SOURCES AND APPLICATION OF BANK FUNDS
1 Capital Adequacy
2 Deposits and non-Deposits Sources
3 Sources of Deposits
4 Classification of Deposits
5 Non Deposit sources
6 Designing of Deposit schemes &Pricing of deposit services
7 Investment and lending Functions
8 Types of lending-fund based
8.1 Non fund based lending
8.2 Asset based lending
9 Different types of loans and their features
10 Major components of a loan policy document
11Steps involved in credit analysis
12 Credit Delivery and A dministration
13 Pricing of loans
14 Customer profitability analysis
1 CAPITAL ADEQUACY: Capital to risk (weighted) asset ratio
A bank should have a sufficient capital to provide a stable resources to absorb any losses arising from the risks in its business
Ratio of a bank‘s capital to its risk.
Bank for international settlements(BIS) banks must have a primary capital base equal at least to 8% of their assets& a bank that lends 12 dollars for every dollar of its capital is within a prescribed limit
Basel committee for bank supervision(BCBS)- framed norms(capital requirements) 1988 known as Basel Accord I
To absorb unexpected losses or risks involved.
Higher the risk , it would be needed to back up with capital &vice versa.
CAR= Tier one capital+ Tier two capital / risk weighted assets
Tier one capital= (paid up capital +statutory reserves+disclosed free reserves)- (equity investments in subsidiary+ intangible assets +current & profit/loss)
Tier two capital= General loss reserves + hybrid debt capital instruments & subordinated debts.
Risk weighted assets: Risk& weight is calculated differently for each types of loan
2 DEPOSITS AND NON DEPOSITS SOURCES
It is a sum of money paid into a bank (or) building society account
Parameters to determine the fund mobilization
Cost of funds
3 Sources of deposits
Type of deposit customers
Tenure of deposits
Cost of banks
4 Classification of deposits
1.Transaction deposits/payment deposits
Ø These deposits are repayable by the bank on demand from the depositors.
interest bearing deposits(individual & saving a/c)
Non interest bearing deposits(low rate of interest) 2.Term deposits:
The customers receives a stream of cash flows in the form of interest. These deposits typically the high rate of interest.
USA –MMDA(Money market deposit accounts)
DDA(Demand deposit accounts)
UK- Saving deposits
Canada- term deposits,saving accounts
5 Non deposit sources/whole sale funding sources
It is calculated as the difference between current and projected credit non deposit flows. Shows the projected need for credit exceeding the expected deposit flows
Alternative funding sources
Central bank funds
Certificate on deposits(cd)
Other money market funds Types of non deposit sources
Call & notice money
External commercial borrowings(ECB)
1.Call & notice money
it is a money market instrument
Money market is a market for short term financial assets. Features
Banking &all co-op banks
Outstanding borrowing should not exceeding 100% of banks capital
Non banking institutions cannot operate.
2.External commercial borrowings:
Commercial loan in the form of bank loan,buyers credit,suppliers credit,fixed rate of bonds taken from non resident lenders with a minimum maturity period of 3years
Do not get approval from RBI& GOI
Amount of maturity
End use permitted
Prepayment of ECB
3.Export refinancing from RBI
offer Refinancing for credit
6 Designing and Pricing Of Deposit Services
Pricing of deposit sevices
Servicing costs Vs minimum balance requirements
Deposits volumes and their cost in relation to profits
Lending and investment avenues
Relationship with customers
6.1 Approaches of deposit pricing
Cost plus margin deposit pricingL Banks determine deposit rate
Cost of offering services plus small profit of margin formula: operating expenses per unit of deposit service Estimated overhead expenses allocated to deposit function Market penetration deposit pricing Based on market share (or) Growth of market ,the rate is fixed Conditional pricing - Attracive scheme, Larger volume of amount& higher interest rate- vice versa Upscale Target Pricing Customers are targeted ,Ex:Doctors,managers, lawyers Relationship pricing Banks best customers get best pricing Create good rapport b/w banks & customers
Designing of deposit schemes and pricing of deposit services, application of bank funds – Investments and Lending functions, Types of lending – Fund based, non-fund based, asset based
– Different types of loans and their features, Major components of a typical loan policy document, Steps involved in Credit analysis, Credit delivery and administration, Pricing of loans, Customer profitability analysis.
7 LENDING FUNCTIONS
Primary function of a bank.
