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Chapter 21
Thrift Operations
Financial Markets and Institutions, 7e, Jeff Madura
Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.
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Chapter Outline

Background on savings institutions

Sources and uses of funds

Exposure to risk

Management of interest rate risk

Valuation of a savings institution

Interaction with other financial institutions
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Chapter Outline (cont’d)

Participation in financial markets

Performance of savings institutions

Savings institution crisis

Background on credit unions


Background on Savings Institutions
(cont’d)

Ownership

Most SIs are mutual (owned by depositors)

Many SIs have shifted their ownership structure from
depositors to shareholders through mutual-to-stock-
conversions

Allow SIs to obtain additional capital by issuing stock

Provide owners with greater potential to benefit from
performance

Make SIs more susceptible to hostile takeovers
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Background on Savings Institutions
(cont’d)

Ownership (cont’d)

In an acquisition, both SIs have to be stock-owned

Merger-conversion

The number of SIs today is about one-half of the
number in 1994


Sources of Funds

Deposits

Most funds come from savings and time deposits such
as passbook savings, CDs, and MMDAs

Since 1981, SIs are allowed to offer NOW accounts as
a result of DIDMCA

Since 1982, SIs are allowed to offer MMDAs as a
result of the Garn-St Germain Act

Since 1978, SIs are allowed to offer retail CDs with
rates tied to Treasury bills
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Sources of Funds (cont’d)

Borrowed funds

SIs can borrow from other depository institutions in the federal
funds market

SIs can borrow at the Fed’s discount window

SIs can borrow through repos

Capital

The capital (net worth) of SIs is composed of retained earnings


Other securities

All SIs invest insecurities such as Treasury bonds and
corporate bonds

Provide liquidity

Some thrifts invested in junk bonds prior to 1989
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Uses of Funds (cont’d)

Consumer and commercial loans

Federally chartered SIs are allowed to invest up to 30 percent of
their assets in nonmortgage loans and securities

10 percent can be used to provide non-real estate commercial
loans

Maturities typically range from one to four years

Substituting loans for mortgages reduces interest rate risk but
increases credit risk

Other uses of funds

Repos

Lending in the federal funds market

1980s because of their heavy concentration on fixed-
rate mortgages

Many SIs benefited from their exposure to interest rate
risk in the 2001–2002 period when interest rates
declined
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Exposure to Risk (cont’d)

Interest rate risk (cont’d)

Measurement of interest rate risk

SIs commonly measure the gap between rate-sensitive
assets and liabilities to determine interest rate risk exposure

Gap measurement is dependent on the criteria used to
classify an asset or liability as rate sensitive

Some SIs measure the duration of assets and liabilities to
determine the imbalance in sensitivity of interest revenue
versus expenses
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Management of Interest Rate Risk

Adjustable-rate mortgages (ARMs)

The interest rate on ARMs is tied to market-
determined rates and are periodically adjusted
