the commercial banking industry

Money and Capital Markets

1515C h a p t e r

Eighth Edition

Financial Institutions and Instruments in a Global Marketplace

Peter S. Rose

McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu

The Commercial Banking IndustryThe Commercial Banking Industry

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Learning Objectives

To understand how important commercial banks are to the functioning of a modern economy and financial system.

To explore the makeup of the United States’ banking industry.

To learn about bank financial statements and how to read them.

To see how banks create and destroy money and credit, and why this activity is so vital.


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Introduction

The dominant privately owned financial institution in the U.S. and in the economies of most major countries is the commercial bank.

This institution offers the public both deposit and credit services, as well as a growing list of newer and more innovative services, such as investment advice, security underwriting, selling insurance, and financial planning.


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The Structure of U.S. Commercial Banking

Number Number ofType of Bank of Banks Branch Offices

National banks 2,230 32,808

State-chartered member banks 991 12,954

Total Fed member banks 3,221 45,762

Nonmember state-chartered banks 5,094 18,317

Total U.S.-insured banks 8,315 64,079

Number of U.S.-insured Commercial Banksat Year-end 2000

Source: Federal Deposit Insurance Corporation

The Structure of U.S. Commercial Banking

Source: Board of Governors of the Federal Reserve System

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A Trend Toward Consolidation

One of the most important structural changes affecting the banking industry in recent years is the drive toward consolidation of industry assets into fewer, but larger, banking organizations.


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Branch Banking

The drive toward consolidation of banks into larger organizations is most evident in the long-term shift toward branch banking.

Many of the nation’s largest banks have followed their customers to distant markets across the nation through branching and mergers, so as to protect their sources of funds and their earnings.


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Bank Holding Companies

Paralleling the rapid growth of branch banking has been the growth of bank holding companies – corporations organized to acquire and hold the stock of one or more banks.

Holding companies have become the predominant bank organizational form because of their advantages in raising capital, spreading out their risk exposure, and allowing entry into new business opportunities.


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International Banking

Bank expansion into international markets has taken place through a wide variety of organizational forms: representative offices branch offices acquisitions of existing overseas banks, that then

become subsidiaries of the international bank joint ventures with foreign firms


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The Convergence Trend in Banking

Another important structural change occurring in banking today is convergence – banking organizations are looking more and more like other financial-service providers, offering many of the same services as security firms, insurance companies, etc.

In the U.S., leading banks are moving toward universal (merchant) banking.


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Bank Failures

The rapid expansion of bank services has not protected some banks and banking systems from getting into serious trouble.

Banks have failed due to declining economies, falling real estate and stock prices, bad loans, excessive risk-taking, crime, etc.


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Changing Technology

Banking today is also passing through a technological revolution.

Computer networks and high-speed information processing are transforming the industry, stressing convenience and speed in handling such routine transactions as making deposits and paying for purchases.


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Portfolio Characteristics of Commercial Banks

ASSETS AND LIABILITIES OF FDIC-INSURED COMMERCIAL BANKS (Amounts in Millions of Dollars)

12/31/00 12/31/95 Number of institutions .................................................................… 8,315 9,940 Total assets ................................................................................… 6,238,713 4,312,676 Cash and due from depository institutions (Primary Reserves) . 369,811 306,522 Noninterest-bearing ...............................................................… 264,639 227,402 Interest-bearing ......................................................................… 105,173 79,120 Securities (Secondary Reserves) ............................................… 1,077,668 810,872 U.S. Treasury securities ..........................................................… 75,740 243 U.S. Government agency and corporation obligations ...........… 634,653 13,610 Securities issued by states and political subdivisions ............… 92,625 841 Other domestic debt securities ...............................................… 171,931 1,168 Foreign debt securities ...........................................................… 61,575 4 Equity securities .....................................................................… 41,145 778 Investments in mutual funds ................................................… 13,831 98 Other equity securities .........................................................… 27,314 680 Federal funds sold & securities bought under resell agreements 280,116 180,843



