Alexander Hamilton: Central Banker and Financial Crisis Manager
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T h e F e d e r a l r e s e r v e B a n k o F s T . l o u i s : C e n T r a l T o a m e r i C a ’ s e C o n o m y ™
CenT ral
n e w s a n d v i e w s F o r e i g h T h d i s T r i C T B a n k e r s
S p r i n g
2 0 0 9
F ea tured i n th i s i ssue: Growth in Noncore Funding | Collapse o the Shadow Banking System
By Kim Nelson
In just a little over a year, the Fed-
eral Reserve’s discount window has
become a popular option or many
banks interested in temporary alterna-
tive unding sources.
I you’re thinking o tapping into a
temporary unding program or your
nancial organization, here is a quick
review. The purpose o the discount window is to act as a saety valve to
relieve pressures in the market or
reserves. Normally, the discount
window relieves temporary liquidity
strains or depository institutions and
the banking system; it is not intended
to provide longer-term unding (with
the exception o the very small sea-
sonal credit program). However,
because o the signicant stress in
the nancial markets that started inAugust 2007, the Fed’s Board o Gover-
nors expanded discount window credit
programs to provide longer-term
liquidity to the nancial system.
The Fed introduced several tempo-
rary programs or banks rst. These
included Term Primary Credit, which
makes unding available or 90 days,
and the Term Auction Facility, which
makes unding available or up to
84 days. These programs are avail-
able only to nancial institutions that
are in “generally satisactory” nan-
cial condition. The loans come with
essentially the same requirements as
a traditional discount window loan,
How To Use the Fed’s Discount WindowTraditional and New, Temporary Lending Programs Fit Specic Needs
although loans exceeding 28 days
must have an excess margin o col-
lateral or contingency short-term bor-
rowing purposes.
Ater introducing the temporary
programs or banks, the Board o Gov-
ernors in March 2008 began exercising
its authority under Section 13(3) o the
Federal Reserve Act, which allows theFed to extend credit to individuals,
partnerships and corporations dur-
ing what the Board determines to be
“unusual and exigent circumstances.”
Generally, an “unusual and exigent
circumstance” presents risk o sys-
temic insolvencies. No loans had been
made under this provision since the
Great Depression era o the 1930s.
The Fed established two Section 13(3)
programs to help with the resolution o
specic nancial entities: Bear Stearns
and American Insurance Group (AIG).
Other Section 13(3) programs were
continued on Page 6
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By Michelle Neely
A dismal banking environment and
a very weak economy continuedto wreak havoc on bank balance sheetsand income statements in the ourthquarter, resulting in an awully poor
showing in earnings and asset quality at District banks and their U.S. peers.
At District banks, return on averageassets (ROA) ell 22 basis points to 0.45
percent in the ourth quarter. ROA wasdown 49 basis points rom its year-end2007 level. (See table.) Protability atU.S. peer banks (banks with averageassets o less than $15 billion) plungedin the ourth quarter, resulting in year-
end ROA o just 0.15 percent, a 29 basispoint drop rom its third quarter leveland a stunning 90 basis point declinerom its year-end 2007 level.
The double-digit declines in ROA in
the ourth quarter at both sets o banks
were due to large increases in net non-interest expense and loan loss provi-sions; the average net interest margin
stayed fat at 3.79 percent or Districtbanks and 3.82 percent at peer banks.
Loan loss provisions as a percent o average assets climbed to 0.74 percentat District banks and 1.03 percent at
U.S. peer banks. The LLP ratio hasmore than doubled at District banksand has almost tripled at peer banksover the past year.
