BUSINESS OF BANKINGIncome from Loans and Securities

Presented by S. Cox

Objectives

Describe four common ways banks generate revenue

Explain the connection between customer fees and bank profitability

Income from Traditional Bank Services

First look at their assets Something owned by an individual or other

entity Two largest assets…loans and securities

How banks generate most of their income…also through the fees they charge

Income from Traditional Bank Services

Interest on Loans Largest bank asset and produce the largest income

Interest is the fee charged for borrowing money…called interest income for a bank

Also charge interest on credit cards How much interest?

Depends on competition, market rates, and the borrower’s creditworthiness

Every loan carries risk…if you have a poor credit rating, you may not be as likely to be able to pay back a loan and therefore the interest may be higher

Income from Traditional Bank Services

Interest on Securities Typically bonds and treasury bills Invest in long- and short-term securities

Long – matures in over one year…bonds Short – matures in less than a year

Maturity – the date on which the investor can receive the initial investment

Treasury SecuritiesShort-Term

Security

Treasury Bills

Also Called T-bills

•May be purchased from the Treasury or banks•Yield is what the market will pay on maturity•May be resold•Issued in terms of 4, 13, 26, and 52 weeks•Considered risk free because they are issued by the US government

Short-to-Medium

Term Security

TreasuryNotes

AlsocalledT-notes

•Fixed interest rate•Sold at auction•May be resold

Long-Term Security

SavingsBonds

SeriesEE

•Fixed interest rate•Available in paper or electronically•Earn interest for up to 30 years•Nontransferrable

Series I •Two methods for paying interest—one is fixed, the other is tied to inflation rate•Earn interest for up to 30 years•Nontransferrable

Treasury Bonds

Also CalledT-bonds

•Fixed interest rate•Pays interest every six months (up to 30 years)•May be resold•Considered risk free because they are issued by the US government

Treasury Securities

Banks balance interest income with liquidity by purchasing a mix of short and long term securities Liquidity – the ability to quickly turn an

asset into cash Short term securities are more liquid than

long term Bank regulators restrict the types of

securities banks can by…for example banks cannot invest in common stock

Gains on Securities

Selling a security for more than its purchase price = gain

Loans are bank’s primary asset, securities are the next most profitable If giving loans is high and a bank needs

money to make the loans, they may sell securities and if loan demands are low then they may buy securities

Income from Fees

Many bank fees relate to checking accounts Often charge a monthly fee just for having

a checking account Insufficient funds fee – if there is not

enough money in an account to cover a transaction

Overdraft program – provides funds to cover a check written on an account with insufficient funds Overdraft – a negative balance

Income from Fees

Banks that offer credit cards may charge an annual fee just to have the card, late payment fees, and over the limit fees

ATMs may charge a surcharge…fee to withdraw cash, also called a convenience fee Account inquiry fee – check the balance of your account

Safe deposit box rental fee – fee for individually secured containers, usually within a bank vault, used to store valuables

Money order fees – fee to purchase a money order in the exact amount payable to a specific party

Inactivity fee – if a customer doesn’t make a transaction within some specified period

Common Bank Service Fees

Checking Accounts ATM

Insufficient funds feesOverdraft feesService feesStop payment fees

Account balance feesTransaction fees—using another bankTransaction fees—using ATM internationally

Credit Cards Safe Deposit Boxes

Annual feesOver-the-limit feesLate payment fees

Rental feesLate rental payment feesLost key replacement fees

Miscellaneous

Money order feesInactivity feesElectronic funds transfer fees

BUSINESS OF BANKINGIncome from Nontraditional Services

Objectives

Explain how banks earn income from insurance products

Describe types of operations and how they provide income

Explain how brokerage services operate and provide bank revenue

Describe how banks manage the financial assets of certain customers

Identify the major investment banking activities

Insurance Products

Yes, banks sell insurance!!! The Glass-Steagall Act of 1933 prohibited banks

from insurance activities, but under the Gramm-Leach-Bliley Act of 1999, banks can offer insurance

