Banking Industry: Financial Crisis, Structure, and Performance Analysis

What triggered the Global Financial Crisis of 2007-2009?

A series of crises related to problem mortgages and loans, beginning in mid-2007.

What was a major issue with the mortgages during the crisis?

Mortgages did not require large enough monthly payments to pay off loans, leading to borrower defaults.

What was the originate-to-distribute approach in lending?

Lenders made loans with the intent to sell them, avoiding retention of credit risk.

What led to multiple mortgage bank failures during the crisis?

Home price declines resulted in losses from mortgage defaults, particularly among high-risk borrowers.

What are subprime borrower loans, and what issues did they cause?

Subprime loans often had teaser rates and interest-only payments, resulting in negative amortization.

What was the impact of sustained drops in housing prices during the crisis?

It led to large write-downs and restricted credit availability with increasingly strict terms.

Which major financial institutions collapsed or failed during the crisis?

Bear Stearns, Lehman Brothers, Countrywide, Washington Mutual, and Wachovia.

What actions did the government take in response to the crisis?

Placed Fannie Mae and Freddie Mac into conservatorship and loaned AIG over $150 billion.

What measures were taken to support money market mutual funds during the crisis?

The government insured money market mutual funds.

Which financial institutions were authorized to convert to bank holding companies?

Goldman Sachs, Morgan Stanley, MetLife, and American Express.

What was the Troubled Asset Relief Program (TARP)?

A program established to purchase $125 billion of preferred stock in nine large U.S. banks.

What increase in FDIC coverage was implemented during the crisis?

Increased coverage to $250,000 for domestic deposits and unlimited coverage for business deposits.

What direct action did the Federal Reserve take regarding commercial paper?

Authorized the purchase of commercial paper directly from companies like General Electric.

What was one of the ways the Federal Reserve supported large financial institutions?

Loaned large amounts to major U.S. financial institutions.

What was a significant action regarding FDIC-insured bonds during the crisis?

Authorized the sale of FDIC-insured bonds.

How did hedge funds gain access to liquidity during the crisis?

They were allowed to borrow from the Federal Reserve.

What are the characteristics of global banks?

They offer a wide array of products and services globally.

How do super-regional banks differ from global banks?

Super-regional banks are similar to global banks but are smaller in size and market penetration.

What defines a community bank?

A community bank operates in a smaller trade area with total assets under $1 billion.

What is an independent bank?

An independent bank is a single organization that accepts deposits and makes loans.

What is the role of a Bank Holding Company (BHC)?

A BHC owns a controlling interest in one or more commercial banks and can broaden the scope of products offered.

What is a one-bank holding company?

A one-bank holding company controls only one bank.

What distinguishes a multibank holding company?

A multibank holding company controls at least two commercial banks and can treat subsidiaries like branches or allow them to operate quasi-independently.

What can Bank Holding Companies (BHC) acquire under current regulations?

BHCs can acquire nonbank subsidiaries offering products and services closely related to banking.

What is a Financial Holding Company (FHC)?

An FHC can engage in a wide range of financial activities not permitted in a bank or BHC, including underwriting and selling insurance and securities.

What types of banking does a Financial Holding Company (FHC) engage in?

An FHC can engage in both commercial (individual) and merchant banking (large company).

What can a Financial Holding Company (FHC) own?

A bank, a Bank Holding Company (BHC), a thrift, or a thrift holding company.

What is the tax advantage for the parent company of a Financial Holding Company?

The parent typically pays little income tax because 80% of dividends from subsidiaries are exempt.

How does a parent company of a Financial Holding Company offset its losses?

By using taxable income from its subsidiaries to offset its loss on a consolidated tax return.

What does the term 'Too Big to Fail' (TBTF) refer to?

It refers to large financial institutions that received significant government aid during the financial crisis, as their failure was believed to threaten the global economy.

What was the government's rationale for supporting 'Too Big to Fail' banks?

The government argued that the failure of these firms would lead to a global recession, while smaller banks were considered less economically significant.

What are the different channels for delivering banking services?

Branch banking, Automated Teller Machines (ATMs), Internet banking, call centers, and mobile banking.

What is the primary appeal of Internet (Online) Banking?

