Chapter 15 Nonbank Thrift Institutions: Savings and Loans, Savings Banks, Credit Unions, and Money...

Chapter 15Chapter 15

Nonbank Thrift Institutions: Nonbank Thrift Institutions: Savings and Loans, Savings Savings and Loans, Savings Banks, Credit Unions, and Banks, Credit Unions, and

Money Market Funds Money Market Funds

McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All Rights Reserved.

Learning Objectives Learning Objectives

To see the significant roles that thrift To see the significant roles that thrift institutions play in the functioning of a institutions play in the functioning of a modern economy and financial system.modern economy and financial system.

To learn about the types of services that To learn about the types of services that thrift institutions offer to the public and thrift institutions offer to the public and who their principal competitors are.who their principal competitors are.

To understand the principal similarities To understand the principal similarities and differences among the major types and differences among the major types of thrift institutions.of thrift institutions.

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IntroductionIntroduction

Nonbank financial institutions play a Nonbank financial institutions play a vital role in the flow of money and credit vital role in the flow of money and credit within the financial system, especially within the financial system, especially the home mortgage market and the the home mortgage market and the market for personal savings.market for personal savings.

Recently however, both bank and Recently however, both bank and nonbank financial institutions are nonbank financial institutions are “converging” in terms of the services “converging” in terms of the services they offer and the markets they serve.they offer and the markets they serve.

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Savings and Loan AssociationsSavings and Loan Associations

Savings and loan associationsSavings and loan associations (S&Ls) (S&Ls) Among the largest of all thrift institutions Among the largest of all thrift institutions

Accepting depositsAccepting deposits Extending loansExtending loans Other servicesOther services Primarily to household customersPrimarily to household customers

S&Ls emphasize longer-term loans, S&Ls emphasize longer-term loans, especially mortgage loansespecially mortgage loans

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S&Ls began in the 18S&Ls began in the 18thth century century British building societiesBritish building societies Principal of “neighbors helping neighbors”Principal of “neighbors helping neighbors” Often referred to as Often referred to as building and loan societiesbuilding and loan societies Accepting savings deposits from individuals Accepting savings deposits from individuals

and families and lending those funds to home and families and lending those funds to home buyersbuyers

Frequently disbanded after all member had Frequently disbanded after all member had received loansreceived loans

The first U.S. S&L was in the Philadelphia The first U.S. S&L was in the Philadelphia area in 1831area in 1831

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Early S&Ls were managed and directed Early S&Ls were managed and directed by depositorsby depositors Larger depositors often had greater Larger depositors often had greater

influenceinfluence Over time the S&Ls became major players Over time the S&Ls became major players

in the financial marketplacein the financial marketplace Often savers and borrowers were different Often savers and borrowers were different

groupsgroups Professional managers were hiredProfessional managers were hired Investors in the money and capital markets Investors in the money and capital markets

provided much of the financingprovided much of the financing15-7


Originally a one-product industryOriginally a one-product industryHas been forced to diversify and Has been forced to diversify and

become more aggressivebecome more aggressive More competitionMore competition DeregulationsDeregulations Many failuresMany failures

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Savings and loans can take two different Savings and loans can take two different organizational formsorganizational forms Mutual S&LsMutual S&Ls

Owned by depositorsOwned by depositors Many have converted to stock structuresMany have converted to stock structures

Stockholder-owned S&LsStockholder-owned S&Ls Issue capital stock to increase net worthIssue capital stock to increase net worth Very valuable when funding is needed for Very valuable when funding is needed for

rapid growthrapid growth Tend to be larger than mutualsTend to be larger than mutuals

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LiabilitiesLiabilities Savings provide most of fundingSavings provide most of funding Significant shift in deposit mixSignificant shift in deposit mix

Away from low-cost savings accountsAway from low-cost savings accounts To deposits earning higher ratesTo deposits earning higher rates

MMDA CDs NOW and SNOW Keogh and IRA

Also use nondepository fundsAlso use nondepository funds15-11


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The size of the industry peaked in 1988The size of the industry peaked in 1988 Total financial assets reached $1,640 billionTotal financial assets reached $1,640 billion The sharp decline that followed The sharp decline that followed

