Chapter Eleven
Commercial Banks
McGraw-Hill /Irwin
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Outline
1.
2.
3.
4.
5.
Depository Institutions Definition
Typical Characteristics of Commercial Banks
Trends in Commercial Banks
Bank Size and Activities
Regulation
1. Depository Institutions
• Financial Institutions that:
–
–
–
–
Accept deposits (Insured by government)
Make loans
Have access to payment system
Are heavily regulated
• Three major groups
– Commercial banks
– Savings institutions
– Credit Unions
2. Commercial Banks
• Largest group of depository institutions
• Major liability includes deposits; nondeposit sources of
funds include subordinated notes and debentures
• Loans are broader in range than savings and credit
unions: commercial, real estate, consumer, etc.
• Deposits insured by FDIC
• Regulated separately from savings institutions and
credit unions: Federal Reserve, Office of the
Comptroller of the Currency (OCC), FDIC
Differences in Balance Sheets
Depository Institutions
Assets
Loans
Liabilities
Deposits
Other
financial
assets
Other
nonfinancial
assets
Nonfinancial Firms
Assets
Deposits
Liabilities
Loans
Other
financial
assets
Other
liabilities
and
equity
Other
nonfinancial
assets
Other
liabilities
and
equity
Commercial Bank Balance Sheet (b$, 2004)
Assets
Total cash assets……………….
$ 416.9
U.S. gov securities……………
$ 1047.4
Fed Funds/Repurchase……….
384.6
Other………………………….
447.3
Investment securities…………..
1,879.3
Interbank loans……………….
193.6
Loans exc. Interbank…………
4624.3
Comm. and Indust…………..$ 890.1
Real estate…………………… 2,544.9
Individual……………………. 806.3
All other……………………… 383.0
Less: Reserve for losses………
78.1
Total loans………………………
$4,739.8
Other assets……………………..
1,208.4
Total assets……………………..
$8,244.4
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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Commercial Bank Balance Sheet (b$, 2004)
Liabilities and Equity
Transaction accounts……………
Nontransaction accounts………...
Total deposits……………………
Borrowings………………………
Other liabilities…………………..
Total liabilities…………………..
Equity……………………………
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$ 716.9
4,689.1
$5,406.0
1,769.6
247.4
$7,423.4
821.4
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Commercial Bank Balance Sheet (2004)
Assets
Total cash assets……………….
U.S. gov securities……………
Fed Funds/Repurchase……….
Other………………………….
Investment securities…………..
Interbank loans……………….
Loans exc. Interbank…………
Comm. and Indust…………..
Real estate……………………
Individual…………………….
All other………………………
Less: Reserve for losses………
Total loans………………………
Other assets……………………..
Total assets……………………..
5.1%
12.7%
4.7%
5.4%
22.8%
2.3%
56.1%
10.8%
30.9%
9.8%
4.6%
0.9%
57.5%
14.6%
100%
Commercial Bank Balance Sheet (2004)
Liabilities and Equity
Transaction accounts……………
Nontransaction accounts………...
Total deposits……………………
Borrowings………………………
Other liabilities…………………..
Total liabilities…………………..
Equity……………………………
8.7%
56.8%
65.5%
21.5%
3.0%
90.0%
10.0%
Industry Performance
• A well run bank usually has an ROA of 0.5% to 3%.
• To get an acceptable ROE, banks must resort to using a
very high amount of leverage; the debt/asset ratio at a
bank is usually over 90%.
• The average ROA and ROE for commercial banks in
2003 is 1.40% and 15.31%, respectively, compared to
1989 when ROA and ROE averaged 0.49% and 7.71%.
