Economics 370 Money and Banking

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Economics 370Money and Banking

• Instructor
• Ryan Herzog

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Overview

• Go over homework 3
• Finish Chapter 10
• Evaluations

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Decline of Traditional Banking

• Traditional Banking Make loan term loans and to
  fund them by issuing short-term deposits
• As a source of funds for borrowers, market share
  has fallen
• Banks making loans funded with deposits is no
  longer as important in our financial system
• Share of total financial intermediary assets has
  fallen
• No decline in overall profitability
• Increase in income from off-balance-sheet
  activities

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Decline of Traditional Banking

• Decline in cost advantages acquiring funds
  (liabilities)
• Rising inflation led to rise in interest rates
  and disintermediation
• Until 1960, checkable deposits were low-cost
  source of funds, since have declined in
  importance
• Decline in income advantages on uses of funds
  (assets)
• Information technology
• Decreased need for banks to finance short-term
  credit needs or to issue loans
• Lower transaction costs for other financial
  institutions, increasing competition

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Banks Responses

• Expand into new and riskier areas of lending
• Commercial real estate loans
• Leveraged buyouts
• Corporate takeovers
• Pursue off-balance-sheet activities
• Non-interest income
• Credit line, selling loan packages,
• Concerns about risk

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Bank Consolidation

• The number of banks has declined over the last 25
  years
• From 1985-1992 100 bank failures
• From 1985-1992 3,000 less banks
• From 1992-2005 3,500 less banks
• Most of the bank failures were from smaller banks

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Bank Consolidation

• Consolidation
• Mid 1970s states started to allow interstate
  banking
• Bank holding companies could purchase bank shares
  in other states
• Diversification
• Banks can make loans in other states, protects
  banks from state level recessions
• Superregional Banks
• Bank of America and Banc One

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Bank Consolidation

• Information Technology
• Economies of scale decreasing average costs
• Economies of scope the use of one resource
  provides many services
• Credit Ratings Loan worthiness and stock
  pricing
• Results may be not only a smaller number of banks
  but a shift in assets to much larger banks

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Bank Consolidation

• Deregulation
• Riegle Neal Interstate Banking and Branching
  Efficiency Act of 1994
• Overturns the McFadden Act which prohibited
  interstate banking
• Texas is the only state that has opted out of
  interstate branching
• In 1998 NationsBank and Bank of America merged
  creating the first bank with branches on both
  coasts
• U.S. still has 7,500 banks far more than many
  industrialized countries

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Benefits and Costs of Bank Consolidation

• Benefits
• Increased competition, driving inefficient banks
  out of business
• Increased efficiency also from economies of scale
  and scope
• Lower probability of bank failure from more
  diversified portfolios
• Costs
• Elimination of community banks may lead to less
  lending to small business
• Banks expanding into new areas may take increased
  risks and fail
• Financial intermediaries are encroaching on
  others territory

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Thrift Industry Regulation and Structure

• Savings and Loan Associations
• Chartered by the federal government or by states
• Most are members of Federal Home Loan Bank System
  (FHLBS)
• Deposit insurance provided by Savings Association
  Insurance Fund (SAIF), part of FDIC
• Regulated by the Office of Thrift Supervision
• Most states allowed branching and in 1980
  federally chartered SL were permitted interstate
  branching
• Mutual Banks
• Approximately half are chartered by states
• Regulated by state in which they are located
• Deposit insurance provided by FDIC or state
  insurance

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Thrift Industry Regulation and Structure
(contd)

• Credit Unions
• Tax-exempt
• Chartered by federal government or by states
• Regulated by the National Credit Union
  Administration (NCUA)
• Deposit insurance provided by National Credit
  Union Share Insurance Fund (NCUSIF)
• Owned by members and are generally not for profit
  businesses
• Centered around a particular group, union,
  occupation, or location

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International Banking

• 1960 8 US banks operated in foreign countries
• 2005 100 US banks operate in foreign countries
  with over 1.5 trillion in assets
• Rapid growth
• Growth in international trade and multinational
  corporations
• Global investment banking is very profitable
• Ability to tap into the Eurodollar market

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Eurodollar Market

• Dollar-denominated deposits held in banks outside
  of the U.S.
• Foreign firms often prefer the dollar
• Most widely used currency in international trade
• Eurodollars are not subject to reserve
  requirements
• Offshore deposits not subject to regulations
• Important source of funds for U.S. banks

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Structure of U.S. Banking Overseas

• U.S. bank locations
• Latin America, Far East, Caribbean, and London
• Shell operation
• Banks in the Caribbean (Bahamas and Cayman
  Islands) function as bookkeepers not banks Tax
  Havens
• Edge Act corporation
• U.S. banks that operate overseas (owning foreign
  banks and financial companies)
• International banking facilities (IBFs)
• Not subject to regulation and taxes
• May not make loans to domestic residents

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Foreign Banks in the U.S.

• Foreign Banks hold 10 of U.S. bank assets
• 16 of the market share for lending to U.S.
  corporations
• Agency office of the foreign bank
• Can lend and transfer funds in the U.S.
• Cannot accept deposits from domestic residents
• Not subject to regulations
• Subsidiary U.S. bank
• Subject to U.S. regulations
• Owned by a foreign bank

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Foreign Banks in the U.S. (contd)

• Branch of a foreign bank
• May open branches only in state designated as
  home state or in state that allow entry of
  out-of-state banks
• Limited-service may be allowed in any other state
• Subject to the International Banking Act of 1978
• Basel Accord (1988)
• Example of international coordination of bank
  regulation
• Sets minimum capital requirements for banks