Contents
Similarities between Commercial Banks and NBFIs:
Non-Scheduled Banks of Bangladesh:
Scheduled Banks of Bangladesh
The financial market in Bangladesh
Regulators of the Financial System
Capital Market
Recent Developments in Financial Sector in Bangladesh
Insurance
NBFI
CAMELS
What Is Market Risk?
What Is a Nonperforming Loan?
What is Funds Management
Liquidity Management in Business and Investing
What is Prime Security and Collateral Security?
Primary Security vs Collateral Security
**What is an Offshore Banking Unit (OBU)
**What Is Positive Pay?
What Is Stress Testing?
What Is a Bank Rate?
What Is the Interest Rate Spread?
What Is Cost of Funds?
What Is Core Capital?
Shell bank
What Is Reputational Risk?
Compare Branch Banking VS Unit Banking
What Is a Smurf or Structuring?
What is a Lien
What Is a Set-Off Clause?
What Is Asset/Liability Management?
What is a Classified Loan?
What Is a Loan Loss Provision?
What Is a Beneficial Owner?
Funded & Non-Funded Loan: Definition, Uses etc.
Relationship between Banker and Customer
Politically exposed person (PEP)
False positive
What Is Trust Receipt?
Due diligence
Enhanced due diligence (EDD)
What Is a Suspicious Activity Report (SAR)?
Currency Transaction Report (CTR)
KYC
CTR
STR
KYC - Know Your Customer (Banking) and KYE
RTGS
National Payment Switch Bangladesh (NPSB)
Automated Teller Machines (ATM):
Point of Sales (POS):
Internet Banking Fund Transfer (IBFT):
Payment systems in BB
Mobile Financial Services (MFS)
Payment Service Provider (PSP) and Payment System
Operator (PSO)
BFIU
What Is Electronic Commerce (e-commerce)?What Is Return
on Equity – ROE?
What Is Return on Assets—ROA?
The return on revenue (ROR)
What Is Value at Risk (VaR)?
What is Capital Adequacy Ratio – CAR?
What Is Earnings Per Share?
What Is a Cryptocurrency?
Magnetic Ink Character Recognition (MICR) Line?
Trade-Based Money Laundering (TBML)
What Is Basel II?
What Is Basel III?
Legacy Account
Mutual Evaluation
Credit Deposit Ratio
Different types of Account
Credit Documentation
Recover Classified Loans
Self-Assessment Report
Agent Banking
SME Financing
Similarities between Commercial Banks and NBFIs:
From a functional viewpoint the operations of commercial
banks are similar to those of NBFIs on the following counts:
1. Like NBFIs, commercial banks acquire the primary
securities of borrowers, loans and deposits, and in turn, they provide their
own indirect securities and demand deposits to the lenders. Commercial banks
resemble NBFIs in that both create secondary securities in their role as
borrowers.
2. Commercial banks create demand deposits when they borrow
from the central bank, and NBFIs create various forms of indirect debt when
they borrow from commercial banks.
3. Both commercial banks and NBFIs act as intermediaries in
bringing ultimate borrowers and ultimate lenders together and facilitate the
transfer of currency balances from non-financial lenders to non-financial
borrowers for the purpose of earning profits.
4. Both commercial banks and NBFIs provide liquid funds. The
bank deposits and other assets of commercial banks and the assets provided by
NBFIs are liquid assets. Of course, the degree of liquidity varies in
accordance with the nature and the activity of the concerned financial
intermediaries.
5. Both banks and NBFIs are important creators of loanable
funds. The commercial banks by net creation of money and the NBFIs by
mobilising existing money balance in exchange for their own newly issued
financial liabilities.
Difference between Commercial Banks and NBFIs?
Commercial banks are different from NBFIs in the following
respects:
1.
Credit Creation:
Prof. J. Tobin has shown that the existence of NBFIs
significantly modifies the conventional view of commercial banks as creators of
money because they can directly issue their own new liabilities to acquire
other assets. On the other hand, NBFIs do not create money.
Like all other financial intermediaries (FIs), commercial
banks lend to borrowers only currency deposited with them and make profit by
charging borrowers a high rate than they pay to lenders. But both differ in the
effects of their operations so far as secondary securities are concerned.
The two main financial assets that serve as money are
currency, known as high powered money, and demand deposits of commercial banks.
Demand deposits are the secondary securities issued by commercial banks which
are substitutes for currency.
They represent a promise to pay currency on demand and are
transferred direct by cheque without encashment in settlement of debt. Banks
offer convenient safe-keeping, book-keeping and a large number of other services
to depositors that are not available by holding currency.
Consequently, depositors who lend their currency to
commercial banks receive in return a secondary security that itself serves as a
medium of payment. Loans made or deposits created by any bank through the issue
of cheques will ultimately be deposited by the borrowers or by other persons to
whom they made cheque payments in the commercial banking system. Thus cheques
help in creating credit by the bank credit multiplier.
Money lent by an individual bank is retained as cash reserve
by the banking system minus only a small leakage in money used by the borrower.
The bank credit multiplier implies that banks if uncontrolled would have an
unlimited power to expand deposits, since the latter are determined only by the
amount of primary securities that the banking system purchases.
“Bank money, once created in the process of bank lending,
lives on as a virtually permanent part of the money supply. Thus, banks do
manufacture money; and once manufactured, it is relatively immortal.” It is in
this sense that commercial banks are unique among FIs in their ability to
create money. But in the case of NBFIs, the amount of primary securities they
can buy is limited by the amount of indirect securities they can sell to
lenders.
Since they do not possess the bank credit multiplier power
of commercial banks, they perform the brokerage function of simply transferring
to borrowers the funds entrusted to them by lenders. Moreover, government
regulations prevent NBFIs from offering chequing facilities on their
liabilities and convertibility into currency on demand.
But a number of secondary securities, such as commercial
bank time and demand deposits and deposits in some thrift institutions while
directly not transferable by cheque can be turned into cash quickly, easily,
conveniently and without cost. Therefore, they are a close substitute of money
than other assets, are called near money assets.
Thus NBFIs can create liquidity and not money. Since the
majority of NBFIs are small, the banking system multiplier does not operate
fully in their case because of the leakages to banks of the money lent. Suppose
a small non-banking financial institution lends and issues a cheque on its bank
as payment.
This will lead to a drain on its resources unless an equal
amount is re-deposited by some other borrower. In the case of small NBFIs, the
redeposit ratio is low which makes it difficult for them to continue in
business unless they have sufficient assets. But a commercial bank faces no
problem of this type and can create money as well as liquidity to meet its
lending requirements.
2. Cash Reserve Requirements:
Commercial banks, like other FIs, have to earn a higher rate
on their total assets than they pay on their total liabilities. They have to
keep cash reserves. But cash reserves do not earn income. So banks wish to
maintain their cash reserves as low as possible. But, unlike NBFIs, they are
legally required to maintain a minimum cash reserve ratio (CRR).
