FINMA 3 Module 3

1 Module 3 – Commercial Banking
INTRODUCTION
There are many different types of banks, all of which have different target customers and
perform different functions. But what exactly are the differences? Though they dictate a large portion
of our financial lives, many people don't know the difference between the many different types of
banks. Discover what each bank does and how you can choose the right one for your needs.
It may seem simple, but it's a question people don't ask enough. Banks play a huge role in
our lives, so it's important to fully understand what they are. At a high level, banks are financial
institutions that are certified to receive deposits of money and provide loans that allow people to
borrow money. However, many banks offer other services as well, including financial advising and
currency exchange services.
Some banks only serve a specific set of people, while many others serve the general public.
Other types of banks, serve as regulatory bodies for national governments.
MODULE LEARNING OUTCOME
In this module, you should be able to:

1. understand functions of a commercial banks;
2. analyze the reasons why departmentalization is established;
3. comprehend the significance of deposits to banks; and
4. discuss the financial allied and non-financial allied undertakings.
Lesson 1: Commercial Bank and its Functions
SPECIFIC LEARNING OUTCOMES
In this lesson, you are expected to:

1. explain the functions of commercial banks;
2. discuss the importance of deposit;
3. differentiate the various types of deposits;
4. explain the importance of departmentalization; and
5. discuss the different types of loans.
PRE-ASSESSMENT
Instruction: Read each item carefully then choose the letter of your choice.
1. ________Which of the following is a transactional deposit account held at a financial institution

that allows for withdrawals and deposits?
a. Business accounts
b. Capital market accounts
c. Deposit accounts
d. Checking accounts
2. _______What is the principle on a loan?

a. The interest paid
b. The interest unpaid
c. The total amount paid
d. The initial amount loaned
3. _______How does the public have a small degree of control over the money supply?
a. Through investments
b. Through deposits
c. Through cash
d. Through credit cards
4. _______All of the following would be considered money, narrowly defined except….

a. Savings account
b. Checking account
c. Coins
d. Currency
5. _______The TWO PRIMARY functions of commercial banks are to:

a. Set interest rates and support the federal reserve
b. Create money and promote
c. Hold demand deposits and make loans
d. Pay interests and provide customers economic security
6. _______The liabilities of a commercial bank include

a. Loans
b. Demand deposits
c. Net worth
d. Shares of stock
7. _______The assets of a commercial bank

a. Savings account
b. Demand deposits
c. Net worth
d. Loans
8. ______ is a deposit account provided by a bank or other financial institutions for individuals to
save money and earn the modest interest for that money held in the account.
a. Fixed deposit account
b. Savings bank account
c. Recurring account
d. Current account
9. ______ is a product to provide a person with an opportunity to build up saving through regular
monthly deposits of fixed sum over a period of time.
a. Savings bank account
b. Fixed deposit account
c. Recurring deposit account
d. Current account
10. _______ is a type of deposit account that caters to professionals and businessmen alike.
a. Recurring account
c. Current account
d. Savings account
LESSON MAP
FUNCTIONS OF A COMMERCIAL BANK AND OPENING AN ACCOUNT

COMMERCIAL BANK DEPOSITS
BANK SERVICES
ITYPES OF DEPOSITS
DEPARTMENTALIZATION
The map above shows the various considerations in a commercial bank and deposit.
CORE CONTENTS
ENGAGE:
Activity 1: Picture Analysis

Instruction: Observe and analyze what is the picture all about.
Guide Questions:
1. How do these banks differ from each other?

__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
2. What are their similarities with regards to services?

__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
EXPLORE: Reading Concepts

COMMERCIAL BANKS
A commercial bank is a financial institution which performs the functions of accepting
deposits from the general public and giving loans for investment with the aim of earning profit.
In fact, commercial banks, as their name suggests, axe profit-seeking institutions, i.e., they
do bank business to earn profit. They generally finance trade and commerce with short-term loans.
They charge high rate of interest from the borrowers but pay much less rate of Interest to their
depositors with the result that the difference between the two rates of interest becomes the main
source of profit of the banks.
FUNCTIONS OF COMMERCIAL BANKS

The two most distinctive features of a commercial bank are borrowing and lending, i.e.,
acceptance of deposits and lending of money to projects to earn Interest (profit). In short, banks
borrow to lend. The rate of interest offered by the banks to depositors is called the borrowing rate
while the rate at which banks lend out is called lending rate.
 The difference between the rates is called ‘spread’ which is appropriated by the banks.
 All financial institutions are not commercial banks because only those which perform dual
functions of:
o accepting deposits
o giving loans are termed as commercial banks.
 Functions of commercial banks are classified in to two main categories—
o Primary functions
o Secondary functions.
Primary Functions
1. It accepts deposits:
 A commercial bank accepts deposits in the form of current, savings and fixed deposits. It
collects the surplus balances of the Individuals, firms and finances the temporary needs of
commercial transactions. The first task is, therefore, the collection of the savings of the
public. The bank does this by accepting deposits from its customers. Deposits are the lifeline
of banks.
 Deposits are of three types:
o Current account deposits:
Such deposits are payable on demand and are, therefore, called demand deposits.
These can be withdrawn by the depositors any number of times depending upon the
balance in the account. The bank does not pay any Interest on these deposits but
provides cheque facilities. These accounts are generally maintained by businessmen and
Industrialists who receive and make business payments of large amounts through
cheques.
o Fixed deposits (Time deposits):

