Chapter Eleven

Commercial Banks:
Industry Overview

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Commercial Banks
Commercial
Commercialbanks
banksare
arethe
thelargest
largestgroup
groupof
offinancial
financial
institutions
institutionsin
interms
termsof
oftotal
totalassets
assets
Major
Majorassets
assetsare
areloans
loans
Major
Majorliabilities
liabilitiesare
aredepositsthus,
depositsthus,they
theyare
areconsidered
considered
depository
depositoryinstitutions
institutions
Perform
Performservices
servicesessential
essentialto
toU.S.
U.S.financial
financialmarkets
markets

play
playaakey
keyrole
roleininthe
thetransmission
transmissionof
ofmonetary
monetarypolicy
policy
provide
providepayment
paymentservices
services
provide
providematurity
maturityintermediation
intermediation

Banks
Banksare
areregulated
regulatedto
toprotect
protectagainst
againstdisruptions
disruptionsto
tothe
the
services
servicesthey
theyperform
perform
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Commercial Bank Assets

Loans
Loansgenerate
generaterevenue
revenuefor
forbanks
banks

commercial
commercialand
andindustrial
industrialloans
loansare
aredeclining
decliningbecause
becauseof
of
nonbank
nonbanksubstitutes
substitutessuch
suchas
ascommercial
commercialpaper
paper
mortgages
mortgagesare
areincreasing
increasingin
inimportance
importance

Investment
Investmentsecurities
securitiesgenerate
generaterevenue
revenueand
andprovide
provide
banks
bankswith
withliquidity
liquidity
Cash
Cashassets
assetsare
areheld
heldto
tomeet
meetreserve
reserverequirements
requirements
and
andto
toprovide
provideliquidity
liquidity
Other
Otherassets
assetsinclude
includepremises
premisesand
andequipment,
equipment,other
other
real
realestate
estateowned,
owned,etc.
etc.
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Commercial Bank Assets

Commercial
Commercial banks
banks face
face unique
unique risks
risks because
because of
of
their
their asset
asset structure
structure

credit
credit(default)
(default)risk
riskisisthe
therisk
riskthat
thatloans
loansare
arenot
not
repaid
repaid
liquidity
liquidityrisk
riskisisthe
therisk
riskthat
thatdepositors
depositorswill
willdemand
demand
more
morecash
cashthan
thanbanks
bankscan
canimmediately
immediatelyprovide
provide
interest
interestrate
raterisk
riskisisthe
therisk
riskthat
thatinterest
interestrate
ratechanges
changes
erode
erodenet
networth
worth
credit,
credit,liquidity,
liquidity,and
andinterest
interestrate
raterisk
riskall
allcontribute
contributeto
toaa
commercial
commercialbanks
bankslevel
levelof
ofinsolvency
insolvencyrisk
risk

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Commercial Bank Liabilities

Transaction
Transactionaccounts
accountsare
arethe
thesum
sumof
ofnoninterest-bearing
noninterest-bearing
demand
demanddeposits
depositsand
andinterest-bearing
interest-bearingchecking
checkingaccounts
accounts
interest
interestbearing
bearingdeposit
depositaccounts
accountsare
arecalled
callednegotiable
negotiable
order
of
withdrawal
(NOW)
accounts
order of withdrawal (NOW) accounts

Household
Household(retail)
(retail)savings
savingsand
andtime
timedeposits
depositshave
havebeen
been
declining
decliningin
inrecent
recentyears
yearsbecause
becauseof
ofMMMFs
MMMFs
passbook
passbooksavings
savingsaccounts
accounts
retail
retailtime
timedeposits
deposits

Large
Largetime
timedeposits
deposits

negotiable
negotiableCDs
CDsare
arefixed-maturity
fixed-maturityinterest-bearing
interest-bearingdeposits
deposits
with
withface
facevalues
valuesof
of$100,000
$100,000or
ormore
morethat
thatcan
canbe
beresold
resoldin
in
the
thesecondary
secondarymarket
market

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Commercial Bank Liabilities & Equity

Non-deposit
Non-deposit liabilities
liabilities
fed
fedfunds
fundspurchased
purchased
repos
repos
notes
notesand
andbonds
bonds

