Chap 2, Class 2

Purpose: Introduce different types of Depository Institutions

and provide an overview of their functions and
history
Outline:

Different types of depository institutions

Commercial banks
Savings institutions
Savings & Loans
Savings Banks

Credit unions
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Different Types of Depository

Institutions

Commercial Banks:
Generally large banks that offer a wide range of services
Usually service larger clients

Savings Institutions
Generally smaller banks that offer fewer services
Usually service smaller clients

Credit Unions
Generally smaller institutions that specialize in personal banking

for a select group of clients (depositors) who also own the bank

Savings Banks: Operate as a more diversified savings institution

Savings & Loan: Traditionally focus on mortgage lending

 Owned

by depositors

Accept deposits in the form of shares

Lend

to members

Mainly smaller consumer loans

COMMERCIAL BANKS

Equity Capital = 1,500.7

Equity Capital = 137.06

Equity Capital = 104.8

Commercial Banks are by far the largest Depository Institutions

 Services:
Checking and deposit accounts attract deposits
Consumer and residential lending
Commercial and industrial lending (C&I loans)

In

General:

Commercial banks provide a wider array of

services to customers than other DIs

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Why

Source: FDIC Quarterly Banking

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Source: FDIC Quarterly Banking

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1.

Struggling financial sector

Started in the 1980s the banking sector was hit by high inflation (

prime rate > 20%)

Meant to allow DIs to better compete

Deregulation Acts
with non-DI financial institutions
1980 Depository Deregulation and Monetary Control Act (DIDMCA)
(allowed banks to merge)
1982 Garn-St. Germain Depository Institution Act (DIA)
Competitive Equality in Banking Act

2.

Regulatory Changes
1994 Riegle-Neal Interstate Banking and Branching Efficiency Act

Allowed bank holding companies to acquire banks in other states

Makes mergers more attractive

Big bank mergers

Bank of America and FleetBoston ($47 billion in 2003)
J.P. Morgan Chase & Bank One ($60 billion in 2004)
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How did the merger wave change the industry?

Number of banks
Under 100 mill

Over 1 bill

1984

2012

Smallest banks % of total

83.2%

33%

Small bank % of total

14.9%

58.5%

Large Banks % of total

1.9%

8.5%

% small banks
% large banks

Share of Financial Assets

1984

2012

Smallest banks % of total

16.1%

0.9%

Small bank % of total

20.5%

8.1%

Large Banks % of total

63.4%

91%

85 banks controlled 79.9% of

financial sector assets

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Average size of banks has been increasing due to mergers.

Large banks often rely on quantitative information (factual

financial info.) on their borrowers lend to larger borrowers.

Small banks focus on relationship lending (qualitative

information) lend to smaller borrowers

The effect of large bank mergers on credit availability to small

businesses?
Large firms have access to capital markets (through commercial paper

and corporate bonds).

Small business financing became more difficult to obtain

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Commercial Bank

Business Loans
(C&I Loans)

Transaction Deposits
Non-transaction Deposits

Securities
Real Estate Loans
Consumer Loans

Subordinated Debt
(issued only by large banks)
Equity Capital
(Net worth)
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C&I Loans (10.72%):

Loans to businesses, not secured by real estate. These loans are

generally illiquid due to the information collection and monitoring
services of banks.

Securities (29.91%): Mainly:

U.S. Treasuries
Municipal bonds
Investment grade corporate bonds

Real Estate Loans (27.31%):

Commercial loans to businesses that are secured by real estate
Residential loans (e.g. home mortgages).
They are becoming increasingly liquid due to securitization!

Consumer Loans (13.97%):

Credit cards; auto loans; student loans; etc.
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Transaction Deposits:
They are deposits that you can write a check against; the most liquid kind

of deposits (on average 8% of total liabilities in 2009).

Demand Deposits():
The bank must give you your funds on demand and cannot pay interest
on them (regulation).

They are insured by the regulator (FDIC).

Banks hold a certain % of them on reserve at the FED.
NOW (Negotiable Order of Withdrawal) Accounts:
They pay interest but revert to the status of a demand deposit if the
funds fall below a minimum balance.
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Non-transaction Deposits (on average 56% in 2009):

(Savings account)
Passbook Savings and Money Market Deposit Accounts:
Pay interest and are liquid since the holder can withdraw funds anytime.
MMDAs have limitations on the number of transactions and generally have a
minimum balance requirements.

Time Deposits:
Pay higher interest but are less liquid than MMDAs and passbook accounts
(with maturities of at least 14 days).

Negotiable CDs:
Time deposits with a value greater than $100,000 (this is the cut-off to be
fully insured by FDIC)
They are traded in the secondary market just like bonds.
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Subordinated Debt:
Large banks may issue longer-maturity publicly-traded bonds.
They are subordinate (junior) to the banks other liabilities

(for regulatory reasons).

Issued only by large banks.

Capital (Net worth):

Difference between bank assets and liabilities.
It is important as a buffer to prevent bankruptcy.
Banks must hold minimum 8% of their risk weighted assets as

capital.

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Activities that are not reported on the balance sheet but are
moved back on when a contingent event occurs.
Examples: letter of credit, derivative contracts, loan
commitments.
Can be used to avoid regulatory costs and taxes.
Can be used to hedge interest rate, credit and FX risks.
Can significantly increase risk exposure!!!!

