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Symbi Banking Lecture Notes
Symbi Banking Lecture Notes
Please include the different types of banks and functions, Central Banks definition and function,
scheduled and non scheduled banks,
Evolution of Banking
The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the
Reserve Bank of India Act, 1934. The Indian Banking Regulation Act 1949 was formulated to govern
the financial sector.
In 1921 the presidency Banks of Bengal, Bombay and Madras with their 70 branches were merged in
1921 to form the Imperial Bank of India. During the First 5 year plan in 1951, an act was passed in
Parliament in May 1955 nationalizing the Imperial Bank and the State Bank of India was constituted
on 1 July 1955
During the period 1906-1911, several Commercial banks such as BOI, Central Bank of India, BoB,
Bank of Mysore etc were established which were all Joint Stock Banks
Definition of a Bank
Indian Banking Regulation Act (1949) defines Banking as the Acceptance of money for the purpose of
lending or investment, from deposits received from the public, repayable on demand or otherwise
withdrawable by cheques, drafts or order to otherwise (Standing Instructions, ECS).
Nationalization of Banks
First only State Bank of India (SBI) was nationalized in July 1955 under the SBI Act of 1955.
Nationalization of Seven State Banks of India (formed subsidiary) took place on 19th July, 1960.
In 1969, Mrs. Indira Gandhi the then prime minister nationalized 14 banks then. These banks were
mostly owned by businessmen and even managed by them.
Central Bank of India
Bank of Maharashtra
Dena Bank
Punjab National Bank
Syndicate Bank
Canara Bank
Indian Bank
Indian Overseas Bank
Bank of Baroda
Union Bank
Allahabad Bank
United Bank of India
UCO Bank
Bank of India
1980 : Nationalisation of seven more banks with deposits over 200 crores.
Problems: Nationalized banks had job guarantee so employee efficiency very low, indiscipline and
high absenteeism, trade union problems etc. Compare with present banks
1. Central Bank
2. State Bank of India
3. Scheduled and Non Scheduled Banks
4. Retail Banking
5. Private Banking
6. Co operative Banking
7. Investment Banking
8. Corporate Banking
In the RBI ACT OF 1934, all banks listed in the second schedule is known as Scheduled banks
All Scheduled bank operations are under strict surveillance of RBI. All nationalised banks, most
private sector banks, foreign banks are scheduled. Most cooperative banks are non- scheduled (not
subjected to strict financial discipline).
Advantages of scheduled banks:
1. RBI can rediscount the bills already discounted by them
2.Their drafts, bank guarantee, letter of credit accepted in all government offices
3.RBI acts as lender of last resort
4. All government accounts and transaction through them
5. More account holders and lesser interest payment towards deposits as compared to non
scheduled banks
4. RETAIL BANKING
Basic Functions
1. Acceptance of Deposits:
Classification of Deposits:
Demand Deposits/Current Deposits-Repayable on demand-Savings accounts for individuals, Current
Accounts for businesses (CASA)
Fixed Deposits/Time Deposits
The deposit is placed for a fix time period and fixed interest rate/ instructions needed for premature
withdrawal. In exchange for the lack of liquidity, banks offer a higher yield on time deposits than
they offer on regular savings accounts.
2. Loans & Advances: Accepts funds so that they can lend out credit to customers for consumption
towards cars, houses, consumer goods, construction etc
3. Use of Cheques: Since the deposits with banks are withdrawable by cheques it elevates bank
deposits to the position of money
Negotiable Instruments
Transactions related to NI are governed by the negotiable instruments act 1881. Section 13 defines “
a negotiable instrument means a promissory payable either to order or bearer”
Bills of exchange/cheques/drafts/ certificate of deposits-unsecured borrowing by scheduled banks
for a period ranging 3 months to 1 yr by issuing promissory notes/ Accommodation bill- it is a bill of
exchange where a reputed third party is providing a guarantee towards repayment as a favor
without any compensation for the same. This third party remains liable till the bill amount is repaid
to the bank
KYC-Know your Customer or Client/ AML- Placement, Layering and Integration (Please refer to
notes given in class)
Step 1: Bank A
Liability Asset
New Dep: Rs 2000 New cash: 2000
Total: Liab: 2000 Asset: 2000
Step 2: bank A
Liability Asset
Deposit: 2000 Cash: 400
Loan to X: 1600
Total: Liab: 2000 Asset: 2000
Step 4: bank B
Liability Asset
Deposit:
1600 Cash in hand:320
Loan to Y: 1280
Total Liability: 1600 Total Asset: 1600
Step 5: Bank C (Y is an Account holder)
Liability Asset
Therefore K=1/5% which is 20 times. Thus Credit creation can take place up to 20 times the initial
deposit amount.
