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Sunday, July 22, 2012

CommercialBanks Vs. Thrifts

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Commercial Bank vs. Thrift Institution


Commercial banks are considered to be the largest group of depository institutions when measured by asset size; they are very distinguishable from savings institutions and credit unions in the size, regulation and composition of their loans and deposits. Deposits are the main source of funding for commercial banks while their liabilities may include various non-deposit funds such as subordinated notes and debentures.


Commercial banks have two main assets on their balance sheet; loans and investment securities. Loans are responsible for the majority of assets held by commercial banks and are considered to be the most important revenue generator. The four main types of commercial bank loans are; business loans, real-estate loans, individual loans, and various other loans, which may be loans to emerging countries. Real-estate loans rank as the largest asset of the four main types of loans. Investment securities represent the second major asset on a commercial bank balance sheet. These consist of items such as; interest bearing deposit purchases from other financial institutions, federal funds sold to other banks, repurchase agreements and U.S. Treasury securities, just to mention a few. Investment securities benefit commercial banks in liquidity management, generation of interest income, low default risk and are effectively traded in the secondary market. Due to the high levels of liquidity risk for commercial banks, they usually hold large amounts of cash and investment securities in order to meet the claims of their liability customers, upon liquidation. In the event of loan default the losses are charged off against the bank equity, thus reducing retained earnings and the equity of the bank.


Commercial banks have two main sources of funds, deposits and borrowed money, which are represented as liabilities on their balance sheet. Deposit accounts are comprised of four major sections; non-transaction accounts and transaction accounts, which include the sum of non-interest bearing demand deposits and interest bearing checking accounts, make up the first section. A second section is retail or household savings and time deposits; normally these are individual account holdings of less than one- hundred dollars. Large time deposits in excess of one hundred dollars make up the third section; these are usually negotiable certificates of deposit that can be sold in the secondary market to outside investors. A final section is nondeposit liabilities, which include instruments such as repurchase agreements and federal fund purchases. When examining a commercial bank balance sheet an interesting aspect that distinguishes them from other financial institutions is their high debt to assets ratio, which implies that a very large amount assets is funded by debt, either being deposits or borrowed funds.


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Commercial bank balance sheets also consist of off balance sheet activities. These may be various fee-generating activities such as issuing letters of credit or engaging in futures, forwards, options and swap contracts. When an off-balance-sheet asset occurs it is recognized on the asset side of the balance sheet or income will be attributed to the income statement. On the other hand when an off-balance-sheet liability occurs this item is represented on the liability side of the balance sheet or an expense is recognized on the income statement. Off-balance-sheet activities are beneficial to banks in that they allow banks to earn additional fees to complement declining business margins. Since reserve requirements and deposit insurance premiums are not taxed on off-balance-sheet activities this creates a tax incentive for commercial banks.


The commercial banking industry has become highly competitive due to the rapid advancements in technology, bank mergers, and the increase in the number of non-bank institutions. One of the most significant technological advances made by commercial banks has been the automated teller machine; this has made banking much easier for customers, 4 hours a day. Online banking has also been a major competitive tool for commercial banks; customers are now able to satisfy the majority of their banking online. Technology has not been the only reason for job declines in commercial banks; mergers and bank failures have also had a major effect on commercial banking. Mergers lead to fewer jobs because similar operations are consolidated.


Deregulation in commercial banks began in 180 when congress passed the Depository Institutions Deregulatory and Monetary Control Act. This act gradually abolished the restrictions on interest rates, and allowed the Growth of ATM’s over state lines. Prior to this act banks had been subject to a ceiling on the level of interest paid to depositors. With the elimination of this ceiling interest rates became a major selling point, thus increasing competition among banks.


With commercial banks mainly focusing on the needs of businesses, thrift institutions were introduced in the early 1800’s to serve the needs of individuals wanting to purchase homes. There are three main types of thrift institutions savings associations, savings banks, and credit unions.


Savings associations and savings banks specialize in real estate lending, particularly loans for single-family homes and other residential properties. Shareholders or depositors and borrowers can own these two types of thrifts. These institutions are referred to as thrifts, because they originally offered only savings accounts, or time deposits. Over the past two decades, however, they have acquired a wide range of financial powers, and now offer checking accounts and make business and consumer loans as well as mortgages, just as commercial banks.


Both saving associations and savings banks may be chartered by either the federal Office of Thrift Supervision (OTS) or by a state government regulator. Generally, the Savings Association Insurance Fund (SAIF) insures savings and loan associations, and the Bank Insurance Fund (BIF) insures savings banks.


Savings institutions must hold a certain percentage of their loan portfolio in housing-related assets to retain their charter, as well as their membership in the Federal Home Loan Bank System. This is called the qualified thrift lender (QTL) test. Savings institutions must maintain 65% of their portfolio in housing-related or other qualified assets to maintain their status.


Credit unions (Cus) are not-for-profit depository institutions, owned by their members, and accept deposits in a variety of accounts. Unlike commercial banks credit unions are prohibited from serving the general public, members are required to have a common bond such as having a university affiliation. All credit unions’ offer savings accounts, or time deposits; the larger institutions also offer checking and money market accounts, similar to commercial banks. Credit unions financial powers have expanded to include almost anything a bank or savings association can do, including making home loans, issuing credit cards, and even making some commercial loans. Credit unions are exempt from federal taxation and sometimes receive subsidies, in the form of free space or supplies, from their sponsoring organizations.


The number of thrifts declined dramatically in the late 180’s and early 10’s. The savings and loan crisis of the 180’s forced many institutions to close or merge with others, at great costs to the federal government. However, there has been a resurgence of thrifts in recent years.





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