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Module 1: Principle of Banking

Retail Banking-
Retail banking is when a bank executes transactions directly with consumers, rather than
corporations or other banks. Services offered include savings and transactional accounts
,mortgages, personal loans, debit cards, and credit cards. The term is generally used to
distinguish these banking services from investment banking, commercial banking or wholesale
banking. It may also be used to refer to a division of a bank dealing with retail customers and can
also be termed as Personal Banking services.
Retail banking refers to the division of a bank that deals directly with retail customers. Also
known as consumer banking or personal banking, retail banking is the visible face of banking to
the general public, with bank branches located in abundance in most major cities. Banks that
focus purely on retail clientele are relatively few, and most retail banking is conducted by
separate divisions of banks, large and small. Customer deposits garnered by retail banking
represent an extremely important source of funding for most banks.
Products and Services Retail Banking encompasses a wide variety of products and services,
Checking and savings accounts customers are generally charged a monthly fee for checking
accounts; savings accounts offer slightly higher interest rates than checking accounts but
generally cannot have checks written on them.
Certificates of Deposit and Guaranteed Investment Certificates (in Canada) these are the most
popular investment products with conservative investors, and an important funding source for
banks since the funds in these products are available to them for defined periods of time.
Mortgages on residential and investment properties Because of their size, mortgages account
for both a substantial part of retail banking profits, as well as the biggest chunk of a banks
exposure to its retail client base.
Automobile financing banks offer loans for new and used vehicles, as well as refinancing for
existing car loans.
Credit cards the high interest rates charged on most credit cards makes this a lucrative source
of interest income and fees for banks.
Lines of credit and personal credit products Home equity lines of credit (HELOC)have
diminished significantly in their importance as a profit center for banks after the housing collapse
in the U.S. and subsequent tightening of mortgage lending standards.
Foreign currency and remittance services the increase in cross-border banking transactions by
retail clients, and the higher spreads on currencies paid by them, makes these services a
profitable offering for retail banking.
Retail banking clients may also be offered the following services, generally through another
division or affiliate of the bank:

Stock brokerage (discount and full-service)
Wealth management
Private banking
The level of personalized retail banking services offered to a client depends on his or her income
level and the extent of the individuals dealings with the bank. While a client of modest means
would generally be served by a teller or customer service representative, a high net worth
individual who has an extensive relationship with the bank would typically have his or her
banking requirements handled by an account manager or private banker.

Although brick-and-mortar branches are still necessary to convey the sense of solidity and
stability that is crucial to banking, the reality is that retail banking is perhaps one area of banking
that has been most impacted by technology, thanks to the proliferation of ATMs and the
popularity of online and telephone banking.
Savings and Current Accounts
Current Account is generally for business purposes and banks pay no interest on the balances
held therein but such type of accounts can be helpful to have Overdraft Limits against security or
can have a clean (i.e. without any security) overdraft limit. There is no binding of number of
transactions in such type of accounts.

Savings Bank account is one in which small savings can be made and earn small amount of
interest (which is 3.5% p.a. and paid once in six months) on the balances held in the accounts
between 10th day and last day of the month in India. There are some restrictions on transactions
in such accounts.

In case you have substantial surplus amount and can spare for longer period, it would be better if
you keep them in fixed deposit accounts for longer period to earn some better looking interest.

Traditionally banks in India have four types of deposit accounts, namely Current Accounts,
Saving Banking Accounts, Recurring Deposits and, Fixed Deposits. However, in recent years,
due to ever increasing competition, some banks have introduced new products, which combine
the features of above two or more types of deposit accounts. These are known by different
names in different banks, e.g 2-in-1 deposits, Smart Deposits, Power Saving Deposits, Automatic
Sweep Deposits etc. However, these have not been very popular among the public.
What is a Current Account? Who uses current accounts? Current Accounts in Banks
Current Accounts are basically meant for businessmen and are never used for the purpose of
investment or savings. These deposits are the most liquid deposits and there are no limits for
number of transactions or the amount of transactions in a day. Most of the current account are
opened in the names of firm / company accounts. Cheque book facility is provided and the
account holder can deposit all types of the cheques and drafts in their name or endorsed in their
favour by third parties. No interest is paid by banks on these accounts. On the other hand, a
bank charges certain service charges, on such accounts.
Features of Current Accounts:
(a) The main objective of Current Account holders in opening these accounts is to enable them
(mostly businessmen) to conduct their business transactions smoothly.
(b) There are no restrictions on the number of times deposit in cash / cheque can be made or the
amount of such deposits;
(c) Usually banks do not have any interest on such current accounts. However, in recent times
some banks have introduced special current accounts where interest (as per banks' own
guidelines) is paid
(d) The current accounts do not have any fixed maturity as these are on continuous basis

