CHAPTER 3

DEPOSITORY INSTITUTIONS
DEPOSITORY INSTITUTIONS

- commercial banks (simply banks)

- savings and loan association (S&Ls)
- savings banks
- credit unions

• These financial institutions accept deposits.

Deposits
S&Ls, savings banks, and credit unions are commonly called
"thrifts" which are specialized types of depository institutions.

Depository institutions are highly regulated because of the

important role they play in the financial system.
 ASSET/LIABILITY PROBLEM OF
DEPOSITORY INSTITUTIONS

A depository institution seeks to earn a

positive spread between the assets in which
it invests ( loans and securities) and the cost
of its funds (deposits and other sources).
The spread is referred to as :

Spread Income

- allows the institution to meet the operating

expenses and earn a fair profit on its capital
In generating spread income a depository
institution faces several risks including :

Credit Risk
- refers to the risk that a borrower will default on a
loan obligation to the depository institution.

Regulatory Risk
- is the risk that regulators will change the rules and
affect the earnings of the institution unfavorably.

Funding Risk
LIQUIDITY CONCERNS
- a depository institution must be prepared to satisfy
withdrawals of funds by depositors and to provide loans to
customers.

A depository institution can accommodate withdrawal

and loan demand in several ways :

1.) attract additional deposits.

2.) use existing securities as a collateral for borrowing from

a federal agency or other financial institution.

3.) sell securities that it owns.

4.) raise short term funds in the monetary market.

The Risk that regulator concerned regarding on Depository Institutions

Credit Risk
- is the risk that the obligor of a
financial instrument held by a
financial institution will fail to fulfill
its obligation on the due date.
Settlement Risk
- the risk that when there is a settlement of a trade
or obligation, the transfer fails to take place as
expected.

Settlement consist of :
(COUNTERPARTY RISK AND LIQUIDITY RISK)

Counterparty risk ( a form of credit risk)

- is the risk that a counterparty in a trade fails to
satisfy its obligation.
Liquidity Risk
- means that the counterparty can eventually meet its
obligation, but not at the due date.

A.) Market Liquidity Risk

- risk that a financial institution is unable to transact

in a financial instrument at a price near its value.

B.) Funding Liquidity Risk

- risk that the financial institution will be unable to
obtain funding to obtain cash flow necessary to satisfy
its obligations.
Market Risk
- is the risk to a financial institution's economic
well being that results from an adverse
movement in the market price of assets.

Operational Risk
- is defined by bank regulators as the "risk of loss
resulting from inadequate or failed internal
process people and system, or from external
events"
Legal Risk
- the risk of loss resulting from
failure to comply with laws as
well as prudent ethical standards
and contractual obligations.
Major categories of operational risk.

1.Employee: Loss events resulting from the actions or inactions of

person who works for firm.

2.Business process: loss events arising from a firm's execution pf

business operations.

3.Relationships: Loss events caused by the connection or contract

that a firm has with clients, regulators, or third parties.

4.Technology: loss events due to privacy, theft, failure, break down,

or other discruption in technology,data or information.

5.External: Loss events caused by people or entities outside a firm;

the firm cannot control their actions.
BANK SERVICES
- Commercial banks provide numerous
services in the US financial system.

The services can be broadly classified as follows :

• Individual Banking
• Institutional Banking
• Global Banking
INDIVIDUAL BANKING

Encompasses consumer lending, residential

mortgage lending, consumer installment
loans, credit card financing, automobile and
boat financing, brokerage services, student
loans, and individual-oriented financial
investment services such as personal trust
and investment services
GLOBAL BANKING
- Involves corporate financing and capital market and
foreign-exchange products and services.

Glass steagall act

- It was designed to separate commercial banking and
investment banking.

Gramm-leach- bliley act

- the Act addressed concerns relating to consumer financial
privacy.
BANK FUNDING

In describing the nature of the banking

business, we focus on how a bank can
generate an income.
UNITED STATES LARGEST
BANK
RANK 1
Bank of America Corp. (Charlotte, N.C.)
-$1,082.243

RANK 2
J.P. Morgan Chase & Company (Columbus, Ohio)
- 1,013.985

RANK 3
Citigroup (New York, N.Y.)
-706,497

RANK 4
Wachovia Corp. (Charlotte, N.C.)
-472,143.

RANK 5
Wells Fargo & Company (Sioux Falls, S.D.)
-403,258
DEPOSITS
- Several types deposit are available.

