Chapter 21
Thrift Operations
Outline
Background on Savings Institutions
Ownership
Regulation of Savings Institutions
Sources and Uses of Funds
Sources of Funds
Uses of Funds
Balance Sheet of Savings Institutions
Interaction with Other Savings Institutions
Participation in Financial Markets
Valuation of a Savings Institution
Factors That Affect Cash Flows
Factors That Affect the Required Rate of Return
Exposure to Risk
Liquidity Risk
Credit Risk
Interest Rate Risk
Management of Interest Rate Risk
Adjustable-Rate Mortgages (ARMs)
Interest Rate Futures Contracts
Interest Rate Swaps
Conclusions about Managing Interest Rate Risk
Exposure of Savings Institutions to Crises
Savings Institution Crisis in the Late 1980s
Credit Crisis of 2008-2009
Reform in Response to the Credit Crisis
Credit Unions
Ownership of Credit Unions
Advantages and Disadvantages of Credit Unions
Deposit Insurance for Credit Unions
Regulatory Assessment of Credit Unions
Credit Union Sources of Funds
Credit Union Uses of Funds
Exposure of Credit Unions to Risk
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Key Concepts
1. Describe the savings institution’s main sources and uses of funds.
2. Compare the sources and uses of funds between savings institutions and banks to explain why the
savings institution’s exposure to risk differs from that of banks (especially interest rate risk).
3. Explain the cause of the credit crisis in 2008-2009, and the solutions.
4. Explain the sources and uses of funds for credit unions.
POINT/COUNTER-POINT:
Can All Savings Institutions Avoid Failure?
WHO IS CORRECT? Use InfoTrac or some other source search engine to learn more about this issue
and then formulate your own opinion.
Questions
1. SI Sources and Uses of Funds. Explain in general terms how savings institutions differ from
commercial banks with respect to their sources of funds and uses of funds. Discuss each source of
funds for savings institutions. Identify and discuss the main uses of funds for savings institutions.
Chapter 21: Thrift Operations ❖ 3
The major sources of funds for savings institutions are as follows:
1. Deposits, which include passbook savings, retail CDs, and money market deposit accounts;
The main uses of funds for savings institutions are:
1. Cash to satisfy reserve requirements enforced by the Federal Reserve System and to
2. Ownership of SIs. What are the alternative forms of ownership of a savings institution?
3. Regulation of SIs. What criteria are used by regulators to examine a savings institution?
4. MMDAs. How did the creation of money market deposit accounts influence the savings institution’s
overall cost of funds?
5. Offering More Diversified Services. Discuss the entrance of savings institutions into consumer and
commercial lending. What are the potential risks and rewards of this strategy? Discuss the conflict
between diversification and specialization of savings institutions.
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6. Liquidity and Credit Risk. Describe the liquidity and credit risk of savings institutions, and discuss
how each is managed.
7. ARMs. What is an adjustable-rate mortgage (ARM)? Discuss potential advantages such mortgages
offer a savings institution.
8. Use of Financial Futures. Explain how savings institutions could use interest rate futures to reduce
interest rate risk.
9. Use of Interest Rate Swaps. Explain how savings institutions could use interest rate swaps to reduce
interest rate risk. Will savings institutions that use swaps perform better or worse than those that were
unhedged during a period of declining interest rates? Explain.
10. Risk. Explain why many savings institutions experience financial problems at the same
time.
11. Hedging Interest Rate Movements. If market interest rates were expected to decline over time, will
a savings institution with rate-sensitive liabilities and a large amount of fixed-rate mortgages perform
best by (a) using an interest rate swap, (b) selling financial futures, or (c) remaining unhedged?
Explain.
12. Exposure to Interest Rate Risk. The following table discloses the interest-rate sensitivity of two SIs
(dollar amounts are in millions).
Interest Sensitivity Period
From From
Within 1–5 5–10 Over 10
1 Year Years Years Years
Lawrence S&L
Interest-earning assets $ 8,000 $3,000 $7,000 $3,000
Interest-bearing liabilities 11,000 6,000 2,000 1,000
Manhattan S&L
Interest-earning assets 1,000 1,000 4,000 3,000
Interest-bearing liabilities 2,000 2,000 1,000 1,000
Based on this information only, which institution’s stock price would likely be affected more by a
given change in interest rates? Justify your opinion.