What is a Savings Bank Account? Who uses Saving Bank Accounts?
These deposits accounts are one of the most popular deposits for individual accounts. These
accounts not only provide cheque facility but also have lot of flexibility for deposits and
withdrawal of funds from the account. Most of the banks have rules for the maximum number
of withdrawals in a period and the maximum amount of withdrawal, but hardly any bank
enforces these. However, banks have every right to enforce such restrictions if it is felt that the
account is being misused as a current account. Till 24/10/2011, the interest on Saving Bank
Accounts was regulated by RBI and it was fixed at 4.00% on daily balance basis. However,
wef 25th October, 2011, RBI has deregulated Saving Fund account interest rates and now banks
are free to decide the same within certain conditions imposed by RBI. Under directions of RBI,
now banks are also required to open no frill accounts (this term is used for accounts which do not
have any minimum balance requirements). Although Public Sector Banks still pay only 4% rate
of interest, some private banks like Kotak Bank and Yes Bank pay between 6% and 7% on such
deposits. From the FY 2012-13, interest earned up to Rs 10,000 in a financial year on Saving
Bank accounts is exempted from tax.

Loan Products-
Plastic Money -
Plastic money is a term that is used predominantly in reference to the hard plastic cards we use
every day in place of actual bank notes. They can come in many different forms such as cash
cards, credit cards, debit cards, pre-paid cash cards and store cards.
Cash Cards - A card that will allow you to withdraw money directly from your bank via an
Authorized Teller Machine (ATM) but it will not allow the holder to purchase anything directly
with it.
Credit Cards - Again this card will permit the card holder to withdraw cash from an ATM, and a
credit card will allow the user to purchase goods and services directly, but unlike a Cash Card the
money is basically a high interest loan to the card holder, although the card holder can avoid any
interest charges by paying the balance off in full each month.
Debit Cards - This type of card will directly debit money from your bank account, and can
directly be used to purchase goods and services. While there is no official credit facility with
debit cards per se, as it is linked to the bank account the limit is the limit of what is in the
account, for instance if an overdraft facility is available then the limit will be the extent of the
Pre-paid Cash Cards - As the name suggests the user will add credit to the card themselves, and
will not exceed that amount. These are usually re-useable in that they can be 'topped up' however
some cards, usually marketed as Gift Cards are not re-useable and once the credit has been spent
they are disposed of.
Store Cards - These are similar in concept to the Credit Card model, in that the idea is to
purchase something in store and be billed for it at the end of the month. These cards can be
charged at a very high interest rate and can are limited in the places they can be used, sometimes
as far as only the store brand that issued it.

Wholesale Banking
Wholesale banking is the provision of services by banks to organizations such as Mortgage
Brokers, large corporate clients, mid-sized companies, real estate developers and investors,
international trade finance businesses, institutional customers (such as pension funds and
government entities/agencies), and services offered to other banks or other financial institutions.
Wholesale banking refers to banking services that are provided between merchant banks and
other financial institutions. Wholesale banking involves the provision of a broad suite of services
to large corporations, mid-sized companies, and small businesses. Modern wholesale banks
services include: finance wholesaling, underwriting, market making, consultancy, mergers and
acquisitions, fund management.
Wholesale banking is a banking service that deals with large institutions such as institutional
customers, international trade finance businesses and other large corporate clients. Some of those
services might comprise working capital financing, currency conversion and large trade
This type of banking will provide services to other banks or large corporations. Some retail
banking covers business transactions but not in the same scale as wholesale banking, thinks of it
like the discount superstore that deals in such large amounts that they can offer special prices or
reduced fees, on a per dollar basis.
Off Balance Sheet Business-
An asset or debt that does not appear on a company's balance sheet. Items that are considered off
balance sheet are generally ones in which the company does not have legal claim or
responsibility for.

For example, loans issued by a bank are typically kept on the bank's books. If those loans are
securitized and sold off as investments, however, the securitized debt is not kept on the bank's
books. One of the most common off-balance sheet items is an operating lease.
Off balance sheet items are of particular interest to investors trying to determine the financial
health of a company. These items are harder to track, and can become hidden liabilities.
Collateralized debt obligations, for instance, may become a toxic asset before investors realize a
company's exposure.
Differences between on- and off-balance sheets:-
Traditionally, banks lend to borrowers under tight lending standards, keep loans on their balance
sheets and retain credit riskthe risk that borrowers will default (be unable to repay interest and
principal as specified in the loan contract). In contrast, securitization enables banks to remove
loans from balance sheets and transfer the credit risk associated with those loans. Therefore, two
types of items are of interest: on-balance sheet and off-balance sheet. The former is represented
by traditional loans, since banks indicate loans on the asset side of their balance sheets. However,
securitized loans are represented off the balance sheet, because securitization involves selling the
loans to a third party (the loan originator and the borrower being the first two parties). Banks
disclose details of securitized assets only in notes to their financial statements.