Fixed deposits have a fixed period of maturity and are referred to as time deposits. These
are deposits for a fixed term, i.e., period of time ranging from a few days to a few years.
These are neither payable on demand nor they enjoy cheque facilities.
They can be withdrawn only after the maturity of the specified fixed period. They carry
higher rate of interest. They are not treated as a part of money supply Recurring deposit
in which a regular deposit of an agreed sum is made is also a variant of fixed deposits.
o Savings account deposits:

These are deposits whose main objective is to save. Savings account is most suitable for
individual households. They combine the features of both current account and fixed
deposits. They are payable on demand and also withdraw able by cheque. But bank
gives this facility with some restrictions, e.g., a bank may allow four or five cheques in a
month. Interest paid on savings account deposits in lesser than that of fixed deposit.
 Difference between demand deposits and time (term) deposits:
o Deposits which can be withdrawn on demand by depositors are called demand
deposits, e.g., current account deposits are called demand deposits because they are
payable on demand but saving account deposits do not qualify because of certain
conditions on withdrawal. No interest is paid on them. Term deposits, also called time
deposits, are deposits which are payable only after the expiry of the specified period.
 Demand deposits do not carry interest whereas time deposits carry a fixed
rate of interest.
 Demand deposits are highly liquid whereas time deposits are less liquid.
 Demand deposits are chequable deposits whereas time deposits are not.
2. It gives loans and advances:

 The second major function of a commercial bank is to give loans and advances particularly
to businessmen and entrepreneurs and thereby earn interest. This is, in fact, the main
source of income of the bank.
 A bank keeps a certain portion of the deposits with itself as reserve and gives (lends) the
balance to the borrowers as loans and advances in the form of cash credit, demand loans,
short-run loans, overdraft as explained under.
o Cash Credit:
An eligible borrower is first sanctioned a credit limit and within that limit he is allowed to
withdraw a certain amount on a given security. The withdrawing power depends upon the
borrower’s current assets, the stock statement of which is submitted by him to the bank
as the basis of security. Interest is charged by the bank on the drawn or utilized portion of
credit (loan).
o Demand Loans:
A loan which can be recalled on demand is called demand loan. There is no stated
maturity. The entire loan amount is paid in lump sum by crediting it to the loan account of
the borrower. Those like security brokers whose credit needs fluctuate generally, take
such loans on personal security and financial assets.
o Short-term Loans:
Short-term loans are given against some security as personal loans to finance working
capital or as priority sector advances. The entire amount is repaid either in one
instalment or in a number of instalments over the period of loan.
3. Investment:
 Commercial banks invest their surplus fund in 3 types of securities:
o Government securities
o Other approved securities
o Other securities.
 Banks earn interest on these securities.
Secondary Functions
Apart from the above-mentioned two primary (major) functions, commercial banks perform
the following secondary functions also.
1. Discounting bills of exchange or bundles:

 A bill of exchange represents a promise to pay a fixed amount of money at a specific point of
time in future.
 It can also be encashed earlier through discounting process of a commercial bank.
 Alternatively, a bill of exchange is a document acknowledging an amount of money owed in
consideration of goods received.
 It is a paper asset signed by the debtor and the creditor for a fixed amount payable on a fixed
date. It works like this:
o Suppose, A buys goods from B, he may not pay B immediately but instead give B a
bill of exchange stating the amount of money owed and the time when A will settle
the debt. Suppose, B wants the money immediately, he will present the bill of
exchange (Hundi) to the bank for discounting. The bank will deduct the commission
and pay to B the present value of the bill. When the bill matures after specified
period, the bank will get payment from A.
2. Overdraft facility:
 An overdraft is an advance given by allowing a customer keeping current account to
overdraw his current account up to an agreed limit. It is a facility to a depositor for
overdrawing the amount than the balance amount in his account.
 In other words, depositors of current account make arrangement with the banks that in case
a cheque has been drawn by them which are not covered by the deposit, then the bank
should grant overdraft and honour the cheque.
 The security for overdraft is generally financial assets like shares, debentures, life insurance
policies of the account holder, etc.
 Difference between Overdraft facility and Loan:
o Overdraft is made without security in current account but loans are given against
security.
o In the case of loan, the borrower has to pay interest on full amount sanctioned but in
the case of overdraft, the borrower is given the facility of borrowing only as much as
he requires.
o Whereas the borrower of loan pays Interest on amount outstanding against him but
customer of overdraft pays interest on the daily balance.
3. Agency functions of the bank:

 The bank acts as an agent of its customers and gets commission for performing agency
functions as under:
Transfer of funds
It provides facility for cheap and easy remittance of funds from place-to-place through demand
drafts, mail transfers, telegraphic transfers, etc.
Collection of funds
It collects funds through cheques, bills, bundles and demand drafts on behalf of its customers.
Payments of various items

It makes payment of taxes. Insurance premium, bills, etc. as per the directions of its customers.
Purchase
It buys sells and keeps in safe custody securities and shares on behalf of its customers.
Collection of dividends, interest on shares and debentures is made on behalf of its

customers
Acts as Trustee and Executor of property of its customers on advice of its customers
Letters of References
It gives information about economic position of its customers to traders and provides similar
information about other traders to its customers.
4. Performing general utility services:
The banks provide many general utility services, some of which are as under:
Traveller’s cheques
The banks issue traveler’s cheques and gift cheques.
Locker facility
The customers can keep their ornaments and important documents in lockers for
safe
custody.
Underwriting securities issued by government, public or private bodies.
Purchase and sale of foreign exchange (currency).
CREDIT (MONEY) CREATION BY COMMERCIAL BANKS

 Bangko Sentral ng Pilipinas produces money while commercial banks increase the supply of
money by creating credit which is also treated as money creation. Commercial banks create
credit in the form of secondary deposits.
 Total deposits of a bank are of two types:
o Primary deposits (initial cash deposits by the public)
o Secondary deposits (deposits that arise due to loans given by the banks which are
assumed to be redeposited in the bank.) Money creation by commercial banks is
determined by two factors namely:
 Primary deposits i.e. initial cash deposits
 Legal Reserve Ratio (LRR), i.e., minimum ratio of deposits which is legally
compulsory for the commercial banks to keep as cash in liquid form.
 Broadly when a bank receives cash deposits from the public, it keeps a fraction of deposits
as cash reserve (LRR) and uses the remaining amount for giving loans. In the process of
lending money, banks are able to create credit through secondary deposits many times more
than initial deposits (primary deposits).
 Process of money (credit) creation:
o Suppose a man, say X, deposits P2,000,000.00 with a bank and the LRR is 10%,
which means the bank keeps only the minimum required P200,000.00 as cash
reserve (LRR).
o The bank can use the remaining amount P1,800,000.00 (= 2,000,000 – 200,000) for
giving loan to someone. (Mind, loan is never given in cash but it is redeposited in the
bank as demand deposit in favour of borrower.)
o The bank lends 1,800,000.00 to, say, Y who is actually not given loan but only
demand deposit account is opened in his name and the amount is credited to his
account.
o This is the first round of credit creation in the form of secondary deposit
(P1,800,000.00), which equals 90% of primary (initial) deposit. Again 10% of Y’s
deposit (i.e., 1,800,000.00) is kept by the bank as cash reserve (LRR) and the
balance P1,620,000.00 (=1,800,000 – 180,000) is advanced to, say, Z.
o The bank gets new demand deposit of P1,620,000. This is second round of credit
creation which is 90% of first round of increase of P1,800,000. The third round of
credit creation will be 90% of second round of P1,620,000. This is not the end of
story.
o The process of credit creation goes on continuously till derivative deposit (secondary
deposit) becomes zero.
o In the end, volume of total credit created in this way becomes multiple of initial
(primary) deposit. The quantitative outcome is called money multiplier.
o In short, money (or credit) creation by commercial banks is determined by (i) amount
of initial (primary) deposits and (ii) LRR. The multiple is called credit creation or
money multiplier.
WHAT ARE THE DIFFERENT DEPARTMENTS OF A BANK?

The internal structure of a typical commercial bank generally consists of 10 different
departments. These include:
 retail banking
 loan servicing
 wealth management
 investment banking
 deposit operations
 wire transfer operations
 cash management
 electronic banking
 commercial banking
 mortgage banking.
Tellers, loan officers and customer service managers work within retail banking. These
banking professionals help customers with savings and checking accounts, personal loans, credit
cards, debit cards and mortgages.
Loan servicing agents handle individual and business loan payments and collections, while
wealth management professionals help the bank's customers with financial planning and investment
portfolio management services.
Deposit operations managers handle account set-up and maintenance duties, while wire
transfer operators ensure that paperless, computerized account transactions are adequately
processed. The cash management department ensures the bank has enough liquid assets to meet
scheduled obligations. They also select short-term investment opportunities that the bank can
liquidate quickly for additional cash flow when necessary.
A bank's electronic banking department is responsible for the set-up and maintenance of the
bank's online financial transactions. Some employees in this market are computer hacking
specialists that protect the bank's databases from being accessed by unauthorized personnel.
The mortgage banking department of a bank helps borrowers secure loans for homes and
investment properties. This department also manages all of the loan payments and provides
customer service to the bank's mortgage customers.
DEPARTMENTALIZATION
Departmentalization or Departmentation is a process wherein jobs/teams are combined
together into functional units called as departments on the basis of their area of specialization, to
achieve the goals of the organization. So, in this way, the entire organization is divided into parts,
i.e. departments which comprise of a group of employees, who carry out activities of similar nature.
 It determines the functions/activities which are to be housed together and coordinated at the
same place. Further, it groups the personnel, who will undertake the delegated
functions/tasks.
 In a corporate ladder, every level below the top is departmentalized, and each subsequent
level is further differentiated into departments.
 The top-level executives, groups activities in various departments, such as production,
marketing, finance, human resource, research and development, etc.
 These departments are headed by senior executives, called as managers of the respective
department.
 The departmental managers can delegate tasks and duties to the subordinates, and they are
accountable to the chief executive for the performance of the department.
Objectives of Departmentalization
 To specialize activities.
 To simplify the process and operations of the organization
 To maintain control
Departmentalization of activities results in the increase in efficiency of the management and

