Lecture 1.

An Overview of the Changing Financial- Services Sector

I. What Is a Bank?
II. The Financial System and Competing Financial-Service Institutions
III. Bank regulation
1. Goal
2. Why are banks so closely regulated?
3. Shortcomings of restrictive bank regulation
4. What is Regulated?
5. The Federal Reserve System
IV. Bank functions
V. Bank organisation
VI. Key trends affecting all financial-service firms
1. Fundamental forces of change
Lecture 2. The Financial Statements of Banks and Their Principal Competitors
I. An Overview of Balance Sheets and Income Statements
II. The Balance Sheet (Report of Condition)
1. The Principal Types of Accounts
2. Recent Expansion of Off-Balance-Sheet Items in Banking
3. The Problem of Book-Value Accounting
4. Auditing: Assuring Reliability of Financial Statements
III. Components of the Income Statement (Report of Income)
1. Financial Flows and Stocks
2. Comparative Income Statement Ratios for Different-Size Financial Firms
IV. The Financial Statements of Leading Nonbank Financial Firms: A Comparison to Bank
Statements
V. An Overview of Key Features of Financial Statements and Their Consequences
Lecture 3. Managing and Pricing Deposit Services
I. Types of Deposit Accounts Offered
II. Pricing Deposit Services
III. Conditional Deposit Pricing
IV. Rules for Deposit Insurance coverage
V. Disclosure of Deposit terms
VI. Lifeline Banking
Lecture 4. Lending to Business Firms and Pricing Business Loans
I. Types of Business Loans: Short term vs Long term
II. Analyzing business loans requests
III. Financial Ratio Analysis of a Customer’s Financial Statements
IV. Collateral and Contingent Liabilities
1. Contingent Liabilities
V. Sources and Uses of Business Funds
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 VI. Pricing Business Loans
VII. Customer Profitability Analysis (CPA)
Lecture 5. Consumer Loans, Credit Cards, and Real Estate Lending
1. Types of Loans for Individuals and Families
2. Unique Characteristics of Consumer Loans
3. Evaluating a Consumer Loan Request
4. Credit Cards and Credit Scoring
5. Laws & Regulations Applying to Consumer Loans
6. Real Estate Loans
7. Pricing Consumer and Real Estate Loans: Determining the Rate of Interest and other
loan terms

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Lecture 1. An Overview of the Changing Financial-
Services Sector
I. What Is a Bank?
● A bank can be defined in terms of:
○ The economic functions it performs: Institutions involved in transferring funds
from savers to borrowers (financial intermediation) & in paying for goods and
services
○ The services it offers its customers: Accept deposits, make commercial loans,
offer trust services, manage cash, etc
○ The legal basis for its existence
● Historically, banks have been recognized for the great range of financial services they
offer
○ Bank service menus are expanding rapidly today to include investment banking,
insurance protection, financial planning, advice for merging companies, the sale
of risk-management services to businesses and consumers, and numerous other
innovative financial products
● The Legal Basis for Banking
○ A bank is any business offering deposits (tiền gửi) subject to withdrawal on
demand and making loans of a commercial or business nature (cho vay có tính
chất thương mại/kinh doanh)
○ Congress then defined a bank as any institution that could qualify for deposit
insurance administered by the Federal Deposit Insurance Corporation (FDIC)
○ Under federal law in the U.S., a bank had come to be defined, not so much by its
array of service offerings, but by the government agency insuring its deposits
● The Legal Basis for Banking in Vietnam
○ In Vietnam, a bank is a credit institution (tổ chức tín dụng) permitted to conduct
all banking activities and other related business operations.
○ "Banking activities" are monetary business activities and banking services, the
regular operation of which is the receipt of deposits and use of that to extend
credits, provide payment services;
○ "Non-bank credit institution" is a credit institution permitted to engage in some
banking activities as its regular business, but not permitted to receive individual
deposits and to provide payment services.

II. The Financial System and Competing Financial-Service Institutions

● Roles of the Financial System
○ The primary purpose of the financial system is to encourage saving and to
transfer those savings to individuals and institutions planning to invest and
needing credit to do so
○ This process of encouraging savings and transforming savings into investment
spending causes the economy to grow, new jobs to be created, and living
standards to rise
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 ○ The financial system also provides a variety of supporting services:
■ Payment services
■ Risk protection services
■ Liquidity services
● Leading Competitors with Banks
○ Savings Associations
○ Credit Unions
○ Fringe Banks
○ Money Market Funds
○ Mutual Funds (Investment Companies)
○ Hedge Funds
○ Security Brokers and Dealers
○ Investment Banks
○ Finance Companies
○ Financial Holding Companies
○ Life and Property/Casualty Insurance Companies

III. Bank regulation

1. Goal
● Ensure safety and soundness of banks protecting public’s savings and confidence
● Provide an efficient and competitive financial system
● Provide monetary stability to achieve national broad economic goals
● Maintain the integrity of the payments system
● Ensure equal opportunity and fairness in the public’s access to financial services
● Provide government with credit, tax revenues and other services
● Help sectors that have special credit needs

2. Why are banks so closely regulated?

● Banks are among leading repositories (kho lưu trữ) of public’s savings
● Bank’s power of creating money in form of readily spendable deposits
● Banks provide individuals and businesses with loans for consumption and investment,
which should be equally and adequately supplied.
● Governments rely upon banks in conducting economic policies, collecting taxes and
dispensing (phân phối) government payment.

3. Shortcomings of restrictive bank regulation

● May encourage monopoly due to conditional entry
● Does not prevent bank failure
● Cannot eliminate economic risk
● Does not guarantee that bank management will make good decisions, but create a
struggle between regulators and banks going on definitively
● Less-regulated businesses win customers away from more-regulated banks.

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 4. What is Regulated?
● Initial creation of depository institutions
○ Initial licensing and chartering
○ Location and number of physical branches, offices
○ Initial board of directors and officers
○ Minimum cash and capital requirements to open
● On-going operations
○ Mergers and acquisitions
○ Opening or closing of offices, branches
○ Many operations procedures
○ What financial services/products may be offered
● Assets
○ Diversification of assets
○ Quality of assets
○ Liquidity of assets
○ Level of cash reserves
● Liabilities & equity
○ Types of liabilities created
○ Distribution of financing of assets
○ Quality of liability and equity accounts
○ Minimum capital requirements
● Others
○ Community involvement
○ Degree of market share in each market area
○ Non-discriminatory operating policies
● Regulatory Process
○ Examinations
○ Reports
○ CAMELS Rating: C-apital adequacy; A-sset Quality; M-anagement
Quality; E-arnings – amount & stability; L-iquidity; S-ensitivity to market risk

5. The Federal Reserve System

● Fundamental Functions
○ Conduct monetary policy
○ Provide and maintain the payments system
○ Supervise and regulate banking operations
● Organisation
○ Board of Governors
○ 12 Federal Reserve District Banks
● Monetary Policy Tools
○ Open Market Operation: Open market purchases (sales) increase (decrease)
reserves & the money supply

