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Presented By:A. NaumanMehwish Ali
COMMERCIAL BANK OPERATIONS
BackgroundBank
History: Form around 1600 (Only make profit) The bank of America 1782 Colonial land North banks End of 18th Century Formed Dozen of banks Pooled the wealth & lent to group of
Enterprises Since 1920 commercial banks equal about
50% aggregate output of U.S Economy Glass steagall act 1933 (Repealed 1999)
Pakistan
• Comprehensive restructuring in 1997• Promotion of Saving, investment, growth• Pressure points on commercial banks since 1997
1) Multipronged reforms introduce by SBP
2) Freezing of foreign currency
3) Fluctuation in economic activities and growth
4) Drive for accountability and loan recovery
Functions of Commercial Banks
Commercial Banks
General Functions
Primary
Functions
Agency
Functions
Bank Sources of Funds
Deposit Accounts • Transaction deposits • Savings deposits • Time deposits • Money market deposit accounts
Borrowed Funds • Federal funds purchased (borrowed)• Borrowing from the central bank• Repurchase agreements
Bank Sources of Funds
Transaction deposits• Demand deposit account
• Require a small minimum balance and pays no interest
• Negotiable order of withdrawal• Provide checking services as well as interest
services
Saving deposits
Bank Sources of Funds (cont)
Time deposits • Deposits that cannot be withdrawn until a
specified maturity date • Certificates of deposits (Retail CDs)
• Minimum amount of funds for a specified period of time
• Annual interest rates offered• No organized secondary market
Negotiable Certificates of Deposits • Some large banks offer to companies• Similar to retail CDs• Secondary market does exist
Bank Sources of Funds (cont)
Money Market Deposit Accounts • Different from time deposits in that they do not
specify a maturity • More liquid than retail CDs from the depositor’s point
of view
Federal funds purchased (Borrowed) This allows depository institutions to
accommodate the short term liquidity needs of other financial institutions federal funds purchased represent a liability to the borrowing bank and an asset to the lending bank sells them
Loans in the federal funds market are typically for 1-7 days.
Bank Sources of Funds (cont) Federal fund rate If many banks have excess funds and few banks are
short of funds, the federal funds rate will be low.
Borrowing from the central bank Central bank also provide short term loans to banks This is called borrowing at discount window. Interest rate charged on these loans is known as
discount rate. • Banks rely on the central bank’s fund market for normal
short term financing, and use of discount window as a last resort. Short term loans, from one day to a few weeks. First obtain the central bank’s approval. Temporary shortage of funds.
Bank Sources of Funds (cont)
Repurchase Agreements The bank simply sells some of its government
securities to a corporation with a temporary excess of funds and buys those securities back shortly thereafter.
Long term Sources of Funds
Bonds issued by the bank• Fixed assets (land, building, etc.) of banks are
usually financed by the issuance of bonds• Such bonds are purchased by the households and
various financial institutions.
Bank capital • Obtained from issuing stock or retaining earnings• No obligation to pay out funds in the future• Must be sufficient to absorb operating losses• As of 1992: risk-based capital requirement
Uses of Funds
Cash Bank must hold some cash as reserves to meet the
reserve requirement enforced by the central bank
Banks also hold cash to maintain some liquidity and accommodate any withdrawal requests by depositors.
Bank do not earn income from cash, they hold only as much cash as is necessary to maintain a sufficient degree of liquidity.
Uses of Funds
Bank loans Working Capital Loan ( self liquidating loan) Term loans
Used primarily to finance the purchase of fixed assets
Assets purchased with the borrowed funds may serve as collateral on the loan
Contains Protective agreements because of long term
Direct lease loan Bank can purchase the asset and leasing them to
the firm in need
Uses of Funds
Loan Participation • Some large corporation wish to borrow
a large amount of funds than any individual bank is willing to provide.
• To accommodate a corporation, several banks may be willing to pool their available funds in what is referred to as loan participation.
Off-Balance sheet activities
Loan commitment• A loan commitment is an obligation by a
bank to provide a specified loan amount to particular firm upon the firm’s request
• The interest rate and purpose of the loan may also be specified
• The bank charges a fee for offering the commitment
Standby Letters of Credit • Backs a customer’s obligation to a third party• Banks earn fee income
Forward Contract • Agreement between a customer and bank to
exchange one currency for another on a particular future date at a specified exchange rate
• Allows customers to hedge their exchange-rate risk
Swap Contract • Banks also serve as intermediaries for interest
rate swaps, where by two parties agree to periodically exchange interest payments on a specified estimated amount of principal
• Bank receives a transaction fee for its services
Off-Balance sheet activities (Con..)
International BankingInternational banks can be characterized by the
type of services they provide that distinguish them from domestic banks
Major Functions:
1. Trade financing
2. Cross-border transactions
3. Exchange rate risk
4. Trade foreign exchange products
5. Deal in Euro/Dollar currency market6. International loan syndicate – lending
to MNCs- project financing7. Underwriting of Eurobonds and foreign
bonds8. Consultancy and advice on (strategies,
interest rate and currency swap financing and international cash management)
International Banking (cont)
Factors affect interest rates
4 Factors are:
Production opportunitiesThe return (or yield) available within an economy from investments in productive (cash-generating) assets.
Time preferences for consumption
The preference of consumers for current consumption as opposed to saving for future consumption.
Interest??It is the cost of MoneyTransforms money-today into money-tomorrow
Factors affect interest rates
RiskThe chance that an investment will not provide the expected return.
Expected inflationThe tendency of prices to increase over time
Determinants of Interest RatesFormula:
r = r* + DRP + LP + MRP + IP
r• required return on a
debt security
r* • real risk-free rate of interest
IP • inflation premium
DRP • default risk premium
LP • liquidity premium
MRP • maturity risk premium
The Loanable Funds theory
We use the term “loanable funds market” to describe the arrangements and institutions by which saving of households
is made available to borrowers.
DemandSupply
Consu
mpt
ion1. According to the
Classical theory, the loanable funds market acts transfer of funds from households (suppliers) to firms and government (Demanders).
2. Saving (S) is the “source” of loanable funds.
Saving
Net taxes
Factor income
Why do households save?
1. To have a more secure future, to start a business, to finance a child’s education etc….
2. To earn interest. We view interest as
the “reward for saving
Saving = Supply of Funds
Dollars0
Inte
rest
rat
e
3%
5%
1.5 1.75
Supply of FundsInterest rate = Supply
Investment Demand
Dollars0
Inte
rest
rat
e
3%
5%
1.5
Demand for Funds by Business
1.0
A
B
Interest rate = Demand
Question Answer Session
Thank You