BANKING BEAT COUNCIL ‘12BANK OPERATIONS Prepared By Ghada taha sara saeed
TOPIC NO 1BANK OPERATIONSCOURSE CONTENT Importance of banking How banks operate Functions of banks Types of bank according to Ownership, function , scope Departments within the banks Credit department Loan policy Lending process Credit analysis External operations department Letter of credit Letter of guarantee Risk management department Types of risks
The importance of bankingBanks are essential for each country’s economy, since no growth can be achievedunless savings are efficiently channeled into investment. They are a primarysource of funds for both individuals and businesses In this respect, the lack of afull-fledged banking system has often been identified as a major weakness of anyeconomy.What is a Bank?Banks are privately-owned institutions that, generally, accept deposits and makeloans. Deposits are money people leave in an institution with the understandingthat they can get it back at any time or at an agreed-upon future time. A loan ismoney let out to a borrower to be generally paid back with interest. This action oftaking deposits and making loans is called financial intermediation. A banksbusiness, however, does not end there.How Banks Create MoneyBanks cant lend out all the deposits they collect, or they wouldnt have funds topay out to depositors. Therefore, they keep primary and secondary reserves.Primary reserves are cash, deposits due from other banks, and the reservesrequired by the CBE. Secondary reserves are securities banks purchase, whichmay be sold to meet short-term cash needs. These securities are usuallygovernment bonds .the central bank of Egypt sets requirements for thepercentage of deposits a bank must keep on reserve, either at the central bank orin its own vault. Any money a bank has on hand after it meets its reserverequirement is its excess reserves.Its the excess reserves that create money. This is how it works (using atheoretical 10% reserve requirement): You deposit $500 in Your Bank. your Bankkeeps $100 of it to meet its reserve requirement, but lends $400 to Ms. Smith.
She uses the money to buy Toyota car. The Toyota Company deposits $400 in itsaccount at Their Bank. their Bank keeps $80 of it on reserve, but can lend out theother $320 as its own excess reserves. When that money is lent out, it becomes adeposit in a third institution, and the cycle continues. Thus, in this example, youroriginal $500 becomes $1,220 on deposit in three different institutions. Thisphenomenon is called the multiplier effect. The size of the multiplier depends onthe amount of money banks must keep on reserve.The central bank can contract or expand the money supply by raising or loweringbanks reserve requirements. Banks themselves can contract the money supply byincreasing their own reserves to guard against loan losses or to meet sudden cashdemands. A sharp increase in bank reserves, for any reason, can create a "creditcrunch" by reducing the amount of money a bank has to lend.How Banks Make MoneyWhile public policymakers have long recognized the importance of banking toeconomic development, banks are privately-owned, for-profit institutions. Banksare generally owned by stockholders; the stockholders stake in the bank formsmost of its equity capital, a banks ultimate buffer against losses. At the end of theyear, a bank pays some or all of its profits to its shareholders in the form ofdividends. The bank may retain some of its profits to add to its capital.Stockholders may also choose to reinvest their dividends in the bank.Banks earn money in three ways: They make money from what they call the spread, or the difference between the interest rate they pay for deposits and the interest rate they receive on the loans they make. They earn interest on the securities they hold.