Result of large numbers of failuresResult of large numbers of failures Many were unprofitable Many had little net worth

Conversion of some S&Ls into other kinds of Conversion of some S&Ls into other kinds of financial institutionsfinancial institutions

Others were merged into other financial Others were merged into other financial institutionsinstitutions

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Primary cause for the low profitability Primary cause for the low profitability Many S&L assets (fixed-rate mortgage Many S&L assets (fixed-rate mortgage

loans) were interest-rate insensitive loans) were interest-rate insensitive Most of their liabilities (deposits) were Most of their liabilities (deposits) were

highly sensitive to interest rateshighly sensitive to interest rates

During periods of rapidly rising market During periods of rapidly rising market interest rates, the industry’s net interest interest rates, the industry’s net interest margin were often severely squeezedmargin were often severely squeezed

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S&Ls needS&Ls need Sound diversification decisionsSound diversification decisions Carefully managed loan portfoliosCarefully managed loan portfolios Risk managementRisk management Further relaxation of government regulationsFurther relaxation of government regulations

S&L management today more aggressiveS&L management today more aggressive Branching out in multiple directions Branching out in multiple directions

Real estate modelReal estate model Family financial centers Family financial centers Diversified modelDiversified model

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Savings BanksSavings Banks

Savings banksSavings banks began in Scotland began in Scotland 1810 by Reverend Henry Duncan, minister of 1810 by Reverend Henry Duncan, minister of

Ruthwell Church in DumfriesshireRuthwell Church in Dumfriesshire Customer-owned institutionsCustomer-owned institutions Originally set up to combat povertyOriginally set up to combat poverty Until then savers shut out of credit market Until then savers shut out of credit market

Idea spread rapidlyIdea spread rapidly Particularly in Europe and East Coast of U.S.Particularly in Europe and East Coast of U.S. First savings bank in the U.S.First savings bank in the U.S.

Philadelphia Savings Fund SocietyPhiladelphia Savings Fund Society Appeared in 1816Appeared in 1816

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Historically focused on two instrumentsHistorically focused on two instruments Savings accountsSavings accounts Residential mortgage loansResidential mortgage loans

Today they have expanded their Today they have expanded their servicesservices Trading corporate and government bondsTrading corporate and government bonds Offering credit and debit cardsOffering credit and debit cards Granting construction loansGranting construction loans Granting consumer installment loansGranting consumer installment loans

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The number of savings banks is small The number of savings banks is small There were 1300 in 2005There were 1300 in 2005 Scattered throughout the United StatesScattered throughout the United States Massachusetts leads the list of states with the Massachusetts leads the list of states with the

most savings banks, followed by New Yorkmost savings banks, followed by New YorkThe distinction among S&Ls, savings The distinction among S&Ls, savings

banks, and commercial banks is banks, and commercial banks is becoming blurred, especially because becoming blurred, especially because they are readily convertible from one form they are readily convertible from one form to anotherto another

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Savings banks can be state or Savings banks can be state or federally regulatedfederally regulated The primary rule-maker is the Office of The primary rule-maker is the Office of

Thrift Supervision (OTS)Thrift Supervision (OTS) Regulate both S&Ls and savings banksRegulate both S&Ls and savings banks Established in the U.S. Treasury Established in the U.S. Treasury

Department in 1989Department in 1989 Supervisory activities supported by Supervisory activities supported by

assessments and feesassessments and fees

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Owned by their depositorsOwned by their depositorsKey asset is mortgage-related assetsKey asset is mortgage-related assets

Most are direct mortgage loansMost are direct mortgage loans To build single-family homeTo build single-family home ApartmentsApartments Etc.Etc.

