2. 2-2
Definitions
Professor Gilbert
“ A bank or banker is a dealer in capital, or, more properly a
dealer in money. He is an intermediary party between the
borrower and the lender”.
Professor Kinly
“A bank is an institution which receives deposits and advances
loans”
According To English Finance Act 1915
“Bank is the institution which is engage in the banking business
under the rules of banking”
3. 2-3
Commercial Banks
Definition (Banking Companies Ordinance 1962)
A bank is an institution which deals in debts of his own and
others. It receives deposits from the people who have surplus
money and lends to the people in need.
Banking means the accepting deposits from the public for the
purpose of lending or investment, repayable on demand and
with drawnable by cheques ,drafts, order or otherwise”.
4. 2-4
Commercial Banks
• Largest depository institutions are commercial banks
measured by size.
• Accept deposits and make loans.
• Major source of funding is Deposits
• Loans are Consumer , Commercial , International and Real
Estate loans.
• http://www.sbp.org.pk/f_links/index.asp
7. 2-7
Primary Functions
1. RECEIVING DEPOSITS
Commercial banks receive deposits from the people who have
surplus money and willing to deposit with banks for the purpose of
safety and interest etc.
To meet the needs of people the banks offer following deposit
schemes:
Current Account
Saving Account
Fixed Deposit (Term Deposits)
Profit and Loss Sharing (PLS) accounts
Foreign Currency Accounts
8. 2-8
Primary Functions
2. ADVANCING LOANS
Commercial bank lend the money collected from the
people under different accounts, to the borrowers.
The bank provide loans of following nature.
• Cash credit
• Over draft
• Call loans
• Discounting of bills
• Investment loans
» Short-term loans
» Medium-term loans
» Long-term loans
9. 2-9
Functions of Commercial Banks
Agency Functions
• Collection & Payment Services
• Purchase & Sale Service
• Execution of Standing Instructions
• Collection of Dividends and Interest on Securities
• Transfer of Funds
• Bank as Guarantor
• Income Tax Facility
• Collection of Zakat
10. 2-10
Functions of Commercial Banks
General Utility Functions
• Issuance of Letter of Credit
• Discounting of Bills
• Issuance of Traveler’s Cheques
• Lockers Facility
• Foreign Exchange Transactions
• Act as an under writer
• Compile Statistics
11. 2-11
The role of Commercial Banks in the Economic
Growth & development of a country
Mobility of savings The banks by launching a vigorous
campaign both in the villages and cities can mobilize the idle
savings and can increase the investment rate in all sectors which
leads to economic growth of a country.
Credit creation
Agricultural development
Industrial development
Employment
Trade expansion
Help to government
12. 2-12
Income distribution :Commercial banks borrow from the people of the
higher-income group and lend it to the people of the lower income group.
Poverty alleviation :Commercial bank help the poor people by lending
money so as to improve their standard of life
Creation and distributors of money: They purchases securities and
allow money to play an active role in the economy.
Influencing economic activity: Commercial banks influence economic
activity in two ways. First by lowering the interest rate. Secondly , by making
the capital available to the investors.
Export promotion cell: To boost up exports, banks have established export
promotion cells to provide information and guidance to exporters. Through this,
export volume increases, which fetches more foreign exchange.
The role of Commercial Banks in the Economic
Growth & development of a country
13. 2-13
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
14. 2-14
Bank Sources of Funds
Long term sources of funds
Bonds issued by the bank
Bank capital
15. 2-15
Sources of Funds: Deposit Accounts
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
16. 2-16
Time deposits
» Deposits that cannot be withdrawn until a specified
maturity date
• Certificates of deposits (Retail CDs)
» Requires a minimum amount of funds to be deposited for
a specified period of time
» Annualized interest rates offered on CDs vary among
banks, and even among maturity types at single bank
» Some FIs have begun to offer CDs with a callable
features
» No organized secondary market
Sources of Funds: Deposit Accounts
17. 2-17
• Negotiable Certificates of Deposits
» Some large banks offer to companies
» Similar to retail CDs
» Secondary market does exist
» The level of large time deposits is much more volatile
than that of small time deposits
Money Market Deposit Accounts
• Different from conventional time deposits in that
they do not specify a maturity
• More liquid than retail CDs from the depositor’s
point of view
Sources of Funds: Deposit Accounts
18. 2-18
Sources of Funds: Borrowed funds
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 one to
seven days.
• A bank may act as a lender of federal funds on one day and
as borrower shortly thereafter, as its funds balance changes
every day.
