Chapter Thirteen

Managing Nondeposit Liabilities

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Key Topics
• Liability Management
• Customer Relationship Doctrine
• Alternative Nondeposit Funds Sources
• Measuring the Funds Gap
• Choosing Among Different Funds Sources
• Determining the Overall Cost of Funds

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Customer Relationship Doctrine

The First Priority of the Bank is to

Make Loans to All Qualified Customers
and If Funds are Not Available the
Bank Should Seek Out the Lowest Cost
Source of Funding to Meet Customers’
Needs.

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Liability Management
• The Bank Buys Funds in Order to Satisfy
Loan Requests and Reserve Requirements

• It is an Interest-Sensitive Approach to
Raising Bank Funds

• It is Flexible – The Bank Can Decide Exactly

How Much They Need and For How Long

• The Control Mechanism to Regulate

Incoming Funds is the Price of Funds

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Nondeposit Sources of Funds

• Federal Funds Market

• Repurchase Agreements
• Federal Reserve Bank
• Advances from the Federal Home Loan
Bank
• Negotiable CDs
• Eurocurrency Deposit Market
• Commercial Paper
• Long Term Sources

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Recent Growth in Nondeposit Sources

of Borrowed Funds at FDIC-Insured Institutions

What are the trends?

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Alternative Nondeposit Sources of Funds

• The usage of nondeposit sources of funds
has risen

• Larger institutions rely on the nondeposit

funds market as a key source of short-term
money to meet loan demand and
unexpected cash emergencies

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Federal Funds Market

• Immediately Available Reserves Are Traded
Between Financial Institution and Usually
Returned Within 24 hours.

• Deposits with Correspondent Banks and

Demand Deposit Balances of Security
Dealers and Governments Can Be Used For
Loans to Institutions.

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Types of Fed Funds Loan Agreements

• Overnight Loans
▫ Negotiated via wire or telephone, returned the next
day
▫ Normally not secured by specific collateral,
although might

• Term Loans
▫ Longer term Fed funds contracts (several days,
weeks, or months)

• Continuing Contracts
▫ Automatically renewed each day
▫ Normally between smaller respondent institutions
and their larger correspondents

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Repurchase Agreements
• Can be Thought of as Collateralized Fed Funds
Transactions; More Complex; Less Exposure to
Credit Risk

• Involves the Temporary Sale of High-Quality

Assets (usually Government Securities)
Accompanied by an Agreement to Buy Back
Those Assets On a Specific Future Date At a
Predetermined Price or Yield

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Borrowing from the Fed: The Three Types

of Loans at the Discount Window
• Primary Credit – This Loan is Available for Short
Terms and to Institutions in Sound Financial
Condition. Rate is Slightly Higher than the Federal
Funds Rate
• Secondary Credit – These Loans are Available at a
Higher Interest Rate to Institutions not Qualifying
for Primary Credit. Monitored by the Federal
Reserve to Control Excess Risk
• Seasonal Credit - These loans Cover Longer
Periods Than Primary Credit for Small and Medium
Institutions Experiencing Seasonal Swings in
Deposits and Loans
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Advances from the Federal Home

Loan Bank
• Allows Institutions (Home Mortgage Lenders) to
Use Home Mortgages as Collateral for Advances
• A Way to Improve the Liquidity of Home
Mortgages and Encourage more Lenders to
Provide Credit
• Number of Loans has Increased Dramatically in
Recent Years
• Maturities Range from Overnight to More than
20 Years
• FHLB Has 12 Regional Banks
• Has Federal Charter and Can Borrow Cheaply
and Pass Savings to Institutions
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Negotiable CD

An Interest-Bearing Receipt
Evidencing the Deposit of Funds in the
Bank for a Specified Period of Time for
a Specified Interest Rate. It is
Considered a Hybrid Account Since it
is Legally a Deposit

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The Four Types of Negotiable CDs

• Domestic CDs – Issued By Domestic Banks

in the U.S.
• Euro CDs – Dollar Denominated CDs Issued
Outside the U.S.
• Yankee CDs – Issued By Foreign Banks in
the U.S.
• Thrift CDs – Issued By Large Savings and
Loans and Other Nonbanks in the U.S.

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Eurocurrency Deposit Market

• Eurodollars are Dollar-Denominated

Deposits Placed in Banks Outside the U.S.
• Eurocurrency Deposits Originally Were
Developed in Western Europe to Provide
Liquid Funds to Swap Among Institutions or
Lend to Customers
• Labeled ‘Liabilities to Foreign Branches’
When a Foreign Branch Lends Eurodeposits
to its Home Office

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Commercial Paper
• Short-Term Notes With Maturities from 3 or
4 Days to 9 Months Issued By Well-Known
Companies.
• Two Types
▫ Industrial Paper- -Purchase Inventories
▫ Finance Paper – Issued by Finance Companies
and Financial Holding Companies
• Banks Cannot Issue These Directly But
Affiliated Companies Can Issue Them.

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Long-Term Nondeposit Sources of Funds

Mortgages to Fund the Construction of

New Buildings and Capital Notes and
Debentures are Examples of Long
Term Sources of Funds

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The Funds Gap

• Gap is Based on:
▫ Current and Projected Demand and
Investments the Bank Desires to Make
▫ Current and Expected Deposit Inflows and
Other Available Funds
• Size of This Gap Determines Need for
Nondeposit Funds

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Nondeposit Funding Sources: Factors to

Consider

• The Relative Costs of Raising Funds From

Each Source
• The Risk of Each Funding Source
• The Length of Time for Which Funds are
Needed
• The Size of the Institution
• Regulations Limiting the Use of Various
Funding Sources

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Check

First Gulf Bank has new loan requests of $225 million, needs to
purchase $100 million in U.S. Treasury securities to meet pledging
requirements, and anticipates draws against credit lines of $135 million.
Deposits received today total $215 million and the bank expects to bring
in an additional $100 million next week. What is First Gulf Bank
estimated funds gap for the coming week?

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