William Chittenden edited and updated the PowerPoint slides for this edition.
Funding the Bank and Managing
Liquidity
Chapter 8
Bank Management, 6th edition. Timothy W. Koch and S. Scott MacDonald Copyright © 2006 by South-Western, a division of Thomson Learning
1
The Relationship Between Liquidity
Requirements, Cash, and Funding Sources
The amount of cash that a bank holds
is influenced by the bank’s liquidity
requirements
The size and volatility of cash
requirements affect the liquidity
position of the bank
Deposits, withdrawals, loan
disbursements, and loan payments
affect the bank’s cash balance and
liquidity position 2
Effect of Maturing Certificates of Deposit and Loan Use on a Bank’s Deposit Balances at the Federal Reserve
3
Recent Trends in Bank Funding Sources
Bank customers have become more
rate conscious
Many customers have demonstrated a
a strong preference for shorter-term
deposits
Core deposits are viewed as
increasingly valuable
Bank often issue hybrid CDs to appeal
to rate sensitive depositors
4
Types of Hybrid CDs
Jump Rate (Bump-up) CDs
Customers have the option (right) to request
a change in rate one time prior to maturity.
Indexed CD
CD rates float with some base rate (index)
such that the yield changes as the index
changes
CD Special
CDs with unusual maturities (13 months or
23 months) in which the bank pays an above
market rate. At maturity the CD converts to a
traditional 12 month or 2-year CD. 5
Recent Trends in Bank Funding Sources
Retail Funding
Deposit Accounts
Transaction accounts
Money market deposit accounts
Savings accounts
Small time deposits
Borrowed Funding
Federal Funds purchased
Repurchase agreements
Federal Home Loan Bank borrowings 6
Recent Trends in Bank Funding Sources
Wholesale Funding
Includes borrowed funds plus large
CDs
Equity Funding
Common stock
Preferred stock
Retained earnings
7
Recent Trends in Bank Funding Sources
Volatile Liabilities
Funds purchased from rate-sensitive
investors
Federal Funds purchased
Repurchase agreements
Jumbo CDs
Eurodollar time deposits
Foreign Deposits
Investors will move their funds if other
institutions are paying higher rates 8
Change in Total Deposits, Borrowed Funds, Subordinated Notes, and Total Equity Over Time, 1935–2004
0%
5%
10%
15%
20%
25%
'04'98'92'86'80'74'68'62'56'50'44'38
Bo
rro
we
d F
un
ds
, S
ub
. N
ote
s a
nd
To
tal
Eq
uit
y
50%
60%
70%
80%
90%
100%
To
tal
De
po
sit
s
Borrowed Funds
Total Deposits
Subordinated Notes
Total Equity
Percent of total funding Percent of total funding
9
Change in the Percentage Contribution of Various
Bank Funding Components, 1992–2004
0%
25%
50%
75%
Total d
eposi
ts h
eld in
dom
estic
offic
es
Transa
ctio
n acc
ounts
Nontr
ansa
ctio
n acc
ounts
Money
mar
ket d
eposi
t acc
ounts (M
MDAs)
Oth
er s
avin
gs dep
osits
Time
deposi
ts o
f les
s th
an $
100,
000
Vola
tile
liabili
ties
Time
deposi
ts o
f $10
0,00
0 or
more
Dep
osits
hel
d in fo
reig
n offic
es
Oth
er b
orrow
ed fu
nds
Subord
inat
ed d
ebt
Equity
cap
ital
Perc
en
t o
f T
ota
l F
un
din
g (
To
tal
Assets
)12/31/1992 12/31/1996
12/31/2000 12/31/2004
10
The Percentage Contribution of Various Sources of Bank Funds by Bank Size, 2004
< $100 M $100M - $1B
$1B - $10B
> $10 B All CBs
Number of institutions reporting 3655 3530 360 85 7630
Total deposits 83.68% 80.85% 68.50% 63.47% 66.48%
Deposits held in domestic offices 83.67% 80.67% 67.36% 49.93% 49.93%
Transaction accounts 26.29% 19.76% 10.03% 6.69% 6.69%
Demand deposits 13.90% 11.48% 7.28% 5.42% 5.42%
Nontransaction accounts 57.38% 60.91% 57.33% 43.24% 43.24%
Money market deposit accounts (MMDAs) 10.59% 15.87% 23.47% 23.74% 23.74%
Other savings deposits (excluding MMDAs) 9.19% 11.60% 10.42% 7.20% 7.20%
Time deposits of less than $100,000 24.97% 19.68% 11.53% 5.08% 5.08%
Time deposits of $100,000 or more 12.63% 13.76% 11.91% 7.22% 7.22%
Deposits held in foreign offices 0.01% 0.18% 1.14% 13.55% 13.55%
Federal funds purchased & repurchase agreements 0.91% 2.54% 8.17% 7.50% 6.87%
Trading liabilities 0.00% 0.00% 0.00% 4.45% 3.33%
Other borrowed funds 3.28% 5.73% 10.05% 9.17% 8.75%
FHLB advances 3.10% 5.37% 6.77% 2.01% 2.97%
Memo: Volatile liabilities 14.69% 18.61% 26.57% 34.96% 31.68%
Subordinated debt 0.01% 0.08% 0.40% 1.67% 1.31%
All other liabilities 0.60% 0.79% 1.97% 3.76% 3.15%
Equity capital 11.52% 10.00% 10.90% 9.95% 10.10%
Deposits held in domestic offices 83.67% 80.67% 67.36% 49.93% 49.93%
Noninterest-bearing deposits 14.09% 13.55% 11.89% 11.72% 11.72%
Interest-bearing deposits 69.58% 67.12% 55.47% 38.21% 38.21%
Core (retail) deposits 71.04% 66.92% 55.45% 42.71% 42.71%
IRAs and Keogh plan accounts 4.17% 3.63% 2.63% 1.61% 1.61%
Brokered deposits 1.45% 2.86% 4.35% 4.58% 4.58%
Fully insured 1.25% 2.61% 3.52% 2.34% 2.34%
Estimated insured deposits 67.31% 58.43% 41.51% 28.24% 28.24%
11
Average Annual Interest Cost of
Liabilities by Bank Size, 2004
<$100M $100M–
$1B $1B–$10B >$10B All CB
Total interest expense on total liabilities 1.55% 1.56% 1.44% 1.36% 1.34% Interest expense on deposits 1.49% 1.43% 1.22% 1.16% 1.17%
Domestic deposits 1.49% 1.43% 1.22% 1.02% 1.09% MMDAs and savings deposits 0.54% 0.45% 0.35% 0.34% 0.34% Time deposits <$100K 2.36% 2.42% 2.21% 2.21% 2.19% Time deposits >$100K 2.47% 2.59% 2.47% 2.51% 2.45%
Deposits foreign offices 0.57% 1.22% 1.50% 1.67% 1.62% Fed funds purchased 2.55% 3.83% 4.20% 4.96% 4.54% U.S. notes & other borrowed funds 3.60% 3.44% 2.88% 3.01% 2.73% Subordinated notes & deb. 3.91% 4.69% 4.25% 4.80% 4.49%
Source: BankSearch, Highline Data, © Highline Data, LLC.