This ratio is always more than what the banks would wish to
maintain. As a result, banks do not normally hold cash reserves in excess of
those legally required and invest all excess cash in earning assets. With a
reduction of required cash reserve ratio, the volume of bank intermediation
would expand, and vice versa.
As deposits are preferred to currency, an increase in the
stock of high powered money results in an increase in the public’s demand for
bank deposits. This leads to increase in deposits with the banking system. So
long as the average cost of providing and servicing demand deposits is low
relative to the interest rate earned on primary securities, banks have a profit
incentive to lend all excess cash by buying securities and granting loans.
Consequently, the volume of bank intermediation expands.
This process will continue until bank assets and deposits have risen to a level
where the required cash reserves and actual reserves are equal.
It should, however, be noted that the foreign exchange
liabilities of commercial banks are not required to meet cash reserve
requirements. So this part of the bank business can be regarded like an NBFI.
On the other hand, NBFIs are not subject to any such restrictions.
They are thus in an advantageous position over the banks.
But this regulatory distinction between banks and NBFIs does not apply now in
almost all the developed and developing countries of the world because reserve
equirements have been enforced in one form or another on NBFIs with the
exception of insurance companies, pension funds, and investment and unit
trusts.
3. Portfolio Structure:
Commercial banks differ from NBFIs in their portfolio
structure. Bank liabilities are very liquid. The liabilities of a bank are
large in relation to its assets, because it holds a small proportion of its
assets in cash. But its liabilities are payable on demand at a short notice.
Many types of assets are available to a bank with varying degree of liquidity.
The most liquid is cash. The next most liquid assets are
deposits with the central bank, treasury bills and other short-term bills
issued by the centre and state governments and large firms, and call loans to
other banks, firms, dealers and brokers in government securities.
The less liquid assets are the various types of loans to
customers and investment in longer-term bonds and mortgages. Thus banks have a
large and varied portfolio on the basis of which they create liquidity.
NBFIs also create liquidity but in the form of savings and
time deposits which are not used as a means of payment. They are limited in the
choice of their assets and are also prohibited from holding certain assets.
Thus the size of their portfolio is very small as compared with banks.
They generally issue claims against themselves that are
fixed in money terms and have maturities shorter than the direct securities
they hold. They borrow for short period, and lend for long period. This is
because of the small size of their portfolio and they hold less liquid assets
than banks.
4. Risk:
Banks have to follow certain norms at the time of advancing
loans. There are detailed appraisals of projects and hence delays in
sanctioning loans. On the other hand, NBFIs do not enter into detailed
appraisals of projects, they have to follow less stringent rules for advances.
There are no time delays in granting loans. Thus NBFIs are able to take greater
risk and lesser supervision as compared to banks.
5. Security:
NBFIs insist on greater security than banks before lending.
Normally, it is in the form of shares and post-dated cheques. This is to ensure
that if one project goes bad, they can recover from the others.
6. Recovery:
NBFIs are very innovative in their methods of recovery and
calculation of interest rates. They combine a good security with other factors
such as upfront fee, and higher lending rates. Consequently, their recovery
rates are good and the percentage of bad debts to their assets is very low.
Banks, on the other hand have to follow specific norms in
making loans. Their prime lending rates are much lower than the NBFIs. Since
banks advance huge loans to corporates, the rate of default is very high in
their case.
Non-Scheduled Banks of Bangladesh:
1. Ansar
VDP Unnayan Bank
2. Jubilee
Bank
3. Karmashangosthan
Bank
4. Palli
Sanchay Bank
5. Grameen
Bank
Scheduled Banks of Bangladesh
1. AB Bank Limited http://www.abbl.com
2. Agrani Bank Limited http://www.agranibank.org
3. Al-Arafah Islami Bank Limited http://www.al-arafahbank.com/
4. Bangladesh Commerce Bank Limited http://bcblbd.com/
5. Bangladesh Development Bank Limited http://www.bdbl.com.bd
6. Bangladesh Krishi Bank http://www.krishibank.org.bd
7. Bank Al-Falah Limited http://www.bankalfalah.com
8. Bank Asia Limited http://www.bankasia-bd.com
9. BASIC Bank Limited http://www.basicbanklimited.com
10. BRAC Bank Limited http://www.bracbank.com
11. Citibank N.A http://www.citi.com/domain/index.htm
12. Commercial Bank of Ceylon Limited http://www.combank.net/bdweb/
13. Community Bank Bangladesh Limited http://www.communitybankbd.com
14. Dhaka Bank Limited http://dhakabankltd.com
15. Dutch-Bangla Bank Limited http://www.dutchbanglabank.com
16. Eastern Bank Limited http://www.ebl.com.bd
17. EXIM Bank Limited http://www.eximbankbd.com
18. First Security Islami Bank Limited http://www.fsiblbd.com
19. Habib Bank Ltd. http://globalhbl.com/Bangladesh/
20. ICB Islamic Bank Ltd. http://www.icbislamic-bd.com/
21. IFIC Bank Limited http://www.ificbank.com.bd/
22. Islami Bank Bangladesh Ltd http://www.islamibankbd.com
23. Jamuna Bank Ltd http://www.jamunabankbd.com
24. Janata Bank Limited http://www.janatabank-bd.com
25. Meghna Bank Limited http://www.meghnabank.com.bd
26. Mercantile Bank Limited http://www.mblbd.com
27. Midland Bank Limited http://www.midlandbankbd.net/
28. Modhumoti Bank Ltd. http://modhumotibankltd.com/
29. Mutual Trust Bank Limited http://www.mutualtrustbank.com
30. National Bank Limited http://www.nblbd.com
31. National Bank of Pakistan http://www.nbp.com.pk
32. National Credit & Commerce Bank
Ltd http://www.nccbank.com.bd
33. NRB Bank Limited http://www.nrbbankbd.com
34. NRB Commercial Bank Limited http://www.nrbcommercialbank.com/
35. NRB Global Bank Limited http://www.nrbglobalbank.com
36. One Bank Limited http://www.onebankbd.com
37. Padma Bank Limited http://www.padmabankbd.com/
38. Premier Bank Limited http://www.premierbankltd.com
39. Prime Bank Ltd https://www.primebank.com.bd/
40. Probashi Kollyan Bank http://www.pkb.gov.bd/
41. Pubali Bank Limited http://www.pubalibangla.com
42. Rajshahi Krishi Unnayan Bank http://www.rakub.org.bd
43. Rupali Bank Limited https://rupalibank.org/en/
44. Shahjalal Islami Bank Limited http://www.sjiblbd.com/
45. Shimanto Bank Limited https://www.shimantobank.com/
46. Social Islami Bank Ltd. http://www.siblbd.com
47. Sonali Bank Limited http://www.sonalibank.com.bd
48. South Bangla Agriculture &
Commerce Bank Limited http://www.sbacbank.com/
49. Southeast Bank Limited https://www.southeastbank.com.bd
50. Standard Bank Limited http://www.standardbankbd.com
51. Standard Chartered Bank http://www.standardchartered.com/bd
52. State Bank of India https://bd.statebank/
53. The City Bank Ltd. http://www.thecitybank.com
54. The Hong Kong and Shanghai Banking
Corporation. Ltd. http://www.hsbc.com.bd
55. Trust Bank Limited http://www.trustbank.com.bd
56. Union Bank Limited http://www.unionbank.com.bd/
57. United Commercial Bank Limited http://www.ucb.com.bd/
58. Uttara Bank Limited http://www.uttarabank-bd.com
59. Woori Bank http://www.wooribank.com
The financial market in Bangladesh
1. Money Market: The money market
comprises banks and financial institutions as intermediaries, 20 of them are
primary dealers in treasury securities. Interbank clean and repo based lending,
BB's repo, reverse repo auctions, BB bills auctions, treasury bills auctions
are primary operations in the money market, there is also active secondary
trade in treasury bills (upto 1 year maturity).