Despite the large increases in provi-
sions, the coverage ratio (the loan lossreserve as a percentage o nonperorm-ing loans) has tumbled signicantly atboth sets o banks over the past two
years. At year-end 2006, District bankshad $1.78 reserved or every dollar o nonperorming loans; at year-end 2008,the coverage ratio stood at just 84 cents.U.S. peer banks had just 65 cents
reserved or every dollar o nonper-
orming loans, down dramatically rom$1.83 at year-end 2006.Increases in loan loss provisions
and declines in coverage ratios can be
traced to continued deterioration inasset quality at District and U.S. peerbanks. The ratio o nonperorming
Q u a r t e r ly r e p o r t
Perormance Ratios Go rom Badto Worse at District and U.S. Banks
Fm B W
Q4 2007 Q3 2008 Q4 2008
RetuRn on aveRage assets
District Banks 0.94% 0.67% 0.45%
Peer Banks 1.05 0.44 0.15
net inteRest maRgin
District Banks 3.89 3.79 3.79
Peer Banks 3.99 3.82 3.82
Loan Loss PRovision Ratio
District Banks 0.35 0.60 0.74
Peer Banks 0.35 0.77 1.03
nonPeRfoRming Loans Ratio
District Banks 1.55 1.68 1.76
Peer Banks 1.26 2.19 2.63
SOURCE: Reports of Condition and Income for Insured Commercial Banks
Banks with assets of more than $15 billion have been excluded from the analysis. All earningsratios are annualized and use year-to-date average assets or average earning assets in the
denominator. Nonperforming loans are those 90 days or more past due or in nonaccrual status.
loans to total loans rose to 1.76 percentat District banks and 2.63 percent at
peer banks in the ourth quarter. Inthe District, increases in nonperorm-ing commercial and industrial loans
and commercial real estate loans werethe main contributors to the rise in the
composite nonperorming loan ratio.More than 5 percent o District banks’outstanding construction and land
development (CLD) loans were nonper-
orming at the end o the ourth quar-ter. At U.S. peer banks, the decline in
quality was even more pronounced, with almost 9 percent o outstandingCLD loans in nonperorming status.
Despite the dreary earnings andasset quality numbers, District banks
remain on average well-capitalized. Atthe end o the ourth quarter, only oneDistrict bank (out o 700) ailed to meet
at least one o the regulatory capitalminimums. District banks averaged a
leverage ratio o 8.99 percent.
Michelle Neely is an economist at the Federal
Reserve Bank o St. Louis.
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By Rajeev Bhaskar and Yadav Gopalan
Noncore unding sources have
always played an important und-
ing role or banks; however, in the lastdecade, reliance on them has increased.
Noncore unding sources include
ederal unds purchased, Federal HomeLoan Bank (FHLB) advances, subor-
dinated notes and debentures, CDs o
more than $100,000 (jumbo CDs) and
brokered deposits. Aside rom a blipduring the 2000-01 recession, reliance
on these noncore unds has increased
e C o n o m i C F o C u S
Noncore Funding Growing in Importanceamong Most Types o Banks
steadily at banks o all sizes over the
last decade. (See Figure 1.)As the nancial services industry
has evolved over the past 10 to 20
years, depositors have had the oppor-tunity to invest in the stock market,
mutual unds and money market
unds. As such, there has been a shitin core deposits away rom banks to
these alternate investment vehicles,
which have potentially higher return.
Banks, meanwhile, have experiencedtremendous growth in loans over the
same period. To keep up, banks haveturned to more nontraditional noncore
sources o unds.
As a percentage o assets, noncoreunds are more important to large
banks than community banks. Still,
the growth in noncore unding hasbeen much aster at community banks.
a u.s. Bk
For all U.S. banks, average noncoreunding as a percentage o total assets
has grown by 11 percentage points
over the past 12 years. The ratio was43 percent at the end o September
2008, compared with 32 percent at the
end o September 1996. For the largerU.S. banks, which are weighted heavily
in all bank averages, oreign depos-
its make up the largest component o noncore unding, ollowed by other
borrowed money (OBM) and jumboCDs. Since the credit crisis began,both OBM and brokered deposits have
risen sharply. Other borrowed money
is a broad category and includes Fed-eral Reserve discount window loans
and FHLB advances. The growth in
this category is not surprising, givendeterioration in the nancial sector
and banks’ sudden inability to access
unsecured market sources.
Cmm Bk
For all U.S. community banks—
banks with $500 million or less in totalassets—average noncore unding as a
percentage o total assets has doubled
over the period, rising rom 14 percent
43
38
33
28
23
18
13
1 9 9 6
1 9 9 7
1 9 9 8
1 9 9 9
2 0 0 0
2 0 0 1
2 0 0 2
2 0 0 3
2 0 0 4
2 0 0 5
2 0 0 6
2 0 0 7
2 0 0 8
All U.S. banks
All Eighth Districtbanks
U.S. community banks
Eighth Districtcommunity banks
35
30
25
20
15
10
5
0
Total noncorefunding
Jumbo CDs
Forgeign deposits Brokered deposits
Other borrowedmoneyFed funds purchased and repos
1 9 9 6
1 9 9 7
1 9 9 8
1 9 9 9
2 0 0 0
2 0 0 1
2 0 0 2
2 0 0 3
2 0 0 4
2 0 0 5
2 0 0 6
2 0 0 7
2 0 0 8
NOTE: Data were captured on Sept. 30 of each year.