12
Characteristics of Retail-Type Deposits
Retail Deposits
Small denomination (under $100,000)
liabilities
Normally held by individual investors
Not actively traded in the secondary
market
13
Transaction Accounts
Most banks offer three different
transaction accounts
Demand Deposits
DDAs
Negotiable Order of Withdrawal
NOWs
Automatic Transfers from Savings
ATS
14
Transaction Accounts
Demand Deposits
Checking accounts that do not pay
interest
Held by individuals, business, and
governmental units
Most are held by businesses since
Regulation Q prohibits banks from
paying explicit interest on for-profit
corporate checking accounts
15
Transaction Accounts
NOW Accounts
Checking accounts that pay interest
ATS Accounts
Customer has both a DDA and savings
account
The bank transfers enough from
savings to DDA each day to force a
zero balance in the DDA account
For-profit corporations are prohibited
from owning NOW and ATS accounts 16
Transaction Accounts
Although the interest cost of
transaction accounts is very low, the
non-interest costs can be quite high
Generally, low balance checking
accounts are not profitable for banks
due to the high cost of processing
checks
17
Non-Transaction Accounts
Non-transaction accounts are interest-
bearing with limited or no check-
writing privileges
Money Market Deposit Accounts
Pay interest but holders are limited to 6
transactions per month, of which only
three can be checks
Attractive to banks because they are
not required to hold reserves against
MMDAs 18
Non-Transaction Accounts
Savings Accounts
Have no fixed maturity
Small Time Deposits (Retail CDs)
Have a specified maturity ranging from
7 days on up
Large Time Deposits (Jumbo CDs)
Negotiable CDs of $100,000 or more
Typically can be traded in the
secondary market
19
Estimating the Cost of Deposit Accounts
Interest Costs
Legal Reserve Requirements
Check Processing Costs
Account Charges
NSF fees
Monthly fees
Per check fees
20
Estimating the Cost of Deposit Accounts
Transaction Account Cost Analysis
Classifies check-processing as:
Deposits
Electronic
Non-Electronic
Withdrawals
Electronic
Non-Electronic
21
Estimating the Cost of Deposit Accounts
Transaction Account Cost Analysis
Classifies check-processing as:
Transit Checks
Deposited
Cashed
Account Opened or Closed
On-Us checks cashed
General account maintenance
Truncated
Non-Truncated 22
Estimating the Cost of Deposit Accounts
Transaction Account Cost Analysis
Electronic Transactions
Conducted through automatic deposits,
Internet, and telephone bill payment
Non-Electronic Transactions
Conducted in person or by mail
Transit Checks
Checks drawn on any bank other than
the bank it was deposited into
23
Estimating the Cost of Deposit Accounts
Transaction Account Cost Analysis
On-Us Checks Cashed
Checks drawn on the bank’s own customer’s accounts
Deposits
Checks or currency directly deposited in the customer's account
Account Maintenance
General record maintenance and preparing & mailing a periodic statement
24
Estimating the Cost of Deposit Accounts
Transaction Account Cost Analysis
Truncated Account
A checking account in which the physical check is ‘truncated’ at the bank and the checks are not returned to the customer
Official Check Issued
A check for certified funds.
Net Indirect Costs
Those costs not directly related to the product such as management salaries or general overhead costs 25
Cost and Revenue Accounting Data for
Deposit Accounts at FirstBank Unit Cost
Demand Savings Time
Income Interest income (estimated earnings credit) 2.6% 2.5% 3.0% Noninterest income (monthly estimates per account) Service charges $ 2.80 $ 0.44 $ 0.11 Penalty fees $ 4.32 $ 0.28 $ 0.27 Other $ 0.63 $ 0.16 $ 0.05
Total noninterestiIncome $ 7.75 $ 0.88 $ 0.42
Expenses Activity charges (unit costs per transaction) Deposit—electronic $ 0.0089 $ 0.0502 $ 0.1650 Deposit—nonelectronic $ 0.2219 $ 0.7777 $ 3.1425 Withdrawal—electronic $ 0.1073 $ 0.4284 $ 0.5400 Withdrawal—nonelectronic $ 0.2188 $ 0.7777 $ 1.4933 Transit check deposited $ 0.1600 $ 0.5686 Transit check cashed $ 0.2562 On-us check cashed $ 0.2412 Official check issued $ 1.02 Monthly overhead expense costs Monthly account maintenance (truncated) $ 2.42 $ 4.10 $ 1.99 Monthly account maintenance (nontruncated) $ 8.60 Net indirect expense $ 4.35 $ 1.81 $ 18.38 Miscellaneous expenses Account opened $ 9.46 $ 33.63 $ 5.78 Account closed $ 5.67 $ 20.18 $ 3.38
26
Calculating the Average Net Cost of Deposit
Accounts
Average Historical Cost of Funds
Measure of average unit borrowing
costs for existing funds
Average Interest Cost
Calculated by dividing total interest
expense by the average dollar amount
of liabilities outstanding
Ratio) Reserve Required - (1 x Float of Net Balance Average
Income tNoninteres - Expense tNoninteres Expense Interest
sLiabilitie Bank of Cost Net Average
27
Calculating the Average Net Cost of Deposit
Accounts
Example:
A demand deposit account that does
not pay interest has $20.69 in
transaction costs charges, $7.75 in
fees, an average balance of $5,515, and
5% float would have a net cost of
3.29%
3.29%12.10) - (1 .05) - (1 $5,515
$7.75 - $20.69 $0
Deposit Demand of Cost Net Average
28
Calc
ula
tin
g t
he
Aver
age
Net
Cost
of
Dep
osi
t A
ccou
nts
Low Balance, Low Activity, Truncated
Medium Balance, High Activity, Nontruncated High Balance
Activity
Monthly Income /
Expenses Activity
Monthly Income /
Expenses Activity
Monthly Income /
Expenses Income
Interest income $ 500 $ 0.93 $ 4,589 $ 8.50 $11,500 $ 21.30 on average monthly balance (after float)
Noninterest income (average montly estimates)
Service charges $ 2.80 $ 2.80 $ 2.80 Penalty fees (estimated for account) $ 8.56 $ 6.32 $ 2.01 Other $ 0.63 $ 0.63 $ 0.63 Total noninterest income $ 11.99 $ 9.75 $ 5.44
Total revenue $ 12.92 $ 18.25 $ 26.74 Expenses
Activity charges Deposit—electronic 1 $ 0.01 2 $ 0.02 2 $ 0.02 Deposit—nonelectronic 1 $ 0.22 3 $ 0.67 3 $ 0.67 Withdrawal—electronic 15 $ 1.61 12 $ 1.29 10 $ 1.07 Withdrawal—nonelectronic 3 $ 0.66 14 $ 3.06 8 $ 1.75 Transit check deposited 1 $ 0.16 2 $ 0.32 2 $ 0.32 Transit check cashed 1 $ 0.26 2 $ 0.51 2 $ 0.51 On-us checks cashed 2 $ 0.48 3 $ 0.72 3 $ 0.72 Official check issued $ - $ - $ -
Total activity expense $ 3.40 $ 6.59 $ 5.06
