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Chapter Twelve Funding the Bank. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e ©...
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Transcript of Chapter Twelve Funding the Bank. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e ©...
Chapter TwelveFunding the Bank
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Key Issues Depository Institutions Are Faced With:1. Where can funds be raised at lowest
possible cost?
2. How can management ensure that there are enough deposits to support lending and other services the public demands?
12-2
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Types of Deposit Accounts•Transaction (Payment or Demand) Deposits▫Making Payment on Behalf of Customers▫One of The Oldest Services▫Provider is Required to Honor Any Withdrawals
Immediately•Nontransaction (Savings or Thrift) Deposits▫Longer-Term ▫Higher Interest Rates Than Transaction Deposits▫Generally Less Costly to Process and Manage
12-3
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Transaction Deposit
An Account Used Primarily to Make Payments for Purchases of Goods and Services
12-4
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Types of Transaction Deposits•Noninterest-Bearing Demand Deposits▫Interest Was Prohibited by Glass-Steagall
Act▫One of the Most Volatile and Unpredictable
Sources of Funds▫Most Deposits are Held by Business Firms
• Interest-Bearing Demand Deposits▫Negotiable Orders of Withdrawal (NOW)-
hybrid savings instrument▫Money Market Deposit Account (MMDA) and
Super NOW due to Garn-St Germain Depository Institution Act of 1982
12-5
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Nontransaction (Savings or Thrift) Deposit
An Account Whose Primary Purpose is to Encourage the Bank Customer to Save Rather than Make Payments
12-6
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Types of Savings or Thrift Deposits
•Passbook Savings Account•Statement Savings Deposit•Time Deposit (CD)•Individual Retirement Account (IRA) -
The Economic Recovery Tax Act of1981•Keogh Deposit – have tax benefits•Roth IRA – The Tax Relief Act of 1997
Allows Non-Tax-Deductible Contributions
•Default Option Retirement Plans – The Pension Protection Act of 2006
12-7
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Interest Rates on Deposits Depend On:•The Maturity of the Deposit
•The Size of the Offering Institution
•The Risk of the Offering Institution
•Marketing Philosophy and Goals of the Offering Institution
12-8
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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The Changing Composition of Deposits in the US
12-9
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Core Deposits
A Stable Base of Funds that is Not Highly Sensitive to Movements in Market Interest Rates (Low Interest-Rate Elasticity) and Which Tend to Remain with the Bank
12-10
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Pricing Deposit-Related Services
•The Glass-Steagall Act of 1933 – Federal Limits on Interest Rates Paid on Deposits – why?
•Nonprice Competition•The Depository Institutions Deregulation
Act of 1980▫Cost-Plus Pricing▫Marginal Cost of Deposits▫Conditional Pricing▫Relationship Pricing
12-11
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Cost Plus Profit Deposit Pricing
Unit Price Charged the
Customer for Each Service
=
Operating Expense
Per Unit of Deposit Service
+
Estimating Overhead Expense
Allocated to the Deposit
Function
+
Planned Profit from
Each Service Unit
Sold
12-12
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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The Marginal Cost Approach: Historical Average Cost Approach
Determines the Bank’s Cost of Funds by Looking at the Past. It Looks at What Funds the Bank Has Raised to Date and What those Funds Have Cost
12-13
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Pooled Funds Approach
Determine the Bank’s Cost of Funds by Looking at the Future. What minimum Rate of Return is the Bank Going to Have to Earn on Any Future Loans and Securities to Cover the Cost of all New Funds Raised?
12-14
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Using Marginal Cost to Set Interest Rates on Deposits
Many Financial Analysts Would Argue That the Added Cost (Not Weighted Average Cost) of Bringing New Funds into the Bank Should Be Used to Price Deposits.
12-15
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Market Penetration Deposit Pricing
The Method of Selling Deposits That Usually Sets Low Prices and Fees Initially to Encourage Customers to Open an Account and Then Raises Prices and Fees Later On.
12-16
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Conditional Pricing•Schedule of Fees were Low If Customer
Stayed Above Some Minimum Balance - Fees Conditional On How the Account Was Used
•Conditional Pricing Based On One or More Of the Following Factors▫The Number of Transactions Passing Through
the Account▫The Average Balance Held in the Account
During the Period▫The Maturity of the Deposit
12-17
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Upscale Target Pricing
Bank Aggressively Goes After High-Balance, Low-Activity Accounts. Bank Uses Carefully Designed Advertising to Target Established Business Owners and Managers and Other High Income Households.
12-18
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Relationship Pricing
The Bank Prices Deposits According to the Number of Services Purchased or Used. The Customer May Be Granted Lower Fees or Have Some Fees Waived If Two or More Services are Used.