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 ○ Discount Rate: Decreasing (Increasing) the discount rate makes bank borrowing
less (more) expensive, which leads to an increase (decrease) in the money supply
○ Reserve Requirements: Decreasing (Increasing) reserve requirements increases
(decreases) the money supply

● State bank of Vietnam

IV. Bank functions

● Bank functions
○ Banks are the primary conduit (cầu nối chính) for monetary policy
○ Banks are the primary source of credit for most small businesses and many
individuals
○ Banks are the major repository of public savings
○ Banks are the principal operator of the payment system.
● Services banks and many of their closest competitors offer the public: Services banks
have offered for centuries
○ carrying out currency exchange
■ Bank trade one form of currency to another in return for fee
■ Start from early days of banks
■ Become more complicated in the global financial market
■ Be provided by large and well-experienced banks
○ discounting commercial notes (chiết khấu thương phiếu) and making business
loans
■ Discounting commercial notes/making loans to merchants based on
accounts receivable
■ Making direct loans for purchasing inventories of goods (short-term) or
for constructing new facilities (long-term)
■ Be provided by banks and many other financial- service competitors
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 ■ Be the core and main revenue-earning service of many banks
○ offering savings deposits
■ Be the earliest and major source of fund for making loan
■ Composed of many types different in maturity (kỳ hạn), form of currency,
interest, etc.
■ Be the most stable funding source
■ Deposit is subject to reserve requirement and insurance
○ safekeeping of valuables and certification of value
■ Keep gold and other valuables of customers in secure vaults in return for
fee
■ Start since the old days of banks in the Middle Ages
○ supporting government activities with credit
■ Banks in Europe during the Industrial Revolution and in America during
the Revolutionary War had to purchase government bonds with a portion
of deposits.
■ The custom continues in the modern world
■ Banks use government bond as a shelter of liquidity
○ offering checking accounts (demand deposits)
■ Demand deposits permit depositors to write draft/cheque for payment of
goods and services
■ Be one of the most important offerings of the industry
■ Service is provided by not only banks but also credit unions, savings
associations, etc.
■ Today the service is extended to the internet with the use of smart cards
■ Provide banks with cheap source of fund
○ offering trust services
■ Banks manage financial affairs and property of individuals and firms in
return for fee
■ In property management, banks act as a trustee for wills, managing the
deceased customer’s estate,…
■ In the commercial trust department, the bank manages pension plans for
businesses and acts as an agent issuing stocks and bonds.
○ granting consumer loans
■ By early 20th century, banks started lending consumers given the heavy
competition for business deposits and loans
■ The trend has increased rapidly after the World War 2
■ Other current competitors for the consumer credit accounts are credit
unions and credit card companies.
■ The service bears high risk but returns high earnings
○ providing financial advising:
■ Banks gains good reputation for understanding and experience in the
financial market

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 ■ Customers ask for advice, particularly in credit utilisation, saving or
investing funds
■ Services provided are plentiful including financial plan preparation,
marketing opportunity consultation, fund seeking, investment options, etc.
○ managing cash
■ Bank handle cash collection and disbursement for firms, invest temporary
cash surpluses
■ Service is expanded to individuals and firms
■ Bank earns not only fee, but also low-cost fund in demand deposit
accounts
○ offering equipment leasing:
■ Equipment leasing is popular for both businesses and lenders: businesses
get needed equipment without a big upfront cost, and lenders benefit from
tax breaks on depreciation. (giảm thuế khấu hao)
■ Equipment leasing: win-win for businesses (lower upfront cost) and
lenders (tax advantages).
○ making venture capital loans
■ Finance the start-up cost of new companies
■ Implement through a venture capital firm because added risk
■ The venture capital firm raise fund from investors looking for high profit
○ selling insurance policies
■ Bank sell insurance policies through acquiring control of insurance
companies
■ Bank can gain high earning in the high-risk insurance industry
■ Banks possess privileges over independent insurers in terms of customers,
branches, system, etc.
■ Insurance agencies are affiliates or BHC or FHC
○ selling and managing retirement plans
■ Bank actively involved in managing retirement plan of businesses make
available to employees
■ Incoming fund is invested to wisely selected securities ensuring
acceptable risk and return
■ Bank also is in charge of dispensing payment to retired or disabled
employees
○ dealing in securities (chứng khoán): offering security brokerage and investment
banking services
■ Bank provides security brokerage service (dịch vụ môi giới chứng khoán)
and security underwriting/investment banking services
■ Bank offer mutual funds, annuities and other investment products with
clear consultation to customers regarding higher expected yields and risk
■ Bank temporarily buy stocks of large corporation aiding new business
launching or company expansion by offering merchant banking services

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 ■ Bank acts as risk intermediation providing customers with risk hedging
tools (e.g. swap, option, future contract) offered by themselves or from
third party
■ Services are provided through affiliated securities firms or insurance
companies.
○ offering mutual funds, annuities, and other investment products
○ offering merchant banking service
○ offering risk management and hedging services

V. Bank organisation
● Unit Banks
○ offer all services from one office
○ one of the oldest kinds of banks
○ new banks are generally unit banks until can grow and attract more resources
● Branch Banks
○ offer full range of services from several locations
○ senior management at the home office
○ each branch has its own management team with limited decision making ability
○ some functions are highly centralised, while others are decentralised
● Reasons for Growth of Branching
○ exodus of population to suburban communities (sự di cư của người dân đến
ngoại ô)
○ increased bank failures in recent years
○ business growth
● Bank branch policy in Vietnam: New branch set up – Circular No. 21/2013/TT-NHNN
VND 300 billion x N1 + VND 50 billion x N2 < C
Of which:
○ C: the real value of the charter capital of a commercial bank till the time of
request (VND billion).
○ N1: quantity of branches which have been established and requested for
establishment at Hanoi and Ho Chi Minh urban area.
○ N2: quantity of branches which have been established and requested for
establishment at Hanoi suburban, Ho Chi Minh suburban; and other provinces
and centrally-run cities
● Electronic Branches
○ internet banking services
○ automated teller machines (atms)
○ point of sale (pos) terminals
● Bank Holding Companies (BHC)
○ A Corporation Chartered for the Purpose of Holding the Stock of One or More
Banks
○ Control of a bank is Assumed When 25% or More of the Stock is Owned
○ Must Get Approval from Federal Reserve Board to Control a Bank
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 ○ One-Bank Holding Companies vs. Multibank Holding Companies
● Organisational Structure of a BHC

