170CHAPTER 13COMMERCIAL BANK OPERATIONSCHAPTER OVERVIEW AND LEARNING OBJECTIVES This chapter surveys the structure and importance of the U.S. commercial banking industry. The chapter describes the basic operation of commercial banks in terms of their sources and uses of funds as reflected in their major balance sheet accounts. The chapter explains how banks make decisions about risk-taking, funding, and pricing. The chapter discusses the development and structure of bank and financial holding companies.CAREER PLANNING NOTE: THE ENTRY LEVEL IN COMMERCIAL BANKINGLarge banks have a well-defined entry level for college graduates. New recruits complete one to two years of training. The first phase immerses them in accounting, finance, regulation, and the banks policies and procedures. The second phase involves rotations among the banks key lines of business. Then trainees undergo a placement process to find their first permanent assignment. Those ranking nearer the top of their training class will have more nearly their first choice. Today, banking involves a wide range of career options, both functionally and geographically. The nations largest banks now operate in practically all 50 states, and deliver many services either not permitted or not invented 20 years ago. READING THE WALL STREET JOURNAL: HITTING THE HIGHLIGHTSThe Journals layout is designed to get a busy reader up to speed in a matter of minutes. In a hurry first thing in the morning? Scan the “Whats News” columns on the front page, then page through Section C (Money & Investing). These items make up the financial worlds “daily brief”. TOPIC OUTLINE AND KEY TERMSI. An Overview of the Banking IndustryA. Fewer banks, more branches.1. Less than 8,000 banks: The number of banks has declined significantly as the industry has consolidated. 2. More than 80,000 banking offices: The number of branches has increased significantly as geographical restrictions on banking have relaxed.B. Many small banks, a few very large banks.1. 94% of U.S. banks hold only 18% of banking industry deposits.2. The largest 89 banks (about 1% of U.S. banks) hold 67% of total deposits.C. Holding companies predominate.1. A “bank holding company” is a company owning an interest in at least 1 bank.2. As of 2005, some 5,154 holding companies controlled 6,160 banks with about 96% of U.S. commercial bank assets.171II. Bank Balance Sheet: Uses of Funds (Assets) = Sources of Funds (Liabilities + Capital).A. Sources of Funds: Liabilities + Capital1. Deposit Liabilities: Transaction Deposits; Savings Deposits; Time Deposits.a. Transaction Deposits: Demand Deposits; NOW Accounts: (1) Demand Deposits, also known as checking accounts.(2) NOW (Negotiable Order of Withdrawal) Accountsi. pay interest;ii. just for individuals, governments, and nonprofitsb. Savings Deposits: Savings Accounts; MMDAs.(1) Savings Accounts comprise about 13% of all deposits(2) MMDAs (Money Market Deposit Accounts)i. comprise about 40% of all depositsii. interest plus limited transactional featuresc. Time Deposits: Certificates of Deposit; Negotiable Certificates of Deposit(1) Non-transferable Certificates of Depositi. usually under $100,000ii. terms of 30 days to 5 years(2) Negotiable (or “Jumbo”) CDstransferable in secondary marketi. $100,000 or moreii. terms rarely exceed 90 days2. Non-deposit Liabilities: Fed Funds Purchased; Repurchase Agreements; Othera. Fed Funds Purchased: Most important non-deposit source of funds.(1) Recall purpose of Fed Funds Market from Chapters 2 and 3(2) Banks buy and sell Fed Funds “overnight” to adjust liquidity.b. Repurchase Agreements: Another liquidity adjustment mechanism.(1) Bank sells securities but agrees to repurchase themi. essentially a self-securing loanii. usually “overnight” but can last longer(2) T-Bills are a common form of collateral.c. Other Borrowings(1) Trading Liabilities(2) Eurodollars (See Chapter 12). (3) Bankers Acceptances (see Chapters 7 and 12).(4) Federal Home Loan Bank Advances(5) Discount Window Loans (see Chapters 2 and 3).(6) Capital Notes or Bondsi. usually subordinate to depositors claimsii. may count as “capital” for some regulatory purposes3. Capital Accounts: Capital stock; Undivided Profits; Special Reserve Accounts.a. Capital Stock: Direct investments of common or preferred equity.b. Undivided Profits: Accumulated earnings not paid out in dividends.c. Special Reserve Accounts: Against losses on loans or securities.172B. Uses of Funds: Assets1. Cash Assets: About 4% of industry assets.a. Vault cash-Physical currency and coin counts for reserve requirements.b. Reserves at the Fed (see Chapters 2 and 3).(1) Required reserves per Reg D(2) Excess reservesi. for settling transactions with Fedii. for check-clearingiii. for Fed Funds transactionsc. Balances at other banks.d. Fed Funds Sold (see Chapters 2 and 3).e. Reverse Repurchase Agreements.2. Investments: About 17% of industry assets; risk discouraged in favor of liquidity