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Chapter 2

Depository Institutions

K. R. Stanton

© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.

Overview of Depository Institutions

2-2

In this segment, we explore the depository FIs:
   

Size, structure and composition Balance sheets and recent trends Regulation of depository institutions Depository institutions performance

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© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.

Products of U.S. FIs

2-3

Comparing the products of FIs in 1950, to products of FIs in 2003:

  

Much greater distinction between types of FIs in terms of products in 1950 than in 2003 Blurring of product lines and services over time Wider array of services offered by all FI types (Refer to Tables 2-1A and 2-1B in the text)

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Specialness of Depository FIs

2-4

Products on both sides of the balance sheet

Loans

Business and Commercial

Deposits

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Inc. Fiduciary services  By 2003. products and services further expanded to include:  Underwriting of debt and equity.. . Savings products. Insurance and risk management products McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. All Rights Reserved.Other outputs of depository FIs  2-5 Other products and services 1950:  Payment services.

regulatory changes. global competition. Inc. All Rights Reserved.Size of Depository FIs Consolidation has created some very large FIs  Combined effects of disintermediation. competition across different types of FIs  2-6 McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. . technological developments..

2 188.S. Morgan Chase* Bank of America** Wells Fargo Wachovia Bank One* Washington Mutual Fleet Boston** U.9 736.0 2-7 McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies.0 326.208.4 393. Bancorp SunTrust Banks $1.Largest Depository Institutions Total Assets ($Billions) Citigroup J. All Rights Reserved.6 275.2 200.P..9 770.9 388. . Inc.8 181.

Differences in operating characteristics and profitability across size classes. Inc.. All Rights Reserved. • Notable differences in ROE and ROA as well as the spread  Thrifts    S&Ls Savings Banks Credit Unions  Mix of very large banks with very small banks McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. .Depository Institutions  2-8 Commercial Banks   Largest depository institutions are commercial banks.

.  Example: changes permitting interstate branching  Reigle-Neal Act McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies..Functions & Structural Differences  2-9 Functions of depository institutions  Regulatory sources of differences across types of depository institutions.  Structural changes generally resulted from changes in regulatory policy. All Rights Reserved. Inc.

Commercial Banks  2-10 Primary assets:     Real Estate Loans: $2.3 billion C&I loans: $870.8 billion  Inference: Importance of Credit Risk McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. Inc.3 billion  Of which.005.. . Treasury bonds: $1.5 billion Investment security portfolio: $1.789. All Rights Reserved.6 billion Loans to individuals: $770.272.

643. Inc.9 billion Borrowings: $1. . All Rights Reserved..2 billion  Inference:  Highly leveraged McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies.3 billion Other liabilities: $238.Commercial Banks  2-11 Primary liabilities:    Deposits: $5.028.

All Rights Reserved. Inc. . Nation 2-12 C&I 14% Credit Card 1% Consumer 8% Real Estate 63% Other 14% McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies..Small Banks.

. . All Rights Reserved. Nation 2-13 C&I 18% Real Estate 44% Credit Card 7% Consumer 10% Other 21% McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. Inc.Large Banks.

1990s Consolidation has reduced asset share of small banks McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies.744 in 1989 7.769 in 2004  Mostly the result of Mergers and Acquisitions   M&A prevented prior to 1980s.416 commercial banks in 1985 12.Structure and Composition  2-14 Shrinking number of banks:    14.. All Rights Reserved. Inc. .

. All Rights Reserved.Structure & Composition of Commercial Banks  2-15 Financial Services Modernization Act 1999  Allowed full authority to enter investment banking (and insurance)  Limited powers to underwrite corporate securities have existed only since 1987 McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. Inc. .

Citigroup.Composition of Commercial Banking Sector 2-16 Community banks  Regional and Super-regional   Access to federal funds market to finance their lending activities Bank of New York. J.P.. Morgan Chase. McGraw-Hill/Irwin . Deutsche Bank (Bankers Trust). All Rights Reserved. Inc. HSBC Bank USA   Money Center banks  declining in number © 2006 The McGraw-Hill Companies.

. Inc. .Balance Sheet and Trends  2-17 Business loans have declined in importance  Offsetting increase in securities and mortgages  Increased importance of funding via commercial paper market  Securitization of mortgage loans McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. All Rights Reserved.

Inc..000 that can be resold in the secondary market.  2-18 McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. All Rights Reserved. .Some Terminology Transaction accounts  Negotiable Order of Withdrawal (NOW) accounts  Money Market Mutual Fund  Negotiable CDs: Fixed-maturity interest bearing deposits with face values over $100.

.Off-balance Sheet Activities  2-19 Heightened importance of off-balance sheet items      Large increase in derivatives positions is a major issue Standby letters of credit Loan commitments When-issued securities Loans sold McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. Inc. All Rights Reserved..

.Trading and Other Risks  2-20 Allied Irish / Allfirst Bank  $750 million loss $450 million loss  National Australian Bank  McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. . All Rights Reserved. Inc.

Other Fee-generating Activities Trust services  Correspondent banking     2-21  Check clearing Foreign exchange trading Hedging Participation in large loan and security issuances  Payment usually in terms of noninterest bearing deposits McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. All Rights Reserved. Inc.. .

. State bank regulators Dual Banking System: Coexistence of nationally and state-chartered banks. lender of last resort. . McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. State-chartered banks can elect to become members. FRS: monetary policy.  National banks are automatically members of the FRS. All Rights Reserved. Inc.Key Regulatory Agencies 2-22      FDIC (BIF and SAIF) OCC: Primary function is to charter national banks.

visit: http://www.fdic. .treas..gov  2-23 McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies.Web Resources For more detailed information on the regulators.gov http://federalreserve. Inc.gov http://www.occ. All Rights Reserved.

