Margin loans

The highs and lows of margin loans

A margin loan lets you borrow money to invest and uses your shares or managed funds as
security. It can help you increase your returns but it can also magnify your losses.

Margin loans are for dedicated investors who actively monitor and manage their investments.
Many people have suffered financial ruin when margin loans have gone sour. If you don't fully
understand how margin loans work and the risks involved, don't take out a margin loan.

 How margin loans work

 The risks of margin loans
 Tips for managing margin loan risks

How margin loans work

Let's take shares as an example. When you borrow money to buy shares, the lender takes as
security the shares you buy with the loan. This means the lender can sell the shares to repay the
loan.

Because share prices move frequently, you are exposed to the risk that the shares might fall in
value. To gauge the risk of your loan, lenders use a Loan to Value Ratio (LVR). The LVR is the
amount of your loan divided by the total value of your shares. Most lenders require you to keep
the LVR below a maximum of 70%.

Example of a Loan to Value Ratio

Jane has $10,000 invested in shares and borrows another $5,000 to invest using a margin loan.
This gives her a total share portfolio worth $15,000. Because Jane's loan represents 33% of the
value of her portfolio, she has a Loan to Value Ratio of 33%.

If the value of your investments falls to a point where your loan exceeds the maximum LVR, you
will be required to top up your investment or repay some of the loan. This is known as a 'margin
call'.

In order to meet a margin call and bring the LVR back to an acceptable level, you will have to do
one of these things:

 Find extra cash to pay the lender

 Sell part of your investment to raise cash
 Give the lender additional security (e.g. security over other shares)

The risks of margin loans

Margin loans are very risky. You may:

  Face huge losses if the market falls
 Be forced to sell part of your investment at a low price to meet a margin call
 Get an unexpected margin call if your lender decides to lower the maximum LVR for one
of your investments
 Not always be contacted by your lender when a margin call is made*

In extreme circumstances you could also:

 Owe more than your original investment was worth

 Lose your home if you borrow against it for the investment
 Be forced to pay off your loan at short notice if your lender decides the investment is no
longer suitable as security

What is a 'Letter Of Credit'

A letter of credit is a letter from a bank guaranteeing that a buyer's payment to a seller will be
received on time and for the correct amount. In the event that the buyer is unable to make
payment on the purchase, the bank will be required to cover the full or remaining amount of the
purchase. Due to the nature of international dealings, including factors such as distance, differing
laws in each country, and difficulty in knowing each party personally, the use of letters of credit
has become a very important aspect of international trade.

Example of a Letter of Credit

Citibank offers letters of credit for buyers in Latin America, Africa, Eastern Europe, Asia and the
Middle East who may have difficulty obtaining international credit on their own. Citibank’s
letters of credit help exporters minimize the importer’s country risk and the issuing bank’s
commercial credit risk. Citibank can provide letters of credit typically within two business days,
guaranteeing payment by the confirming Citibank branch. This benefit is especially valuable
when a client is located in a potentially unstable economic environment.

What is CRR, SLR & Repo Rate?

Under CRR a certain percentage of the total bank deposits has to be kept in the current account
with RBI which means banks do not have access to that much amount for any economic activity
or commercial activity, says Amit Trivedi, author & founder of Karmayog Knowledge Academy.

Reserve Bank of India (RBI), the central bank, one of its primary functions is to control the
supply as well as the cost of credit. Which means how much money is available for the industry
or the economy and what is the price that the economy has to pay to borrow that money which is
nothing but liquidity and interest rates.
So, RBI has a role to play to control these two things because eventually these two have an
impact on the inflation and growth in the economy. For this, RBI has got some tools available in
their hands and these tools are maintaining certain basic ratios or maintaining certain rates.

Repo rate is a rate at which banks borrow from RBI for short periods up to 7 or 14 days but
predominantly overnight. RBI manages this repo rate which is the cost of credit for the bank.
This becomes a floor below which the short-term interest rates don’t go. Higher the repo rate
means the cost of short-term money is very high. Lower the repo rate means the cost of short-
term rate is low which means at higher repo rates the economy growth may slowdown whereas at
lower repo rate economy growth may get enhanced.

CRR and SLR are the two ratios. CRR is a cash reserve ratio and SLR is statutory liquidity ratio.
Under CRR a certain percentage of the total bank deposits has to be kept in the current account
with RBI which means banks do not have access to that much amount for any economic activity
or commercial activity. Banks can’t lend the money to corporates or individual borrowers, banks
can’t use that money for investment purposes. So, that CRR remains in current account and
banks don’t earn anything on that.

