Depository institutions include commercial banks and thrifts. Thrifts include savings, savings banks, credit unions and credit unions. As the name suggests these institutions accept deposits which represent the liabilities of the deposit taking institution i.e. loans. Depository institutions make loans to various entities, including businesses, consumers, state and local governments, with funds raised through depository and non-depository sources by issuing debt obligations in the financial markets.

Commercial banks are the largest type of depository institution and receive the most attention here. A commercial bank is a financial institution owned by shareholders and engaged in accepting deposits and lending for profit. The bank is owned by the bank holding company BHC. It is a company owned by one or more banks.

As of September 30, 2009, the five largest bank holding companies in the United States and the Federal Reserve System, according to the National Information Center, have total assets in the billions:

Bank of America $2,253

JPMorgan Chase & Co. $2,041

Citigroup $1,889

Wells Fargo & Company $1,229

Goldman Sachs Group $883

Bank services

The main services provided by commercial banks are:

  • Personal Banking
  • Institutional Banking
  • Global Banking

Personal banking includes personal oriented financial investment services such as consumer loans, residential mortgage loans, consumer installment loans, credit card financing, automobile, boat financing, brokerage services, student loans, personal trust and investment services.

Institutional banking includes lending to both non-financial, financial businesses and government entities, institutions engaged in commercial real estate financing and leasing activities.

In global banking, commercial banks compete with other types of financial institutions, such as investment banking firms. Banks in the global arena engage in corporate financing, which includes procuring funds for the bank's customers, going beyond traditional bank lending to provide underwriting securities and letters of credit and other forms of guarantees, and financial advice on matters such as strategies for raising funds, corporate restructuring, divestitures, acquisitions, etc. . Capital markets and foreign exchange products and services include transactions where a bank may act as a seller or broker in a service.

Bank Funds

Banks are highly leveraged financial institutions meaning that most of their funding comes from borrowing. One form of borrowing involves deposits. There are four types of deposit bank accounts issued by banks:

Demand Deposit

Savings Deposit

Time Deposit

Money market demand accounts

Demand deposits, more popularly known as checking accounts, can be withdrawn on demand and pay minimal interest. Savings deposits pay interest (usually below the market rate of interest), have no specific maturity and are usually withdrawable on demand. Time deposits, more popularly referred to as certificates of deposit or CDs, have a fixed maturity date and offer either a fixed or floating interest rate. A money market demand account pays interest based on short term account interest rates.

Apart from loans available to banks, deposits are sources

(1) Borrowing by issuing instruments in the money and bond markets.

(2) Stock borrowing in the federal funds market.

(3) One source is borrowing from the Federal Reserve Fed through the discount window facility.

The first source is self-explanatory. The last two require clarification.

A bank cannot invest $1 for every $1 it raises through deposits because it must maintain a certain percentage of deposits in a noninterest-bearing account at one of 12 Federal Reserve banks. These specified percentages are reserve ratios, and the dollar amount required to hold deposits at the Federal Reserve Bank is called required reserves.

Reserve ratios are established by the Federal Reserve Board, representing one of the monetary policy tools employed by the Fed. Banks meet these reserve requirements each period through actual reserves, which are defined as the average amount of reserves held by the Federal Reserve Bank at the close of business. If the actual reserves are more than the required reserves, the difference is referred to as excess reserves. As reserves are held in non-interest bearing accounts, the opportunity cost is associated with additional reserves. However, if there is a shortfall, the Fed imposes a penalty. As a result banks are encouraged to manage their reserves to meet reserve requirements as accurately as possible. There is a market where banks that are temporarily short of their required reserves can borrow reserves from banks that have excess reserves. This market is called the federal funds market and the interest rate charged for borrowing funds in this market is called the federal funds rate.

Since the Federal Reserve Bank is effectively a banker's bank, lending to banks to meet liquidity needs is charged at the Fed discount window. This means the Federal Reserve Bank is the bank of last resort. If a bank is temporarily short of funds it can borrow from the Fed at its discount window, however the bank requesting funds to borrow at the discount window must post collateral to do so. That is, the Fed is willing to make secured or collateralized loans. The Fed establishes the types of collateral eligible for borrowing at the discount window. The interest rate the Fed charges to borrow funds at the discount window is called the discount rate. The Fed changes rates periodically to implement monetary policy.

Bank regulation

Because of their important role in financial markets, depository institutions are highly regulated and supervised by many federal and state government agencies. At the federal level it is supervised by the Federal Reserve Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (FDIC). Banks are insured by the Bank Insurance Fund or BIF, which is administered by the Federal Deposit Insurance Corporation. Federal Depository Insurance Started in 1930, this insurance program is administered by the FDIC.

As already mentioned capital structure of banks is highly leveraged. That means the ratio of equity capital to total assets is less than 8%. As a result there are concerns by regulators about possible insolvency due to low levels of capital provided by owners. An additional concern is that the amount of equity capital is insufficient because of potential liabilities that do not appear on the bank's balance sheet, so-called off-balance sheet liabilities such as letters of credit and liabilities on OTC derivatives. This is addressed by regulators through risk-based capital requirements.

The Basel Committee on Banking Supervision is an international body that has established guidelines for risk-based capital requirements. The committee is made up of banking supervisory authorities from 13 countries. By risk based it is meant that a bank's capital requirement depends on the various risks it is exposed to.

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