Minimum
Minimumlevels
levels of
of equity
equity capital
capital are
are required
required by
by
regulators
regulators to
to act
act as
as aa buffer
buffer against
against losses
losses
common
commonand
andpreferred
preferredstock
stock
surplus
surplusor
oradditional
additionalpaid-in
paid-incapital
capital
retained
retainedearnings
earnings
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Off-Balance-Sheet Activities
Commercial
Commercialbanks
banksengage
engagein
inmany
manyfee-related
fee-relatedactivities
activities
that
thatare
areconducted
conductedoff
offthe
thebalance
balancesheet
sheet

guarantees
guaranteessuch
suchas
asletters
lettersof
ofcredit
credit
future
futurecommitments
commitmentstotolend
lend
derivative
derivativetransactions
transactions(e.g.,
(e.g.,futures,
futures,forwards,
forwards,options,
options,and
and
swaps)
swaps)

Off-balance-sheet
Off-balance-sheetasset
asset

when
whenan
anevent
eventoccurs,
occurs,this
thisitem
itemmoves
movesonto
ontothe
theasset
assetside
sideof
ofthe
the
balance
balancesheet
sheetor
orincome
incomeisisrealized
realizedon
onthe
theincome
incomestatement
statement

Off-balance-sheet
Off-balance-sheetliability
liability

when
whenan
anevent
eventoccurs,
occurs,this
thisitem
itemmoves
movesonto
ontothe
theliability
liabilityside
sideof
of
the
balance
sheet
or
an
expense
is
realized
on
the
income
the balance sheet or an expense is realized on the income
statement
statement

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Commercial Banks
The
The Reigle-Neal
Reigle-NealAct
Act of
of1994
1994allowed
allowednationwide
nationwide
branch
branch networks
networksto
toevolve
evolve
14,483
14,483banks
bankswith
withsome
some60,000
60,000branches
branchesin
in1984
1984
7,350
7,350banks
bankswith
withsome
some83,000
83,000branches
branchesin
in2007
2007

The
The Financial
Financial Services
ServicesModernization
ModernizationAct
Act of
of
1999
1999

gave
gavecommercial
commercialbanks
banksthe
thefull
fullauthority
authorityto
toenter
enterthe
the
investment
investmentbanking
bankingand
andinsurance
insurancebusiness
business

Industrial
Industrial loan
loancorporations
corporations(ILCs)
(ILCs) are
are
considered
considered non-bank
non-bank banks
banks
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Commercial Banks
AAmegamerger
megamergerisisaamerger
mergerof
ofcommercial
commercialbanks
bankswith
withassets
assets
of
of$1
$1billion
billionor
ormore
more
Economies
Economiesof
ofscale
scalerefer
referto
tothe
thedegree
degreeto
towhich
whichaafirms
firms
average
averageunit
unitcosts
costsof
ofproducing
producingfinancial
financialservices
servicesfall
fallas
asits
its
output
outputof
ofservices
servicesincrease
increase

diseconomies
diseconomiesof
ofscale
scaleoccur
occurwhen
whenthe
thecosts
costsof
ofjoint
jointproduction
productionof
of
FI
services
are
higher
than
they
would
be
if
they
were
produced
FI services are higher than they would be if they were produced
independently
independently

Economies
Economiesof
ofscope
scoperefer
referto
tothe
thedegree
degreeto
towhich
whichaafirm
firmcan
can
generate
generatecost
costsynergies
synergiesby
byproducing
producingmultiple
multiplefinancial
financial
service
serviceproducts
products
XXefficiencies
efficienciesrefer
referto
tocost
costsavings
savingsdue
dueto
togreater
greatermanagerial
managerial
efficiency
efficiency
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Commercial Banks
Retail
Retailbanking
bankingisisconsumer-oriented
consumer-oriented

residential
residentialand
andconsumer
consumerloans
loansare
arefunded
fundedby
byaccepting
accepting
small
smalldeposits
deposits
community
communitybanks
banksspecialize
specializein
inretail
retailbanking
banking

Wholesale
Wholesalebanking
bankingisiscommerce-oriented
commerce-oriented

commercial
commercialand
andindustrial
industrialloans
loansare
areoften
oftenfunded
fundedwith
with
purchased
purchasedfunds
funds
regional
regionalor
orsuperregional
superregionalbanks
banksengage
engagein
inaacomplete
complete
array
arrayof
ofwholesale
wholesalebanking
bankingactivities
activities
money
moneycenter
centerbanks
banksrely
relyheavily
heavilyon
onnondeposit
nondepositor
or
borrowed
borrowedsources
sourcesof
offunds
fundsoften
oftenborrowed
borrowedin
inthe
thefederal
federal
funds
fundsmarket
market

