2. 13-2
The purpose of this chapter is to
learn about the principal
nondeposit sources of funds that
financial institutions can borrow to
help finance their activities and to
see how managers choose among
various nondeposit fund sources
currently available to them.
3. 13-3
Liability Management
Customer Relationship Doctrine
Alternative Nondeposit Funds Sources
Measuring the Funds Gap
Choosing Among Different Funds Sources
Determining the Overall Cost of Funds
4. The first priority of the bank is to
make loans to all qualified
customers and if funds are not
available the bank should seek out
the lowest cost source of funding to
meet customers’ needs.
5. The bank buys funds in order to satisfy
loan requests and reserve requirements
It is an interest-sensitive approach to
raising bank funds
It is flexible – the bank can decide
exactly how much they need and for how
long
The control mechanism to regulate
incoming funds is the price of funds
6. Federal Funds Market
Repurchase Agreements
Federal Reserve Bank
Advances from the Federal Home Loan Bank
Negotiable CDs
Eurocurrency Deposit Market
Commercial Paper
Long Term Sources
7. 13-7
Recent Growth in Nondeposit Sources
of Borrowed Funds at FDIC-Insured Institutions
What are the trends?
8. 13-8
The usage of nondeposit sources of
funds has risen
Larger institutions rely on the
nondeposit funds market as a key
source of short-term money to meet
loan demand and unexpected cash
emergencies
9. Immediately available reserves are
traded between financial institution
and usually returned within 24 hours.
Deposits with correspondent banks
and demand deposit balances of
security dealers and governments can
be used for loans to institutions.
Most popular source of borrowed
funds
10. Overnight Loans
Term Loans
Continuing Contracts
11. Involves the temporary sale of
high-quality assets (usually
government securities)
accompanied by an agreement to
buy back those assets on a specific
future date at a predetermined
price or yield.
12. Happy Valley Bank borrows $125 million
overnight through a repurchase agreement (RP)
collateralized by Treasury bills. The current RP
rate is 3.65 percent. How much will the bank pay
in interest costs due to this borrowing?
Interest cost of RP
= $125,000,000 x 0.0365 x 1/360= $12,673.61
13-12
13. A bank with immediate reserve
needs can borrow from the federal
reserve. There are three types of
loans for different needs, each with
its own interest rate. There are
limitations on borrowing at the
federal reserve discount window.
14. Primary credit – this loan is available for
short terms and to institutions in sound
financial condition. Rate is slightly higher
than the federal funds rate.
Secondary credit – these loans are available
at a higher interest rate to institutions not
qualifying for primary credit. Monitored by
the federal reserve to control excess risk
Seasonal credit - these loans cover longer
periods than primary credit for small and
medium institutions experiencing seasonal
swings in deposits and loans
15. 13-15
• What is liability management?
• For what kinds of funding situations
are Federal funds best suited?
16. 13-16
• Allows institutions (home mortgage lenders) to use
home mortgages as collateral for advances
• A way to improve the liquidity of home mortgages
and encourage more lenders to provide credit
• Number of loans has increased dramatically in recent
years
• Maturities range from overnight to more than 20
years
• FHLB System is composed of 12 regional banks
• Has federal charter and can borrow cheaply and pass
savings to institutions
18. An interest-bearing receipt
evidencing the deposit of funds in
the bank for a specified period of
time for a specified interest rate. It
is considered a hybrid account
since it is legally a deposit.
19. Domestic CDs – issued by domestic
banks in the U.S.
Euro CDs – dollar denominated CDs
issued by banks outside the U.S.
Yankee CDs – issued by foreign banks in
the U.S.
Thrift CDs – issued by large savings and
loans and other nonbanks in the U.S.
20. Rockfish Corporation purchases a 60-day
negotiable CD with a $5 million
denomination from Bait Bank and Trust,
bearing a 3.75 percent annual yield. How
much in interest will the bank have to pay
when this CD matures? What amount in
total will the bank have to pay back to
Rockfish at the end of 60 days?
13-20
21. Interestowed
60
Rockfish Corp. $5,000,000 .0375 $31,250.00
360
by bank
T otalamount
owed Rockfish P rinciple Interest
in 60 days
$5,000,000 $31,250.00 $5,031,250.00
13-21
22. Eurodollars are dollar-denominated
deposits placed in banks outside the
U.S.
Eurocurrency deposits originally
were developed in western Europe
to provide liquid funds to swap
among institutions or lend to
customers
23. Short-term notes with
maturities from 3 or 4 days to
9 months issued by well-
known companies.
Banks cannot issue these
directly but affiliated
companies can issue them.
24. Mortgages to fund the
construction of new buildings
and capital notes and
debentures are examples of
long term sources of funds.
