Depository Institutions

Depository Institutions
Include:

 Institutions which take deposits

 Deposits represent Liabilities (debt) for DI’s

Include:
 Banks
 Savings & Loan institutions
 Savings Banks
 Credit Unions
Asset/liability problem of Depository
institutions

A depository institution seeks to earn a

positive spread between the assets it in
invests in (loans and securities) and the
costs of funds(deposits and other sources)
 How do DI’s make money?

3 ways:

 Loans
Make direct loans to entities
 Securities investments
Investing in securities & holding portfolios
 Fees
Charged to their customers
Asset/liability problem of Depository
institutions
Risks faced by the depository institutions

Credit risk-default risk that the borrower will

default on his loan obligation or that the issuer of
the security that the depository institution holds
defaults on its obligation.

Regulatory risk-regulators will change the rules

so as to impact the earnings of the institution
unfavorably
Asset/liability problem of Depository
institutions
Funding risk
Illustration
 Suppose that the depository institution raises $100
million by issuing a deposit account that has a maturity
of one year and by agreeing to pay 7% interest

 Suppose that $100 million is invested in a government

security that matures in 15 years , paying an interest rate
of 9%
Asset/liability problem of Depository
institutions

If interest rates declines, the spread will increase

If Interest rates rise

What position should you have?

If interest rates fall

What position should you have?
Asset/liability problem of Depository
institutions
When interest rates are expected to
decline, depository institutions borrow
short and lent long

When interest rates are expected to rise,

depository institutions borrow long and
lent short
 Asset-Liability Problem of DI’s?

Threats of positioning:

 Adverse financial consequences

If expectations are not realized, Huge losses can occur

 No one can predict interest rates consistently

Highly risky?

 Becomes same as gambling

Long run losses highly likely?
Liquidity concerns
A depository institution must be prepared to
satisfy withdrawals of funds by depositors and to
provide loans to customers

4 ways to solve liquidity issues?

Attract additional deposits
Borrowing from the federal agency or other
financial institutions
Sell securities that it owns
Raise short term funds in the money market
Commercial Banks
5 largest banks of Pakistan
Commercial Banks
Bank services:
Individual banking
Institutional banking-loans to non financial
corporations , financial corporations and
government entities. Leasing , real estate financing
and factoring also fall into this category.
Global banking-
 Corporate financing
 Capital market products
 Foreign exchange products and services
Bank Funding
Three sources of funds for banks:

Deposits
Nondeposit borrowing
Common stocks and retained earnings
Bank Funding
Deposits

Demand deposits
Savings deposits
Time deposits
Bank Funding
Reserve requirements and borrowing in
the federal funds market
All banks must maintain a specified
percentage of their deposits in a non-
interest bearing account at the State bank.
Reserve ratio
Required reserve
Bank Funding
Excess reserves- when actual reserves exceed
required reserves.
Banks temporarily short of funds can borrow
reserves from banks that have excess reserves.
The market where banks can borrow or lend
reserves is called the federal funds market.
The interest rate that is charged to borrow funds
in this market is called the federal funds rate.
Bank Funding
Borrowing at the Fed discount window:
Banks temporarily short of funds can
borrow from the Fed at its discount window
Collateral is necessary to borrow
Discount rate- the interest rate that the Fed
charges to borrow funds at the discount
window
Borrowing from the Fed is done basically
to meet short term liquidity needs
Bank Funding
Other non deposit borrowing
Issuing obligations in the money market,
or intermediate to long term in the form of
issuing securities in the bond market.
Regulation
Ceilings imposed on the interest rates that can
be paid on deposit accounts

Geographical restrictions on branch banking

Permissible activities for commercial banks

Capital requirements for commercial banks

Savings and loan Associations
Provision of funds for financing of a
home.

Thecollateral for the loans would be the

home being financed

Mutually owned or corporate stock

ownership
Savings and loan Associations
Assets:
Traditionally,
the only assets in which S&L’s
were allowed to invest have been mortgages,
and government securities.

Problem:
Maturity matching problem
Savings and loan Associations
Otherinvestments:
Consumer loans( loans for home
improvement , automobiles, education , business
or credit cards)
Non consumer loans ( commercial , corporate
, business or agriculture loans)
Junk bonds
Investment in short term assets for
operational or regulatory purposes.
Savings and loan Associations
Funding:
Savings and time deposits
Negotiable order of withdrawal (NOW)
accounts
Money market deposit accounts (MMDA)
The S&L Crisis
Credit unions
“Common bond” requirement for credit
union membership
No corporate ownership
Purpose:
Serve member’s saving and borrowing
needs
Credit unions are owned by their
members, member deposits are called
shares.