1 Chapter 17 Commercial Bank Operations Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline  Commercial banks as financial intermediaries  Bank market structure  Bank sources of funds  Uses of funds by banks  Off-balance sheet activities  International banking 3 Commercial Banks as Financial Intermediaries  Commercial banks serve all types of surplus and deficit units  Offer deposit accounts with the size and maturity characteristics desired by surplus units  Repackage funds received from deposits to provide loans of the size and maturity desired by deficit units 4 Bank Market Structure  Banks are continuing to consolidate:  Interstate regulations were changed in 1994 to allow banks more freedom to acquire banks across state lines  Competition among banks increased  Banks needed to become more efficient as a means of survival  Acquisitions were a convenient method to grow quickly  The number of banks today is about one-half that existed in 1985  The largest 100 banks now represent about 75 percent of all bank assets 5 Bank Market Structure (cont’d)  Bank participation in financial conglomerates  Some commercial banks have acquired other types of financial service firms  Conglomerates are composed to various units offering specialized services  Impact of the Financial Services Modernization Act  The Act gave banks and other financial service firms more freedom to merge, without having to divest some of the financial services that they acquired  The Act allowed financial institutions to offer a diversified set of financial services 6 Bank Market Structure (cont’d)  Benefits of diversified services to individuals and firms  Individuals and firms have various financial needs that they can now satisfy with one conglomerate  Some financial conglomerates specialize in the services desired by individuals or large firms  Benefits of diversified services to financial institutions  Financial institutions can reduce their reliance on the demand for any single service they offer  Diversification may result in less risk for the institution  The units of a financial conglomerate may generate some new business just because they offer convenience to clients who already rely on its other services 7 Bank Sources of Funds  A financial institution’s liabilities represent its sources of funds  Transaction deposits  A demand deposit account (checking account) is offered to customers who desire to write checks  A conventional account requires a small minimum balance and pays no interest  A negotiable order of withdrawal (NOW) account provides checking services as well as interest but requires a larger minimum balance  Electronic transactions  About two-thirds of all employees in the U.S. have direct deposit accounts  More than 60 percent of bank customers use ATMs  Debit cards and preauthorized debits can be used for recurring monthly payments 8 Bank Sources of Funds (cont’d)  Savings deposits  Until 1986, Regulation Q restricted the interest rate banks could offer on passbook savings  Ceilings prevented commercial banks from competing for funds during periods of higher interest rates  An automatic transfer service (ATS) account allows customers to maintain an interest-bearing savings account that automatically transfers funds to their checking account when checks are written 9 Bank Sources of Funds (cont’d)  Time deposits  Time deposits are deposits that cannot be withdrawn until a specified maturity date  Retail certificates of deposit (CDs) require a specified minimum amount of funds to be deposited for a specified period of time  Annualized interest rates vary among banks and maturity types  There is no organized secondary market  Depositors will normally forgo a portion of their interest as a penalty for early withdrawal 10 Bank Sources of Funds (cont’d)  Time deposits (cont’d)  Certificates of deposit (cont’d)  Bull-market CDs reward depositors if the market performs well  Bear-market CDs reward depositors if the market performs poorly  Callable CDs can be called by the financial institution early  Pay a slightly higher interest rates, which compensates depositors for risk  Negotiable certificates of deposit (NCDs):  Are offered by some large banks to corporations  Typically have short-term maturities  Typically require a minimum deposit of $100,000  Do not have a secondary market [...]... requirements that were completely phased in by 1992   The required level of capital is dependent on its risk Assets with low risk are assigned low weights, and assets with high risk are assigned high weights 17 Bank Sources of Funds (cont’d) 18 Uses of Funds by Banks  Cash  Banks are required to hold some cash as reserves by reserve requirements imposed by the Fed  Banks hold cash to maintain some liquidity . 1 Chapter 17 Commercial Bank Operations Financial Markets and Institutions, 7e, Jeff. ©2006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline  Commercial banks as financial intermediaries  Bank market