Major sources of income
Risk also involved
Some of the securities against which the banks lends are
Consumer durable goods
Document of title
Functions of bank lending
To provide interest income of the bank
It helps in promoting private sector development
It helps to stabilize, broaden and increase the efficiency of financial markets.
Helps to promoting & developing the various financial institutions
To provide education aloans,housing loan etc to the people.
To provide direct finance to agriculture which includes short,medium&long term loans
8 Types of lending – Fund based, non-fund based, asset based
Fund based lending
Purchase of bills of exchange
Oldest & very popular form of lending by banks
Loans- financial assistance is given for a specific purpose and for a fixed period
With or without security(advance)
Loans (demand &term loan)
Demand loan(payable on demand, short term loans& granted to meet the working capital requirements of the business
Term loan( repayment is spread over long period .
Medium Term loan- (repayable 1 to 5 years)
Long term loan-(repayable after 5 years)
Banks lend money against the security of commodities and debt.
It runs like a current account except that the money that can be withdrawn from this account is not restricted to the amount deposited in the account.
Instead, the account holder is permitted to withdraw a certain sum called "limit" or "credit facility" in excess of the amount deposited in the account.
Division of funds
Non utilization of funds.
An arrangement where by the bank allows the customers to overdraw from its current deposit account.
security (assets& personal)
Charging of interest
Interest is to be paid only for the funds that people use
No additional expenses for prepayment of BOD.
Administrative fees can be charged
Necessary to maintain the current account
Difficult in calculation
8.1 Non fund based lending
Does not commit the physical flow of funds
It can be made in two forms
Letter of credit
Ø issuing bank agreement client
to meet the claims put forward by the client against the customer on behalf of whom guarantee is issued.
guarantee may be oral or written.
It is non fund based credit.
Sec 126 of Indian contract act (contract of guarantee)
A Contract to perform the promise or discharge the liability,of a third person in case of his default.
surety person who gives the guarantee
principal debtor person in respect of whose default the guarantee is given creditor person to whom the guarantee is given is called
Letter of credit
A binding document that a buyer can request from his bank in order to guarantee that the payment for goods will be tranferred to the seller.
Domestic /inland letter of credit
Foreign letter of credit/board letter of credit
8.2 Asset based lending
Ø Which the asset being bought(inventory, land or machine) is used as collateral.
Quality of the collateral
Off balance sheet financing
Asset based lender focus on
Inventory turnover rates
Orderly liquidation asset values
Forced liquidation asset values
Forms of asset based lending
The raising of funds required to finance an economically separable capital investment proposal in which the lenders mainly rely on the estimated cashflow from the project to service their loans.
Risk spreading/joint ventures
Complexity of project financing
Indirect credit support
Higher transaction costs
9 DIFFERENT TYPES OF LOAN AND IT‟S FEATURES
Loans for working capital
WC= (CA-CL) Investment in current assets
Working capital gap determined by borrowers decisions
Ø Loan for capital expenditure &industrial credit
Debit service coverage ratio
Loan for syndication
2 or more banks agree to jointly to make a loan to the borrower.
Loan for agriculture
Short term loan
Sales realization(Harvest time)
Long term loan(investment in land,equipment etc) Loans are paid after the harvest
Loans for infrastructure – Profit finance
Asset based lending
Identifying &Entering suitable contracts
Supplementary credit agreement& Mode of credit through term loans.
Loans for customers(or) retail lending
Purchase of durable goods,education,medical care,housing &other expenses Repayement periods from 1-5 years
Credit cards &Removal of default risk To improve profitability
Non fund based credit (Non interest income) ex: LC
10 COMPONENTS OF A TYPICAL LOAN POLICY DOCUMENT
Major components of a typical loan policy document
Volume &mix of loans
Loan evaluation Procedure
v Lending rates
communicate to credit officers & other decision makers
Volume &mix of loans
Specific industries,sectors,geographic areas.
Portfolio of loans
Pricing of loans
Loan evaluation Procedure
Establishment of loans
Consider bank‘s over all strategy Selection of borrowers
Post sanction monitoring
Lending activities are risky
To ensure credit decision are taken by experienced officers Hierarchical level of banks.