● Bank subsidiaries
○ Bank controls one or more subsidiaries. Subsidiaries offer other services such as
insurance and security brokerage services
○ Profits and losses of each subsidiary impact parent Bank
○ Parent company’s net income is typically derived from dividends, interest,
management fees from equity in subsidiaries, and interest paid on holding
company debt.
● Joint-venture, foreign branch and 100% foreign banks
○ Allowed to conduct operations similar to domestic banks
○ Obligatorily follow regulations in VN
○ For foreign branch, decisions are made depending on the foreign home bank
policy → less independence
● Rep office (văn phòng đại diện) of foreign banks
○ Operate as liaison office (văn phòng liên lạc)
○ Conduct market research
○ Develop investment projects of foreign credit institutions in Vietnam ;
○ Promote and monitor the implementation of contracts, agreements signed
between foreign credit institutions and Vietnamese Credit institutions and
enterprises, projects funded by foreign credit institutions in Vietnam
→ No direct profitable activities
● Nonbank Businesses of BHCs
○ Finance Companies ○ Data Processing Companies
○ Mortgage Companies ○ Factoring Companies

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 ○ Security Brokerage Firms ○ Credit Card Companies
○ Financial Advising ○ Leasing Companies
○ Credit Insurance ○ Insurance Companies and
Underwriters Agencies
○ Merchant Banking ○ Real Estate Services
○ Investment Banking Firms ○ Savings Associations
○ Trust Companies
● Reasons for the Growth of BHCs
○ geographic diversification
○ product line diversification
○ tax sheltering
○ double leveraging
○ source of strength
○ a way around regulatory restrictions
● Reasons for Full-Service Interstate Banking
○ need to bring new capital to revive struggling local economies
○ the expansion by non bank financial institutions with fewer restrictions
○ a strong desire by large banks to expand geographically
○ belief among regulators that large banks are more efficient and less prone to
failure
○ advances in technology

VI. Key trends affecting all financial-service firms

1. Fundamental forces of change
● Securitization: The process of converting assets into marketable securities
○ Mortgages
○ Credit card receivables
● Off-Balance Sheet Activities
○ Loan commitments
○ Loan guarantees
○ Standby letters of credit
○ Interest rate swaps
○ Futures, forwards & options
○ Leases
● Increased Competition
○ For Deposits: Interest rate ceilings and inflation
○ For Loans
■ Commercial paper
■ Junk bonds
■ Credit scoring
■ Credit derivatives
● Impact of Non Bank Competition

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 ○ Captive Finance Companies: A subsidiary whose purpose is to provide financing
to customers buying the parent company's product (e.g. General Motors
Acceptance Corporation (GMAC))
○ General Finance Companies: Fund their loans by issuing commercial paper and
long-term bonds. Their cost of funds is higher than a bank’s, but they charge
higher rates
● Competition for Payments Services
● Competition for Other Bank Services
○ Trust services ○ Real estate appraisal
○ Brokerage services ○ Credit life insurance
○ Data processing ○ Personal financial consulting
● Change Investment Banking
○ National full-line firms
○ Investment banking firms
○ Underwriter: Underwriter syndicate
○ Broker versus Dealer
● Role of Regulation
○ Regulatory Dialectic
○ Process of regulation, market response, and reregulation
○ Financial Innovation
● Deregulation and Re-regulation
○ Deregulation: Eliminating existing regulations
○ Reregulation: Implementing new restrictions on banking activities
● Financial Innovation
○ Innovation may be caused by a bank wanting to:
○ Enter into a new geographic market
○ Enter into a new product market
○ Deliver services less expensively.
● Advances and Technology
○ Advances in technology increase the scope of the global marketplace and
competition
○ Advances in technology also reduce the need for an intermediary by providing
easy access to information
○ Increasing competition by reducing the cost of being an information intermediary
● Globalisation: Is the evolution of markets and institutions where geographic boundaries
do not restrict financial transactions or competition

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Lecture 2. The Financial Statements of Banks and Their
Principal Competitors
I. An Overview of Balance Sheets and Income Statements
● The Report of Condition shows the amount and composition of funds sources (financial
inputs) drawn upon to finance lending and investing activities and how much has been
allocated to loans, securities, and other funds uses (financial outputs) at any given point
in time
● In contrast, the financial inputs and outputs on the Report of Income show how much it
has cost to acquire funds and to generate revenues from the uses the financial firm has
made of those funds
● The Report of Income also shows the revenues (cash flow) generated by selling services
to the public, including making loans and servicing customer deposits
● The Report of Income shows net earnings after all costs are deducted from the sum of
all revenues, some of which will be reinvested in the financial firm for future growth
and some of which will flow to stockholders as dividends
II. The Balance Sheet (Report of Condition)
1. The Principal Types of Accounts
● A balance sheet lists the assets, liabilities, and equity capital (owners’ funds) held by or
invested in a bank or other financial firm on any given date
Asset = Liabilities + Equity capital
● For banks and other depository institutions the assets on the balance sheet are of four
major types:
○ Cash in the vault and deposits held at other depository institutions (C)
○ Government and private interest-bearing securities purchased in the open market
(S)
○ Loans and lease financings made available to customers (L)
○ Miscellaneous assets (MA) (các tài sản khác)
● Liabilities fall into two principal categories:
○ Deposits made by and owed to various customers (D)
○ Nondeposit borrowings of funds in the money and capital markets (NDB)
● Equity capital represents long-term funds the owners contribute (EC)
C + S + L + MA = D + NDB + EC
○ Cash assets (C) are designed to meet the financial firm’s need for liquidity
○ Security holdings (S) are a backup source of liquidity and include investments
that provide a source of income
○ Loans (L) are made principally to supply income
○ Miscellaneous assets (MA) are usually dominated by fixed assets (plant and
equipment) and investments in subsidiaries (if any)
○ Deposits (D) are typically the main source of funding for banks
○ Nondeposit borrowings (NDB) are carried out mainly to supplement deposits and
provide the additional liquidity that cash assets and securities cannot provide
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 ○ Equity capital (EC) supplies the long-term, relatively stable base of financial
support upon which the financial firm will rely to grow and to cover any
extraordinary losses it incurs
● One useful way to view the balance sheet identity is to note that liabilities and equity
capital represent accumulated sources of funds, which provide the needed spending
power to acquire assets
● A bank’s assets, on the other hand, are its accumulated uses of funds, which are made to
generate income for its stockholders, pay interest to its depositors, and compensate its
employees for their labour and skill
● Thus, the balance sheet identity can be pictured simply as:
Accumulated uses of funds = Accumulated sources of funds
(assets) (liabilities and equity capital)
● Cash Assets
○ Account is called Cash and Deposits Due from Bank
○ Includes:
■ Vault Cash
■ Deposits with Other Banks (Correspondent Deposits)
■ Cash Items in Process of Collection
■ Reserve Account with the Federal Reserve
○ Sometimes called primary reserves
● Investment Securities - The Liquid Portion
○ Short Term Government Securities
○ Privately Issued Money Market Securities
■ Interest Bearing Time Deposits
■ Commercial Paper
○ Often called secondary reserves
● Investment Securities - The Income-Generating Portion
○ Taxable Securities
■ U.S. Government Notes
■ Government Agency Securities
■ Corporate Bonds
○ Tax-Exempt Securities
■ Municipal Bonds
● Trading Account Assets
○ Securities purchased to provide short-term profits from short-term price
movements
○ Occurs when the bank acts as a securities dealer
○ Valued at Market – FASB 115
● Federal Funds Sold and Reverse Repurchase Agreements
○ Includes mainly temporary loans (usually extended overnight, with the funds
returned the next day) made to other depository institutions, securities dealers, or
major industrial corporations

