Chapter 8 Flashcards
<p>List all types of Banks</p>
<p>Commercial Banks = institutions that accepts checking and savings deposits and lends to individuals and firms (Money-Center Banks, Regional & Superregional Banks, Community Banks)
Thrift Institutions (Savings Institutions, Credit Unions)
*Finance Companies</p>
<p>Money-Center Bank</p>
<p>Commercial bank = located in major financial center that raises funds primarily by borrowing from other banks or by issuing bonds.
-Accepts deposits, but they are not main source of funds</p>
<p>Regional & Superegional Banks</p>
<p>-Core functions of deposit taking and lending
Regional Bank = commercial bank with assets above $1 billion that operates in one geographic region
Superregional Bank = commercial bank with assets above $1 billion that operates across most of US</p>
<p>Community Bank</p>
<p>Community Bank = has less than $1 billion in assets, operates in small geographic area.
- Raises funds from local depositors and lends to consumers and small businesses
- Most of banks in America are community banks but even all together, they hold relatively few assets
-Still exist because of niche in small business lending, they gather information about local businesses, better screening because of proximity</p>
<p>Savings Institutions</p>
<p>Savings Institution = bank created to accept savings deposits and make loans for home mortgages
-Originally created to lend to individuals for mortgages, because in the past commercial banks mainly lent to businesses
Mutual Bank = owned by their depositors and did not issue stock, this is how savings institutions were originally</p>
<p>Credit Union</p>
<p>Credit Union = not-for-profit bank, owned by depositors who are called members, they are drawn from a group of people with something in common
-Only members can borrow, reduces asymmetric information because qualifying for membership means low default risk </p>
<p>Finance Company</p>
<p>Finance Company = non-bank financial institution that makes loans but does not accept deposits, raise funds exclusively by issuing bonds & borrowing from banks
- Meet only HALF the definition of a bank
- Often operate in subprime lending</p>
<p>Motives for Mergers</p>
<p>Economies of Scale = Banks reduce transaction costs, larger bank means lower cost of making loan/managing accounts, save on operating cost
Diversification = expand globally, fewer patterned defaults, reduce sensitivity to local problems
Empire Building = managers/employees make more money and have more power in bigger insttutions
Too Big To Fail = doctrine that large financial institutions facing failure must be rescued by government to protect financial system
(Economies of Scope) = cost reductions from combining different functional activities in an organization</p>
<p>International Banking</p>
<p>-Foreign expansion was spurred by international trade, US firms abroad wanted US banks - when US Banks went there, they also worked with locals
Eurodollars = deposits of dollars outside the United States, whether in foreign banks or foreign branches of US banks</p>
<p>Financial Holding Companies</p>
<p>Financial Holding Companies = conglomerates that own groups of financial institutions, both commercial banks AND securities firms (allowed because of repeal of Glass-Steagall)
PROS: Economies of Scope = benefits from reducing costs by combining activities
CONS: Problem in one unit of FHC can hurt other unites</p>
<p>Glass-Steagall Act & Dodd Frank Act</p>
<p>Glass-Steagall Act = restricted scope of banks activities, forbidden to engage in business of securities firms - no owning stocks/underwriting. (Eventually repealed by Gramm-Leach-Bliley Act)
Dodd-Frank Act = Wall Street Reform and Consumer Protection Act 2010, like the Glass-Steagall, aimed to restrict risk-taking by banks, smaller separation of commercial banks & securities firms than Glass-Steagall but similar</p>
Securitization
Securitization = banks sell loans as securities rather than holding them as assets
1) Banks & Finance companies make loans then sell them
2) Securitizer = financial institution that gathers pools of loans with similar characteristics, issues securities that entitle owner to a share of payments on the loan pool
3) Securities are bought and resold on secondary markets. BENEFITS TO BUYERS = they are highly liquid, safe because backed by prime loans, pay a bit more interest than government bonds
BENEFITS TO BANK = Possible default makes it risky to hold onto loans, selling them shifts risk elsewhere. Bank earns profit from the sale.
Fannie Mae & Freddie Mac
Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Corporation (Freddie Mac) = created to increase supply of mortgage loans
How? They buy mortgages from banks, giving banks more assets to loan again!
Government Sponsored Enterprise = private corporation with links to the government
-At first they bought and held mortgages, then they began selling Mortgage Backed Securities (only on Prime mortgages, they held Subprime ones)
4 Subprime Lenders
Finance Companies = regulated less by government because they don’t accept deposits, so they lend to people who can’t get loans from commercial banks.
Payday Lenders = company that provides cash in return for a post-dated check
Pawnshop = small lender that holds an item of value as collateral
Illegal Loan Sharks = lender that violates usury laws and collects debts through illegal means
-Usury Laws = legal limit on interest rate, around 40% a year
How Subprime Lenders deal with Default Risk
Finance Companies have credit scoring and high interest rates
Payday Lenders have post dated checks and high interest rates
Pawnshops have very high collateral
Illegal Loan Sharks have very high interest rates and threats to defaulters