3. TELLERS (CASHIERS)
1. Receipt and payment of cash over the counter and following certain security norms in case the
amounts are very large i.e. letter from customer stating source of funds or its usage/Pan Card
copy etc
2. Account to account fund transfers within the same bank/ branch.
3. Safeguard interest of customers from fraudulent practices by identifying signature mismatches
and forgery on cheques, since they have a specimen signature on the records
4. Identify and destroy counterfeit currency
5. Encashment and also issuance of traveller’s cheques, gift cheques and demand drafts.
6. RTGS-real Time Gross Settlement-/ NEFT-National Electronic Fund transfer
7. Maintenance of Cash in ATMs
8. Exchanging foreign currency OTC
9. Acceptance and Clearing of cheques
RTGS: The acronym 'RTGS' stands for Real Time Gross Settlement. RTGS system is a funds
transfer mechanism where transfer of money takes place from one bank to another on a 'real
time' and on 'gross' basis. This is the fastest possible money transfer system through the banking
channel. Settlement in 'real time' means payment transaction is not subjected to any waiting
period. The transactions are settled as soon as they are processed. 'Gross settlement' means the
transaction is settled on one to one basis without bunching with any other transaction. NEFT
settlement takes place 6 times a day during the week days (9.00 am, 11.00 am, 12.00 noon.
13.00 hours, 15.00 hours and 17.00 hours) and 3 times during Saturdays (9.00 am, 11.00 am and
12.00 noon). Any transaction initiated after a designated settlement time would have to wait till
the next designated settlement time. Contrary to this, in RTGS, transactions are processed
continuously throughout the RTGS business hours. The minimum amount to be remitted through
RTGS is Rs.1 lakh. There is no upper ceiling for RTGS transactions. No minimum or maximum
stipulation has been fixed for EFT and NEFT transactions.
5. PRIORITY BANKING
HSBC- Premier/ ABN Amro-Van Gogh Preferred Banking/ Citibank-Citigold/ Standard Chartered-
Priority Circle
Value proposition with account opening amounts ranging from 25 – 30 lacs
1. Experienced Relationship Managers and Customer Service Managers assigned to fewer groups of
customers for personalised and specialised services
2. Wealth Management Services to customers, consolidating previous, existing and fresh
investments spanning equity, debt and sectoral mutual funds, stocks, bonds, gold, deposits,
commodities, insurance, foreign investments, real estate etc. Thereby providing customised
investment solutions which are extensively tracked, rebalanced and allocated according to
customer risk profiling and cash flows
3. Structured investment products using derivatives etc are designed especially for these clients
4. Higher Deposit rates are offered, while fees are waived off in mostly all banking transactions and
products
5. Very high limits offered on debit and credit cards with international service facilities included
which are either free or heavily subsidised. All annual charges on cards are waived.
