1. The Financial Services Industry: Depository Institutions2
Chapter
The Financial Services Industry: Depository Institutions

2. Definitions of Bank
The word “BANK” is derived from Latin word “BANKO/BANCUS” which means a bench.
Derived from a German word “BACK” which means “joint stock fund”.
A bank can be classified into several types on the basis of functions, ownership, status and domicile.

3. Definitions Professor Gilbert
“ A bank or banker is a dealer in capital, or, more properly a dealer in money. He is an intermediary party between the borrower and the lender”.
Professor Kinly
“A bank is an institution which receives deposits and advances loans”
According To English Finance Act 1915
“Bank is the institution which is engage in the banking business under the rules of banking”

4. Commercial Banks Definition (Banking Companies Ordinance 1962)
A bank is an institution which deals in debts of his own and others. It receives deposits from the people who have surplus money and lends to the people in need.
Banking means the accepting deposits from the public for the purpose of lending or investment, repayable on demand and with drawnable by cheques ,drafts, order or otherwise”.

5. Commercial Banks
Largest depository institutions are commercial banks measured by size.
Accept deposits and make loans.
Major source of funding is Deposits
Loans are Consumer , Commercial , International and Real Estate loans.

6. of Financial Sector in Pakistan
Structure
of Financial Sector in Pakistan
Scheduled Banks
(47)
- Commercial banks
- Specialised banks
NBFIs
- Modarabas
- Leasing companies
- Mutual funds
- Specialised financial (DFIs)
- Investment banks
- Housing Finance Companies
Specialised
Banks
Commercial
Foreign
(22)
Domestic
(25)

7. Functions of Commercial Banks
Primary
Functions
Agency
Functions
General
Functions

8. Primary Functions 1. RECEIVING DEPOSITS
Commercial banks receive deposits from the people who have surplus money and willing to deposit with banks for the purpose of safety and interest etc.
To meet the needs of people the banks offer following deposit schemes:
Current Account
Saving Account
Fixed Deposit (Term Deposits)
Profit and Loss Sharing (PLS) accounts
Foreign Currency Accounts

9. Primary Functions 2. ADVANCING LOANS
Commercial bank lend the money collected from the people under different accounts, to the borrowers.
The bank provide loans in the following shapes.
Cash credit
Over draft
Call loans
Discounting of bills
Investment loans
Short-term loans
Medium-term loans
Long-term loans

10. Functions of Commercial Banks
Agency Functions
Collection & Payment Services
Purchase & Sale Service
Execution of Standing Instructions
Collection of Dividends and Interest on Securities
Transfer of Funds
Bank as Guarantor
Income Tax Facility
Collection of Zakat

11. Functions of Commercial Banks
General Utility Functions
Issuance of Letter of Credit
Discounting of Bills
Issuance of Traveler’s Cheques
Lockers Facility
Foreign Exchange Transactions
Act as an under writer
Compile Statistics

12. The role of Commercial Banks in the Economic Growth & development of a country
Mobility of savings The banks by launching a vigorous campaign both in the villages and cities can mobilize the idle savings and can increase the investment rate in all sectors which leads to economic growth of a country.
Capital formation
Generation of savings
Mobilization of savings
Credit creation
Agricultural development
Industrial development
Employment
Trade expansion
Help to government

13. The role of Commercial Banks in the Economic Growth & development of a country
Help to central bank
Promotion of savings
Income distribution :Commercial banks borrow from the people of the higher-income group and lend it to the people of the lower income group.
Poverty alleviation :Commercial bank help the poor people by lending money so as to improve their standard of life
Creation and distributors of money: They purchases securities and allow money to play an active role in the economy.
Influencing economic activity: Commercial banks influence economic activity in two ways. First by lowering the interest rate. Secondly , by making the capital available to the investors.
Export promotion cell: To boost up exports, banks have established export promotion cells to provide information and guidance to exporters. Through this, export volume increases, which fetches more foreign exchange.

14. Bank Sources of Funds Deposit Accounts Borrowed Funds
Transaction deposits
Savings deposits
Time deposits
Money market deposit accounts
Borrowed Funds
Federal funds purchased (borrowed)
Borrowing from the central bank
Repurchase agreements

15. Bank Sources of Funds Long term sources of funds
Bonds issued by the bank
Bank capital

16. Sources of Funds: Deposit Accounts
Transaction deposits
Demand deposit account
Require a small minimum balance and pays no interest
Negotiable order of withdrawal
Provide checking services as well as interest services
Saving deposits

17. Sources of Funds: Deposit Accounts
Time deposits
Deposits that cannot be withdrawn until a specified maturity date
Certificates of deposits (Retail CDs)
Requires a minimum amount of funds to be deposited for a specified period of time
Annualized interest rates offered on CDs vary among banks, and even among maturity types at single bank
Some FIs have begun to offer CDs with a callable features
No organized secondary market

18. Sources of Funds: Deposit Accounts
Negotiable Certificates of Deposits
Some large banks offer to companies
Similar to retail CDs
Secondary market does exist
The level of large time deposits is much more volatile than that of small time deposits
Money Market Deposit Accounts
Different from conventional time deposits in that they do not specify a maturity
More liquid than retail CDs from the depositor’s point of view

19. Sources of Funds: Borrowed funds
Federal funds purchased (Borrowed)
This allows depository institutions to accommodate the short term liquidity needs of other financial institutions federal funds purchased represent a liability to the borrowing bank and an asset to the lending bank sells them
Loans in the federal funds market are typically for one to seven days.
A bank may act as a lender of federal funds on one day and as borrower shortly thereafter, as its funds balance changes every day.