SLR, statutory liquidity ratio is the amount of money that is invested in certain specified
securities predominantly central government and state government securities. Once again this
percentage is of the percentage of the total bank deposits available as far as the particular bank is
concerned. The SLR, the money goes into investment predominantly in the central government
securities as I mentioned earlier which means the banks earn some amount of interest on that
investment as against CRR where it earns zero.
Let us look at this combination of CRR and SLR. That is the amount of money which remains
blocked for statutory reasons and is not available for investment in various other high earning
avenues like loans are securities markets or other bonds. That means it puts a certain amount of
pressure on the banks balance sheets. However, at the same time that money remains safe and
with that mechanism RBI also offers safety to the depositors who have invested money in the
banks.

What is 'Balance Of Trade - BOT'

The balance of trade (BOT) is the difference between a country's imports and its exports for a
given time period. The balance of trade is the largest component of the country's balance of
payments (BOP). Economists use the BOT as a statistical tool to help them understand the
relative strength of a country's economy versus other countries' economies and the flow of trade
between nations. The balance of trade is also referred to as the trade balance or the international
trade balance.

BREAKING DOWN 'Balance Of Trade - BOT'

A country that imports more goods and services than it exports has a trade deficit. Conversely, a
country exports more goods and services than it imports has a trade surplus. The formula for
calculating the BOT can be simplified to imports minus exports. However, the actual calculation
is comprised of several elements.

To make complete sense, the raw number of the trade deficit or surplus must be compared to the
country's gross domestic product (GDP), since larger economies may be better suited to handle
large deficits and surpluses.

Examples of Balance of Trade

There are countries where it is almost certain that a trade deficit will occur. For example, the
United States has had a trade deficit since 1976, in large part due to its imports of oil and
consumer products. Conversely, China, a country that produces and exports many of the world's
consumable goods, has recorded a trade surplus since 1995.

A trade surplus or deficit, taken on its own, is not necessarily a viable indicator of an economy's
health. The numbers must be taken in context relative to the business cycle and other economic
indicators. For example, in a recession, countries like to export more, creating jobs and demand
in the economy. In a strong expansion, countries prefer to import more, providing price
competition, which limits inflation.

In 2015, the European Union, Germany, China and Japan all had very large trade surpluses,
while the United States, the United Kingdom, Brazil, Australia and Canada had the largest trade
deficits.

What is a 'Trade Deficit'

Trade deficit is an economic measure of international trade in which a country's imports exceeds
its exports. A trade deficit represents an outflow of domestic currency to foreign markets.

Trade Deficit = Total Value of Imports – Total Value of Exports

Also called a negative balance of trade.

BREAKING DOWN 'Trade Deficit'

Nations of the world trade with each other and keep track of their trades in their balance of
payment (BOP) ledgers. One of the primary accounts in the balance of payments is the current
account which keeps track of the goods and services leaving (exports) and entering (imports) a
country. The current account shows direct transfers such as foreign aid, asset income such
 as foreign direct investment (FDI), net income i.e. income received by residents minus income
paid to foreigners, and the trade balance (BOT).

What is a 'Balance Of Payments (BOP)'

A statement that summarizes an economy’s transactions with the rest of the world for a specified
time period. The balance of payments, also known as balance of international payments,
encompasses all transactions between a country’s residents and its nonresidents involving goods,
services and income; financial claims on and liabilities to the rest of the world; and transfers such
as gifts. The balance of payments classifies these transactions in two accounts – the current
account and the capital account. The current account includes transactions in goods,
services, investment income and current transfers, while the capital account mainly includes
transactions in financial instruments. An economy’s balance of payments transactions and
international investment position (IIP) together constitute its set of international accounts.

BREAKING DOWN 'Balance Of Payments (BOP)'

Despite its name, the “balance of payments” data is not concerned with actual payments made
and received by an economy, but rather with transactions. Since many international transactions
included in the balance of payments do not involve the payment of money, this figure may differ
significantly from net payments made to foreign entities over a period of time.

Does the “balance of payments” actually balance? In theory, a current account deficit would
have to be financed by a net inflow in the capital and financial account, while a current account
surplus should correspond to an outflow in the capital and financial account for a net figure of
zero. In actual practice, however, the fact that data are compiled from multiple sources gives rise
to some degree of measurement error.

Balance of payments and international investment position data are critical in formulating
national and international economic policy. Certain aspects of the balance of payments data, such
as payment imbalances and foreign direct investment, are key issues that a nation’s economic
policies seek to address.

Economic policies are often targeted at specific objectives that, in turn, impact the balance of
payments. For example, a country may adopt policies specifically designed to attract foreign
investment in a particular sector. Another nation may attempt to keep its currency at an
artificially depressed level to stimulate exports and build up its currency reserves. The impact of
these policies is ultimately captured in the balance of payments data.