6. Extremely competitive rates are offered on currency conversion, while remittance charges are
mostly waived or discounted
7. Multiple account facilities in different countries offered to High Net worth clients with business
interest across the globe
8. Interest Rates charged on Home loans and personal loans are at a significant discount to Branch
banking customers, and also with much lesser documentation requirements
6. RELATIONSHIP MANAGEMENT
1. Wealth Management: Financial Planning, Investor profiling, Asset allocation & Product
selection, Portfolio tracking & rebalancing
2. Managing incremental cross sale of investments and other banking products
3. Retention of customers, deepen the relationship with constant interaction and ensure
quality service and resolution of queries within given TAT
4. Acquire new relationships and grow their balances through investments in various products
5. Sales of all categories of Life Insurance products i.e. market linked plans (ULIPs), term
policies and Endowment Plans
6. Equity research, advisory, monitoring and stock trading through the Portfolio Management
Services route
7. Constant reviewing and monitoring customer’s portfolios and detailed financial planning to
address any need gaps using proprietary software. Thereby make changes in the portfolio
based on current market levels and movements debt, equity and commodities side
8. Provide structured products to HNI clients. Most products are designed with inbuilt features
to participate in the derivatives segment and involve aggressive option trading strategies
and positions in Futures, to either enhance profitability or hedge risks
9. Track foreign currency markets to enable Non Resident customers profit from exchange rate
fluctuations
10. Also focus on the corporate relationship segment (company accounts) as an avenue for high
revenue from large company investments, by liaising with the corporate banking channel
11. Ensuring all audit and compliance norms are followed. Cross border investment and
insurance norms have been followed. All investments have to be documented extensively
capturing the minutest of investor/investment details
12. Conduct regular market research to review, assess, analyze, report on competitor activities
of other banks and financial institutions ,and capturing changing consumer behavior and
general industry trends
7. RETAIL ASSETS
1 Selling Home loans, car loans and Personal loans to existing and new customers
2. For home loans, liaison with designated lawyers and property valuers to ensure that the
property to be kept as mortgage is secure with clear title, no encumbrances and with
required market valuation for ensuring the security of the loan.
4. Credit managers verify customer income documents, calculate his repayment capacity
and then Sanction loans.
5. The final Disbursal of loan ie. Cheque handed out to borrower, takes place post a clear
legal report of the property papers from lawyers and based on the technical valuation report
by property valuer of the current market value of property
6. Hold marketing events at the bank, companies, societies, clubs, malls, multiplexes etc
sometimes offering concessional interest rates to promote loans.
8. RETAIL LIABILITIES
1. Selling CASA: Current accounts and savings accounts
2. Selling Fixed deposits to increase the banks deposit base
1. Initiating and implementing Marketing efforts for acquiring new accounts by individual sales
efforts, organizing customer meets, seminars & events
2. Procuring databases from various sources for cold calling and selling banking propositions
3. Taking customer references from existing and prospective clients for sourcing more accounts
4. Collecting and completing the required documentation for account opening
10. TRAINING & DEVELOPMENT
1. Ensure all mandatory certifications are completed by the sales and service staff and provide
training for the same
2. Develop Learning & management modules covering a wide range of banking, finance and
investment topics with online tests for getting a formal qualification
3. Extensive training provided on identifying money laundering trails and investments routed
from high risk countries.
4. Provide training on new product launches, changes in bank policies, new technologies,
rebranding and re launching existing products
5. Regular training on investments, insurance and financial planning for customers
6. Create talent pools by identifying and segregating employees based on various skill sets
ranging from team management, selling skills, knowledge quotient, customer handling
techniques etc by conducting regular workshops
7. Update staff on new legislations, competitor strategies and prevailing market opportunities
Back office functions. Issuance of cheque books, debit and credit cards and their respective
passwords, placement and withdrawal of deposits, generating internet & phone banking passwords,
generating account opening kits, bank statement etc
14. COLLECTIONS
Recovery and settlement of bad loans, credit card defaults etc
Customer background checks, field investigation reports and risk management measures such as
verifying customer’s area of residence and whether he stays in a negative area , healthiness of his
prior banking transactions, previous loan repayment records etc before the bank authorizes loans or
credit cards
PLR-PRIME LENDING RATE: RBI: 11-12%/ 5 top Commercial Banks 11-15%- Prime Lending Rate (PLR)
is that rate of interest at which a bank lends to its best customers with highest credit worthiness
CASH RESERVE RATIO: 5.75%- liquid cash that banks have to maintain with the Reserve Bank of India
(RBI) as a percentage of their demand and time liabilities and borrowing from CBLO market
STATUTORY LIQUIDITY RATIO: 25% - SLR refers to the amount that all banks require to maintain in
form of approved government securities.
