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Chapter 11- Commercial Banks

Terms in this set (25)

Balance Sheet for Commercial Banks
Assets
Loans 53.7%
Investments(Treasuries/Federal Funds) 26.7%
Cash(Reserves) 11.8%
Other Assets(Equipment, Real Estate) 7.8%
Four Categories of Loans
1.Real Estate, about 55%, includes both commercial and residential
2.Business, about 25%, also called commercial and industrial
3.Individual Loans, about 15%, such as loans for auto purchases, credit cards
4.Other, about 5%, loans to emerging market countries
Credit/Default Risk Example
Risk that a borrower (or security issuer) will default on a loan (or security)
As probability of default increases so does the interest rate
(1/probability)=1+r
Loan(rate)=how much to charge to breakeven
Balance Sheet of Commercial Bank
Liabilities and Equity
Deposits 76.1%
Borrowings 10.4% (Bonds/Fed Funds)
Other 2.2%
Total Liabilities 88.7% of assets
Total Equity 11.3%

Debt Ratio (30%-40%)
Leverage in a bank
The high use of leverage is a defining characteristic of a commercial bank
Liquidity: Liabilities are MORE liquid than assets
Maturity: Liabilities have SHORTER maturities than assets

This creates risks for banks
Equity in Commercial Banks
Regulators require a minimum level of equity as a buffer against losses from OBS due to the low cost of obtaining deposits, banks choose to set equity close to the minimum. Banks are subject to "stress tests", which analyze bank solvency for a wide range of economic conditions
Balance Sheet Risks (How to manage)
Large amount of loans as assets- Credit/Default Risk (Diversify, Screen, Monitor, Collateral, OBS, Covenants)
Liabilities are more liquid than assets- Liquidity Risk(Reserves, Investment Securities)
Liabilities have shorter maturity than assets- Interest Rate risk(OBS)
Little Equity- Insolvency risk(Raise Adequate Capital)
Savings and Loan Crisis
Pre Crisis (1970s):
Over 3000 Savings and Loans > 20% of assets in financial industry
Crisis (1970s/1980s)
High/Volatile Interest Rates (Volcker-Inflation)
Post-Crisis
About 1000 S&Ls <5% of assets
Threats to bank BS
Threats to Loans: Competition from commercial paper (G.E, Home Depot) bond market
Threats to Deposits: Competition from money market mutual funds
Shadow Banking: Activities of nonbank firms that perform banking services (ex.Money Market Mutual Funds)
Off Balance Sheet Activities
When an event occurs, the item moves on the asset side of the balance sheet or income is realized on the income statement
Examples: derivative transactions, issuing guarantees such as letters of credit, and other fee-related activities
Benefits to bank: earn fee income, don't have to hold reserves against OBS assets, removes credit risk from books, manage interest rate risk
Costs to Bank: Involve risks that can increase chance of insolvency, reduced incentives to screen loan applicants
Community Banks
specialize in retail or consumer banking
Retail Banking
is consumer oriented, such as providing residential and consumer loans and accepting smaller deposits
regional or superregional banks
are those that engage in a complete array of wholesale commercial banking activities
Wholesale banking
is commercial-oriented banking, such as providing commercial and industrial loans funded with purchased funds
Money Center Bank
rely heavily on non deposit or borrowed sources of funds
Summary of Trends (banks in SC and US)
1.Decrease in the number of banks
2.Increase in the number of branches
3.Increase in the Banking industry
Consolidation in banking can potentially harm lending to small businesses because:
1.Centralization of decision making authority
2.More complexity in the organization may make it more difficult to lend to small businesses
Benefits to having large banks
Lower costs for borrowers
Convenience
Costs to having large banks
Systematic risk
Moral hazard of "too big to fail"
Increased lobbying power
Poor customer service, relative to smaller banks
Loss of jobs from consolidation
How to shrink banks
1.Limites on growth
2.Force banks to split into smaller banks
3.Force large banks to sell non-banking assets
Current plan to deal with large banks
A living will is a credible plan for how to unwind the bank in a crisis without sowing panic, about 30 banks plus a handful of nonbank must submit annual living wills
Regulators
1.Federal Deposit Insurance Corporation
2.Office of the Comptroller of the Currency
3.Federal Reserve System
4.State Authorities
Regulation on Nationally Chartered Banks
FDIC
OCC
FED
Regulation on State Chartered Banks
FDIC
FED
State Authority
Dual Banking System
Coexistence of both nationally and state chartered banks
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