Depository

Institutions
Chapter 4
About Depository Institution
Depository: Depository Institutions include:
 Commercial banks (or simple banks),
 Savings and loan associations (S&Ls),
 Savings banks
 Credit unions
About Depository Institution
Depository
Fund Raised(Deposit, Non-Deposit)
Income Source
 Loan Interest
 Security Purchase
 Fee Income
About Depository Institution
Regulation of Depository
Important role in Country’s Monitory System
Demand deposit accounts are the principal
means that individuals and business entities
use for making payments, and government
monetary policy is implemented through the
banking system.
About Depository Institution
Regulation of Depository
special privileges
• access to government deposit insurance
• access to government entity that provides funds
for liquidity or emergency needs.

Thrifts: It is common to refer to S&Ls, savings

banks, and credit unions as ‘thrifts’, which are
specialized types of depository institution.
About Depository Institution
Regulation of Thrifts: Traditionally, thrifts
have not been permitted to accept
deposits transferable check (negotiable),
or, as they are more properly known,
checking accounts.
Instead, they have obtained funds
primarily by tapping the savings of
households.
About Depository Institution
Regulation of Thrifts: By law, the
investments that thrifts are permitted to
make have been much more limited than
those permitted to banks.
Recent legislation, however, has
expanded the range of investments
allowed by thrifts so that they can
complete more effectively with banks.
Asset/Liability Problem of
Depository Institution
A depository institution seek to earn a
positive spread between the assets it
invests in (loans and securities) and the
cost of its fund (deposits and other
sources). The spread is referred to as
spread income or margin. The spread
income should allow the institution to
meet operating expenses and earn a fair
profit on its capital.
Asset/Liability Problem of
Depository Institution
Three Types of Risks
1. Credit risk: Default Risk
2. Regulatory risk: Regulation rule change
risk
3. Funding risk: Spread Interest Risk
Controlling Act
a) Floating Rate Notes
b) Adjustable Rate Mortgage
c) Interest Rate Swap
Liquidity Concerns
1. Demand fulfill
• satisfy depositors withdrawals
• provide loans
Ways to fulfill Demand
a) Attract additional deposits
b) Loan from government agency or other financial
institution (investment bank) at discounted rate
c) Raise short-term funds in the money
market(Repurchasable Security)
d) Sell security(lowest liquidity and Price Risk)
Liquidity Concerns
2. Regulatory requirements
Government Regulated Reserve
Commercial Bank Services
3 types of services
- Individual
- Institutional
- Global
Commercial Bank Services
1. Individual banking
- credit card financing
- automobile and boat financing
- brokerage services
- student loans
- individual-oriented financial investment
services such as
- personal trust and investment
services.
Commercial Bank Services
2. Institutional banking:
Give Loans Primarily:
 Financial Institution
 Non-Financial Institution
 Government Entity
Commercial Bank Services
2. Institutional banking
- Real Estate Financing
- Leasing act
- Factoring
- Management of private and public pension funds,
- Fiduciary and custodial services, and
- Cash management services

Income: Loan & Leasing interest

FINISH
Commercial Bank Services
3. Global banking: It covers a broad range of
activities involving:
a) Corporate financing: It involves two
components:
i) First is the procuring of funds for a bank’s
customers. This can go beyond traditional bank
loans to involve the underwriting of securities. In
assisting its customers in obtaining funds, banks
also provide bankers acceptances, letter of credit,
and other types of guarantees for their customers.
Commercial Bank Services
3. Global banking:
a) Corporate financing: It involves two
components:
ii) Second area of corporate financing involves
advice on such matters as strategies for obtaining
funds, corporate restructuring, divestitures, and
acquisitions.
b) Capital market (portfolio) business: Some banks
are dealers in government or other securities.
Customer who wish to transact in the securities can
do so through the government desk of the bank.
Commercial Bank Services
3. Global banking:
c) Foreign exchange business: Some
bank maintain a foreign exchange
operation, where foreign currency is
bought and sold. Bank customers in
need of foreign exchange can use the
services of the bank.
Commercial Bank Services
3. Global banking:
c) Foreign exchange business: In the role as
dealers, banks can generate income in three
ways:
- the bid-ask spread
- capital gains on the securities or foreign
currency they have transacted in, and
- in case of securities, the spread between
interest income by holding the security and the
cost of funding the purchase of that security.
Commercial Bank Funding
1. Deposits
a) Demand deposit (checking /current
account):
* No Interest
* Withdraw when demanded
b) Deposit account(DPS)
* Negotiable Interest
* Maturity
* Interest pay at month end
* Credit Union  Share Draft
Commercial Bank Funding
1. Deposits
c) Savings deposit:
* Below Market Interest Rate
* No maturity
* Withdrawal limit
d) Time deposit(Fixed Deposit / Certificate of Deposit)
* Fixed Maturity
* Interest rate: Fixed or Floating
* Interest Rate > Market Rate
e) Money market demand account: It pays interest
based on short-term interest rates.
Commercial Bank Funding
1. Deposits
e) Money market demand account
* Withdrawal Period  Negotiable
* Short term interest rate
Commercial Bank Funding
2. Inter-bank borrowing
• Emergency Case
• Short-Term Loan
• Fund Shortage
• Central Bank Loan = Not Possible
• Interest Rate >(Very High) Market Rate (Call
Money Rate)
• Lender Bank  Extra Reserve
Commercial Bank Funding
3. Borrowing from central bank
 Central Bank = Banker of Banks
 Last Resort Option
 Short Term Borrowing
 Lowest Interest Rate(Market Rate)
 Collateral Needed