They earn fees for customer services, such as checking accounts, financial counseling, loan servicing and the sales of other financial products (e.g., insurance and mutual funds).Why I have to deal with bank ?Small savers face costs of Searching; Contacting; Negotiating; Trying to diversify; Monitoring; Enforcement etcGiven the large number of savings and deposit by banks, related transaction costsare either falling or constant , lets clarify the importance of banks by defining itsfunctions : 1- Reduce transaction costsBanks reduce costs through several other ways including :provision of convenientplaces of business ,standardized products andless costly expertise through the use of tested procedures and routines. Thisbesides the regulation and supervision of banks by regulatory and supervisorybodies to ensure conformity with acceptable codes of behavior frees customersfrom the burden of collecting information and monitoring banks. 2-Delegate monitoringContracts are necessarily incomplete, soBorrowers need to be monitored to ensure maximum probability that loanedfunds will be repaid. Lending contracts are incomplete in that the value in largepart is determined by the behavior of the borrower after the issuance of the loan.Depositors delegate banks to monitor the behavior of borrowers.3. provide liquidityBorrowers and lenders have different liquidity preferences so,
banks pool funds together ,banks rely on the law of averages to be able to offerliquidity to their customers.The existence of banks can be derived from the bank’s balance sheet. Liabilities side: banks accept deposits and in turn provide transaction services. Asset side: banks issue loans, thereby providing liquidity.As Small-business borrowers find bank lending important because due to smallsize and relative opacity, funding through public markets is virtual impossible.Banks build relationships with customers that give them valuable informationabout their operations. Enhanced bank-customer relationships help smallbusinesses access funding because the bank has got special knowledge about thefirm.4-Payment systemBanks administer payment systems which are core to an economy.Through payment system: o banks execute customers’ payment instructions by transferring funds between their accounts. o customers receive payments and pay for the goods and services by cheques, credit or debit cards or orders o funds to flow between individuals, retail business and wholesale markets quickly and safely. o Currently, we have to pay electricity, phone buying mobile phone bills, send money via atm, paying employee salaries using bank services.These services very easy and gives a sense of security and comfort to those who use it.4- Risk transformationWith risk transformation borrowers’ promises are converted into a single promiseby the bank itself. Depositors who hold the institutions’ liabilities must be able toregard them as absolutely safe. Banks’ loans inevitably bear some risk.Banks’ ability to transform these risky assets into riskless liabilities depends onseveral factors : they control risk by incorporating an allowance for probable losses they spread risk to guard against the probability that loans to some customers or categories of customers will lead to unusually heavy losses.
they ensure that their own capital is adequate to absorb any losses they may incur through a failure to control risk properlyDifferent types of banks :Banks can be divided according to Types of banks Function Scope Ownership o Commercial banks o National banks o Investment banks o Private banks o Public banks o International o Retail banks o Specialized banks banks o Central banks o Multinational banksAccording to function:Retail banksRetail banks are banking in which banking institutions execute transactionsdirectly with consumers, rather than corporations or other banks. Services offeredinclude: savings and transactional accounts, mortgages, personal loans, debitcards, credit cards, and so forth.Investment BankA financial intermediary that performs a variety of services. This includesunderwriting, acting as an intermediary between an issuer of securities and theinvesting public, facilitating mergers and other corporate reorganizations, andalso acting as a broker for institutional clients.
Investment banking isnt one specific service or function. It is an umbrella term fora range of activities: underwriting, selling, and trading securities (stocks andbonds); providing financial advisory services, such as mergers and acquisitionadvice; and managing assets. Investment banks offer these services to companies,governments, non-profit institutions, and individuals.Specialized banks : are those banks which are specialized in serving a certain sector inthe economy as industry, agriculture & soon , examples of specialized banks :Industrial Banks / Development BanksIndustrial / Development banks collect cash by issuing shares & debentures andproviding long-term loans to industries. The main objective of these banks is toprovide long-term loans for expansion and modernization of industries.Land Mortgage / Land Development BanksLand Mortgage or Land Development banks are also known as Agricultural Banksbecause these are formed to finance agricultural sector. They also help in landdevelopment.Development BanksBusiness often requires medium and long-term capital for purchase of machineryand equipment, for using latest technology, or for expansion and modernization.Such financial assistance is provided by Development Banks.Central BankA bank which is entrusted with the functions of guiding and regulating thebanking system of a country is known as its Central bank. Such a bank does notdeal with the general public. It acts essentially as Government’s banker; maintaindeposit accounts of all other banks and advances money to other banks, whenneeded. The Central Bank provides guidance to other banks whenever they faceany problem. It is therefore known as the banker’s bank. The Central Bankmaintains record of Government revenue and expenditure under various heads.
It also advises the Government on monetary and credit policies and decides onthe interest rates for bank deposits and bank loans. In addition, foreign exchangerates are also determined by the central bank.Another important function of the Central Bank is the issuance of currency notes,regulating their circulation in the country by different methods. No other bankthan the Central Bank can issue currency . (this is only a brief note about thecentral bank as it will be explained in more detail later)Commercial BanksCommercial Banks are banking institutions that primarily handle banking needsfor large and small businesses but it also accept deposits and grant short-termloans and advances to their customers. In addition to giving short-term loans,commercial banks also give medium-term and long-term loan to businessenterprises. Now-a-days some of the commercial banks are also providinghousing loan on a long-term basis to individuals. So commercial banks provide awide range of service whether to business or individuals , ex : Accepting Deposits ,checks, loans, paying bills ….etc.According to ownershipPublic Sector Banks: These are banks where majority stock is held by theGovernment so the government conducts most of the banking operations.Private Sectors Banks:bank owned by individual or small group ,a bank that is owned by a single personor a limited number of private stockholders, bank for wealthy clients, meaningthat it provides banking facilities to high net worth individuals.According to scopeInternational bankingBanking transactions crossing national ,Boundaries so this financial institutionsallow foreign clients---both companies and individuals---to use their services. Asthese banks are beneficial for the Companies seeking to conduct business indifferent countries set up accounts with international banks to facilitateinternational transactions.
Multinational banksAre banks that mange its operations & deliver its services in at least twocountries, for ex : Citibank open its offices in more than 90 countries around theworld.Bank departmentsCredit departmentdepartment in a bank that evaluates the financial condition of credit applicantsand maintains a log of loan payments on currently outstanding loans. Creditinformation is gathered on a confidential basis and stored for future reference.The credit department also responds to requests by other lenders for creditinformation on a particular borrower.Note:In the past, credit departments have been responsible for handling mostly clericaltasks and identifying obvious trends in companies financial performance. Today,credit analysts need to be responsible for more than a basic knowledge offinancial statement analysis. They should understand a prospective borrowersoperation, be knowledgeable about specific industries, and be able to determinewhether projected financial performance is realistic. An analyst should also beable to identify appropriate loan structures and provide suggestions onimplementing terms and conditions, loan covenants, and loan monitoring.The credit department should be an independent part of the credit approvalprocess. Senior managers should stress that loan officers bear the ultimateresponsibility for loan approval. The role of the credit department is to analyze acredit request thoroughly and suggest how to improve the loan structure so thatit is an acceptable risk. However, it is the responsibility of the loan committee orothers with loan approval …
Establishing a written loan policy :Establishing a written loan policy is an important technique to make sure that thebank loans meet its regulatory standards as such policy gives the loan officers &management specific guidelines in making loan decisions & in shaping the overallloan portfolio, as the bank loan portfolio should reflect what its loan policy says ,such policy may contain these elements :1. A goal for the entire loan portfolio ( characteristics of good loan portfolio interms of types , maturities, size, & quality of loans) .2. Operating procedures for soliciting , evaluating & making decisions oncustomer loan applications.3. The required documentation that’s required with each loan application &what must be kept in the lender’s files ( financial statement , security agreements…. Etc) .4. Line of authority defining who is responsible for maintaining & reviewingthe institutions’ credit files.5. Guidelines for taking , evaluating , & perfecting loan collateral.6. Procedures for setting loan rates & fees & schedules for loan repayment.7. Identifying limits for the total loan outstanding ( the maximum ratio of totalloans to total assets allowed).8. Putting procedures for detecting & working out loan problem situations (ex: loan failure).Steps of the lending process:1. Finding loan customers
