Loans and discount function (Book: Money, Credit and Banking by Cristobal M Pagoso)
- 2. Loans and Discount Function Banks do not only accept deposits but also extended loans It is Important that the bank will be able to collect the amount needed to pay the interest to their depositor While most on the customers of commercial bank are businessmen. Their need is mostly short term
- 3. Types of Loans Granted by Banks Demand or callable loan Does not have definite maturity Time loan Payable at specified future time Short-term, medium-term, or long-term Banks may extend loans against the general credit standing of the borrower In this case the loan might be in character loan or clean loan. Usually short-term Collateral is required if the loan is longer than a year. It’s called collateralized loan
- 5. Federal Reserve System -is the central banking system of the United States Fed presented a new set of unprecedented measured aimed at stimulating credit and lowering to all sectors of the economy. Gift #1 – Cutting the fed funds rate near to zero. Cuts fed funds rate target between 0 and 0.25% LIBOR rate has declined from 4.6% to 4.2%
- 6. Federal Reserve System Gift #2 – Commitment to buy mortgage bonds and other assets at a massive scale. It has unlimited flexibility to stimulate the housing market and the broader economy by buying the mortgage-backed securities, Fannie Mae and Freddie Mac corporate debt, and other assets. Mortgage Backed System is a type of asset-backed security that is secured by a mortgage or collection of mortgages.
- 7. Federal Reserve System Federal National Mortgage Association (FNMA), usually known as Fannie Mae, is a government-sponsored enterprise that buys loans from mortgage lenders, packages them together, and sells them as a mortgage-backed security to investors on the open market. This increases the supply of money available for mortgage lending and increases the money available for new home purchases. Federal Home Loan Mortgage Corporation (FHLMC), known as Freddie Mac, is a public government-sponsored enterprise (GSE). They expand the secondary market for mortgages in the US.
- 8. Federal Reserve System Along with Fannie Mae, Freddie Mac buys mortgages on the secondary market, pools them, and sells them as a mortgage- backed security to investors on the open market. This secondary mortgage market increases the supply of money available for mortgage lending and increases the money available for new home purchases. Gift #3 – Pledge to keep rates low for a long period of time. It will keep interest rates low as long as necessary.
- 10. Another Great depression During the 1930’s great depression and the deflation period in japan, Fed constricted money supply. Now fed is pumping large amount of money to make sure there is enough liquidity in the system. Fed is now authorized to buy hard-to-value securities. By buying these assets Fed improves transparency in the system and enables banks to sell these securities to raise capital.
- 11. Another Japan Between 2001 and 2006, the bank of japan sets its policy rate to zero using ‘quantitative easing’ to end deflation Little risk of liquidity shortage
- 12. No More Bullets Since the short-term policy rate is 0.25%, the lowering is no longer feasible. Bernanke noted that quantitative easing can stimulate the economy even when interest rates are near zero. He said that that it could still affect the economy through the following channels...
- 13. No More Bullets 1. Portfolio Substitutions Large increase in money supply will lead investors to rebalance portfolios, raising prices and reducing yields on alternative, non-monetary assets. 2. Altering expectations of the future path of policy rate Keeping reserves at high level and committing to maintain it until certain conditions have been fulfilled is a more visible and credible way. 3. Expansionary fiscal By expanding its balance sheet and replacing public holdings of interest-bearing of government debt with non-interest bearing (or very low interest) money and reserves Making borrowing cheaper, and cutting the cost of expansionary fiscal policy.
- 14. Helicopter Santa Bernanke once threatened to send monetary helicopters if that were necessary to avoid deflation and other great depression.
- 16. Other Classifications of Bank Loans 1. According to purpose a. Commercial or mercantile credit—A pre-approved amount of money issued by a bank to a company that can be accessed by the borrowing company at any time to help meet various financial obligations. b. Investment credit—A tax credit that is given to a company for making a certain type of investment. The investment may be in building a new plant, purchasing certain equipment, or undertaking other investments that the government wants to encourage.
- 17. Other Classifications of Bank Loans c. Industrial credit—Made to a business or corporation, but never to an individual. Can also be created in order to provide either working capital or to finance major capital expenditures. d. Agricultural credit—It is the amount of investment funds made available for agricultural production from resources outside the farm sector. e. Real Estate credit—Purposely for construction, acquisition, expansion or improvement of real estate properties. f. Personal credit— (Consumer credit) A credit which a person possesses as an individual, and which is founded on the opinion entertained of his character and business standing.
- 18. Other Classifications of Bank Loans 2. According to the form on how credit is granted a. Direct loan—A loan made available to a borrower directly from the issuing bank. No third-party is used to any part of the loan. May result in lower interest rates and fees. b. Discount loan and rediscount loan—Discount loan is the interest and financing charges are deducted from the face amount when the loan is issued. Rediscount is the act of discounting a short-term negotiable debt instrument for a second time. c. Overdraft line—A line of credit that banks offer to their customers to cover their overdrafts. Overdraft protection kicks in when a customer writes a check for more than the amount in their account.
- 19. Other Classifications of Bank Loans 3. According to maturity a. Short-term b. Medium-term c. Long-term 4. According to security a. Secured loan—It is a loan in which the borrower pledges some asset as collateral for the loan b. Unsecured loan—It is obtained without the use of property as collateral for the loan. Borrowers generally must have high credit ratings to be approved.
- 20. Other Classifications of Bank Loans 5. According release of the loans a. Lump sum release—A one-time payment for the total or partial value of an asset. b. Installment release as the project progresses—A series of payments that a buyer makes instead of a lump sum to compensate the seller. 6. According to manner of payment a. Lump sum basis b. Installment basis