Monthly expenses Monthly account maintenance (truncated) 1 $ 2.42 $ - $ - Monthly account maintenance (nontruncated) - $ - 1 $ 6.60 1 $ 6.60 Net indirect expense $ 4.35 $ 4.35 $ 4.35
Total reoccurring monthly expenses $ 6.77 $ 10.95 $ 10.95
Interest expense $ - $ - $ - Total expense $ 10.17 $ 17.54 $ 16.01
Net revenue per month $ 2.75 $ 0.71 $ 10.73 Average percentage cost (net of service charges and fees) -5.12% 2.38% 1.29%
Average interest cost 0.00% 0.00% 0.00% Average noninterest cost 28.53% 5.36% 1.95% Average noninterest income 33.66% 2.98% 0.66%
Average account balance $ 500 $ 4,589 $ 11,500 Required reserves 10% 10% 10% Float 5% 5% 5%
29
Characteristics of Large Wholesale Liabilities
Wholesale Liabilities
Customers move these investments on
the basis of small rate differentials, so
these funds are labeled:
Hot Money
Volatile Liabilities
Short-Term Non-Core funding
30
Characteristics of Large Wholesale Liabilities
Wholesale Liabilities
Includes:
Jumbo CDs
Federal Funds Purchased
Repurchase Agreements
Eurodollar Time Deposits
Foreign Deposits
31
Characteristics of Large Wholesale Liabilities
Jumbo CDs
$100,000 or more
Negotiable
Can be traded on the secondary market
Minimum maturity of 7 days
Interest rates quoted on a 360-day year basis
Insured up to $100,000 per investor per institution
Issued directly or indirectly through a dealer or broker (Brokered Deposits) 32
Characteristics of Large Wholesale Liabilities
Jumbo CDs
Fixed-Rate
Variable-Rate
Jump Rate (Bump-up) CD Depositor has a one-time option until
maturity to change the rate to the prevailing market rate
Callable
Zero Coupon
Stock Market Indexed
Rate tied to stock market index performance
33
Characteristics of Large Wholesale Liabilities
Individual Retirement Accounts
Each year, a wage earner can make a
tax-deferred investment up to $3,000 of
earned income
Funds withdrawn before age 59 ½ are
subject to a 10% IRS penalty
This makes IRAs an attractive source of
long-term funding for banks
34
Characteristics of Large Wholesale Liabilities
Foreign Office Deposits
Eurocurrency
Financial claim denominated in a
currency other than that of the country
where the issuing bank is located
Eurodollar
Dollar-denominated financial claim at a
bank outside the U.S.
35
The Origin and Expansion of Eurodollar Deposits
36
Characteristics of Large Wholesale Liabilities
Federal Funds Purchased
The term Fed Funds is often used to refer to
excess reserve balances traded between
banks
This is grossly inaccurate, given reserves
averaging as a method of computing reserves,
different non-bank players in the market, and
the motivation behind many trades
Most transactions are overnight loans,
although maturities are negotiated and can
extend up to several weeks
Interest rates are negotiated between trading
partners and are quoted on a 360-day basis 37
Characteristics of Large Wholesale Liabilities
Repurchase Agreements (RPs or
Repos)
Short-term loans secured by
government securities that are settled
in immediately available funds
Identical to Fed Funds except they are
collateralized
Technically, the RPs entail the sale of
securities with a simultaneous
agreement to buy them back later at a
fixed price plus accrued interest 38
Characteristics of Large Wholesale Liabilities
Repurchase Agreements (RPs or
Repos)
Most transactions are overnight
In most cases, the market value of the
collateral is set above the loan amount
when the contract is negotiated.
This difference is labeled the margin
The lender’s transaction is referred to
as a Reverse Repo
39
Characteristics of Large Wholesale Liabilities
Borrowing from the Federal Reserve
Discount Window
Discount Rate
Policy is to set discount rate 1% (1.5%) over the
Fed Funds target for primary (secondary) credit
loans
To borrow from the Federal Reserve, banks
must apply and provide acceptable collateral
before the loan is granted
Eligible collateral includes U.S. government securities,
bankers acceptances, and qualifying short-term
commercial or government paper
40
Characteristics of Large Wholesale Liabilities
Borrowing from the Federal Reserve
Primary Credit
Available to generally sound depository
institutions on a very short-term basis,
typically overnight
It serves as a backup source of short-
term funds for sound depository
institutions
Secondary Credit
Available to depository institutions that
are not eligible for primary credit 41
Characteristics of Large Wholesale Liabilities
Borrowing from the Federal Reserve
Seasonal Credit
Designed to assist small depository institutions in managing significant seasonal swings in their loans and deposits
Emergency Credit
May be authorized in unusual and exigent circumstances by the Board of Governors to individuals, partnerships, and corporations that are not depository institutions
42
Characteristics of Large Wholesale Liabilities
Federal Home Loan Bank Advances
The FHLB system is a government-sponsored enterprise created to assist in home buying
The FHLB system is one of the largest U.S. financial institutions, rated AAA because of the government sponsorship
Any bank can become a member of the FHLB system by buying FHLB stock
If it has the available collateral, primarily real estate related loans, it can borrow from the FHLB
FHLB advances have maturities from 1 day to as long as 20 years
43
Commercial Banks with FHLB Advances,
1991–2004
Commercial Banks with FHLB Advances
$50
$100
$150
$200
$250
$300
$350
$400
$450
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Bil
lio
ns o
f D
oll
ars
of
FH
LB
Ad
van
ces
100
1,100
2,100
3,100
4,100
5,100
Nu
mb
er
of
Ban
ks w
ith
FH
LB
Ad
van
ces
Amount Outstanding (Billions)Number of Banks
44
Electronic Money
Intelligent Card
Contains a microchip with the ability to store and secure information
Memory Card
Simply store information
Debit Card
Online
PIN based
Transaction goes through the ATM system
Offline
Signature based transactions
Transaction goes through the credit card system
45
Distribution of the Number of Noncash
Payments in 2000 and 2003
Check, 57.79%Credit Card,
21.52%
ACH, 8.55%
Offline Debit,
7.31%
Online Debit,
4.14%EBT, 0.69%
Check, 45.20%
Credit Card,
23.40%
ACH, 11.21%
Offline Debit,
12.68%
Online Debit,
6.53%
EBT, 0.99%
2000 2003
Source: The 2004 Federal Reserve Payments Study, http://www.frbservices.org/Retail/pdf/2004PaymentResearchReport.pdf.