I nternational Banking
An International Banking Facility (IBF) is a separate account established by a U.S. bank, or a
US branch/subsidiary of a foreign bank, or an Edge Act Corporation in the United States to offer
services to only non-US residents and institutions. The services offered include deposit and loan
services. (Note, an IBF is not necessarily a separate legal entity.)
Banks may maintain IBFs in their existing quarters, but the IBF's accounting must be separate
from the bank's main books. Deposit and loan services provided by IBFs are free of Federal
Reserve System reserve requirements, and are not insured by the Federal Deposit Insurance
Corporation. Thus, deposits may earn greater interest than deposits made by U.S. residents.
The IBF concept was initially proposed to the Federal Reserve Board of Governors by the New
York Clearing House association in July 1978. It took until June 18, 1981 until the Board of
Governors approved establishment of IBFs from December 3. IBFs were established to attract
some of the money flowing out to offshore banking centers.
In the early 1980s, New York competed with other states, such as Florida, to attract IBF
business. For instance, New York exempted the income of an IBF from New York bank
franchise tax. Florida, in turn, exempted the income of Florida IBFs from Florida corporate
income tax and also allowed Florida IBFs to deduct their losses.
In other words, IBF is a business that is carried on by or with a registered bank that is locate or
operated in a foreign county. This institution includes such financial services as account
payments and lending that is secured by a bank customer from an international bank.
International banking is often associated with Swiss banking and it is sometimes called offshore
A facility that allows depository institutions in the United States to offer deposit and loan
services to foreign residents and institutions, while being exempted from reserve requirements
imposed by the Federal Reserve and some state and local income taxes. Because of these
exemptions, IBFs enable U.S. banks and U.S.-based financial institutions to compete more
effectively for overseas deposits and loans business in the Eurocurrency markets.
While banks are permitted to conduct IBF activities from their existing offices, they are required
to maintain separate books for their IBF business. The Federal Reserve Board of Governors
approved the establishment of IBFs in the early 1980s. IBF operations remain under the
jurisdiction of the Federal Reserve and other state and federal regulators.
Correspondent Banking-
A correspondent account is an account (often called a nostro or vostro account) established by
a banking institution to receive deposits from, make payments on behalf of, or handle
other financial transactions for another financial institution.
Commonly, correspondent accounts are the accounts of foreign banks that require the ability to
pay and receive the domestic currency. The accounts allow them to pay others from the account
or receive money from others into the account. This allows the bank to offer various services to
their customers such as foreign exchange and foreign currency denominated loans and deposits,
despite them not having a bank license for the foreign country in that country's currency.
Such accounts are necessary for international trade which demands people and business pay for
things in a currency other than their own. It is impractical to transport large amounts of currency
around the world and physically exchange domestic currency for the currency that your
customer/supplier demands. Instead money is taken out of an account at a local bank (which is in
local currency) and an equivalent amount of money is put in the customer/suppliers account at
their local bank (in a foreign currency). The money from your account goes to an internal
account of your bank. The money to your customer/supplier comes from an account your local
bank holds with a bank in your supplier's country - your bank's correspondent account, at
their correspondent bank.
For Example - A customer of Wells Fargo Bank may wish to pay a German firm EUR1,000,000
for machinery. Wells Fargo determines that this is equivalent to USD1,200,000. Wells Fargo
takes the $1,200,000 out of the customers bank account, and instruct their German correspondent
bankperhaps Deutsche Bankto take EUR1,000,000 out of Wells Fargo's correspondent
account with Deutsche Bank, and pay the money into the German company's EUR. So, the
customer has their machinery. The supplier have their money (in EUR) . Wells Fargo is square
by having fewer EUR, correspondingly greater amount of USD. It is established through bilateral
agreements between two counterparts (in this case two financial organizations) to support the
multi-lateral economic balances established throughout the globe.
Correspondent Bank is a financial institution that provides services on behalf of another, equal
or unequal, financial institution. A correspondent bank can conduct business transactions, accept
deposits and gather documents on behalf of the other financial institution. Correspondent banks
are more likely to be used to conduct business in foreign countries, and act as a domestic bank's
agent abroad.
Correspondent banks are used by domestic banks in order to service transactions originating in
foreign countries, and act as a domestic bank's agent abroad. This is done because the domestic
bank may have limited access to foreign financial markets, and cannot service its client accounts
without opening up a branch in another country.