2. Taka Treasury Bond market: The Taka
treasury bond market consists of primary issues of treasury bonds of different
maturities (2, 5, 10, 15 and 20 years), and secondary trade therein through
primary dealers. 20 banks performing as Primary Dealers participate directly in
the primary auctions. Other bank and non bank investors can participate in
primary auctions and in secondary trading through their nominated Primary
Dealers. Non-resident individual and institutional investors can also
participate in primary and secondary market, but only in treasury bonds. Monthly
data on primary and secondary trade volumes in treasury bills and bonds and
data on outstanding volume of treasury bonds held by non residents can be
accessed at Monthly data of Treasury Bills & Bonds .
3. Capital market: The primary issues and
secondary trading of equity securities of capital market take place through two
(02) stock exchanges-Dhaka Stock Exchange and Chittagong Stock Exchange. The
instruments in these exchanges are equity securities (shares), debentures and
corporate bonds. The capital market is regulated by Bangladesh Securities and
Exchange Commission (BSEC).
4. Foreign Exchange Market: Towards
liberalization of foreign exchange transactions, a number of measures were
adopted since 1990s. Bangladeshi currency, the taka, was declared convertible
on current account transactions (as on 24 March 1994), in terms of Article VIII
of IMF Article of Agreement (1994). As Taka is not convertible in capital
account, resident owned capital is not freely transferable abroad. Repatriation
of profits or disinvestment proceeds on non-resident FDI and portfolio investment
inflows are permitted freely. Direct investments of non-residents in the
industrial sector and portfolio investments of non-residents through stock
exchanges are repatriable abroad, as also are capital gains and
profits/dividends thereon. Investment abroad of resident-owned capital is
subject to prior Bangladesh Bank approval, which is allowed only sparingly.
Bangladesh adopted Floating Exchange Rate regime since 31 May 2003. Under the
regime, BB does not interfere in the determination of exchange rate, but
operates the monetary policy prudently for minimizing extreme swings in
exchange rate to avoid adverse repercussion on the domestic economy. The
exchange rate is being determined in the market on the basis of market demand
and supply forces of the respective currencies. In the forex market banks are
free to buy and sale foreign currency in the spot and also in the forward
markets. However, to avoid any unusual volatility in the exchange rate,
Bangladesh Bank, the regulator of foreign exchange market remains vigilant over
the developments in the foreign exchange market and intervenes by buying and
selling foreign currencies whenever it deems necessary to maintain stability in
the foreign exchange market.
Regulators of the Financial System
Central
Bank
Bangladesh
Bank acts as the Central Bank of Bangladesh which was established on December
16, 1971 through the enactment of Bangladesh Bank Order 1972- President’s Order
No. 127 of 1972 (Amended in 2003).
The
general superintendence and direction of the affairs and business of BB have
been entrusted to a 9 members' Board of Directors which is headed by the
Governor who is the Chief Executive Officer of this institution as well. BB has
45 departments and 10 branch offices.
In
Strategic Plan (2010-2014), the vision of BB has been stated as, “To develop
continually as a forward looking central bank with competent and committed
professionals of high ethical standards, conducting monetary management and
financial sector supervision to maintain price stability and financial system
robustness, supporting rapid broad based inclusive economic growth, employment
generation and poverty eradication in Bangladesh”.
The
main functions of BB are (Section 7A of BB Order, 1972) -
1. to formulate and implement monetary
policy;
2. to formulate and implement
intervention policies in the foreign exchange market;
3. to give advice to the Government on
the interaction of monetary policy with fiscal and exchange rate policy, on the
impact of various policy measures on the economy and to propose legislative
measures it considers necessary or appropriate to attain its objectives and
perform its functions;
4. to hold and manage the official
foreign reserves of Bangladesh;
5. to promote, regulate and ensure a
secure and efficient payment system, including the issue of bank notes;
6. to regulate and supervise banking
companies and financial institutions.
Core
Policies of Central Bank
Monetary
policy
The
main objectives of monetary policy of Bangladesh Bank are:
a. Price
stability both internal & external
b. Sustainable
growth & development
c. High
employment
d. Economic and
efficient use of resources
e. Stability of
financial & payment system
Bangladesh
Bank declares the monetary policy by issuing Monetary Policy Statement (MPS)
twice (January and July) in a year. The tools and instruments for
implementation of monetary policy in Bangladesh are Bank Rate, Open Market
Operations (OMO), Repurchase agreements (Repo) & Reverse Repo, Statutory
Reserve Requirements (SLR & CRR).
Reserve
Management Strategy
Bangladesh
Bank maintains the foreign exchange reserve of the country in different
currencies to minimize the risk emerging from widespread fluctuation in
exchange rate of major currencies and very irregular movement in interest rates
in the global money market. BB has established Nostro account arrangements with
different Central Banks. Funds accumulated in these accounts are invested in
Treasury bills, repos and other government papers in the respective currencies.
It also makes investment in the form of short term deposits with different high
rated and reputed commercial banks and purchase of high rated
sovereign/supranational/corporate bonds. A separate department of BB performs
the operational functions regarding investment which is guided by investment
policy set by the BB's Investment Committee headed by a Deputy Governor. The
underlying principle of the investment policy is to ensure the optimum return
on investment with minimum market risk.
Interest
Rate Policy
Under
the Financial sector reform program, a flexible interest policy was formulated.