Note: Online debit payments are PIN-based, which includes purchases at the point of sale with ATM cards, and offline debit
payments, which are signature-based transactions. EBTs are electronic benefits transfers. Data does not include Fedwire or CHIPS
wire transfers.
46
Check 21
Check Clearing for the 21st Century Act
Facilitates check truncation by
reducing some of the legal
impediments
Foster innovation in the payments and
check collection system without
mandating receipt of check in
electronic form
Improve the overall efficiency of the
nation’s payment system 47
Check 21
Check Truncation
Conversion of a paper check into an
electronic debit or image of the check
by a third party in the payment system
other than the paying bank
Facilitates check truncation by
creating a new negotiable instrument
called a substitute check
48
Check 21
Substitute Check
The legal equivalent of the original check and includes all the information contained on the original
Check 21 does NOT require banks to accept checks in electronic form nor does it require banks to create substitute checks
It does allow banks to handle checks electronically instead of physically moving paper checks
49
Substitute Check Authorized by Check 21
50
The Check Clearing Process
51
Check Clearing Process
Banks typically place a hold on a check until it verifies that the check is “good”
Expedited Funds Availability Act
Under Reg CC, it states that:
Local check must clear in no more than two business days
Non-local checks must clear in no more than five business days
Government, certified, and cashiers checks must be available by 9 a.m. the next business day 52
Measuring the Cost of Funds
Average Historical Cost of Funds
Many banks incorrectly use the average historical costs in their pricing decisions
The primary problem with historical costs is that they provide no information as to whether future interest costs will rise or fall.
Pricing decisions should be based on marginal costs compared with marginal revenues
53
Measuring the Cost of Funds
Marginal Cost of Funds
Marginal Cost of Debt
Measure of the borrowing cost paid to
acquire one additional unit of
investable funds
Marginal Cost of Equity
Measure of the minimum acceptable
rate of return required by shareholders
Marginal Cost of Funds
The marginal costs of debt and equity 54
Measuring the Cost of Funds
Costs of Independent Sources of Funds
It is difficult to measure marginal costs
precisely
Management must include both the interest
and noninterest costs it expects to pay and
identify which portion of the acquired funds
can be invested in earning assets.
Marginal costs may be defined as :
j Liability of Balance Investable Net
Insurance Costs Acquistion Costs Servicing Rate Interest
j Liability of Cost Marginal
55
Measuring the Cost of Funds
Costs of Independent Sources of
Funds
All elements in the numerator are
expected costs
56
Measuring the Cost of Funds
Costs of Independent Sources of Funds
Example:
Market interest rate is 2.5%
Servicing costs are 4.1% of balances
Acquisition costs are 1.0% of balances
Deposit insurance costs are 0.25% of
balances
Net investable balance is 85% of the balance
(10% required reserves and 5% float)
9.24% 0.09240.85
0.00250.010.0410.025Cost Marginal
57
Measuring the Cost of Funds
Cost of Debt
Equals the effective cost of borrowing
from each source, including interest
expense and transactions costs
This cost is the discount rate, which
equates the present value of expected
interest and principal payments with
the net proceeds to the bank from the
issue
58
Measuring the Cost of Funds
Cost of Debt
Example:
Assume the bank will issue:
$10 million in par value subordinated notes
paying $700,000 in annual interest and a 7-
year maturity.
It must pay $100,000 in flotation costs to an
underwriter.
The effective cost of borrowing (kd) is 7.19%:
7.19% k Thus
)k(1
0$10,000,00
)k(1
$700,000$9,900,000
d
7
d
7
1tt
d
59
Measuring the Cost of Funds
Cost of Equity
The marginal cost of equity equals the
required return to shareholders
It is not directly measurable because
dividend payments are not mandatory.
Several methods are commonly used to
approximate this required return:
Dividend Valuation Model
Capital Asset Pricing Model (CAPM)
Target Return on Equity Model
Cost of Debt + Risk Premium 60
Measuring the Cost of Funds
Preferred Stock
Preferred stock acts as a hybrid of debt and common equity
Claims are superior to those of common stockholders but subordinated to those of debt holders
Preferred stock pays dividends that may be deferred when management determines that earnings are too low.
The marginal cost of preferred stock can be approximated in the same manner as the Dividend Valuation Model however, dividend growth is zero
61
Measuring the Cost of Funds
Trust Preferred Stock
Trust preferred stock is attractive because it effectively pays dividends that are tax deductible
To issue the securities, a bank or bank holding company establishes a trust company.