2.1 Trends in Commercial Banks
• Portfolio Shift
– As a percentage of the typical bank’s balance sheet,
over the last 50 years, mortgages have risen and
securities have fallen
• Loss of Market Share
– 20 years ago banks had 40% share
– 10 years ago banks had 26% share
– Today banks have 19% share
2.2 Trends in Commercial Banks
• Movement toward off-balance sheet activities
– Movement away from net spread income (interest
income minus interest expense)
– Movement toward fee income
Balance Sheet Items
• Assets
– loans and investment securities
• Liabilities
– transaction accounts - the sum of noninterest-bearing demand
deposits and interest-bearing checking accounts
– NOW account - an interest-bearing checking account
– negotiable CDs - fixed-maturity interest-bearing deposits with
face values of $100,000 or more that can be resold in the
secondary market
• Equity
– common and preferred stock, surplus or additional paid-in
capital, and retained earnings
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Examples of Off-Balance Sheet Activities
• Loan commitments
– promises to make loans in return for fees
• Trust services
– generates fees by holding and managing individuals
or corporations assets
• Correspondent banking
– generates fees by provision of banking services to
other banks
2.3 Trends in Commercial Banks
• Consolidation
– Number of Banks
•
•
•
•
•
1989
1993
1999
2001
2004
12,709
10,958
8,579
8,080
7,660
Economies of Scale and Scope
• Economies of scale
– the degree to which a firm’s average unit costs of producing
financial services fall as its output of services increase
• Economies of scope
– the degree to which a firm can generate cost synergies by
producing multiple financial service products
• X efficiencies
– cost savings due to the greater managerial efficiency of the
acquiring firm
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4. Commercial Banks by Asset Size (2004)
Size Range
Number
%
Assets
%
< $100 million
3,755
49.0%
$194.6
2.4%
$100 million - $1
billion
3,458
45.2%
$927.8
11.2%
$1 billion - $10
billion
360
4.7%
$971.3
11.8%
> $10 billion
87
1.1%
$6,150.7
74.6%
Total Industry
7,660
100.0%
$8244.4
100.0%
Bank Size Classifications
• Community bank - a small bank that frequently
specializes in retail or consumer banking
• Regional bank - a mid-sized bank that engages in a
complete array of wholesale commercial banking
activities
• Super regional bank – a large regional bank – usually
does business in more than one state
• Money center bank - a bank that relies heavily on
nondeposit or borrowed sources of funds
• Financial conglomerate – a large bank that does a lot
of other financial activities – investment banking,
insurance etc.
Bank Size and Activities
• Large banks have easier access to capital
markets and can operate with lower amounts of
equity capital
• Large banks tend to have fewer core deposits
• Large banks lend to larger corporations which
means that their interest rate spread is narrower
• Large banks are more diversified, have more offbalance-sheet activities and generate more
noninterest income
Bank Size and Concentration
• Wholesale banking
– provide commercial and industrial loans
funded with purchased funds
• Retail banking
– provide residential and consumer loans
and accepting small deposits
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Wholesale Banking Services
•
•
•
•
•
•
•
Controlled disbursement accounts
Account reconciliation
Lockbox services
Electronic lockbox
Funds concentration
Electronic funds transfer
Check deposit services
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Wholesale Banking Services (cont..)
•
•
•
•
•
•
•
Electronic initiation of letters of credit
Treasury management software
Electronic data interchange
Facilitate business-to-business e-commerce
Electronic billing
Verifying identities
Assist small business entry in e-commerce
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Retail Banking Services
•
•
•
•
•
•
Automated teller machines (ATMs)
Point-of-sale debit (POS) cards
Preauthorized debits/credits
Paying bills via telephone
On-line banking
Smart cards (stored-value cards)
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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
5. Regulators
• Federal Deposit Insurance Corporation (FDIC)
– insures the deposits of commercial banks
• Office of the Comptroller of the Currency (OCC)
– function is to charter national banks as well as close them
– has the power to approve/disapprove of mergers
• Federal Reserve System
– requires all banks to meet the same noninterest-bearing
reserve requirements
• State Authorities
– performs for state chartered banks similar functions as the
OCC does for national banks