BANK RATE: 6%- Longer term borrowing rate from RBI, bill re discounting rate
REPO RATE: 4.75%- Short term Bank borrowing from RBI by pledging government bonds as security
when banks have to meet temporary shortfalls
REVERSE REPO RATE: 3.25%- Short term lending to RBI when banks have surplus liquidity
CAR- Capital Adequacy Ratio- As per Basel 2 norms the minimum is 8% while RBI has fixed 9% as CAR
-It is amount of a bank's capital expressed as a percentage of its risk weighted credit exposures i.e.
(Capital/Risk) determines the capacity of the bank in terms of honoring deposit withdrawals and
managing other risk such as credit default risk, operational risk.
In case of Scheduled Commercial Banks CAR= 9 per cent
For New Private Sector Banks CAR = 10 per cent
For Banks undertaking Insurance Business CAR = 10 per cent
For Local Area Banks CAR =15 per cent
LAF: Liquidity Adjustment facility- The RBI uses Repo and Reverse Repo to aid banks in adjusting
their liquidity requirements and help in meeting Monetary policy measures
1. Cash Management:
Maintaining the cash reserves, capital and liquidity of the bank. Ensuring that the bank maintains
the Cash reserve ratio and Statutory Liquidity Ratio requirements as laid down by the central bank.
Participating in Repo, Interbank call money markets & CBLO incase of shortfall and park excess
money in Reverse Repo market or lend in the Call money markets in case of surplus
Bank Treasury also participates in the derivative markets such as Interest rate futures to reduce risk
from bond price fluctuations. The underlying instrument for this is a 10-year notional coupon-
bearing government security. This underlying security is assumed to pay interest (called a coupon) at
a rate compounded at 7% p.a. on a half-yearly basis. For example go short on the underlying bond in
the interest rate futures market if the Spot price of Government Securities is expected to fall, thus
offsetting the loss in the Spot segment by gaining in the futures segment (explain in details in class)
4. Capital Issuance: Raising capital for the bank through the following methods
a. Public offer through IPO or FPO, Divestment, issuance of ADRs, GDRs and Rights issue (Rights are
issued whereby existing shareholders have the privilege to buy a specified number of new shares
from the firm at a specified price within a specified time)
b. Private placement of stocks or bonds (QIP-Qualified Institutional placements with DII, FII, PE funds
etc)
c. Raising fund in the short term via the Repo window, interbank call money markets (overnight to
14 days), CBLO, COD-Certificate of deposits (3 months to 1 year unsecured promissory notes issued
by scheduled banks)
d. Raising long term funds through Bonds, FCCB,CD, NCD and Preferred stocks (preferred stocks are
not traded in the stock exchanges and share holders receive fixed percentage of dividend per share
every year. The core right is that of preference in the payment of dividends. There is a negotiated
fixed coupon payment with cumulative option and non cumulative. In case of bankruptcy or
liquidation preferential share holders will get their part before common stock holders. Preferential
share holders are not entitled to voting rights.
d. Securitization: It is a process of aggregating a portion of existing debt of a bank where there is a
cash flow receivable over a period of time into a common pool, and thereby issuing new securities
backed by this pool to collect fresh funds from public or financial institutions etc. These securities
are often known as MBS- Mortgage Backed Securities, CDO- Collateralized Debt Obligation and ABS-
Asset Backed Securities
Type of Accounts
Resident Accounts /NRE- Non Resident External/NRO- Non Resident Ordinary/FCNR/ RFC
FCNR: Foreign Currency Non Resident Accounts: In this type of accounts funds are held in foreign
currencies but only in the form of fixed deposits.
RFC-Resident Foreign currency accounts. These accounts are held by Indians who travel abroad very
frequently and do not wish to pay conversion charges on foreign currencies each time they travel.
Thus in these accounts funds are held in foreign currencies. However no interest is paid on this
account.
Caters to Super High Net worth customers- minimum account opening cheques: 4 crores (HSBC), 1
Crore (ICICI). Aim is to make fee based incomes by offering structured and specialized investment
services from which bank earns commissions. Stress is mainly on customized investment products.