Nostro and vostro (nostro and vostro; English, 'ours' and 'yours') are accounting terms used to
distinguish an account held for another entity from an account another entity holds. The entities
in question are almost always, but need not be, banks.
It helps to recall that the term account refers to a record of transactions, whether current, past or
future, and whether in money, or shares, or other countable commodities. Originally a bank
account just meant the record kept by a banker of the money they were holding on behalf of a
customer, and how that changed as the customer made deposits and withdrawals (the money
itself probably being in the form of specie, such as gold and silver coin).
Some customers will keep their own records of their transactions, for instance, so they can check
for errors by the bank. That record kept by the customer is also an account, of the money the
bank is holding for them. When that customer is another bank, since they also keep other
accounts (of the money they are holding for their customers) there is a need to clearly
differentiate between these two types of accounts.
The terms nostro and vostro remove the potential ambiguity when referring to these two
separate accounts of the same balance and set of transactions. Speaking from the bank's point-of-
A nostro is our account of our money, held by you
A vostro is your account of your money, held by us
Note - that all "bank accounts" as the term is normally understood, including personal or
corporate checking, loan, and savings accounts, are treated as vostros by the bank. They also
regard as vostro purely internal funds such as treasury, trading and suspense accounts; although
there is no "you" in the sense of an external customer, the money is still "held by us".
A client bank elects to open an account - nostro with another facilitator bank, in the absence of
having access to primary clearing arrangements (generally with the Central Bank in the country
where the currency is considered a local currency), for settling Treasury or Trade transactions.
The facilitator bank may or may not directly be a participant of the primary clearing system or
even be in the country of the origin of currency. From the facilitator bank's perspective,
the client bank's account is a vostro.
Conventions- A bank counts a nostro account with a debit balance as a cash asset in its balance
sheet. Conversely, a vostro account with a credit balance (i.e. a deposit) is a liability, and a
vostro with a debit balance (a loan) is an asset. Thus in many banks a credit entry on an account
("CR") is regarded as negative movement, and a debit ("DR") is positive - the reverse of usual
commercial accounting conventions.
With the advent of computerized accounting, nostros and vostros just need to have opposite signs
within any one bank's accounting system; that is, if a nostro in credit has a positive sign, then a
vostro in credit must have a negative sign. This allows for a reconciliation by summing all
accounts to zero (a trial balance) - the basic premise of double-entry bookkeeping.

Vostro Account: Account held by a foreign bank in a domestic bank is called vostro account.
For example UBS of Switzerland opening an account in SBI in India, this is vostro account for
SBI India.
Nostro Account: Account held by a particular domestic bank in a foreign bank is called Nostro
Here in the above example given in Vostro account the same account is a Nostro account for
UBS Switzerland, or if SBI India opens an account in UBS Switzerland then that account is a
Nostro account for SBI India. Nostro accounts are usually in the currency of the foreign country.
This allows for easy cash management because currency doesn't need to be converted.

The Society for Worldwide Interbank Financial Telecommunication (SWIFT) provides a
network that enables financial institutions worldwide to send and receive information about
financial transactions in a secure, standardized and reliable environment. Swift also
sells software and services to financial institutions, much of it for use on the SWIFTNet
Network, and ISO 9362. Business Identifier Codes (BICs) are popularly known as "SWIFT
The chairman of SWIFT is Yawar Shah, originally from Pakistan, and its CEO is Gottfried
Leibbrandt, originally from the Netherlands. The majority of international interbank messages
use the SWIFT network. As of September 2010, SWIFT linked more than 9,000 financial
institutions in 209 countries and territories, who were exchanging an average of over 15 million
messages per day (compared to an average of 2.4 million daily messages in 1995). SWIFT
transports financial messages in a highly secure way but does not hold accounts for its members
and does not perform any form of clearing or settlement.
SWIFT does not facilitate funds transfer; rather, it sends payment orders, which must be settled
by correspondent accounts that the institutions have with each other. Each financial institution, to
exchange banking transactions, must have a banking relationship by either being a bank or
affiliating itself with one (or more) so as to enjoy those particular business features.
SWIFT hosts an annual conference every year called SIBOS which is specifically aimed at
the financial services industry.
SWIFT is a cooperative society under Belgian law and it is owned by its member financial
institutions. It has offices around the world. SWIFT headquarters, designed by Ricardo
Bofill Taller de Arquitectura are in La Hulpe, Belgium, near Brussels.


The Clearing House Interbank Payments System (CHIPS) is a bank-owned, privately operated
electronic payments system. CHIPS is both a customer and a competitor of the Federal Reserves
Fedwire service. The average daily value of CHIPS transactions is about $1.2 trillion a day.
The Clearing House Interbank Payments System (CHIPS) is an electronic payments system that
transfers funds and settles transactions in U.S. dollars. CHIPS enable banks to transfer and settle
international payments more quickly by replacing official bank checks with electronic
bookkeeping entries. As of January 2002, CHIPS had 59 members, including large U.S. banks
and U.S. branches of foreign banks.
History -
The New York Clearing House Association, a group of the largest New York City commercial
banks, organized CHIPS in 1970 for eight of its members with Federal Reserve System
membership. Participation in CHIPS expanded gradually in the 1970s and 1980s to include other
commercial banks, Edge corporations, United States agencies and branches of foreign banks, and
other financial institutions.
Until 1981, final settlement, or the actual movement of balances at the Federal Reserve, occurred
on the morning after a transfer. Sharply rising settlement volumes raised concerns that next-day
settlement exposed funds unduly to various overnight and over-weekend risks. In August 1981,
the Federal Reserve agreed to provide same-day settlement to CHIPS participants through
Fedwire, the Feds electronic funds and securities transfer network.
The number of CHIPS members has fallen from about 140 in the late 1980s, mainly because of
consolidations in the banking industry. Membership might have fallen even more sharply if
CHIPS had not acted in 1998 to eliminate a requirement that members maintain an office in New
York City.
CHIPS is governed by a ten-member board consisting of senior officers of large banks that
establishes rules and fees and admits and reevaluates participants. CHIPS handle about 240,000
transactions a day with a total dollar value of about $1.2 trillion. Historically, CHIPS specialized
in settling the dollar portion of foreign exchange transactions, and CHIPS estimates that it
handles 95 percent of all U.S. dollar payments moving between countries. However, the CHIPS
focus has shifted to domestic business since CHIPS introduced intraday settlement in January
Intraday Settlement
Until January 2001, CHIPS conducted all of its settling at the end of the business day. Now,
however, CHIPS provides intraday payment finality through a real-time system. CHIPS settles
small payments, which can be accommodated by the banks available balances, individually.
Other payments are netted bilaterally (e.g., when Bank A has to pay $500 million to Bank B, and
Bank B has to pay $500 million to Bank A), without any actual movement of funds between
CHIPS participants.
Other payments are netted multilaterally. Suppose Bank A must pay $500 million to Bank B, and
Bank A is also expecting to receive $500 million from Bank C. Without netting, Bank A would
send $500 million to Bank B, and it would thus experience a decline in its available cash while it
was awaiting the payment from Bank C.
Using the CHIPS netting system, however, Bank A submits its $500 million payment for Bank B
to a payments queue, where it waits until Bank Cs offsetting payment is received. The effect of
matching and netting these payments is that Bank As cash position is simultaneously reduced by
its payment to Bank B and increased by receipt of its payment from Bank C. The overall effect
on Bank As cash position is thus zero.
Payments for which no match can be found are not made until the end of the day, but each
payment is final as soon as it is made. To facilitate the working of the intraday netting system,
each participant pre-funds its CHIPS account by depositing a certain amount between 12:30 and
9:00 a.m. The size of this "security deposit," which is recalculated weekly, is set by CHIPS based
on the number and size of the banks recent CHIPS transactions, and none of it can be withdrawn
during the day. At the end of the day, CHIPS uses these deposits to settle any still-unsettled
transactions. Any participant that has a negative closing position at the end of the day (that is, it
owes more than what it has in its security deposit) has 30 minutes to make up the difference. The
30-minute period is referred to as the final prefunding period. If any banks do not meet their final
prefunding requirement, CHIPS settles as many of the remaining payments as possible with
funds that are in the system, and any payments still unsettled must be settled outside of CHIPS.
Banks that have positive closing positions at the end of the day receive the amounts that they are
due in the form of Fedwire payments. Because the ultimate CHIPS settlements are provided by
Fedwire, CHIPS is a customer, as well as a competitor, of Fedwire. The vast majority of CHIPS
members are also Fedwire participants, and the daily value of CHIPS transfers is about 80
percent of Fedwires non-securities transfers.
CHIPS has recently added electronic data interchange (EDI) capability to its payment message
format. EDI allows participants to transmit business information (such as the purpose of a
payment) along with their electronic funds transfers.