Chapter 13

Managing Nondeposit Liabilities and Other Sources of Borrowed Funds

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.
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

2 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Liability Management
The

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

Bank Buys Funds in Order to Satisfy Loan Requests and Reserve Requirements It is an Interest-Sensitive Approach to Raising Bank Funds It is Flexible The Bank Can Decide Exactly How Much They Need and For How Long The Control Mechanism to Regulate Incoming Funds is the Price of Funds
3 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Nondeposit Sources of Funds

Federal

Funds Market Repurchase Agreements Federal Reserve Bank Advances from the Federal Home Loan Bank Negotiable CDs Eurocurrency Deposit Market Commercial Paper Long Term Sources
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

4 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Federal Funds Market

Deposits Held by U.S. Banks at Federal Reserve Banks, Deposits with Correspondent Banks and Demand Deposit Balances of Security Dealers and Governments Can Be Used For Loans to Institutions
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

5 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Types of Fed Funds Loan Agreements

Overnight

Loans Term Loans Continuing Contracts

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

6 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Repurchase Agreements
Involves the Temporary Sale of HighQuality Assets (usually Government Securities) Accompanied by an Agreement to Buy Back Those Assets On a Specific Future Date At a Predetermined Price or Yield

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

7 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Borrowing From the Federal Reserve Bank

A Bank With Immediate Reserve Needs Can Borrow From the Federal Reserve. There are Three Types of Loans for Different Needs, Each With Its Own Interest Rate. There are Restrictions on the Frequency of Borrowing at the Federal Reserve.
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

8 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

The Three Types of Federal Reserve Loans

Primary Credit This Loan is Available for Short Terms and to Institutions in Sound Financial Condition. Rate is Slightly Higher than the Federal Funds Rate. Secondary Credit These Loans are Available at a Higher Interest Rate to Institutions not Qualifying for Primary Credit. Monitored by the Federal Reserve to Control Excess Risk Seasonal Credit - These loans Cover Longer Periods Than Primary Credit for Small and Medium Institutions Experiencing Seasonal Swings in Deposits and Loans

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

9 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Advances from the Federal Home Loan Bank

Allows Institutions to Use Home Mortgages as Collateral for Advances A Way to Improve the Liquidity of Home Mortgages and Encourage more Lenders to Provide Credit Number of Loans has Increased Dramatically in Recent Years Maturities Range from Overnight to More than 20 Years FHLB Ca Borrow Cheaply and Pass Savings to Institutions
10 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

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
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

11 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

The Four Types of Negotiable CDs

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.
Domestic
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

12 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

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 Eurodeposits to its Home Office
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

13 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Commercial Paper
Short-Term

Notes With Maturities from 3 or 4 Days to 9 Months Issued By WellKnown 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.
14 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

Long-Term Nondeposit Sources of Funds

Mortgages to Fund the Construction of New Buildings and Capital Notes and Debentures are Examples of Long Term Sources of Funds

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

15 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

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 Nondeposit Funds

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e

16 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Nondeposit Funding Sources: Factors to Consider

The Relative Costs of Raising Funds From Each Source The Risk of Each Funding Source The Length of Time for Which Funds are Needed The Size of the Institution Regulations Limiting the Use of Various Funding Sources
17 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin Bank Management and Financial Services, 7/e