ultimately the enterprise. It is helpful in fixing responsibilities and accountability.
Methods of Departmentalization
1. Departmentalization by Function
When the creation of department is on the basis of specified functions, such as production,
marketing, purchase, finance etc. In this method, all the activities related to a function or
which are of similar nature are combined in a single unit, to give proper directions to the
entire group in one go.
2. Departmentalization by Process
In departmentation by the process, the activities are grouped as per the production
processes. These departments require manpower and material so as to carryout operations.
3. Departmentalization by Product
When the activities related to product development and delivery are combined into a
particular division, it is called as product departmentalization. It is appropriate for large-scale
multi-product enterprises.
4. Departmentalization by Customer
The grouping of the organization according to the different classes of customer or clients. It
focuses on special customer needs.
5. Departmentalization by Territory
When the division is based on the geographical area, it is called as territorial
departmentalization. This is suitable for the organizations, that have widespread operations
at different locations.
6. Departmentalization by Project
In project departmentalization, the organizational activities are classified by differentiated or
special ventures or activities.
The choice of departmentalization basis is influenced by the factors such as the degree of
specialization, coordination, control, cost consideration, adequate attention to key areas, etc.
BANK CREDIT
The term bank credit refers to the amount of credit available to a business or individual from
a banking institution in the form of loans. Bank credit, therefore, is the total amount of money a
person or business can borrow from a bank or other financial institution. A borrower's bank credit
depends on their ability to repay any loans and the total amount of credit available to lend by the
banking institution. Types of bank credit include car loans, personal loans, and mortgages.
Understanding Bank Credit

 Banks and financial institutions make money from the funds they lend out to their clients.
These funds come from the money clients deposit in their checking and savings accounts or
invest in certain investment vehicles such as certificates of deposit (CDs).
 In return for using their services, banks pay clients a small amount of interest on their
deposits. As noted, this money is then lent out to others and is known as bank credit
 Bank credit consists of the total amount of combined funds that financial institutions advance
to individuals or businesses.
 It is an agreement between banks and borrowers where banks make loans to borrowers.
 By extending credit, a bank essentially trusts borrowers to repay the principal balance as well
as interest at a later date. Whether someone is approved for credit and how much they
receive is based on the assessment of their creditworthiness.
 Approval is determined by a borrower’s credit rating and income or other considerations.
This includes collateral, assets, or how much debt they already have.
 There are several ways to ensure approval, including cutting the total debt-to-income (DTI)
ratio. An acceptable DTI ratio is 36%, but 28% is ideal.
 Borrowers are generally encouraged to keep card balances at 20% or less of the credit limit
and pay off all late accounts.
 Banks typically offer credit to borrowers who have adverse credit histories with terms that
benefit the banks themselves—higher interest rates, lower credit lines, and more restrictive
terms.
 Bank credit is the total amount of funds a person or business can borrow from a financial
institution.
 Credit approval is determined by a borrower's credit rating, income, collateral, assets, and
pre-existing debt.
 Bank credit may be secured or unsecured.
Special Considerations
Bank credit for individuals has grown considerably as consumers have become used to
relying on debt for various needs. This includes financing for large purchases such as homes
and automobiles, as well as credit that can be used to make items needed for daily
consumption. Businesses also use bank credit in order to fund their day-to-day operations.
Many companies need funding to pay startup costs, to pay for goods and services, or to
supplement cash flow. As a result, startups or small businesses use bank credit as short-
term financing.
Forms of Bank Credit

Bank credit comes in two different forms—secured and unsecured.