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 ○ The funds for these temporary loans often come from the reserves a bank has on
deposit with the Federal Reserve Bank in its district
○ Some of these temporary credits are extended in the form of reverse repurchase
(resale) agreements (RPs) in which the banking firm acquires temporary title to
securities owned by the borrower and holds those securities as collateral (tài sản
thế chấp) until the loan is paid off
● Loan Accounts
○ The Major Asset
○ Gross Loans – Sum of All Loans
○ Allowance for Possible Loan Losses
■ Contra Asset Account
■ For Potential Future Loan Losses
○ Net Loans
○ Unearned Discount Income
○ Nonperforming Loans
● Types of Loans
○ Commercial and industrial (or business) loans
○ Consumer (or household) loans
○ Real estate (or property-based) loans
○ Financial institutions loans
○ Foreign (or international) loans
○ Agricultural production loans
○ Security loans
○ Leases
● Loan Losses
Beginning Allowance for Loan Losses + This Year’s Provision for Loan Loss -
Actual Charge-Offs of Worthless Loans + Recoveries from Previous Charge-Offs =
Ending Allowance for Loan Losses
● Specific and General Reserves
○ Specific Reserves
■ Set aside to cover a particular Loan
■ Designate a portion of ALL or
■ Add more reserves to ALL
○ General Reserves: Remaining ALL
○ Determined by management but influenced by taxes and government regulation
○ Loans to lesser developed countries require allocated transfer reserves
○ ALL = allowance for loans losses
● Miscellaneous Assets
○ Bank Premises and Fixed Assets
○ Other Real Estate Owned (OREO)
○ Goodwill and Other Intangibles
● Liabilities of the Banking Firm:
○ Deposits
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 ■ Non interest-Bearing Demand Deposits
■ Savings Deposits
■ NOW Accounts (negotiable order of withdrawal)
■ Money Market Deposit Accounts (MMDA)
■ Time Deposits
○ Nondeposit Borrowings
■ Fed Funds Purchased
■ Securities Sold Under Agreement to Repurchase (Repurchase
Agreements)
■ Acceptances Outstanding
■ Eurocurrency Borrowings
■ Subordinated Debt
■ Limited Life Preferred Stock
■ Other Liabilities
● Equity Capital of the Banking Firm
○ Preferred Stock
○ Common Stock
○ Common Stock Outstanding
○ Capital Surplus
○ Retained Earnings (Undivided Profits)
○ Treasury Stock
○ Contingency Reserve

2. Recent Expansion of Off-Balance-Sheet Items in Banking

● Unused Commitments
● Standby Credit Agreements
● Derivative Contracts
○ Futures Contracts
○ Options
○ Swaps
● OBS transactions expose a firm to counterparty risks
● OBS items have grown so rapidly that, for the banking industry as a whole, they exceed
total bank assets many times over
3. The Problem of Book-Value Accounting
● Original (historical, book-value) cost
● Amortised cost
● Market-value
● Held-to-maturity and available-for-sale securities
● Window Dressing (làm đẹp báo cáo tài chính)
● Auditing Financial Statements
○ Audit Committees
○ Sarbanes-Oxley Accounting Standards Act

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 4. Auditing: Assuring Reliability of Financial Statements
III. Components of the Income Statement (Report of Income)
1. Financial Flows and Stocks
● Indicates the amount of revenue received and expenses incurred over a specific period
of time
● Shows how much it has cost to acquire funds and to generate revenues from the uses of
funds in the Report of Conditions
● Shows the revenues (cash flow) generated by selling services to the public
● Shows net earnings after all costs are deducted from the sum of all revenues
Net income = Total revenue items - Total expense items

Revenue Items
○ Cash assets x average yield on cash assets
+ Security investments x average yield on security investments
+ Loans outstanding x average yield on loans
+ Miscellaneous assets x average yield on miscellaneous assets
+ Income from fees and trading account gains
Minus (-) Expense Items
○ Total deposits x average interest cost on deposits
+ Nondeposit borrowings x average interest cost on nondeposit borrowings
+ Owners’ capital x average cost of owners’ capital
+ Employee salaries, wages, benefits expense
+ Overhead expense
+ Provision for possible loan losses
+ Miscellaneous expense
+ Tax owed

● Income statements are a record of financial flows over time

● Therefore, we can represent the income statement as a report of financial outflows
(expenses) and financial inflows (revenues)
● Four main sections
○ Interest income
○ Interest expenses
○ Noninterest income
○ Noninterest expenses

Net Interest Income = Interest Income – Interest Expenses

● Interest Income Sources
○ Interest and Fees on Loans
○ Taxable Securities Revenue
○ Tax-Exempt Securities Revenue
○ Other Interest Income
● Interest Expense Sources
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 ○ Deposit Interest Costs
○ Interest on Short-Term Debt
○ Interest on Long-Term Debt

Net Noninterest Income = Non Interest Income – Noninterest Expenses

● Noninterest Income Sources
○ Fees Earned from Fiduciary Activities (hoạt động ủy thác)
○ Service Charges on Deposit Accounts
○ Trading Account Gains and Fees
○ Additional Noninterest Income
● Noninterest Expense Sources
○ Wages, Salaries, and Employee Benefits
○ Premises and Equipment Expense
○ Other Operating Expenses

2. Comparative Income Statement Ratios for Different-Size Financial Firms

IV. The Financial Statements of Leading Nonbank Financial Firms: A Comparison to
Bank Statements
● The financial statements of nonbank financial firms have, in recent years, come closer
and closer to what we see on bank statements
○ Especially true of thrift institutions (định chế tiết kiếm - là định chế tài chính ký
gửi mà chức năng chủ yếu là khuyến khích tiết kiệm cá nhân và sở hữu nhà ở
thông qua cho vay cầm cố)
■ Thrifts’ balance sheet are dominated by loans, deposits from customers,
and borrowings in the money market
■ Thrifts’ income statements are heavily tilted toward revenue from loans
and by the interest they must pay on deposits and money market
borrowings
○ Other groups in the financial-service industries such as finance companies, life
and property/casualty insurers, mutual funds, and security brokers and dealers
■ Their financial statements include sources and uses of funds unique to the
functions of these industries

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V. An Overview of Key Features of Financial Statements and Their Consequences