Used for making decision
Continous evaluation of company
Mandatory format is used
Types of collateral bank can accept the security for the loans
Security should cover the advances made
Nature of margins/compensating balances
Proper credit monitoring system is followed
Procedure for restructuring loan
Role of credit department in bank
Role of recovery department in bank
Role of legal department in bank
11 Steps involved in Credit analysis
Step:1 –Building the credit file
Step:2- Project & financial appraisal
Step:3- Qualitative analysis
Step:4- Due diligence
Step:5- Risk assessment
Step:6-Making the recommendations
Building the credit file
To assess the borrowers willingness
Desire to repay the loan
To examine the borrowers track record
Project & financial appraisal
Past financial statement
Cash flow statement
To find out the current financial health
To assess the quality of team
Poor credit decisions have been the result of not knowing enough about the customer.
Due diligence -is an investigation of a business or person prior to signing a contract, or an act with a certain standard of care.
Time consuming activity
Checking the borrowers details
Analyse the technology used by the borrowers
Assessment of debt service capacity
Identify andanalysis the risk
Identify internal and external risk
Standard pricing of loan decisions and terms of loan agreement must be considered.
Making the recommendations
Analyze of fitness & loan policy
Accept /reject of lending process
Specify credit terms including loan amount, maturity,pricing repayment schedule etc
12 Credit delivery and administration,
Credit delivery: it involves the trade off between the perceived default risk of the credit applicant and potential returns from granting requested credit
To determine the optimal amount of credit to deliver
Understand the customer current transaction behaviour &attitude Customer research to assess their economic impact
Develop an integrated channel migration plan (right initiatives at right customers) Protect sales effectiveness
Design non branch channel
Credit administration(Preparation of loan agreement,Renewal notices are sent systemmatically&Updation of credit files)
Credit administration function
Credit files are neatly organised
Borrowers has registered the required insurance policy
Borrowers should Repay the lease rent properly
Credit facilities are disbursed only after the contractual terms&conditions
Collateral value is regularly monitored
Borrowers should repay the interest,principal &fees &commissions in a particular time limit
13 Pricing of loans
Fixed & floating rate loan
Fixed rate loan are long term debt contracts whose interest rate payments are fixed at the time the loan is made
Floating rate :the interest is fixed for a short period and when that period expires a new interest rate is fixed for the next period
14 Customer profitability analysis(next chapter)
Relationship based pricing
Prime or base rate is established by the bank for its most credit worthiness of customers on short term working capital loans
Cost benefit loan pricing
The bank is charging enough for a loan to fully compensate it for all the costs and risk involved
Estimate the revenue the loan will generate under variety of loan interest rates &other fees Estimate the net amount of loanable funds
Estimate the before tax yield from the loan(revenue/ net amount of loanable funds
Cost plus pricing
Interest rate is charged for the following components:
Cost of funds
Cost of servicing the loan
Risk based pricing
A borrower with better credit will always get a lower rate,due to expected lower losses to be incurred from his account
Pricing of loans(process)
Step:1 Arrive at cost of funds
Step:2 Determine servicing cost for the customers
Step:3 Assess the default risk &enforceability of risks
Step:4 Fixing the profit margin
Arrive at cost of funds
Loan pricing= cost of funds + desired profit margin
It covers the variable costs.
Determine servicing cost for the customers
Identify the full list of services used by the customers
Assess the cost providing for the service
Multiply with the unit cost with the extent to which such non credit services are availed.
Cost of credit services depends on the loan size & forms a major portion of service costs.
Assess the default risk &enforceability of risks
It is a credit scoring system
Sanction of loan & analysis the risk.
E(r)= P(R)+P(D)* (R(P+Pr)/P)-1
P(R)=Probability of recovery
P(D)=probability of default
R=recovery rate in the event of default
r= contracted rate of interest Step:4 Fixing the profit margin ROE=(ROA* EM)
CUSTOMER PROFITABILITY ANALYSIS.
CUSTOMER PROFITABILITY ANALYSIS
It is a loan pricing method that takes into account the lender‘s entire relationship with the customer when pricing the loan
Identify all the services used by the customers (deposit services, loan availed, payment services, service relating to transfer of funds, custodial services and other fee based services.) STEP:2
Identify the cost of providing each services. STEP:3
Cost estimates for non credit related services can be obtained by multiplying the unit cost of each service by corresponding activity levels.
Major portion of costs is in respect of credit related services STEP:5
Credit related expenses has a non cash component the allocation of default risk expenses STEP:6
Assess the revenues generated by the relationship with the borrower. STEP:7
Assess the fee based income generated.fees are charged on the basis of price. STEP:8
Assess the revenue from loans.