Lending functions are secondary and a part of the service functions. Customer service being
rendered on a more personal basis, dedicated Relationship Managers with 8 to 10 years of
investment experience. All products and services are offered at discounted or special rates. Deposit
rates better, remittance charges waived, foreign exchange conversion rate few paises plus minus the
interbank rate, loan rates discounted, documentation waived (fundamentally similar services given
to HNIs in Retail banking except Investment products which are personally customized for these
individual clients while in Retail HNI banking, products are customized for the entire group of
customers)
6. COOPERATIVE BANKING
Definition by Paul Lambert: It is an enterprise formed and directed by an association of users,
applying within itself the rules of democracy and directly intended to serve both its own members
and the community as a whole. It is a voluntary concern with equitable participation and control
among all concerned.
1. It is organized by those who themselves need credit
2. Runs as a democracy: Run by Board of Director elected on the basis of one vote per member
1. Rural Co-operative banks: predominantly agriculture credit banks-short, medium and long term
to agriculture, handicraft, cottage industries. Issues: Recovery, problem of valuing land, livestock,
perishable agricultural commodities, improper title of property as security, limited resources,
chances of financial mis-management by the management itself (corruption).
2. Urban Co-operative banks: Formed for meeting the credit requirement of the urban lower middle
class which larger banks do not wish to lend due to high cost of advancing and recovery. Nor do
these people have large incomes or large assets to offer as security. Membership open to traders,
merchant, professionals etc who have to contribute to share capital. They have their own funds
(paid up share capital) and borrowed funds (deposits and borrowing from other banks)
6. INVESTMENT BANKING
1. Investment banking is a field of banking that aids companies in acquiring funds, through the
public or through Venture capitalists, Private equity funds and Mezzanine funds.
Thus through investment banking, an institution generates funds in two different ways.
a. They may draw on public funds through the capital market by selling stock in their
company
b. They may also seek out venture capital or private equity in exchange for a stake in their
company.
Venture capital and Private equity Funds typically invest in early-stage, high-potential, growth
companies in the interest of generating a return through an eventual realization event such as an
IPO or sale of stake in the company in the secondary markets. These investments are generally made
as cash in exchange for shares in the invested company. Venture capital typically comes from
institutional investors and high net worth individuals and is pooled together by dedicated investment
firms. Venture Capitalists look more towards new early ventures which are starved of funds with
exponential growth potential while PE firms look more towards high growth existing companies in
need of funds.
Mezzanine funds are like a hybrid PE fund acquiring part equity and part debt to finance the
expansion of existing companies. The debt holding provides for regular interest payment, while
superior upside comes from the equity holding. The debt capital also gives the Fund the rights to
convert to an ownership or equity interest in the company if the loan is not paid back in time and in
full.
In India, the venture capital funds (VCFs) can be categorised into the following groups:-
2. An investment banking firm also does a large amount of Fee based consulting on Mergers,
Acquisitions and Take Overs.
Mergers : They combine two or more previously separate firms into a single legal entity. The
combined business, through structural and operational advantages secured by the merger,
can cut costs and increase profits, boosting shareholder values for both groups of
shareholders. The sum of its parts is worth more than the individual parts. In a merger of two
corporations
Acquisitions: It is characterized by the purchase of a smaller company by a much larger one
Takeover: Hostile or otherwise involves buying the management rights through outright
purchase of shares
3. Track the market in order to give advice on when to make public offerings and how best to
manage the business assets, when to sell them and the pricing for the same. Also advice on
debt restricting and company restructuring.
4. Fee based consultative activities such as buy-and-sell advice on equities, commodities, debt,
derivatives, advisory on foreign exchange trading and calls based on foreign currency
fluctuations and predictions.
5. Merchant banking services to companies for equity sale such as price band calculation, Lot
size, timing for sale.
