credit Union Membership The Federal Credit Union Act of 1934 limited membership in these depository institutions to “groups having a common bond of occupation or association, or to groups within a well- defined neighborhood, community, or rural district.”