Mgmt of Fin Institutions Chap 2 Hw - Fall 2014 Temple U

3. Four factors contributed to the decline of commercial and industrial loan volume relative to other assets for commercial banks since 1987. First, commercial paper provided firms with an alternative to financing. This allowed firms to finance their current assets with short-term debt instruments, thereby reducing the volume of loans taken out from commercial banks. Second, the securitization of mortgages dramatically increased the shift to mortgage assets on commercial banks’ balance sheets. Third, the credit crunch between 1989-92 and 2001-02 made it difficult for firms to obtain loans from banks. Fourth, the financial crisis of 2007-09 reduced all areas of lending, further reducing the volume of commercial and industrial loans. To deal with the changing environment of the financial services industry, many banks merged with others which consolidated the number of commercial banks. Additionally, banks went on to become financial holding companies after Congress passed the Financial Services Modernization Act.

4. The major uses of funds for a commercial bank are loans and investment securities. Loans make up 51.6% of total assets while investment securities make up 29.9%. Because over half of a commercial bank’s assets are tied with loans, and because banks are highly leveraged, credit risk is critical to the continuing operation of a bank.

5. The major sources of funding for commercial banks are deposits, borrowed or other liability funds, and stock. Commercial banks are highly leveraged, with about 88.5% of assets funded by deposits and borrowed liability funds. However, banks are subject to annual stress tests as part of the Wall Street Reform and Consumer Protection Act. Stress tests measure the financial soundness of banks in adverse economic conditions and help determine whether banks are properly capitalized. Additionally, the Capital Purchase Program encourages financial institutions to raise equity to facilitate the flow of capital to other firms....