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Chapter 2

Chapter 2. Depository Institutions. Overview of Depository Institutions. In this segment, we explore the depository FIs: Size, structure and composition Balance sheets and recent trends Regulation of depository institutions Depository institutions performance. Products of U.S. FIs.

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Chapter 2

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  1. Chapter 2 Depository Institutions

  2. Overview of Depository Institutions • In this segment, we explore the depository FIs: • Size, structure and composition • Balance sheets and recent trends • Regulation of depository institutions • Depository institutions performance

  3. Products of U.S. FIs • 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)

  4. Specialness of Depository FIs • Products on both sides of the balance sheet • Loans • Business and Commercial • Deposits

  5. Other outputs of depository FIs • Other products and services 1950: • Payment services, Savings products, Fiduciary services • By 2003, products and services further expanded to include: • Underwriting of debt and equity, Insurance and risk management products

  6. Size of Depository FIs • Consolidation has created some very large FIs • Combined effects of disintermediation, global competition, regulatory changes, technological developments, competition across different types of FIs

  7. Largest Depository Institutions Citigroup $1,208.9 J.P. Morgan Chase* 770.9 Bank of America** 736.4 Wells Fargo 393.9 Wachovia 388.0 Bank One* 326.6 Washington Mutual 275.2 Fleet Boston** 200.2 U.S. Bancorp 188.8 SunTrust Banks 181.0 Total Assets ($Billions)

  8. Depository Institutions • Commercial Banks • Largest depository institutions are commercial banks. • Differences in operating characteristics and profitability across size classes. • 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

  9. Functions & Structural Differences • Functions of depository institutions • Regulatory sources of differences across types of depository institutions. • Structural changes generally resulted from changes in regulatory policy. • Example: changes permitting interstate branching • Reigle-Neal Act

  10. Commercial Banks • Primary assets: • Real Estate Loans: $2,272.3 billion • C&I loans: $870.6 billion • Loans to individuals: $770.5 billion • Investment security portfolio: $1,789.3 billion • Of which, Treasury bonds: $1,005.8 billion • Inference: Importance of Credit Risk

  11. Commercial Banks • Primary liabilities: • Deposits: $5,028.9 billion • Borrowings: $1,643.3 billion • Other liabilities: $238.2 billion • Inference: • Highly leveraged

  12. Small Banks, Nation

  13. Large Banks, Nation

  14. Structure and Composition • Shrinking number of banks: • 14,416 commercial banks in 1985 • 12,744 in 1989 • 7,769 in 2004 • Mostly the result of Mergers and Acquisitions • M&A prevented prior to 1980s, 1990s • Consolidation has reduced asset share of small banks

  15. Structure & Composition of Commercial Banks • 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

  16. Composition of Commercial Banking Sector • Community banks • Regional and Super-regional • Access to federal funds market to finance their lending activities • Money Center banks • Bank of New York, Deutsche Bank (Bankers Trust), Citigroup, J.P. Morgan Chase, HSBC Bank USA • declining in number

  17. Balance Sheet and Trends • Business loans have declined in importance • Offsetting increase in securities and mortgages • Increased importance of funding via commercial paper market • Securitization of mortgage loans

  18. 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 $100,000 that can be resold in the secondary market.

  19. Off-balance Sheet Activities • 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

  20. Trading and Other Risks • Allied Irish / Allfirst Bank • $750 million loss • National Australian Bank • $450 million loss

  21. Other Fee-generating Activities • Trust services • Correspondent banking • Check clearing • Foreign exchange trading • Hedging • Participation in large loan and security issuances • Payment usually in terms of noninterest bearing deposits

  22. Key Regulatory Agencies • FDIC (BIF and SAIF) • OCC: Primary function is to charter national banks. • FRS: monetary policy, lender of last resort. • National banks are automatically members of the FRS. State-chartered banks can elect to become members. • State bank regulators • Dual Banking System: Coexistence of nationally and state-chartered banks.

