Business of BankingChapter 3

Bellringer

Complete the online pretest for Chapter 3

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Income from Loans and Securities Describe four common ways banks generate

revenue Explain the connection between customer fees

and bank profitability.

Turn off the lights! Biz Kid$ Video

Income from Traditional Bank Services Asset: something

owned by an individual or other entity

Two largest assets of banks—loans and securities

Interest on Loans Banks make most of income by extending loans to

customers Interest: fee charged for borrowing money (interest

income) Also charge interest on credit card balances

Interest on Loans3 Main Factors How Much Interest a Bank Charges Competition Market rates Borrower’s creditworthiness

Creditworthiness

Poor credit=high risk Risky loans=higher interest

rates Good credit=good risk Good risk=lower interest rates The lower the risk, the less a

borrower has to pay.

Interest on Securities Banks invest money in securities (bonds and

treasury bills) Securities: investments that represent ownership

or debt (example: bond) Bonds pay interest Investor receives the purchase price plus interest

back when the bond matures (date the investor can receive the initial deposit)

Bonds are a type of long-term security Banks invest in treasury bonds issued by US

Treasury Department

Short-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

Short-to-Medium-Term Security

Treasury Notes

Also called T-notes

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

Long-Term Security

Savings Bonds

Treasury Bonds

Series EE

Series I

Also called T-bonds

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

• Two methods for paying interest—one is fixed, the other is tied to inflation rate

• Earn interest for up to 30 years• Nontransferrable

• Fixed interest rate• Pays interest every six months (up to 30 years)• May be resold

Treasury Securities

Gains on Securities Gain: increase in

income Securities are the next

most profitable (next to loans)

Banks can sell securities when money runs low

Research Activity What is the Credit Card Act of 2009? What does it require?

Income from Fees Larger source of

income for banks Banks have raised

fees to generate more income

Some are waived with a certain balance

Insufficient funds fee if there isn’t enough money in acct to cover transaction

Overdraft program provides funds to cover a check written on an acct w/insufficient funds

Overdraft = negative balance

ATM fees: surcharge (convenience fee), account inquiry fee

Safe deposit boxes Money order: payable

to a specific party Inactivity fee (really?)

Checkpoint: On Target!!1. What is interest?2. How do loans earn income for banks?3. What are the two ways banks earn income on

securities?4. List four types of treasury securities.5. List three of the fees a bank may charge for

checking accounts.

Bellringer

Fill in the blank

_____________ is used to manage exposure to financial risk.

Income from Nontraditional Services Explain how banks earn income from insurance

products Describe types of trust 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 Risk is the chance that something unfavorable

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

that can cause financial loss. Major types: life, health, and property

Life Insurancebeneficiary receives the financial protection from the policy.

Credit Life Insurance Pays off a loan if insured dies Offered at the time borrower

applies for the loan

Mortgage Life Insurance Pays off mortgage upon death

Property and Casualty Insurance and Liability InsuranceProperty and Casualty Covers things Lost or stolen Will pay for replacement or

repair i.e. automobile and

homeowner’s

Liability Protects against financial

losses that may occur if the insured is found responsible for property loss or injuries to others

i.e. medical expenses

Types of Health InsuranceWhat it is How it works

Indemnity Health Insurance

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

The insurance pays a portion of covered health-care costs.

Health Maintenance Organization (HMO)

An association of doctors, hospitals, and other health-care providers that provides comprehensive medical services.

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

Preferred Provider Organization (PPO)

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

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

Checkpoint Why do people purchase insurance? How do banks make money from selling

insurance? What are the biggest costs associated with liability

cases?

Trust Services

Involve handling financial assets for a customer

Bank becomes the trustee (person/institution that controls the financial assets for the customer)

Trusts define the customer’s assets and how those assets should be handled

Generally provided by large banks

Individual Clients

Overview of Trust ServicesRetirement Planning • Open IRA, 401(k), variable annuity

Estate Planning • Prepare a will or trust document that arranges for transfer of assets

Estate Settlement • Determines estate value• Prepares and files all necessary

documents• Pays taxes• Distributes assets as called for in the

will• Probate laws pertain to the will (state

laws)

An estate is the property and possessions of an individual.

Checkpoint List the major services offered by bank trust

departments.

Trust Services

Treasury and cash management services include accounting, capital, collections, credit card, and information services.

Pension funds are plans that provide retirement income for the employees of a business.

Contributions from employees, employers, or both go into the pension fund.

Payment of dividends to stockholders are handled by banks.

Business Clients

Trust Services

A broker may buy and sell securities for a customer (trading).

Common stock Bonds Treasury securities

Brokerage Services

Checkpoint What is the major source of income from

brokerage services?

Trust Services

Grouped into 3 categories Fixed income—mostly bonds Equities—mostly stocks Cash equivalents—cash or investments that can be

readily sold for cash, i.e. T-bills or CDs

Asset Management

Investment Banking ServicesUnderwriting Securities Occurs when an investment

bank buys a new stock directly from the company wanting to generate cash, then selling to the public.

Underwriting spread is the difference between the price paid by the investment bank and the price sold to the public.

Mergers and Acquisitions Merger takes place when 2

companies agree to combine Acquisition happens when 1

company buys another company

International Banking Focus largely on trade Conduct business beyond the borders Advantage: access to more customers Disadvantage: exposure to economic and political

conditions of the country its in Federal Reserve monitors and regulates branches

of foreign banks doing business in the US

Banking ExpensesInterest Expense When the bank pays interest to

customers for using their money (largest expense)

Banks pay interest to entice customers

Operating Expenses Costs that are incurred to keep

the bank in business Banks increase profit by

increasing income, decreasing expenses, or a combo of both

Profit = total income – total expenses

Activity: List the banking activities in the appropriate columnBank Income Bank Expenses

• Investment banking income• Interest paid on deposits• Interest income from loans and securities• Security expenses• Gains on securities• Equipment costs• Employee wages and salaries• Brokerage commissions• Money order fees• Building and utility costs• Inactivity fees• Employee benefits• Credit card fees• ATM fees• Employee training costs• Safe deposit box rental fees• Checking account fees

Take-home quiz . . . Write these down!

1. What is the largest expense for banks?2. What type of expense are utilities?3. Total income minus what equals profit?4. Why do banks pay interest to depositors?5. How can banks increase their profits?