The Banking System: Commercial Bank Balance Sheets

Commercial Bank Balance Sheets Box 8 shows the actual balance sheets of all commercial banks in the United States as of January 1990. Assets of commercial banks, the dominant depository institutions in the United States, totaled slightly over $3,200 billion at the beginning of 1990. Notice that actual reserves on deposit at Federal Reserve banks and other cash items constituted only 7.5 percent of total assets. The required reserve ratio for commercial banks currently ranges from 0.03 to 0.12, depending on the type of deposit. Commercial banks typically hold about 20 percent of their assets in the form of highly liquid government securities, often called secondary reserves. In January 1990, liquid securities accounted for 17.6 percent of commercial bank assets. The sum of cash and government securities is the banking system's liquidity base used to meet deposit withdrawal demands. Loans of various types accounted for over 67 percent of bank assets in January ships, and corporations. 1990. The bulk was in commercial and industrial credit to proprietorships, partner-On the liability side of the balance sheet, checkable deposits accounted for about 20 percent of the sum of all liabilities and net worth. Savings deposits and various certificates of deposit amounted to close to 50 percent of liabilities and net worth. As you can see from the data in Box 8, total borrowings accounted for slightly over 17 percent of the sum of total liabilities and net worth in January 1990. Banks borrow from the Federal Reserve System, from other commercial banks, and from corporations. The net worth of commercial banks amounts to about 6 percent of their assets. Some Disturbing Trends in Commercial Banking Although the U.S. banking system remains sound for the most part, it is clear that changes in financial markets have adversely affected the profitability of commercial banks. Bank failures, which were rare in the United States in 1980, had climbed to over 200 per year by 1989. By 1990, rating agencies were lowering the credit ratings of many banks and bank stocks were plummeting in value. The banking industry was facing more competition than ever before in credit markets. Large corporations, once the major clients of commercial banks, were borrowing directly from individual lenders by issuing commercial paper and raising more funds through direct issue of stock. When corporations did borrow from banks, many of the outstanding loans seemed in trouble as some debt-ridden corporations faced bankruptcy. Real estate loans were also souring as land values in many metropolitan markets began to fall. The lucrative consumer credit business was getting more difficult because companies such as Sears and AT&T entered credit card markets, and auto companies used their own subsidiaries to finance car loans. In 1990, the Chase Manhattan Bank began writing off some bad loans and laying off thousands of workers. Commercial banks still have a relatively large net worth to cushion losses. It is generally agreed that U.S. commercial banks are better managed and lack the problems of fraud that plagued the undercapitalized savings and loan industry. But because of increased competition in the credit market, banks have had to cut the rates they charge on loans, which has cut into profits. Losses on loans increased from a bit more than one quarter of one percent per year in 1980 to slightly more than 1 percent in 1989. Much of the $40 billion in loans to Third World nations has decreased substantially in value because of the inability of these nations to make full payment. As of early 1990, commercial banks in the United States also had over $50 billion in loans outstanding that were made to finance corporate mergers and acquisi-tions. Some of these corporate loans were in trouble because a decline in corporate profits and an economic slowdown in 1990 and 1991 made it difficult for some companies to make their debt payments. A large percentage of these loans have had to be written off. In early 1990 there were more than 12,000 commercial banks in operation. Many experts argued that the industry was larger than it had to be, and that costs could be trimmed through mergers. Mergers would allow banks to share overhead facilities and cut costs but would require major changes in federal and state banking laws. One estimate indicated that if two large New York banks were to merge, the cost saving would be as much as $700 million per year. There are likely to be significant changes in U.S. banking in the 1990s as pressure mounts to allow banks to expand into new markets in order to increase profits. The number of banks is likely to decrease as mergers and some bank failures occur. Ultimately, in a free market economy, a sound banking system must be a profitable banking system. Unless measures are taken to allow the U.S. banking system to cover costs and earn a reasonable rate of return, bank failures will increase and the viability of the U.S. financial system will suffer. The Balance Sheet of Savings and Loan Associations and Savings Banks In the past, savings and loan associations, mutual savings banks, and credit unions were not able to offer checkable deposits. The Depository Institutions Deregulation and Monetary Control Act of 1980 changed all that. Since that time thrift institutions have been able to issue checkable deposits and compete with commercial banks for these accounts. The law also allowed both thrift institutions and commercial banks to pay interest on certain types of checking accounts, a situation that was illegal prior to 1980. However, major distinctions between commercial banks and thrift institutions still remain. Savings and loan associations, the dominant thrift institutions, accounted for about two thirds of the assets of all thrift institutions in the United States as of October 1989. Box 9 shows the balance sheet of all U.S. savings and loan associations and savings banks. Look at the asset side of the balance sheet. About 70 percent of the assets are in mortgage loans or mortgagebacked securities. These are mainly loans to homeowners to finance the purchase of residences. Cash and investment securities, the primary and secondary reserves of the thrift institutions, amounted to 12.6 percent of their assets in October 1989.