20. Sources of Funds: Borrowed funds
Interest rates charged in the federal funds market is called federal fund rate
If many banks have excess funds and few banks are short of funds, the federal funds rate will be low.
Borrowing from the central bank
Central bank also provide short term loans to banks (as well as to some other depository institutions)
This is called borrowing at discount window.
Interest rate charged on these loans is known as discount rate.

21. Sources of Funds: Borrowed funds
Banks rely on the central bank’s fund market for normal short term financing, and use of discount window as a last resort.
Loans from the discount window are short term , commonly from one day to a few weeks.
Banks that wish to borrow at that discount window must first obtain the central bank’s approval.
Discount window is mainly used to resolve a temporary shortage of funds.
This is the source of funds for banks that experience unanticipated shortages of reserves.

22. Sources of Funds: Borrowed funds
Repurchase Agreements
REPO represents the sale of securities by one part to another with an agreement to repurchase the securities at a specified date and price.
Banks often use a REPO as a source of funds when they expect to need funds for just few days.
The bank simply sells some of its government securities to a corporation with a temporary excess of funds and buys those securities back shortly thereafter.

23. Sources of Funds: Borrowed funds
The government securities involved in the REPO transaction serve as security for the corporation providing funds to the bank.
REPO transactions occur through a telecommunication network connecting large banks, other corporations, government securities dealers, and federal funds brokers.
The federal funds brokers match up firms or dealer that need funds with those that have excess funds.
The yield on REPO agreements is slightly less than the federal funds rate at any given point in time because the funds loaned out are backed by collateral.

24. Sources of Funds: Borrowed funds Long term Sources
Bonds issued by the bank
Fixed assets (land, building, etc.) of banks are usually financed by the issuance of bonds
Such bonds are purchased by the households and various financial institutions.
Bank capital

25. Uses of Funds by Banks Cash Bank loans Investment in securities
Federal funds sold (loaned out)
Repurchase agreements
Eurodollar loans
Fixed assets

26. Uses of Funds: Cash Cash
Bank must hold some cash as reserves to meet the reserve requirement enforced by the central bank
Banks also hold cash to maintain some liquidity and accommodate any withdrawal requests by depositors.
Bank do not earn income from cash, they hold only as much cash as is necessary to maintain a sufficient degree of liquidity.

27. Uses of Funds: Bank Loans
Working Capital Loan ( self liquidating loan)
Term loans
Used primarily to finance the purchase of fixed assets
Assets purchased with the borrowed funds may serve as partial or full collateral on the loan
Contains Protective agreements because of long term
Direct lease loan
Bank can purchase the asset and leasing them to the firm in need

28. Uses of Funds: Bank Loans
Informal line of credit
Which allow the business to borrow up to specified amount within a specified period of time
This useful for the firms that may experience a sudden need for funds but do not know precisely when
The interest rate charged on any borrowed funds is typically adjustable in accordance with the prevailing market rates.
Banks are not legally obligated to provide funds to the business, but they usually honor the arrangement to avoid harming their reputation

29. Uses of Funds: Bank Loans
Revolving credit line
Which obligates the bank to offer up to some specified maximum amount of funds over a specified period of time ( typically less than five years)
Bank charge a commitment fee on any unused funds
Loan Participation
Some large corporation wish to borrow a large amount of funds than any individual bank is willing to provide.
To accommodate a corporation, several banks may be willing to pool their available funds in what is referred to as loan participation.

30. Uses of funds by banks
Most common form, one of the banks serves as the lead bank by arranging for the documentation, disbursement, and payment structure of the loan.
The main role of the other banks is to supply funds that are channeled to the borrower by the lead bank.
The borrower may not even realized that much of the funds have been provided by other banks.
As interest payments are received, the lead bank passes the payment on to the other participants in proportion to the original loan amounts they provided.

31. Uses of funds by banks
The lead bank receive fees for servicing the loan in addition to its share of interest payments.
All participating banks are exposed to credit risk.

32. Uses of funds by banks Loans supporting Leveraged buyouts
Some commercial banks finance leveraged buyouts
LBO financing is the relatively high loan rate that can be charged.
Collateral requirements on business loans
Commercial banks are increasingly accepting intangible assets (patents, brand name) as collateral for commercial loans.
This is important to service oriented companies that do not have tangible assets.

33. Uses of funds by banks Types of consumer loans Installment loans
Commercial banks provide installment loans to individuals to finance purchase of cars and household products
Periodic payments
Credit cards
Interest rate on credit card loans and personal loans ID typically much higher than the cost of funds
Real estate loans

34. Investment in securities
Bank purchase Treasury securities as well as securities issued by agencies of the federal government.
Banks also purchase corporate bonds
Risk and Returns

35. Federal funds sold
Some banks often lend funds to other banks in the federal funds market.
The fund sold or lent out, will be returned at the time specified in the loan agreement, with interest
The loan period is typically very short, such as a day or few days
If the transaction is executed by a broker, the borrowers cost on a federal funds loan is slightly higher than the lender’s return, because the broker matching up the two parties charges a transaction fee.

36. Off-Balance sheet activities
Loan commitment
Standby letters of credit
Forward contract
Swap contracts

37. Off-Balance sheet activities
Loan commitment
A loan commitment is an obligation by a bank to provide a specified loan amount to particular firm upon the firm’s request
The interest rate and purpose of the loan may also be specified
The bank charges a fee for offering the commitment

38. Off-Balance sheet activities
Standby Letters of Credit
Forward Contract
Swap Contract
Banks also serve as intermediaries for interest rate swaps, where by two parties agree to periodically exchange interest payments on a specified estimated amount of principal
Bank receives a transaction fee for its services
If it guarantees payments to both parties, it is exposed to the possibility that one of the parties will default on its obligation.

39. End of Chapter
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