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Cap 13 Managing Nondeposit and Borrowed Funds
Cap 13 Managing Nondeposit and Borrowed Funds
-The traditional source of funds for depository institutions is the deposit account.
But what does management do to find new money when deposit volume is
inadequate to support all the loans and investments the institutions would
like to make?
Customer relationship doctrine:
The first priority of a lending institution is to make loans to all those customers from
whom the lender expects to receive positive net earnings.
The customer relationship doctrine spawned the liquidity management strategy known
as Liability Management.
Liability Management consists of buying funds, mainly from other financial
institutions, in order to cover good quality credit requests and satisfy any legal reserve
requirements on deposits and other borrowings that law or regulation may require.
The hallmark of liability management are:
1) Buying funds by selling liabilities in the money market
2) Using price (the interest rate offered) as the control lever to regulate the volume and
timing of incoming funds.
Excess reserves that commercial banks deposit at regional Federal Reserve banks. Federal
funds
can then be lent to other commercial banks with insufficient reserves. These loans are made at
a
relatively low interest rate, called the federal funds rate or overnight rate, and they typically
have
an extremely short duration: overnight. Federal funds help commercial banks meet their daily
reserve requirements. Banks are required to maintain a certain level of reserves based on the
amount of customer deposits they are responsible for.
INVESTOPEDIA EXPLAINS 'FEDERAL FUNDS'
When federal funds are freely available for borrowing, credit is easy to obtain and the credit
market is considered healthy. When federal funds are difficult to obtain, credit becomes tight. If
credit is too freely available, the Federal Reserve may buy back some of the government bonds
it
has issued to decrease the money supply and try to prevent inflation. The federal funds rate is
closely related to short-term interest rates in the broader market.
The FED will make the loan trough its discount window, three types of loans are available from
the Feds discount window;
1-Primary Credit: Loans available for short terms (usually overnight but occasionally
extending
over a few weeks). Users of primary credit do not have to show (as they did in the past) that
they
have exhausted other sources of founds before asking the FED for loan. The borrowing
institution is no longer prohibited from borrowing from the FED and then loaning that money to
other depository institution in the FED funds market.
2-Secondary Credit: Loans Available at a higher interest rate to depository institutions not
qualifying for primary credit. These Loans are subject to monitoring by the federal reserve
banks
to make sure that borrower is not taking on excessive risk.
3- Seasonal Credit: Loans covering longer periods than primary credit for small and medium
sized depository institutions experiencing seasonal swings in their deposits and loans. (such as
those swings experienced by farm banks during planting and harvesting time).
http://www.newyorkfed.org/banking/discountwindow.html
Deposit Market began in Europe in the 1950s , Eurocurrency deposit were developed in
Western Europe
to provide liquid funds that could be swapped among multinational banks or loaned to
them.
The Eurocurrency market consists of banks (called Eurobanks) that accept deposits and
make loans in foreign currencies. A Eurocurrency is a freely convertible currency deposited
in a bank located in a country which is not the native country of the currency. The deposit
can be placed in a foreign bank or in the foreign branch of a domestic US bank.
In the Eurocurrency market, investors hold short-term claims on commercial banks which
intermediate to transform these deposits into long-term claims on final borrowers.
Eurodollarsaretime depositsdenominated inU.S. dollarsatbanksoutside theUnited
States, and thus are not under thejurisdictionof theFederal Reserve. Consequently, such
deposits are subject to much less regulation than similar deposits within the U.S.. The term
was originally coined for U.S. dollars in European banks, but it expanded over the years to
its present definitiona U.S. dollar-denominated deposit in Tokyo or Beijing would be
likewise deemed a Eurodollar deposit. There is no connection with theeurocurrency or
theEurozone.
Late in the 1960s , large banks and finance companies faced with intense demand
for loans found a new
source of loanable funds.
Commercial paper market consists of short-term notes, with maturities ranging
from three or four days
to nine months , issued by well-known companies to raise work capital. The notes
are generally sold at a
discount from their face value through security dealers.
A substantial portion of this paper (often called industrial paper) is designed to
finance the purchase of
inventories of goods or raw material.
The demand for no deposits funds is determined basically by the size of the gap
between the
institutions total credit demands and its deposits and other available monies.
The difference between current and current and projected outflows and inflows of
funds yields and
estimate of each institutions available funds gap.
For Example , suppose a commercial bank has new loan request that meet its
quality standard of $150
million ; it wishes to purchase $ 75 million in new treasury securities being issued
this week and expects
drawing on credit lines from its best corporate customers of $135 million. Deposits
and other
customers funds received today total $185 million , and those expected in the
coming week will bring in
another $100 million.