Lecture 3. Managing and Pricing Deposit Services

I. Types of Deposit Accounts Offered
● Transaction (Payment or Demand) Deposits
○ Making payment on behalf of customers
○ One of the oldest services
○ Provider is required to honour any withdrawals immediately
○ Hottest item in the transaction deposit field today appears to be the mobile check
deposit: Designed principally for customers on the move, carrying camera-
equipped smartphones
● Nontransaction (Savings or Thrift) Deposits
○ Longer-Term
○ Higher Interest Rates Than Transaction Deposits
○ Generally Less Costly to Process and Manage
● Transaction Deposit: An account used primarily to make payments for purchases of
goods and services
● Types of Transaction Deposits
○ Non Interest-Bearing Demand Deposits
■ Interest was prohibited by Glass-Steagall Act
■ One of the most volatile and unpredictable sources of funds
■ Most deposits are held by business firms
○ Interest-Bearing Demand Deposits
■ Negotiable Orders of Withdrawal (NOW)
■ Money Market Deposit Account (MMDA) and Super NOW due to Garn-
St Germain Depository Institution Act of 1982
19
 ● Nontransaction Deposit: An account whose primary purpose is to encourage the bank
customer to save rather than make payments
● Types of Nontransaction Deposits
○ Passbook Savings Account/Statement Savings Deposit
○ Time Deposit (CD)
○ Retirement Savings Deposits
■ Individual Retirement Account (IRA) - The Economic Recovery Tax Act
of 1981
■ Keogh Plan retirement accounts – available to self-employed persons
■ Roth IRA – The Tax Relief Act of 1997 allows non-tax-deductible
contributions that can grow tax free and pay no tax on investment
earnings when withdrawn
■ Default Option Retirement Plans – The Pension Protection Act of 2006
● The Composition of Deposits
○ Bankers would generally prefer a high proportion of transaction deposits
(including regular checking or demand accounts) and low yielding time and
savings deposits
○ These accounts are among the least expensive of all sources of funds and often
include a substantial percentage of core deposits
● The Ownership of Deposits: The dominant holder of bank deposits inside the United
States is the private sector
● The Cost of Different Deposit Accounts: Managers of depository institutions would
prefer to sell only the cheapest deposits to the public but it is predominantly public
preference that determines which types of deposits will be created
II. Pricing Deposit Services
● In pricing deposit services, management is caught in a dilemma (trade off)
○ It needs to pay a high enough interest return to attract and hold customer funds,
but must avoid paying an interest rate so costly it erodes any potential profit
margin
● An individual depository institution has little control over its prices in a financial
marketplace that approaches perfect competition
○ It is the marketplace, not the individual financial firm, that ultimately sets prices
○ Financial institutions, like most other businesses, are price takers, not price
makers
● Deregulation has brought more frequent use of unbundled service pricing as greater
competition has raised the average real cost of a deposit for deposit-service providers
● This means that deposits are usually priced separately from other services
● Cost-plus pricing formula
Unit price Estimated Planned
charged the Operating overhead expense profit margin
customer for = expense per unit + allocated to the + from each
each deposit of deposit service deposit service service unit
service function sold

20
III. Conditional Deposit Pricing
● The marginal cost of moving the deposit rate from one level to another
● The marginal cost rate, expressed as a percentage of the volume of additional funds
coming into the bank

Marginal cost = Change in total cost = New interest rate x Total funds raised at new rate
- Old interest rate x Total funds raised at old rate

Change∈total cost
Marginal cost rate = Additional funds raised

● Conditional Pricing
○ Where a depository sets up a schedule of fees in which the customer pays a low
fee or no fee if the deposit balance remains above some minimum level, but
faces a higher fee if the average balance falls below that minimum
○ Conditional pricing techniques vary deposit prices based on one or more of these
factors
■ The number of transactions passing through the account (e.g., number of
checks written, deposits made, wire transfers, stop payment orders, or
notices of insufficient funds issued)
■ The average balance held in the account over a designated period (usually
per month)
■ The maturity of the deposit in days, weeks, months, or years
○ Deposit pricing policy is sensitive to at least two factors:
■ The types of customers each depository institution plans to serve
■ The cost that serving different types of depositors will present to the
offering institution

IV. Rules for Deposit Insurance coverage

● Related to the idea of targeting the best customers for special treatment is the notion of
pricing deposits according to the number of services the customer uses
○ Customers who purchase two or more services may be granted lower deposit fees
compared to the fees charged customers having only a limited relationship to the
offering institution
● In theory, relationship pricing promotes greater customer loyalty and makes the
customer less sensitive to the prices posted on services offered by competing financial
firms

V. Disclosure of Deposit terms

● Consumers must be informed of the deposit terms before they open a new account
● Depository institutions must disclose:

21
 ○ Minimum balance to open
○ Minimum to avoid fees
○ How the balance is figured
○ When interest begins to accrue
○ Penalties for early withdrawal
○ Options at maturity
○ The APY (annual percentage yield - chỉ số dùng để tính toán tỷ suất lợi nhuận
hàng năm)

VI. Lifeline Banking

● Should every adult citizen be guaranteed access to certain basic financial services, such
as a checking account or personal loan?
● A recent survey found that a substantial segment of the U.S. population is either
○ “Unbanked”: No deposits or loans of any kind
○ “Underbanked”: Having access to some critical services but not others
● Among the “underbanked” are those families relying on expensive payday loans, check
cashing firms, pawnshops, and money order services to pay their bills
● Racial and ethnic minorities are substantially more likely than the general population to
be “underbanked”

Lecture 4. Lending to Business Firms and Pricing

Business Loans
I. Types of Business Loans: Short term vs Long term
- Short-term business loans:
+ Self-liquidating inventory loans:
● usually were used to finance the purchase of inventory – raw materials or
finished goods to sell
● take advantage of the normal cash cycle inside a business firm
● appears to be less of a need for traditional inventory financing due to the
development of just in time (JIT) and supply chain management
techniques
+ Working capital loans:
● Short-run credit that lasts from a few days to one year
● Secured by accounts receivable or by pledges of inventory
● Carry a floating interest rate
● A commitment fee is charged on the unused portion of the credit line and
sometimes on the entire amount of funds made available
● Compensating deposit balances may be required from the customer:
Recently compensating deposit balances as a part of a business-loan
arrangement has been on the decline