Comparison Chart

BASIS FOR
NBFC BANK
COMPARISON
BASIS FOR
NBFC BANK
COMPARISON

Meaning An NBFC is a company that provides Bank is a government authorized financial

banking services to people without intermediary that aims at providing banking
holding a bank license. services to the general public.

Incorporated under Companies Act 1956 Banking Regulation Act, 1949

Demand Deposit Not Accepted Accepted

Foreign Investment Allowed up to 100% Allowed up to 74% for private sector banks

Payment and Not a part of system. Integral part of the system.

Settlement system

Maintenance of Not required Compulsory

Reserve Ratios

Deposit insurance Not available Available

facility

Credit creation NBFC do not create credit. Banks create credit.

Transaction services Not provided by NBFC. Provided by banks.

Key Differences Between NBFC and Bank

The difference between NBFC and bank can be drawn clearly on the following grounds:

1. A government authorised financial intermediary that aims at providing banking services to the
general public is called the bank. An NBFC is a company that provides banking services to
people without holding a bank license.
2. An NBFC is incorporated under the Indian Companies Act, 1956 whereas a bank is registered
under Banking Regulation Act, 1949.
3. NBFC is not allowed to accept such deposits which are repayable on demand. Unlike banks,
which accepts demand deposits.
4. Foreign Investments up to 100% is allowed in NBFC. On the other hand, only banks of the
private sector are eligible for foreign investment, and that would be not more than 74%.
5. Banks are an integral part of payment and settlement cycle while NBFC, is not a part of the
system.
6. It is mandatory for bank maintain reserve ratios like CRR or SLR. As opposed to NBFC, which
does not require to maintain reserve ratios.
7. The deposit insurance facility is allowed to the depositors of banks by Deposit Insurance and
Credit Guarantee Corporation (DICGC). Such facility is unavailable in the case of NBFC.
8. Banks create credit, whereas NBFC is not involved in the creation of credit.
9. Banks provide transaction services to the customers, such as providing overdraft facility, the
issue of traveller’s cheque, transfer of funds, etc. Such services are not provided by NBFC.

What is an 'Expense'

An expense consists of the economic costs a business incurs through its operations to
earn revenue. Businesses are allowed to write off tax-deductible expenses on their income tax
returns to lower their taxable income and thus their tax liability. Common business expenses
include payments to suppliers, employee wages, factory leases and equipment depreciation, but
the Internal Revenue Service has strict rules on which expenses business are allowed to claim as
a deduction.

BREAKING DOWN 'Expense'

The term "expense" also operates as a verb, and it means to write off an expense. For example, a
freelance writer may expense the cost of buying writing utensils for his business, or the executive
may expense the cost of taking his clients to dinner because the group discussed business at the
table.
Deductible Business Expenses

According to the IRS, to be deductible, a business expense must be both ordinary and necessary.
Ordinary means the expense is common or accepted in that industry, while necessary means the
expense is helpful in the pursuit of earning income. Business owners are not allowed to claim
their personal, nonbusiness expenses as business deductions.

Recording Expenses

Accountants record expenses through one of two accounting methods: cash basis or accrual
basis. Under cash basis accounting, expenses are recorded when they are paid. For example, if a
business owner schedules a carpet cleaner to clean the carpets in his office and the cleaner
invoices the company for the service, a company using cash basis records the expense when it
pays the invoice. Under the accrual method, however, expenses are recorded when they are
incurred, and to continue with the above example, the business accountant records the carpet
cleaning expense when the company receives the service.
 Capital Expenses

The IRS treats capital expenses differently than most other business expenses. While most costs
of doing business can be expensed or written off against business income the year they are
incurred, capital expenses must be capitalized or written off incrementally.

Capital expenses are typically large expenditures considered investments into a company. They
include business startup costs; business assets such as real estate, vehicles, equipment and
patents; and improvements such as putting a new HVAC system into a building. Rather than
writing off these expenses in the year they are incurred, business owners must write them off
slowly over time. The IRS has a schedule that dictates the portion of a capital asset a business
may write off each year until the entire expense is claimed. The number of years over which a
business writes off a capital expense varies based on the type of asset.

What is 'Capital Expenditure (CAPEX)'

Capital expenditure, or CapEx, are funds used by a company to acquire or upgrade physical
assets such as property, industrial buildings or equipment. It is often used to undertake new
projects or investments by the firm. This type of outlay is also made by companies to maintain or
increase the scope of their operations. These expenditures can include everything from repairing
a roof to building, to purchasing a piece of equipment, or building a brand new factory.

BREAKING DOWN 'Capital Expenditure (CAPEX)'

In terms of accounting, an expense is considered to be a capital expenditure when the asset is a

newly purchased capital asset or an investment that improves the useful life of an existing capital
asset. If an expense is a capital expenditure, it needs to be capitalized. This requires the company
to spread the cost of the expenditure (the fixed cost) over the useful life of the asset. If, however,
the expense is one that maintains the asset at its current condition, the cost is deducted fully in
the year of the expense.

