Banking & Insurance

Finance (Sem III)

Banking systems
Role of Bank
Transfer of excess/surplus funds to the credit hungry activities Efficient usage of money in the economy

Function of bank
Deposit facilities Cash credits (ODs) Advances Bill discounting by trade finance typically working capital finance Rollover credits Mortgages Ebanking

Banking System Commercial banking

Basic banking activity thru borrowing of funds and lending it to business with restriction on tenor/risk taken by the bank Banking structure

Banking systems
Commercial banking (continued)
Branch Banking Banks bigger in size Presence across nation thru branches Controlled by Head-office Pattern took shape in UK Clearing banks with national level organization and commonality in banking Conduct business from Head Office Occupies different regions with branch network Controlled by same Board of Directors and committees

Banking systems
Branch Banking
Preference for opening branches Rural policy Industry specific policy In India RBI regulates branch licenses matching with government policy Advantages/Strengths Scale of economy i.e. size Efficient use of saving Division of labour Remittances facilities Risk spread

Banking systems
Commercial banking
Branch Banking (continued ..)
Disadvantages / Challenges
Delegation of power Decision making delays Loss of initiatives

Unit Banking
Localized banking structure typically got developed on account of constraint on communication and transport facility Linked thru correspondent bank system Concentration in particular region Pattern took shape in USA (Texas, Illinois) Advantages/Strengths Local needs Friendly Image Mobilization of local deposits

Banking systems
Commercial banking Unit Banking Advantages/Strengths (continued)
Speed (decision making) Customer Friendly

Disadvantages/Challenges
Inefficient usage of deposits Issues for remittance of funds Risk Concentration

Group Banking
Holding company for banking institutions as per bank holding company act (1956) USA Owns commercial banking as well as NBFCs and other financial institutions All group companies under holding company exerting control over all group entities

Advantages/Strenghts
Low reserves as managed centrally Economies of scale Breaking of banking principal ->different sources of assets as well as liabilities

Disadvatages/Challenges
Interconnectivity Funding among group entities Financial conglomerate may run higher risk for the system as a whole

Banking systems
Commercial banking
Retail banking
Retail operations Mobilization of retail deposits from small customers Retail loan portfolio (lending to small business) High Volume low value transactions

Whole Sale banking

Big Deals Generally catering towards needs of big corporate Typically seen in US for financing wall street in Pre War era Tailor made nature of advances Development of secondary banking systems Innovation in banking assets/liabilities

Banking systems
Commercial banking
Whole Sale banking

Characteristics
Domestic and Foreign currency business Size of deposits and lending at cheaper processing cost Nature of advances making it suitable for customer Growth of secondary market

Matching and Liquidity distribution

Matching principle Liquidity distribution theory Banks are liquidity brokers and converts primary securities into technically different products Liquidity gets distributed without creating it Reduce cost, more market information

Banking systems
Merchant Banking
Widely and loosely used term with major emphasis on following
Corporate financial advice Issuance of bonds/shares, M&As Loan Syndication Holding and dealing in quoted and unquoted securities Fund management on behalf of clients

Investment Banking
Originator + Underwriter + Retailer Originator enters into primary negotiations with issuing corporations Gathering and analyzing of all info regarding issuer intent of issuance/markets/products/history etc. Technical/financial and legal analyst to vet details Agreement with issuer to bring out issue and public subscriptions Long term capital/financing avenues thru IBs Entrepreneur of Entrepreneurs

Banking systems
Universal Banking
Mixed bag banking with short as well as long term financing
Term typically used to distinguish from specialist bank Expansion of banking activities from working capital loan to project finance Combination of different banking systems with some restrictions on either of forms Financial services supermarket Combination of commercial banking and investment banking Seen these activities in European and US banking organizations Glass - Steagall Act for differentiating between commercial and investment/merchant banking activities

Advantages/Strengths
Lower cost Higher output Better products

Banking systems
Universal Banking (continued)
Disadvantages/Challenges
Size of banking institutions Failure impact Systemic Risk for the economy

Banking systems
Commercial Banking General commercial Principles Emphasis on safety by regulator
Custodian of surplus funds Guardian of delicate system doing business with funds of others Banking Theory Self Liquidity paper theory
Earning assets of banks limited to short term self liquidating loans Includes Commercial papers, working capital loans (bill of Exchange drawn on raw material) Liquidity Perspective Economic cycle matching Easy to gauge liquidity posiiton

Banking systems
Banking Theory (continued..) Anticipated Income Theory
SLP need not always guarantee liquidity for the portfolio (abnormal fall in prices for the commodities held under loan) Addition of Long Term Loans against only short term loans Loans granted on specific agreed conditions between borrower and lender on how to conduct business Tried to overcome limitations of SLP theory and opening door for new avenues

Liquidity
Banks are thought of producers of liquid instruments What is liquidity ? Shift ability without incurring losses Measures for Liquidity -> Reserves such as cash reserve ratios Maximize cash holding=> Increase liquidity Minimize Cash holding=> Increase profitability Trade off between Liquidity and profitability Needs banking experience, customer banking mindedness/habits, locality

Banking systems
Employments of funds by commercial banks
Cash in hand
Cash reserves with central bank and demand deposits with other banks Anticipation of cash requirement considering variables such as banking awareness of customers, banking habits, seasonal demands, locality and rivals

Earning assets
Call money/Notice money Bills discounted automatically liquidating on sale of goods covered by such bill Investments Liquid instruments Loans and advances short term v/s/ long term For long term loan bank should consider margin on security, fluctuation and shiftability 3 Cs cardinal principals for lending -> character, capacity and capital of borrower

Banking systems
Fund generation or Liabilities for bank
Deposits
The most acceptable way for generating funds Banks are licensed authority to create this liability Helps creating pool of retail savings employed for activities helping economy

Money market operations

Call money/Notice money Issuance of Certificates of deposits (CDs) Inter bank markets Secondary markets ADR/GDR issuance- Overseas borrowing

Liability side has undergone a change from typical deposit generation to market borrowing

Banking systems
Mechanism of credit generation

Holding of idle cash at lowest level possible This increases amount of money in circulation Bank while lending money does not give out whole cash in one go It creates credit for borrower and allows to draw cheques to fulfill borrowers obligations When cheques deposited by third party, their deposit amt go up What about transacting securities-> it has also similar characteristics One hypothetical example in which there is single bank with deposit of INR 10,000 and required cash reserve ratio of 10% B/s of bank will be shown as follows

Banking systems
Mechanism of credit generation
Hypothetical example (continues )
Liabilities Assets Deposits 10,000 Cash in hand 10,000

As per our assumption bank needs to maintain cash reserve ratio of 10% i.e INR 1000 The bank is now eligible to make loans of INR 9000 which will be placed in credit of the borrower giving right to them to operate their account using cheques and creating obligation on bank to honour the payment
Liabilities Deposits Credit to borrower Assets 10,000 9,000 10,000 Cash in hand Loans to 9,000 client

This INR 9,000 gives purchasing power to borrower and works as good as money

Banking systems
Mechanism of credit generation
Hypothetical example (continues ) The payees of this cheque will not require actual cash over the counter and they will deposit this in their bank account It cause merely transfer of credit balance from one account to other Thus legal tender money in the economy is INR 10000, through the process of creating additional credit line for borrower the bank has added 9,000 more to money circulation The continuation of process will increase money supply further
Liabilities Deposits Credit to borrower Credit to subsequent custy 10,000 9,000 a) 9000 b) 8,100 Cash in hand Assets 10,000

8,100 Loans to client

17,100

Banking systems
Mechanism of credit generation
Hypothetical example (continues ) Limitation to creation of credit
Cash reserve ratio Money supply by central bank

Bankers are not just merely purveyors of money but the artist manufacturing money

New age banking

Bank with single branch operating in many places IT revolution -> Ebanking and online payments/transfer facilities Does the Place among 5 Ps of marketing matter?

Banking systems
Mechanism of credit generation
Hypothetical example (continues ) Limitation to creation of credit
Cash reserve ratio Money supply by central bank

Bankers are not just merely purveyors of money but the artist manufacturing money

New age banking

Bank with single branch operating in many places IT revolution -> Ebanking and online payments/transfer facilities Does the Place among 5 Ps of marketing matter?

Banking systems
India banking system
Scheduled banks

Scheduled commercial banks

Scheduled Cooperative banks

Public sector bankss

Private bankss

Nationalized bankss

SBI and Associated banks

Old private banks

New Private Banks