22
 + Interim construction financing (tài trợ xây dựng tạm thời): Secured short-term
loan used to support the construction of homes, apartments, office buildings,
shopping centers, and other permanent structures
+ Security dealer financing: Dealers in securities need short-term financing to
purchase new securities and carry their existing portfolios of securities until they
are sold to customers or reach maturity
+ Retailer and equipment financing: Lenders support installment purchases of
automobiles, home appliances, and other durable goods by financing the
receivables that dealers selling these goods take on when they write installment
contracts to cover customer purchases
+ Asset-based loans (accounts receivable financing, factoring, and inventory
financing): Credit secured by the shorter-term assets of a firm that are expected
to roll over into cash in the future
+ Syndicated loans (các khoản vay hợp vốn): A loan package extended to a
corporation by a group of lenders
- Long-term business loans:
+ Term loans to support the purchase of equipment, rolling stock, and structures:
Designed to fund longer-term business investments, such as the purchase of
equipment or the construction of physical facilities, covering a period longer than
one year
+ Revolving credit financing (tài trợ tín dụng quay vòng):
● Allows a customer to borrow up to a prespecified limit, repay all or a
portion of the borrowing, and reborrow as necessary
● One of the most flexible of all business unsecured loans
● May be short-term or long-term
● Lenders normally charge a loan commitment fee
● Two types: formal loan commitment and confirmed credit line (hạn mức
tín dụng)
+ Project loans:
● Credit to finance the construction of fixed assets
● Most risky of all business loans
● Some of the risks of project loans:
1. Large amounts of funds are usually involved
2. The project may be delayed by weather or shortage of materials
3. Laws and regulations in the region where the project lies may
change
4. Interest rates may change
+ Loans to support acquisitions of other business firms:
● The 1980s and 1990s ushered in an explosion of loans to finance mergers
and acquisitions
● Leveraged buyouts (LBOs) usually involve acquiring a controlling
interest in another firm with the use of a great deal of debt (leverage) to
finance the transaction
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 II. Analyzing business loans requests
- Often business loans are of such large denomination (mệnh giá) that the lending
institution itself may be at risk if the loan goes bad
- The most common sources of repayment for business loans are:
1. The business borrower’s profits or cash flows
2. Business assets pledged as collateral behind the loan
3. A strong balance sheet with ample amounts of marketable assets and net worth
4. Guarantees given by the business, such as drawing on the owners’ personal
property to backstop a loan
- Analysis of a Business Borrower’s Financial Statements:

III. Financial Ratio Analysis of a Customer’s Financial Statements

- Information from balance sheets and income statements is typically supplemented by
financial ratio analysis
- Critical areas of potential borrowers loan officers consider:
1. Ability to control expenses
2. Operating efficiency in using resources to generate sales
3. Marketability of product line
4. Coverage that earnings provide over financing cost
5. Liquidity position, indicating the availability of ready cash
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 6. Track record of profitability
7. Financial leverage (or debt relative to equity capital)
8. Contingent liabilities (Các khoản nợ tiềm tàng) that may give rise to
substantial claims (các yêu cầu bồi thường đáng kể) in the future
- The Business Customer’s Control over Expenses: A barometer of the quality of a firm’s
management is how it controls its expenses and how well its earnings are likely to be
protected and grow
- Selected financial ratios to monitor a firm’s expense control:
+ Wages and salaries/Net sales
+ Overhead expenses/Net sales
+ Depreciation expenses/Net sales
+ Interest expense on borrowed funds/Net sales
+ Cost of goods sold/Net sales
+ Selling, administrative, and other expenses/Net sales
+ Taxes/Net sales
- Operating Efficiency: Measure of a Business Firm’s Performance Effectiveness.
+ It is also useful to look at a business customer’s operating efficiency.
+ Important financial ratios here include:
● Annual cost of goods sold/Average inventory (or inventory turnover ratio)
● Net sales/Net fixed assets
● Net sales/Total assets
● Net sales/Accounts and notes receivable

- Marketability of the Customer’s Product or Service:

+ In order to generate adequate cash flow to repay a loan, the business customer
must be able to market goods, services, or skills successfully
+ The gross profit margin (GPM), defined as

+ A closely related and somewhat more refined ratio is the net profit margin
(NPM)

- Coverage Ratios: Measuring the Adequacy of Earnings:

+ Coverage refers to the protection afforded creditors (sự bảo vệ chủ nợ) based on
the amount of a business customer’s earnings
+ The best-known coverage ratios include

25
 - Liquidity Indicators for Business Customers: The borrower’s liquidity position reflects
his or her ability to raise cash in timely fashion at reasonable cost, including the ability
to meet loan payments when they come due

- Profitability Indicators: Popular bottom line indicators include:

+ Before-tax net income / total assets, net worth, or total sales
+ After-tax net income / total assets (or ROA)
+ After-tax net income / net worth (or ROE)
+ After-tax net income / total sales (or ROS) or profit margin
- The Financial Leverage Factor as a Barometer of a Business Firm’s Capital Structure:
+ Any lender is concerned about how much debt a borrower has taken on in
addition to the loan being sought
+ Key financial ratios used to analyze any borrowing business’s credit standing
and use of financial leverage include

IV. Collateral and Contingent Liabilities

- It is standard practice to compare each business customer’s performance to the
performance of the customer’s entire industry:
+ Dun & Bradstreet Industry Norms and Key Business Ratios
+ RMA Annual Statement Studies

26
 1. Contingent Liabilities
- Usually not shown on customer balance sheets are other potential claims against the
borrower:
1. Guarantees and warranties behind the business firm’s products
2. Litigation or pending lawsuits against the firm
3. Unfunded pension liabilities
4. Taxes owed but unpaid
5. Limiting regulations
- These contingent liabilities can turn into actual claims against the firm’s assets and
earnings at a future date
- Loan officer must ask the customer about pending or potential claims against the firm
- Environmental Liabilities:
+ The Comprehensive Environmental Response, Compensation, and Liability Act
(CERCLA) and its Super Fund Amendments: Make current and past owners of
contaminated property or of businesses located on contaminated property and
those who dispose of or transport hazardous substances potentially liable for any
cleanup costs associated with environmental damage
- Underfunded Pension Liabilities:
+ Under Financial Accounting Standards Board (FASB), borrowing customers
may be compelled to record employee pension plan surpluses and deficits on
their balance sheets
+ If projected pension-plan liabilities exceed expected funds sources, the result
may be an increase in liabilities
V. Sources and Uses of Business Funds
The Statement of Cash Flows illustrates how cash receipts and disbursements are generated by
operating, investing, and financing activities

27
VI. Pricing Business Loans
- One of the most difficult tasks in lending is deciding how to price a loan: Lender wants
to charge a high enough interest rate to ensure each loan will be profitable and
compensate the lending institution for the risks involved
- The Cost-Plus Loan Pricing Method:

- The Price Leadership Model:

- In the U.S., the prevailing prime rate is considered to be the most common base rate
- Two different floating prime rate formulas were soon developed by leading money
center banks:
+ Prime-plus method

28
 + Times-prime method
- London Interbank Offered Rate (LIBOR):
+ Leading commercial lenders have switched to LIBORbased loan pricing due to
the growing use of Eurocurrencies as a source of loanable funds
+ LIBOR-based loan rate = LIBOR + Default-risk premium + Profit margin
- Below-Prime Market Pricing:
+ Banks announced that some large corporate loans covering only a few days or
weeks would be made at low money market interest rates
+ Federal funds rate on domestic loans plus a small margin
VII. Customer Profitability Analysis (CPA)
- New loan pricing technique that is similar to the cost-plus loan pricing technique
- Assumes that the lender should take the whole customer relationship into account when
pricing a loan