The trust company sells preferred stock to investors and loans the proceeds of the issue to the bank
Interest on the loan equals dividends paid on the preferred stock
This loan interest is tax deductible such that the bank effectively gets to deduct dividend payments as the preferred stock
62
Measuring the Cost of Funds
Weighted Marginal Cost of Total Funds
This is the best cost measure for
asset-pricing purposes
It recognizes both explicit and implicit
costs associated with any single
source of funds
It assumes that all assets are financed
from a pool of funds and that specific
sources of funds are not tied directly
to specific uses of funds 63
Measuring the Cost of Funds
Weighted Marginal Cost of Total Funds
Steps to compute WMC
1. Forecast the desired dollar amount of financing to be obtained from each individual debt and equity source
2. Estimate the marginal cost of each independent source of funds
3. Combine the individual estimates to project the weighted costs, which equals the sum of the weighted component costs across all sources
64
Measuring the Cost of Funds
Weighted Marginal Cost of Total
Funds
Steps to compute WMC
4. Management should combine the
individual estimates to project the
weighted cost, where wj equals each
source’s weight and kj equals the
single-source j component cost of
financing such that:
m
1j
jjkwWMC65
Measuring the Cost of Funds
Example
Liabilities and Equity
(a) Average Amount
(b) Percent of Total
(c) Interest
Cost
(d) Processing
and Acquisition
Costs
(e) Nonearning Percentage
(f) Component
Marginal Costs
(g) Weighted Marginal Cost of Funds (b) x (f)
Demand deposits $ 28,210 31.0% 8.0% 18.0% 9.76% 0.0302
Interest checking $ 5,551 6.1% 2.5% 6.5% 15.0% 10.59% 0.0065
Money market demand accounts $ 13,832 15.2% 3.5% 3.0% 3.0% 6.70% 0.0102
Other savings accounts $ 3,640 4.0% 4.5% 1.2% 1.5% 5.79% 0.0023
Time deposits < $100,000 $ 18,382 20.2% 4.9% 1.4% 1.0% 6.36% 0.0129
Time deposits > $100,000 $ 9,055 10.0% 5.0% 0.3% 0.5% 5.34% 0.0053
Total deposits $ 78,670 86.5%
Federal funds purchased $ 182 0.2% 5.0% 0.0% 0.0% 5.00% 0.0001
Other liabilities $ 4,550 5.0% 0.0% 40.0% 0.00%
Total liabilities $ 83,402 91.7%
Stockholders' equity $ 7,599 8.4% 18.9%* 4.0% 19.69% 0.0164
Total liabilities and equity $ 91,001 100.0%
Weighted marginal cost of capital ———————————————————————————-> 8.39%
66
Funding Sources and Banking Risks
Banks face two fundamental
problems in managing liabilities.
Uncertainty over:
What rates they must pay to retain and
attract funds
The likelihood that customers will
withdraw their money regardless of
rates
67
Funding Sources: Liquidity Risk
The liquidity risk associated with a
bank’s deposit base is a function of:
The competitive environment
Number of depositors
Average size of accounts
Location of the depositor
Specific maturity and rate
characteristics of each account
68
Funding Sources: Liquidity Risk
Interest Elasticity
How much can market interest rates change
before the bank experiences deposit
outflows?
If a bank raises its rates, how many new
funds will it attract?
Depositors often compare rates and move
their funds between investment vehicles to
earn the highest yields
It is important to note the liquidity advantage
that stable core deposits provide a bank
69
Funding Sources: Interest Rate Risk
Today, many depositors and investors
prefer short-term instruments that can
be rolled over quickly as interest rates
change
Banks must offer a substantial
premium to induce depositors to
lengthen maturities
Those banks that choose not to pay
this premium will typically have a
negative one-year GAP 70
Funding Sources: Interest Rate Risk
One strategy is to compete for
aggressively compete for retail core
deposits
Individual are not as rate sensitive as
corporate depositors and will often
maintain their balances through rate
cycles as long as the bank provides
good service
71
Funding Sources: Credit and Capital Risk
Changes in the composition and cost of bank funds can indirectly affect a bank’s credit risk by forcing it to reduce asset quality
For example, banks that substitute purchased funds for lost demand deposits will often see their cost of funds rise
Rather than let their interest margins deteriorate, many banks make riskier loans at higher promised yields
While they might maintain their margins in the near-term, later loan losses typically rise with the decline in asset quality
72
Holding Liquid Assets
Banks hold cash assets to satisfy
four objectives:
1. To meet customers’ regular
transaction needs
2. To meet legal reserve requirements
3. To assist in the check-payment
system
4. To purchase correspondent banking
services
73
Holding Liquid Assets
Banks own four types of liquid assets
Vault Cash
Demand Deposit Balances at the
Federal Reserve
Demand Deposit Balances at private
financial institutions
Cash Items in Process of Collection
(CIPC)
74
Holding Liquid Assets
“Cash Assets”
Do not earn any interest
Represents a substantial opportunity cost for
banks
Banks attempt to minimize the amount of cash
assets held and hold only those required by
law or for operational needs
Liquid Assets
Can be easily and quickly converted into
cash with minimum loss
75
Holding Liquid Assets
“Cash Assets” do not generally satisfy
a bank’s liquidity needs
If the bank holds the minimum amount
of cash assets required, an unforeseen
drain on vault cash (perhaps from an
unexpected withdrawal) will cause the
level of cash to fall below the
minimum for legal and operational
requirements
76
Holding Liquid Assets
Assets That Provide Bank Liquidity
Cash and due from banks in excess of
requirements
Federal funds sold
Reverse repurchase agreements
Short-term Treasury and agency
obligations
High-quality, short-term corporate and
municipal securities
77
Holding Liquid Assets
For a financial institution that regularly borrows in the financial markets, liquidity takes on the added dimension of the ability to borrow funds at minimum cost or even the ability to issue stock.
It explicitly recognizes that such firms can access cash by:
Selling assets
New borrowings
New stock issues
Bank Liquidity
Refers to a bank’s capacity to acquire immediately available funds at a reasonable price
78
Objectives of Cash Management
Banks must balance the desire to hold
a minimum amount of cash assets
while meeting the cash needs of its
customers
The fundamental goal is to accurately
forecast cash needs and arrange for
readily available sources of cash at
minimal cost
79
Reserve Balances at the Federal Reserve Bank
Banks hold deposits at the Federal
Reserve because:
The Federal Reserve imposes legal
reserve requirements and deposit
balances qualify as legal reserves
To help process deposit inflows and
outflows caused by check clearings,
maturing time deposits and securities,
wire transfers, and other transactions
80
Reserve Balances at the Federal Reserve Bank
Required Reserves and Monetary Policy
The purpose of required reserves is to
enable the Federal Reserve to control
the nation’s money supply
The Fed has three distinct monetary
policy tools:
Open market operations
Changes in the discount rate
Changes in the required reserve ratio
81
Reserve Balances at the Federal Reserve Bank
Required Reserves and Monetary Policy
Changes in reserve requirements
directly affect the amount of legal
required reserves and thus change the
amount of money a bank can lend out
82
Reserve Balances at the Federal Reserve Bank
Required Reserves and Monetary Policy
For example, a required reserve ratio of 10% means that a bank with $100 in demand deposits outstanding must hold $10 in legal required reserves in support of the DDAs
The bank can thus lend out only 90% of its DDAs
If the bank has exactly $10 in legal reserves, the reserves do not provide the bank with liquidity
If the bank has $12 in legal reserves, $2 is excess reserves, providing the bank with $2 in immediately available funds
83
Reserve Balances at the Federal Reserve Bank
Impact of Sweep Accounts on Required Reserve Balances
Under Reg. D, banks have reserve requirements of 10% on demand deposits, ATS, NOW, and other checkable deposit (OCD) accounts
MMDAs are considered personal saving deposits and have a zero required reserve requirement ratio.