The amount of capital expenditures a company is likely to have depends on the industry it
occupies. Some of the most capital intensive industries have the highest levels of capital
expenditures including oil exploration and production, telecom, manufacturing and utilities.

Capital expenditure should not be confused with revenue expenditure or operating

expenses (OPEX). Revenue expenses are shorter-term expenses required to meet the ongoing
operational costs of running a business, and therefore they are essentially identical to operating
expenses. Unlike capital expenditures, revenue expenses can be fully tax-deducted in the same
year in which the expenses occur.

BASIS FOR
LETTER OF CREDIT BANK GUARANTEE
COMPARISON
Meaning Letter of credit is an financial document
for assured payments, i.e. an
undertaking of the buyer's bank to make
payment to seller, against the documents
stated.
A bank guarantee is a guarantee given by
the bank to the beneficiary on behalf of
the applicant, to effect payment, if the
applicant defaults in payment.

Liability Primary Secondary

Risk Less for merchant and more for bank. More for merchant and less for bank.

Parties Involved 5 or more 3

Default Doesn't wait for applicant's default and Becomes active only when the applicant
beneficiary to invoke undertaking. defaults in making payment.

Payment Payment is made only when the Payment is made on the non-fulfillment
condition specified is fulfilled. of obligation.

Suitable for Import and Export business Government contracts

Comparison Chart

Key Differences Between Letter of Credit and Bank Guarantee

The points given below are noteworthy, so far as the difference between letter of credit and bank
guarantee is concerned:

1. Letter of Credit is a commitment of buyer’s bank to the seller’s bank that it will accept the
invoices presented by the seller and make payment, subject to certain conditions. A guarantee
given by the bank to the beneficiary on behalf of the applicant, to effect payment, if the applicant
defaults in payment, is called Bank Guarantee.
2. In a letter of credit, the primary liability lies with the bank only, which collects payment from the
client afterwards. On the other hand, in a bank guarantee, the bank assumes liability, when the
client fails to make payment.
3. When it comes to risk, the letter of credit is more risky for the bank but less for the merchant. As
opposed, the bank guarantee is more risky for the merchant but less for the bank.
 4. There are five or more parties involved in a letter of credit transaction, as in applicant,
beneficiary, issuing bank, advising bank, negotiating bank and confirming bank (may or may not
be). As opposed, only three parties are involved in a bank guarantee, i.e. applicant, beneficiary
and the banker.
5. In a letter of credit, the payment is made by the bank, as it becomes due, such that it does not
wait for applicant’s default and beneficiary to invoke undertaking. Conversely, a bank guarantee
becomes effective, when the applicant defaults in making payment to the beneficiary.
6. A letter of credit ensures that the amount will be paid as long as the services are performed in a
defined manner. Unlike, bank guarantee mitigates loss, if the parties to the guarantee, does not
satisfy the stipulated conditions.
7. A letter of credit is appropriate for import and export business. In contrast, a bank guarantee suits
government contracts.

BASIS FOR
INVESTMENT BANK COMMERCIAL BANK
COMPARISON

Meaning Investment bank refers to a financial Commercial bank is a bank that provides
institution, that offers services like services like accepting deposits, lending
underwriting of securities, brokerage money, payment on standing order and many
services and so on. more.

Offers Customer specific service Standardized service

Associated with Performance of financial market. Nation's economic growth and demand for
credit

Customer base Few hundreds only Millions

Banker to Individuals, government and corporations. All citizens

Income Fees, commissions or profit on trading Fees and interest income

activities.

Key Differences Between Investment Bank and Commercial Bank

The basic difference between investment bank and commercial bank are indicated below:
1. A financial intermediary set up to provide investment and advisory services to the companies is
known as an investment bank. Commercial Bank is a bank established to provide banking
services to the general public.
2. Investment bank offers customer specific service whereas commercial bank offers standardized
services.
3. The customer base of a commercial bank is comparatively higher than an investment bank.
4. The investment bank is related to the performance of the stock market while economic growth
and the credit demand affect the rate of interest charged by the commercial bank.
5. The investment bank is a banker to the individual, government, corporations, etc. On the other
hand, commercial bank is a banker to all the citizens of the country.
6. The investment bank generates its income from fees and commission. Unlike Commercial Bank,
which generates income from interest and fees.

Comparison Chart

BASIS FOR
CENTRAL BANK COMMERCIAL BANK
COMPARISON

Meaning The bank which looks after the The establishment, which provides
monetary system of the country is banking services to the public is known
known as Central Bank. as Commercial Bank.

What is it? It is a banker to the banks and the It is the banker to the citizens of the
government of the country. nation.