Insurance provides protection from risk Risk – the chance that something unfavorable could

happen to a person or property Insurance – provides protection from certain risks

that can cause a financial loss…death, illness, or accident

Many types of loss = many types of insurance

Insurance Products

Life insurance – protects people from a financial loss in the vent of a death…paid to a beneficiary Credit Life – will pay off a loan if the insured

dies Mortgage Life – pays off the loan balance

on your home on your death

Insurance Products

Property and Casualty Insurance and Liability Insurance – covers things rather than people Property and Casualty…Houses and cars for example

Automobile insurance Liability covers the medical and property expenses of

somebody else if you cause an accident…required by all states Collision pays for damage to your vehicle as the result of a

vehicle on vehicle accident…no matter fault Comprehensive covers other types of damage to your vehicle…

if a tree falls on your car while parked on the street Homeowner’s insurance – protection to your home and its

contents…fire, theft, hail, and flood Businesses…commercial insurance protects the physical

assets of the business…buildings, equipment, and furniture

Insurance Products

Liability protects against the financial losses that may occur if the insured is found responsible for property loss or injuries to others…if someone falls on your front steps

Insurance Products

Types of Health Insurance

IndemnityHealth

Known as a fee-for-service plan. Lets the insured go to any doctor he or she chooses

The insurance pays a portion of covered healthcare costs

Health Maintenance Organization (HMO)

An association of doctors, hospitals, and other healthcare providers that provides comprehensive medical services.

The insurance pays part or all of the healthcare costs only if the insured uses a doctor that is part of the HMO.

Preferred Provider Organziation (PPO)

An association of providers that offers services at a lower cost to subscribers. Gives the insured more choice than an HML

The insurance pays part or all of the healthcare costs only if the insured uses a doctor that is part of the PPO.

Trust Services

Since the early 1900s Involve handling financial assets for a

customer The bank becomes the trustee, the person

or institution that controls the financial assets for the customer

A legal document (trust) is drawn up to define the customer’s assets and how those assets should be handled

Trust Services

Individual Clients Estate Planning – preparing for the transfer

of assets after a client’s death Business Clients

Relate to cash management Accounting services – payroll Capital services – expenditures…purchase of a

new building Collection services Credit card services – processing, issuing, and

credit analysis

Trust Services

Brokerage Services Securities trading…buying and selling

securities for a customer Common stock, bonds, and treasury securities

Asset Management – for clients who don’t have the time or expert knowledge needed to handle their own investments Fix income—mostly bonds, equities—mostly

stocks, and cash equivalents

Investment Banking Services Underwriting Securities – occurs when

an investment bank buys a new stock directly from the company wanting to generate cash…the bank then sells the stock to the public When investment banks underwrite a stock

offering they make money through the underwriting spread which is the difference between the price paid and the price sold to the public

Investment Banking Services Mergers and Acquisitions

Companies are often merging with and acquiring other companies

Merger takes place when two companies agree to combine

Acquisition happens when one company buys another company, setting itself up as the new owner

International Banking

Focuses on trade beyond the borders of the US

Types of financial institutions that offer international banking services US based banks that do business

internationally Foreign banks doing business in the US Other International banking entities

BUSINESS OF BANKING

Banking Expenses

Objectives

Explain how deposits cause interest expense

Identify the major non-interest expense items for a bank

Interest Expense

Interest expense – when the bank pays interest to customers for using their money Largest expense Customers will shop around to get the

highest interest rate (percentage paid for the use of borrowed money)

Not all deposit accounts pay interest Many checking do not

If they do, they may have restrictions for example if you fall below a certain balance, no interest is paid

Operating Expenses

Operating expenses – costs that are incurred to keep the bank in business…utilities, rent, and employee wages and benefits Employee wages and salaries are a major expense for

banks Often we only see the tellers and loan officers but there are

many in other areas Employee benefits such as health insurance and

retirement plans as well as training employees use a considerable amount of money

Other operating expenses Office equipment purchases and maintenance Security expenses Advertising and marketing costs