13. SI Crisis. What were some of the more obvious reasons for the SI crisis?
14. FIRREA. Explain how the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA)
reduced the perceived risk of savings institutions.
15. Background on Credit Unions. Who are the owners of credit unions? Explain the tax status of credit
unions and the reason for that status. Why are CUs typically smaller than commercial banks or
savings institutions?
16. Sources of Credit Union Funds. Describe the main source of funds for credit unions. Why might the
average cost of funds to credit unions be relatively stable even when market interest rates are volatile?
17. Regulation of Credit Unions. Who regulates CUs? What are the regulators’ powers? Where do
credit unions obtain deposit insurance?
18. Risk of Credit Unions. Explain how credit union exposure to liquidity risk differs from that of other
financial institutions. Explain why credit unions are more insulated from interest rate risk than some
other financial institutions.
19. Advantages and Disadvantages of Credit Unions. Identify some advantages of credit unions.
Identify disadvantages of credit unions that relate to their common bond requirement.
ANSWER: Possible answers are:
20. Impact of Credit Crisis. Explain how the credit crisis in the 2008-2009 period affected some savings
institutions. Compare the causes of the credit crisis to the causes of the savings institution crisis in the
late 1980s.
Chapter 21: Thrift Operations ❖ 7
21. Impact of Interest Rates on an SI. Explain why savings institutions may benefit when interest
rates fall.
22. Impact of Economic Growth on an SI. How does high economic growth affect an SI?
CRITICAL THINKING QUESTION
The Future of Thrift Operations Write a short essay on the future of thrift operations? Should they be
merged into the banking industry, or should they remain distinctly different from commercial banks?
ANSWER
Interpreting Financial News
Interpret the following statements made by Wall Street analysts and portfolio managers.
a. “Deposit insurance can fueled a crisis because it allows weak SIs to grow.”
b. “Thrifts are no longer so sensitive to interest rate movements, even if their assets and liability
compositions have not changed.”
8 ❖ Chapter 21: Thrift Operations
© 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Thrifts now use derivatives such as interest rate swaps to hedge their exposure to interest rate
risk.
c. “Many SIs did not understand that higher returns from subprime mortgages must be weighed
against risk.”
Managing in Financial Markets
Hedging Interest Rate Risk
As a consultant to Boca Savings & Loan Association, you notice that a large portion of 15-year, fixed-rate
mortgages are financed with funds from short-term deposits. You believe the yield curve is useful in
indicating the market’s anticipation of future interest rates and that the yield curve is primarily determined
by interest rate expectations. At the present time, Boca has not hedged its interest rate risk. Assume that a
steep upward-sloping yield curve currently exists.
a. Boca asks you to assess its exposure to interest rate risk. Describe how Boca will be affected by
rising interest rates and by a decline in interest rates.
b. Given the information about the yield curve, would you advise Boca to hedge its exposure to
interest rate risk? Explain.
c. Explain why your advice to Boca may possibly backfire.
Flow of Funds Exercise
Market Participation by Savings Institutions
Chapter 21: Thrift Operations ❖ 9
Rimsa Savings is a savings institution that provided Carson Company with a mortgage for its office
building. Rimsa recently offered to refinance the mortgage if Carson Company would prefer a fixed-rate
loan rather than an adjustable-rate loan.
a. Explain the interaction between Carson Company and Rimsa Savings.
Carson Company benefits from Rimsa because it has access to funds that it needs to pay for its
b. Why is Rimsa willing to allow Carson Company to transfer its interest rate risk to Rimsa? [Recall
that there is an upward-sloping yield curve.]
Rimsa offers to provide a fixed-rate loan because the initial spread on the loan is increased.
c. If Rimsa maintains the mortgage on the office building purchased by Carson Company, who is
the ultimate source of the money that was provided for the office building? If Rimsa sells the
mortgage in the secondary market to a pension fund, who is the source that is essentially
financing the office building? Why would a pension fund be willing to purchase this mortgage in
the secondary markets?
If Rimsa maintains the mortgage, its depositors provide the money. If Rimsa sells the mortgage to