According to that, banks are free to charge/fix their deposit (Bank /Financial
Institutes) and Lending (Bank /Financial Institutes) rates other than Export
Credit. At present, except Pre-shipment
export credit and agricultural lending, there is no interest rate cap on
lending for banks. Yet, banks can differentiate interest rate up to 3%
considering comparative risk elements involved among borrowers in same lending
category. With progressive deregulation of interest rates, banks have been
advised to announce the mid-rate of the limit (if any) for different sectors
and the banks may change interest 1.5% more or less than the announced mid-rate
on the basis of the comparative credit risk. Banks upload their deposit and
lending interest rate in their respective website.
Capital
Adequacy for Banks and FIs
Basel-III
has been introduced with a view to strenghening the capital base of banks with
the goal of promoting a more resilient banking sector. The Basel III regulation
will be adopted in a phased manner starting from the January 2015, with full
implementation of capital ratios from the beginning of 2019. Now, scheduled
banks in Bangladesh are required to maintain minimum capital of Taka 4 billion
or Capital to Risk Weighted Assets Ratio (CRAR) 10%, whichever is higher. In
addition to minimum CRAR, Capital Conservation Buffer (CCB) of 2.5% of the
total RWA is being introduced which will be maintained in the form of CET1.
Besides the minimum requirement all banks have a process for assessing overall
capital adequacy in relation to their risk profile and a strategy for
maintaining capital at an adequate level.
For
FIs, full implementation of Basel-II has been started in January 01, 2012
(Prudential Guidelines on Capital Adequacy and Market Discipline (CAMD) for
Financial Institutions). Now, FIs in Bangladesh are required to maintain Tk. 1
billion or 10% of Total Risk Weighted Assets as capital, whichever is higher.
Deposit
Insurance
The
deposit insurance scheme (DIS) was introduced in Bangladesh in August 1984 to
act as a safety net for the depositors. All the scheduled banks Bangladesh are
the member of this scheme Bank Deposit Insurance Act 2000. The purpose of DIS
is to help to increase market discipline, reduce moral hazard in the financial
sector and provide safety nets at the minimum cost to the public in the event
of bank failure. A Deposit Insurance Trust Fund (DITF) has also been created
for providing limited protection (not exceeding Taka 0.01 million) to a small
depositor in case of winding up of any bank. The Board of Directors of BB is
the Trustee Board for the DITF. BB has adopted a system of risk based deposit
insurance premium rates applicable for all scheduled banks effective from
January - June 2007. According to new instruction regarding premium rates,
problem banks are required to pay 0.09 percent and private banks other than the
problem banks and state owned commercial banks are required to pay 0.07 percent
where the percent coverage of the deposits is taka one hundred thousand per
depositor per bank. With this end in view, BB has already advised the banks for
bringing DIS into the notice of the public through displaying the same in their
display board.
Insurance
Authority
Insurance
Development and Regulatory Authority (IDRA) was instituted on January 26, 2011
as the regulator of insurance industry being empowered by Insurance Development
and Regulatory Act, 2010 by replacing its predecessor, Chief Controller of
Insurance. This institution is operated under Ministry of Finance and a 4
member executive body headed by Chairman is responsible for its general
supervision and direction of business.
IDRA
has been established to make the insurance industry as the premier financial
service provider in the country by structuring on an efficient corporate
environment, by securing embryonic aspiration of society and by penetrating
deep into all segments for high economic growth. The mission of IDRA is to
protect the interest of the policy holders and other stakeholders under
insurance policy, supervise and regulate the insurance industry effectively,
ensure orderly and systematic growth of the insurance industry and for matters
connected therewith or incidental thereto.
Regulator
of Capital Market Intermediaries
Securities
and Exchange Commission (SEC) performs the functions to regulate the capital
market intermediaries and issuance of capital and financial instruments by
public limited companies. It was established on June 8, 1993 under the
Securities and Exchange Commission Act, 1993. A 5 member commission headed by a
Chairman has the overall responsibility to administer securities legislation
and the Commission is attached to the Ministry of Finance.
The
mission of SEC is to protect the interests of securities investors, to develop
and maintain fair, transparent and efficient securities markets and to ensure
proper issuance of securities and compliance with securities laws. The main
functions of SEC are:
1. Regulating
the business of the Stock Exchanges or any other securities market.
2. Registering
and regulating the business of stock-brokers, sub-brokers, share transfer
agents, merchant bankers and managers of
issues, trustee of trust deeds, registrar of an issue, underwriters,
portfolio managers, investment advisers and other intermediaries in the
securities market.
3. Registering,
monitoring and regulating of collective investment scheme including all forms
of mutual funds.
4. Monitoring
and regulating all authorized self regulatory organizations in the securities market.
5. Prohibiting
fraudulent and unfair trade practices in any securities market.
6. Promoting
investors’ education and providing training for intermediaries of the
securities market.
7. Prohibiting
insider trading in securities.
8. Regulating
the substantial acquisition of shares and take-over of companies.
9. Undertaking
investigation and inspection, inquiries and audit of any issuer or dealer of
securities, the Stock Exchanges and
intermediaries and any self regulatory organization in the securities
market.
10. Conducting
research and publishing information.
Regulator of Micro Finance
Institutions
To bring Non-government Microfinance
Institutions (NGO-MFIs) under a regulatory framework, the Government of
Bangladesh enacted "Microcredit Regulatory Authority Act, 2006’" (Act
no. 32 of 2006) which came into effect from August 27, 2006. Under this Act,
the Government established Microcredit Regulatory Authority (MRA) with a view
to ensuring transparency and accountability of microcredit activities of the
NGO-MFIs in the country. The Authority is empowered and responsible to
implement the said act and to bring the microcredit sector of the country under
a full-fledged regulatory framework. MRA’s mission is to ensure transparency
and accountability of microfinance operations of NGO-MFIs as well as foster
sustainable growth of this sector. In order to achieve its mission, MRA has set
itself the task to attain the following goals:
1. To formulate
as well as implement the policies to ensure good governance and transparent financial
systems of MFIs.
2. To conduct
in-depth research on critical microfinance issues and provide policy inputs to
the government consistent with the national strategy for poverty eradication.
3. To provide
training of NGO-MFIs and linking them with the broader financial market to
facilitate sustainable resources and efficient management.
4. To assist
the government to build up an inclusive financial market for economic
development of the country.
5. To identify
the priorities in the microfinance sector for policy guidance and dissemination
of information to attain the MRA’s social responsibility.
According
to the Act, the MRA will be responsible for the three primary functions that
will need to be carried out, namely:
1. Licensing of
MFIs with explicit legal powers;
2. Supervision
of MFIs to ensure that they continue to comply with the licensing requirements;
and
3. Enforcement
of sanctions in the event of any MFI failing to meet the licensing and ongoing
supervisory requirements.
