Commercial Bank Operations

Commercial Bank Operations

Bank Participation in Financial Conglomerates

n     Benefits of diversified services to individuals and firms

l      Individuals can obtain all their financial services at a single financial conglomerate

u   Deposits

u   Loans

u   Investing (brokerage)

u   Insurance

l      Businesses can obtain loans, issue stocks and bonds, and have their pension fund managed by the same institution

Bank Participation in Financial Conglomerates

n     Benefits of diversified services to the financial institution

l      Reduce reliance on demand for single service

l      Diversification may result in less risk

l      Generate new business

Bank Sources of Funds

n     Demand deposit (checking) account

l      Requires small minimum balance but pays no interest

n     Savings Deposits

l      Does not permit check writing

l      Restrictions regarding amount and timing of withdrawal

l      Often have no minimum balance

l      Automatic Transfer Service (ATS) to checking account

Bank Sources of Funds

n     Time Deposits

l      Certificate of deposit (CD)

u   No secondary market

l      Negotiable CD

u   Short-term, minimum $100,000

u   Can trade among investors via dealer

n     Money Market Deposit Accounts (MMDAs)

l      More liquid than CDs : no specified maturity

l      Limited check writing

Bank Sources of Funds

n     Federal Funds Purchased

l      Short-term loans between banks

l      Allows banks to meet reserve requirement or funding needs

l      Interest rate charged is the federal funds rate

n     Borrowing from the Federal Reserve Banks (lender of last resort)

l      Rate slightly higher than federal funds rate

u   Intended for meeting temporary short-term needs

l      Must get Fed approval

n     Repurchase agreements

Bank Sources of Funds

n     Eurodollar borrowings

l      Banks outside the United States make dollar-denominated loans

n     Bonds issued by the bank

l      Like other businesses, banks issue bonds to finance long-term fixed assets

l      Usually subordinated to deposits

l      Secondary capital

Bank Sources of Funds

n     Bank capital

l      Obtained from issuing stock or retaining earnings

l      No obligation to pay out funds in the future

l      Primary capital

l      Must be sufficient to absorb operating losses

Uses of Funds by Banks

n     Cash balances at institutions

l      Reserve requirements imposed by Fed

u   Tool for controlling the money supply

l      Also hold cash and due from balances to maintain liquidity and accommodate withdrawal requests by depositors

Uses of Funds by Banks

n     Bank Loans

l      Types of business loans

u   Working capital loans

u   Term loans

n   Financing purchase of fixed assets

u   Informal line of credit

u   Revolving credit loan

Uses of Funds by Banks

n     Bank Loans

l      Loan participations/syndications

u   Sometimes large firms seek to borrow more money than an individual bank can provide

u   Lead bank: initiates and services the loan for fees

l      Collateral requirements on business loans

u   Increasingly accepting intangible assets

u   Important to service-oriented firms

Uses of Funds by Banks

n     Bank Loans

l      Types of consumer loans

u   Installment loans

u   Credit cards

l      Real estate loans (Mortgages)

Uses of Funds by Banks

n     Investment securities (bank income and liquidity)

l      Treasury securities

l      Government agency securities

u   Freddie Mac and Fannie Mae

l      Corporate and municipal securities

u   Investment grade only

n     Federal funds sold

l      Lending funds in the federal funds market

Uses of Funds by Banks

n     Repurchase agreements (reverse repo)

n     Eurodollar loans and deposits

n     Fixed assets

l      Office buildings and land

Off-Balance Sheet Activities

n     Loan commitments (“Limits”)

l      Obligation of bank to provide a specified loan amount to a particular business upon request

l      Note issuance facility (NIF)

l      Banks earn fee income for risk assumed

n     Asset Securitization

n     Standby letters of credit (SLC)

l      Backs a customer’s obligation to a third party

l      Banks earn fee income