25. Gap is based on:
Current and projected demand and
investments the bank desires to make
minus
Current and expected deposit inflows
and other available funds
Size of this gap determines need for
nondeposit funds
26. Rosemary Bank of New York expects new deposit inflows next month of
$375 million and deposit withdrawals of $500 million. The bank's
economics department has projected that new loan demand will reach
$460 million and customers with approved credit lines will need $175
million in cash. The bank will sell $480 million in securities, but plans to
add $85 million in new securities to its portfolio. What is the projected
available funds gap?
Projected funds gap
= $460 + $175 + ($85 - $480) – ($375 - $500)
= $365 million
13-26
27. The relative costs of raising funds from
each source
The risk of each funding source
The length of time for which funds are
needed
The size of the institution
Regulations limiting the use of various
funding sources
28. Effective cost = Current int cost non - interest cost
investable funds
Non-interest cost = (cost of staff,
transaction, facilities)x funds borrowed
29. Banks and other lending affiliates within the
holding company of Interstate National Bank
are reporting heavy loan demand this week
from companies in the southeastern United
States that are planning a significant expansion
of inventories and facilities before the
beginning of the fall season. The holding
company and its lead bank plan to raise $850
million in short-term funds this week, of which
about $835 million will be used to meet these
new loan requests.
13-29
30. Current annual interest rates on alternative sources of funds are:
Market Noninterest
Interest Rates Cost Rates
Federal Funds 2.25% 0.25%
Negotiable CDs 2.40 0.25
Eurodollars 2.30 0.35
Commercial paper 2.35 0.50
Fed. Discount Rate 3.25 0.25
Calculate the effective cost rates of each of these sources of funds for
Interstate and make a management decision on what sources to
use.
13-30
31. Current interest Noninteres costs
t
cost on amounts incurred
Effectivecost rateon
borrowed to access thesefunds
deposit and nondeposit
Net investablefunds raised
sources of funds
from thissource
Effective
Federal = 0.0225x $850Million 0.0025x $850Million
Funds Cost $835Million
Rate $19.13million $2.125million
= = 2.54%
$835 million
13-31
33. Effective
Commercial 0.0235 $850million 0.0050 $850million
=
Paper Cost $835 million
Rate
$19.98million $4.25million
= = 2.90%
$835million
Effective
Cost of 0.0325 $850million 0.0025 $850million
=
Borrowing $835 million
from the Fed
$27.63million $2.125million
= = 3.56%
$835 million
13-33
34. The cheapest source of all would be
borrowing from the federal funds
market.
13-34
35. 13-35
Which institutions are allowed to borrow from
the FHLBs?
Why were negotiable CDs developed?
Suppose a customer purchases a $1 million 90-
day CD, carrying a promised 6% annualized
yield. How much in interest income will the
customer earn when this 90-day instrument
matures?
What is commercial paper? What types of
organizations issue such paper?
36. Customer Relationship Doctrine
Sources of Funds
Federal Funds Market Negotiable CDs
Repurchase Agreements Eurocurrency Deposits
Federal Reserve Borrowings Commercial Paper
Home Loan Banks Capital Notes and
Debentures
Choosing Nondeposit Sources
Funds Gap Term
Costs Size of borrowing bank
Risks Regulations
37. Firefly Bank and Trust has received $800 million in total funding from the
sources listed below with their associated costs also shown.
Amount Interest Nonint. Add. Total
Funding Source ($ millions) Costs Costs Costs Costs
Checkable Deposits 200 0.75% 2.00% .75% 3.50%
Time & Savings Deposits 400 2.50% .50% .50% 3.50%
Money-Mkt. Borrowings 100 3.25% .25% .25% 3.75%
Stockholders' Equity 100 13.00% ----- ----- 13.00%
13-37
38. Firefly's costs in millions of dollars:
Amount Interest Other Total
Funding Source ($ millions) Costs($) Costs($) Costs($)
Checkable Deposits 200 1.50 5.5 7.00
Time & Savings Dep. 400 10.00 4.0 14.00
Money-Mkt. Borrowings 100 3.25 0.5 3.75
Stockholders' Equity 100 ----- ----- -----
Totals ($) 800 14.75 10.0 24.75
13-38
39. (a) Calculate Firefly’s weighted average interest cost on
total volume funds raised, figured on a before-tax
basis?
Weighted Average Interest Cost
= (Total dollar interest) / (Total deposits and borrowing)
= $14.75 million / $700 million
= 0.0211 or 2.11%
Note: the equity - $100million does not have an interest cost
and is not included above
13-39
40. (b) If the bank's earning assets total $700 million,
what is its break-even cost rate?
Break-even cost rate
= (Total funding costs) / (earning assets)
= 24.75/700 = 0.0354 or 3.54%
13-40