Capital Market
After the independence, establishment of Dhaka
Stock Exchange (formerly East Pakistan Stock Exchange) initiated the pathway of
capital market intermediaries in Bangladesh. In 1976, formation of Investment
Corporation of Bangladesh opened the door of professional portfolio management
in institutional form. In last two decades, capital market witnessed number of
institutional and regulatory advancements which has resulted diversified
capital market intermediaries. At present, capital market intermediaries are of
following types:
1. Stock Exchanges:
Apart from Dhaka Stock Exchange, there is another stock exchange in Bangladesh
that is Chittagong Stock Exchange established in 1995.
2. Central
Depository: The only depository system for the transaction and settlement of
financial securities, Central Depository Bangladesh Ltd (CDBL) was formed in
2000 which conducts its operations under Depositories Act 1999, Depositories
Regulations 2000, Depository (User) Regulations 2003, and the CDBL by-laws.
3. Stock
Dealer/Sock Broker: Under SEC (Stock Dealer, Stock Broker & Authorized
Representative) Rules 2000, these entities are licensed and they are bound to
be a member of any of the two stock exchanges. At present, DSE and CSE have 238
and 136 members respectively.
4. Merchant
Banker & Portfolio Manager: These institutions are licensed to operate
under SEC (Merchant Banker & Portfolio Manager Rules) 1996 and 45
institutions have been licensed by SEC under this rules so far.
5. Asset
Management Companies (AMCs): AMCs are authorized to act as issue and portfolio
manager of the mutual funds which are issued under SEC (Mutual Fund) Rules
2001. There are 15 AMCs in Bangladesh at present.
6. Credit
Rating Companies (CRCs): CRCs in Bangladesh are licensed under Credit Rating
Companies Rules, 1996 and now, 5 CRCs have been accredited by SEC.
7. Trustees/Custodians:
According to rules, all asset backed securitizations and mutual funds must have
an accredited trusty and security custodian. For that purpose, SEC has licensed
9 institutions as Trustees and 9 institutions as custodians.
8. Investment
Corporation of Bangladesh (ICB): ICB is a specialized capital market
intermediary which was established in 1976 through the ordainment of The
Investment Corporation of Bangladesh Ordinance 1976. This ordinance has
empowered ICB to perform all types of capital market intermediation that fall
under jurisdiction of SEC. ICB has three subsidiaries:
8.1. ICB Capital Management
Ltd.,
8.2. ICB Asset Management Company Ltd.,
8.3. ICB Securities Trading Company Ltd.
8.2. ICB Asset Management Company Ltd.,
8.3. ICB Securities Trading Company Ltd.
Recent Developments in Financial Sector in
Bangladesh
Automation
and Technological Development:
Banking
sector experienced remarkable progress in respect of automation in functioning
in last several years. For the pro-active and forward-visioning approach of
Bangladesh Bank, numbers of automation initiatives have been implemented in
banking sector. These initiatives include:
Bangladesh
introduced the Market Infrastructure (MI) Module for automated auction and
trading of government securities.
To create
a disciplined environment for borrowing, the automated Credit Information
Bureau (CIB) service provides credit related information for prospective and
existing borrowers. With this improved and efficient system, risk management
will be more effective. Banks and financial institutions may furnish credit
information to CIB database 24 by 7 around the year; and they can access credit
reports from CIB online instantly.
L/C
Monitoring System has been introduced for preservation and using the all
necessary information regarding L/C by the banks through BB website. This
system allows the authorized users of banks to upload and download their L/C
information.
In terms
of article 36(3) of Bangladesh Bank Order, 1972, all scheduled banks are
subject to submit Weekly Statement of Position as at the close of business on
every Thursday to the Department of Off-site Supervision. This statement now is
submitted through on-line using the web upload service of BB website within o3
(three) working days after the reporting date which is much more time and labor
efficient that the earlier manual system.
The
e-Returns service has been introduced which is An Online Portal Service for
Scheduled Banks to submit Electronic Returns using predefined template for the
purpose of Macro Economy Analysis through related BB Departments.
Online
Export Monitoring System is used for monitoring export of Bangladesh. Through
this service, Banks and AD Branches of Banks issue & reports export report.
Bangladesh
Automated Clearing House (BACH) started to work by replacing the ancient manual
clearing system which allows the inter-bank cheques and similar type
instruments to be to settled in instant manner.
Electronic
Fund Transfer (EFT) has been introduced which facilitates the banks to make
bulk payments instantly and using least paper and manpower.
The
initiation of Mobile Banking has been one of the most noteworthy advancement in
banking. Through this system, franchises of banks through mobile operators can
provide banking service to even the remotest corner of the country.
Almost every
commercial bank is now using their own core banking solution which has made
banking very faster and efficient. Usage of plastic money has much more
increased in daily life transactions. Full or partial online banking is now
being practiced by almost every bank.
Inauguration
of internet trading in both of the bourses (DSE & CSE) in the country is
the most significant advancement for capital market in last several years.
Micro Finance Institutions submit their reports to the regulator through the
Online Report Submission Tools for MFIs.
Institutional
Development:
Through
the Central Bank Strengthening Project, there have been a good number of
achievements regarding the institutional development in BB which can be
observed below:
The
implementation of Enterprise Resource Planning (ERP) has been a big step in
automation of operational structure of BB.
The
establishment of Enterprise Data Warehouse (under process) will bring the whole
banking and FI industry under a single network through which data sharing,
reporting and supervision will enter in a new horizon.
Bangladesh
Bank now possesses the most informative and resourceful website of the country
regarding economic and financial information.
Internal
networking system with required online communication facilities have been
developed and in operation for the officers of BB.
BB has
hosted number of international seminars on different economic and financial
issues over last several years.
MRA was
established in 2006 for bringing NGO-MFIs under supervision. For the pro active
role of MRA, this sector (MFI) is now in a good shape regarding the
accountability and regulation.
For
abolishing anomaly and fetching discipline in insurance industry, IDRA was
established in 2011. In one year, IDRA has taken number of appreciable steps to
regularize this industry.
After the
massive crash of local bourses in 2010-2011, the executive body of SEC was
redesigned in full and some good results have come after that.
Regulatory Development:
Banking
and FI industries have experienced diversified regulatory development over last
few years:
1. Basel-III has been introduced in a
phased manner starting from the January 2015, with full implementation of
capital ratios from the beginning of 2019.
2. Guidelines on Environmental and
Climate Change Risk Management for banks and FIs have been circulated. Policy
guidelines on Green Banking also have been issued.
3. Guidelines on Stress Testing for banks
and FIs have been issued which is aimed to assess the resilience of banks and
FIs under different adverse situations.
4. Number of Policy initiatives for
Financial Inclusion has been undertaken.
5. Banks have been asked to build up
separate Risk Management Unit for comprehensive and intensive risk management.
6. Banks have been instructed to create
separate subsidiary for capital market operations and capital market operations
of banks are now minutely monitored.
