BasicsCommercialBankMgt

Basics of Commercial Bank Management

• Commercial banks are key financial intermediaries in the U.S. and globally, providing deposit and credit services.

• They have evolved to offer innovative services like investment advice and financial planning, becoming akin to a "financial department store."

• Overview of topics to be covered this semester:

  • Financial statements of commercial banks.

  • Trends in the commercial banking industry.

  • Key areas of commercial bank management.

Commercial Bank Balance Sheet

Assets

• Types of Assets:

  • Primary Reserves: Cash and deposits with other banks, serving as a buffer against withdrawals.

  • Secondary Reserves: Marketable securities held to meet short-term needs, primarily money market instruments or capital market instruments.

  • Loans: Major asset category, consisting of various loan types.

Loans Types

C&I Loans (Commercial and Industrial)

1. Transaction Loans: Specific-purpose loans, secured by financed assets.

2. Working Capital Loans: Short-term loans for routine transactions, usually secured by accounts receivable or inventory.

3. Term Loans: Long-term loans for fixed asset purchases, with repayment typically coming from cash flows generated.

4. Combinations: Feature provisions allowing short-term borrowings to convert into term loans.

Consumer Loans

• Direct Loans: Financing for durable goods, secured by purchased assets.

• Bank Credit Cards: Unsecured, short-term credits used for various expenses.

Mortgage Loans

• Intended for real estate acquisition or improvement, typically secured by property.

• Securitization has increased marketability of mortgage loans.

Commercial Bank Liabilities

• Sources of funds primarily drawn from deposits, supplemented by non-deposit sources such as federal funds and repos.

Types of Deposits

• Demand Deposits: Checking accounts, essential for payments.

• Savings Accounts: Low-interest deposits, withdrawable without notice.

• Time Deposits: Fixed maturity deposits, offering high-interest rates, includes CDs.

Commercial Bank Equity Capital

• Equity capital constitutes about 8% of total funds, crucial for bank stability during losses.

• Different categories of equity capital:

  • Capital Stock: Investments including par value and surplus.

  • Retained Earnings: Profits not distributed as dividends.

  • Special Reserve Accounts: Set aside for anticipated losses on loans.

Commercial Bank Income Statement

• Revenue Streams: Primarily from interest and fees on loans, with increasing contributions from non-interest income like service charges.

• Expenses: Major costs include interest on deposits and employee salaries.

• Interest Margin: Key profitability indicator derived from interest income minus interest expenses.

• Noninterest Margin: Difference between noninterest income and expenses, increasingly significant in profitability.

Trends in the Commercial Banking Industry

• As of 2010, the U.S. had about 6,676 commercial banks, decreased from 30,000 in 1920, mainly due to mergers and acquisitions.

Commercial Bank Management and Profitability

• The balance between profitability and safety is crucial for bank management. Effective risk management is vital to prevent regulatory issues or takeovers.

Credit Analysis in Commercial Banks

Five Cs of Credit:

1. Capacity: The borrower’s ability to pay back debts, both legally and financially.

2. Character: Borrower’s credit history and willingness to repay debts.

3. Capital: The borrower’s equity which can signal confidence about future profitability.

4. Collateral: Assets pledged against a loan, reducing lender risk.

5. Conditions: Economic context impacting borrowers' ability to repay loans.

Risk Management in Commercial Banking

• Management involves day-to-day operations, crisis management for unexpected issues, and strategic planning for new opportunities.