Notes on Chapter 18 “The Commercial Banking Industry”



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Notes on Chapter 18

“The Commercial Banking Industry”

A. Role of Commercial Banks- Distribution of funds from source to usage


B. Other Services:

  • Investment advise

  • Security underwriting

  • Financial Planning such as creation of trust

C. Policy Impact



  • Money supply impact

  • Main purchaser of U.S. government debt

D. The Structure of U.S. Commercial Banks



  • Size—As of March 2001, due to consolidation the number of U.S. commercial banks dropped from 10,000 in mid 90s to 8,237. The consolidation has not stopped and Mega Banks continues to replace smaller commercial banks. Of the 8,237 commercial banks, 6030 were state chartered banks and only 980 were members of Federal Reserve System. However the member banks hold more than 75% of all deposits in U.S. The five largest U.S. commercial banks based on assets are Citigroup, JP Morgan Chase, Bank of America, Wachovia, and Wells Fargo.

  • Branch Banking—The Mc Fadden Act of 1927 allowed each state the right to set its own rules on intrastate branch banking. In 1994 Congress passed the Riegle-Neal Intrastate Banking and Branching Efficiency Act permitting adequately capitalized and managed bank holding companies to acquire banks in any state subject to certain limitation and approval by Fed. Starting June 1997, this single legislation allowed all the mergers which took place in the last few years.

  • Bank holding company is a corporation that holds the stocks of one or more banks. There are around 6000 holding companies currently in U.S. that hold more than 90 percent of all U.S. banks assets.

  • International Banking

  1. Office representation-no services locally provided

  2. Brach office- all services locally provided

  3. Full subsidiary with its own charter and capital stock

  4. Joint venture

Foreign banks with branches in U.S. have a competitive edge because they can under-write corporate equity where as American charter branch cannot engage in such activity. This is the reason International Banking Act of 1978 and Improvement Act of 1991 was created, to watch the irregular behavior of international banks in U.S. However the Gramm-Leach-Bliely Legislative Act of 1999 broke these barriers for U.S. banks. It permitted holding companies affiliation between banks and insurance underwriting. It also created a new financial holding company authorized to engage in underwriting and selling securities.


  1. Universal or Merchant Banks- In addition to regular services they offer other services such as consulting, insurance, real estate sale and under-writing of securities (many of these actions are porhabited for American charter banks), examples include; Barclay Bank of England, Deutsche Bank of Germany, Royal Bank of Canada.




  1. Technology and Banking

a. ATMs Automated Teller Machines

b. POS Point-of-Sale…instant purchase debit or credit card in terminals located in retail stores

c. ACH Automated Clearing House…Transfers financial information from one institution to

another, images are transferred so the paper does not have to move.

d. ALM Automated Loan Machines


  1. Portfolio Characteristics of Commercial Banks

  • Cash and dues from banks-primary reserve

  1. Cash in temporary investment

  2. Short-term loans to other banks

  • Security holdings-secondary reserve

  1. Municipal securities

  2. Federal Agencies securities

  3. Treasury Bills

  4. Corporate bonds (in small amount)

  • Loans

  1. Direct loan

  2. Term loans-direct loans with maturity of more than a year

  3. Lease financing…the equipment belongs to the bank , under lease to customer

  4. Real-estate loans

  5. Loans for consumer products such as automobile

  • Deposits

  1. Demand deposits-checking accounts

  2. Saving accounts

  3. Time deposits-Certificate of Deposit (CD)

  4. Transaction accounts

  1. Negotiable Orders of Withdrawal (NOW)

  2. Automatic Transfer Services (ATS)-Zero Balance Account

  3. Money Market Deposit Accounts (MMDA)

  • Non-deposit source of funds

    1. Purchase of reserve including Federal Fund

    2. Security purchase agreement such as American Depository Receipt (ADR)

    3. Stand by credit letters

    4. Sales of block of loans

    5. Floating-rate or variable CD’s and notes

    6. Securitization (auto, home mortgage loans…)

H. Other Issues in Banking Industry



      • Deregulation of banking industry

      • Globalization of banking and sever competition

      • Technical evolution in banking industry

      • Future need for uniformity of regulation and supervision in banking industry

I. Reserve Requirement



Total Required Legal Reserve = Reserve Requirement on deposit x Daily average of net deposit hold over a fixed period + Reserve requirement of long-term deposits such as saving accounts x Daily average amount of saving hold for a period of time


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