Commercial Banking

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Commercial Banking

• Banks Balance Sheet
• Bank Management
• Off-Balance-Sheet Activities
• Banks Income Statement
• Banks Regulations

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Ten Largest U.S. Banks
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Ten Largest Banks in the World
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Uniform Bank Performance Report (UBPR)

• A comprehensive analytical too created by the
  FDIC on a quarterly report requirement
• Contain banks profitability and risk
  information in a consistent and uniformed basis
• To obtain information http//www2.fdic.gov/ubp
  r and then follow instruction

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The Bank Balance Sheet
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Assets Uses of Funds

• Reserves
• Cash Items in Process of Collection
• A check written on an account at another bank is
  deposited in bank A and the funds for this check
  have not yet been received from the other bank.
• Deposits at Other Banks
• Securities debt securities only
• US government and agency securities
• State and local gov. (municipal) securities
• Others (investment-grade securities)
• Bank Loans

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Alternative types of loans

• Commercial loans
• business borrowing
• Temporary working capital need (prime rate)
  credit line
• Long-term uses, e.g., equipment purchases, plant
  expansion
• Consumer Loans
• Non-mortgage loans to consumers
• Installment loans (purchase of cars and household
  products)
• Credit card loans (interest rate is quite high)
• Real Estate Loans
• Agriculture Loans
• Short term

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Liabilities and Equity Sources of Funds

• Checkable Deposits
• non-interest-bearing checking accounts (demand
  deposits)
• interest-bearing NOW (negotiable order of
  withdrawal)
• money market deposit account (MMDAs)
• Nontransaction Deposits
• Saving Accounts
• Time Deposits small-denomination
  large-denomination
• Borrowing
• discount loan and other borrowings
• Bank Capital

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Bank Management

• 1. Liquidity management
• 2. Asset management
• A. Managing credit risk
• B. Managing interest-rate risk
• 3. Liability management
• 4. Managing capital adequacy

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Liquidity Management Reserve
requirement 10, Excess reserves 10 million
Assets
Liabilities Reserves 20 million
Deposits 100 million Loans
80 million Bank Capital
10 million Securities 10 million
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Liquidity Management

• Deposit outflow of 10 million
• Assets
  Liabilities
• Reserves 10 million Deposits
  90 million
• Loans 80 million Bank Capital
  10 million
• Securities 10 million
• With 10 reserve requirement, bank still has
  excess reserves of 1 million no changes needed
  in balance sheet

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Liquidity Management

• No excess reserves
• Assets
  Liabilities
• Reserves 10 million Deposits
  100 million
• Loans 90 million Bank
  Capital 10 million
• Securities 10 million
• Deposit outflow of 10 million
• Assets
  Liabilities
• Reserves 0 million Deposits
  90 million
• Loans 90 million Bank Capital
  10 million
• Securities 10 million
• With 10 reserve requirement, it has 9 million
  reserve shortfall

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Liquidity Management

• 1. Borrow from other banks or corporations
• Assets
  Liabilities
• Reserves 9 million Deposits
  90 million
• Loans 90 million Borrowings
  9 million
• Securities 10 million Bank Capital
  10 million
• 2. Sell securities
• Assets
  Liabilities
• Reserves 9 million
  Deposits 90 million
• Loans 90 million Bank
  Capital 10 million
• Securities 1 million

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Liquidity Management

• 3. Borrow from Fed
• Assets
  Liabilities
• Reserves 9 million Deposits
  90 million
• Loans 90 million Discount Loans 9
  million
• Securities 10 million Bank Capital 10
  million
• 4. Call in or sell off loans
• Assets
  Liabilities
• Reserves 9 million Deposits
  90 million
• Loans 81 million Bank Capital
  10 million
• Securities 10 million
• Conclusion excess reserves are insurance
  against
• above 4 costs from deposit outflows

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Asset and Liability Management

• Asset Management
• 1. Get borrowers with low default risk, paying
  high interest rates
• 2. Buy securities with high return, low risk
• 3. Diversify
• 4. Manage liquidity
• Liability Management
• 1. Important since 1960s
• 2. No longer primarily depend on checkable
  deposits, more on other borrowing
• 3. When see loan opportunities, borrow or issue
  CDs to acquire funds (first developed in 1961)

