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COMMERCIAL BANK OPERATIONS CHAPTER OBJECTIVES 1. This is the first of three chapters on commercial banking. Commercial banks, the largest category of financial institution and the one most present in daily life, are widely diversified in their business activities, are the main transmitter of monetary policy, and are the center of the payments system. 2. The chapter examines commercial banks as profit-maximizing, risk-managing firms. Their principal business activities are evident in their balance sheets. Transaction and time deposits are the major source of funds; loans and investments are the major uses of funds. 3. The chapter surveys the management and pricing of loans, deposits, and fee-based bank services, as well as “off-balance-sheet” activities. 4. The chapter explains the importance of bank holding companies and financial holding companies. Bank holding companies have been used to circumvent geographic limitations on branching and functional limitations on services. The Financial Services Modernization Act of 1999 provided for financial holding companies, which can acquire insurance and investment banking subsidiaries. CHANGES FROM THE LAST EDITION All tables and exhibits have been updated. CHAPTER KEY POINTS 1. The structure of the industry reflects both consolidation and deregulation. There are fewer banks as the industry consolidates, but more branches as limits on geographical expansion relax. Small banks outnumber large banks about, but large banks control the vast majority of industry assets. 2. Banks are profit maximizers. They earn most of their income from loans and investments financed by both deposit and nondeposit liabilities. Fee-based services and “off-balance- sheet” activities have become increasingly important, providing revenue without additional capital or regulatory burden. 3. The main source of bank funds is various types of transaction and time deposits. Other borrowings to support lending and investment include Fed funds, Eurodollars, repurchase agreements, Discount Window loans, and Bankers' acceptances. Capital notes, bonds, and equity capital are sources of funds related less to operations and more to permanent structure. 4. The main use of bank funds is lending (with leasing considered an extension of lending). Point out the wide variety of loans banks make compared to other lenders. Bank investment portfolios exist chiefly to provide liquidity and some income, representing less risk than loans. Compare and contrast the limited number of low-risk investment choices available to banks with the variety of loans they can make. Compare and contrast lending with leasing from the bank’s point of view. 5. The “evolution” of the prime rate convention is a useful starting point to explain loan pricing, which applies the now-familiar idea of a nominal rate comprising some base rate adjusted for risk. Matched-funding and fixed-rate loan pricing represent practical applications of term structure. Loan
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This note was uploaded on 02/23/2011 for the course FINA 4090 taught by Professor S during the Spring '11 term at Toledo.

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