19. 2-19
• Interest rates charged in the federal funds market is called
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 (as well
as to some other depository institutions)
• This is called borrowing at discount window.
• Interest rate charged on these loans is known as discount
rate.
Sources of Funds: Borrowed funds
20. 2-20
Banks rely on the central bank’s fund market for normal short term
financing, and use of discount window as a last resort.
Loans from the discount window are short term , commonly from one day to
a few weeks.
Banks that wish to borrow at that discount window must first obtain the
central bank’s approval.
Discount window is mainly used to resolve a temporary shortage of funds.
This is the source of funds for banks that experience unanticipated shortages
of reserves.
Sources of Funds: Borrowed funds
21. 2-21
Repurchase Agreements
• REPO represents the sale of securities by one part to another
with an agreement to repurchase the securities at a specified
date and price.
• Banks often use a REPO as a source of funds when they
expect to need funds for just few days.
• 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.
Sources of Funds: Borrowed funds
22. 2-22
• The government securities involved in the REPO transaction serve as
security for the corporation providing funds to the bank.
• REPO transactions occur through a telecommunication network
connecting large banks, other corporations, government securities
dealers, and federal funds brokers.
• The federal funds brokers match up firms or dealer that need funds with
those that have excess funds.
• The yield on REPO agreements is slightly less than the federal funds rate
at any given point in time because the funds loaned out are backed by
collateral.
Sources of Funds: Borrowed funds
23. 2-23
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
Sources of Funds: Borrowed funds
Long term Sources
24. 2-24
Uses of Funds by Banks
Cash
Bank loans
Investment in securities
Federal funds sold (loaned out)
Repurchase agreements
Eurodollar loans
Fixed assets
25. 2-25
Uses of Funds: Cash
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.
26. 2-26
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
partial or full 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: Bank Loans
27. 2-27
Bank loans
• Informal line of credit
» Which allow the business to borrow up to specified
amount within a specified period of time
» This useful for the firms that may experience a sudden
need for funds but do not know precisely when
» The interest rate charged on any borrowed funds is
typically adjustable in accordance with the prevailing
market rates.
» Banks are not legally obligated to provide funds to the
business, but they usually honor the arrangement to avoid
harming their reputation
Uses of Funds: Bank Loans
28. 2-28
• Revolving credit line
» Which obligates the bank to offer up to some specified
maximum amount of funds over a specified period of time (
typically less than five years)
» Bank charge a commitment fee on any unused 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.
Uses of Funds: Bank Loans
29. 2-29
Uses of funds by banks
Most common form, one of the banks serves as the lead bank by arranging for the
documentation, disbursement, and payment structure of the loan.
The main role of the other banks is to supply funds that are channeled to the
borrower by the lead bank.
The borrower may not even realized that much of the funds have been provided by
other banks.
As interest payments are received, the lead bank passes the payment on to the other
participants in proportion to the original loan amounts they provided.
30. 2-30
Uses of funds by banks
The lead bank receive fees for servicing the loan in
addition to its share of interest payments.
All participating banks are exposed to credit risk.
31. 2-31
Uses of funds by banks
Loans supporting Leveraged buyouts
• Some commercial banks finance leveraged buyouts
• LBO financing is the relatively high loan rate that can be
charged.
Collateral requirements on business loans
• Commercial banks are increasingly accepting intangible
assets (patents, brand name) as collateral for commercial
loans.
• This is important to service oriented companies that do not
have tangible assets.
32. 2-32
Uses of funds by banks
Types of consumer loans
• Installment loans
» Commercial banks provide installment loans to
individuals to finance purchase of cars and household
products
» Periodic payments
» Credit cards
» Interest rate on credit card loans and personal loans ID
typically much higher than the cost of funds
• Real estate loans
33. 2-33
Investment in securities
Bank purchase Treasury securities as well as
securities issued by agencies of the federal
government.
Banks also purchase corporate bonds
Risk and Returns
34. 2-34
Federal funds sold
Some banks often lend funds to other banks in the federal funds market.
The fund sold or lent out, will be returned at the time specified in the
loan agreement, with interest
The loan period is typically very short, such as a day or few days
If the transaction is executed by a broker, the borrowers cost on a federal
funds loan is slightly higher than the lender’s return, because the broker
matching up the two parties charges a transaction fee.
36. 2-36
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
37. 2-37
Off-Balance sheet activities
Standby Letters of Credit
Forward Contract
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
• If it guarantees payments to both parties, it is exposed to
the possibility that one of the parties will default on its
obligation.
