Outline March 30

1
Outline March 30

• Current Events
• Loan Pricing
• Examples
• Consumer Loans/Credit Cards
• Liquidity Measurement and Management
• Chapters 13-14
• Next Capital Measurement and Management
• Chapter 16

2
Consumer Loans

• Open-end vs. close-end loans
• no maturity vs. specific maturity
• Installment loans
• Revolving loans
• credit cards
• check overdrafts
• Credit cards vs. debit cards
• Three main types
• same bank issuer and maintains accounts
• one bank issuer and agent banks establish
  merchant accounts
• affiliate with another type of card like American
  Express

3
Bank Credit Cards

• prearranged line of credit
• Process
• cardholder makes purchase
• retail merchant submits sales draft to merchant
  bank (agent) for payment less a merchant discount
  (0 to 6)
• merchants volume of credit card activity
• average size of each sale
• compensating balances at the bank
• combination
• merchant bank reimburses merchant
• merchant bank submits charge to VISA/MasterCard
• VISA/Master Card forwards charge to issuer bank
• issuer bank makes payment to VISA/MasterCard
• VISA/MasterCard forwards payment to merchant bank
• card issuing bank bills cardholder
• card holder pays the bank

4
Calculation of Finance Charges

• Suppose your credit card has 100 balance on 5/31
  and there will be no finance charge if paid by
  6/30. On June 1 you make 100 purchase. On June
  15 you make a 20 payment on the loan. The
  interest rate charged is 1.5 monthly or 18
  annually.
• What is the finance charge?
• 4 Methods
• adjusted balance
• previous balance
• average daily balance excluding current
• average daily balance including current

5
Methods

• Adjusted balance
• amount that has been billed less payments
• purchases not counted
• 100 - 20 80 x 1.5 1.20
• Previous Balance
• Based on original amount billed no consideration
  to payment or purchases.
• 100 x 1.5 1.50
• ADB excluding current
• 100 for 15 days and 80 for 15 days 90 ADB x
  1.5 1.35
• ADB including current
• 200 for 15 days and 180 for 15 days 190
  average x 1.5 2.85.
• lose your grace period if payment is partial or
  skipped
• retroactive

6
LiquidityLearning Objectives

• Understand the role of liquidity in financial
  intermediaries.
• Describe how to measure liquidity.
• Measure the costs of liquidity.
• Understand the mechanics of regulators reserve
  requirement.

7
FI Liquidity

• Defined
• What makes it different than other firms?
• Asset liquidity
• sources
• Liability liquidity
• sources
• core deposits

8
Sources and Uses of Liquidity Consolidated
Statement

• Sources of liquidity
• 1. Total cash-type assets
• 2. Maximum borrowed funds limit
• 3. Excess cash reserves
• Uses of liquidity
• 1. Funds borrowed
• 2. Federal reserve borrowing
• Discount window

9
FI Liquidity Risk

• Defined
• What makes it different than other firms?
• Asset-side liquidity risk
• potential causes
• Liability-side liquidity risk
• potential causes

10
Measuring Liquidity Risk Exposure

• Financing gap
• Average loans - average core deposits
• - liquid assets borrowed funds

11
Liquidity Management

• Estimating Liquidity Needs

12
Reserve Requirements of Depository
InstitutionsJanuary 1998

• Net transaction accounts
• 0-47.8 million 3
• More than 47.8 10
• Nonpersonal time deposits 0
• Eurocurrency liabilities 0
• First 4.7 million transaction accounts are
  subject to 0
• Transaction accounts all accounts that are
  permitted to make withdrawals by instruments.
  Accounts with limits of 6 or less transfers may
  be excluded.
• Reserves held as vault cash or deposits at
  Federal Reserve Banks

13
Reserve Requirements of Depository
InstitutionsJanuary 1998

• Net transaction accounts
• 0 - 4.7 0
• 4.7-47.8 million 3
• More than 47.8 10
• Nonpersonal time deposits 0
• Eurocurrency liabilities 0
• First 4.7 million transaction accounts are
  subject to 0
• Transaction accounts all accounts that are
  permitted to make withdrawals by instruments.
  Accounts with limits of 6 or less transfers may
  be excluded.
• Reserves held as vault cash or deposits at
  Federal Reserve Banks

14
Calculate Reserve Requirements
Computation period
Tuesday
Maintenance period
Thursday
Friday x 3
Friday x 3
Monday
Wednesday
15
Reserve Target

• Undershooting
• 4 error can be made up in next period
• else penalties, explicit implicit
• Overshooting
• opportunity costs
• 4 can be carried to next period

16
Problem

• The average demand deposits at a bank during the
  most recent computation period has been estimated
  at 225 million over a 14 day period (Tuesday to
  Monday). The average daily reserves at the Fed
  during the 14-day reserve maintenance period has
  been 16 million and the corresponding daily
  vault cash during this period was 4 million.
• What is the average daily required reserves to be
  held at the bank during the maintenance period?
• Is the bank in compliance?
• What is the amount in excess that can be carried
  forward?
• What is the loss of the carryover if the
  opportunity cost is 6

17
Sources of Liquidity

• Borrowing vs Selling
• Asset liquidity vs. liability liquidity
• Liquidity of securities
• Borrowing from regulators
• discount window
• FHLB advances

18
Liability Management

• Funding costs and funding risks
• demand deposits
• interest bearing checking
• passbook savings
• MMDAs
• Retail Time deposits and CDs
• Wholesale CDs
• Federal funds

19
Liquidity Measures

• Liquid Assets
• Cash
• Fed Funds Sold and securities/resell
• Assets in trading accounts
• Debt securities with remaining mat. less than 1
  year (fixed or variable rate)
• Commercial paper
• Remember pledged securities
• Temporary Investments
• Basically same exceptOnly interest bearing
  Cash accounts