©2003 McGraw-Hill Companies Inc. All rights reserved Slides by Kenneth StantonMcGraw Hill / Irwin 2-1 2 Chapter The Financial Services Industry: Depository.

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-1

2Chapter

The Financial Services Industry:

Depository Institutions

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-2

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

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

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Products of U.S. FIs

Comparing the products of FIs in 1950, to products of FIs in 2000:• Much greater distinction between types of FIs in

terms of products in 1950 than in 2000• 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

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

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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

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-5Largest Depository Institutions, 2000 by total assets (billions)

Citigroup $804.3

J.P. Morgan Chase 707.5

BankAmerica 671.7

Banc One 283.4

First Union 246.6

Wells Fargo 241.1

Washington Mutual 190.8

Fleet Boston 179.1

SunTrust Banks 100.6

HSBC 87.1

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

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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

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-7Functions and 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

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-8

Commercial Banks

Primary assets:• Real Estate Loans: $1,670.3 billion• C&I loans: $1,048.2 billion• Loans to individuals: $609.7 billion• Other loans: $367.5 billion• Investment security portfolio: $1,662.0 billion

» Of which, Treasury bonds: $710.0 billion

Inference: Importance of Credit Risk

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-9

Commercial Banks

Primary liabilities:• Deposits: $4,176.6 billion• Borrowings: $1,532.5 billion• Other liabilities: $401.0 billion

Inference:• Highly leveraged

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-10

Small Banks, Nation

C&I17.96%

Credit Card1.55%

Consumer10.98%

Other6.74%

Real Estate62.77%

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-11

C&I29.38%

Credit Card7.55%

Consumer9.12%Other

14.10%

Real Estate39.85%

Large Banks, Nation

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-12

Structure and Composition

Shrinking number of banks:• 14,416 commercial banks in 1985• 12,744 in 1989• 8,315 in 2000

Mostly the result of Mergers and Acquisitions• M&A prevented prior to 1980s, 1990s• Consolidation has reduced asset share of small

banks

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-13Structure and 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

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-14Composition 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, Bank One, Bankers Trust,

Citigroup, J.P. Morgan/Chase, HSBC Bank USA» declining in number

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-15

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

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-16

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.

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-17

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

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

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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

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-19

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.

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-20

Web Resources

For more detailed information on the regulators, visit:

http://www.fdic.gov

http://www.occ.treas.gov

http://federalreserve.gov

Web Surf

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

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Other Regulatory Issues

Importance of Bank Holding Companies is increasing.

BHCs regulated by FRS.

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-22

Key Regulatory Legislation

1927 McFadden Act: Controls branching of national banks.

1933 Glass-Steagall: separates securities and banking activities.

1956 Bank Holding Company Act and subsequent amendments specifies permissible activities and regulation by FRS of BHCs.

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

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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

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-24

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.

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-25

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

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

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Legislation (continued)

1991 FDIC Improvement Act• Introduced Prompt Corrective Action• Risk-based deposit insurance premiums • Limited “too big to fail”

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-27

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.

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-281999 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

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-29

Industry Performance

Economic expansion and falling interest rates through 1990s• Commercial banks record earnings of $71.6 billion

Downturn in early 2000s• Reduction in performance• Increased provision for loan losses

Only 6 failures in 2000 versus 206 in 1989• Technology risks remain

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-30

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.

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-31

Savings Institutions: Recent Trends

Industry is smaller overall Intense competition from other FIs

• mortgages for example Concern for future viability

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-32

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).

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-33

Web Resources

For more information on the regulation of savings institutions, visit:

Treasury www.ots.treas.gov

FDIC www.fdic.gov

Web Surf

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-34

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

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-35

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 2/3 federally chartered and subject to NCUA regulation.

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-36

Web Resources

For information on credit unions visit:

American Bankers Association www.aba.com

Web Surf

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-37

Global Issues

Near crisis in Japanese Banking 19 of the biggest Japanese banks on credit

watch list European banks continued to perform well Implications for future competitiveness

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-38

Other Trends

Number of banks continues to decline. Increase in off-balance-sheet activities. Increase in income derived from fees-for-

service rather than spread income. Increased competition between banks and

across financial services sectors. Increased competition from foreign FIs.

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

2-39

Pertinent Websites

www.federalreserve.gov

www.cuna.org

www.fdic.gov

www.occ.treas.gov

www.ots.treas.gov

www.us-banker.comWeb Surf

©2003 McGraw-Hill Companies Inc. All rights reservedSlides by Kenneth StantonMcGraw Hill / Irwin

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*Financial Statement Analysis

Time series analysis of key ratios ROE framework

• ROE = ROA × EM• ROA = PM × AU