 Secured credit or debt is backed by a form of collateral, either in the form of cash or
another tangible asset. In the case of a home loan, the property itself acts as collateral.
Banks may also require certain borrowers to deposit a cash security in order to get a secured
credit card. Secured credit reduces the amount of risk a bank takes in case the borrower
defaults on the loan. Banks can seize the collateral, sell it, and use the proceeds to pay off
part or all of the loan. Because it is secured with collateral, this kind of credit tends to have a
lower interest rate and more reasonable terms and conditions. Banks normally charge lower
interest rates on secured credit because there's a higher risk of default on unsecured credit
vehicles.
 Unsecured credit, on the other hand, is not backed by collateral. These kinds of credit
vehicles are riskier than secured debt because the chance of default is higher. As such,
banks generally charge higher interest rates to lenders for unsecured credit.
Examples of Bank Credit

 The most common form of bank credit is a credit card. A credit card approval comes with a
specific credit limit and annual percentage rate (APR) based on the borrower's credit history.
The borrower is allowed to use the card to make purchases. They must pay either the
balance in full or the monthly minimum in order to continue borrowing until the credit limit is
reached.
 Banks also offer mortgage and auto loans to borrowers. These are secured forms of credit
that use the asset—the home or the vehicle—as collateral.
 Borrowers are required to make fixed payments at regular intervals, usually monthly, bi-
weekly, or monthly, using a fixed or variable interest rate.
 One example of business credit is a business line of credit (LOC). These credit facilities are
revolving loans granted to a company. They may be either secured or unsecured and give
corporations access to short-term capital.
 Credit limits are normally higher than those granted to individual consumers because of the
needs of businesses, their creditworthiness, and their ability to repay. Business LOCs are
normally subject to annual reviews.
SOURCES OF BANK FUNDS

A bank is a business firm. Its main aim is to earn profit. In order to achieve this objective, it
provides services to the customers. It offers a variety of interest-bearing obligations to the public.
These obligations are the sources of funds for the bank and are shown on the liability side of the
balance sheet of a commercial bank. The main sources which supply funds to a bank are as follows:
 Bank’s Own Funds
o Paid up capital
o Reserve fund
o Portion of undistributed profit.
 Borrowed Funds
Banks Own Funds

1. Paid up capital
 Bank’s own paid-up capital. The amount with which a banking company is
registered is called nominal or authorized capital.
 It is the maximum amount of capital which is mentioned in the capital clause of the
memorandum of association of the company.
 Capital is further divided into:
o paid up capital; and
o subscribed capital
2. Reserve fund
 Reserve is another source of fund which is maintained by all commercial banks.
 At the time of declaring dividend, a certain portion of the profit is transferred to the
reserve fund.
 This reserve belongs to the shareholders and at the time of liquidation, the
Shareholders are entitled to these reserves along with the capital.
 The main purpose of setting aside part of profit is to meet unforeseen expenses of the
bank. The Banking Companies Ordinance has made it obligatory (binding) for every
banking company incorporated in Pakistan to create a reserve fund.
3. Profit
 Profit is another source to a bank for the purpose of business.
 Profits signify the credit balance of the profit and loss account which has not been
distributed.
 The accumulated profits over the years increase the working capital of the bank and
strengthens its financial position.
Borrowed Funds
The borrowed capital is a major and an important source of fund for any banking business. It
mainly comes from deposits which are accepted on varying terms in different accounts.
Bank’s borrowing is mostly in the form of deposits. Bank collects three kinds of deposits from
its customers: (1) current or demand deposits (2) saving deposits and (3) fixed or time
deposits. The larger the deposits of bank, the larger will be its (use) fund for employment and
so higher are its profit.
Borrowing from central bank

The commercial banks in times of emergency borrow loans from the central bank of the
country. The central bank extends help as and when financial help is required by the
commercial banks.
Other sources
Bank also raise funds by issuing bonds, debentures, cash certificates etc. etc. Though it is
not common but is a dependable source of borrowing.
a. Bonds
In finance, a bond is a debt security, in which the authorized issuer owes the holders a
debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) to
use and/or to repay the principal at a later date, termed maturity. A bond is a formal
contract to repay borrowed money with interest at fixed intervals
b. Debenture
A type of debt instrument that is not secured by physical asset or collateral. Debentures
are backed only by the general creditworthiness and reputation of the issuer. Both
corporations and governments frequently issue this type of bond in order to secure
capital. Like other types of bonds, debentures are documented in an indenture.
c. Cash certificates
Cash certificates and recurring deposits are similar types of banking investments. The
terms are used most often in relation to the services that Indian banks provide their
customers. These deposits are not directly related to stock market or bond speculation,
but instead give investors a way to earn interest on money in a safer setting.
Deposits
Public deposits are a powerful source of funds to a bank. There are’ three types of bank
deposits (i) current deposits (ii) saving deposits and (iii) time deposits. Due to the spread of
literacy, banking habits and growth in the volume of business operations, there is a marked
increase in deposit money with banks.
a. Current Deposit
In deposit terminology, the term Current Deposit refers to a deposit to a bank account or
financial institution without a specified maturity date. These types of Current Deposit
account generally only earn demand deposit interest. Interest is very low for current
account.
b. Saving deposits
A deposit account held at a bank or other financial institution that provides principal
security and a modest interest rate. Depending on the specific type of savings account,
the account holder may not be able to write checks from the account (without incurring
extra fees or expenses) and the account is likely to have a limited number of free
transfers/transactions. Savings account funds are considered one of the most liquid
investments outside of demand accounts and cash. In contrast to savings accounts,
checking accounts allow you to write checks and use electronic debit to access your
funds inside the account. Savings accounts are generally for money that you don't intend
to use for daily expenses
c. Time Deposit
A time deposit also known as a term deposit, is a money deposit at a banking institution
that cannot be withdrawn for a certain "term" or period of time (unless a penalty is paid).
When the term is over it can be withdrawn or it can be held for another term. Generally
speaking, the longer the term the better the yield on the money. A certificate of deposit is
a time-deposit product
Factors determine the cost of sourcing of bank funds