Governing Statute Reserve Bank of India Act, 1934. Banking Regulation Act, 1949.

Ownership Public Public or Private

Profit motive It does not exist for making profit It exist for making profit for its owners.
for its owners

Monetary Authority It is the supreme monetary No such authority.

authority with wide powers.

Objective Public welfare and economic Earning Profits

development.
BASIS FOR
CENTRAL BANK COMMERCIAL BANK
COMPARISON

Money supply Ultimate source of money supply No such function is performed by it.
in the economy.

Right to print and issue Yes No

currency notes

Deals with General Public Banks and Governments

How many banks are Only one Many

there?

What is 'Money Laundering'

Money laundering is the process of creating the appearance that large amounts of money
obtained from criminal activity, such as drug trafficking or terrorist activity, originated from a
legitimate source. The money from the illicit activity is considered dirty, and the process
"launders" the money to make it look clean.

BREAKING DOWN 'Money Laundering'

Illegally earned money needs laundering in order for criminal organization to use it effectively.
Dealing in large amounts of illegal cash is inefficient and dangerous. The criminals need a way
to deposit the money in financial institutions, yet they can only do so if the money appears to
come from legitimate sources.

There are three steps involved in the process of laundering money: placement, layering and
integration. Placement refers to the act of introducing "dirty money" (money obtained through
illegitimate, criminal means) into the financial system in some way. Layering is the act of
concealing the source of that money by way of a series of complex transactions and bookkeeping
tricks. Integration refers to the act of acquiring that money in purportedly legitimate means.

What are 'Open Market Operations - OMO'

Open market operations (OMO) refers to the buying and selling of government securities in
the open market in order to expand or contract the amount of money in the banking system,
facilitated by the Federal Reserve (Fed). Purchases inject money into the banking system and
stimulate growth, while sales of securities do the opposite and contract the economy. The Fed's
goal in using this technique is to adjust and manipulate the federal funds rate, which is the rate at
which banks borrow reserves from one another.

BREAKING DOWN 'Open Market Operations - OMO'

OMO is the most flexible and most common tool that the Fed uses to implement and
control monetary policy in the United States. However, the discount rate and reserve
requirements are also used.

The Fed can use various forms of OMO, but the most common OMO is the purchase and sale of
government securities. Buying and selling government bonds allows the Fed to control the
supply of reserve balances held by banks, which helps the Fed increase or decrease short-term
interest rates as needed.

Federal Open Market Committee

The Federal Open Market Committee (FOMC) is the Fed's committee that decides on monetary
policy. The FOMC enacts its monetary policy by setting a target federal funds interest rate and
then implementing OMO, discount rate or reserve requirement strategies to move the
current federal funds rate to target levels. The federal funds rate is extremely important to control
because it affects most other interest rates in the United States, including the prime rate, home
loan rates and car loan rates.

The FOMC normally uses OMO first when trying to hit a target federal funds rate. It does this by
enacting either an expansionary monetary policy or a contractionary monetary policy.

Expansionary Monetary Policy

The Fed enacts an expansionary monetary policy when the FOMC aims to decrease the federal
funds rate. The Fed purchases government securities through private bond dealers and deposits
payment into the bank accounts of the individuals or organizations that sold the bonds. The
deposits become part of the cash that commercial banks hold at the Fed, and therefore increase
the amount of money that commercial banks have available to lend. Commercial banks actively
want to loan cash reserves and try to attract borrowers by lowering interest rates, which includes
the federal funds rate.

Contractionary Monetary Policy

The Fed enacts a contractionary monetary policy when the FOMC looks to increase the federal
funds rate and slow the economy. The Fed sells government securities to individuals and
institutions, which decreases the amount of money left for commercial banks to lend. This
increases the cost of borrowing and increases interest rates, including the federal funds rate.
What is a 'Bank Rate'

A bank rate is the interest rate at which a nation's central bank lends money to domestic banks,
often in the form of very short-term loans. Managing the bank rate is method by which central
banks affect economic activity. Lower bank rates can help to expand the economy by lowering
the cost of funds for borrowers, and higher bank rates help to reign in the economy when
inflation is higher than desired.

BREAKING DOWN 'Bank Rate'

In the United States, the bank rate is often referred to as the federal funds rate or the discount
rate. In the United States, the Board of Governors of the Federal Reserve System sets the
discount rate as well as the reserve requirements for banks. The Federal Open Market
Committee (FOMC) buys or sells Treasury securities to regulate the money supply. Together,
the federal funds rate, the value of Treasury bonds and reserve requirements have a huge impact
on the economy. The management of the money supply in this way is referred to as monetary
policy.