Sweep accounts are accounts that enable depository institutions to shift funds from OCDs, which are reservable, to MMDAs or other accounts, which are not reservable
84
Growth of Sweep Transaction Deposits into
MMDAs: 1994–2004
0
100
200
300
400
500
600
700
Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04
Monthly Averages of Initial Amounts Cumulative Total
Bil
lio
ns
of
Do
lla
rs
.
85
Reserve Balances at the Federal Reserve Bank
Sweep Accounts
Two Types
Weekend Program
Reclassifies transaction deposits as
savings deposits at the close of business
on Friday and back to transaction
accounts at the open on Monday
On average, this means that for three days
each week, the bank does not need to hold
reserves against those balances
86
Reserve Balances at the Federal Reserve Bank
Sweep Accounts
Two Types
Threshold Account
The bank’s computer moves the customer’s
DDA balance into an MMDA when the dollar
amount reaches some minimum and returns
funds as needed
The number of transfers is limited to 6 per
month, so the full amount of funds must be
moved back into the DDA on the sixth
transfer of the month
87
Meeting Legal Reserve Requirements
Required reserves can be met over a
two-week period
There are three elements of required
reserves:
The dollar magnitude of base liabilities
The required reserve fraction
The dollar magnitude of qualifying
cash assets
88
Meeting Legal Reserve Requirements
Type of Deposit Percentage
Effective Date
of Applicable
Percentages
Net transactions Accounts
Exempt amt. $ 7.00 mill 0.00% 12/23/2004
Up to $ 47.60 mill 3.00% 12/23/2004
Over $ 47.60 mill 10.00% 12/23/2004
All other liabilities 0.00% 12/27/1990
89
Meeting Legal Reserve Requirements
Historical Problems with Reserve Requirements
Historically, reserve requirements varied with the type of bank charter and each bank’s geographic location
Currently, banks use a lagged reserve account (LRA) system
Reserves are held for a two-week period against deposit liabilities held for the two-week period ending almost three weeks earlier
90
Meeting Legal Reserve Requirements
Lagged Reserve Accounting
Computation Period
Consists of two one-week reporting
periods beginning on a Tuesday and
ending on the second Monday
thereafter
Maintenance Period
Consists of 14 consecutive days
beginning on a Thursday and ending
on the second Wednesday thereafter 91
Meeting Legal Reserve Requirements
Lagged Reserve Accounting
Reserve Balance Requirements
The balance to be maintained in any
given maintenance period is measured
by:
Reserve requirements on the
reservable liabilities calculated as of
the computation period that ended 17
days prior to the start of the
maintenance period
Less vault cash as of the same
computation period 92
Meeting Legal Reserve Requirements
Lagged Reserve Accounting
Reserve Balance Requirements
Both vault cash and Federal Reserve
Deposits qualify as reserves
The portion that is not met by vault
cash is called the reserve balance
requirement
93
Reserve Requirement Percentages for
Depository Institutions
Type of Deposit Percentage
Effective Date of Applicable Percentages
Net transactions accounts
Exempt amt. $ 7.0 mill 0.0% 12/23/2004
Up to $ 47.6 mill 3.0% 12/23/2004
Over $ 47.6 mill 10.0% 12/23/2004
All other liabilities 0.0% 12/27/1990
94
Relationship between the Reserve Maintenance and Base Computation Periods under Lagged Reserve Accounting
Sun Mon Tue Wed Thu Fri Sat
8-Aug 9-Aug 10-Aug 11-Aug 12-Aug 13-Aug 14-Aug
15-Aug 16-Aug 17-Aug 18-Aug 19-Aug 20-Aug 21-Aug
22-Aug 23-Aug 24-Aug 25-Aug 26-Aug 27-Aug 28-Aug
29-Aug 30-Aug 31-Aug 1-Sep 2-Sep 3-Sep 4-Sep
5-Sep 6-Sep 7-Sep 8-Sep 9-Sep 10-Sep 11-Sep
12-Sep 13-Sep 14-Sep 15-Sep 16-Sep 17-Sep 18-Sep
19-Sep 20-Sep 21-Sep 22-Sep 23-Sep 24-Sep 25-Sep
Lagged reserve computation period and vault cash application period
Reserve maintenance period
95
Report of Reversible Liabilities and
Offsetting Asset Balances
Balances at Close of Business Day (millions of dollars)
Lagged Computation Tue Wed Thu Fri Sat Sun Mon Tue Wed Thu Fri Sat Sun Mon
Period 10-Aug 11-Aug 12-Aug 13-Aug 14-Aug 15-Aug 16-Aug 17-Aug 18-Aug 19-Aug 20-Aug 21-Aug 22-Aug 23-Aug
Two- Week Total
Daily Average
DDAs 992 995 956 954 954 954 989 996 960 959 958 958 958 990 $ 13,573 $ 969.50
Auto trans from savings 0 0 0 0 0 0 0 0 0 0 0 0 0 0 $ 0.0 $ 0.0
NOW and Super NOW 221 221 222 223 223 223 223 224 225 225 225 225 225 225 $ 3,130 $ 223.57
Deductions: $ 0.0 $ 0.0
DD bal from U.S. dep. 163 281 190 186 186 186 159 159 274 178 182 182 182 164 $ 2,672 $ 190.86
CIPC 96 96 78 78 78 78 95 98 92 79 81 81 81 88 $ 1,199 $ 85.64
Net trans. accounts 954 839 910 913 913 913 958 963 819 927 920 920 920 963 $ 12,832 $ 916.57
Vault Cash 28 30 31 33 33 33 38 30 31 32 32 32 32 36 $ 451 $ 32.21
96
Required Reserves Report, August 10–23
Reservable Liabilities for
Daily Avg. Deposit
Liab. ($mill) Reserve
Percentage
Daily Avg. Requirement
($ mill)
Aug 10–23
Net trans. accounts
Exempt up to $ 7.0 mill 7.00 0.0% $0.000
Over 7 up to $ 47.6 mill $ 40.60 3.0% $1.218
Over $ 47.6 mill $ 868.97 10.0% $86.897
Total $ 916.57
Gross reserve requirement $88.115
Daily average vault cash $32.214
Net reserve requirement $55.901
Reserve carry-forward (from prior period) ($ 2.276)
Minimum reserves to be maintained with Federal Reserve $58.177
Maximum reserves to be maintained $61.702
(0.04 x 88.115) + 58.177
If a surplus carry forward of $ 1.500
Minimum reserves to be maintained with Federal Reserve $54.401
Carry forward (4% of gross reserve requirement) $3.525
Maximum reserves to be maintained $57.926
(0.04 x 88.115) + 54.401
97
Correspondent Banking Services
System of interbank relationships in
which the correspondent bank
(upstream correspondent) sells
services to the respondent bank
(downstream correspondent)
98
Correspondent Banking Services
Common Correspondent Banking Services
Check collection, wire transfer, coin and
currency supply
Loan participation assistance
Data processing services