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Federal Charter

State Charter

OCC

State Agency

Primary Supervisor

Primary Supervisor

Chose to be part of the

Federal Reserve System

Federal Reserve

Chose to not to be
part of the Federal
Reserve System

FDIC

Charter determines a banks power, capital requirements and lending limits

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Savings Institutions

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Savings & Loans (Thrifts): Traditionally focus on mortgage lending

Main functions:

Accept Deposits
Lend funds in several forms but mainly residential mortgages

Savings Banks: Operate as a more diversified saving institution

Main functions:

Accept Deposits
Lend funds in many forms:

Residential mortgages
Commercial and Industrial Loans (C&L)
Corporate Bonds
Stocks

Functions
Established primarily to serve personal savers collect short-term deposits

and use them to make residential mortgage loans

Today they perform services similar to commercial banks (but must hold at

least 65 % of their assets as mortgages or mortgage-backed securities)

only Savings and Loans (thrifts)

Many thrifts began as mutual organizations that were legally owned by their

depositors.

Recently, they have converted to stock-issuing institutions and therefore

they raise equity from public investors.

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Both Saving Banks and Savings & Loans are chartered by:
Federally The Office of the Comptroller of Currency (OCC)
State

Originally:
Deposits:
Savings Banks Federal Deposit Insurance Corp. (FDIC)
Savings & Loans Federal Savings & Loans Insurance Corp (FSLIC)

Savings banks were limited by law to only offer savings accounts and

to make their income from mortgages and student loans.

Management at Savings & Loans is determined by depositors
The weight of each depositors vote depends on the percent of bank funds deposited by
the individual

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Currently:
Changes in bank regulation have made the operations of these two

banks almost indistinguishable

The main difference between the two is that management in an
S&L is determined by depositors

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S&L Crisis 1980s

Increasing interest rates due to monetary and foreign policy exposed

S&Ls to severe interest rate risk

S&Ls were locked into long-term mortgages that paid fixed interest
rates
The rates on short-term deposits adjusted upward so S&Ls faced a
negative margin

Recapitalized FSLIC

Margin = r(mortgage) r(deposits)

Replaced FSLIC with FDIC

Excessive risk taking in lending (gambling for resurrection)

Federal Savings and Loan Insurance Corporation (FSLIC) the

insurance provider for S&L deposits suffered severe capital shortages

1987 Competitive Equality in Banking Act
1989 Financial Institutions Reform Recovery and Enforcement Act FIRREA
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Real estate fall out

Real estate in Texas and the Southwest collapsed
S&Ls were exposed to a large number of defaults

Their numbers decreased by 35% during the 1980s

There were about 1,300 S&Ls as of 2006 year-end.

Deposit insurance cost of these failures exceeded $160B.

Now they are under the regulation of FDIC and pay risk-based deposit

insurance premiums.

Savings Banks
Mainly located on the East Coast
Location insulated banks against large losses in real estate values in the

southwest

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1990-1991 real estate fallout in New England

Real estate market crash severely affected Savings Banks

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Financial Institution Reform and Recovery Act 1989

Abolished Federal Savings and Loan Insurance Corporation (FSLIC)
Created Savings Association Insurance Fund (SAIF) (FDIC managed)
Created Resolution Trust Corp. to close the most insolvent SIs
Restricted SIs non-mortgage related asset holdings

Federal Deposit Insurance Corporation Improvement Act 1991

Introduced risk-based depository insurance premiums
Introduced regulatory intervention whenever bank capital falls below a

certain point
Limited the use of too-big-to fail bailouts
Extended federal regulation to branches of foreign banks

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 Cash and due forms

US Treasuries
Mortgage loans
MBS
Bonds and notes
Commercial loans
Consumer loans

9.58%
0.56%
44.88%
20.75%
5.12%
4.66%
7.65%

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Total Deposits
Other Borrowing
Fed Repurchase Agreements
Other Liabilities
Net worth (capital)

76.48%
7.23%
2.68%
1.72%
11.89%

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Federal Charter

State Charter

State Agency

OCC

Primary Supervisor

Formerly regulated by the Office

of Thrift Supervision 2011 OTS
was consolidated with OCC

Saving & Loan

Federal Reserve

Saving Bank

FDIC

Charter determines a banks power, capital requirements and lending limits

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Credit Unions

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Non-profit depository institutions, owned by their members.

Investors paid an entrance fee and invested funds to buy at least

one share

CUs lend the deposited funds to other members

Limited customer base (only members common attribute)

Profession
Residential location
Affiliation (University)

Generally charge lower rates to members and pay higher rates to

depositors from non-profit status

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 Cash equivalents
US Gov. securities
MBS
Corporate Bonds
Other investment securities
Home Mortgages
Consumer Credit
Business Loans
Other loans

4.3%
19.9%
4.9%
2.0%
3.5%
28.1%
23.8%
4.0%
4.7%
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 Share drafts
Small time and savings
Large time deposits
Misc. liabilities
Net worth (capital)

shares

10.8%
67.9%
7.2%
3.8%
10.3%

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Question: how do Credit Unions make their profits?

Answer: They dont !!!!!
Credit Unions are non-profit organizations, so they take the
money they earn on loans and distribute it to their owners
the depositors
They only take what they need to cover costs. This allows
them to pay higher rates on deposits and charge lower rates
on loans

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Federal Charter

National Credit Union

Administration
Deposits insured by the National
Credit Union Insurance Fund

State Charter

State Agency
Primary Supervisor

Deposits may be insured by the

National Credit Union Insurance Fund

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Depositor Institution Comparison

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In 2009:
All three types of DIs have the largest fraction of their assets in

mortgages
Commercial banks have a large fraction of their business in C&I loans
Commercial banks use investment securities more than other DIs
Commercial banks are more diversified
Credit unions are more customer oriented (more consumer loans)
Savings banks focus on residential mortgages
The main source of funding for all three banks is deposits

Different types of Depository Institutions

Commercial Banks
Savings Institutions
Credit Unions

Functions
Assets
Liabilities

History (trends)
Merger wave
S&L Crisis
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