Depository Institutions
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Transcript of Depository Institutions
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Depository Institutions
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Depository InstitutionsInclude:
Institutions which take deposits Deposits represent Liabilities (debt) for DI’s
Include: Banks Savings & Loan institutions Savings Banks Credit Unions
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Asset/liability problem of Depository institutions
A depository institution seeks to earn a positive spread between the assets it in invests in (loans and securities) and the costs of funds(deposits and other sources)
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How do DI’s make money?
3 ways:
LoansMake direct loans to entities
Securities investmentsInvesting in securities & holding portfolios
FeesCharged to their customers
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Asset/liability problem of Depository institutionsRisks faced by the depository
institutions
Credit risk-default risk that the borrower will default on his loan obligation or that the issuer of the security that the depository institution holds defaults on its obligation.
Regulatory risk-regulators will change the rules so as to impact the earnings of the institution unfavorably
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Asset/liability problem of Depository institutionsFunding riskIllustrationSuppose that the depository institution
raises $100 million by issuing a deposit account that has a maturity of one year and by agreeing to pay 7% interest
Suppose that $100 million is invested in a government security that matures in 15 years , paying an interest rate of 9%
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Asset/liability problem of Depository institutionsIf interest rates declines, the spread will
increase
If Interest rates riseWhat position should you have?
If interest rates fallWhat position should you have?
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Asset/liability problem of Depository institutionsWhen interest rates are expected
to decline, depository institutions borrow short and lent long
When interest rates are expected to rise, depository institutions borrow long and lent short
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Asset-Liability Problem of DI’s?
Threats of positioning:
Adverse financial consequences If expectations are not realized, Huge losses can occur
No one can predict interest rates consistentlyHighly risky?
Becomes same as gamblingLong run losses highly likely?
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Liquidity concernsA depository institution must be prepared to
satisfy withdrawals of funds by depositors and to provide loans to customers
4 ways to solve liquidity issues?Attract additional depositsBorrowing from the federal agency or other
financial institutionsSell securities that it ownsRaise short term funds in the money market
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Commercial Banks5 largest banks of Pakistan
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Commercial BanksBank services:Individual bankingInstitutional bankingGlobal banking-Corporate financingCapital market productsForeign exchange products and services
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Bank FundingThree sources of funds for banks:
DepositsNon deposit borrowingCommon stocks and retained
earnings
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Bank FundingDeposits
Demand depositsSavings depositsTime deposits
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Bank FundingReserve requirements and
borrowing in the federal funds market
All banks must maintain a specified percentage of their deposits in a non- interest bearing account at the State bank.
Reserve ratioRequired reserve
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Bank FundingExcess reserves- when actual reserves
exceed required reserves. Banks temporarily short of funds can
borrow reserves from banks that have excess reserves.
The market where banks can borrow or lend reserves is called the federal funds market.
The interest rate that is charged to borrow funds in this market is called the federal funds rate.
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Bank FundingBorrowing at the Fed discount window:Banks temporarily short of funds can
borrow from the Fed at its discount window
Collateral is necessary to borrowDiscount rate- the interest rate that
the Fed charges to borrow funds at the discount window
Borrowing from the Fed is done basically to meet short term liquidity needs
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Bank FundingOther non deposit borrowingIssuing obligations in the money
market, or intermediate to long term in the form of issuing securities in the bond market.
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Regulation Ceilings imposed on the interest rates that
can be paid on deposit accounts
Geographical restrictions on branch banking
Permissible activities for commercial banks
Capital requirements for commercial banks
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Savings and loan AssociationsProvision of funds for financing of
a home.
The collateral for the loans would be the home being financed
Mutually owned or corporate stock ownership
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Savings and loan AssociationsAssets:Traditionally, the only assets in which
S&L’s were allowed to invest have been mortgages, and government securities.
Problem:Maturity matching problem
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Savings and loan AssociationsOther investments:Consumer loans( loans for home
improvement , automobiles, education , business or credit cards)
Non consumer loans ( commercial , corporate , business or agriculture loans)
Junk bondsInvestment in short term assets for
operational or regulatory purposes.
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Savings and loan AssociationsFunding:Savings and time depositsNegotiable order of withdrawal
(NOW) accountsMoney market deposit accounts
(MMDA)
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The S&L Crisis
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Credit unions“Common bond” requirement for
credit union membership No corporate ownershipPurpose:Serve member’s saving and
borrowing needsCredit unions are owned by their
members, member deposits are called shares.