Question

2. [2] What are three causes of banks losing their cost advantages in acquiring funds in recent years?

3. [2] What are three reason banks have been losing income advantages on their assets in recent years

4. [1] Has the invention of the computer been a major factor behind the decline of the banking industry? Explain your answer.

5. [1] Why is loophole mining so prevalent in the banking industry in the United States?

6. [1] What role did the shadow banking system play in the decline of U.S. commercial banking?

7.[1] How do sweep accounts allow banks to avoid reserve requirements?

8. [1] How did commercial banks respond to their relative decline in traditional banking?

9. [2] Tyler Bank starts its first day of operations with $9 million in capital. A total of $130 million in checkable deposits is received. The bank makes a $25 million commercial loan and another $50 million in mortgages. Assume that required reserves are 8%. (a) What does the bank balance sheet look like? (b) How well capitalized is the bank? (c) Calculate the risk-weighted assets and risk-weighted capital ratio after the bank’s first day assuming reserves risk weights are 0%, mortgages rates are 50% and commercial loan rates are 100%.

Assets	Liabilities

Answer 1

1. Until 1980, banks were subject to deposit rate ceilings that restricted them from paying an interest on checkable deposits and (under Regulation Q) limited them to paying a maximum interest rate of a little over 5% on time deposits. Until th e1960's these restrictions worked to the banks' advantage because their major source of funds was checkable dposits (over 60%) and the zero interest cost on these deposits meant that the banks had a very low cost of funds. Unfortunately, this cost advantage for banks did not last The rise in inflation from the late 1960s on led to higher interest rates, which made investors more sensitive to yield diffferentials on different assets. The result was a process of disintermediation in which households and business began to take their money out of banks, with their low interest rates on both checkable and time deposits, and began to seek out higher-yielding investments.

At the same time, attempts to get around deposit rate ceilings and reserve requirements led to the financial innovation of money market mutual funds, which put the banks at an even further disadvantage because depositors could now obtain a high yielding substitute for a savings account. One manifestation of these changes in the financial system was that the low-cost source of funds, checkable deposits, declined dramatically in importance for banks, falling from over 60% of bank liabilities to around 20% today.

The growing difficulty for banks in raising funds led to their supporting legislation in the 1980s that eliminated Regulation Q ceilings on time deposit interest rates and allowed checkable deposits like NOW accounts that paid interest. Although these changes in regulation helped make banks more competitive in their quest for funds, it also meant that their cost of acquiring funds had risen substantially, thereby reducing their earlier cost advantage over other financial institutions.