7. Supervision has been intensified to
increase the participation of banks in Corporate Social Responsibility (CSR).
8. For the efficient and timely action of
BB, foreign exchange reserve of Bangladesh did not face any adversity during
global financial turmoil of 2007-09.
9. To meet international standard on Anti
Money Laundering (AML)/Combating Financing of Terrorism (CFT) issues,
guidelines for Money Changers, Insurance Companies and Postal Remittance have
already been circulated.
10. SEC has updated Public Issue Rules,
2006 and Mutual Fund Rules, 2001. Apart from that, numbers of AMCs, merchant
banks and are Mutual Funds are permitted by SEC which has increased the
participation of institutional investors. The trend of capital market research
has been upward which indicates the potential of analytical investment
decision.
Insurance
Act 2010 was formulated to meet demand of concurrent time for shifting the
insurance industry in a better shape. Apart from that, several initiatives have
been undertaken by IDRA for prohibiting the malpractices in the industry
regarding insurance commission, agent, premium etc and corporate governance
issues.
Insurance
Insurance sector
in Bangladesh emerged after independence with 2 nationalized insurance
companies- 1 Life & 1 General; and 1 foreign insurance company. In mid 80s,
private sector insurance companies started to enter in the industry and it got
expanded. Now days, 62 companies are operating under Insurance Act 2010. Out of
them-
18 are
Life Insurance Companies including 1 foreign company and 1 is state-owned
company,
44 General
Insurance Companies including 1 state-owned company.
Insurance
companies in Bangladesh provide following services:
Life
insurance,
General
Insurance,
Reinsurance,
Micro-insurance,
Takaful or
Islami insurance.
NBFI
Non Bank
Financial Institutions (FIs) are those types of financial institutions which
are regulated under Financial Institution Act, 1993 and controlled by
Bangladesh Bank. Now, 34 FIs are operating in Bangladesh while the maiden one
was established in 1981. Out of the total, 2 is fully government owned, 1 is
the subsidiary of a SOCB, 15 were initiated by private domestic initiative and
15 were initiated by joint venture initiative. Major sources of funds of FIs
are Term Deposit (at least three months tenure), Credit Facility from Banks and
other FIs, Call Money as well as Bond and Securitization.
The major
difference between banks and FIs are as follows:
FIs cannot
issue cheques, pay-orders or demand drafts.
FIs cannot
receive demand deposits,
FIs cannot
be involved in foreign exchange financing,
FIs can
conduct their business operations with diversified financing modes like
syndicated financing, bridge financing, lease financing, securitization
instruments, private placement of equity etc.
CAMELS
CAMELS
Rating is the
rating system wherein the bank regulators or examiners (generally the officers
trained by RBI), evaluates an overall performance of the banks and determine
their strengths and weaknesses.
CAMELS
Rating is based on the financial statements of the banks, Viz. Profit and loss
account, balance sheet and on-site examination by the bank regulators. In this
Rating system, the officers rate the banks on a scale from 1 to 5, where 1 is
the best and 5 is the worst. The
parameters on the basis of which the ratings are done are represented by an
acronym “CAMELS”.
1. Capital Adequacy: The capital adequacy measures
the bank’s capacity to handle the losses and meet all its obligations towards
the customers without ceasing its operations.This can be met only on the basis
of an amount and the quality of capital, a bank can access. A ratio of Capital
to Risk Weighted Assets determines the bank’s capital adequacy.
2. Asset Quality: An asset represents all the assets of
the bank, Viz. Current and fixed, loans, investments, real estates and all the
off-balance sheet transactions. Through this indicator, the performance of an
asset can be evaluated. The ratio of Gross Non-Performing Loans to
Gross Advances is one of the criteria to evaluate the effectiveness of
credit decisions made by the bankers.
3. Management Quality: The board of directors and top-level
managers are the key persons who are responsible for the successful functioning
of the banking operations. Through this parameter, the effectiveness of the
management is checked out such as, how well they respond to the changing market
conditions, how well the duties and responsibilities are delegated, how well
the compensation policies and job descriptions are designed, etc.
4. Earnings: Income from all the operations,
non-traditional and extraordinary sources constitute the earnings of a bank.
Through this parameter, the bank’s efficiency is checked with respect to its
capital adequacy to cover all the potential losses and the ability to pay off
the dividends.Return on Assets Ratio measures the earnings of the
banks.
5. Liquidity: The bank’s ability to convert assets
into cash is called as liquidity. The ratio of Cash maintained by Banks
and Balance with the Central Bank to Total Assets determines the
liquidity of the bank.
6. Sensitivity to Market Risk: Through this parameter, the
bank’s sensitivity towards the changing market conditions is checked, i.e. how
adverse changes in the interest rates, foreign exchange rates, commodity
prices, fixed assets will affect the bank and its operations.
Thus,
through CAMELS rating, the overall financial position of the bank is evaluated
and the corrective actions, if any, are taken accordingly.
What Is Market Risk?
Market
risk is the possibility of an investor experiencing losses due to factors that
affect the overall performance of the financial markets in which he or she is
involved. Market risk, also called "systematic risk," cannot be
eliminated through diversification, though it can be hedged against in other
ways. Sources of market risk include recessions, political turmoil, changes in
interest rates, natural disasters and terrorist attacks. Systematic, or market
risk tends to influence the entire market at the same time.
This can
be contrasted with unsystematic risk, which is unique to a specific company or
industry. Also known as “nonsystematic risk,” "specific risk,"
"diversifiable risk" or "residual risk," in the context of
an investment portfolio, unsystematic risk can be reduced through diversification.
Understanding
Market Risk: Market (systematic) risk and specific risk (unsystematic) make up
the two major categories of investment risk. The most common types of market
risks include interest rate risk, equity risk, currency risk and commodity risk.
Publicly
traded companies in the United States are required by the Securities and
Exchange Commission (SEC) to disclose how their productivity and results may be
linked to the performance of the financial markets. This requirement is meant
to detail a company's exposure to financial risk. For example, a company
providing derivative investments or foreign exchange futures may be more
exposed to financial risk than companies that do not provide these types of
investments. This information helps investors and traders make decisions based
on their own risk management rules.
In
contrast to market risk, specific risk or "unsystematic risk" is tied
directly to the performance of a particular security and can be protected
against through investment diversification. One example of unsystematic risk is
a company declaring bankruptcy, thereby making its stock worthless to
investors.
Main Types
of Market Risk: Interest rate risk covers the volatility that may accompany
interest rate fluctuations due to fundamental factors, such as central bank
announcements related to changes in monetary policy. This risk is most relevant
to investments in fixed-income securities, such as bonds.
Equity
risk is the risk involved in the changing prices of stock investments, and
commodity risk covers the changing prices of commodities such as crude oil and
corn.