1. Cost of funds
Cost of funds are the expenses incurred on obtaining funds from various sources in the form
of share capital, reserves, deposits, and borrowings. Thus, it generally refers to interest
expenses. Lower the cost of funds, higher the profitability.
2. Cost Interest Rate Risk

The risk of loss due to a change in interest rates. Interest rate risk is important to
transactions like interest rate swaps. In such a transaction, the party receiving the floating
rate will receive a smaller amount should the floating rate decrease. Interest rate risk is also
important to bonds; if interest rates rise, the prices of bonds fall. This affects the secondary
market for bonds; for example, if one purchases a bond with a 3% interest rate and the
prevailing rate rises to 5%, it becomes difficult or impossible to resell the bond at a profit.
Finally, interest rate risk is important also a factor which influenced the cost of sourcing of
bank funds.
3. Yield on funds
The funds raised by the bank through various sources are deployed in various assets. These
assets yield income in the form of interest. So, higher the interest, greater the profitability and
if yield of fund is good then cost of fund will low.
4. Spread
Spread is defined as the difference between the interest received (interest income) and the
interest paid (interest expense) in funding. Higher spread indicates more efficient financial
intermediation and higher net income so if the interest income is more than cost of capital will
low and banks always sources fund for gaining certain profit. Thus, higher spread leads to
higher profitability and decrease the cost of funding.
5. Level of technology
Use of upgraded technology normally leads to decline in the operating costs of banks and it
also affects the cost of funding. This improves the profitability of banks.
6. Nature of Deposits
Deposits trade with the banks are of various types like time deposits, demand deposits, short
– term deposits, etc. larger demand deposits /short – term deposits also influenced the cost
of funding
Cost of funding is always been calculated by banks by keeping all above elements in mind
because all these elements affect the cost of funding by bank directly or indirectly.
WHAT IS A DEPOSIT?
A deposit is a financial term that means money held at a bank. A deposit is a transaction
involving a transfer of money to another party for safekeeping. However, a deposit can refer to a
portion of money used as security or collateral for the delivery of a good.
How a Deposit Works

 A deposit encompasses two different meanings. One kind of deposit involves a transfer of
funds to another party for safekeeping. Using this definition, deposit refers to the money an
investor transfers into a savings or checking account held at a bank or credit union.
 In this usage, the money deposited still belongs to the person or entity that deposited the
money, and that person or entity can withdraw the money at any time, transfer it to another
person’s account, or use the money to purchase goods.
 Often, a person must deposit a certain amount of money in order to open a new bank
account, known as a minimum deposit. Depositing money into a typical checking account
qualifies as a transaction deposit, which means that the funds are immediately available and
liquid, without any delays.
 The other definition of deposit refers to when a portion of funds is used as a security or
collateral for the delivery of a good. Some contracts require a percentage of funds paid
before the delivery as an act of good faith. For example, brokerage firms often require
traders to make an initial margin deposit in order to enter into a new futures contract.
Types of Deposits
 There are two types of deposits: demand and time.
 A demand deposit is a conventional bank and savings account. You can withdraw the
money anytime from a demand deposit account.
 Time deposits are those with a fixed time and usually pay a fixed interest rate, such as a
certificate of deposit (CD). These interest-earning accounts offer higher rates than savings
accounts. However, time deposit accounts require that money be kept in the account for a
set period of time.
 Example of a Deposit
o Deposits are also required on many large purchases, such as real estate or vehicles,
for which sellers require payment plans. Financing companies typically set these
deposits at a certain percentage of the full purchase price, and individuals commonly
know these kinds of deposits as down payments.
o In the case of rentals, the deposit is called the security deposit. A security deposit's
function is to cover any costs associated with any potential damage done to the
property or asset rented, during the rental period. A partial or a total refund is applied
after the property or the asset is verified at the end of the rental period.
HOW TO OPEN A BANK ACCOUNT?

There are many different types of bank accounts: savings accounts, checking accounts,
payroll accounts, time deposit accounts, and more. Choosing the right bank account will completely
depend on you because each type has its own benefits and drawbacks.
However, when people talk about opening their first bank account, they usually mean
a savings account. The simplest reason for this is that a savings account incurs the least cost with
a few added benefits.

