Chapter 16

Commercial Bank Operations

© 2001 South-Western College Publishing Company

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Chapter Objectives

Describe the most common sources of funds for commercial banks

Describe the most common uses of funds for commercial banks

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Bank Participation in Financial Conglomerates

Impact of the Financial Services Modernization Act (1999)Prompted by the Citicorp-Traveler’s mergerBanks and other financial service firms were

given more freedom to merge and offer a range of financial services

• Insurance

• Securities services

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Bank Participation in Financial Conglomerates

Benefits of diversified services to individuals and firms Individuals can obtain all their financial

services at a single financial conglomerate• Deposits• Loans• Investing (brokerage)• Insurance

Businesses can obtain loans, issue stocks and bonds, and have their pension fund managed by the same institution

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Bank Participation in Financial Conglomerates

Benefits of diversified services to the financial institutionReduce reliance on demand for single

servicesDiversification may result in less riskGenerate new business

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Bank Sources of Funds

Deposit accounts• Transaction deposits• Savings deposits• Time deposits• Money market deposit accounts

Borrowed funds• Federal funds purchased• Borrowing from the Federal Reserve banks• Repurchase agreements• Eurodollar borrowings

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Bank Sources of Funds

Long-term sources of funds

• Bonds issued by the bank

• Bank capital

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Bank Sources of Funds

Transaction depositsDemand deposit account (checking)Negotiable order of withdrawal (NOW)

account• 1981• Requires larger minimum balance

Savings DepositsPassbook savingsRegulation Q until 1986

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Bank Sources of Funds

Time DepositsCertificate of deposit (CD)

• No secondary marketNegotiable CD

• Short-term, minimum $100,000• Can trade among investors

Money Market Deposit Accounts (MMDAs)More liquid than CDs : no specified maturityLimited checkwritingCreated in 1982

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Bank Sources of Funds

Federal Funds PurchasedShort-term loans between banks

• One to seven daysAllows banks to meet reserve requirement Interest rate charged is the federal funds rate

Borrowing from the Federal Reserve BanksBorrowing at the discount windowDiscount rate Intended for meeting temporary short-term

needsMust get Fed approval

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Bank Sources of Funds

Bank capitalObtained from issuing stock or retaining

earningsNo obligation to pay out funds in the futureMust be sufficient to absorb operating losses

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Uses of Funds by Banks

Loans make up about 64 percent of bank assets, while all securities make up about 22 percent of assets. Cash represents 6 percent of bank assets.

CashRequired to hold some cash as reservesReserve requirements imposed by Fed

• Tool for controlling the money supplyAlso hold cash to maintain liquidity and

accommodate withdrawal requests by depositors

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Uses of Funds by Banks

Bank LoansTypes of business loans

• Working capital loans

• Term loans

–Purchasing fixed assets

–Protective covenants

• Informal line of credit

• Revolving credit loan

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Uses of Funds by Banks

Bank LoansLoan participations

• Sometimes large firms seek to borrow more money than an individual bank can provide

• Lead bankLoans supporting leveraged buyouts

• Banks charge a high loan rate• Monitored by bank regulators

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Uses of Funds by Banks

Bank LoansCollateral requirements on business loans

• Increasingly accepting intangible assets• Important to service-oriented firms

Lender liability on business loans• Lender liability lawsuits

Types of consumer loans• Installment loans• Credit cards

Real estate loans

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Uses of Funds by Banks

Investment in securitiesTreasury securitiesGovernment agency securities

• Freddie Mac and Fannie MaeCorporate and municipal securities

• Investment grade only Federal funds sold

Lending funds in the federal funds market