Collateral  1) Treasury, Govt. Agency, Municipal

Securities: Maturity < 6 Months
2) Commercial, Industrial Loans( Loan
Sanction Paper)
Commercial Bank Funding
3. borrowing from central bank
 Periodical Change of Interest Rate  Monetary
Policy
 Stops/ Restricts borrowing of banks  Continuous
Borrowing(Short Term Interest)
Commercial Bank Funding
4. Other non-deposit borrowing
 Short Term Borrowing
 Types:

Issuing Obligation  Money Market  Short

Term
Issuing Securities  Bond Market
Common Stock  Retained Earnings
Money Centric Market  Fund Collection 
Money Market/ Non Deposit Borrowing
Regional Bank  Fund Collection  Deposit
Collection
FINISH
Commercial Bank Regulation
Because of the special role that commercial banks play
in the financial system, banks are regulated and
supervised by the central bank and government
entities. The regulations historically cover four
areas:
1. Regulation of interest rates: While regulation of
the interest rates that banks can pay has been all but
eliminated for accounts other than demand deposits.
Central bank regulations prohibit the payment of
interest (checking) accounts.
Commercial Bank Regulation
2. Geographical restrictions: Each area
has the right to set its own rules on intra
area branch banking. This rather
outdated legislation was intended to
prevent large banks from expanding
geographically and thereby forcing out
or taking over smaller banking entities,
possibly threatening competition.
Commercial Bank Regulation
2. There are some places where banks
cannot establish branches and other places
that have virtually no restrictions on
branching. Country legislation is under
consideration to permit inter area banking.
3. Permissible activities for commercial
banks: The activities of banks and bank
holding companies are regulated by the
central bank board.
Commercial Bank Regulation
3. Permissible activities for commercial
banks: The permissible activities of bank
holding companies are limited to those that
are viewed by the central bank “closely
related to banking”. Example: Banks can
neither (1) underwrite securities and stock,
nor (2) act as dealers in the secondary
market for securities and stock.
Commercial Bank Regulation
4. Capital requirements for commercial
banks: The capital structure of banks, like
that of all corporations, consists of equity and
debt (i.e. borrowed funds). Commercial
banks are highly leveraged institutions, that
is, the ratio of equity capital to total assets is
low. This gives rise to regulatory concern
about potential insolvency resulting from the
low level of capital provided by the owners.
Commercial Bank Regulation
4. Capital requirements for commercial banks:
An additional concern is that the amount of
equity capital is even less adequate because of
potential liabilities that do not appear on the
bank’s balance sheet. On implication of the new
capital guidelines is that it will encourage banks
to sell off their loans in the open market. An
alternative is for a bank to pool loans and issue
securities that are collateralized by the pool of
loans. This process is referred to as “asset
securitization”.
Savings and Loan Associations
The basic motivation behind creation of S&Ls was
provision of funds for financing the purchase of a
home. The collateral for the loans would be the home
being financed. S&Ls are either:
1. Mutually owned: It means there is no stock
outstanding, so technically the depositors are the
owners. Or
2. Corporate stock ownership: To increase the ability
of S&Ls to expand the sources of funding available to
bolster their capital, legislation facilitated the
conversion of mutually-owned companies into a
corporate stock ownership structure.
S&Ls Assets/Investments
Mortgage Investment: Traditionally, the only assets in
which S&Ls were allowed to invest have been
mortgages, mortgage-backed securities, and government
securities. Mortgage loans include fixed-rate mortgages,
adjustable-rate mortgages, and other types of mortgages
such as graduated payment mortgages.
Extent loan: The acceptable list of investments for S&Ls
now includes consumer loans ( loans for home
improvement, automobiles, education, mobile homes,
and credit cards), non-consumer loans (commercial,
corporate, business, or agricultural loans), and
municipal securities.
S&Ls Assets/Investments
Short-term investment: S&Ls invest in short term assets
for operational (liquidity) and regularity purposes.
Acceptable assets include cash, short-term
government agency and corporate securities,
certificates of deposit of commercial banks, other
money market assets and treasury funds.
Funding: The bulk of the liabilities of S&Ls consisted of
passbook savings accounts and time deposits.
Deregulation also extended the types of accounts that
may be offered by S&Ls – NOW (Negotiable Order
of Withdrawal) accounts and money market deposit
accounts.
S&Ls Assets/Investments
Funding: S&Ls have been more active in raising funds
in the money market. Some larger S&Ls have issued
commercial paper as well as medium-term notes.
They borrow in the treasure funds market and they
can also borrow from the government home loan
banks. These borrowings, called advances, can be
short-term or long-term in maturity, and the interest
rate can be fixed or floating.
S&Ls Assets/Investments
Regulation: As in bank regulation, S&Ls historically
have been regulated with respect to the maximum
interest rates on deposit accounts, geographical
operations, permissible activities (types of accounts
and types of investments), and capital adequacy
requirements. In addition there have been
restrictions on the sources of non-deposit funds and
liquidity requirements.
Credit Unions
Membership: Credit unions are the smallest and the
newest of the depository institutions. Membership in
a credit union “shall be limited to groups having a
common bond of occupation or association, or to
groups within a well-defined neighborhood,
community, or rural district”. They are either
cooperatives or mutually owned. There is no
corporate stock ownership.
Purpose: The dual purpose of credit unions is therefore
to serve their members’ saving and borrowing
needs.
Credit Unions
Member’s concern: Technically, because credit unions are
owned by their members, member deposits are called
shares. The distribution paid to members is therefore in
the form of dividends, not interest.
Regulation: Regulated by the credit union law.
Funding: Credit unions obtain their funds primarily from
deposits of their members.
Liquidity: Credit union provides short-term loans to
member credit unions with liquidity needs.
Investment/Assets: Credit union assets consist primarily of
small consumer loans to their members. They also
provide credit card loans.