Fin 308 - Topic 4 Outline
Fin 308 - Topic 4 Outline 308
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This 9 page Class Notes was uploaded by ag28 on Wednesday October 7, 2015. The Class Notes belongs to 308 at Clemson University taught by Chernykh in Fall 2015. Since its upload, it has received 27 views. For similar materials see Financial Institutions and Markets in Finance at Clemson University.
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Date Created: 10/07/15
Clemson University Department of Finance FIN 3080 Dr Lucy Chernykh Financial Institutions and Markets Topic 4 Commercial Banks Ch 11 Outline 0 FIs overview Financial assets vs real assets FIs vs non financial firms types of FIs 0 Commercial Banks Industry Size and Structure 0 Commercial Banks Financial Statements Performance and Risks 0 Commercial Banks Regulation WHY FIs ARE SPECIAL Financial Assets vs Real Assets Financial asset a contract that offers a promise of payment in the future form the party that issued that contract 0 ex securities loans much riskier than real assets because price can change extremely quick amp much more exposure to interest rate risk Real assets assets expected to provide benefits based on their fundamental qualities 0 ex real estate inventory equipment Differences between Financial Institutions and Nonfinancial Firms Financial institutions Nonfinancial firms Assets Financial assets 95 Real assets 95 Leverage High operate with a lot of borrowed Moderate funds Liquidity High Moderate Differences in Balance Sheets Depository institutions Nonfinancial Firms Assets Liabilities Assets Liabilities Loans Deposits Deposits Loans Other Other nancial non nancial assets assets Other Other Other Other non nancial liabilities nancial liabilities assets and equity assets and equity A small decrease in loans causes a huge hit to owner s equity capital because the sides must balance If bank has an equity to asset ratio of less than 2 they must raise capital Types of Financial Institutions Depository Institutions commercial banks thrift institutions 0 savings amp loan associations 0 savings banks credit unions taxes are lower than commercial banks fees 0 owned by their customers deposits 0 similar operations to commercial banks Non Depository Institutions finance companies contractual intermediaries O pension funds 0 insurance companies investment companies 0 mutual find management companies 0 real estate investment trusts REITs securities firms 0 securities brokers 0 investment bankers Industrv Differences Differences between financial institutions in asset amp liability structures balance sheet services offered to the public riskiness of invested funds legal structure regulations EXAM NOTE Know for each type of F1 that we cover COMMERCIAL BANKS INDUSTRY SIZE AND STRUCTURE Commercial Banks Overview Commercial banks are the largest group of HS in term of size balance sheet structure 0 Major liabilities are federally insured deposits insures deposits up to 250000 to prevent people from fearing stability and withdrawing 0 Major assets are loans Banks are regulated to protect against disruptions to the services they perform Number of banks about 6300 banks highly concentrated 2 of banks control 80 of assets Bank Assets bv bank size group Greater than 10B control more than 80 Less than 100M control 07 of assets 1B to 10B control 103 of assets Structure and Composition Shrinking number of banks in US 14500 commercial banks in 1982 peak 6500 as of mid 2015 Number of Commercial Banks Trends of commercial banks has decreased over time due to mergers amp acquisitions Banks Failures in US 80s to 90s MampA consolidation that has created some very large FIs Wells Fargo B of A recent trend FDIC assisted acquisitions of failed banks by healthy banks 4 1921 1933 14807 failures big bank run where people withdrew funds in fear of failure 1981 1990 1178 failures savings amp loans association crisis Higher regulation 2008 mid 2015 500 failures new wave of strict regulations from Recession COMMERCIAL BANKS FINANCIAL STATEMENTS STRUCTURE PERFORMANCE AND RISKS Balance Sheet Structure C S L MA D NDB EC C Cash Assets S Security Holdings T bills some are for investment purposes L Loans the biggest item on the bank s balance sheet specifically mortgages MA Miscellaneous Assets buildings computers Very small portion 5 D Deposits largest liability NDB Non deposit Borrowings borrowing from Fed Funds rate issuing commercial paper EC Equity Capital owner s equity ARM adjustable rate mortgage when interest rate changes your rate changes risk default Bank faces interest rate risk from loans because mortgages are very long 30 years Asset structure net loans amp leases 5720 if too small you re not earning enough If too large you have credit risk Cash 5 Securities 23 All other assets 759 Trading account assets 551 Fixed assets 116 other real estate owned from defaults on mortgages Liabilities and Equitv structure uninsured deposits 356 amount over 250000 is uninsured gets higher interest rate insured deposits 401 equity capital 112 all other liabilities 39 other borrowed funds 91 sudden liquidity needs expensive short term funds Off Balance Sheet Items contingent Assets and Liabilities that may affect a bank s balance sheet andor income statement very difficult to asses risk on these items Examples unused loan commitments letters of credit derivative contracts futures forwards swaps options Letters of credit bank will guarantee you will make payment to someone else and will agree to step in if you default Income Statement Interest income mostly loans amp securities Less Interest expense interest rates paid on depositsnon deposits Net Interest Income NII Less Provision for loan losses PLL cushion against deterioration of loan portfolio Non interest income Less Non interest expense admin expenses buildings salaries Pretax Net Operating Income Less Tax and extraordinary items Net Income NI burden non interest expense non interest income Performance Measures EXAM NOTE given balance sheet know how to calculate each Net Interest Income NII Interest Income Interest Expense KNOW Net interest margin NIM NII Earning Assets profitability measure KNOW Net non interest margin Non interest Income Non interest expense Earning Assets Net Charge Offs is percent of loans written off as uncollectable pure loss Universal ratios KNOW ROA NI TA ROENIE Equity multiplier TA E measure the degree of leverage Bank performance trends ROA of 1 is good for banking industry relatively small due to high leverage ROE is good in banking industry compared to other industries BANK RISKS Major risks credit risk risk on loan portfolio customer default 7 capital risk insolvency not enough capital liquidity risk deposits are Short term so need liquid items on asset side interest rate risk can manage well if you have balance on loans amp deposits Other risks operational risk fraud credit risk legal amp compliance risk heavily regulated industry regulations always changing reputation risk competitive risk customers are adverse so they withdraw Problem banks names of banks are never disclosed 2010 close to 900 problem banks 2015 100 problem banks COMMERCIAL BANKS REGULATION Bank Regulators 50 state banking agencies monitor state nonmember banks amp member banks FDIC monitors everyone Federal reserve monitors member banks Office of the comptroller of the currency Office of thrift supervision New agencies created by Dodd Frank Act US Dual Banking System coeXistence of nationally and state charted banks 0 federal national charter I office of comptroller of currency I office of thrift supervision I national credit union administration 8 0 state banking commissions in the 50 states for state banks all the banks obtain FDIC Deposit Insurance as part of the chartering process Unresolved regulatorv issues bankers take on more risk 0 they get the benefit while the government assumes the costs Too big to fail policy 0 ie authorities will not permit large banks to fail as banks become larger amp more compleX can the regulators effectively oversee what these banks are doing Can we simplify the current regulatory structure Largest US Commercial Banks Top 4 JP Morgan 73 assets 21T consolidated assets Wells Fargo 98 assets 16T consolidated assets B of A 95 assets 16T consolidated assets Citibank 56 assets 13T consolidated assets Current regulatorv changes tighter rules for making loans dodd frank act higher capital requirements Basel III tighter regulations of derivatives dodd frank act monitoring of higher systematic risks imposed by super large FIs SIFIs new regulations to control customer finance products