Financial Institutions

Transcription

1 Financial Institutions 1

2 Learning Objectives The role of financial intermediaries. Commercial banks and the impact of reserve requirements. Federal Reserve regulation of financial institutions. The difference between savings and loans and commercial banks. Operation of credit unions. Distinguish among finance companies, insurance companies, and pension funds. 2

3 The Role of Financial Institutions as Intermediaries ( Middle Persons ) A household with surplus funds can purchase a savings account at a financial institution. The bank, S&L, or credit union channels those surplus funds to a firm, government entity, or a household that needs them. In this way, small surplus units can be packaged together to meet the needs of large deficit economic units. 3

4 Services offered by Financial Institutions Denomination matching Link to Federal Deposit Insurance Corporation 4

5 Services offered by Financial Institutions Denomination matching Households generally have small amounts of surplus funds to invest. They can put small amounts into savings at a time. 5

6 Services offered by Financial Institutions Denomination matching Households generally have small amounts of surplus funds to invest. They can put small amounts into savings at a time. Those who need loans usually require larger amounts of funds. They can borrow for business purposes, or to buy a home or automobile. 6

7 Services offered by Financial Institutions Maturity Matching Household and business savers generally want to lend for only a short time. Savings and checking accounts are usually available for immediate withdrawal. 7

8 Services offered by Financial Institutions Maturity Matching Household and business savers generally want to lend for only a short time. Savings and checking accounts are usually available for immediate withdrawal. Borrowers often want long-term financing. Institutions can give 30 year mortgages and long-term loans to businesses and government entities. 8

9 Services offered by Financial Institutions Absorbing Credit Risk Individual lenders cannot easily evaluate the credit risk of borrowers. They also cannot generally afford to take the risk of losing their limited savings. 9

10 Services offered by Financial Institutions Absorbing Credit Risk Individual lenders cannot easily evaluate the credit risk of borrowers. They also cannot generally afford to take the risk of losing their limited savings. Institutions have the necessary expertise and also are in a better position to absorb an occasional loss. 10

11 The Role of Financial Institutions Intermediaries help to facilitate the flow of funds in the financial marketplace. $$ Securities Financial Institution Securities $$ 11

12 Financial Intermediation Example 1 $$ Checking accounts Businesses Commercial Bank Households Commercial loans $$ 12

13 Financial Intermediation Example 2 $$ Insurance Insurance policies Company Businesses Households Stocks, Bonds $$ 13

14 Types of Financial Institutions Commercial Banks Link to Federal Reserve Bank of Boston Link to Federal Reserve Bank of Dallas Link to Federal Reserve Bank of Kansas City 14

15 Types of Financial Institutions Commercial Banks The primary purpose of commercial banks is to take in business deposits and to lend funds to businesses. 15

16 Types of Financial Institutions Commercial Banks Savings and Loans 16

17 Types of Financial Institutions Commercial Banks Savings and Loans Savings and loans primary purpose is to take in deposits from households and to lend funds for home mortgages. 17

18 Types of Financial Institutions Commercial Banks Savings and Loans Credit Unions 18

19 Types of Financial Institutions Commercial Banks Savings and Loans Credit Unions Credit Unions are owned by depositors (actually share owners) who are individuals, not businesses. Credit Unions take in funds and primarily make personal loans. 19

20 Types of Financial Institutions Commercial Banks Savings and Loans Credit Unions } Depository Institutions 20

21 Types of Financial Institutions Commercial Banks Savings and Loans Credit Unions } Depository Institutions Take in deposits Make loans 21

22 Types of Financial Institutions Finance Companies 22

23 Types of Financial Institutions Finance Companies Non-bank firms that borrow funds to make short and medium term loans to higher risk borrowers. 23

24 Types of Financial Institutions Finance Companies Insurance Companies 24

25 Types of Financial Institutions Finance Companies Insurance Companies Receive premiums for insurance policies. This pool of funds is used to reimburse policyholders who incur losses that are covered under the policy. Life Insurers: Insure against financial hardship caused by death. Property and Casualty: Insure against damage to person and property (health, autos, homes, theft, earthquake, etc.) 25

26 Types of Financial Institutions Finance Companies Insurance Companies Pension Funds 26

27 Types of Financial Institutions Finance Companies Insurance Companies Pension Funds Workers and/or employers contribute funds. Defined Benefit Plans (DBP) versus Defined Contribution Plans (DCP). 27

28 Types of Financial Institutions Finance Companies Insurance Companies Pension Funds } Non- Depository Institutions 28

29 Types of Financial Institutions Finance Companies Insurance Companies Pension Funds } Non- Depository Institutions Funds come from borrowing, selling insurance policies, and other claims. Funds used to buy securities and make loans. 29

30 Reserve Requirement of Depository Institutions A specified percentage of deposits must be held as non-earning reserves. Required by the Fed. Insures that institutions have some liquidity to meet demand for withdrawals and helps to control the money supply. 30

31 Simplified Balance Sheet of Commercial Bank Reserves Investments Loans Deposits Borrowed Funds Bank Capital (Equity) Fixed Assets 31