What is a Savings Account?
This is a bank account where you can keep your extra cash or emergency fund, and it is
available for withdrawal. You can deposit cash and checks but you can’t issue checks with this type
of bank account. One of the biggest reasons why you would want to start with a savings account is
because the initial deposit and maintaining balance is typically much lower than other types of
accounts. You can open one for as low as ₱100 with ₱2,000 as a maintaining balance.
 The biggest downside to it is that its annual interest rates are typically less than 1%.
 Like other accounts, you can also incur penalties up to ₱500 if your account goes below its
maintaining balance for over 30 days.
 You’re also limited to a specific withdrawal amount and even per transaction per day. This
varies from bank-to-bank.
 Take note that if you withdraw or check your balance from an ATM of another bank, you will
be charged with a service fee.
Basic Requirements
Typical requirements for opening a savings account are:
 2 Valid IDs like:
o School ID
o Company ID
o UMID
o Passport
o Driver’s License
o Postal ID
 Two 1×1 ID pictures taken in the last six months
 Proof of Billing like
o Electric bill
o Telco bill
o Water bill
 Tax Identification Number
 Initial Deposit (varies depending on the bank)
How Do I Choose My Bank?

Just like in choosing which type of bank account best fits your needs, the same decision
applies in choosing which bank to start your first bank account with. The factors you need to
consider are:
 Initial Deposit
 Maintaining balance
 Required balance to incur interest
 Interest rates
 Accessibility
 Online banking services
EXPLAIN: Discussing Concepts

INSTRUCTIONS: Answer the following questions below.
1. Differentiate savings accounts from current accounts.
2. How do commercial banks create money? Explain

__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
3. Differentiate the three (3) types of deposits.
EXTEND: TAKING OPINIONS
INSTRUCTIONS: Answer the following questions below.

1. What are the functions of commercial bank? Discuss each.
2. Is saving/depositing money in a bank important? Why or why not?

____________________________________________________________________________
____________________________________________________________________________
____________________________________________________________________________
____________________________________________________________________________
____________________________________________________________________________
3. Give at least three (3) importance of departmentalization.

____________________________________________________________________________
____________________________________________________________________________
____________________________________________________________________________
____________________________________________________________________________
____________________________________________________________________________
4. If you are going to deposit your money, what type of deposit will you prefer and why?
____________________________________________________________________________
____________________________________________________________________________
____________________________________________________________________________
____________________________________________________________________________
____________________________________________________________________________
EVALUATE: GOING DEEPER
Role Playing
Instructions: Perform or re-enact how to apply or open a bank account through a video
presentation. Your video must not be more than 3 minutes. Assume that you are the one to apply
and look for a person who will act as the teller. You will be evaluated by a scoring rubric.
Rubrics on Role Play
CRITERIA 4 3 2 1
Accuracy and Point-of-view, Point-of-view, Point-of-view Point-of-view
believability of role arguments and arguments and arguments and arguments, and
solutions proposed solutions proposed solutions proposed solutions proposed
were always were usually were often realistic were rarely realistic
realistic and realistic and in and in character. and in character.
consistently in character
character
Clarity of speech Speech is always Speech is usually Speech is often Speech is rarely
clear and easy to clear and easy to always clear and clear and easy to
understand understand easy to understand understand
Expression and Always expresses Usually expresses Often expresses Rarely expresses
body language emotion through emotion through emotion through emotion through
voice, facial voice, facial voice, facial voice, facial
expression, and expression, and expression, and expression and
gesture gesture gesture gesture.
Knowledge gained Can clearly explain Can clearly explain Can clearly explain Cannot explain in
several ways in several ways in one way in which any ways in which
which his or her which his or her his or her character his or her character
character”saw” character “saw” :saw” things “saw” things
things differently things differently differently than differently than
than other than other other other character other characters
characters and can character
explain why
TOPIC SUMMARY
In this lesson, you have learned that …

 Commercial Bank is a financial institution which performs the functions of accepting
deposits from the general public and giving loans for investment with the aim of earning
profit.
 A deposit can refer to a portion of money used as security or collateral for the delivery
of a good.
 Fixed deposits have a fixed period of maturity and are referred to as time deposits.
 An eligible borrower is first sanctioned a credit limit and within that limit he is allowed to
withdraw a certain amount on a given security.
 Short-term loans are given against some security as personal loans to finance working
capital or as priority sector advances.
 An overdraft is an advance given by allowing a customer keeping current account to
overdraw his current account up to an agreed limit.
 The security for overdraft is generally financial assets like shares, debentures, life
insurance policies of the account holder, etc.
 Deposit operations managers handle account set-up and maintenance duties, while
wire transfer operators ensure that paperless, computerized account transactions are
adequately processed.
 A bank's electronic banking department is responsible for the set-up and maintenance
of the bank's online financial transactions.
 Departmentalization or Departmentation is a process wherein jobs/teams are combined
together into functional units called as departments on the basis of their area of
specialization, to achieve the goals of the organization.
 Bank credit refers to the amount of credit available to a business or individual from a
banking institution in the form of loans.
 Secured credit or debt is backed by a form of collateral, either in the form of cash or
another tangible asset.
POST-ASSESSMENT
IDENTIFICATION.
Instruction: Read each item carefully then choose the letter of your choice.
1. All of the following would be considered money, narrowly defined except….