  23. Web Resources • For more detailed information on the regulators, visit: http://www.fdic.gov http://www.occ.treas.gov http://federalreserve.gov

  24. Other Regulatory Issues • Importance of Bank Holding Companies is increasing. • BHCs regulated by FRS.

  25. Key Regulatory Legislation • 1927 McFadden Act: Controls branching of national banks. • 1933 Glass-Steagall: separates securities and banking activities, established FDIC, prohibited interest on demand deposits. • 1956 Bank Holding Company Act and subsequent amendments specifies permissible activities and regulation by FRS of BHCs.

  26. Legislation (continued)... • 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

  27. Legislation (continued) • 1980 DIDMCA and 1982 DIA (Garn-St. Germain Depository Institutions Act) • Mainly deregulation acts. • Phased out Regulation Q. • 1987 Competitive Equality in Banking Act (CEBA) • Redefined bank to limit growth of nonbank banks.

  28. Legislation (continued) • 1989 FIRREA • Imposed restrictions on investment activities • Replaced FSLIC with FDIC-SAIF • Replaced FHLB with Office of Thrift Supervision • Created Resolution Trust Corporation

  29. Legislation (continued) • 1991 FDIC Improvement Act • Introduced Prompt Corrective Action • Risk-based deposit insurance premiums • Limited “too big to fail”

  30. Legislation (continued) • 1994 Riegle-Neal Interstate Banking and Branching Efficiency Act • Permits BHCs to acquire banks in other states. • Invalidates some restrictive state laws. • Permits BHCs to convert out-of-state subsidiary banks to branches of single interstate bank. • Newly chartered branches permitted interstate if allowed by state law.

  31. 1999 Financial Services Modernization Act • Financial Services Modernization Act • Allowed banks, insurance companies, 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

  32. Recent Legislative Changes • USA Patriot Act of 2001 • Sarbanes-Oxley Act of 2002

  33. Industry Performance • Economic expansion and falling interest rates through 1990s • Brief downturn in early 2000 followed by strong performance improvements • Record earnings $106.3 billion 2003 • Only 3 failures in 2003 versus 206 in 1989 • Serious concerns regarding expected interest rate increases

  34. Banking and Ethics • Bank of America and Fleet Boston Financial 2004 • J.P. Morgan Chase and Citigroup 2003 role in Enron • Riggs National Bank and money laundering concerns 2003

  35. Savings Institutions • 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.

  36. Savings Institutions: Recent Trends • Industry is smaller overall • Intense competition from other FIs • mortgages for example • Concern for future viability

  37. Primary Regulators • Office of Thrift Supervision (OTS). • Charters and examines all federal S&Ls. • FDIC-SAIF Fund. • Oversees and manages Savings Association Insurance Fund (SAIF).

  38. Web Resources • For more information on the regulation of savings institutions, visit: Treasury www.ots.treas.gov FDIC www.fdic.gov

  39. Savings Banks • 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

  40. Credit Unions • Nonprofit depository institutions owned by member-depositors with a common bond. • Exempt from taxes and Community Reinvestment Act (CRA). • Expansion of services offered in order to compete with other FIs. • Approximately 56% federally chartered and subject to NCUA regulation.

  41. Web Resources • For information on credit unions visit: American Bankers Association www.aba.com

  42. Global Issues • Near crisis in Japanese Banking • Eight biggest banks reported positive six-month profits • China • Deterioration, NPLs at 50% levels • Opening to foreign banks (WTO entry) • German bank problems in early 2000s • Implications for future competitiveness

  43. Pertinent Websites Federal Reserve www.federalreserve.gov Credit Union National Association www.cuna.org FDIC www.fdic.gov National Credit Union Administration www.ncua.gov Office of Comptroller of the Currency www.occ.treas.gov Office of Thrift Supervision www.ots.treas.gov Wall Street Journal www.wsj.com

  44. *Financial Statement Analysis • Time series analysis of key ratios • ROE framework • ROE = ROA × EM • ROA = PM × AU

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