COMMERCIAL BANK

1
CHAPTER 17

• COMMERCIAL BANK
• SOURCES AND USES OF FUNDS

2
The Banks Balance Sheet

• Recall the basic identity of any balance sheet
• The same identity is true for a banks balance
  sheet however a banks assets and liabilities
  are somewhat different from those of the typical
  firm

3
The Banks Balance Sheet

• Liabilities
• Deposits
• Demand deposits accounts (DDA)
• Savings accounts
• Time deposits
• Money market accounts

4
The Banks Balance Sheet

• Borrowed Funds -- nondeposit, uninsured sources
  of funds.
• Federal funds purchased (borrowed)
• Federal Reserve bank borrowing
• Capital Notes and Bonds

5
The Banks Balance Sheet

• Bank Capital Accounts
• Common stock
• Preferred stock
• Retained earnings
• Note capital is critical in the banking industry
  (for absorbing losses and protecting depositors).
  At the same time, banks as a whole are thinly
  capitalized relative to firms in other industries.

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The Banks Balance Sheet

• Assets
• Cash
• U.S. Treasury securities
• U.S. government agency securities Municipal
  securities
• Federal funds sold
• Loans- personal, commercial mortgage etc. etc.
• Buildings and equipment

7
The Banks Balance Sheet

• Off balance sheet activities
• Letters of credit
• Loan commitments
• Derivatives

8
Bank Loans

• Types of Loans
• Lines of credit
• Term loans
• Revolving credit agreements
• Bridge loans
• Seasonal loans -- working capital needs

9
Bank Loans

• Consumer loans
• Bank credit cards loans
• Real estate loans
• Commercial and industrial loans

10
Pricing Bank Loans

• Loans are evaluated using the 5 Cs of credit
• character -- willingness to pay.
• capacity -- cash flow.
• capital -- wealth.
• collateral -- pledged assets.
• conditions -- current and future economic
  conditions.

11
Pricing Bank Loans

• Historically the prime rate was a key benchmark
  for establishing loan rates
• What is the prime rate?
• However, it has diminished in importance in
  recent years

12
Pricing Bank Loans

• In general the loan rate is determined by adding
  a spread to the deposit cost to cover
• administrative costs
• default risk
• a competitive return to bank
  shareholders.

13
Pricing Bank Loans

• The Effective Rate of Interest (ERI)
• As a borrower, you care about the ERI on the loan
  (not just the stated interest rate).
• What is the difference between the ERI and the
  stated/quoted interest rate?

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Pricing Bank Loans

• A few examples will illustrate the point. Lets
  focus on two methods for computing interest
• Simple Interest
• Discount Interest

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Pricing Bank Loans

• The following example will illustrate how the
  method used affects the ERI
• Assume 10,000 loan for 30 days at 12 percent
  annually.
• ERI I/LP 360/n
• where I amount of interest
• LP loan proceeds
• n of days for which funds are borrowed

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Pricing Bank Loans

• Assuming simple interest the ERI is
• 10,000 0.12 (30/360) 360
• 10,000 30
• ERI 12
• Bottomline

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Pricing Bank Loans

• If instead we assume discount interest, the ERI
  becomes
• 10,000 0.12 (30/360) 360 10,000 -
  (10,000 0.12 (30/360)) 30
• ERI 12.12
• What causes the rate to be higher?

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Pricing Bank Loans

• Another feature that affects the ERI is the
  compensating balance requirement (CBR).
• What is a CBR?

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Pricing Bank Loans

• Assume the same example as before but now we
  introduce a 10 CBR. How does that change our
  original answers?
• Lets see.

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Pricing Bank Loans

• Assuming simple interest and 10 CBR
• 10,000 0.12 (30/360) 360 10,000 -
  10,000(0.10) 30
• ERI 13.33

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Pricing Bank Loans

• Assuming discount interest and 10 CBR
• 10,000 0.12 (30/360) 360
• 10,000 - (10,000 0.12 (30/360))-
  10,000(.10) 30
• ERI 13.48
• Bottomline

22
Fee-Based Services

• Increasingly, banks are relying on fee-based
  services for revenue
• Some sources of fee-based income are
• ATM fees
• Credit card fees
• Correspondent banking

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Fee-Based Services

• Leasing
• Trust operations
• Loan servicing functions
• Standby letters of credit (SLC)
• Securitization

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In Summary

• A banks balance sheet has the same identity as a
  regular balance sheet - but components are
  different
• The loan pricing method impacts the ERI
• Fee-based services are becoming increasingly
  important to banks