Banking Banking in the U. in the U.

S.S.

ECO 473Dr. D. Foster

Institutions . . .Institutions . . .

• Commercial Banks “Money Center” banks

Regional (& Super-) banks

Community Banks

• Savings Institutions Lost 50% of deposits 1989 - 2001

1980s - Congress relaxes lending rules

• Credit Unions 1934-strict member rules; relaxed since.

no fed’l tax - deposit rates & loan rates

Commercial Bank Commercial Bank Assets Assets

($ Billions), June 2008 ($ Billions), June 2008Commercial & industrial loans 1,507 13.5%Consumer loans 831 7.5%Real estate loans 3,645 32.7%Interbank loans 454 4.1%Other loans (net) 918 8.2%Total loans 7,355 66.1%

U.S. government securities 1,113 10.0%Other securities 1,358 12.2%Total securities 2,471 22.2%

Cash assets 300 2.7%

Other assets 1,004 9.0%Total assets 11,130 100.0%

Dec.Dec.20142014

1,784 11.9%1,198 8.0%3,629 24.2%

86 0.6%1,195 8.0%7,892 52.6%

2,045 13.6%884 5.9%

2,929* 19.5%

2,821 18.8%

1,363 9.1%15,005 100.0%

* $1,393 bill. is in * $1,393 bill. is in mortgaged-backed mortgaged-backed

securities (MBS)securities (MBS)

Commercial Bank LiabilitiesCommercial Bank Liabilitiesand Equity Capital and Equity Capital

($ Billions), June 2008($ Billions), June 2008

Transactions deposits 603 Small time and savings deposits 4,180 Large time deposits 2,126 Total deposits 6,909

Borrowings from banks 480Other borrowings 1,829 Total borrowings 2,309

Trading liabilities --- Other liabilities 674

Net due to foreign offices -18

Equity capital 1,155 Total liabilities & equity 11,029

5.5%37.9%19.3%62.6%

4.4%16.6%20.9%

--- 6.1%

-0.2%

10.5%100.0%

Dec.Dec.20142014

--- ---8,736 58.2%

1,700 11.3%10,436 69.5%

118 0.8%1,663 11.1%

1,781 11.9%

226 1.5%423 2.8%

505 3.4%

1,642 10.9%15,013 100.0%

Commercial Bank Asset AllocationsCommercial Bank Asset Allocations Dec. Dec. 20142014

6060%%

2020%%2020%%

Commercial Bank LiabilitiesCommercial Bank Liabilitiesand Equity Capitaland Equity Capital Dec. Dec.

20142014

7070%%

1919%%

1111%%

Misc. Data on Banks & Savings Institutions Misc. Data on Banks & Savings Institutions (FDIC)(FDIC)

Misc. Data on Credit Unions (FDIC)Misc. Data on Credit Unions (FDIC)

The Top Fifteen Banks* [based on The Top Fifteen Banks* [based on assets] in the United States (FRS)assets] in the United States (FRS)

*Bank Holding CompaniesAs of September 30, 2014

Assets in thousands of dollars.

Sources of Commercial Bank RevenuesSources of Commercial Bank Revenues

Commercial Bank Expenses

Equity as a Percentage of Bank Equity as a Percentage of Bank Assets in the United States, Assets in the United States,

1840–Present1840–Present

Evolution of theories of bank Evolution of theories of bank management & risk.management & risk.

• Real bills doctrineReal bills doctrine

• Shiftability theoryShiftability theory

• Anticipated incomeAnticipated income

• Conversion of fundsConversion of funds

• Gap managementGap management

• Duration gap managementDuration gap management

• Real bills doctrine – Real bills doctrine – managing liquidity riskmanaging liquidity risk

• Shiftability theory

• Anticipated income

• Conversion of funds

• Gap management

• Duration gap management

Make low-risk loans with high liquidity…Make low-risk loans with high liquidity… Lend to finance shipment of goods:Lend to finance shipment of goods:

-- paid off quickly to known buyer.-- earns low return.

Lend for production…Lend for production…-- “self-liquidating” loans; repaid as sold.-- relatively low risk.

• Real bills doctrine

• Shiftability theoryShiftability theory – – managing credit riskmanaging credit risk

• Anticipated income

• Conversion of funds

• Gap management

• Duration gap management

Return with longer-term loans…Return with longer-term loans…-- adds to the default risk.-- offset with purchases of gov’t. securities.

- “Secondary reserves” add liquidity.

Popular until the Crash of 1929:Popular until the Crash of 1929:-- falling prices means converting to cash involves a capital loss.-- exacerbated circumstances, as loans were going into default as well.

• Real bills doctrine

• Shiftability theory

• Anticipated income -Anticipated income - managing interest rate riskmanaging interest rate risk

• Conversion of funds

• Gap management

• Duration gap management

Initiation of the “installment loan”…Initiation of the “installment loan”…-- mitigates default risk through ongoing payments.-- gives the bank a highly predictable stream of income.-- has features that make it a “super-liquidating” loan.

• Real bills doctrine

• Shiftability theory

• Anticipated income

• Conversion of fundsConversion of funds - - managing interest rate managing interest rate riskrisk

• Gap management

• Duration gap management

Match asset & liability maturities…Match asset & liability maturities…-- long-term loans with CDs.-- short-term loans with deposits.

Events that change interest rates will Events that change interest rates will be neutralized.be neutralized.

• Real bills doctrine

• Shiftability theory

• Anticipated income

• Conversion of funds

• Gap Management – Gap Management – managing profitmanaging profit

Duration gap managementDuration gap management

Relate assets & liabilities by interest…Relate assets & liabilities by interest…-- manage the “gap” to bank’s advantage.-- if re is rising, then make gap positive.-- if re is falling, then make gap negative.

Measure ave. time for payments (in or out)…Measure ave. time for payments (in or out)…-- if positive and interest rates fall, bank profits rise.-- if negative and interest rates rise, profits rise.

Does Bank Size Matter?Does Bank Size Matter?

Economies of scale-- Efficient structure theory.-- Cost savings seem minor; mgt. savings.

Concentration will . . .

-- raise costs?

-- lower costs?

Consolidation stats (1990 vs. 2007): Community bank % of all banks: 92%92% Community bank % of total bank assets: 14%14%

Universal BankingUniversal Banking

• Banks own firms-- Better informed about financial condition.-- Conflict of interest?

• Firms own banks-- Does the FED regulate the firm as well?

• Banks do . . . Whatever (economies of scope):-- Insurance.-- Real estate.-- Stock brokers.

Banking Banking in the U. in the U.

S.S.

ECO 473Dr. D. Foster