common sources of funds for commercial banks common uses of funds for commercial banks typical off-balance sheet activities for commercial banks

1. 1
17
Commercial
Bank
Operations
© 2003 South-Western/Thomson Learning

2. 2
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

3. 3
Bank Participation in Financial
Conglomerates
 Impact of the Financial Services
Modernization Act (1999)
 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

4. 4
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

5. 5
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

6. 6
Bank Sources of Funds
 Transaction deposits
 Demand deposit account (checking)
 Savings Deposits
 Passbook savings

7. 7
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

8. 8
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

9. 9
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

10. 10
Bank Sources of Funds
 Eurodollar borrowings
 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

11. 11
Bank Sources of Funds
 Bank capital
 Obtained from issuing stock or retaining earnings
 No obligation to pay out funds in the future
 Must be sufficient to absorb operating losses

12. 12
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

13. 13
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

14. 14
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

15. 15
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
 Types of consumer loans
 Installment loans
 Credit cards
 Real estate loans

16. 16
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

17. 17
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

18. 18
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

19. 19
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

20. 20
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