Currency
risk, or exchange-rate risk, arises from the change in the price of one
currency in relation to another; investors or firms holding assets in another
country are subject to currency risk.
Volatility
and Hedging Market Risk: Market risk exists because of price changes. The
standard deviation of changes in the prices of stocks, currencies or
commodities is referred to as price volatility. Volatility is rated in annualized
terms and may be expressed as an absolute number, such as $10, or a percentage
of the initial value, such as 10%.
Investors
can utilize hedging strategies to protect against volatility and market risk.
Targeting specific securities, investors can buy put options to protect against
a downside move, and investors who want to hedge a large portfolio of stocks
can utilize index options.
Measuring
Market Risk: To measure market risk, investors and analysts use the
value-at-risk (VaR) method. VaR modeling is a statistical risk management
method that quantifies a stock or portfolio's potential loss as well as the
probability of that potential loss occurring. While well-known and widely
utilized, the VaR method requires certain assumptions that limit its precision.
For example, it assumes that the makeup and content of the portfolio being
measured is unchanged over a specified period. Though this may be acceptable
for short-term horizons, it may provide less accurate measurements for
long-term investments.
Beta is
another relevant risk metric, as it measures the volatility or market risk of a
security or portfolio in comparison to the market as a whole; it is used in the
capital asset pricing model (CAPM) to calculate the expected return of an
asset.
What Is a Nonperforming Loan?
A
nonperforming loan (NPL) is a sum of borrowed money upon which the debtor has
not made the scheduled payments for a specified period. Although the exact
elements of nonperformance status vary, depending on the specific loan's terms,
"no payment" is usually defined as zero payments of either principal
or interest. The specified period also varies, depending on the industry and
the type of loan. Generally, however, the period is 90 days or 180 days.
How a
Nonperforming Loan Works
A
nonperforming loan (NPL) is considered in default or close to default. Once a
loan is nonperforming, the odds the debtor will repay it in full are
substantially lower. If the debtor resumes payments again on an NPL, it becomes
a reperforming loan, even if the debtor has not caught up on all the missed
payments.
In
banking, commercial loans are considered nonperforming if the debtor has made
zero payments of interest or principal within 90 days, or is 90 days past due.
For a consumer loan, 180 days past due classifies it as an NPL.
KEY
TAKEAWAYS
A
nonperforming loan (NPL) is a loan in which the borrower hasn't made any
scheduled payments of principal or interest for some time.
In
banking, commercial loans are considered nonperforming if the borrower is 90
days past due.
The
International Monetary Fund considers loans that are less than 90 days past due
as nonperforming if there's high uncertainty surrounding future payments.
Types of
Nonperforming Loans
A debt can
achieve "nonperforming loan" status in several ways. Examples of NPLs
include:
A loan in
which 90 days' worth of interest has been capitalized, refinanced, or delayed
due to an agreement or an amendment to the original agreement.
A loan in
which payments are less than 90 days late, but the lender no longer believes
the debtor will make future payments.
A loan in
which the maturity date of principal repayment has occurred, but some fraction
of the loan remains outstanding.
Official
Definitions of Nonperforming Loans
Several
international financial authorities offer specific guidelines for determining
nonperforming loans.
The
European Central Bank: The European Central Bank (ECB) requires asset and
definition comparability to evaluate risk exposures across euro area central
banks. The ECB specifies multiple criteria that can cause an NPL classification
when it performs stress tests on participating banks.
In 2014,
the ECB performed a comprehensive assessment and developed criteria to define
loans as nonperforming if they are:
90 days
past due, even if they are not defaulted or impaired
Impaired
with respect to the accounting specifics for U.S. GAAP and International
Financial Reporting Standards (IFRS) banks
In default
according to the Capital Requirements Regulation
An
addendum, issued in 2018, specified the time frame for lenders to set aside
funds to cover nonperforming loans: two to seven years, depending on whether
the loan was secured or not. As of 2019, eurozone lenders still have
approximately $990 billion worth of nonperforming loans on their books.
A nonperforming loan (NPL) is one in which
payments of either interest or principal have not been made for a set number of
days, for whatever reason.
The
International Money Fund
The
International Monetary Fund (IMF) also sets out multiple criteria for a
nonperforming loan classification.
In 2005,
the IMF defined nonperforming loans as loans whose:
Debtors
have not paid interest and/or principal payments in at least 90 days or more
Interest
payments equal to 90 days or more have been capitalized, refinanced, or delayed
by agreement
Payments
have been delayed by less than 90 days, but come with high uncertainty or no
certainty the debtor will make payments in the future
What is Funds Management
Funds
management is the overseeing and handling of a financial institution's cash
flow. The fund manager ensures that the maturity schedules of the deposits
coincide with the demand for loans. To do this, the manager looks at both the
liabilities and the assets that influence the bank's ability to issue credit.
BREAKING
DOWN Funds Management
Funds
management – also referred to as asset management – covers any kind of system
that maintains the value of an entity. It may be applied to intangible assets
(e.g., intellectual property and goodwill), and tangible assets (e.g.,
equipment and real estate). It is the systematic process of operating,
deploying, maintaining, disposing, and upgrading assets in the most
cost-efficient and profit-yielding way possible.
A fund
manager must pay close attention to cost and risk to capitalize on the cash
flow opportunities. A financial institution runs on the ability to offer credit
to customers. Ensuring the proper liquidity of the funds is a crucial aspect of
the fund manager's position. Funds management can also refer to the management
of fund assets.
In the
financial world, the term "fund management" describes people and
institutions that manage investments on behalf of investors. An example would
be investment managers who fix the assets of pension funds for pension
investors.
Fund
management may be divided into four industries: the financial investment
industry, the infrastructure industry, the business and enterprise industry,
and the public sector.
Financial
Fund Management: The most common use of "fund management" refers to
investment management or financial management, which are within the financial
sector responsible for managing investment funds for client accounts. The fund
manager's duties include studying the client's needs and financial goals, creating
an investment plan, and executing the investment strategy.
Classifying
Fund Management: Fund management can be classified according to client type,
the method used for management, or the investment type.
When
classifying fund management according to client type, the fund managers are
either business fund managers, corporate fund managers, or personal fund
managers who handle investment accounts for individual investors. Personal fund
managers cover smaller investment portfolios compared to business fund
managers. These funds may be controlled by one fund manager or by a team of
many fund managers.
Some funds
are managed by hedge fund managers who earn from an upfront fee and a certain
percentage of the fund's performance, which serves as an incentive for them to
perform to the best of their abilities.
Liquidity Management in Business and Investing
Liquidity
management takes one of two forms based on the definition of liquidity. One
type of liquidity refers to the ability to trade an asset, such as a stock or
bond, at its current price. The other definition of liquidity applies to large
organizations, such as financial institutions. Banks are often evaluated on
their liquidity, or their ability to meet cash and collateral obligations
without incurring substantial losses. In either case, liquidity management
describes the effort of investors or managers to reduce liquidity risk
exposure.
