Chapter (4)

Commercial Banking
◼ In banking, net worth is known as capital accounts, or capital.
◼ Capital may be viewed as the owner’s equity in the bank.
◼ Another way of viewing the balance sheet is as a statement of
the sources of and uses for bank funds.
◼ Banks obtain funds by issuing debt (liabilities) in the form of
demand deposits and saving and time deposits, by borrowing
funds from other banks or the public and by obtaining funds
from the owners (shareholder) of the bank through the
capital account.
◼ Banks Use these funds to grant loans, invest in securities,
purchase equipment and facilities, and hold cash items such
as currency and deposits in other banks.
◼ The interest earned from loans and securities generates the
bulk of commercial banks revenues. These revenues are used
to cover the cost of bank operation and to provide a profit for
the banks owners.
◼ Banks : are in business to earn a profit: They do so by
borrowing funds (issuing debt) at relatively low interest rates
and lending or investing the funds at higher interest rates. The “
spread” between the rate banks pay for funds and the rate earn
is the major determinant of bank profits, although in recent
years service fees have increased in importance.
◼ The best way to learn about the business of banking is to
examine a typical bank’s balance sheet.
◼ The balance sheet of any entity is a statement of its assets,
liabilities and net worth at a given point of time.
◼ A bank Assets are indicators of what the bank owns or claims
the bank has on external (non bank) entities ‫بخالف البنوك‬.
◼ Bank liabilities are indicators of what the bank owes or claims
on the bank that are held by external entities.
◼ Assets = Liabilities + Net worth (capital)
◼ Net worth is calculated by subtracting total liabilities from total
assets.
 Commercial Banking
Balance Sheet
Assets Liabilities
1- Cash 1- Deposits
2- Loans Transaction Deposit ❑
Real State Loan Non-Transaction Deposit ❑

Consumer Loan 2- Borrowing

Business Loan 3- Other liabilities
Other Loans 4- Capital=Assets-Liabilities
3- Securities
4- Other Assets
Commercial Bank Liabilities:
◼ Bank liabilities are the funds banks obtain and the
debt they incur, primarily to make loans and purchase
securities. These bank liabilities include various types
of deposits, borrowings, and other liabilities.
◼ Bank deposits may be divided into two categories,
transaction deposits and non-transaction deposits.
Liabilities:
• Deposits
• Borrowing
• Other Liabilities
• Capital
 Deposits

Transaction Non-Transaction
Deposits Deposits
 Transaction Deposits
◼ Transaction deposits also known checkable
deposits are deposits against which checks may be
written.
◼ Transaction deposits are payable on demand (you
can walk into your bank and withdraw funds from
your checking account at any time) you can also
order your bank to transfer funds to someone else
simply by written a check.
◼ Transaction deposits included demand deposits,
which are non-interest –bearing checking
account‫حسابات بنكية بدون فائدة‬
Other types of checkable accounts do pay interest included are:
1. Negotiable order of withdrawal (NOW) accounts.
2. Automatic transfer service (ATS) accounts.
3. Money Market deposits (MMD) accounts).
( NOW Account : Negotiable order of withdrawal
◼ From the 1930 to the early 1980s, federal law generally prohibited depository
institutions from paying interest on checking accounts.
◼ NOW account is essentially a saving account on which checks may be written.
◼ The spread of NOW accounts beyond New England was prohibited till the 1980.
(ATS Account : Automatic transfer service
◼ At the same time that NOW accounts were legalized nation wide, a similar
instrument , the ATS account was authorized. With an ATS account, the customer
maintains a minimal checking account balance and holds additional funds in an
interest-bearing saving account.
Ex. 500.000
100.000 checkable
400.000 Saving.
MMD account Money Market Deposit)
◼ Are interest bearing transactions deposits that were authorized in 1982 to
permit banks to compete with money market mutual funds. MMD account
offer only limited check writing privileges.
 NON-TRANSACTION Deposit
◼ Non transaction Deposit is interest bearing
deposit on which checks can not be written.
◼ Non transaction deposit are currently the
primary source of bank funds, accounting for
more than twice as many funds as transactions
deposits.
◼ Non transaction included passbook saving
account, small consumer –type time deposits or
certificates of depositor (CDs) and large
negotiable CDs issued in minimum 100.000 $.
1. Passbook saving account:
For generation passbook saving accounts have been popular
with middle-class American, they are symbolized by a little
blue or green book (the pass book) in which transaction and
occurred interest recorded.
They have no maturity date, funds maybe added to the
account at anytime.
This type of deposit has declined in popularity, chiefly
because of financial innovations that have made attractive
new instrument available to the public.
2. Large negotiable CDs:
Are issued in minimum 100.000 and are typically purchased
by corporations and money market mutual funds as an
alternative to short-term government securities issued in
specific maturities they provide a reliable source of funds for
the large, well known banks that issue them.
3. Small time Deposit
Are issued in specific maturities such as 3,6 month, 1 year
because these instrument are less liquid and less likely to be
withdrawn than passbook saving account and MMD
account, banks pay a higher interest rate on them.
 Non-Deposit Borrowing:

◼ In addition to borrowing from depositors, commercial banks

borrow funds from the fed, from other banks and from
corporations.
◼ Loans made by the fed to commercial banks are known
discount loans, the rate charged is called the discount rate.
◼ Such loans are typically made for only 1 day and can not be
granted for the purpose of extending additional loans to the
public.
◼ Banks can also borrow funds, overnight from other banks (
in the form of deposits at the fed) in the federal funds
market, the interest rate payable is called the federal funds
rate.
◼ Banks also borrow from their parent companies (holding
company through latter’s issuing of commercial paper, and
from other corporation.
 Other Liabilities:

◼ Among the other liabilities banks carry are

notes and bonds issued by the banks, bills
payable and certain other items this liability
category is relatively small.
 Commercial Bank Assets :

◼ Commercial Bank assets use their funds primarily to

purchase income-earning assets.‫ أصول تعطي دخل‬On the
aggregate commercial bank balance sheet , balance sheet
are divided into four categories cash assets, loans,
securities and other assets.
◼ Loans and securities ---- more 85% of earning asset
bank.
◼ The acquisition of earning assets by commerical banks is
constrained by federal Reserve Regulations that require
banks to maintain a certain percentage of their deposit
liabilities in reserves.
◼ Reserves include Currency and coins in the bank + the
Bank’s deposit at the fed.
Assets:
• Cash
• Loans
• Securities
• Other Assets
1. Cash assets:
Cash assets provide a bank with the funds
to meet reserve requirement and the
liquidity to meet the withdrawal of
deposits and accommodate new loans
demand . Included in this category are
currency and coins called “ vault cash”
2. Loans:
Are the largest source of income for banks. There are several types of banks
loans, in order of current magnitude, real estate loans, business loans and
consumer loans. Loans also have a higher default risk than other assets. In
compensation for their lower liquidity and higher risk , loans yield the higher
rate of return among bank assets.
- Real estate loans: include long term mortgage on residential properties,
farms and business properties, short-term loans to building contractors,
which are generally paid off when the property is completed and sold and
home equity loans.
- Business loans : banks have a comparative advantage in making business
loan. Their familiarity with business depositors allow them to do careful
evaluation and monitoring of potential borrowers.
- Consumer loans: banks grant loans to individuals , commonly known as
consumer loans. Many consumer loans are for durable goods automobiles.
Consumer loans are generally more liquid than other types of loans.
- Other loans : other types of loans granted by banks include to financial
institutions, loans to dealers, brokers, and individuals to purchase stock, for
farmers.
3. Securities:
Important item on the bank balance sheet,
accounting for almost one-fourth of bank assets
and contributing 15% of bank income.
U.S. government and agency securities are
highly liquid because of the well-developed
market in which they are traded. Because they
are issued by the fed, they are safe from the risk.
They are subject to market risk – the risk that
interest rate may rise, causing a decline in the
price of the securities.
State and local government securities have a tax
advantage for banks, interest income earned on
them is not taxable.
4. Other assets :
Include the physical assets of a bank buildings,
computers, automatic teller machines, and other
equipment.
Also include the collateral the bank has re
possessed from borrowers in defult.
Commercial Bank Capital Account: The differ
between total assets and total liabilities (net
worth).
Bank capital derives from the issue of stock in
the bank and from retained earnings-profits
earned by the bank that are not paid out to the
owners (stock holders).