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Capital Adequacy Management

• 1. Bank capital is a cushion that prevents bank
  failure
• 2. Higher is bank capital, lower is return on
  equity
• ROA Net Profits/Assets
• ROE Net Profits/Equity Capital
• EM Assets/Equity Capital
• ROE ROA x EM (EM is equity multiplier)
• Capital ?, EM ?, ROE ?
• 3. Tradeoff between safety (high capital) and ROE
• 4. Banks also hold capital to meet capital
  requirements
• 5. Strategies for Managing Capital
• A. Sell or retire stock
• B. Change dividends to change retained earnings
• C. Change asset growth

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Off-Balance-Sheet Activities

• Involve trading financial instruments and
  generating income from fees and loan sales,
  activities that affect bank profits but do not
  appear on bank balance sheet
• For example, hedging with financial
  derivatives are off-balance-sheet activities.
  They are used to reduce Fis risk exposures, but
  they all involve risks.

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Off-Balance-Sheet Activities

• Loan Sales
• Fee income from
• A. Foreign exchange trades for customers
• B. Servicing mortgage-backed securities
• C. Guarantees of debt
• D. Backup lines of credit
• 2. Financial futures and options
• 3. Foreign exchange trading
• 4. Interest rate swaps

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Banks' Income Statement
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Banks Income Statement

• Operating Income
• interest income
• non-interest income
• Operating Expenses
• interest expenses
• non-interest expenses
• provisions for loan losses

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Income Statement

• Net Operating Income Difference between
  Operating Income and Operating Expenses
• Gains/losses on Securities
• Gains/lossesExtraordinary Items events or
  transactions that are unusual and infrequent
• Income taxes profit after tax

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Measures of Bank Performance

• ROA Net Profits/ Assets
• ROE Net Profits/ Equity Capital
• NIM Interest Income - Interest Expenses/
  Assets

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Bank Regulation

• Regulatory Structure
• A charter from state/federal gov is needed for
  open a commercial bank
• State bank having state charter, regulated by
  state agency
• National bank having federal charter
• Regulated by the office of Comptroller of
  Currency (issue charter)
• FDIC
• Federal Reserve

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Branching Regulations

• Branching Restrictions
• Anticompetitive
• Response to Branching Restrictions
• 1. Bank Holding Companies
• A. Allowed purchases of banks outside state
• B. BHCs allowed wider scope of activities by Fed
• C. BHCs dominant form of corporate structure for
  banks
• 2. Nonbank Banks
• Not subject to branching regulations, but
  loophole closed in 1987
• 3. Automated Teller Machines
• Not considered to be branch of bank, so networks
  allowed

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Bank Consolidation and Number of Banks
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Nationwide Banking and Bank Consolidation

• Bank Consolidation Why?
• 1. Branching restrictions weakened
• 2. Development of superregional banks
• Riegle-Neal Act of 1994
• 1. Allows full interstate branching
• 2. Promotes further consolidation
• Future of Industry Structure
• Will become more like other countries, but not
  quite
• Several thousand, not several hundred

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Separation of Banking and Securities Industries
Glass-Steagall

• Case for Glass-Steagall
• 1. FDIC gives unfair advantage to banks
• 2. Allowing banks into underwriting is dangerous
  because FDIC promotes too much risk taking
• 3. Potential conflicts of interest
• Case Against Glass-Steagall
• 1. Decreases competition
• 2. Unfair to banks
• 3. Hinders diversification
• Will Separation Continue?
• No, Gramm-Leach-Bliley Financial Service
  Modernization Act of 1999
• 1) allow banks to underwrite insurance and
  securities and engage in real estate
• 2) allows securities firms and insurance
  companies to purchase banks

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Separation of Banking and Securities Industries
Glass-Steagall

• Separation in Other Countries
• 1. Universal banking Germany
• 2. British-style universal banking
• 3. U.S./Japan separation

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Other Depositary Institutions

• Thrifts (or thrift institutions)
• Mutual saving banks depositors are owners of
  firms
• SLs (saving and loan Associations) getting
  deposits and make long-term mortgage loans
• Credit unions financial institutions that focus
  on servicing the banking and lending needs of its
  members