Overview of Depository Institutions

Size, Structure and Composition of Depository FIs

Definition of Commercial Bank Accept demand deposits and make commercial loans. Consolidation has created some very large depository FIs Depository institutions Commercial Banks Specialize in short-term business credit Largest depository institutions are commercial banks Shrinking number of banks: 14,416 commercial banks in 1985, 12,744 in 1989, 8,315 in 2000 and 6911 in 2009. Mostly the result of mergers and acquisitions Commercial banks are also classified as Community banks Regional and Super-regional: Access to federal funds market to finance their lending activities Money Center banks: Bank of New York, Citigroup, J.P. Morgan/Chase, HSBC Bank USA Financial Services Modernization Act 1999: Allowed full authority to enter investment banking (and insurance) Thrifts Savings & loan associations (S&Ls): Founded in mid-1800s Specialize in real estate loans Members pooled funds to loan to members to buy houses Originally all were mutual associations, the board elected by members; now some are stock-issuing corporations Savings Banks: Founded in early 1800s Provided savings accounts for individuals Existed then and now only in New England Credit Unions Fields of membership requirements: employee groups, associations, religious affiliations and residential areas Not- for-profit organization Offers lower average fees and more competitive rates than banks do

Understanding Commercial Banks Balance Sheets

Balance Sheet Assets = Liabilities + Equity Bank assets Cash and due from banks: vault cash, deposits held at the Fed and other financial institutions, and cash items in the process of collection 1

Investment Securities: assets held to earn interest and help meet liquidity needs Loans: the major asset, generate the greatest amount of income, exhibit the highest default risk and are relatively illiquid Other assets: bank premises and equipment, interest receivable, prepaid expenses, other real estate owned, and customers' liability to the bank Commercial banks primary assets: 2000 2009 Real Estate Loans: $1,670.3 billion $3,799.3 billion C&I loans: $1,048.2 billion $1,210.7 billion Loans to individuals: $609.7 billion $959.1 billion Other loans: $367.5 billion Investment security portfolio: $1,662.0 billion $3,335.2 billion Of which, Treasury bonds: $710.0 billion $1,225.5 billion

Bank liabilities and equity Assets = Liabilities + Equity Bank liabilities Demand deposits: transactions accounts that pay no interest Negotiable orders of withdrawal (NOWs) and automatic transfers from savings (ATS) accounts: pay interest set by each bank without federal restrictions Money market deposit accounts (MMDAs): pay market rates, but a customer is limited to no more than six checks or automatic transfers each month Savings and time deposits represent the bulk of interest-bearing liabilities at banks: Deposits held in foreign offices: balances issued by a bank subsidiary located outside the U.S. Rate-sensitive borrowings: Federal Funds purchased and Repos Core vs. volatile funds Core deposits include: demand deposits, NOW accounts, MMDAs, and small time deposits Core deposits are stable deposits that are not highly interest rate-sensitive Core deposits are more sensitive to the fees charged, services rendered, and location of the bank Volatile liabilities or net non-core liabilities include: large CDs (over 100,000), deposits in foreign offices, federal funds purchased, repurchase agreements, and other borrowings with maturities less than one year Large, or volatile, borrowings are liabilities that are highly rate-sensitive Commercial banks primary liabilities: 2000 2009 Deposits: $4,176.6 billion $8,178.2 billion Borrowings: $1,532.5 billion $2,065.6 billion Other liabilities: $401.0 billion $307.4 billion

Stockholders equity Subordinated notes and debentures: notes and bonds with maturities in excess of one year Ownership interest in the bank: common and preferred stock and retained earnings The income statement Interest income (II): the sum of interest and fees earned on all of a bank's assets, interest income includes interest from: Loans Deposits held at other institutions Municipal and taxable securities, and Investment and trading account securities Interest expense (IE) is the sum of interest paid on all interest-bearing liabilities Interest income less interest expense is net interest income (NII) Loan-loss provisions (PLL): represent management's estimate of potential lost revenue from bad loans Noninterest income (OI) Noninterest expense (OE) Personnel expense: salaries and fringe benefits paid to bank employees Occupancy expense : rent and depreciation on equipment and premises, and Other operating expenses: utilities and deposit insurance premiums Evaluating bank performance Return on equity (ROE) Return on assets (ROA) Trends of bank balance sheets Business loans have declined in importance Offsetting increase in securities and mortgages Increased importance of funding via commercial paper market Securitization of mortgage loans

Regulation of Depository Institutions

Goals and Functions of Bank Regulation Ensure the Safety and Soundness of Banks Provide an Efficient and Competitive Financial System Provide Monetary Stability Maintain the Integrity of the Payments System Protect Consumers from Abuses o Dual Banking System: Coexistence of nationally and state-chartered banks. Office of the Comptroller of the Currency (OCC) Charters national banks Office of Thrift Supervision (OTS) Charters federal savings banks and savings associations National Credit Union Administration

Charters federal credit unions State Banking Authorities Charter state banks State Savings Authorities Charter state savings banks State Credit Union Authorities Charter state credit unions Federal Deposit Insurance Depositors are currently insured up to $250,000 per qualify account per insured bank FDIC maintains the deposit insurance fund at 1.25% of insured deposits. Currently, the fund is well-funded and over 90% of banks pay no insurance premium National versus State Charter All banks obtain FDIC deposit insurance as part of the chartering process National banks must join the Fed Primary regulator is the OCC State banks may join the Fed State banks are regulated by their state banking authority. State banks also have a primary federal regulator The primary federal regulator of state banks that are members of the Fed is the Federal Reserve The primary federal regulator of Non-Fed member state banks is the FDIC What is Regulated? Initial creation of depository institutions Initial licensing and chartering Location and number of physical branches, offices Initial board of directors and officers Minimum cash and capital requirements to open On-going operations Mergers and acquisitions Opening or closing of offices, branches Many operations procedures What financial services/products may be offered Assets Diversification of assets Quality of assets Liquidity of assets Level of cash reserves Liabilities & equity Types of liabilities created Distribution of financing of assets Quality of liability and equity accounts Minimum capital requirements Others

Community involvement Degree of market share in each market area Non-discriminatory operating policies Degree of risk created through the use of derivatives and other financial instruments Regulatory Process Examinations Federal Financial Institutions Examination Council (FFIEC) Securities & Exchange Commission State Regulatory Departments Reports Multiple agencies Multiple areas CAMELS Rating: C apital adequacy; A sset Quality; M anagement Quality; E arnings amount & stability; L iquidity; S ensitivity to market risk One versus Multiple Regulators Multiple regulators Provide more ability to detect problems Provide cross-checks Are inefficient and costly to maintain One regulator More efficient and lower cost Too much power concentrated in one place

Fundamental Forces of Change in Banking

Deregulation Financial Innovation Securitization Globalization Advances in Technology