.  BHCs regulated by FRS.Other Regulatory Issues Importance of Bank Holding Companies is increasing..  2-24 McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. Inc. All Rights Reserved.

prohibited interest on demand deposits.  1933 Glass-Steagall: separates securities and banking activities. Inc. established FDIC.. All Rights Reserved. McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. .Key Regulatory Legislation  2-25 1927 McFadden Act: Controls branching of national banks.  1956 Bank Holding Company Act and subsequent amendments specifies permissible activities and regulation by FRS of BHCs.

. All Rights Reserved.  2-26 1970 Amendments to the Bank Holding Company Act: Extension to one-bank holding companies  1970 International Banking Act: Regulated foreign bank branches and agencies in USA McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies...Legislation (continued).. Inc.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies.Legislation (continued)  2-27 1980 DIDMCA and 1982 DIA (Garn-St. Germain Depository Institutions Act)   Mainly deregulation acts. Inc.. All Rights Reserved. . Phased out Regulation Q.  1987 Competitive Equality in Banking Act (CEBA)  Redefined bank to limit growth of nonbank banks.

Legislation (continued) 2-28  1989 FIRREA     Imposed restrictions on investment activities Replaced FSLIC with FDIC-SAIF Replaced FHLB with Office of Thrift Supervision Created Resolution Trust Corporation McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. All Rights Reserved. .. Inc.

Legislation (continued)  2-29 1991 FDIC Improvement Act    Introduced Prompt Corrective Action Risk-based deposit insurance premiums Limited “too big to fail” McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. All Rights Reserved.. . Inc.

. . Permits BHCs to convert out-of-state subsidiary banks to branches of single interstate bank. Inc. Invalidates some restrictive state laws. Newly chartered branches permitted interstate if allowed by state law.Legislation (continued)  2-30 1994 Riegle-Neal Interstate Banking and Branching Efficiency Act     Permits BHCs to acquire banks in other states. McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. All Rights Reserved.

insurance companies. . Inc.1999 Financial Services Modernization Act  2-31 Financial Services Modernization Act      Allowed banks. All Rights Reserved. and securities firms to enter each others’ business areas Provided for state regulation of insurance Streamlined regulation of BHCs Prohibited FDIC assistance to affiliates and subsidiaries of banks and savings institutions Provided for national treatment of foreign banks McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies..

. Inc..Recent Legislative Changes USA Patriot Act of 2001  Sarbanes-Oxley Act of 2002  2-32 McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. All Rights Reserved.

Inc.3 billion 2003 Serious concerns regarding expected interest rate increases  Only 3 failures in 2003 versus 206 in 1989  McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies.. . All Rights Reserved.Industry Performance Economic expansion and falling interest rates through 1990s  Brief downturn in early 2000 followed by strong performance improvements   2-33 Record earnings $106.

.Banking and Ethics  2-34 Bank of America and Fleet Boston Financial 2004  J.. Morgan Chase and Citigroup 2003 role in Enron  Riggs National Bank and money laundering concerns 2003 McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies.P. Inc. All Rights Reserved.

All Rights Reserved. McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. Inc. .Savings Institutions  2-35 Comprised of:    Savings and Loans Associations Savings Banks   Effects of changes in Federal Reserve’s policy of interest rate targeting combined with Regulation Q and disintermediation. Effects of moral hazard and regulator forbearance. Qualified Thrift Lender (QTL) test..

Savings Institutions: Recent Trends 2-36 Industry is smaller overall  Intense competition from other FIs   mortgages for example  Concern for future viability McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. . Inc.. All Rights Reserved.

Primary Regulators  2-37 Office of Thrift Supervision (OTS).  FDIC-SAIF Fund. . All Rights Reserved.. Oversees and manages Savings Association Insurance Fund (SAIF). Inc.  Charters and examines all federal S&Ls.  McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies.

.Web Resources  2-38 For more information on the regulation of savings institutions. Inc. All Rights Reserved.ots.fdic.. visit: Treasury www.gov FDIC www.treas.gov McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies.

. . Inc. All Rights Reserved.Savings Banks  2-39 Mutual organizations     Primarily East Coast Not exposed to the oil-based shocks of 1980s Real estate price exposure Demutualization  May be regulated at both state and federal level McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies.

All Rights Reserved. McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies.. .  Approximately 56% federally chartered and subject to NCUA regulation.  Exempt from taxes and Community Reinvestment Act (CRA).  Expansion of services offered in order to compete with other FIs. Inc.Credit Unions  2-40 Nonprofit depository institutions owned by member-depositors with a common bond.

com McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies.. . All Rights Reserved. Inc.aba.Web Resources  2-41 For information on credit unions visit: American Bankers Association www.

All Rights Reserved.. . NPLs at 50% levels Opening to foreign banks (WTO entry) German bank problems in early 2000s  Implications for future competitiveness  McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies. Inc.Global Issues  2-42 Near crisis in Japanese Banking  Eight biggest banks reported positive sixmonth profits  China   Deterioration.

gov Wall Street Journal www.org FDIC www.occ. .treas.gov Office of Thrift Supervision www.cuna.gov Office of Comptroller of the Currency www..Pertinent Websites 2-43 Federal Reserve www.ncua.federalreserve.treas.gov Credit Union National Association www.com McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies.ots. All Rights Reserved.fdic. Inc.wsj.gov National Credit Union Administration www.

All Rights Reserved. . Inc.*Financial Statement Analysis Time series analysis of key ratios  ROE framework    2-44 ROE = ROA × EM ROA = PM × AU McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies..