Banking Self Study Guide
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Banking Self Study Guide

Banking Self Study Guide

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Banking Self Study Guide Banking Self Study Guide Presentation Transcript

  • Banking Self Study Guide Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide Financial Series Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide • THE GOALS OF A BANK • FOREIGN EXCHANGE TRANSACTIONS • RISK MANAGEMENT OVERVIEW • TREASURY OPERATIONS • OVERVIEW OF THE FLOW • LENDING AND CARD OF ROUTINE SERVICES TRANSACTIONS • TRADE FINANCE • THE CENTRAL POOL OF FUNDS AND MANAGING • INVESTMENTS THE SPREAD Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide This self study guide is designed to enable management staff to gain a basic understanding of the activities that a retail bank performs before they become involved in a banking engagement. After completing this guide it you should be able to:- 1. Describe the routine processes that enable a bank to function and fulfill its objectives. 2. Understand the practical aspect of how banks generate profit 3. Understand how a typical bank is structured by department 4. Understand the various departments interactions and their role in the objectives of the bank 5. Understand the unique risks faced by each department and how auditors address those risks Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide THE GOALS OF A BANK The basis of banking is to put capital at risk in the pursuit of earnings. A bank takes risks, transforms risks and embeds risks in banking products/services. The goals of a bank are also driven by regulatory requirements laid down by central banks. The central role of risk based capital in regulations focuses on the capital adequacy principle, which states that capital should match risks. As capital is a limited and expensive resource the advancement of regulation has contributed to the above shift in goals. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide RISK MANAGEMENT OVERVIEW In its core principles, the Basle Committee on Banking Supervision 1 sets out eight key risks which must be managed by banks. Banks’ organizational structure is designed to manage these risks either on a process basis or, more commonly, by department such that the institution can meet its goals. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide RISK MANAGEMENT OVERVIEW The risk are as follows:- Credit risk a major risk that banks face is credit risk or the failure of a counterparty to perform according to a contractual arrangement. This risk applies not only to loans but to other on- and off-balance sheet exposures such as guarantees, acceptances and securities investments. Serious banking problems have arisen from the failure of banks to recognize impaired assets, to create reserves for writing off these assets, and to suspend recognition of interest income when appropriate. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide RISK MANAGEMENT OVERVIEW The risk are as follows:- Country and transfer risk In addition to the counterparty credit risk inherent in lending, international lending also includes country risk, which refers to risks associated with the economic, social and political environments of the borrower’s home country. Country risk may be most apparent when lending to foreign governments or their agencies, since such lending is typically unsecured, but is important to consider when making any foreign loan or investment, whether to public or private borrowers. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide RISK MANAGEMENT OVERVIEW The risk are as follows:- Market risk Banks face a risk of losses in on- and off-balance sheet positions arising from movements in market prices. Established accounting principles cause these risks to be typically most visible in a bank’s trading activities, whether they involve debt or equity instruments, or foreign exchange or commodity positions. One specific element of market risk is foreign exchange risk. Banks act as “market-makers” in foreign exchange by quoting rates to their customers and by taking open positions in currencies. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide RISK MANAGEMENT OVERVIEW The risk are as follows:- Interest rate risk Interest rate risk refers to the exposure of a bank’s financial condition to adverse movements in interest rates. This risk impacts both the earnings of a bank and the economic value of its assets, liabilities and off-balance sheet instruments. Interest rate risk can arise in both the banking and trading book. Although such risk is a normal part of banking, excessive interest rate risk can pose a significant threat to a bank’s earnings and capital base. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide RISK MANAGEMENT OVERVIEW The risk are as follows:- Liquidity risk Liquidity risk arises from the inability of a bank to accommodate decreases in liabilities or to fund increases in assets. When a bank has inadequate liquidity, it cannot obtain sufficient funds, either by increasing liabilities or by converting assets promptly, at a reasonable cost, thereby affecting profitability. In extreme cases, insufficient liquidity can lead to the insolvency of a bank. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide RISK MANAGEMENT OVERVIEW The risk are as follows:- Operational risk The most important types of operational risk involve breakdowns in internal controls and corporate governance. Such breakdowns can lead to financial losses through error, fraud, or failure to perform in a timely manner or cause the interests of the bank to be compromised in some other way, for example, by its dealers, lending officers or other staff exceeding their authority or conducting business in an unethical or risky manner. Other aspects of operational risk include major failure of information technology systems or events such as major fires or other disasters. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide RISK MANAGEMENT OVERVIEW The risk are as follows:- Legal risk Banks are subject to various forms of legal risk. This can include the risk that assets will turn out to be worth less or liabilities to be greater than expected because of inadequate or incorrect legal advice or documentation. In addition, existing laws may fail to resolve legal issues involving a bank; a court case involving a particular bank may have wider implications for banking business and involve costs to it and many or all other banks; and, laws affecting banks or other commercial enterprises may change. Banks are particularly susceptible to legal risks when entering new types of transactions and when the legal right of a counterparty to enter into a transaction is not established. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide RISK MANAGEMENT OVERVIEW The risk are as follows:- Reputation risk Reputation risk arises from operational failures, failure to comply with relevant laws and regulations, or other sources. Reputation risk is particularly damaging for banks since the nature of their business requires maintaining the confidence of depositors, creditors and the general marketplace. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide OVERVIEW OF THE FLOW OF ROUTINE TRANSACTIONS Profit Centers All identifiable departments in banks are either profit centers or cost centers. Profit centers are those that offer products that generate interest revenue or fee based services. Other departments such as settlements, accounting, and reconciliations departments do not offer services outside the bank and therefore are cost centers. In order to measure the profitability of these various lines of activity the bank assigns a cost of funds for all banking activities. This cost of funds is the rate at which money can be invested risk free in the money markets. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide OVERVIEW OF THE FLOW OF ROUTINE TRANSACTIONS Deposits When customers choose to place their excess money with a bank the bank records this liability to the client and either invests the money or lends it to another bank client. Banks accept many more deposits than they can lend out so excess deposits are invested in interest earning assets such as Treasury bills and other money market products. The branch then earns LIBOR on all of its deposits and pays something less than LIBOR to its client leaving an interest rate spread that yields profits. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide OVERVIEW OF THE FLOW OF ROUTINE TRANSACTIONS Loans Loans are granted by the branch to its clients and these are assumed to be funded by borrowing money at LIBOR and lending it to a client. The branch then charges its client interest greater than LIBOR to generate a profit on the interest rate spread. Therefore all loans are priced with LIBOR as its basis. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide OVERVIEW OF THE FLOW OF ROUTINE TRANSACTIONS Managing interest rate risks with transfer pricing and cost of funds Some banks may centralize the management of interest rate risk in a unit of the bank, usually the treasury unit, using a funds transfer pricing system. Funds transfer pricing allows the bank to transfer the impact on earnings of changing interest rates from individual business lines to the central unit. Profits of the bank are unaffected however, the earnings of the business lines can then be traced more directly to the business decisions of management. Funds transfer pricing also induces line managers to make pricing decisions that are with the interest rate risk management objectives of the treasury. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide OVERVIEW OF THE FLOW OF ROUTINE TRANSACTIONS Funds in Foreign Currencies All banks deal in foreign currencies so that their clients can convert money earned outside the country into domestic currency and convert domestic currency into foreign currency when they have to make payments outside the country. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide FOREIGN EXCHANGE TRANSACTIONS Introduction Refer to Diagram on Operations in Foreign Currency Foreign currencies in general and the process of exchanging the currency of one country for the currency of another country are both referred to as ‘foreign exchange’. This exchanging process or the conversion of one currency into another can take place locally, for example, when members of the public purchase foreign currency notes and travelers cheques or internationally when the conversion involves the receipt or payment of one currency for that of another. The market in which international conversions take place is known as the foreign exchange market. The price at which the exchange of currencies takes places is known as the rate of exchange. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide FOREIGN EXCHANGE TRANSACTIONS Reasons behind foreign exchange transactions The market for foreign exchange mirrors the physical trade that occurs between countries. For every sale/purchase of goods or services, there is a corresponding monetary transaction. It also reflects capital flows between countries. In simple terms, the market for foreign exchange enables debts between different countries to be settled by the exchange of one currency for another. The originators for foreign exchange funds are usually the large corporate entities. The foreign trade that they undertake e.g.. Buy foreign raw materials necessitate the need for foreign funds to pay for such goods and services. Banks may be approached if the size of funds required is huge but usually foreign exchange brokers are used. They in turn will contact the banks and transact on their clients behalf. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide FOREIGN EXCHANGE TRANSACTIONS “SQUARING” the balance sheet: Once the USD 100 is sold, the assets in USD will equal the liabilities and the bank is no longer exposed to adverse changes in exchange rates. That is, the balance sheet is “squared”. Similarly once the DM 500 loan is borrowed from another bank, the liabilities in DM will equal the assets and the bank is no longer exposed to changes in exchange rates. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide FOREIGN EXCHANGE TRANSACTIONS Foreign Exchange Transaction Defined a. Spot When a sale or purchase is made spot, it means that delivery of the foreign exchange and the corresponding base currency must be made simultaneously at a fixed date within a few days after the sale or purchase was contracted (normally two business days for most currencies). Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide FOREIGN EXCHANGE TRANSACTIONS Foreign Exchange Transaction Defined c. Rates The value of the world's currencies in the forward market is expressed in the forward rates which reflect current expectations and a large variety of related market forces. If a certain foreign currency is quoted at a higher rate ‘spot’ than ‘forward’, its forward rate is a ‘discount’. If the forward rate is higher, it is said to be trading at a ‘premium’. Different forward rates are quoted for different periods (one, two, three, six, or twelve months forward). It is possible that forward rates may be at a premium for one period and at a discount for the next. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide FOREIGN EXCHANGE TRANSACTIONS Foreign Exchange Transaction Defined b. Forward A forward exchange transaction involves the purchase or sale of foreign currency for delivery at some fixed future date. The rate at which the transaction is concluded is also fixed at the time of sale, but settlement is not made until the foreign currency is delivered by the seller at the fixed future date. The majority of forward exchange transactions are concluded for periods up to six months but can be concluded for considerably longer maturities, particularly in the more stable currencies. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide FOREIGN EXCHANGE TRANSACTIONS Foreign Exchange Transaction Defined c. Arbitrage An arbitrage deal involves the simultaneous spot and forward transactions to take advantage of differences in exchange rates and interest rates. The most common form of arbitrage deal is interest arbitrage, whereby a bank attempts to take advantage of interest differentials between currencies and make a profit or derive funds for on-lending in currencies other than dollars at a cost which should be offset by the additional interest obtainable by lending in those other currencies. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide FOREIGN EXCHANGE TRANSACTIONS Foreign Exchange Transaction Defined d. Swaps Swaps involve two linked exchange transactions for an identical amount of a currency with different value dates, for example, a spot purchase and a forward sale. A swap can take place when each party can access a particular market (either interest basis or currency) on comparatively better terms than the other. Parties will enter the markets where they have the advantage, and will agree to exchange (swap) payments and receipts between them which will result in better terms in their preferred market than if they had entered it directly themselves. The most usual types of swaps are interest rate swaps and currency swaps Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide FOREIGN EXCHANGE TRANSACTIONS Foreign Exchange Profit are made The two most common ways in which a bank makes a profit from the foreign exchange market are:- - From the quot;spreadquot; in quoting currency prices - From holding a currency position. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide FOREIGN EXCHANGE TRANSACTIONS Risks involved in foreign exchange (a) Open positions As explained above, a position in a currency arises when a bank is unmatched in that currency i.e. an excess of assets or liabilities in that currency. If there is a long position and the value of that currency falls in home currency terms, a loss will arise. Similarly, if there is a short position and the currency rises in home currency terms, again the bank will experience losses. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide FOREIGN EXCHANGE TRANSACTIONS Risks involved in foreign exchange b. Liquidity exposure This is the risk that a bank may not be able to cover, on a particular day, net cash outflows which arise from sizeable mismatched exchange positions. Examples whereby the bank may not be able to cover such cash outflows are tight liquidity resulting from a central bank squeeze, (i.e. when the government reduces the amount of money in the economy), temporary market closure, sudden concern over the bank's credit standing or where selling new deposits and assets in adverse market conditions is insufficient to meet these outflows. This risk could lead to a forced sale of the banks assets which may not realize the full value of the assets. Large losses to the bank may not be avoided. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide FOREIGN EXCHANGE TRANSACTIONS Risks involved in foreign exchange c. Maturity mismatch This is due to spot and forward transactions which may be matched as to amount but individual transactions may mature on different dates. Maturity mismatch can therefore occur even though the bank may only have small open position but significant mismatching of maturity dates. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide FOREIGN EXCHANGE TRANSACTIONS Risks involved in foreign exchange d. Credit risk This is the risk that the counter party may be unable, or unwilling to complete his part of the transaction. The potential loss when the bank becomes aware of the counterparty not being able to complete the transaction is the difference between the contracted value of the transaction and the cost of completing it with another party. Unlike credit risk in lending, the bank is not subjected to total loss in the value of transaction. This is because, in the event of default, the bank can undertake another equivalent transaction, albeit not at such favorable terms, and thus suffer partial loss. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide FOREIGN EXCHANGE TRANSACTIONS Risks involved in foreign exchange e. Settlement risk This is where, on value date, the bank transmits and pays funds to the benefit of the counterparty but the counterparty is unable to meet its obligations. The bank is therefore at risk of losing all the funds transmitted. This usually results from the time gap between paying out funds in one centre (e.g.. London) and the confirmation of receipt of funds in another centre (e.g.. New York), a 5-6 hour time zone difference. To minimize such risks, limits on the value of unmatured deals with individual customers should be set and regularly monitored. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide TREASURY OPERATION Dealing Activity When a customer calls the desk a dealer completes the transaction for the customer as follows: 1. The dealer checks that deal amount is within his limits and quotes a rate that currently the market is willing the purchase the dollars at plus a small commission.(spread) 2. He then checks counterparty limits (to ensure they are within authorized limits) and sell the dollars. At this point the settlement date and correspondent banks brokers are also agreed between the dealers. 3. The dealer fills out his deal ticket as the deal was agreed with the counterparty 4. A confirmation comes to the dealer either from Reuters (a secure information gathering system) or by fax if it is with a broker not on the Reuters system. 5. The deal ticket is then agreed to the confirmation to ensure that both parties agree to the terms of the deal. 6. Both the deal tickets and confirmations are numerically sequenced as a completeness control over recorded deals. 7. The dealer then updates his own foreign currency position and passes a copy of the deal ticket to the back office. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide TREASURY OPERATION Back office The back office is segregated from the dealing function and is an integral control over treasury operations. They manage the cash flow of the bank by producing all the reports regarding the bank’s positions as follows: Once the back office gets the deal ticket it also obtains its own confirmation either from a printer running in parallel with the dealing room or from Reuters itself. It is crucial that the confirmation function is segregated from the dealing function. The back office agrees the deal tickets to the confirmation and ensures it is within limits and with a suitable counterparty. The deal is then coded for input to the bank’s records by assigning the appropriate bank accounts the deal will be settled from with correspondent banks. If a broker is used with accounts in common with the bank a draft is issued to settle the deal. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide TREASURY OPERATION Input processing The processing department consists mainly of input clerks who will input the details of the deal tickets into the computer as well as other tasks as follows: Enters the approved deal ticket into the computer (i.e.. the date the transaction will be paid and from what accounts) Various reports will be generated such as daily deal listing, credit limits exceeded report. The deals are then printed as they have been input into the computer and returned to back office for further checking. Accounting records of the bank are now updated as soon as deals are input A settlements listing featuring amounts, currencies, dates and account numbers is sent to settlements department to ensure all amounts are paid as agreed on original deal tickets. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide TREASURY OPERATION Input processing The processing department consists mainly of input clerks who will input the details of the deal tickets into the computer as well as other tasks as follows: Enters the approved deal ticket into the computer (i.e.. the date the transaction will be paid and from what accounts) Various reports will be generated such as daily deal listing, credit limits exceeded report. The deals are then printed as they have been input into the computer and returned to back office for further checking. Accounting records of the bank are now updated as soon as deals are input A settlements listing featuring amounts, currencies, dates and account numbers is sent to settlements department to ensure all amounts are paid as agreed on original deal tickets. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide TREASURY OPERATION Settlements and Nostro/Vostro accounts Once the settlements listing is obtained the settlements department actually moves the funds around the bank. Banks have current accounts with each other in order to settle transactions. These are called Nostro/Vostro accounts. Nostro is our account with you and Vostro is your account with us. If a bank has to pay money to another bank it is placed in a Nostro account with them. If a bank is owed money they collect it from its vostro account. A facility known as “SWIFT”(Society for Worldwide Interbank Telecommunication) then simultaneously collects the funds from the Nostro account and deposits them in the Vostro account on the value date. 1. They ensure that funds are deposited to accounts by the value dates so that SWIFT can collect the funds. 2. If Nostro accounts go overdrawn because funds are not there according to value dates high 3. penalty interest is charged. Nostro accounts don’t earn interest for excess funds either. 4. Since interest is not earned on Nostro accounts it is up to Settlements department not to deposit funds too quickly or opportunities to generate interest are lost. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide TREASURY OPERATION Reconciliations department Once the deal has been settled the reconciliations department reconciles all of the Nostro accounts daily to ensure all deals that were intended to settle have been completed. That is, all funds have been withdrawn by SWIFT from the Nostro accounts. 1. Reconciliations department looks at each Nostro and ensures that SWIFT has taken the specified 2. amount of funds from the accounts. If there are discrepancies they are investigated. 3. This is a key control to ensure that all deals have been completed as were originally agreed to. 4. If there are old outstanding items in these accounts an enquiry is raised and sent to the 5. counterparty to investigate the reason for the discrepancy. 6. Statements are sent by the correspondent banks detailing all the activity in the accounts to help facilitate the reconciliations process. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide CLEARING DEPARTMENT-DOMESTIC BRANCH PAYMENTS Cheques drawn on a domestic bank If a customer deposits a cheque into his account the bank has to “clear” it. That is, the cheque must be paid by the financial institution it is drawn on. In this case the process of clearing a cheque drawn on a domestic bank will be detailed. A customer deposits a cheque for USD$500 into his USD savings account. The bank then starts paying him interest on the money but has not yet received the $500 from the bank it is drawn on. At the end of the day the teller balances all cheques that were processed that day and sends them to the clearing department of the bank. The clearing department then separates all the cheques from that branch into domestic banks and foreign banks. For each domestic bank all cheques drawn on that bank are bundled together and that total amount of money is owed by that bank. The bundle is then taken that night to a Central Clearing agent where all the other domestic banks have sent their cheques drawn on all other banks. The Central clearing agent then balances the two positions to reconcile which bank owes the other more money. That is, if bank A honoured more cheques of Bank B’s then a draft is sent along with Bank A’s cheques drawn on Bank B or vice versa. Now the clearing department has inward clearing negotiated at another bank the previous day. Therefore, all customers accounts are updated to reflect the cheque clearing their account. If there are no funds for withdrawal the cheque “bounces back” to the bank who negotiated it. The Amir Saif honoured the cheque then has to try to obtain the funds back from its customer. bank who amirsaiftaz@gmail.com
  • Banking Self Study Guide CLEARING DEPARTMENT-DOMESTIC BRANCH PAYMENTS Holding funds When a cheque that bounces is returned to a bank unpaid this places funds at risk because there is no guarantee that the funds will be recoverable from the depositor. The bank can avoid this situation all together by placing a hold on the cheque when it is deposited. That is, the cheque is deposited but funds aren’t advanced on it until the danger of it being returned unpaid has lapsed. This is usually 3 days for cheques drawn on domestic banks. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide CLEARING DEPARTMENT-DOMESTIC BRANCH PAYMENTS Items sent on collection The other alternative is for the bank to send the cheque out on collection. The bank sends the cheque in the outward clearing again with instructions to the bank it is drawn on to hold on to it for a period of time (usually 30 days). In this time period the bank tries to withdraw the funds from the account each day for the next 30 days in hopes of recovering the funds. If, after 30 days the cheque can’t be paid the cheque is sent back again and the bank must take a loss on the negotiation of the cheque or try more vigorously to recover the funds from the depositor. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide CLEARING DEPARTMENT-DOMESTIC BRANCH PAYMENTS International payments When a customer presents a cheque drawn on an international bank it cannot clear in the same manner as a cheque drawn on a domestic bank. This is because the central clearing agent cannot deal with the foreign bank to obtain the funds to pay the domestic bank. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide CLEARING DEPARTMENT-DOMESTIC BRANCH PAYMENTS International collections When a customer presents such a cheque the teller cannot give deposit value to it or cash it. It can take a substantial amount of time for the cheque to be paid and if it is in the customer’s account earning interest during this time the bank cannot invest the proceeds from the cheque in the money markets. Banks are unwilling to pay interest on funds that they cannot reinvest. Therefore, the customer obtains an assurance from the teller that once the funds are paid by the bank the funds will be deposited in their account. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide CLEARING DEPARTMENT-DOMESTIC BRANCH PAYMENTS Correspondent accounts and banks When the foreign bank receives the cheque on collection it, in effect, receives instructions from the domestic bank to act as follows: Withdraw funds from the foreign customer’s account. Use those funds to purchase a draft drawn on a bank in the same country as the domestic bank who sent the item on collection. The foreign bank then interacts with its settlements department to move funds from the customer’s account and place them in the foreign banks Nostro account with a bank in that particular country. The draft is then sent back to the domestic bank who then deposit the draft drawn on a domestic bank now and sends it through the domestic bank clearing because it is now merely a cheque drawn on a bank in the same country. The domestic bank the cheque is drawn on pays it by releasing the money from its Nostro account where the foreign bank placed it. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide LENDING AND CARD SERVICES Advances repayments A customer makes an installment or pays his credit card balance at a branch. The loan or card account is updated for the transaction on either the card subsystem or the loans subsystem. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide LENDING AND CARD SERVICES Treasury department The acceptance or advancing of funds whether in foreign currency or domestic currency requires action by the treasury department If FC is transacted the treasury department must either buy or sell the FC as described earlier in the foreign exchange section. The deal is then settled by the settlements department exactly as any other F/X transaction. The treasury department is also given a money market position. That is, they either have a surplus of funds to invest or a shortfall of funds and need to borrow. Therefore, as described in the diagram the money is borrowed in the money market to fund a loan or invested in the money market in the case of cash surpluses. The borrowing or placement is then settled by settlements department exactly as described previously. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide LENDING AND CARD SERVICES Credit card transactions There are a few unique features to card services. These unique transactions are between the card service provider and the card issuing bank. When a customer spends money in a foreign location the merchant is reimbursed by the card service provider, for example, MasterCard or Visa. When MasterCard or VISA interact with the customer’s bank, the card account is updated in domestic currency at the same rate the card company reimbursed the merchant at. credit extended to corporate and personal customers, lending often carries the greatest risk to the bank, to which much emphasis and importance is placed by us as auditors. Loans and advances may be categorized in various ways: 1 Retail or wholesale - these terms are vaguely used to distinguish between local, often branch based lending as opposed to the larger corporate inter bank and institutional lending which is usually head office based. 2 Personal or corporate. Amir Saifterm, medium term or long term. 3 Short amirsaiftaz@gmail.com
  • Banking Self Study Guide LENDING AND CARD SERVICES Types of Lending Facility Overdrafts This is an agreed line of credit or borrowing facility (in writing) that a customer may use by drawing on a specified current account. Originally overdrafts were regarded as temporary facilities but in the Middle East it is far from unusual for a customer to maintain a ‘permanent’ overdraft albeit the balance fluctuating from day to day. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide LENDING AND CARD SERVICES Types of Lending Facility Term Loans These are made for a fixed period of time and can be repayable either in installment or in full at the maturity date. A short term loan is generally regarded as being a loan which is repayable within one year from when it is granted. A medium term loan is generally regarded as being repayable after at least one year but before the expiry of five years. A long term loan is generally regarded as one that is not finally repayable until at least five years after it was granted. The interest rate is normally predetermined for short term loans and is likely to be of a floating nature for medium to long term loans. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide LENDING AND CARD SERVICES Types of Lending Facility Syndicated Loans A syndicated loan is one that is provided jointly by a number of banks or financial institutions who would be individually either unwilling or unable to provide in view of the size and nature of the amount. These banks or financial institutions are usually brought together by one or possibly more managing banks which have organized and negotiated the whole package. The managing (or sometime it's called lead) bank handles the negotiations with the borrower, perhaps the documentation, collects the funds from participants and then disburses the full amount to the borrower. Subsequently the managing bank is responsible for collecting all sums due from the borrower (both principal and interest) and for passing their share of these sums to the participants. Apart from the managing bank, the syndicate participants do not have any direct dealing with the borrower as all their information needs and any required action (e.g.. default) is dealt with solely by the managing bank. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide LENDING AND CARD SERVICES Types of Lending Facility Personal (or Consumer) Loans In addition 1 Fixed rate loans are generally provided to finance the purchase of cars or consumer durables. Often up to 3 year periods the documentation is simple and provides for usually equal monthly repayments of both principal and interest. Interest is usually fixed. 2 Mortgage loans are becoming more usual and are for longer periods usually over 5 years. Loans are specifically granted for the purchase of property and are repayable in installment (monthly, quarterly or half yearly). Interest is seldom of a fixed nature but likely to be floating. 3 Credit cards are becoming more and more common and regarded as a strong marketing tool. Please note there is a difference between a ‘charge’ card (e.g.. American Express, Diners Club) and a ‘credit’ card (e.g.. Visa, MasterCard). Only the latter permits any form of extension of credit and the former requires immediate settlement on issue of the statement. Obviously in the case of the charge card there is an interest free credit period between when the card is used and the issue of the statement. Credit cards usually earn interest on the unpaid monthly balance at fixed monthly rates of interest and also the bank earns commission of varying amounts based on gross sale value of the transaction Amir the retailer or service company. from Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide LENDING AND CARD SERVICES Types of Lending Facility Sovereign Loans Banks in the Middle East lend substantial sums to foreign governments, public sector organizations and large corporations in overseas countries. These loans are usually large in amount and of a medium or long term period. Often there is little or no security and reliance is placed on the credit worthiness of the country and also sometimes the guarantee of the borrowing government is provided. See also c), Syndicated Loans, which may also be part of the bank's overall sovereign risk. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide LENDING AND CARD SERVICES Factors Governing Lending Decisions Having now seen the various types of lending let us look briefly at the basic Factors taken into account by bankers when principles and factors governing lending. taking lending decisions include: Firstly there is the principle of the quality of the borrower (includes value stewardship i.e.. the bank is using money and quality of security being offered) deposited with it by members of the the purpose or nature of loan public, companies and other banks and not its own and therefore this places on the amount of loan, the period of loan, management a high moral duty to the repayment schedule proposed exercise care and integrity. Secondly the banks own policy limits (e.g.. currency of banks must make a reasonable return on loan, country, nature of industry). their lending. The basis here is that the higher the risk then the higher the Essentially a bank will look initially at the expected rate of return. It is however the purpose of a loan, relating this to the ability to strike an acceptable or amount requested, and of extreme reasonable balance between these two importance, their clients demonstrated conflicting principles which makes ability to repay. banking such a fine art and is the Amir Saif essence of good banking. amirsaiftaz@gmail.com
  • Banking Self Study Guide LENDING AND CARD SERVICES Loan Security A bank may lend with or without security. If the latter it is referred to as 'clean' i.e.. quot;cleanquot; loan or quot;cleanquot; overdraft. However when a bank takes security it does not usually expect to obtain repayment of the loan by realizing that security. The security is there to reduce the risk that a loan will not be repaid if the borrower defaults. Therefore if the risk involved is to be totally eliminated then the security needs to be sufficient at its realizable value to repay the bank in full. It can be seen then that security evaluation against outstanding loans is an on-going and continuing process. There are two aspects to be considered - (a) Has the market value been maintained or has it fallen? e.g.. value of land or shares, and (b) Has the outstanding loan amount been reduced within the terms of the loan agreement. Thus a comparison of the loan outstanding amount should be regularly made against the current value of security held. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide LENDING AND CARD SERVICES Loan Security Internal Control As mentioned earlier bank lending i.e.. loans and advances, usually represents the largest class of asset as the balance sheet. It is also a bank's greatest source of exposure to loss, and this necessitates a high degree of internal control, essentially in the following areas: • Authorization and terms of credit facilities • Identification and treatment of potentially doubtful credit risks. • Authorization and terms of credit facilities • Identification and treatment of potentially doubtful credit risks Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide TRADE FINANCE Documentary letters of credit Where international trade occurs and each counterparty is to be satisfied as to the creditworthiness of the other, documentary letters of credit are used. The buyer must be satisfied that the seller has the capacity to produce, ship and deliver on time, and the seller must be satisfied that the buyer can and will pay on time. However, the seller may have little idea of the creditworthiness of the buyer. The com Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide TRADE FINANCE Procedure 4.Once the seller has received a copy of the Letter of The buyer and seller conclude a sales contract Credit and is satisfied that he can meet its terms providing for payment by way of a Documentary and conditions he is in a position to dispatch the Letter of Credit. goods to the buyer. 1.The buyer then approaches his own bank, quot;the 5.Having dispatched the goods and accumulated the Issuing Bankquot;, and requests the bank to issue a required documents, the seller then sends the Documentary Letter of Credit in favor of the documents stipulated in the Letter of Credit to the seller. advising/confirming Bank. 2.Assuming the Issuing Bank is satisfied with the credit 6.The advising/confirming Bank then checks the standing of the buyer, it will issue the documents against the Letter of Credit. Assuming Documentary Letter of Credit and request a bank the documents meet with the requirements of the in the seller's country to advise or confirm the Letter of Credit, the seller will receive payment in credit. However, if the Issuing Bank is accordance with the terms stated in the Letter of dissatisfied, the buyer will have to provide Credit. guarantees in the form of assets (money deposits and similar collateral) before the Issuing Bank is F7. finally the Issuing Bank releases the documents willing to issue the Letter of Credit. If this is not and where these documents represent title to the possible, the deal could be rejected. goods, the buyer on presentation of these documents to the carrier gains possession of the 3. The advising/confirming Bank then advises the relevant goods. seller that the Documentary Letter of Credit has Amir Saif been issued. amirsaiftaz@gmail.com
  • Banking Self Study Guide TRADE FINANCE Letter of Guarantee A guarantee is a promise by the guarantor to be liable for the debt of another person, the principal debtor, should the principal debtor fail to perform an obligation, provided that the guarantor is notified of that fact by the creditor. The guarantee is usually given after the bank has been suitably furnished with collateral (e.g. customer deposits, title deeds to property). In international trade, the provision by a bank of a guarantee can enable the customer, who is perhaps new to a country, and may be unknown to local banks and suppliers, but already has an established credit rating in another country, to enjoy normal trading relationships. Income sources for the guarantor bank are: Commission over the period of guarantee. In some cases, an interest-free or ‘cheap’ deposit as security from the customer. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide TRADE FINANCE Documentary letters of credit Where international trade occurs and each counterparty is to be satisfied as to the creditworthiness of the other, documentary letters of credit are used. The buyer must be satisfied that the seller has the capacity to produce, ship and deliver on time, and the seller must be satisfied that the buyer can and will pay on time. However, the seller may have little idea of the creditworthiness of the buyer. T Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide TRADE FINANCE The advising/confirming Bank then advises the seller that the Documentary Letter of Credit has been Procedure issued. The buyer and seller conclude a sales contract 1. Once the seller has received a copy of the providing for payment by way of a Letter of Credit and is satisfied that he can Documentary Letter of Credit. meet its terms and conditions he is in a position The buyer then approaches his own bank, quot;the to dispatch the goods to the buyer. Issuing Bankquot;, and requests the bank to issue a 2. Having dispatched the goods and accumulated Documentary Letter of Credit in favor of the the required documents, the seller then sends seller. the documents stipulated in the Letter of Credit Assuming the Issuing Bank is satisfied with the to the advising/confirming Bank. credit standing of the buyer, it will issue the 3. The advising/confirming Bank then checks the Documentary Letter of Credit and request a documents against the Letter of Credit. bank in the seller's country to advise or confirm Assuming the documents meet with the the credit. However, if the Issuing Bank is requirements of the Letter of Credit, the seller dissatisfied, the buyer will have to provide will receive payment in accordance with the guarantees in the form of assets (money terms stated in the Letter of Credit. deposits and similar collateral) before the 4. Finally the Issuing Bank releases the Issuing Bank is willing to issue the Letter of documents and where these documents Credit. If this is not possible, the deal could be represent title to the goods, the buyer on rejected. presentation of these documents to the carrier gains possession of the relevant goods. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide TRADE FINANCE Letter of Guarantee A guarantee is a promise by the guarantor to be liable for the debt of another person, the principal debtor, should the principal debtor fail to perform an obligation, provided that the guarantor is notified of that fact by the creditor. The guarantee is usually given after the bank has been suitably furnished with collateral (e.g.. customer deposits, title deeds to property). In international trade, the provision by a bank of a guarantee can enable the customer, who is perhaps new to a country, and may be unknown to local banks and suppliers, but already has an established credit rating in another country, to enjoy normal trading relationships. Income sources for the guarantor bank are: Commission over the period of guarantee. In some cases, an interest-free or ‘cheap’ deposit as security from the customer. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide TRADE FINANCE Bills of exchange (Trade bills) It is defined as an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand, or at a fixed or determinable future time, a sum of money to, or to the order of, a specified person or bearer. There are three types of bills normally encountered in banking:- 1 Trade bills 2 Treasury bills 3 Bank bills Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide TRADE FINANCE Performance bonds A performance bond is a form of guarantee issued normally in connection with a long-term contract whereby the guarantor is liable for a fixed sum, due if the customer fails to complete a contract. The performance bond has recently become an important feature in the international construction industry. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide INVESTMENTS Securities (investments) usually represent a material, but relatively small part of the total assets of a bank. It is not usual for banks to deal actively in securities or to be long term holders of fixed interest stocks or other bonds. The underlying reasons why are simply because banks may find it difficult to switch from fixed term assets such as loans to liquid assets in order to meet any unexpected demand from its depositors. Consequently, banks hold such securities as ‘reserves’ and these not only generate income, and possibly capital appreciation, but are also readily convertible into cash. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide INVESTMENTS Types of Investment Banks may hold security both for dealing and for longer term investment. Their characteristics are as follows: 1 Dealing - Transactions are made frequently with the sole purpose of taking advantage of short-term changes in market prices and yields. 2 Investment - These are held for the longer term, usually to maturity. The bank's aim is to obtain regular interest (or dividend yield) and possibly, in the long term, capital appreciation. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide INVESTMENTS Specific types of securities Securities held by banks (whether for investment or dealing purposes) are usually described in their financial statements as investments and include the following: securities issued, or guaranteed by governments, which, in the case of British Government securities, are often described as gilt-edged and are usually dated; liabilities of corporate bodies, which may take the form of shares, debentures, loans stocks or bonds. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide INVESTMENTS Specific types of securities Gilt-edged securities Gilt-edged securities, which are either issued or guaranteed by the UK government, are usually listed and are considered absolutely safe in terms of interest payments and repayment at maturity. They present the investor with less risk but a potentially lower return than an investment in equities. The market value of gilt-edged securities is influenced by, among other factors, actual and prospective interest rates and their value will not, therefore be necessarily more stable than other securities. However, provided that they are dated, the total yield to maturity is guaranteed at the time of purchase. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide INVESTMENTS Specific types of securities Treasury bills These are issued weekly to fund the government's short-term borrowing requirements and to control the money supply by absorption of surplus funds from the money market. Treasury bills do not carry any interest and therefore, when potential buyers tender for such bills, the tender price will be set at such a level that the difference between the offer price and the face value, known as the discount, will represent a reasonable rate of return in exchange to prevailing market conditions. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide INVESTMENTS Specific types of securities Equities Equities (or ordinary shares) that are listed on a recognized stock exchange are generally more marketable than those that are unlisted. Although equities involve a higher degree of risk and may, in a thin market, be difficult to realize, they offer the opportunity to participate in a company's growth in both capital and income terms. Banks may therefore choose to hold some equities in order to provide a means to maintaining the value of their capital base. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide INVESTMENTS Specific types of securities Preference shares Preference shares entitle holders to dividends, usually at a fixed annual rate, which are paid in priority to dividends on ordinary shares. These dividends are often cumulative (that is to say, if a preference dividend is passed because of an insufficiency of profits, it must be made good before any dividend can be paid on the ordinary shares in later years). Preference shareholders normally do not have voting rights; in the event of a liquidation, they rank before ordinary shareholders. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide INVESTMENTS Specific types of securities Bonds A Bond is a document under seal requiring the payment of principal and interest on due dates. Bearer bonds, so called because they are payable to bearer, rather than registered in the name of a holder, are negotiable instruments to which title can be passed on transfer for value, in good faith and without notice of any defect. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide INVESTMENTS Specific types of securities Eurobonds A Eurobond is an instrument that evidences a long-term loan, often denominated in US dollars but which may also be in other currencies including sterling, issued by a large concern of international standing. It may carry a fixed or variable rate of interest. There is a secondary market for dealing in Eurobonds and prices vary with the quality of the borrower and the prevailing rate of interest on Eurocurrency deposits. The market in Eurobonds goes back many years, but developed significantly after the Second World War when large amounts of US aid were given to European countries during the reconstruction period. In recent years the market has become very large indeed because of the calls made on banks to recycle petrodollars, the absence of regulation in the market and the levels of interest rates prevailing internationally. Amir Saif amirsaiftaz@gmail.com
  • Banking Self Study Guide I hope this will help you a lot to understand the banking procedure Thank you, Amir Saif amirsaiftaz@gmail.com