ASSETS AND LIABILITIES OF FDIC-INSURED COMMERCIAL BANKS … continued12/31/00 12/31/95

Loans and leases, net ..............................................................… 3,752,138 2,550,125 Plus: allowance for losses and allocated transfer risk reserve .. 64,054 52,838 Loans and leases, total ........................................................… 3,816,191 2,602,963 Plus: unearned income ......................................................… 2,915 5,853 Loans and leases, gross ...................................................… 3,819,107 2,608,816 Loans secured by real estate, total ..............................… 1,670,278 1,080,116 Construction and land development ........................… 162,131 68,696 Secured by farmland ................................................… 34,040 23,907 Secured by 1-4 family residential properties ............… 916,383 625,990 Secured by multifamily residential properties ...........… 60,178 35,788 Secured by nonfarm nonresidential properties ............ 465,512 298,533 Loans to depository institutions ....................................… 120,458 86,972 Loans for agricultural production & other farm loans ........ 48,078 40,180 Commercial and industrial loans ....................................... 1,048,248 661,417 Loans to individuals ......................................................… 609,713 535,348 Other loans ....................................................................… 155,651 147,279 Lease financing receivables ............................................. 166,681 57,503 Assets held in trading accounts ...............................................… 304,249 217,179 Bank premises and fixed assets ................................................... 75,701 61,425 Other real estate owned ..........................................................… 3,198 6,644 Intangible assets ......................................................................… 102,703 30,218 All other assets .........................................................................… 273,130 148,850



Total liabilities, limited-life preferred stock, and equity capital ....... 6,238,713 4,312,676 Total liabilities ..........................................................................… 5,709,130 3,963,106 Deposits, total ........................................................................… 4,176,575 3,027,574 Noninterest-bearing .............................................................… 765,893 611,986 Foreign offices ...................................................................… 40,551 18,380 Interest-bearing ...................................................................… 3,410,682 2,415,589 Foreign offices ...................................................................… 666,115 435,714 Deposits, domestic offices: Total .................................................................................… 3,469,908 2,573,480 Demand deposits ...........................................................… 531,400 576,709 Savings deposits ............................................................… 1,566,992 1,030,048 Time deposits ................................................................… 1,371,516 966,723 Memoranda: Time CDs of $100,000 or more .....................................… 575,173 267,480 Estimated insured deposits ............................................… 2,398,423 1,958,944

Source: Federal Deposit Insurance Corporation 15 - 15

Portfolio Characteristics of Commercial BanksSource: Federal Deposit Insurance Corporation 15 - 16


(Nondeposit Sources of Funds) Federal funds purchased and securities sold under agreements to repurchase ................................................… 475,182 326,506 Demand notes issued to the U.S. Treasury ...........................… 14,210 11,870 Trading liabilities ....................................................................… 211,663 143,161 Other borrowed money...........................................................… 555,102 288,636 Subordinated notes and debenture ........................................… 87,043 43,536 All other liabilities ...................................................................… 189,356 121,819 Total equity capital ...................................................................… 529,583 349,571 Perpetual preferred stock .......................................................… 3,377 1,835 Common stock .......................................................................… 31,249 35,883 Surplus ..................................................................................… 259,409 146,781 Undivided profits ....................................................................... 236,867 166,067 Cumulative foreign currency translation adjustments ............... (1,319) (995) Memoranda: Loans and leases past due 30-89 days .................................… 47,936 33,689 Loans and leases past due 90 or more days .........................… 10,890 8,096 Loans and leases in nonaccrual status .................................… 32,021 22,254 Income earned, not collected on loans .................................… 32,127 20,249 Total assets in foreign offices ................................................… 759,871 585,096


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INCOME AND EXPENSE OF FDIC-INSURED COMMERCIAL BANKS (Amounts in Millions of Dollars)

2000 1995

Number of institutions ................................................................… 8,315 9,940 Number of employees (full-time equivalent) ..............................… 1,662,335 1,484,421

Total interest and fee income ....................................................... 427,985 302,383 Domestic office loans .............................................................… 294,837 200,106 Foreign office loans ................................................................… 24,533 23,349 Lease financing receivables ...................................................… 10,781 3,705 Balances due from depository institutions ..............................… 6,441 6,147 Investment securities ..............................................................… 68,456 51,213 Assets held in trading accounts ..............................................… 9,424 8,244 Federal funds sold & securities bought under resell agreements 13,513 9,618