Portfolio analysis and investment advice
Federal funds trading
Securities safekeeping
Arrangement of purchase or sale of securities
Investment banking services
International financial transactions 99
Liquidity Planning
Short-Term Liquidity Planning
Objective is to manage a legal reserve
position that meets the minimum
requirement at the lowest cost
100
Short-Term Liquidity Planning
Below are some of the factors that
affect the bank’s legal reserve position
Factors Increasing Reserves Factors Decreasing Reserves
Nondiscretionary
Yesterday's immediate cash letter
Deferred availability items
Excess from local clearinghouse
Deposits from U.S. Treasury
Nondiscretionary
Remittances charged
Deficit in local clearinghouse
Treasury tax and loan account calls
Maturing certificates of deposit, Eurodollars
not rolled over
Discretionary
Currency/coin shipped to Federal Reserve
Security sales
Borrowing from Federal Reserve
Federal funds purchased
Securities sold under agreement to repurchase
Interest payments on securities
New certificates of deposit, Eurodollar issues
Discretionary
Currency and coin received from Federal
Reserve
Security purchases
Payment on loans from Federal Reserve
Federal funds sold
Securities purchased under agreement to resell
101
Managing Float
During any single day, more than $100 million in checks drawn on U.S. commercial banks is waiting to be processed
Individuals, businesses, and governments deposit the checks but cannot use the proceeds until banks give their approval, typically in several days.
Checks in process of collection, called float, are a source of both income and expense to banks.
102
The Payments System
Payments between banks can be made either by check or electronically
Checks drawn against transactions accounts are presented to the customer’s bank for payment and ultimately “cleared” by reducing the bank’s deposit balance at the Federal Reserve or a correspondent bank
Payments made electronically directly and immediately alter balances held at Federal Reserve Banks
103
The Payments System
Example of the Check Clearing Process
104
The Payments System
Electronic Funds Transfer Networks
Fedwire
Operated by the Federal Reserve
Clearinghouse Interbank Payments
System (CHIPS)
Operated by New York Clearing House
Typically handles Eurodollar transfers
or foreign exchange trading
105
Liquidity versus Profitability
There is a short-run trade-off between
liquidity and profitability
The more liquid a bank is, the lower are
its return on equity and return on
assets, all other things equal
In a bank’s loan portfolio, the highest
yielding loans are typically the least
liquid
The most liquid loans are typically
government-guaranteed loans 106
The Relationship Between Liquidity, Credit,
and Interest Rate Risk
Liquidity risk for a poorly managed bank closely follows credit and interest rate risk
Banks that experience large deposit outflows can often trace the source to either credit problems or earnings declines from interest rate gambles that backfired
Potential liquidity needs must reflect estimates of new loan demand and potential deposit losses
107
The Relationship Between Liquidity, Credit,
and Interest Rate Risk
New Loan Demand
Unused commercial credit lines
outstanding
Consumer credit available on bank-
issued cards
Business activity and growth in the
bank’s trade area
The aggressiveness of the bank’s loan
officer call programs
108
The Relationship Between Liquidity, Credit,
and Interest Rate Risk
Potential deposit losses are affected by:
The composition of liabilities
Insured versus uninsured deposits
Deposit ownership between: money fund traders, trust fund traders, public institutions, commercial banks by size, corporations by size, individuals, foreign investors, and Treasury tax and loan accounts
Large deposits held by any single entity
Seasonal or cyclical patterns in deposits
The sensitivity of deposits to changes in the level of interest rates 109
Traditional Aggregate Measures of Liquidity
Risk
Asset Liquidity Measures
The most liquid assets mature near
term and are highly marketable
Any security or loan with a price above
par, in which the bank could report a
gain at sale, is viewed as highly liquid
Liquidity measures are normally
expressed in percentage terms as a
fraction of total assets
110
Traditional Aggregate Measures of Liquidity
Risk
Highly Liquid Assets
Cash and due from banks in excess of required holdings
Federal funds sold and reverse RPs.
U.S. Treasury securities and agency obligations maturing within one year
Corporate obligations and municipal securities maturing within one year and rated Baa and above
Loans that can be readily sold and/or securitized
111
Pledging Requirements
Not all of a bank’s securities can be easily sold
Like their credit customers, banks are required to pledge collateral against certain types of borrowings
U.S. Treasuries or municipals normally constitute the least-cost collateral and, if pledged against debt, cannot be sold until the bank removes the claim or substitutes other collateral
112
Pledging Requirements
Collateral is required against four
different liabilities:
Repurchase agreements
Discount window borrowings
Public deposits owned by the U.S.
Treasury or any state or municipal
government unit
FLHB advances
113
Liability Liquidity Measures
Liability Liquidity
The ease with which a bank can issue
new debt to acquire clearing balances
at reasonable costs.
Measures typically reflect a bank’s
asset quality, capital base, and
composition of outstanding deposits
and other liabilities.
114
Liability Liquidity Measures
The following measures are commonly used:
Total equity to total assets
Risk assets to total assets
Loan losses to net loans
Reserve for loan losses to net loans
The percentage composition of deposits
Total deposits to total liabilities
Core deposits to total assets
Federal funds purchased and RPs to total liabilities
Commercial paper and other short-term borrowings to total liabilities.
