What is a bank's cheapest source of funds?

Answer 1

There are two main categories of sources that generate funds for a commercia bank:

1.Non Deposit Sources of Funds

These include: Service fees, Cash handling charges, Panelties and Interests etc.

2.Deposit Sources of Funds

These include: Current accounts, Saving accounts and Term deposits etc.

(By: Nadeem - Citibank 03004351154)

Answer 2

A bank's source of funds are usually: deposits, CD (retail and broker), issuance of CP and such

DEPOSIT ACCOUNTS

· TRANSACTION DEPOSITS

· SAVINGS DEPOSITS

· TIME DEPOSITS

· MONEY MARKET DEPOSITS

BORROWED FUNDS

· FED FUNDS

· FEDERAL RESERVE BORROWING

· REPOS

· EURODOLLAR BORROWING

LONG-TERM CAPITAL

· BONDS

· BANK CAPITAL

Sources of Bank Funds:

1. Checkable Deposits - (10%)

a. Demand deposits (non-interest-bearing checking)

b. NOW accounts - interest-bearing checking

c. Money market deposit accounts (MMDAs) - money market mutual funds.

Checkable deposits are payable on demand, you can write a check for any amount, including your entire balance. Checkable deposits are lowest cost source of funds for a bank, sometimes 0 (demand deposits), because people like the liquidity of checking accounts and will forego interest for convenience of checks.

2. Nontransaction Deposits (59%) are the Primary source of bank funds

a. Savings accounts (passbook savings)

b. Small-denomination Time Deposits (CDs, certificate of deposits), fixed maturity from several months to 10 years, less than $100,000. Higher interest rates than passbook savings, penalties for early withdrawal, less liquid, more costly for the bank.

c. Large-denomination Time Deposits, over $100,000, bought by corporations, money market funds and other banks. Liquid, negotiable, marketable, can be resold in secondary market before they mature, like a corporate bond or T-bond. Alternative to commercial paper and T-bills.

3. Borrowings (23%) of bank funds:

a. from other banks - Fed Funds Market - to meet reserve requirements

b. from FRS - discount rate - to meet reserve requirements

c. from parent companies - bank holding companies

d. from corporations and from foreign banks - negotiable CDs and Eurodollar deposits

3. Bank capital (8%), equity from issuing new stock or capital from retained earnings. Bank capital is also a cushion against a drop in the value of its assets, to protect against insolvency, bankruptcy.

NOTE: Banks are usually highly leveraged - 92% D/A ratio, very thinly capitalized.

BANK ASSETS = Uses of Bank Funds:

A bank uses its deposits to acquire income-earning assets, to make profits, by earning more interest on assets than they pay out on liabilities.

1. Reserves (1%): Deposits kept on account at the Fed (all banks have an account at the Fed) + Vault cash on hand at bank, stored in the vault overnight.

Some reserves are required by FRS, as a percentage of deposits. Reserve requirements - percentage a bank is requiredto hold as a percent of certain deposits. Notice that reserves (R) are only about 1.6% of Deposits (D), checking and saving deposits, (1 / 63). Banks also hold excess reserves, in addition to required reserves for increased liquidity, to meet demand for cash withdrawals and check clearing.

2. Securities (22%): Banks also hold securities like Tbills and muni bonds and GNMA bonds, etc. Commercial banks are not allowed to own stock, must only own government debt instruments.

3. Loans (72%): Most bank profits come from Loans. Loans make up 72% of bank assets:

a. Commercial loans to businesses

b. real estate loans (mortgages, home improvement loans, etc.)

c. consumer loans (credit card, automobiles)

d. interbank loans, Federal Funds market

e. other loans

Loans are less liquid than other assets (e.g. securities, TBills, etc.) because the assets tied up for the length of the loan, 30 years in the case of a typical mortgage. Loans are also more risky, higher default risk than securities. Because loans are more risky and less liquid, they earn more interest for banks.

4. Other Assets (5%): Property, plant and equipment. Buildings, office equipment, computer systems, etc.

Answer 3

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