slike bài giảng quản trị ngân hàng chương 4managing and pricing non-deposit liabilities

Customer relationship doctrineThe first priority of the bank is to make loans to all qualified customers and if funds are not available the bank should seek out the lowest cost source o

William Chittenden edited and updated the PowerPoint slides for this edition.

MANAGING AND PRICING NON-DEPOSIT LIABILITIES

Chapter 4

Key topics

1. Liability management

2. Customer relationship doctrine

3. Alternative non-deposit funds sources

4. Measuring the funds gap

5. Choosing among different funds sources

6. Determining the overall cost of funds

13-2

Customer relationship doctrine

The first priority of the bank is to make loans to all qualified customers and if funds are not available

the bank should seek out the lowest cost source of

funding to meet customers’ needs.

13-3

Nondeposit sources of funds

 Federal Funds Market

 Repurchase Agreements

 Federal Reserve Bank

 Advances from the Federal Home Loan Bank

Recent Growth in Non-deposit Sources

of Borrowed Funds at FDIC-Insured Institutions

What are the trends?

13-6

Alternative non-deposit sources of funds

 The usage of non-deposit sources of funds has risen

 Larger institutions rely on the non-deposit funds

market as a key source of short-term money to meet loan demand and unexpected cash emergencies

13-7

Federal funds market

 Immediately available reserves are traded between

financial institution and usually returned within 24

hours, although maturities are negotiated and can

extend up to several weeks

 Deposits with correspondent banks and demand

deposit balances of security dealers and governments can be used for loans to institutions

 Interest rates are negotiated between trading partners and are quoted on a 360-day basis

13-8

Types of Fed funds loan agreements

 Automatically renewed each day

 Normally between smaller respondent institutions and their larger correspondents

13-10

Repurchase agreements (Repos)

 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

13-11

Repurchase agreements

 Most transactions are overnight

 In most cases, the market value of the collateral

is set above the loan amount when the contract

is negotiated

 This difference is labeled the margin

 The lender’s transaction is referred to as a

Reverse Repo

Borrowing from the Federal Reserve

 Discount window

 Discount rate

 Policy is to set discount rate 1% (1.5%) over the Fed

Funds target for primary (secondary) credit loans

 To borrow from the Federal Reserve, banks must apply

and provide acceptable collateral before the loan is

granted

 Eligible collateral includes U.S government securities, bankers acceptances, and qualifying short-term commercial or government paper

Borrowing from the Federal Reserve

 Primary Credit

 Available to generally sound depository institutions on a very short-term basis, typically overnight

 It serves as a backup source of short-term funds for

sound depository institutions

 Secondary Credit

 Available to depository institutions that are not eligible for primary credit Monitored by the federal reserve to control excess risk

Borrowing from the Federal Reserve

 Seasonal Credit

 Cover longer periods than primary credit to assist small depository institutions in managing significant seasonal swings in their loans and deposits

 Emergency Credit

 May be authorized in unusual and exigent circumstances

by the Board of Governors to individuals, partnerships, and corporations that are not depository institutions

Federal home loan bank advances

 The FHLB system is a government-sponsored

enterprise created to assist in home buying

 The FHLB system is one of the largest U.S

financial institutions, rated AAA because of the

government sponsorship

 FHLB has federal charter and can borrow cheaply

and pass savings to institutions

 FHLB Has 12 Regional Banks

 Any bank can become a member of the FHLB

system by buying FHLB stock

Advances from the Federal Home Loan Bank

 If it has the available collateral, primarily real

estate related loans, it can borrow from the

FHLB, as a way to improve the liquidity of

home mortgages and encourage more lenders

Commercial Banks with FHLB Advances, 1991–2004

Commercial Banks with FHLB Advances

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

13-19

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.

13-20

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 Euro-deposits to its home

office

13-21

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.

13-22

Long-term non-deposit sources of funds

 Mortgages to fund the construction of new

buildings

 Capital notes and Debentures are examples of long

term sources of funds

13-23

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 non-deposit

funds

13-24

Non-deposit funding sources: factors to

consider

 Relative costs of raising funds from each source

 Risk of each funding source

 Length of time for which funds are needed

 Size of the institution

 Regulations limiting the use of various funding

sources

13-25

Relative costs

 Borrowed funds in increasing order of costs:

 Federal funds borrowings

 Domestic CDs and Eurocurrency deposits

 Commercial paper (short-term unsecured notes)

 Borrowings from the FED

Relative costs: Federal funds borrowings

 Rates are volatile with wide fluctuations,

fluctuating around the central bank’s (intended) Fed fund rate

Relative costs: CDs and commercial papers

 Advs:

 Rates are more stable, though close to and slightly

above Fed funds rate due to longer maturities and

marketing costs in finding buyers

 Better for long-term needs over several days or weeks

 Disavds:

 Less popular in short run than Fed funds and

borrowing from the discount window

Relative costs: effective cost rate (marginal cost)

 Costs of Independent Sources of Funds

 Example:

 Market interest rate is 2.5%

 Servicing costs are 4.1% of balances

 Acquisition costs are 1.0% of balances

 Deposit insurance costs are 0.25% of balances

 Net investable balance is 85% of the balance (10% required reserves and 5% float)

9.24%

0.0924 0.85

0.0025 0.01

0.041

0.025 Cost

Relative costs: overall cost of funds

 The historical average cost approach

 The pool-fund approach

(see Chapter 13: pp 440-441)

The risk factor

 Interest rate risk: the volatility of credit costs

 Credit availability risk: no guarantee that lender will be willing and able to accommodate every borrower, due to

 Tight credit conditions

 High risk of borrowers

Length of time for which funds are needed

 Some fund sources may be difficult to access

immediately → funds needed in the short run should

be borrowed from the Fed fund market

 If funds are not needed for a few days → selling

longer-term debt might be a more viable options.

Size of the institution

 Standard trading unit for most money market loans

is $1mil, often exceeding borrowing requirements of smallest financial institutions

 Small depository institutions may not have credit

standing to issue large negotiable CDs

 Central bank’s window and Fed funds can make

relatively small denomination loans

 FED may limit borrowings from the discount

window, particularly by depository institutions

appearing to display significant risk of failure

 Some borrowing forms maybe subject to reserve requirements in case of tight-money policies

Questions & Problems

1 Compare and contrast Fed funds transactions with RPs?

2 What are the advantages and disadvantages of CDs as a funding

source?

3 What long-term non-deposit funds sources do banks and some of

their closest competitors draw upon today? How do these

interest costs differ from those costs associated with most money market borrowings?

4 What factors must the manager of a financial institution weigh

in choosing among the various non-deposit sources of funding available today?

5 Problem 6, 11 and 12 (page 445-6)

William Chittenden edited and updated the PowerPoint slides for this edition.

MANAGING AND PRICING NON-DEPOSIT LIABILITIES

Chapter 4