Demand
(checking account)

Time deposit
(certificate of deposit)
Reserve Requirement
Borrowing
- occurs when banks borrow funds from the
central bank to meet their mandated reserve
requirements. Banks are required to hold a
certain percentage of their deposits as
reserves, and if they fall short, they can
borrow from the central bank to fulfill this
obligation. This borrowing helps banks
maintain liquidity and ensures stability in the
banking system.
Nondeposit borrowing
refers to sources of funds that banks and
financial institutions obtain outside of
traditional customer deposits. These sources
can include borrowing from other financial
institutions, issuing bonds, obtaining loans
from the central bank, or participating in
repurchase agreements (repos).
Issuance of Debt Securities
Another form of nondeposit borrowing
for banks and financial institutions is
through issuing debt securities such as
bonds and commercial paper.
Bonds :
Banks can issue bonds to raise funds
from investors. Bonds are debt securities
that promise to repay the principal
amount along with periodic interest
payments to bondholders.
Commercial Paper :
This is a short-term debt instrument
issued by corporations and financial
institutions to raise funds for immediate
financing needs. Commercial paper
typically matures within a few days to a
few months and is often used by banks to
meet short-term liquidity requirements.
CAPITAL REQUIREMENTS FOR
BANKS
- regulatory standards for banks
that determine how much liquid
capital (easily sold assets) they
must keep on hand, concerning
their overall holdings.
BASIC COMMITTEE ON BANKING
SUPERVISION
- This committee is made up of banking
supervisory authorities from 13
countries.

RISK-BASED CAPITAL
REQUIREMENTS
- In July 1988, the Basel Committee released
its first guidelines in a document referred to as
the Capital Accord of 1988.
BASIL I FRAMEWORK
- The primary objective of the Basel I
Framework was to establish minimum
capital standards designed to protect
against credit risk.
BASEL II FRAMEWORK
- The purpose of the Basel II Framework
was to improve on the rules as set forth
in the Basel I Framework by bringing risk-
based capital requirements more in line
with the underlying risks to which banks
are exposed.
THREE “PILLARS”
• Minimum risk-based capital
requirements

• Supervisory review of capital

adequacy

• Market discipline through public

disclosure
CREDIT RISK AND RISK-
BASED CAPITAL
REQUIREMENTS

- Consider two banks, A and B, with $1

billion in assets. Suppose that both invest
$400 million in identical assets, but the
remaining $600 million in different
assets.
RISK-BASED CAPITAL
GUIDELINES

- recognize credit risk by segmenting and

weighting requirements.

First, capital consists of Tier 1 and Tier 2

capital, and minimum require ments are
established for each tier.
CORE CAPITAL
- it consists basically of common stockholders'
equity, certain types of preferred stock, and
minority interest in consolidated subsidiaries.

SUPPLEMENTARY CAPITAL
- includes loan-loss reserves, certain types of
preferred stock, perpetual debt (debt with no
maturity date), hybrid capital instruments and
equity contract notes, and subordinated debt.
 ASSETS Book Value (in millions)

U.S. Treasury securities $ 100

Municipal general obligation bonds 100
Residential mortgages 500
Commercial loans 300 .
Total Book Value $ 1,000
RISK WEIGHT EXAMPLE OF ASSET
INCLUDED

0%
U.S. Treasury securities
Mortgage-backed securities issued by the
Government National
Mortgage Association

20% Municipal general obligation

bonds

50%
Municipal revenue bonds
Residential mortgages

100%
Commercial loans and commercial mortgages
LDC loans
Corporate bonds
 SAVINGS AND LOANS
ASSOCIATIONS (S&Ls)
also known as a thrift institution, is a financial entity
that primarily accepts savings deposits and provides
mortgage and other types of loans.

THE S&L CRISIS

It involved the collapse and failure of a significant
number of savings and loan associations, which were
financial institutions specializing in accepting savings
deposits and providing mortgage and other loans.
 ASSET
is a resource with economic value that an
individual, corporation, or country owns or
controls with the expectation that it will
provide a future benefit.

FUNDING
is the act of providing resources to
finance a need, program, or project.
REGULATION
refers to the rules and oversight imposed on
these financial institutions to ensure their
stability, protect depositors' funds, and
maintain the integrity of the financial system.

SAVINGS BANK
are financial institutions that specialize in
accepting savings deposits and providing
mortgage and other loans
List of Savings Banks in the Philippines:

1. BDO Network Bank

2. Philippine Savings Bank (PSBank)
3. BPI Direct BanKo
4. RCBC Savings Bank
5. Security Bank Savings
6. UnionBank Savings Bank
7. EastWest Rural Bank
8. PNB Savings Bank
9. China Bank Savings
10. Robinsons Bank Savings
CREDIT UNION
is a type of financial institution that
operates as a cooperative, providing
traditional banking services to its
members.
List of Credit Union in the Philippines :

1. Pag-IBIG Fund (Home Development

Mutual Fund)
2. Government Service Insurance System
(GSIS)
3. Land Bank of the Philippines
4. Development Bank of the Philippines
5. Philippine National Bank (PNB)
6. BDO Unibank (BDO)
7. Metrobank
8. UnionBank of the Philippines
9. Security Bank
10. EastWest Bank