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2009, The McGraw-Hill Companies, All Rights

Commercial Banks
Because
Becauselarger
largerbanks
banksgenerally
generallylend
lendto
tolarger
larger
corporations,
corporations,their
theirinterest
interestrate
ratespreads
spreadsand
andnet
netinterest
interest
margins
marginsare
areusually
usuallynarrower
narrowerthan
thanthose
thoseof
ofsmaller
smallerbanks
banks
interest
interestrate
ratespread
spreadisisthe
thedifference
differencebetween
betweenlending
lendingand
and
deposit
depositrates
rates
net
netinterest
interestmargin
marginisisinterest
interestincome
incomeminus
minusinterest
interestexpense
expense
divided
dividedby
byearning
earningassets
assets

Large
Largebanks
bankstend
tendto
topay
payhigher
highersalaries
salariesand
andinvest
investmore
morein
in
buildings
buildingsand
andpremises
premisesthan
thansmall
smallbanks
banks
Large
Largebanks
bankstend
tendto
todiversify
diversifytheir
theiroperations
operationsmore
moreand
and
generate
generatemore
morenoninterest
noninterestincome
incomethan
thansmall
smallbanks
banks
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Industry Performance
U.S.
U.S.commercial
commercialbanks
banksflourished
flourishedduring
duringthe
the
economic
economicexpansion
expansionof
ofthe
the1990s
1990s
The
Theeconomic
economicdownturn
downturnof
ofthe
theearly
early2000s
2000scaused
caused
performance
performanceto
todeteriorate
deteriorateonly
onlyslightly
slightly
By
By 2003
2003ROA
ROAand
andROE
ROEhad
hadreached
reachedall-time
all-timehighs
highs
In
Inthe
thefourth
fourthquarter
quarterof
of2006
2006mortgage
mortgagedelinquencies
delinquencies
(particularly
(particularly subprime
subprimemortgages)
mortgages)surged
surged
Losses
Lossesfrom
fromfalling
fallingvalues
valuesof
ofsubprime
subprimemortgages
mortgages
caused
causedfourth
fourthquarter
quarter2007
2007net
netincome
incometo
tohit
hitaa1616year
yearlow
low
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Wholesale Banking Services

Controlled
Controlleddisbursement
disbursement
accounts
accounts
Account
Accountreconciliation
reconciliation
Lockbox
Lockboxservices
services
Electronic
Electroniclockbox
lockbox
Funds
Fundsconcentration
concentration
Electronic
Electronicfunds
fundstransfer
transfer
Check
Checkdeposit
depositservices
services
Electronic
Electronicinitiation
initiationof
of
letters
lettersof
ofcredit
credit
McGraw-Hill/Irwin

11-13

Treasury
Treasurymanagement
management
software
software
Electronic
Electronicdata
data
interchange
interchange
Facilitating
Facilitatingbusiness-tobusiness-tobusiness
businesse-commerce
e-commerce
Electronic
Electronicbilling
billing
Verifying
Verifyingidentities
identities
Assisting
Assistingsmall
smallbusiness
business
entries
entriesin
ine-commerce
e-commerce

2009, The McGraw-Hill Companies, All Rights

Retail Banking Services

Automated
Automatedteller
tellermachines
machines(ATMs)
(ATMs)
Point-of-sale
Point-of-sale(POS)
(POS)debit
debitcards
cards
Preauthorized
Preauthorizeddebits
debitsand
andcredits
credits
Paying
Payingbills
billsvia
viatelephone
telephone
Online
Onlinebanking
banking
Smart
Smartcards
cards(stored-value)
(stored-value)cards
cards
Internet
Internetbanking
banking

complements
complementsexisting
existingbusiness
businessfor
foralready
alreadyexisting
existingbanks
banks
some
somenew
newinternet-only
internet-onlybanks
bankshave
haveno
nobrick
brickand
andmortar
mortar

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2009, The McGraw-Hill Companies, All Rights

