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ChapterThirteenManagingNondepositLiabilities
KeyTopicsLiabilityManagementCustomerRelationshipDoctrineAlternativeNondepositFundsSourcesMeasuringtheFundsGapChoosingamongDifferentFundsSourcesDeterminingtheOverallCostofFunds
IntroductionThetraditionalsourceoffundsformostdepositoryinstitutionsisthedepositaccountButwhatdoesmanagementdotofindnewmoneywhendepositvolumeisinadequatetosupportallloansandinvestmentstheseinstitutionswouldliketomake?Inthischapterweexploreyetanotherimportantnondepositsourceoffunding–sellingIOUsinthemoneyandcapitalmarketsforperiodsoftimethatmaystretchfromovernighttoseveralyears
LiabilityManagementandtheCustomerRelationshipDoctrineTheCustomerRelationshipDoctrineThefirstpriorityofalendinginstitutionistomakeloanstoallthosecustomersfromwhomthelenderexpectstoreceivepositivenetearningsThus,lendingdecisionsoftenprecedefundingdecisionsAllloansandinvestmentswhosereturnsexceedtheircostandwhosequalitymeetsthelendinginstitution’screditstandardsshouldbemadeIfenoughdepositsarenotimmediatelyavailabletocovertheseloansandinvestments,thenmanagementshouldseekoutthelowest-costsourceofborrowedfundsavailabletomeetitscustomers’creditneedsDuringthecollapseofthesubprimemortgagemarketinthe2007-2009businessrecession,regulatorsfoundthatmanymortgagelenderswentoverboardinapprovingloans,fallingwellbelownormalindustrystandardswithlittleornodocumentation
LiabilityManagementandtheCustomerRelationshipDoctrine(continued)LiabilityManagementDuringthe1960sand1970s,thecustomerrelationshipdoctrinespawnedtheliquiditymanagementstrategyknownasliabilitymanagementThebankbuysfundsinordertosatisfyloanrequestsandreserverequirementsItisaninterest-sensitiveapproachtoraisingbankfundsItisflexible–ThebankcandecideexactlyhowmuchtheyneedandforhowlongThecontrolmechanismtoregulateincomingfundsisthepriceoffunds
TABLE13–1SampleUseofNondepositFundsSourcestoSupplementDepositsandMakeLoans
AlternativeNondepositSourcesofFundsFederalFundsMarketRepurchaseAgreementsBorrowingfromFederalReserveBanksAdvancesfromtheFederalHomeLoanBankNegotiableCDsEurocurrencyDepositMarketCommercialPaperLong-TermNondepositFundsSourcesTheusageofnondepositsourcesoffundshasrisenLargerinstitutionsrelyonthenondepositfundsmarketasakeysourceofshort-termmoneytomeetloandemandandunexpectedcashemergencies
TABLE13–2RecentGrowthinNondepositSourcesofBorrowedFundsatFDIC-InsuredBanksandThrifts
TABLE13–3TheRelationshipbetweentheSizeofBanksandTheirUseofNondepositBorrowings(2007figuresforFDIC-insuredbanks)
AlternativeNondepositSourcesofFunds(continued)FederalFundsMarketBorrowingfromFederalReserveBanksImmediatelyavailablereservesaretradedbetweenfinancialinstitutionsandusuallyreturnedwithin24hoursDepositswithcorrespondentbanksanddemanddepositbalancesofsecuritydealersandgovernmentscanbeusedforloanstoinstitutionsTypesofFedFundsLoanAgreementsOvernightLoansNegotiatedviawireortelephone,returnedthenextdayNormallynotsecuredbyspecificcollateralTermLoansLongertermFedfundscontracts(severaldays,weeks,ormonths)ContinuingContractsAutomaticallyrenewedeachdayNormallybetweensmallerrespondentinstitutionsandtheirlargercorrespondents
AlternativeNondepositSourcesofFunds(continued)RepurchaseAgreements(RPs)asaSourceofFundsLesspopularthanFedfundsandmorecomplexViewedascollateralizedFedfundstransactionsWithRPs,thepurchaserofFedfundsprovidescollateralintheformofmarketablesecurities,reducingthecreditriskMostdomesticRPsaretransactedacrosstheFedWiresystemAnRPtransactionisoftenforovernightfundsItmaybeextendedfordays,weeks,orevenmonthsMajorinnovationintheRPmarketwastheinventionofGeneralCollateralFinance(GCF)RPs
AlternativeNondepositSourcesofFunds(continued)BorrowingfromFederalReserveBanksTheFedwillmaketheloanthroughitsdiscountwindowbycreditingtheborrowinginstitution’sreserveaccountEachloanmadebytheFederalReservebanksmustbebackedbycollateralacceptabletotheFedSeveraltypesofloansareavailablefromtheFed’sdiscountwindowPrimaryCreditThisloanisavailableforshorttermsandtoinstitutionsinsoundfinancialconditionRateisslightlyhigherthanthefederalfundsrateSecondaryCreditTheseloansareavailableatahigherinterestratetoinstitutionsnotqualifyingforprimarycreditSeasonalCreditTheseloanscoverlongerperiodsthanprimarycreditforsmallandmediuminstitutionsexperiencingseasonalswingsindepositsandloans
AlternativeNondepositSourcesofFunds(continued)AdvancesfromFederalHomeLoanBanksAllowsinstitutions(homemortgagelenders)tousehomemortgagesascollateralforadvancesAwaytoimprovetheliquidityofhomemortgagesandencouragemorelenderstoprovidecreditNumberofloanshasincreaseddramaticallyinrecentyearsMaturitiesrangefromovernighttomorethan20yearsFederalHomeLoanBank(FHLB)Systemhas12regionalbanksHasfederalcharterandcanborrowcheaplyandpasssavingsontoinstitutions