What is 'Cost Of Funds'

Cost of funds is the interest rate paid by financial institutions for the funds that they deploy in
their business. The cost of funds is one of the most important input costs for a financial
institution, since a lower cost will generate better returns when the funds are deployed in the
form of short-term and long-term loans to borrowers. The spread between the cost of funds and
the interest rate charged to borrowers represents one of the main sources of profit for most
financial institutions.

BREAKING DOWN 'Cost Of Funds'

For lenders such as banks and credit unions, cost of funds is determined by the interest rate paid
to depositors on financial products including savings accounts and time deposits. Although the
term cost of funds usually refers to financial institutions, most corporations that rely on
borrowing are impacted by the costs they must incur to gain access to capital.

What is 'Know Your Client - KYC'

The Know Your Client form is a standard form in the investment industry that ensures
investment advisors know detailed information about their clients' risk tolerance, investment
knowledge and financial position.

KYC forms protect both clients and investment advisors. Clients are protected by having
their investment advisor know what investments best suit their personal situations. Investment
advisors are protected by knowing what they can and cannot include in their client's portfolio.

BREAKING DOWN 'Know Your Client - KYC'

The Know Your Client (KYC) rule is an ethical requirement for those in the securities industry
who are dealing with customers during the opening and maintaining of accounts. There are two
rules which were implemented in July 2012 that cover this topic together: Financial Industry
Regulatory Authority (FINRA) Rule 2090 (Know Your Customer) and FINRA Rule 2111
(Suitability). These rules are in place to protect both the broker-dealer and the customer and so
that brokers and firms deal fairly with clients.

The Know Your Customer Rule 2090 essentially states that every broker-dealer should use
reasonable effort when opening and maintaining client accounts. It is a requirement to know and
keep records on the essential facts of each customer as well as identify each person who has
authority to act on the customer’s behalf.

The KYC rule is important at the beginning of a customer-broker relationship to establish the
essential facts of each customer before any recommendations are made. The essential facts are
those required to effectively service the customer’s account and to be aware of any special
handling instructions for the account. In addition, the broker-dealer needs to be familiar with
each person who has authority to act on behalf of the customer, and the broker-dealer needs to
comply with all the laws, regulations and rules of the securities industry.

DEFINITION of 'Foreign Account Tax Compliance Act (FATCA)'

FATCA is a tax law that compels US citizens at home and abroad to file annual reports on any
foreign account holdings. The Foreign Account Tax Compliance Act (FATCA) was endorsed in
2010 as part of the HIRE Act in order to promote transparency in the global financial services
sector.

BREAKING DOWN 'Foreign Account Tax Compliance Act (FATCA)'

The Hiring Incentives to Restore Employment (HIRE) Act was signed into law by President
Barack Obama in 2010 to incentivize businesses to hire unemployed workers so as to reduce the
high unemployment rate that was brought about by the 2008 financial crisis. One of the
incentives offered to employers through the HIRE Act include an increase in business tax
credit for each new employee hired and retained for at least 52 weeks. Other incentives
include payroll tax holiday benefits and an increase in a firm’s expense deduction limit for new
equipment purchased in 2010.

In order to fund the costs of these incentives, Congress included revenue generating provisions in
the HIRE Act through FATCA. FATCA provisions require all US tax payers to report yearly all
assets held outside of the country. By taxing these foreign-held assets, the US increases its
revenue stream, which is put towards its incentive account for job stimulation. Penalties are
imposed on US residents who do not report their foreign account holdings and assets that exceed
$50,000 in value in any given year.

Non-US Foreign Financial Institutions (FFI) and Non-Financial Foreign Entities (NFFE) are also
required to comply to this law by disclosing the identities of US citizens and the value of their
assets held in their banks to the Internal Revenue Service (IRS) or the FATCA
Intergovernmental Agreement (IGA). FFIs that do not comply with the IRS will not only be
excluded from the US market, but will also have 30% of the amount of any withholdable
payment deducted and withheld from them as a tax penalty. Withholdable payments in this
instance refers to income generated from US financial assets held by these banks and
include interests, dividends, remunerations, wages and salaries, compensations, periodic profits,
etc. FFIs and NFFEs that agree to the law must annually report the name, address, and tax
identification number (TIN) of each account holder that meets the criteria of a US citizen; the
account number; the account balance; and any deposits and withdrawals on the account for the
year.

Although the price to pay for not complying to FATCA is high, compliance costs are also high.
TD Bank, Barclays, and Credit Suisse reportedly spent millions of dollars in fighting this law
given that they faced compliance costs of about $100 million. Large banks like HSBC,
Commerzbank, and Deutsche, following the enactment of the law, either limited the services
offered to Americans or completely stopped serving US investors in an effort to mitigate the high
compliance cost.

FATCA seeks to eliminate tax evasion by American individuals and businesses that are
investing, operating, and earning taxable income abroad. While it is not illegal to control
an offshore account, failure to disclose the account is considered illegal since the US taxes all
income and assets of its citizens on a global scale.