NOTE: Data were captured on Sept. 30 of each year.
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navigate the Fiacial Crisiswith new St. Louis Fed Web Site
Don’ g os d h sos, vns, uos,
nss nd cons suoundng h cun nnccss. mk sns o h n, dnc S. lous
Fd b s.
The Financial Crisis: A Timeline of Events and Policy
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at the end o September 1996 to 28 percent at theend o September 2008. Despite the tremendousgrowth, this ratio is still much lower than that o all U.S. banks. Jumbo CDs make up the bulk o this unding, ollowed by OBM. Like the trendsat all U.S. banks, there has been a noticeableupsurge in brokered deposits and OBM sincemid-2007. However, the growth in jumbo CDs
has remained fat over this period.
eg dc Bk
At most Eighth District banks (mostly commu-nity banks), the noncore-unding ratio remainsabove that o U.S. community banks but less thanthat o all U.S. banks. Noncore unds as a per-centage o total assets rose 12 percentage pointsrom 21 percent in September 1996 to 33 percentin September 2008. Here, too, jumbo CDs com-
prise the largest component o noncore unds.Figure 2 shows the breakdown o the noncore-unding ratio by component at Eighth Districtbanks over the past 12 years. During the past
year and a hal, the jumbo CD share has beendecreasing while the importance o OBM andbrokered deposits has been rising.
Trends at Eighth District community bankshave paralleled those at U.S. community banks.In the past, the District’s community banksrelied on noncore unds (as a percent o assets)slightly more than their peers did. (See Figure 1.)However, peer banks caught up over the past ew quarters. The trend lines have merged: Noncoreunds to total assets now stands at 28 percent orboth U.S. and Eighth District community banks.
As is the case with most banks, both OBM—romthe Fed and the FHLB banks—and brokered depos-its have spiked during the recent credit crisis.
Rajeev Bhaskar is a senior research associate and Yadav
Gopalan is a research associate, both with the Bank-
ing Supervision and Regulation division at the Federal
Reserve Bank o St. Louis.
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Changing economic conditions arepresenting new challenges or
those working in community develop-
ment. Financing, particularly in mod-erate- and low-income areas, is getting
more dicult, and understanding how to leverage limited resources is moreimportant than ever.
The Federal Reserve Bank o St. Louis is hosting an April 22-24
conerence in St. Louis to addressnancing, resources and other com-munity development topics. The 2009
Exploring Innovation in Community
Development conerence, “Innovationin Changing Times,” will be o interestto bank senior management, directors,loan ocers and Community Reinvest-ment Act ocers.
Katherine D. Siddens, U.S. Bank inSt. Louis, attended the rst Explor-
ing Innovation conerence, in 2007 “Asthe community development manageror U.S. Bank, I ound the Exploring
Innovation conerence to be extremely benecial to me, but also truly believe
it would be a worthwhile experienceor any bank representative who is
interested in better understandingcommunity needs,” Siddens says. “Theinormation helped me uncover new opportunities to ulll our CRA obliga-tions and provided armation that
bankers can serve as important con-
nectors between the nancial industry
and the community at large.”
Loura Gilbert, a mortgage ocer with Commerce Bank in Clayton, Mo.,
who also went to the 2007 conerence,
says “The regulators are continually
urging banks to be innovative in their
response to CRA guidelines. And I
welcome any opportunity to meet with
other bankers and experts to brain-
storm ideas about these issues.”
This year’s conerence will bring
together high-level leaders rom across
the industry to explore best practices,
innovative policies, and thinking in
community and economic develop-
ment. Topics will include:
expanding economic opportunities•
through nancing innovations,
building wealth in urban•
and rural areas,
accelerating regional•
development, and
examining the uture•
o community development.
For more inormation, visit the con-
erence web site at www.exploring
innovation.org. For an invitation, con-
tact Cynthia Davis at 314-444-8761 or
Bankers Invited To Explore Community Innovationand Financing in Changing Times
established to “unreeze” securities
markets. These programs include the
Primary Dealer Credit Facility, the
Residential Mortgage-Backed Securi-
ties Facility and the Collateralized Debt
Obligations Facility.