12-19
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Nondeposit Sources of Funds
•Federal Funds Market•Repurchase Agreements•Federal Reserve Bank•Advances from the Federal Home Loan
Bank•Negotiable CDs•Eurocurrency Deposit Market•Commercial Paper•Long Term Sources
13-20
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Recent Growth in Nondeposit Sources of Borrowed Funds at FDIC-Insured Institutions
What are the trends?
13-21
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Alternative Nondeposit Sources of Funds•The usage of nondeposit sources of funds
has risen
•Larger institutions rely on the nondeposit funds market as a key source of short-term money to meet loan demand and unexpected cash emergencies
13-22
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Federal Funds Market
• Immediately Available Reserves Are Traded Between Financial Institution and Usually Returned Within 24 hours.
•Deposits with Correspondent Banks and Demand Deposit Balances of Security Dealers and Governments Can Be Used For Loans to Institutions.
13-23
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13-24
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Types of Fed Funds Loan Agreements
•Overnight Loans▫Negotiated via wire or telephone, returned the
next day▫Normally not secured by specific collateral,
although might
• Term Loans▫Longer term Fed funds contracts (several days,
weeks, or months)
• Continuing Contracts ▫Automatically renewed each day▫Normally between smaller respondent institutions
and their larger correspondents
13-25
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Repurchase Agreements
•Can be Thought of as Collateralized Fed Funds Transactions; More Complex; Less Exposure to Credit Risk
• Involves the Temporary Sale of High-Quality Assets (usually Government Securities) Accompanied by an Agreement to Buy Back Those Assets On a Specific Future Date At a Predetermined Price or Yield
13-26
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Borrowing from the Fed: The Three Types of Loans at the Discount Window• Primary Credit – This Loan is Available for Short
Terms and to Institutions in Sound Financial Condition. Rate is Slightly Higher than the Federal Funds Rate (Why? See the “Real Banks, Real Decisions” box).
•Secondary Credit – These Loans are Available at a Higher Interest Rate to Institutions not Qualifying for Primary Credit. Monitored by the Federal Reserve to Control Excess Risk
•Seasonal Credit - These loans Cover Longer Periods Than Primary Credit for Small and Medium Institutions Experiencing Seasonal Swings in Deposits and Loans
13-27
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Advances from the Federal Home Loan Bank•Allows Institutions (Home Mortgage Lenders)
to Use Home Mortgages as Collateral for Advances
•A Way to Improve the Liquidity of Home Mortgages and Encourage more Lenders to Provide Credit
•Number of Loans has Increased Dramatically in Recent Years
•Maturities Range from Overnight to More than 20 Years
•FHLB Has 12 Regional Banks•Has Federal Charter and Can Borrow Cheaply
and Pass Savings to Institutions
13-28
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Negotiable CD
An Interest-Bearing Receipt Evidencing the Deposit of Funds in the Bank for a Specified Period of Time for a Specified Interest Rate. It is Considered a Hybrid Account Since it is Legally a Deposit
13-29
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
The Four Types of Negotiable CDs
•Domestic CDs – Issued By Domestic Banks in the U.S.
•Euro CDs – Dollar Denominated CDs Issued Outside the U.S.
•Yankee CDs – Issued By Foreign Banks in the U.S.
•Thrift CDs – Issued By Large Savings and Loans and Other Nonbanks in the U.S.
13-30
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Eurocurrency Deposit Market
•Eurodollars are Dollar-Denominated Deposits Placed in Banks Outside the U.S.
•Eurocurrency Deposits Originally Were Developed in Western Europe to Provide Liquid Funds to Swap Among Institutions or Lend to Customers
•Labeled ‘Liabilities to Foreign Branches’ When a Foreign Branch Lends Eurodeposits to its Home Office
13-31
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
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Commercial Paper
•Short-Term Notes With Maturities from 3 or 4 Days to 9 Months Issued By Well-Known Companies.
•Two Types▫Industrial Paper- -Purchase Inventories▫Finance Paper – Issued by Finance
Companies and Financial Holding Companies
•Banks Cannot Issue These Directly But Affiliated Companies Can Issue Them.
13-32
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Long-Term Nondeposit Sources of Funds
Mortgages to Fund the Construction of New Buildings and Capital Notes and Debentures are Examples of Long Term Sources of Funds
13-33
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
The Funds Gap
•Gap is Based on:▫Current and Projected Demand and
Investments the Bank Desires to Make▫Current and Expected Deposit Inflows and
Other Available Funds•Size of This Gap Determines Need for
Nondeposit Funds
13-34
McGraw-Hill/IrwinBank Management and Financial Services, 7/e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
Nondeposit Funding Sources: Factors to Consider
•The Relative Costs of Raising Funds From Each Source
•The Risk of Each Funding Source•The Length of Time for Which Funds are
Needed•The Size of the Institution•Regulations Limiting the Use of Various
Funding Sources
13-35