Bouncing of a cheque
When an account has insufficient funds the cheque is is not payable and is returned by the bank
with a reason “Exceeds arrangement” or “funds insufficient”.

Bank Rate
It is the rate of interest charged by a central bank to commercial banks on the advances and the
loans it extends.

Cheque
It is written by an individual to transfer amount between two accounts of the same bank or a
different bank and the money is withdrawn form the account.

Core Banking Solutions (CBS)

In this all the branches of the bank are connected together and the customer can access his/her
funds or transactions from any other branch.

CRR (Cash Reverse Ratio)

the amount of funds that a bank keep with the RBI. If the percentage of CRR increases then the
amount with the bank comes down.
Debit Card
It is a card issued by the bank so the customers can withdraw their money from their account
electronically.

Demat Account
The way in which a bank keeps money in a deposit account in the same way the Depository
company converts share certificates into electronic form and keep them in a Demat account.

E-Banking
It is a type of banking in which we can conduct financial transactions electronically. RTGS,
Credit cards, Debit cards etc come under this category.

EFT – (Electronic Fund Transfer)

In this we use Automatic teller machine, wire transfer and computers to move funds between
different accounts in different or same bank.

Fiscal Deficit
It is the amount of Funds borrowed by the government to meet the expenditures.

Initial Public Offering (IPO)

It is the time when a company makes the first offering of the shares to the pubic.

Leverage Ratio
It is a financial ratio which gives us an idea or a measure of a company’s ability to meet its
financial losses.

Liquidity
It is the ability of converting an investment quickly into cash with no loss in value.

Market Capitalization
The product of the share price and number of the company’s outstanding ordinary shares.

Mortgage
It is a kind of security which one offers for taking an advance or loan from someone.

Mutual Fund
These are investment schemes. It pools money from various investors in order to purchase
securities.

Pass Book
It is a book where all the bank transactions are recorded.They are mainly issued to Current or
Savings Bank account holders.

Repo Rate
Commercial banks borrow funds by the RBI if there is any shortage in the form of rupees. If this
rate increases it becomes expensive to borrow money from RBI and vice versa.

Savings Bank Account

It is account of nominal interest which can only be used for personal purpose and which has
some restrictions on withdrawal.

SLR (Statutory Liquidity Ratio)

It is amount that a commercial bank should have before giving credits to its customers which
should be either in the form of gold,money or bonds.

Teller
He/she is a staff member of the bank who cashes cheques, accepts deposits and perform different
banking services for the general mass.

Universal Banking
When financial institutions and banks undertake activities related to banking like investment,
issue of debit and credit card etc then it is known as universal banking.

Virtual Banking
Internet banking is sometimes known as virtual banking. It is called so because it has no bricks
and boundaries. It is controlled by the world wide web.

Wholesale Banking
It is similar to retail banking with a slight difference that it mainly focuses on the financial needs
of the institutional clients and the industry.

Zero Coupon Bond

It is a bond that is sold at good discount as it has no coupon.

The above mentioned Banking terms for interview are not only helpful for the candidates who
are sitting for an interview but also for the general public as nowadays everyone is connected to
the banking sector in one or the other way.

Internet Banking

Internet Banking is an electronic means of accessing your account information and conducting
your banking online. You can access transaction information as well as transfer funds and pay
bills using BankSA Internet Banking.

Mobile Banking
Mobile Banking allows you to bank from your mobile phone. Please note that mobile banking is
only supported on certain brands of mobile phone with appropriate display technology. Learn
more about Mobile Banking.

1. Overdraft

Yes, you can called it “over withdraw”. This occurs when a customer withdrew more money
from their bank account than the balance in the account. In simple term it is another form of
short term borrowing which attracts fees. This often costly charges can be avoided by keeping
extra money in the account as a buffer. For individuals, you will not often need bank overdraft if
you have practiced some personal savings.

2. Collateral

This is typically a tangible asset used to secure a bank loan. If you fail to make payments on the
amount you borrowed or accrued interest, the bank may be able to seize and sell the property
used as collateral. An example of collateral would include land, house, car, stock and businesses
machines.

3. Working capital

It is more like an accounting term, but banker usually ask business borrowers to confirm their
working capital need. It is used to describe the amount, by which the business’s current assets
exceed its current liabilities. Some people describe it as the funds the firm has available to run its
day-to-day business operations. Working capital can be well managed if one understand the
working capital conversion cycle ( see below).

