Chap 2, Class 2
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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
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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
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
Owned by depositors
 Accept deposits in the form of shares

Lend to members
 Mainly smaller consumer loans
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COMMERCIAL BANKS
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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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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
with non-DI financial institutions
 Deregulation Acts
▪ 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
Regulatory Changes
2.


1994 Riegle-Neal Interstate Banking and Branching Efficiency Act –
Allowed bank holding companies to acquire banks in other states
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?
% small banks
% large banks
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%
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%
Asset share at small banks
Asset share at large banks
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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A
Commercial Bank
Business Loans
(C&I Loans)
L
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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19
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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):
 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 bank’s 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 depositor’s 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 1980’s
 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 1980’s
 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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
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Share drafts
Small time and savings shares
Large time deposits
Misc. liabilities
Net worth (capital)
10.8%
67.9%
7.2%
3.8%
10.3%
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Question: how do Credit Unions make their profits?
Answer: They don’t !!!!!
▪ 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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Depository Institution Asset Distributions
100%
90%
other assets
80%
consumer loans
70%
commercial loans (C & L)
60%
Investment Securities
Mortgage Loans
50%
US Treasury securities
40%
Cash
30%
20%
10%
0%
Commercial Banks
Savings Insitutions
Credit Unions
Total Liabilities
100%
90%
80%
Other Liabilities
70%
Borrowing
60%
Total Deposits
50%
40%
30%
20%
10%
0%
Commercial Banks
Savings Insitutions
Credit Unions
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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