32 The Federal Reserve System The Fed is the central bank of the United States Created in 1913 Link to Board of Governors of the Federal Reserve System 32

33 Purpose of the Fed Monetary authority i.e., control the money supply 33

34 Purpose of the Fed Monetary authority i.e., control the money supply Lender of last resort Fed makes discount loans to depository institutions 34

35 Purpose of the Fed Monetary authority i.e., control the money supply Lender of last resort Fed makes discount loans to depository institutions Check clearing 35

36 Purpose of the Fed Monetary authority i.e., control the money supply Lender of last resort Fed makes discount loans to depository institutions Check clearing Bank Supervision 36

37 Structure of the Fed Board of Governors Seven members Located in Washington, DC Federal Open Market Committee (FOMC) Board of Governors plus five district Federal Reserve Bank presidents Located in Washington, DC Twelve Federal Reserve Banks Corresponding to twelve districts Member Banks 37

38 How the Fed Influences Interest Rates Open Market Operations Discount Rate Policy Reserve Requirements 38

39 Open Market Operations The Fed buys and sells government securities in the open market. Buying securities increases the money supply which tends to decrease interest rates. Selling securities decreases the money supply which tends to increase interest rates. 39

40 When the Fed buys T-Bills T-bills The Fed $ The public 40

41 When the Fed buys T-Bills T-bills The Fed $ The public Reserves are injected into the economy 41

42 When the Fed buys T-bills Bank reserves increase. 42

43 When the Fed buys T-bills Bank reserves increase. This makes banks more willing to lend, increasing the supply of loanable funds. 43

44 When the Fed buys T-bills Bank reserves increase. This makes banks more willing to lend, increasing the supply of loanable funds. {Supply of LF } { i } 44

45 When the Fed buys T-bills Bank reserves increase. This makes banks more willing to lend, increasing the supply of loanable funds. {Supply of LF } { i } Fed decreases rates when it wants to stimulate the economy. 45

46 When the Fed sells T-Bills T-bills The Fed $ The public 46

47 When the Fed sells T-Bills T-bills The Fed $ The public Reserves are extracted from the economy 47

48 When the Fed sells T-bills Bank reserves decrease 48

49 When the Fed sells T-bills Bank reserves decrease This makes banks less willing to lend, decreasing the supply of loanable funds. 49

50 When the Fed sells T-bills Bank reserves decrease This makes banks less willing to lend, decreasing the supply of loanable funds. {Supply of LF } { i } 50

51 When the Fed sells T-bills Bank reserves decrease This makes banks less willing to lend, decreasing the supply of loanable funds. {Supply of LF } { i } Fed raises rates when it wants to slow the economy down. 51

52 Discount Rate Policy When the Fed increases the discount rate This increases the cost of funds to borrowing depository institutions, causing them to increase the rates they charge. 52

53 Discount Rate Policy When the Fed increases the discount rate This increases the cost of funds to borrowing depository institutions, causing them to increase the rates they charge. When the Fed decreases the discount rate This decreases the cost of funds to borrowing depository institutions, causing them to decrease the rates they charge. 53

54 Reserve Requirements When the Fed increases reserve requirements This decreases the amount of funds available for lending 54

55 Reserve Requirements When the Fed increases reserve requirements This decreases the amount of funds available for lending {Supply of LF } { i } 55

56 Reserve Requirements When the Fed increases reserve requirements This decreases the amount of funds available for lending {Supply of LF } { i } When the Fed decreases reserve requirements This increases the amount of funds available for lending 56

57 Reserve Requirements When the Fed increases reserve requirements This decreases the amount of funds available for lending {Supply of LF } { i } When the Fed decreases reserve requirements This increases the amount of funds available for lending {Supply of LF } { i } 57

58 The Federal Reserve As the central bank of the United States, The Fed regulates the financial system, the nation s money supply, and makes loans to financial institutions. The Fed consists of twelve district banks, the Federal Open Market Committee, and the Board of Governors. The latter two are located in Washington DC. 58

59 The Fed Influences Interest Rates by: Buying and selling federal securities ( open market operations ). Selling (buying) securities reduces (increases) the money supply which tends to increase (decrease) interest rates. Discount rate Increasing the cost of funds to financial institutions tends to increase the rates they charge. Reserve Requirements Increasing (decreasing) the amount of non-earning reserves that must be held makes funds less (more) available and generally more (less) costly. 59

60 Deregulation of Savings & Loans Depository Institutions Deregulation and Monetary Control Act of 1980 Removed interest rate cap on deposits Subjected S&Ls to reserve requirements 1982 Garn-St. Germain Act Allowed S&Ls to offer money market accounts. New powers from deregulation resulted in many S&L failures 60

61 Re-regulation of Savings & Loans 1989 Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) Designed to clean up the mess caused by the hundreds of failed and failing S&Ls. Set up the Resolution Trust Corporation to preserve value of remaining S&Ls and liquidate those beyond hope of recovery. 61