4.Working Capital conversion cycle

It describe the dynamics of short-term cash flows that occur during the normal operations of a
business. The working capital conversion cycle is the circular process starting with purchase of
inventories on credit, then to sell that inventories in cash or credit and finally to carry the
resulting accounts receivable that are the proceeds of the inventory. When the receivables are
paid, the firm can then use the proceeds to either repay the debts or to start the cycle all over
again by purchasing new inventories. It is desirable to keep the cycle as short as possible as it
increases the effectiveness of working capital.

5. Warehouse receipt

A written evidence of goods held in a warehouse operated by a third party. The goods may be in
a public (i.e., general), private, or field warehouse. Also known as collateral receipts. The
receipts may be negotiable or non-negotiable. Negotiable warehouse receipts are bearer
instruments. A negotiable warehouse receipt can be sold to a buyer who then owns the inventory
covered by the receipt.
6. Money Laundering

This is when money gained from a crime is put into a bank or any other legal business activities
so that it can be accessed safely by the criminals and terrorists. It makes the proceeds of illegal
activities easier to get to.

7. Standing Order

A regular fixed payment made out of one account to another account or beneficiary. Standing
order has helped many people to transfer funds from their current account to saving account a
soon as they receive salary. It can also be used by business to make payment into an escrow
account when their main account reach certain limit.

8. Available bank balance

The amount of money in your account that is available for immediate use. If the account has no
uncleared cheque or blocked fund, then the available balance should be the same as the total or
book balance.

9. Book Balance

The book balance is the term banks use to describe the amount of money in the account before
any adjustments for cheques that have not yet been cleared. It is sometimes called the ledger
balance.
When other banks cheque are deposited in a bank, it does not get available immediately. It takes
about two to three business days in some countries.

10. Variable interest rate

An interest rate that may fluctuate (adjust) during the term of a loan, line of credit, or deposit
account. Rates may adjust due to changes in an index rate (such as the prime rate) or reference
rate like LIBOR. The next time you think of taking loan, check for the type of rate. Opposite to
this is the fixed interest rate.

11. Time or fixed deposit

An agreement to deposit a stated amount in the bank for a fixed length of time during which a
fixed rate of interest will be paid (unless disclosed as a variable rate). Penalties are typically
levied on the interest if the funds are withdrawn before the end of the agreed-upon period. It is
one of the common banking investment product in the Gambia.

12. Inactive account

Sometimes called dormant account. It is an account in which there have not been any
transactions for an extended period of time (does not include bank own entries). In some cases,
when there has been no activity in the account within a period specified ( 10 years in the
Gambia) by Central bank, the law requires the bank to return the account over to the central bank
as unclaimed funds.

13. Debit card

A plastic card that deducts money from the designated bank account to pay for goods or services.
A debit card can also be used at ATMs to withdraw cash. The most common card are marked
Visa or MasterCard and are accepted almost anywhere with no interest is charged.

14. Cost of Funds

The interest rate paid by financial institutions for the funds that they deploy in their business.
The cost of funds is one of the most important input costs for a financial institution, since a
lower cost will generate better returns when the funds are deployed in the form of short-term and
long-term loans to borrowers. The spread between the cost of funds and the interest rate charged
to borrowers represents one of the main sources of profit for most financial institutions.

15. Trust Receipt

Notice of the release merchandise to a buyer from a bank, with the bank retaining the ownership
title to the released assets. In an arrangement involving a trust receipt, the bank remains the
owner of the merchandise, but the buyer is allowed to hold the merchandise in trust for the bank,
for manufacturing or sales purposes. The buyer of merchandise subject to a trust receipt is
required to maintain the merchandise, and any proceeds’ of the sale of the merchandise, for
remittance to the bank. In this way, the buyer is permitted use of the merchandise for their
business activities, but the bank’s interest in the ownership of the merchandise is protected.

16. Cash Reserve

Bank reserves are the currency deposits which are not lent out to the bank’s clients. A small
fraction of the total deposits is held internally by the bank or deposited with the central bank.
Minimum reserve requirements are established by central banks in order to ensure that the
financial institutions will be able to provide clients with cash upon request.
The main purpose of holding reserves is to avoid bank runs and generally appear solvent. Central
banks place these restrictions on banks, because the banks can earn a much larger return on their
capital by lending out money to clients rather than holding cash in their vaults or depositing it
with other institutions.

Whether you visit the banks for small business relationship, personal banking or even for
interview, it will be nice to understand few banking terms.

What is a 'Merchant Bank'

A merchant bank is a company that deals mostly in international finance, business loans for
companies and underwriting. These banks are experts in international trade, which makes them
specialists in dealing with multinational corporations. A merchant bank may perform some of the
same services as an investment bank, but it does not provide regular banking services to the
general public.

BREAKING DOWN 'Merchant Bank'

One role of a merchant bank is to provide financing to large corporations that do business
overseas. Assume, for example, that XYZ Company is based in the United States and decides to
purchase a supplier that is based in Germany.