INCOME AND EXPENSE OF FDIC-INSURED COMMERCIAL BANKS … continued2000 1995

Total interest expense ...............................................................… 224,195 148,173 Domestic office deposits .........................................................… 114,930 79,404 Foreign office deposits ............................................................… 36,736 25,977 Federal funds purchased and securities sold under agreements to repurchase .................................................… 27,436 18,548 Demand notes issued to the U.S. Treasury & other loans ......... 39,171 21,050 Subordinated notes and debentures ......................................… 5,922 3,193 Net interest income ....................................................................… 203,790 154,210 Provisions for credit losses and allocated transfer risk .............… 29,254 12,603 Total noninterest income ...........................................................… 152,751 82,426 Fiduciary activities ..................................................................… 21,370 12,304 Service charges on deposit accounts .....................................… 23,778 16,046 Trading account gains and fees .............................................… 12,444 6,333 Foreign exchange exposures .............................................… 5,089 2,491 All other noninterest income ...................................................… 95,159 47,743 Total noninterest expense ........................................................… 215,753 149,729 Salaries and employee benefits ............................................… 88,507 63,440 Premises and equipment ......................................................… 26,765 19,618 All other noninterest expense ...............................................… 100,481 66,670


INCOME AND EXPENSE OF FDIC-INSURED COMMERCIAL BANKS … continued2000 1995

Pre-tax net operating income ....................................................… 111,534 74,304

Gains (losses) on securities not held in trading accounts .........… (2,285) 541

Applicable income taxes ...........................................................… 38,043 26,125

Income before extraordinary items ............................................… 71,206 48,720

Extraordinary items, net ............................................................… (30) 26

Net income .................................................................................… 71,176 48,745

Net loan and lease charge-offs .................................................… 23,613 12,202 Total loan and lease charge-offs ............................................… 29,254 18,204 Total loan and lease recoveries .............................................… 5,641 6,002

Cash dividends declared ..........................................................… 53,798 31,053 Cash dividends declared on preferred stock .........................… 105 202 Cash dividends declared on common stock ..........................… 53,693 30,851

Net additions to capital stock ....................................................… 4,304 2,449


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Money Creation and Destruction by Banks

Banks have the power to create money in the form of new checkable deposits, credit card lines, debit cards, and other immediately spendable funds.

As a whole, the banking system can create a volume of money equal to a multiple of any excess reserves deposited with it simply by making loans and purchasing securities.


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Reserve Requirements and Excess Reserves

Vault cash and deposits at the Fed constitute a bank’s holdings of legal reserves – those assets acceptable for meeting legal reserve requirements behind the public’s deposits.

Each bank’s legal reserves may be divided into two categories: required reserves and excess reserves.


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The Creation of Money and Credit

The distinction between excess and required reserves is important because it plays a key role in the growth of credit in the economy and the creation of money by the banking system.

By making loans whenever excess reserves appear, the banking system eventually creates total deposits and total loans several times larger than the original volume of new funds received.


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The Creation of Money and Credit

The maximum total deposits created by the banking system is equal to the initial amount of legal reserves deposited in the system times the deposit multiplier (the reciprocal of the reserve requirement ratio).


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Destruction of Deposits and Reserves

Similarly, the money supply can contract by a multiple amount when legal reserves are withdrawn from the banking system.


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Implications of Money Creation and Destruction

Creation of money by banks is one of the most important sources of credit funds in the global economy.

However, money created by banks is instantly available for spending, and therefore, unless carefully controlled by government action, the creation of money can fuel inflation.


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Money and Capital Markets in Cyberspace

More information about the commercial banking industry can be found at: http://www.federalreserve.gov http://www.occ.treas.gov/ http://www.fdic.gov/ http://www.pueblo.gsa.gov/ http://www.bankstaffers.com/ http://www.ffiec.gov/


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Chapter Review

Introduction The Structure of U.S. Commercial Banking

A Trend Toward Consolidation Branch Banking Bank Holding Companies International Banking The Convergence Trend in Banking Bank Failures Changing Technology


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Chapter Review

Portfolio Characteristics of Commercial Banks Cash and Due from Banks (Primary Reserves) Security Holdings and Secondary Reserves Loans Deposits Nondeposit Sources of Funds Equity Capital Revenues and Expenses


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Chapter Review

Money Creation and Destruction by Banks Reserve Requirements and Excess Reserves The Creation of Money and Credit Destruction of Deposits and Reserves Implications of Money Creation and Destruction

the commercial banking industry

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