7. Underwriting services for IPO/FPO/Bond issues: This is a way of placing a newly issued
security, such as stocks or bonds, with investors. Investment Banks take on the risk of
distributing the securities to investors. Should they not be able to find enough investors,
then they have to purchase the securities themselves. Underwriters make their income from
the price difference, or underwriting spread, between the price they pay the issuer and what
they collect from investors or from broker-dealers who buy portions of the offering –
sometimes they earn fixed underwriting fees, commission on sales , but mostly underwriting
spread
8. Bridge Financing: Providing short term financing to companies before their IPO for the
maintenance of operations. These funds are usually supplied by the investment bank while
they are underwriting the new issue. As payment, the company acquiring the bridge
financing will give a number of shares at a discount to the issue price to the investment bank
that equally offsets the loan. These are also Short term temporary loans given to companies
before they secure long term permanent ones.
9. Investment advisory in highly specialised or niche investment options where the risk and
return probability is very high. The investment bank manufactures structured products
which are derivatives based and customised to suit specific customer requirements and
designed to optimise on current and future market trends.
7. CORPORATE BANKING
Functions:
Non Fund based lending: Here the bank does not actually lend funds to the customer but acts as a
backing to a customer for a certain fee to help him avail funds from another organization. The bank
takes on the risk of meeting payment obligations on behalf of the customer in case the customer
defaults on his payments. These are in the form of Letters of credit and bank guarantees. Thus only if
the customer defaults then the bank has to make the payment on his behalf to the lender and that
becomes fund based lending for the bank. This is a contingent liability for the bank.
Term Loans: Banks lend money in this mode when the repayment is sought to be made in fixed, pre-
determined installments. This type of loan is normally given to the borrowers for acquiring long term
assets i.e. Plants, machinery, business expansion funding-organic/inorganic
Letter of Credit: Letters of credit are used primarily in international trade transactions of significant
value, for deals between a supplier in one country and a customer in another. The parties to a letter
of credit are usually a beneficiary or seller who is to receive the money, the issuing bank of whom
the applicant or buyer is a client, and the advising bank of whom the beneficiary is a client. Almost
all letters of credit are irrevocable, i.e. cannot be amended or cancelled without prior agreement of
the beneficiary, the issuing bank and the confirming bank. It is an instrument used for settling trade
payments, where payment is made against certain Financial documents such as bill of exchange,
Invoice and packing list, shipping documents such as bill of lading for ships, airway bill and insurance
certificate proving the shipment was insured against loss or damage in transit etc. The bank will only
issue a letter of credit if they know the buyer will pay. Some buyers have to deposit (or already have)
enough money to cover the letter of credit, and some customers use a line of credit with the bank. A
seller only gets paid after performing specific actions mentioned in the LOC that the buyer and seller
agree to and the banks simply review documents proving that a seller performed his required
actions
Bank Guarantees: A guarantee from a lending institution ensuring that the liabilities of a debtor will
be met. In other words, if the debtor fails to settle a debt, the bank will cover it. An importer may
request his bank for a bank guarantee against his payment obligation or a business house.
In contrast, a guarantee is a written contract stating that IN THE EVENT the primary party (the buyer)
is unable or unwilling to pay its dues to the supplier only then the bank, as guarantor to the
transaction, would pay the client's debt to the seller.
With a bank guarantee, only if a client defaults the bank assumes liability. With a letter of credit,
liability rests solely with the issuing bank which then must collect the money from its client.
Therefore, the principal character of an LC is that it is a potential claim against the bank, rather than
a bank's client as in the case of bank guarantee. So LC is riskier for the issuing bank as compared to a
bank guarantee.
Pre shipment finance: This is also called Packing Credit, which is short term working capital provided
to exporters to procure raw materials, manufacture, arrange for shipment , warehousing etc. This is
provided to the seller by his bank on furnishing a Letter of credit issued from the buyer’s bank or a
confirmed order from a reputed foreign purchaser. This is provided before the goods are loaded for
departure.
Post shipment finance: Working capital provided to exporters when the bank advances funds from
the time a shipment that has been dispatched to the importer till the time the export proceeds are
realized by seller. Post Shipment Finance is an insured deal, the seller submits to his bank the Bill of
Lading from the Ship, The official Bill charged to the buyer, a copy of the insurance policy insuring
the goods in case the ship sinks, goods damaged etc. against which the bank provides payment.
Incase a letter of credit has been provided by the importer/buyer’s bank, then the exporter/seller’s
bank checks whether these documents are in conformity to the LOC and then provides the capital.
