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Commercial

Bank

Operations

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Chapter Objectives Describe the most common sources of funds

for commercial banks

Describe the most common uses of funds forcommercial banks

Describe typical off-balance sheet activities

for commercial banks

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Bank Participation in Financial

Conglomerates Impact of the Financial Services

Modernization Act (1999)

Banks and other financial service firms weregiven more freedom to merge and offer a range of

financial services

Insurance

Securities services

Banks now a subsidiary of financial

conglomerates

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Bank Participation in Financial

Conglomerates Benefits of diversified services to individuals andfirms

Individuals can obtain all their financial services at a

single financial conglomerate

Deposits

Loans

Investing (brokerage) Insurance

Businesses can obtain loans, issue stocks and bonds,

and have their pension fund managed by the same

institution

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Bank Participation in Financial

Conglomerates Benefits of diversified services to the

financial institution

Reduce reliance on demand for single service Economies of scale and scope

Diversification (service and geographical) may

result in less risk

Generate new business

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Bank Sources of Funds Transaction deposits

Demand deposit account (checking)

Savings Deposits Passbook savings

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Bank Sources of Funds Time Deposits Certificate of deposit (CD)

No secondary market

Negotiable CD

Short-term, minimum $100,000

Can trade among investors via dealer

Money Market Deposit Accounts (MMDAs) More liquid than CDs : no specified maturity

Limited check writing

Created in 1982

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Bank Sources of Funds Federal Funds Purchased Short-term loans between banks

Allows banks to meet reserve requirement or

funding needs Interest rate charged is the federal funds rate

Borrowing from the Federal Reserve Banks

Borrowing at the discount window Discount rate

Intended for meeting temporary short-term reserverequirement needs

Must get Fed approval

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Bank Sources of Funds Repurchase agreements

Sale of securities by one party to another with anagreement to repurchase the securities at aspecified date and price

Banks may sell T-bills to a corporation withtemporary excess cash (bank demand deposit)and then buy them back later

Source of funds for a few days

Collateralized by the treasury bills

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Bank Sources of Funds Eurodollar borrowings

Banks outside the United States make dollar-

denominated loans Eurodollar market is very large

Bonds issued by the bank

Like other businesses, banks issue bonds tofinance long-term fixed assets

Usually subordinated to deposits

Part of secondary regulatory capital

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Bank Sources of Funds

Bank capital

Obtained from issuing stock or retaining earnings

No obligation to pay out funds in the future Must be sufficient to absorb operating losses

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Uses of Funds by Banks

Loans make up about 64 percent of bank assets,while all securities make up about 22 percent ofassets. Cash represents 6 percent of bank assets.

Cash and due from balances at institutions Currency/coin provided via banks

Reserve requirements imposed by Fed

Tool for controlling the money supplyDue from Fed and vault cash count as reserves

Also hold cash and due from balances to maintainliquidity and accommodate withdrawal requests by

depositors

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Uses of Funds by Banks

Bank Loans

Types of business loans

Working capital loans Term loans

Purchasing fixed assets

Protective covenants

Informal line of credit Revolving credit loan

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Uses of Funds by Banks

Bank Loans

Loan participations

Sometimes large firms seek to borrow more money thanan individual bank can provide

Lead bank

Loans supporting leveraged buyouts

Banks charge a high loan rate

Monitored by bank regulators

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Uses of Funds by Banks Bank Loans

Collateral requirements on business loans Increasingly accepting intangible assets

Important to service-oriented firms Increased lending risk with service businesses--telecomm

Types of consumer loans Installment loans

Credit cards

Real estate loans

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Uses of Funds by Banks

Investment securities (bank income and

liquidity)

Treasury securities Government agency securities

Freddie Mac

Fannie Mae

Corporate and municipal securities

Investment grade only

Federal funds sold

Lending funds in the federal funds market

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Uses of Funds by Banks

Repurchase agreements

Eurodollar loans

Branches of U.S. banks located outside of theU.S.

Foreign-owned banks

Fixed assets Office buildings

Land

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Off-Balance Sheet Activities

Loan commitments

Obligation of bank to provide a specified loan

amount to a particular business upon request Note issuance facility (NIF)

Banks earn fee income for risk assumed

Standby letters of credit (SLC) Backs a customers obligation to a third party

Banks earn fee income

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Off-Balance Sheet Activities

Forward contracts

Agreement between a customer and bank to

exchange one currency for another on a particularfuture date at a specified exchange rate

Allows customers to hedge their exchange-rate

risk

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Off-Balance Sheet Activities

Swap contracts

Two parties agree to periodically exchange

interest payments on a specified notional amountof principal

Banks serve as intermediaries or dealer and/or

guarantor for a fee