Chapter 15: Nonbank Thrift Institutions: Savings Banks,

Credit Unions, and Money Market Funds

Learning Objectives
• Knowledge of the Savings and Loan and Savings Bank Industries
o Mutuals versus Stock Companies
o Deregulation and Sources and Uses of Thrifts’ Funds
o aturity Mismatch and Other Thrift Industry Problems
o Possible Remedies for Thrift Industry Problems
• Knowledge of Credit Unions: Services, Size, and Membership
o Credit Union Industry Advantages and Future Challenges
• Money Market Mutual Funds: Origins and Competitive Advantages
o Money Fund Asset Profiles and Safety Concerns

I. Savings Institutions
1. Savings and Loans
• First savings and loans originated in the 18th century England.
• First U.S. savings and loan appeared in the Philadelphia area in 1831.
o Began essentially as a single-product industry,
o Accept savings deposits from individuals and families and lend those
funds to home buyers.

2. Saving Banks
• Established in 1810 in Dumfriesshire, Scotland.
o ustomer-owned institutions were originally set up to grant access to the
financial system on the part of low-income savers and borrowers.
• First saving bank in US: the Philadelphia Savings Fund Society, appeared in
1816.
o Originally concentrated upon the sale of two key services—savings
accounts and residential (home) mortgage loans.
Recently, substantial numbers of S&Ls have converted to savings banks (along with a
number of conversions to commercial bank charters) in an effort to lower their regulatory
costs and further diversify their services.
Today, distinction between savings and loans, savings banks, and commercial banks is
very blurred. The public often cannot tell these depository institutions apart.

3. Mutuals
• depository institutions owned by their depositors; technically the owners.
• Earliest Savings and Loan Associations (S&Ls) were mostly mutuals – owned by
their depositors – but the stockholder-owned S&L corporation has come to
dominate the industry’s recent growth
 • attracting both savings and checking accounts and extending not only home loans
but a wide variety of other forms of credit to consumers.

II. Savings and loan and some savings banks troubles during the 1980s and 1990s
(Note main portfolio balances in Exhibit 15.1; pages 458-464)
a) Primary problem: savings and loans and some savings banks, historically, have issues
mortgage loans carrying mostly fixed interest rates while selling deposits to public whose
interest rates closely mirror changing market conditions.
Page 463: GAP. During periods of rapidly rising market interest rates, the industry’s net
interest margin—the difference between interest earnings on assets and interest costs on
borrowed funds—has often been severely squeezed. Sometimes industry’s net interest
margin turned negative for a time.
b) Individuals and families whose savings provide the bulk of association funds have
become more financially sophisticated, withdrawing deposits whenever high returns are
available elsewhere or whenever there is even hint of trouble in the industry. S&Ls
damaged to some extent by the growth of money market funds)

To remain competitive:
Need help from several sources:
(1) sound decision making to further diversify their activities;
(2) careful management of the loan portfolio to put good loans on the books and
minimize future loan losses;
(3) better use of risk-management tools (such as financial futures, swaps, and options) to
reduce interest-rate risk exposure and minimize damage from maturity mismatches;
(4) further relaxation of government regulations to permit the offering of new services
and the merging of smaller associations into larger financial-service companies.

III. Credit Unions

• Nonprofit associations accepting deposits from and making loans to their

members. (note growth in Exhibit 15.2 and asset composition in Exhibit 15.3)
• Benefited greatly from deregulation,
• Their long-run survival stems mainly from their being able to offer low loan rates
and high deposit interest rates and from their relatively low operating costs.
• Advantages: exemption from federal income taxes, while banks pay a substantial
portion of their earnings (roughly a third in recent years) in federal taxes.
• CUs appear to many bankers to have reached far beyond their original charters
which called for providing small cash loans at reasonable rates to be aggressive
multi-service financial intermediaries, active in such diverse fields as small
business loans, home mortgage and home equity loans, etc
New Loan Composition
• First-mortgage loans to purchase new homes and second-mortgage loans to repair
or improve existing homes: third of all credit loans.
• Finally, loans to small businesses have recently been added to many CUs service
menus, along with auto and equipment leases.
• Most rapidly growing loans included fixed and adjustable-rate first home
mortgages, second home mortgage loans, home equity loans, and lines of credit:
5 year maturity if unsecured; 30 year maturity is secured.
• Become an aggressive competitor of banks and savings associations for both
savings deposits and consumer installment loans, which explains why bankers’
groups have objected strongly to the loosening of regulations that have allowed
credit unions to gain market share.
• The American Bankers Association (ABA) and other banking groups have field
law-suits to limit the services credit unions can offer, restrict how far they can
reach to attract new members, or make them follow the same rules for taxation
and community support as bank face.
• Share drafts
• National Credit Union Administration (1934)

IV. Money market funds (MMFs)

• financial intermediary pooling the savings of thousands of individuals and
businesses and investing those monies in short-term, high-quality money market
instruments.
• take advantage of the fact that interest rates on most deposits offered by
commercial and savings banks were restrained by government regulation, the
money fund offered share accounts whose yields were free to reflect prevailing
interest rates in the money marketplace.
• As market interest rates rose to record heights in the late 1970s and early 1980s
money funds were able to keep up with market rates due to their short-term,
flexible asset portfolios and the absence of federal regulation of the money funds.
Later as market interest rates declined, federal deposit rate ceilings were gradually
phased out, and banks and thrifts were granted authority in 1982 to offer money
market deposit accounts (MMDAs) with ceiling-free, flexible interest rates,
creating more competition for money market funds.
• Money market mutual fund: an investment company, which sells shares to the
public and invests the proceeds in short-term securities (Treasury bills,
commercial paper, bank CDs, repurchase agreements, and other money market
instruments)
• First appeared during the 1970s to offer savers higher, market-sensitive rates of
return on their cash balances rather than the government-regulated interest rates
that banks and other thrifts were then offering on their deposits.
• By law a money fund cannot invest in assets having a maturity of more than 13
months nor having an average weighted asset portfolio maturity of more than 90
days.
• Most funds maintain a NAV fixed at $1 per share.