Factoring: It is a financial transaction whereby a business sells its accounts receivable (i.e. invoices)
to a third party (called a factor) at a discount in exchange for immediate money with which to
finance continued business. The factor (bank) obtains the right to receive the payments made by the
debtor for the invoice amount and must bear the loss if the debtor does not pay the invoice amount.
Factoring is the sale of receivables whereas bill discounting is borrowing where the receivable is
used as collateral. The duration of lending capital under Factoring is usually for less than 180 days.
Factoring is an insured deal (Credit risk- ICICI Lombard, Atradius, Coface, New India Assurance), since
risk is transferred to the bank post purchasing the Bill/ invoice. Factoring does not need a LOC or
bank guarantee from the buyer unlike forfeiting and these are finances for short durations. The
factor charges the seller a service charge, as well as interest based on how long the factor must wait
to receive payments from the debtor. The factor also estimates the amount that may not be
collected due to non-payment, and makes accommodation for this when determining the amount
that will be given to the seller. The factor's overall profit is the difference between the price it paid
for the invoice and the money received from the debtor, less the amount lost due to non-payment
Forfaiting: “ Forfait” is derived from French word “a forfait” which means forfeiting or surrender
of rights. It is a method of export trade financing, especially when dealing in capital goods (which
have long payment periods- 180 days up to 7 years) or with high risk countries. In forfaiting, a bank
advances cash to an exporter against invoices or promissory notes guaranteed by the importer's
bank or against LOC issued by importer’s bank. The amount advanced is always 'without recourse'
to the exporter i.e. once exporter obtains financing payments, he will not be responsible for the
solvency of the debtors any more. The amount funded is less than the invoice or note amount as
it is discounted by the bank. The discount rates depends on the terms of the invoice/note and the
level of the associated risk. There is no more payments or administrative expenses due from the
exporter. Unlike forfeiting however, factoring does not require a bank guarantee or LOC, can be
used by small exporters and covers small amounts and short maturities such as less than 180
days.
Bill discounting: discounting is borrowing by the seller/exporter where the receivable i.e. promissory
note is used as collateral and the seller/ exporter thereby avails working capital from the bank.
Type of bills:
Clean Bills: These bills are not supported by any ‘document of title to goods’ since both the goods
and documents such as bill of lading etc which allows the delivery to buyer has already been sent to
the buyer. Thus this is like an unsecured loan which depends on the creditworthiness and honesty of
counterparties.
Accommodation Bill: Bill of exchange endorsed by a reputable third party (called an accommodation
party or accommodation endorser) acting as a guarantor, as a favor and without compensation. The
bill then can be discounted on the financial strength of the guarantor who remains liable until the bill
is paid.
Documentary Bill: These are bills accompanied by ‘documents of title to goods’ such as airway bills,
bill of lading, lorry receipt , warehouse receipt etc, which gives the holder of these documents the
right to take delivery and possession of these goods. These are safer than Clean bills since they are
backed by the security of the ‘documents of title to goods’ which are endorsed in the favor of the
bank who can take delivery of the goods, liquidate them and realize the debt in the case of
nonpayment.
2 types of these bills is Documents against payment (The buyer has to first pay the seller’s bank,
then collect the documents of title to goods, and then taking delivery of goods) and documentary
usance bill or Document against acceptance (These bills give a credit period to the buyer, where the
seller instructs his bank to hand over the “document of title to goods” only if the buyer accepts the
bill payment in writing mentioning a specified date of payment)
Supply bills: Do not fall under the negotiable Instruments Act. These are raised when the buyer is the
government or some very large corporations. Delivery is made first against a ‘work order’ and post
the buyer inspects the goods an ‘invoice’ is raised by buyer along with a certification of acceptance
of goods. Both these are then submitted to the bank by the supplier and finance is raised..
Cash credit facilities: This account is the primary method in which Banks lend money against the
security of commodities, inventories etc. 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. The banks also levy a ‘commitment charge’ on the
unutilized amount due to opportunity cost.
Cash Credits are, in theory, payable on demand. These are, therefore, counter part of demand
deposits of the Bank.