The rest are pass through securitiesThe rest are pass through securities A distinct second is nonmortgage loansA distinct second is nonmortgage loans

Key financing is through depositsKey financing is through deposits15-20


The savings bank industry faces a number The savings bank industry faces a number of challengesof challenges Savings banks have inflexible asset structures Savings banks have inflexible asset structures Face competition from other financial Face competition from other financial

institutionsinstitutionsTheir future growth depends on their ability Their future growth depends on their ability

to gain the necessary changes in to gain the necessary changes in government regulations to allow them to government regulations to allow them to respond to changing financial market respond to changing financial market conditionsconditions

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Credit UnionsCredit Unions

Credit unionsCredit unions are cooperative, self-help are cooperative, self-help associations of individualsassociations of individuals Deposits and loans are offered only to members Deposits and loans are offered only to members

Began in Germany in the 19Began in Germany in the 19thth century century Serve low-income individuals and familiesServe low-income individuals and families Came to the U.S. in 1909Came to the U.S. in 1909 Long-run survival stems from their strengthsLong-run survival stems from their strengths

Being able to offer low loan rates Being able to offer low loan rates Being able to offer high deposit rates Being able to offer high deposit rates Having relatively low operating costsHaving relatively low operating costs

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Credit unions are organized around a Credit unions are organized around a common affiliation or bond among their common affiliation or bond among their membersmembers Occupation-related bonds are about 2/3 of Occupation-related bonds are about 2/3 of

all U.S. credit unionsall U.S. credit unions Others organized around churches, labor Others organized around churches, labor

unions, or other organizationsunions, or other organizations Common areas of residence have also been Common areas of residence have also been

usedused

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In recent years, the restriction of In recent years, the restriction of common bond has been interpreted common bond has been interpreted liberallyliberally Greatly broadened eligible poolGreatly broadened eligible pool Industry has been growingIndustry has been growing Under attack by bankersUnder attack by bankers

Lenient membership rulesLenient membership rules Special tax advantageSpecial tax advantage

Ongoing political battle over the rules Ongoing political battle over the rules for qualifying for the tax advantagefor qualifying for the tax advantage

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Size of credit unionsSize of credit unions Fewer, larger credit unionsFewer, larger credit unions Larger credit unions outperform smaller onesLarger credit unions outperform smaller ones Credit union membership has continued to growCredit union membership has continued to grow

U.S. credit unions under intense pressure U.S. credit unions under intense pressure Develop new services Develop new services Penetrate new markets Penetrate new markets Increasing competition from other institutions Increasing competition from other institutions Decline in the demand for their historically most Decline in the demand for their historically most

important service – automobile loansimportant service – automobile loans15-25

Money Market FundsMoney Market Funds

Money market mutual fundMoney market mutual fund is a financial is a financial intermediary pooling savings and investing intermediary pooling savings and investing the monies in money market instruments the monies in money market instruments Appeared in 1972Appeared in 1972 Took advantage of the fact that depository rates Took advantage of the fact that depository rates

were constrainedwere constrained Provided competitive ratesProvided competitive rates Drew money away from depository Drew money away from depository

institutionsinstitutions By year-end 1973 assets were $100 millionBy year-end 1973 assets were $100 million Peaked in 1982 with $200 billion in assetsPeaked in 1982 with $200 billion in assets

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Money market funds hold high-quality assetsMoney market funds hold high-quality assets The short maturity of the assets The short maturity of the assets Highly liquid security portfolioHighly liquid security portfolio Quickly adjustable to suit market conditionsQuickly adjustable to suit market conditions

They are mostly “no load” fundsThey are mostly “no load” funds There is no commission charge There is no commission charge

Opening an accountOpening an account Purchasing more sharesPurchasing more shares Redeeming sharesRedeeming shares

The accounts can be accessed easily as wellThe accounts can be accessed easily as well

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An Example of Typical Money Market Fund Information Reported Daily by Security Brokers,

Dealers, and in Daily Newspapers

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Today, money market funds serve as Today, money market funds serve as Cash-management vehicles where market Cash-management vehicles where market

rates can be earned on funds used for daily rates can be earned on funds used for daily transactionstransactions

Tax-sheltering vehicles (when tax-exempt Tax-sheltering vehicles (when tax-exempt funds are chosen)funds are chosen)

Temporary repository for liquid fundsTemporary repository for liquid funds Safety haven for savingsSafety haven for savings

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However money market fund share However money market fund share accounts are not government insuredaccounts are not government insured

The differential between their yield and The differential between their yield and yields offered by banks has narrowed yields offered by banks has narrowed in recent yearsin recent years

The money market fund industry has The money market fund industry has recently shown itself to be vulnerable recently shown itself to be vulnerable to low market interest ratesto low market interest rates