Convenience.

What is the role of Automated Teller Machines (ATMs) in banking services?

They serve as retail outlets where customers can conduct banking business electronically.

What type of banking allows customers to conduct business face-to-face?

Branch banking.

What is the significance of the financial crisis in relation to 'Too Big to Fail' banks?

The crisis led to emergency credit and capital injections from the Federal Reserve and U.S. Treasury, primarily benefiting the largest institutions.

What is a Bank Holding Company (BHC)?

A company that controls one or more banks but does not necessarily engage in banking itself.

What is the tax obligation of each subsidiary under IRS provisions?

Each subsidiary pays taxes quarterly on its taxable income.

How does a consolidated tax return benefit a parent financial holding company?

It allows the parent to offset its taxable income with losses from its subsidiaries.

What is the typical structure of a Financial Holding Company?

It owns a bank or other financial institutions and their subsidiaries.

What is the implication of a bank being labeled as 'Too Big to Fail'?

It implies that the bank's failure would have severe consequences for the economy, leading to government intervention.

What is the function of call centers in banking services?

They provide customer support and assistance for banking inquiries and transactions.

What is the relationship between Financial Holding Companies and their subsidiaries?

The parent company owns subsidiaries directly while also controlling other financial entities.

What are the implications of the term 'holding company' in the context of banking?

It indicates a company that holds controlling interests in other financial institutions.

What is the significance of the term 'financial services industry'?

It encompasses all services provided by financial institutions, including banking, investment, and insurance.

How did the financial crisis affect smaller banks compared to larger institutions?

Smaller banks were often allowed to fail while larger institutions received substantial government support.

What is the role of mobile banking in the delivery of banking services?

It allows customers to conduct banking transactions via their mobile devices.

What were the three main issues reported by depository institutions during the financial crisis?

Worsening asset quality, shrinking net interest income, and declining noninterest income due to trading losses and nonperforming loans.

What defines a high-performance firm in banking?

A firm that achieves exceptional returns to shareholders while managing an acceptable level of risk.

What is the significance of risk assessment in high-performance banking?

It involves generating high returns while carefully pricing the level of risk assumed.

What is the typical characteristic of fixed assets in most depository financial institutions?

They own few fixed assets, resulting in low operating leverage.

What issue arises from the short-term maturities of many bank liabilities?

Interest expense changes create significant asset allocation and pricing problems.

Why do many commercial bank deposits carry below-market interest rates?

Because they are FDIC insured.

How does the equity capital of banks compare to that of nonfinancial companies?

Banks operate with less equity capital, increasing financial leverage and earnings volatility.

What are the four general categories of bank assets?

Loans, investment securities, noninterest cash and due from banks, and other assets.

What is the primary source of income for banks?

Loans, as they generate the greatest amount of income before expenses and taxes.

What purposes do investment securities serve for banks?

To earn interest, meet liquidity needs, speculate on interest rate movements, and meet pledging requirements.

What constitutes noninterest cash and due from banks?

Vault cash, deposits held at Federal Reserve Banks, and cash items in the process of collection.

What are the six major categories of loans?

Real Estate, Commercial, Individual, Agricultural, Other loans in domestic offices, and Loans and leases in foreign offices.

What is the purpose of the loan and lease allowance?

It is a contra asset reserve account that recognizes some loans will not be repaid.

What are short-term securities?

Securities with maturities of one year or less, primarily held to meet liquidity needs.

What is the risk and return characteristic of short-term securities?

Lower risk and short maturity result in significantly less interest than longer-term securities.

What types of instruments are considered short-term securities?

T-bills, municipal securities, and money market instruments.

What are long-term securities?

Securities with maturities of more than one year that may generate non-taxable interest.

What are examples of long-term securities?

U.S. Treasury and agency securities, mortgage-backed securities, and some foreign and corporate bonds.

What is vault cash?

Cash held to meet customer withdrawals.

What are demand balances at the Federal Reserve used for?

To meet legal reserve requirements, assist in check clearing, and facilitate wire transfers.

What do cash items in process of collection (CIPC) represent?

Checks that have been presented but not yet credited to accounts.

What are residual assets in the context of bank assets?