Identifying loan customers can be performed by two ways whether by a directrequest from a customer to fill out a loan application or business loan requestswhich arise from contacts the loan officers & sales representatives develop, ex:(call center, advertisement) as lending game is becoming a sales position ,sometimes the loan officer call on the same company for months before thecustomer agree to fill a loan application & this is due the strong competitionbetween the banks in the market to attract customers.2. Evaluating customer’s character & sincerity of purposeOnce a customer decides to request a loan so he will be forwarded to aninterview with the loan officer in order to give the customer an opportunity toexplain his or her credit needs at the same time this interview gives the officer anopportunity to understand customer’s character & sincerity of purpose ,As the interviewer should be an experienced person in order to be able tounderstand the customer well .3. Evaluating customer’s credit recordThis step involves gathering information about the customers to evaluate hiscredit record as this step can be executed by two ways :a) loan officer may contact other creditors (banks) who had previously loanedmoney to this customer to evaluate customer’s commitment to the loan ,whether the customer was fully adhered to previous loan agreement .b) The loan officer can understand the customer well through reviewing thecustomer’s history from the CBE (note: CBE has records for all the customers whowere engaged in a loan agreement.4. Evaluating customer’s financial conditionThe customer is asked to submit crucial documents in order to evaluate the loanrequest as these documents may include previous financial statement orexpected financial statements , the credit analysis division conduct a thoroughfinancial analysis in order to determine whether the customer has sufficient cashflow , his business is profitable or not & the a brief summary & recommendationis submitted to loan committee for approval .5. Assessing loan collateral & sign loan agreementOnce the loan committee approves the customer request then the creditcommittee or loan officer have to check other property or asset to be pledged,
then when both of loan officer & credit committee are satisfied so the loanagreement is prepared & signed by all parties of agreement.6. Monitoring compliance with loan agreement & othercustomer service needsThe new agreement must be monitored continuously to ensure the terms of theloan are being followed & all required payment of principle & interest are beingmade as promised , as for large commercial credit the loan officer will visit thecustomer’s business periodically to check on the firm’s progress & see what otherservices the customer may need5 C’s of Credit AnalysisKey to Credit Regardless of where you seek funding - from a bank, a localdevelopment corporation or a relative - a prospective lender will review yourcreditworthiness. A complete and thoroughly documented loan request (includinga business plan) will help the lender understand you and your business. The "FiveCs" are the basic components of credit analysis. They are described here to helpyou understand what the lender looks for.The 5CsCapacity to repay is the most critical of the five factors, it is the primary source ofrepayment - cash. The prospective lender will want to know exactly how youintend to repay the loan. The lender will consider the cash flow from the business,the timing of the repayment, and the probability of successful repayment of theloan. Payment history on existing credit relationships - personal or commercial- isconsidered an indicator of future payment performance. Potential lenders alsowill want to know about other possible sources of repayment.Capital is the money you personally have invested in the business and is anindication of how much you have at risk should the business fail. Interestedlenders and investors will expect you to have contributed from your own assetsand to have undertaken personal financial risk to establish the business beforeasking them to commit any funding.
Collateral, or guarantees, are additional forms of security you can provide thelender. Giving a lender collateral means that you pledge an asset you own, suchas your home, to the lender with the agreement that it will be the repaymentsource in case you cant repay the loan. A guarantee, on the other hand, is justthat - someone else signs a guarantee document promising to repay the loan ifyou cant. Some lenders may require such a guarantee in addition to collateral assecurity for a loan.Conditions :describe the intended purpose of the loan. Will the money be usedfor working capital, additional equipment or inventory? The lender will alsoconsider local economic conditions and the overall climate, both within yourindustry and in other industries that could affect your business, to assess industry& economic conditions most lenders maintain file of information, magazine article& research report on the industry represented by by their major borrowingcustomersCharacter is the general impression you make on the prospective lender orinvestor. The lender will form a subjective opinion as to whether or not you aresufficiently trustworthy to repay the loan or generate a return on funds investedin your company. Your educational background and experience in business and inyour industry will be considered. The quality of your references and thebackground and experience levels of your employees will also be reviewed.External operations departmentLetter of creditThe letter of credit is a written commitment issued by a bank (called the source)at the request of the buyer (applicant or order) in favor of the seller (beneficiary),and is committed to the bank by which to fulfill within the limits specified amountduring a certain period when presented seller documents item identical to theinstructions accreditation requirements, and the Banks commitment to fulfill incash or accept a bill of exchange.The letter of credit is used to finance foreign trade, which represents in our timeframe, which is accepted by the other parties in entering the field of international