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Markets on the NetMarkets on the Net

Answers.com at Answers.com at www.answers.comwww.answers.comAmerican Bank at americanfsb.comAmerican Bank at americanfsb.comAmerican Banker’s Association at American Banker’s Association at

www.aba.comwww.aba.comAmerican Credit Union at americancu.orgAmerican Credit Union at americancu.orgBECU at www.becu.orgBECU at www.becu.orgChicago Post Office Employees Credit Union at Chicago Post Office Employees Credit Union at

my-creditunion.commy-creditunion.comCredit Union National Association at Credit Union National Association at

www.cuna.orgwww.cuna.org

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Credit Union Times at cutimes.comCredit Union Times at cutimes.comDWS Scudder at www.dws-scudder.comDWS Scudder at www.dws-scudder.comEncyclopedia.com at encyclopedia.comEncyclopedia.com at encyclopedia.comEtrade financial at bankus.etrade.comEtrade financial at bankus.etrade.comFederal Deposit Insurance Corporation Federal Deposit Insurance Corporation

at at www.fdic.govwww.fdic.govFlatbush Federal Savings and Loan Flatbush Federal Savings and Loan

Association at flatbush.comAssociation at flatbush.com

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Franklin Templeton Investments at Franklin Templeton Investments at www.franklintempleton.comwww.franklintempleton.com

Imoney.net at imoney.netImoney.net at imoney.net IndymacBank at IndymacBank at

www.myindymacbank.comwww.myindymacbank.com ING at ING at www.ing.comwww.ing.com Insurance Information Institute at Insurance Information Institute at

http://www.iii.orghttp://www.iii.org Investment Company Institute at ici.orgInvestment Company Institute at ici.org

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Money Market Funds at Money Market Funds at www.encyclopedia.comwww.encyclopedia.com

National Credit Union Administration at National Credit Union Administration at www.ncua.govwww.ncua.gov

NuUnion Credit Union at NuUnion Credit Union at www.nuunion.orgwww.nuunion.org

OCTFCU at www.octfcu.orgOCTFCU at www.octfcu.orgOffice of Thrift Supervision at Office of Thrift Supervision at

www.ots.treas.govwww.ots.treas.gov15-34


Pentagon Federal Credit Union at Pentagon Federal Credit Union at www.penfed.orgwww.penfed.org

Savings and Retail Banking at Savings and Retail Banking at www.savings-banks.comwww.savings-banks.com

The Committee of Scottish Clearing The Committee of Scottish Clearing Bankers at Bankers at www.scotbanks.org.ukwww.scotbanks.org.uk

The NYCB Family of Banks at The NYCB Family of Banks at atlantic-bank-ny.comatlantic-bank-ny.com

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U.S. Treasury Department at U.S. Treasury Department at www.treasury.gov/press/releases/reportwww.treasury.gov/press/releases/report3070.htm3070.htm

Vanguard MMR Prime Portfolio at Vanguard MMR Prime Portfolio at vanguard.fasttrack.netvanguard.fasttrack.net

Washington Mutual Bank at Washington Mutual Bank at www.wamu.comwww.wamu.com

Wikipedia at Wikipedia at en.wikipedia.orgen.wikipedia.orgWorld Council of Credit Unions at World Council of Credit Unions at

www.woccu.orgwww.woccu.org15-36

Chapter ReviewChapter Review

Introduction to thrift institutionsIntroduction to thrift institutionsSavings and loan associationsSavings and loan associations

Origins of S&LsOrigins of S&Ls How funds are raised and allocatedHow funds are raised and allocated Trends in revenues and costsTrends in revenues and costs Possible ways to strengthen the S&L Possible ways to strengthen the S&L

industry in the futureindustry in the future

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Savings banksSavings banks Number and distributionNumber and distribution How funds are raised and allocatedHow funds are raised and allocated Current trends and future problemsCurrent trends and future problems

Credit unionsCredit unions Credit union membershipCredit union membership Size of credit unionsSize of credit unions New services offeredNew services offered A strong competitive forceA strong competitive force

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Money market fundsMoney market funds

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Chapter 15 Nonbank Thrift Institutions: Savings and Loans, Savings Banks, Credit Unions, and Money...

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