AlternativeNondepositSourcesofFunds(continued)DevelopmentandSaleofLargeNegotiableCDsAninterest-bearingreceiptevidencingthedepositoffundsinthebankforaspecifiedperiodoftimeforaspecifiedinterestrateItisconsideredahybridaccountsinceitislegallyadepositTypesofNegotiableCDsDomesticCDs.EuroCDsYankeeCDsThriftCDsFixed-rateCDsVariable-rateCDs
AlternativeNondepositSourcesofFunds(continued)DevelopmentandSaleofLargeNegotiableCDsInterestratesonfixed-rateCDsarequotedonaninterest-bearingbasisandtherateiscomputedassuminga360-dayyearRepresentthemajorityofalllargenegotiableCDsissuedExampleSupposeadepositoryinstitutionpromisesan8percentannualinterestratetothebuyerofa$100,000six-month(180-day)CDThedepositorwillhavethefollowingattheendofsixmonths
AlternativeNondepositSourcesofFunds(continued)TheEurocurrencyDepositMarketEurocurrencydepositsweredevelopedoriginallyinWesternEuropetoprovideliquidfundsthatcouldbeswappedamongmultinationalbanksorloanedtothebanks’largestcustomersEurodollarsaredollar-denominateddepositsplacedinbankofficesoutsidetheUnitedStatesBecausetheyaredenominatedonthereceivingbanks’booksindollarsratherthaninthecurrencyofthehomecountryandconsistofaccountingentriesintheformoftimedeposits,theyarenotspendableonthestreetlikecurrencyMostEurodollardepositsarefixed-ratetimedepositsFloating-rateCDs(FRCDs)andfloating-ratenotes(FRNs)wereintroducedinanefforttoprotectbanksandtheirEurodepositorsfromtheriskoffluctuatinginterestratesTheEurocurrencymarketisthelargestunregulatedfinancialmarketplaceintheworld
AlternativeNondepositSourcesofFunds(continued)CommercialPaperMarketCommercialpaperconsistsofshort-termnotes,withmaturitiesnormallyrangingfromthreeorfourdaystoninemonths,issuedbywell-knowncompaniestoraiseworkingcapitalIndustrialPaper–purchaseinventoriesFinancePaper–IssuedbyfinancecompaniesandfinancialholdingcompaniesThenotesaregenerallysoldatadiscountfromfacevaluethroughsecuritydealersorthroughdirectcontactwiththeissuingcompanyThisfundssourcetendstobehighinvolumeandmoderateincostbutalsovolatileinavailablecapacityandsubjecttocreditriskRecentlyforeignbankshaveacceleratedtheirminingofbothEuropeanandAmericanpapermarketsdespitethepressuresoftheGreatRecession
AlternativeNondepositSourcesofFunds(continued)Long-TermNondepositFundsSourcesThenondepositsourcesoffundsdiscussedtothispointaremainlyshort-termborrowingsHowever,manyfinancialfirmsalsotaplonger-termnondepositfundsstretchingwellbeyondoneyearExamplesincludemortgagesissuedtofundtheconstructionofbuildingsandcapitalnotesanddebenturesTheselonger-termnondepositfundssourceshaveremainedrelativelymodestovertheyearsduetoregulatoryrestrictionsandtheaugmentedrisksassociatedwithlong-termborrowingAlso,becausemostassetsandliabilitiesheldbydepositoryinstitutionsareshort-tomedium-term,issuinglong-termindebtednesscreatesasignificantmaturitymismatch
ChoosingamongAlternativeNondepositSourcesThedemandfornondepositfundsisdeterminedbasicallybythesizeofthegapbetweentheinstitution’stotalcreditdemandsanditsdepositsandotheravailablemoniesGapisbasedon:CurrentandprojecteddemandandinvestmentsthebankdesirestomakeCurrentandexpecteddepositinflowsandotheravailablefundsSizeofthisgapdeterminestheneedfornondepositfunds
ChoosingamongAlternativeNondepositSources(continued)NondepositFundingSources:FactorstoConsiderTherelativecostsofraisingfundsfromeachsourceTherisk(volatilityanddependability)ofeachfundingsourceThelengthoftime(maturityorterm)forwhichfundsareneededThesizeoftheinstitutionthatrequiresmorefundsRegulationslimitingtheuseofalternativefundssources
ChoosingamongAlternativeNondepositSources(continued)Agoodformulafordoingcostcomparisonsamongalternativesourcesoffunds
QuickQuizWhatisliabilitymanagement?Whatadvantagesandrisksdoesthepursuitofliabilitymanagementbringtoaborrowinginstitution?Whatisthecustomerrelationshipdoctrine,andwhatareitsimplicationsforfund-raisingbylendinginstitutions?WhataretheprincipaladvantagestotheborroweroffundsunderanRPagreement?WhataretheadvantagesofborrowingfromtheFederalReservebanksorothercentralbank?Arethereanydisadvantages?HowisadiscountwindowloanfromtheFederalReservesecured?Iscollateralreallynecessaryforthesekindsofloans?WhywerenegotiableCDsdeveloped?Whatistheavailablefundsgap?Whatfactorsmustthemanagerofafinancialinstitutionweighinchoosingamongthevariousnondepositsourcesoffundingavailabletoday?