Overdraft facilities- Borrower may overdraw his current account up to an agreed limit and pays
interest only for the time the money is used, the act of overdrawing from a Bank account. In other
words, the account holder withdraws more money from a Bank Account than has been deposited in
it.
Difference between Cash Credit and over draft: In the case of Cash Credit, a proper limit is
sanctioned which normally is a certain percentage of the value of the commodities/inventory
pledged by the account holder with the Bank. Overdraft, on the other hand, is allowed against a host
of other securities including financial instruments like shares, units of mutual funds, surrender value
of LIC policy and debentures even personal guarantee of borrower or his ‘net worth’, which is called
a Clean overdraft. This makes it riskier hence a higher interest rate than cash credit. Overdraft is not
on demand like cash credit but has to be appraised by the bank after the customer approaches the
bank
Charge: When banks accept different securities in respect to loans granted, the bank is said to have a
‘charge’ over these assets which constitute these securities. There is Fixed charge (A specific charge
giving the bank the right to sell designated properties to recover debt) and Floating charge (This is a
charge on present and future property and not attached to any specific asset)
Mortgage: It is the transfer of interest to the lender in specific immovable property for the purpose
of securing a loan, on the condition that this interest will be returned to the owner when the terms
of the mortgage have been satisfied. It is a security for the loan that the borrower provides to the
lender. The ownership remains with the borrower, but some rights are transferred to the bank such
as recovering its dues by selling the property. Most prevalent is Equitable mortgage where all the
original title deeds of the property and GPA is given to the bank and taken back by the borrower
once loan is repaid.
Pledge: There should be bailment of goods. Bailment is derived from the French word bailer which
means to deliver. The objective of the bailment should be to hold the goods as security for the
payment of a debt or the performance of a promise. There is actual or constructive delivery of goods
to the lender. The bank is the Plegee, who enters into an explicit contract with borrower (Pledgor)
under which the securities are delivered to the bank. This then can get liquidated and sold by the
bank in case of non payment.
Hypothecation: Hypothecation is a charge against property for an amount of debt where neither
ownership nor possession is passed to the creditor. Hypothecation is a charge against movable
property. The goods will, unlike a pledge, be retained by the borrower and be in the borrower’s
possession. The borrower gives only a letter stating that the goods are hypothecated to the banker
as security for the loan granted. Legally the borrower cannot sell these goods till the time the
repayment is made. The document contains a clause that obligates the borrower to give possession
of the goods to the bank on demand by the bank.
Assignment: The borrower assigns actionable claims to the bank. Actionable claims or receivables
due to the borrower are money due from government departments or semi government
organizations or receipts from Life insurance policies. The bank gets absolute right over the funds
assigned to it and other creditors of the borrower do not get priority over the bank in realizing their
dues from the assigned debt.
Banker’s Lien: ‘Lien’ is the right of the bank to retain the securities given by the borrower until the
debt due is fully repaid.
There is General Lien which confers the right to the bank to retain any goods bailed to them till
payment is recovered. And there is Particular Lien where specific securities are earmarked for
specific debt. The bank has the right to sell the goods and securities of the borrower defaults.
The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act,
2002 (SARFAESI) empowers Banks / Financial Institutions to recover their non-performing assets
without the intervention of the Court. The Act provides three alternative methods for recovery of
non-performing assets, namely: -
Securitization
Asset Reconstruction
Enforcement of Security without the intervention of the Court
The provisions of this Act are applicable only for NPA loans with outstanding above Rs. 1.00 lac. NPA
loan accounts where the amount is less than 20% of the principal and interest are not eligible to be
dealt with under this Act. Non-performing assets should be backed by securities charged to the Bank
by way of hypothecation or mortgage or assignment.
To issue demand notice to the defaulting borrower and guarantor, calling upon them to
discharge their dues in full within 60 days from the date of the notice.
To give notice to any person who has acquired any of the secured assets from the borrower
to surrender the same to the Bank.
To ask any debtor of the borrower to pay any sum due or becoming due to the borrower.
Section2: Page 316: Credit risk transfers : Syndication, Novation, Participation and Securitization
(details not required, just understand the concept)