Small amounts including bank premises, equipment, other real estate owned (OREO), and investments in unconsolidated subsidiaries.

Why is OREO significant for problem banks?

It represents collateral on unpaid loans.

What are banker's acceptances?

Negotiable instruments guaranteeing payment to the owner, often used in trading goods.

What are transaction accounts?

Accounts that allow for transactions, including demand deposits and negotiable orders of withdrawal (NOW).

What are negotiable orders of withdrawal (NOW)?

Accounts that pay interest and are only available to noncommercial customers.

What is a money market deposit account (MMDA)?

An account that pays market rates but limits the number of checks and automatic transfers to six per month.

What exemption do MMDAs have regarding reserves?

Depository institutions are exempt from holding reserves against MMDAs because they are technically savings, not transaction accounts.

What are small CDs and how do they differ from jumbo CDs?

Small CDs are time deposits below the insurance limit with early withdrawal penalties, while jumbo CDs are above the insurance limit, negotiable, and can be bought and sold in the secondary market.

What is the typical size of a jumbo CD?

Typically $1 million.

What are some examples of other borrowings listed on a balance sheet?

Examples include Fed funds purchased, securities sold under agreement to repurchase, brokered deposits, deposits held in foreign offices, Federal Home Loan Bank borrowings, and subordinated notes and debentures.

What constitutes core deposits?

Core deposits consist of demand deposits, NOW and ATS accounts, MMDAs, and other savings and time deposits less than FDIC limits, which are stable and not usually withdrawn over the short term.

What are volatile (noncore) liabilities?

Volatile liabilities are asset-quality sensitive borrowings, including jumbo CDs, deposits in foreign offices, federal funds purchased, repurchase agreements, FHLB borrowings, and commercial paper.

How do common and preferred stock appear on a balance sheet?

Common and preferred stock are listed at par value, while the surplus account represents proceeds in excess of par.

What do retained earnings represent on a balance sheet?

Retained earnings represent cumulative net income minus all dividends paid to shareholders.

What does the term 'minority interest' refer to in a balance sheet?

Minority interest refers to the non-controlling interest in consolidated subsidiaries.

What is included in interest income (II) on an income statement?

Interest income is the sum of interest and fees earned on all assets.

What is the estimated tax benefit for loan and lease financing?

It is the estimated dollar tax benefit from not paying taxes on loan and lease financing and tax-exempt securities income.

How is interest expense (IE) defined?

Interest expense is the sum of interest paid on all interest-bearing liabilities.

What is net interest income (NII)?

Net interest income is calculated as gross interest income minus gross interest expense.

What does Non-Interest Income (OI) include?

Fiduciary activities, deposit service charges, trading income, investment banking fees, insurance commissions, net servicing fees, net gains/losses on sales of loans, and other net gains/losses.

What are the components of Non-Interest Expense (OE)?

Personnel, occupancy and other operating expenses, intangible amortizations, goodwill impairment, provision for loan and lease losses, realized securities gains or losses.

How is Net Income (NI) calculated?

Operating profit less all taxes plus or minus extraordinary items.

What is included in Total Revenue (TR)?

Total interest income, noninterest income, and realized securities gains/losses.

How does Total Expense (EXP) relate to a nonfinancial firm?

It is comparable to cost of goods sold and operating expenses.

What is the formula for calculating Net Income (NI)?

NI = NII - Burden - PLL + SG - T.

What is the relationship between the Balance Sheet and Income Statement?

Assets (Ai) and liabilities (Lj) impact equity (NW) and the pre-tax yields (yi) and costs (cj) associated with them.

What is the significance of realized securities gains or losses in the Income Statement?

They are part of both Non-Interest Income and Non-Interest Expense.

What does the term 'Burden' refer to in the context of Net Income?

It typically refers to the total noninterest expense that affects net income.

What is the purpose of the Income Statement?

To summarize revenues and expenses over a specific period to determine net income.

What type of income is comparable to net sales for a nonfinancial firm?

Total Revenue (TR).

What are extraordinary items in the context of Net Income?

Unusual or infrequent events that can significantly affect net income.

What does the term 'Provision for loan and lease losses (PLL)' represent?

An expense set aside to cover potential losses from loans and leases.