Regulators
The
TheFederal
FederalDeposit
DepositInsurance
InsuranceCorporation
Corporation(FDIC)
(FDIC)
insures
insuresthe
thedeposits
depositsof
ofcommercial
commercialbanks
banks
The
TheU.S.
U.S.has
hasaadual
dualbanking
bankingsystembanks
systembankscan
canbe
be
either
eithernationally
nationallyor
orstate
statechartered
chartered

the
theOffice
Officeof
ofthe
theComptroller
Comptrollerof
ofthe
theCurrency
Currency(OCC)
(OCC)charters
charters
and
regulates
national
banks
and regulates national banks
state
stateagencies
agenciescharter
charterand
andregulate
regulatestate
statebanks
banks

The
TheFederal
FederalReserve
ReserveSystem
System(FRS)
(FRS)has
hasregulatory
regulatory
power
powerover
overnationally
nationallychartered
charteredbanks
banksand
andtheir
theirholding
holding
companies
companiesand
andstate
statebanks
banksthat
thatopt
optin
into
tothe
theFederal
Federal
Reserve
ReserveSystem
System

aaholding
holdingcompany
companyisisaaparent
parentcompany
companythat
thatowns
ownsaacontrolling
controlling
interest
in
a
subsidiary
bank
or
other
FI
interest in a subsidiary bank or other FI

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2009, The McGraw-Hill Companies, All Rights

International Commercial Banking

Commercial
Commercialbanking
bankinghas
hastruly
trulybecome
becomean
an
international
internationaland
andglobal
globalmarket
market
The
Thefour
fourlargest
largestbanks
banksin
inthe
theworld,
world,as
asof
of2007,
2007,are
are
from
fromfour
fourdifferent
differentcountries
countries
UBS
UBSGroup
GroupisisaaSwiss
Swissbank
bankwith
with$1.96
$1.96trillion
trillionin
inassets
assets
Barclays
BarclaysBank
BankisisaaU.K.
U.K.bank
bankwith
with$1.96
$1.96trillion
trillionininassets
assets
BNP
BNPParibas
ParibasisisaaFrench
Frenchbank
bankwith
with$1.90
$1.90trillion
trillionin
inassets
assets
Citigroup
CitigroupisisaaU.S.
U.S.bank
bankwith
with$1.88
$1.88trillion
trillionin
inassets
assets

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International Commercial Banking

Advantages
Advantages of
of international
international expansion
expansion
risk
riskdiversification
diversification
economies
economiesof
ofscale
scale
distribute
distributenew
newproduct
productinnovations
innovationsinternationally
internationally
opportunity
opportunityto
tofind
findthe
thecheapest
cheapestand
andmost
mostavailable
available
sources
sourcesof
offunds
funds
service
servicethe
theneeds
needsof
ofdomestic
domesticmultinational
multinational
corporations
corporations
regulatory
regulatoryavoidance
avoidance
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International Commercial Banking

Disadvantages
Disadvantages of
of international
international expansion
expansion
information
informationand
andmonitoring
monitoringcosts
costsare
aregenerally
generallyhigher
higher
in
inforeign
foreignmarkets
markets
foreign
foreignassets
assetsmay
maybe
besubject
subjectto
tonationalization
nationalizationor
or
expropriation
expropriationby
byhost
hostcountry
countrygovernments
governments
the
thefixed
fixedcosts
costsof
ofestablishing
establishingforeign
foreignorganizations
organizations
may
maybe
beextremely
extremelyhigh
high

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Global Banking Performance

Banks
Banks in
in most
most regions
regions of
of the
the world
world posted
posted strong
strong
performance
performance in
in the
the early
early and
and mid-2000s
mid-2000s
mortgage
mortgagelending
lendingboosted
boostedrevenue
revenuein
inFrance
Franceand
andSpain
Spain
as
aspersonal
personalbankruptcies
bankruptciesrose
roseworldwide,
worldwide,U.K.
U.K.banks
banks
profitability
profitabilitywas
wasmaintained
maintainedbecause
becauseof
ofdiversification
diversification
in
in2001
2001the
theJapanese
Japanesegovernment
governmentbacked
backedthe
thepurchase
purchaseof
of
$90
$90billion
billionof
ofshares
sharesof
ofJapanese
Japanesebanks
banksin
inan
anattempt
attemptto
to
avert
avertaabanking
bankingcollapse
collapse
the
theChinese
Chinesestate-run
state-runbanking
bankingsystem
systemdeteriorated
deterioratedin
inthe
the
early
early2000s,
2000s,which
whichcaused
causedChina
Chinato
toease
easerestrictions
restrictionson
on
foreign
foreignbank
bankoperations
operations

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2009, The McGraw-Hill Companies, All Rights