+ Revenues paid by a borrowing customer may include loan interest, commitment

fees, fees for cash management services, and data processing charges.
+ Expenses incurred on behalf of the customer may include wages and salaries of
the lender’s employees, credit investigation costs, interest accrued on deposits,
account reconciliation and processing costs, and funds’ acquisition costs.
+ Net loanable funds are the amount of credit used by the customer minus his or
her average collected deposits (adjusted for required legal reserves). Trong sách
cũng có ghi cái này là net amount of the Bank’s Reserves Expected to be drawn
upon (rút ra) by the customer và nó bằng Average amount of credit committed to
customer - Average customer deposit balances (net of required reserves)

- If the net rate of return (tỷ suất lợi nhuận ròng) is positive, the proposed loan is
acceptable because all expenses have been met
- If the net rate of return is negative, the proposed loan and other services provided to the
customer are not correctly priced as far as the lender is concerned
- The greater the perceived risk of the loan, the higher the net rate of return the lender
should require
- Earnings Credit for Customer Deposits: In calculating how much in revenues a
customer generates for a lending institution, many lenders give the customer credit for
any earnings received from investing the balance in the customer’s deposit account

29
Lecture 5. Consumer Loans, Credit Cards, and Real Estate
Lending
1. Types of Loans for Individuals and Families
- Consumer loans are classified by:
+ Purpose – what the borrowed funds will be used for
+ Type – whether the borrower must repay in installments or repay in one lump
sum
- Residential Loans:
+ Credit to finance the purchase of a home or fund improvements on a private
residence
+ Usually a long-term loan, typically bearing a term of 15 to 30 years
+ Secured by the property itself
+ May carry either a fixed interest rate or a variable (floating) interest rate
+ Banks are the leading residential mortgage lenders today
- Nonresidential Loans:
+ Installment Loans:
● Short-term to medium-term loans, repayable in two or more consecutive
payments (usually monthly or quarterly)
● Used to buy big-ticket items (e.g., automobiles, furniture, and home
appliances) or to consolidate existing household debts
+ Noninstallment Loans:
● Short-term loans individuals and families draw upon for immediate cash
needs that are repayable in a lump sum
● May be for relatively small amounts and include charge accounts that
often require payment in 30 days or less
● May also be made for a short period (usually six months or less) to
wealthier individuals and can be quite large
- Credit Card Loans and Revolving Credit:
+ One of the most popular forms of consumer credit today is accessed via credit
cards
+ Credit cards offer their holders access to either installment or non-installment
credit
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 + Approximately two-thirds of all credit cards have variable rates of interest
+ Installment users of credit cards are far more profitable due to the interest
income they generate
+ Card providers also earn discount fees (usually 1 to 7 percent of credit card sales)
from merchants who accept their cards
- New Credit Card Regulations:
+ New credit card regulations appeared early in 2003 to slow the expansion of card
offers to customers with low credit ratings
+ There was evidence that some customers were charged high fees but encouraged
to make only low minimum payments → negative amortization
+ Regulatory agencies warned lenders that federal examiners would begin looking
for excessive use of fees and unreasonably liberal credit terms
- New Consumer Regulations: Dodd-Frank, CARD Act, and the New Consumer
Protection Bureau
+ Tricks and Traps - the CARD Act and Revised Regulation Z Appear
● Despite the repeated efforts of credit card regulators to deal with problems
in the credit card industry, consumer complaints continued
● Congress passed the Credit Card Accountability, Responsibility, and
Disclosure Act (“CARD Act”) in May 2009
● The new legislation restricted card issuers from raising Annual Percentage
Rates (APRs) unless adequate written notice of a rate change was given
● Customers must be told the reasons why credit terms were being changed
● Card companies are required to post their contracts on the Internet so
customers can “shop around”
● Card holders must receive periodic billing statements at least three weeks
before monthly payments are due
● An expanded “box” must be included on each monthly billing statement,
indicating the amount of interest paid and the consequences of paying the
minimum amount
● Fall within the Federal Reserve Board’s Regulation Z
- Dodd-Frank Reforms and Protections Push the Rules Farther Down the Road: The
Dodd-Frank Wall Street Reform and Consumer Protection Act
+ Creates the Consumer Financial Protection Bureau (CFPB)
+ The new bureau is directed to write new rules applying to such financial services
as:
● Making of consumer and credit card loans
● Warning consumers of possible damaging financial practices that could
result in losses
● Promoting financial literacy among consumers
● Improving the clarity and transparency of financial-service contracts for
the benefit of the public
+ The new CFPB is to be housed within the Federal Reserve but operate
independently with its own budget
31
 + The consumer protection bureau is expected to be controversial because it must
write hundreds of rules that will likely impact the consumer services side of
financial service providers
2. Unique Characteristics of Consumer Loans
- Lenders regard consumer loans as profitable credits with “sticky” interest rates:
+ Contract interest rates often do not change readily with market conditions as do
interest rates on most business loans
+ As a result, many consumer loans are subject to significant interest rate risk
- Consumer loans are usually priced so high that market interest rates on borrowed funds
and default rates on the loans themselves would have to rise substantially before
consumer credits would become unprofitable
- Interest rates so high on most consumer loans:
+ Consumer loans are among the most costly and most risky to make per dollar of
loanable funds committed to them
+ Consumer loans tend to be cyclically sensitive
+ Household borrowings appear to be relatively interest inelastic. They are more
concerned about the size of the monthly payment rather than the interest rate that
they are charged
+ Education and income levels materially influence consumers’ use of credit
3. Evaluating a Consumer Loan Request
- Character and Purpose:
+ Key factors in analyzing any consumer loan application are the character of the
borrower and the borrower’s ability to pay
+ Consumer lenders nearly always check with one or more credit bureaus
concerning the customer’s credit history
+ In the case of a borrower without a credit record or with a poor track record of
repaying loans, a cosigner may be requested to support repayment
+ Many lenders regard a cosigner as primarily a psychological device to encourage
repayment of the loan
- Other important items for lenders:
+ Income Levels
+ Deposit Balances
+ Employment and Residential Stability
+ Pyramiding of Debt
- How to Qualify for a Consumer Loan:
+ Home ownership or ownership of any form of real property
+ Maintain strong deposit balances
+ The most important thing to do – truthfully answer all of the loan officer’s
questions
4. Credit Cards and Credit Scoring
- The basic theory of credit scoring is that lenders and statisticians can identify the
financial, economic, and motivational factors that separate good loans from bad loans