trade in order to preserve the interest of these parties are all exporters andimporters. For the source, have a guarantee - by letter of credit - that will get the value of the goods which have been contracted for export, and that immediately after the shipment of the goods and documents to the bank, who have let him think that the receipt of accreditation. For the importer, it also ensures that the light of the adoption of the bank will not pay the contractor the value of the goods imported only with the documents of goods shipped an update to the conditions contained in the letter of credit open to him.And participate in the documentary credit four parties are:First, the buyer: it is the request to open the credit, and credit is in the form ofcontract between him and the light bank credit, and includes all the pointsrequested by the importerSecond: World Light Accreditation: is the bank which offers the buyers request toopen the credit, where the study of demand, and in the case of approval and theapproval of the buyer on the terms of the bank, who opens credit and sends iteither to the beneficiary directly in the case of dependence simplex, or one of itscorrespondents in the country seller in the case of post second bank in theprocess of the documentary credit.Third , Beneficiary: a source who is on the implementation of accreditationrequirements in the period of validity, and in the event that the notification basedenhanced from the correspondent bank in his country, the book reported to serveas a new contract between him and the correspondent bank, and under thiscontract receives the beneficiary price of the goods if the documents according tothe accreditation requirements.Fourth, the correspondent bank: the Bank shall inform the beneficiary that thetext of the letter of credit given to him by the issuing bank for approval intervenein cases where more than one bank in the implementation process of thedocumentary credit, as is often, and this adds the correspondent bank.
Why use a Letter of Credit?• The need for a letter of credit is a consideration in the course ofnegotiations between the buyer and seller• When the important matter of method of payment is being discussed.Payment can be made in several• different ways: by the buyer remitting cash with his order; by open accountwhereby the buyer remits payment• at an agreed time after receiving the goods; or by documentary collectionthrough a bank in which case the• buyer pays the collecting bank for account of the seller in exchange forshipping documents which would• Include, in most cases, the document of title to the goods. In theaforementioned methods of payment, the• Seller relies entirely on the willingness and ability of the buyer to effectpayment.• When the seller has doubts about the credit-worthiness of the buyer andwishes to ensure prompt payment,• The seller can insist that the sales contract provides for payment byirrevocable letter of credit. Furthermore, if• the bank issuing the letter of credit (issuing bank) is unknown to the selleror if the seller is shipping to a• foreign country and is uncertain of the issuing bank’s ability to honor itsobligation, the seller can, with the• approval of the issuing bank, request its own bank — or a bank ofinternational repute• to assume the risk of the issuing bank by confirming the letter of credit.•Step-by-step process:• Buyer and seller agree to conduct business. The seller wants a letter ofcredit to guarantee payment.
• Buyer applies to his bank for a letter of credit in favor of the seller.• Buyers bank approves the credit risk of the buyer, issues and forwards thecredit to its correspondent bank (advising or confirming). The correspondent bankis usually located in the same geographical location as the seller (beneficiary).• Advising bank will authenticate the credit and forward the original credit tothe seller (beneficiary).• Seller (beneficiary) ships the goods, then verifies and develops thedocumentary requirements to support the letter of credit. Documentaryrequirements may vary greatly depending on the perceived risk involved indealing with a particular company.• Seller presents the required documents to the advising or confirming bankto be processed for payment.• Advising or confirming bank examines the document for compliance withthe terms and conditions of the letter of credit.• If the documents are correct, the advising or confirming bank will claim thefunds by:o Debiting the account of the issuing bank.o Waiting until the issuing bank remits, after receiving the documents.o Reimburse on another bank as required in the credit.Advising or confirming bank will forward the documents to the issuing bank.Issuing bank will examine the documents for compliance. If they are in order, theissuing bank will debit the buyers account.• Issuing bank then forwards the documents to the buyer.