a. Savings account
b. Checking account
c. Coins
d. Currency
2. The TWO PRIMARY functions of commercial banks are to:

a. Set interest rates and support the federal reserve
b. Create money and promote
c. Hold demand deposits and make loans
d. Pay interests and provide customers economic security
3. The liabilities of a commercial bank include

a. Loans
b. Demand deposits
c. Net worth
d. Shares of stock
4. The assets of a commercial bank

a. Savings account
b. Demand deposits
c. Net worth
d. Loans
5. ______ is a deposit account provided by a bank or other financial institutions for individuals to
save money and earn the modest interest for that money held in the account.
a. Fixed deposit account
b. Savings bank account
c. Recurring account
d. Current account
6. ______ is a product to provide a person with an opportunity to build up saving through regular
monthly deposits of fixed sum over a period of time.
a. Savings bank account

c. Recurring deposit account
d. Current account
7. _______ is a type of deposit account that caters to professionals and businessmen alike.
a. Recurring account
c. Current account
d. Savings account
8. Which of the following is a transactional deposit account held at a financial institution that
allows for withdrawals and deposits?
a. Business accounts
b. Capital market accounts
c. Deposit accounts
d. Checking accounts
9. What is the principle on a loan?

a. The interest paid
b. The interest unpaid
c. The total amount paid
d. The initial amount loaned
10. How does the public have a small degree of control over the money supply?
a. Through investments
b. Through deposits
c. Through cash
d. Through credit cards
REFERENCES
 KENTON W. ECONOMY GOVERNMENT & POLICY: State Banking Department,
retrieved from https://www.investopedia.com/terms/b/banking-department.asp ,
retrieved on December 12, 2020.
 KAGAN J. PERSONAL FINANCE BANKING: Commercial Bank, retrieved from
https://www.investopedia.com/terms/c/commercialbank.asp, retrieved on December
12, 2020.

FINMA 3 Module 3

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

FINMA 3 Module 3

Uploaded by

Copyright:

Available Formats

1 Module 3 – Commercial Banking

2 Module 3 – Commercial Banking

MODULE LEARNING OUTCOME

In this module, you should be able to:

Lesson 1: Commercial Bank and its Functions

SPECIFIC LEARNING OUTCOMES

In this lesson, you are expected to:

1. ________Which of the following is a transactional deposit account held at a financial institution

2. _______What is the principle on a loan?

4. _______All of the following would be considered money, narrowly defined except….

5. _______The TWO PRIMARY functions of commercial banks are to:

6. _______The liabilities of a commercial bank include

7. _______The assets of a commercial bank

FUNCTIONS OF A COMMERCIAL BANK AND OPENING AN ACCOUNT

Activity 1: Picture Analysis

1. How do these banks differ from each other?

2. What are their similarities with regards to services?

EXPLORE: Reading Concepts

FUNCTIONS OF COMMERCIAL BANKS

o Fixed deposits (Time deposits):

o Savings account deposits:

2. It gives loans and advances:

1. Discounting bills of exchange or bundles:

3. Agency functions of the bank:

Payments of various items

Collection of dividends, interest on shares and debentures is made on behalf of its

4. Performing general utility services:

Underwriting securities issued by government, public or private bodies.

Purchase and sale of foreign exchange (currency).

CREDIT (MONEY) CREATION BY COMMERCIAL BANKS

WHAT ARE THE DIFFERENT DEPARTMENTS OF A BANK?

Departmentalization of activities results in the increase in efficiency of the management and

Understanding Bank Credit

Forms of Bank Credit

Bank credit comes in two different forms—secured and unsecured.

Examples of Bank Credit

SOURCES OF BANK FUNDS

Banks Own Funds

Borrowing from central bank

Factors determine the cost of sourcing of bank funds

2. Cost Interest Rate Risk

How a Deposit Works

HOW TO OPEN A BANK ACCOUNT?

How Do I Choose My Bank?

EXPLAIN: Discussing Concepts

2. How do commercial banks create money? Explain

3. Differentiate the three (3) types of deposits.

EXTEND: TAKING OPINIONS

INSTRUCTIONS: Answer the following questions below.

2. Is saving/depositing money in a bank important? Why or why not?

3. Give at least three (3) importance of departmentalization.

EVALUATE: GOING DEEPER

In this lesson, you have learned that …

1. All of the following would be considered money, narrowly defined except….

2. The TWO PRIMARY functions of commercial banks are to:

3. The liabilities of a commercial bank include

4. The assets of a commercial bank

b. Fixed deposit account

9. What is the principle on a loan?

You might also like