32
- Underlying assumption – the same factors that separated good loans from bad loans in
the past will separate good loans from bad ones in the future within an acceptable risk
of error
- Such an automated credit determining system removes personal judgment from the
lending process
- The FICO system:
+ Scores range from 300 to 850 with higher values denoting less credit risk to
lenders
+ FICO score are based on five different types of information (most important to
least important):
1. The borrower’s payment history
2. The amount of money owed
3. The length of a prospective borrower’s credit history
4. The nature of new credit being requested
5. The types of credit that the borrower has already used
5. Laws & Regulations Applying to Consumer Loans
- Numerous laws and regulations limiting the activities of consumer lending institutions
have been enacted
- These laws fall into two categories:
+ 1. Disclosure rules: Mandate telling the consumer about the cost and other terms
of a loan or lease agreement
+ 2. Anti Discrimination laws: Prevent categorizing loan customers according to
their age, sex, race, or other irrelevant factors and denying credit to anyone
solely because of membership in one or more of these groups
- Customer Disclosure Requirements:
+ Truth-in-Lending Act
+ Fair Credit Reporting Act
+ Fair Credit Billing Act
+ Fair Debt Collection Practices Act
- Outlawing Credit Discrimination: Equal Credit Opportunity Act & Community
Reinvestment Act
- Predatory lending: An abusive practice among some lenders where lenders may require
excessive fees as well as unnecessary and excessive loan insurance
- Subprime Loans: Granting loans to borrowers who have below-average credit scores
- The Home Ownership and Equity Protection Act was passed in 1994 to protect home
buyers from loan agreements they could not afford
- Subprime lending is difficult to regulate
6. Real Estate Loans
- Depository institutions and finance and insurance companies make real estate loans to
fund the acquisition of real property (Homes, apartment complexes, shopping centers,
office buildings, and land)
- One of the most rapidly growing areas of lending over the past decade
- Real estate lending is different from other loans
33
- Real estate loans can be among the riskiest forms of credit extended to customers
- Differences between Real Estate Loans and Other Loans:
+ The average size of a real estate loan is usually much larger than the average size
of other loans
+ Mortgage loans tend to have longer maturities versus other types of loans
(Maturities of 15 years to 30 years are typical for single-family homes)
+ With real estate lending, the condition and value of the subject property are
nearly as important as the borrower’s income. Appraisals are critical to the loan
decision and must meet industry standards and government regulations
- Factors in Evaluating Applications for Real Estate Loans:
+ The amount of the down payment pledged by the borrower relative to the
purchase price of mortgaged property. The higher the ratio of loan amount to
purchase price, the less incentive the borrower has to honor the terms of the loan
+ Lenders may be willing to give a mortgage loan customer a lower loan rate for a
pledge that the customer will use the lender’s other financial services
+ Other aspects of each credit application that require assessment:
● Amount and stability of the borrower’s income
● The borrower’s available savings and where the borrower will obtain the
required down payment
● The borrower’s track record in caring for and managing property
● The outlook for real estate sales in the local market in case of
repossession of the property
● The outlook for market interest rates
- Home Equity Lending:
+ Homeowners can borrow the equity in their homes
+ Equity is defined as the difference between a home’s estimated market value and
the amount of the mortgage loans against it
+ Two main types of home equity loans: 1. Traditional Home Equity Loan and 2.
Lines of Credit Against a Home’s Borrowing Base
- The Most Controversial of Home Mortgage Loans: Interest-Only and Adjustable
Mortgages and the Recent Mortgage Crisis
+ When housing prices were soaring upward during the recent housing boom,
lenders make extravagantly priced homes affordable by make home mortgage
loans more readily available to families of even modest means
+ More families were encouraged to sign up for adjustable-rate loans (ARMs)
during a period when market interest rates were at historic lows
+ When home prices continued to rise, clever mortgage lenders came up with yet
another financial innovation – the interest-only adjustable home mortgage loan
(option ARM):
● With this type of credit the home buyer is obligated to pay only the
interest on his or her home loan for an initial period
● After that initial time interval passes, the home buyer would have to pay
both principal and interest until the loan was finally paid off
34
 ● Looked like predatory lending against lower-income families
● In an environment of rising market interest rates, many home buyers with
adjustable-rate loans faced higher interest payments
● Now lenders must disclose more about the actual terms of a home
mortgage loan and not represent a loan’s terms as “fixed” when those
terms can be changed over time
● Dodd-Frank Wall Street Reform and Consumer Protection Act resulted in
tough new rules:
1. Lenders who are pooling and securitizing mortgage loans they
create and sell are responsible for at least 5 percent of the credit
risk attached (qualified mortgages are exempt)
2. Previously lenders “washed their hands” of any responsibility
A Revised Federal Bankruptcy Code as Bankruptcy Filings Soar
- Households in record numbers have sought protection from their creditors under the
U.S. bankruptcy code
- Bankruptcy Abuse Prevention and Consumer Protection Act:
+ Made filing for bankruptcy more expensive and time-consuming
+ Before filing for bankruptcy, applicants must complete a certified credit
counseling program
+ Intended to discourage consumers from taking on too much debt and increasing
their risk profile
7. Pricing Consumer and Real Estate Loans: Determining the Rate of Interest and
other loan terms
- A financial institution prices every consumer loan by setting an interest rate, maturity,
and terms of repayment
- The Interest Rate Attached to Nonresidential Consumer Loans: the Cost-Plus Model

- Annual Percentage Rate (APR):

+ Annualized internal rate of return that equates expected total payments with the
amount of the loan
+ Takes into account how fast the loan is being repaid and how much credit the
customer will actually have use of during the life of the loan
+ Under the Truth-in-Lending Act, lenders must give the household borrower a
statement specifying the APR
+ Allows borrowers to compare a particular loan rate with the loan rates of other
lenders
- Simple Interest Rate:

35
 + Adjusts for the length of time a borrower actually has use of credit
+ If the customer is paying off the loan gradually, this approach determines the
declining loan balance, and that reduced balance is then used to determine the
amount of interest owed
- The Discount Rate Method:
+ Requires the customer to pay interest up front
+ Interest is deducted first and the customer receives the loan amount less any
interest owed
- The Add-On Loan Rate Method:
+ One of the oldest loan rate calculation methods
+ Any interest owed is added to the principal amount of the loan before calculating
required installment payments
+ Only if the loan is paid off in a single lump sum at the end will the add-on rate
equal the simple interest rate
- Rule of 78s:
+ Determine how much interest income a lender is entitled to accrue at any point in
time from a loan that is being paid out in monthly installments
+ Important especially when a borrower wants to pay off a loan early
+ Rule arises from the fact that the sum of the digits 1 through 12 is 78
+ To determine the borrowing customer’s interest rebate from early repayment of
an installment loan, total the digits for the months remaining on the loan and
divide the sum by 78
- Interest rates on Home Mortgage Loans:
+ Since the 1930s, most loans to finance the purchase of new homes were fixed-
rate mortgages (FRMs)
+ In 1981, adjustable-rate mortgages (ARMs) were authorized for offering by all
federally chartered depository institutions, created in response to the pressure of
inflation and volatile interest rates
+ Whether a customer takes out a FRM or ARM, the loan officer must determine
what the initial loan rate will be and what the monthly payments will be
+ The formula to compute monthly mortgage payments is

- Charging the Customer Mortgage Points:

+ Home mortgage loan agreements often require borrowers to pay an additional
charge up front called points
+ Points are prepaid interest and may be deductible as home mortgage interest

36
+ Eg: borrower seeks a $100,000 home loan and the lender assesses the borrower
an up-front charge of two points

37