Finally, the Fed created additional
Section 13(3) programs to ocus on
supporting money market liquidity.
These programs include the Asset-
Backed Commercial Paper Money
Market Mutual Fund Liquidity Facility,
the Commercial Paper Funding Facil-
ity and the Money Market Investor
Funding Facility.
All o these programs are temporary
and will be unwound when the Board
determines that current market tur-
moil has ended.
Inormation regarding traditional
discount window programs is available
at www.rbdiscountwindow.org. Addi-
tional details regarding Section 13(3)
programs are available by e-mailing
the Federal Reserve Bank o New York
> > M o r e o n l i n e
.bdscd.g
.kd.g/ks/Fs__Fd_ldg.d
Kim Nelson is a vice president in the St. Louis
Fed’s Banking Supervision and Regulation
division.
Discount Windowcontinued from Page 1
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the securities included nationally and internationally active investmentbanks, hedge unds and some insur-
ance companies. Most o these entities were not required to be supervised by banking regulators.
It is this part o the lending mar-ket that has collapsed. According toFederal Reserve data, total householdloans outstanding (mortgages andother consumer credit) decreased dur-ing the six months ending Sept. 30,2008. This marked the rst six-monthdecline since at least 1952, when com-
prehensive data rst became available.To the extent that the underpinnings
o the shadow banking system wereunsound, we should not expect that sys-tem to return anytime soon—especially the market or securitized subprimemortgages. For other segments, returno the securitized market will depend oninvestor condence and a move towardincreased transparency or investors.
Julie Stackhouse is senior vice president o
Banking Supervision, Credit and the Cen-ter or Online Learning. Bill Emmons is an
ofcer and economist at the Federal Reserve
Bank o St. Louis.
350
300
250
200
150
100
Issuers of private-labelasset-backed securities
Federally insureddepository institutions
Government-sponsored
enterprises
I n d e x
l e v e
l s
s e t t o
1 0 0
i n
Q 1
2 0 0 0
2 0 0 0
2 0 0 3
2 0 0 6
2 0 0 9
i n - D e p t h
The Credit Crunch Refects Collapseo a “Shadow Banking System”
By Julie Stackhouse and Bill Emmons
Many consumers and business
owners are wondering: Havebanks stopped lending?
The answer depends on the statuso nancial institutions. Most banks,especially in the Eighth District,
remain in generally sound nancialcondition and continue the economicnecessity o lending to customers with
good credit quality. However, somebanks are acing severe nancialdistress, creating a need to preservecapital—which gives the appearanceo a credit crunch. To improve theirregulatory capital-to-asset ratios, some
banks are reducing their total assetson the balance sheet by reducing theamount o loans outstanding. Somebanks are improving ratios by rais-ing more capital either privately or
through recent government programs
i eligibility requirements are met.In large part, the reduction in credit
availability can be attributed to the
partial collapse o the “shadow bank-ing system.”
In its simplest sense, the shadow banking system represents creditinstruments that exist outside o
the traditional commercial bankingsystem, especially those related toconsumer credit. Older parts o theshadow system include nancial assetsissued through government-supported
institutions, such as Fannie Mae andFreddie Mac.
More interesting is the growth inassets in the nongovernment-sup-
ported and nongovernment-insuredsectors. As shown in the chart, theseso-called private label assets grew ata three-old rate over the past eight
years. Some o these nancial instru-
ments, including the vast majority o
the subprime mortgage market, werehigh-risk in nature as well. The secu-rities created rom these assets wereoten complex, with poor transparency
and sometimes questionable suitability or unsophisticated customers. Theintermediaries issuing and trading
figuRe 1
Fcl a: Gwh sc 2000
Cl Bk Sg 2009 | 7
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Federal Reserve Bank of St. Louis
P.O. Box 442
St. Louis, Mo. 63166-0442
FIRST-CLASS
US POSTAGE
PaiD
PERMIT NO 444ST LOUIS, MO
Let Us Know What You Thinko the New Central Banker
B no, ou’v nocd h hs ssu o Central
Banker us n ook. w’v xndd h
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wh oud ou k o kno o bou? wh
dd ou k o no k n n ssu?
Snd ou ds nd suggsons o Sco K,
Central Banker do, [email protected]
o c h 314-444-8593.
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