115
Liability Liquidity Measures
Volatile Deposits
The difference between actual current
deposits and the base estimate of core
deposits
116
Longer-Term Liquidity Planning
Projections are separated into:
Base Trend
Short-Term Seasonal
Cyclical
Liquidity Needs
Equals
Forecasted change in loans + change
in required reserves – forecasted
change in deposits
117
Forecasts of trend, seasonal, and cyclical
components of deposits and loans
reference balance sheet.
Assets Liabilities
Cash and due from banks $ 160 Transaction accounts and
nonnegotiable deposits $1,600
Loans 1,400 Certificates of deposit and other
borrowing 280
Investment securities 400 Stockholders' equity 120
Other assets 40 Total $2,000
Total $2,000
118
Forecasts of trend, seasonal, and cyclical components of deposits and loans Deposit forecast
End of
Month
Trend
Deposits
(2)
Seasonal
Deposit
lndext
(3)
Seasonal
Deposits -
Dec.
Deposits
(4)
Cyclical
Deposits
(5)
Total
January $1,608 99% -$16 -$3 $1,589
February 1,616 102 +32 8 1,656
March 1,623 105 +80 7 1,710
April 1,631 107 +112 10 1,753
May 1,639 101 16 1 1,656
June 1,647 96 -64 - 8 1,575
July 1,655 93 -112 -15 1,528
August 1,663 95 -80 -9 1,574
September 1,671 97 -48 - 4 1,619
October 1,680 101 +16 0 1,696
November 1,688 104 +64 + 3 1,755
December 1,696 100 0 0 1,696
119
Forecasts of trend, seasonal, and cyclical components of deposits and loans Loan forecast
End of
Month
Trend
Loans*
Seasonal
Loan
lndext
Seasonal
Loan-
Dec. Loans
Cyclical
Loans Total
January $1,413 101% $14 $6 $1,433
February 1,427 97 -42 -9 1,376
March 1,440 95 -70 -18 1,352
April 1,454 94 -84 -21 1,349
May 1,467 97 -42 -15 1,410
June 1,481 102 28 -3 1,506
July 1,495 108 112 9 1,616
August 1,510 106 84 17 1,611
September 1,524 103 42 11 1,577
October 1,538 99 -14 5 1,529
November 1,553 98 -28 0 1,525
December 1,568 100 0 0 1,568
120
Monthly liquidity needs
The bank’s monthly liquidity needs
are estimated as the forecasted
change in loans plus required
reserves minus the forecast change
in deposits:
Liquidity needs =
Forecasted Dloans + Drequired
reserves - forecasted Ddeposits
121
Estimates of Liquidity Needs
End of
Month
DDeposits DRequired
Reserves
DLoans Liquidity
Needs*
January 11.0 1.1 $ 33.0 $42.9
February 56.0 5.6 -24.0 -74.4
March 110.0 11.0 -48.0 -147.0
April 153.0 15.3 -51.0 -188.7
May 56.0 5.6 10.0 -40.4
June -25.0 -2.5 106.0 128.5
July -72.0 -7.2 216.0 280.8
August -26.0 -2.6 211.0 234.4
September 19.0 1.9 177.0 159.9
October 96.0 9.6 129.0 42.6
November 155.0 15.5 125.0 -14.5
December 96.0 9.6 168.0 81.6
122
Liquidity GAP measures
Management can supplement this
information with projected changes in
purchased funds and investments with
specific loan and deposit flows.
The bank can calculate a liquidity GAP by
classifying potential uses and sources of
funds into separate time frames according
to their cash flow characteristics.
The Liquidity GAP for each time interval
equals the dollar value of uses of funds
minus the dollar value of sources of funds. 123
0–30 Days 31–90 Days 91–365 Days Potential Uses of Funds Add: Maturing time deposits Small time deposits 5.5 8.0 34.0 Certificates of deposit over $100,000 40.0 70.0 100.0 Eurodollar deposits 10.0 10.0 30.0 Plus: Forecast new loans Commercial loans 60.0 112.0 686.0 Consumer loans 22.0 46.0 210.0 Real estate and other loans 31.0 23.0 223.0 Minus: Forecast net change in transactional accounts Demand deposits - 6.5 105.5 10.0 NOW accounts 0.4 5.5 7.0 Money market deposit accounts 1.6 3.0 6.0 Total uses $173.0 155.0 1,260.0 Potential Sources of Funds Add: Maturing investments Money market instruments 8.0 16.5 36.5 U.S. Treasury and agency securities 7.5 10.5 40.0 Municipal securities 2.5 1.0 12.5 Plus: Principal payments on loans 80.0 262.0 903.0 Total sources 98.0 290.0 992.0
Periodic Liquidity GAP 75.0 -135.0 268.0
Cumulative Liquidity GAP 75.0 - 60.0 208.0
Liquidity gap estimates (millions of dollars)
124
Time Frame 0–30
Days 31–90 Days
91–365 Days
Purchased Funds Capacity Federal funds purchased (overnight and term) $20 $20 $30 Repurchase agreements 10 10 10 Negotiable certificates of deposit Local 50 50 60 National 20 20 25 Eurodollar certificates of deposit 20 20 20
Total $120 $120 $145
Additional Funding Sources Reductions in federal funds sold $5 $5 $5 Loan participations 20 20 20 Sale of money market securities 5 5 5 Sale of unpledged securities 10 10 10
Total $40 $40 $40
Potential Funding Sourcesa $160 $160 $185
Potential Extraordinary Funding Needs
50% of outstanding letters of credit 5 10 15 20% of unfunded loan commitments 25 30 35
Total $30 $40 $50
Excess Potential Funding Sources $130 $120 $135
Potential funding sources (millions of dollars)
125
Considerations in Selecting Liquidity Sources
Asset Sales
Brokerage fees
Securities gains or losses
Foregone interest income
Any increase or decrease in taxes
Any increase or decrease in interest
receipts
126
Considerations in Selecting Liquidity Sources
New Borrowings
Brokerage fees
Required reserves
FDIC insurance premiums
Servicing or promotion costs
Interest expense
127
Considerations in Selecting Liquidity Sources
The costs should be evaluated in
present value terms because interest
income and expense may arise over
time
The choice of one source over another
often involves an implicit interest rate
forecast
128
William Chittenden edited and updated the PowerPoint slides for this edition.
Funding the Bank and Managing
Liquidity
Chapter 8
Bank Management, 6th edition. Timothy W. Koch and S. Scott MacDonald Copyright © 2006 by South-Western, a division of Thomson Learning
129