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8/4/2019 Commercial Bank Operations
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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