Deposit Institutions Traditionally, the United States has had several types of deposit institu-

Deposit Institutions Traditionally, the United States has had several types of deposit institu-

tions: commercial banks, savings and loan associations (referred to as thrift institutions or simply “thrifts”), mutual savings banks, and credit unions. In addition to accepting deposits, these institutions make loans and provide other financial services. These types of institutions are dis- tinguished by their type of ownership (investor or depositor owned) and the type of loans (business or personal).

Commercial banks are corporations that are owned by investors. These banks lend primarily to businesses. Commercial banks may be independent corporations or may be subsidiaries of bank holding com- panies. Bank holding companies are organizations that own one or more other companies in addition to a bank. A common use of a bank holding company is as a device to circumvent regulations regarding bank branching or merging with banks across state lines. The Federal Reserve Board permits bank holding companies to own subsidiaries that are in lines of business related to banking.

Savings and loan associations are owned by their depositors and specialize in making home mortgage loans. The mission of savings and loan associations is to serve the thrift (that is, savings) and home owner- ship needs of consumers. Federally chartered savings and loans are over- seen by the Office of Thrift Supervision (formerly the Federal Home Loan Bank Board, which was created in 1933). Mutual savings banks are also owned by their depositors and focus primarily on loans to the local community. Credit unions are non-profit associations that are owned by the members, the depositors, and their primary focus is mak- ing personal loans to their members. Exhibit 3.2 is a summary of the features of several of the deposit institutions.

EXHIBIT 3.2 Summary of Types of Financial Institutions

Type

Ownership

Primary Mission

Commercial bank

Corporations; owned

Lend to businesses

by investors

Savings and loan (S&L) Either corporations or Offer savings accounts for indi-

owned by depositors

viduals and make loans for home ownership

Mutual savings bank Owned by depositors Lend to the local community Credit union

Non-profit; owned by Lend and provide other finan-

depositors

cial services to members

Financial Institutions and the Cost of Money

Commercial banks traditionally have the widest range of services, including checking accounts, savings accounts, credit cards, business loans, and personal loans. The Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMC) reduced some of the distinc- tions between commercial banks and other institutions by eliminating restrictions on the type of loans, the interest rates on accounts, and the types of investments these other institutions could make. The effect of this act was to allow savings and loans, mutual savings banks, and credit unions to do business much like commercial banks. Adding to these new freedoms, the Garn-St. Germain Depository Act of 1982 permitted both commercial banks and thrifts to provide money market accounts, enabling these institutions to compete with non-bank companies, such as brokerage firms, that offered money market accounts to individuals.

Deposits of commercial banks and savings institutions are insured by the Federal Deposit Insurance Corporation (FDIC), which is an agency created in 1934. Deposits with FDIC-insured institutions are insured up to $100,000 for each depositor and $100,000 for each depositor’s retire- ment account. The role of the FDIC is to monitor these institutions’ earn- ings and capital. Deposit insurance is intended to make the financial system more stable, preventing bank runs or panics—sudden and massive withdrawals of funds by customers.

Commercial Bank Services Commercial banks play an important role in the country’s money supply.

Our purpose in this chapter is not to discuss this role; this topic is typically covered in a course on money and banking or financial markets. Rather, we will discuss the services commercial banks provide to entities seeking to raise funds. These services can be broadly classified as follows: (1) individ- ual banking; (2) institutional banking; and (3) global banking. Of course, different banks are more active in certain of these activities than others.

Individual banking encompasses consumer lending, residential mortgage lending, consumer installment loans, credit card financing, automobile and boat financing, brokerage services, student loans, and individual- oriented financial investment services such as personal trust and investment services. Interest income and fee income are generated from mortgage lending and credit card financing.

Loans to nonfinancial corporations, financial corporations (such as life insurance companies), and government entities (state and local gov- ernments in the United States and foreign governments) fall into the cat- egory of institutional banking. Also included in this category are commercial real estate financing and other activities that will be dis- cussed elsewhere in this book, leasing and factoring.

FOUNDATIONS

It is in the area of global banking that banks began to compete head- to-head with investment banking (or securities) firms. Global banking covers a broad range of activities involving corporate financing and capi- tal market and foreign-exchange products and services.

Corporate financing involves two components. First is the procuring of funds for a bank’s customers. This can go beyond traditional bank loans to involve the underwriting of securities. As we shall explain later, legislation in the form of the Glass-Steagall Act at one time limited bank activities in this area. In assisting customers in obtaining funds, banks also provide bankers acceptances, letters of credit, and other types of guarantees for their customers. That is, if a customer has borrowed funds backed by a letter of credit or other guarantee, its lenders can look to the customer’s bank to fulfill the obligation. The second area of corporate financing involves advice on such matters as strategies for obtaining funds, corporate restructuring, divestitures, and acquisitions.

Capital market and foreign exchange products and services involve transactions where the bank may act as a dealer or broker in a service. Some banks, for example, are dealers in U.S. government or other securi- ties. Customers who wish to transact in these securities can do so through the government desk of the bank. Similarly, some banks maintain a foreign- exchange operation, where foreign currency is bought and sold. Bank customers in need of foreign exchange can use the services of the bank.