Liquidity
Management in Business
Investors,
lenders, and managers all look to a company's financial statements using liquidity
measurement ratios to evaluate liquidity risk. This is usually done by
comparing liquid assets and short-term liabilities, determining if the company
can make excess investments, pay out bonuses or, meet their debt obligations.
Companies that are over-leveraged must take steps to reduce the gap between
their cash on hand and their debt obligations. When companies are
over-leveraged, their liquidity risk is much higher because they have fewer
assets to move around.
All
companies and governments that have debt obligations face liquidity risk, but
the liquidity of major banks is especially scrutinized. These organizations are
subjected to heavy regulation and stress tests to assess their liquidity
management because they are considered economically vital institutions. Here,
liquidity risk management uses accounting techniques to assess the need for
cash or collateral to meet financial obligations. The Dodd-Frank Wall Street
Reform and Consumer Protection Act passed in 2010 raised these requirements much
higher than they were before the 2008 Financial Crisis. Banks are now required
to have a much higher amount of liquidity, which in turn lowers their liquidity
risk.
Liquidity
Management in Investing
Investors
still use liquidity ratios to evaluate the value of a company's stocks or
bonds, but they also care about a different kind of liquidity management. Those
who trade assets on the stock market cannot just buy or sell any asset at any
time; the buyers need a seller, and the sellers need a buyer.
When a
buyer cannot find a seller at the current price, he or she must usually raise
his or her bid to entice someone to part with the asset. The opposite is true
for sellers, who must reduce their ask prices to entice buyers. Assets that
cannot be exchanged at a current price are considered illiquid. Having the
power of a major firm who trades in large stock volumes increases liquidity
risk, as it is much easier to unload (sell) 15 shares of a stock than it is to
unload 150,000 shares. Institutional investors tend to make bets on companies
that will always have buyers in case they want to sell, thus managing their
liquidity concerns.
Investors
and traders manage liquidity risk by not leaving too much of their portfolios
in illiquid markets. In general, high-volume traders, in particular, want
highly liquid markets, such as the forex currency market or commodity markets
with high trading volumes like crude oil and gold. Smaller companies and
emerging tech will not have the type of volume traders need to feel comfortable
executing a buy order.
What is Prime Security and Collateral Security?
To obtain
Bank Loan borrower has to put some assets as security against the loan amount.
Security protects banker and lender against losses in case of default by the
borrower. Bank has the right to seize the security to recover the dues from the
borrower if the borrower fails to repay the loan amount.
Types of
SecurityThere are two types of Security, such as: Prime Security, Collateral
Security
Prime
Security
Prime
Securities are the assets which are directly related to loan and kept that as
security. So, prime security can be the thing that is being financed. Lender
keeps that assets as prime security for securing the financed amount against
any default by the borrower.
For Example,
in case of housing loan, the house is primary security and in case of term loan
for Plant and Machinery, Plant and Machinery will be primary security.
Collateral
Security
Collateral
Security is the secondary security, is used when Primary Security is not
sufficient to cover the whole loan amount in case of default by the borrower.
This security is the additional security to the Primary Security.
Example of
Prime Security and Collateral Security
Suppose,
you have borrowed a housing loan of USD 2 million from a commercial bank to
acquire a residential flat. The bank asks you to mortgage the same flat against
the loan. This is Called Prime Security.
For
example, Bank finance a term loan of 80 lakh for purchase of machinery to an
industrialist. He purchases machinery
worth 1 crore for his factory. Lender bank put a stipulation for residential
flat as collateral security for the above term loan. So Machinery purchase out
of this term loan is prime security while residential flat is collateral
security.
When
Collateral Security is needed?
In case of Cash credit Limits, Stock and book
debt are primary security. But borrower may sell Stocks and book debts, so bank
requires additional security (collateral) in the form of immovable assets
(building, land) to secure the loan.
In the
case of Housing Loan, Car Loan, and Personal Loan, collateral security is not
required.
Micro
Credit doesn’t need any Collateral Security.
Bank Loans
without collateral are known as collateral free loans.
Primary Security vs Collateral Security
What is
Security?
One of the
major functions of a bank is to provide credit to the customers for various
purposes such as home, vehicle etc and a bank’s strength and solvency depends
on the quality of its loans and advances. Security resembles an insurance
against emergency. It provides a protection to the lender in case of loan
default as the lender could acquire the security if the repayment is not done
by the borrower.
What are
Secured and Unsecured loans?
An
arrangement in which a lender gives money or property to a borrower and the
borrower agrees to return the property or repay the money, usually along with
interest, at some future point in time is called a loan.
A loan can
be broadly classified as a secured and unsecured loan.
Secured
loans
Secured
Loans are those which are protected by some sort of asset or collateral, for
example – mortgage, auto loan, construction loan etc. If the lender is unable
to repay the loan, the borrower has the right to sell off the asset to recover the
loan.
Unsecured
loan
Unsecured
loans include things like credit card purchases, education loan where borrower
don’t have to provide any physical item or valuable assets as security for the
loan. If a person is not able to repay this type of loan it leads to a bad
credit history which creates problems in future when he tries to get a loan
from other lenders or the lender may appoint a collection agency which will use
all its possible tools to recover the amount.
|
Basis for comparison
|
Secured loan
|
Unsecured loan
|
|
Asset
|
Compulsory
|
Not compulsory
|
|
Basis
|
Collateral
|
Creditworthiness
|
|
Risk of loss
|
Very less
|
High
|
|
Tenure
|
Long period
|
Short period
|
|
Borrowing limit
|
High
|
Less
|
|
Rate of interest
|
Low
|
High
|
What is
the importance of Asset/collateral?
For
lender: It reduces the risk associated with the loan default as in the case of
insolvency of the borrower the lender could sell off his asset to compensate
the loss occurred. Moreover, the borrower will make payments if he doesn’t want
to lose his pledged security.
For
borrower: Secured loan has a low rate of interest and give more time to repay
the loan so a borrower with low income can easily afford it. Secondly, if a
borrower has bad credit or limited income, most of the financial institutions
are reluctant in providing a loan but if he pledges collateral, the lender may
be more willing to approve his application.
Types of
security
There are
two types of security
Primary
Security
When an
asset acquired by the borrower under a loan is offered to the lender as
security for the financed amount then that asset is called Primary Security. In
simple terms, it is the thing that is being financed.
Example: A
person takes a housing loan of Rs 50 lakh from the bank and purchases a
residential loan. That flat will be mortgaged to the bank as primary security.
Collateral
Security
If the
bank or financial institution feels that the primary security is not enough to
cover the risk associated with the loan it asks for an additional security
along with primary security which is called Collateral Security. It guarantees
a borrower’s performance on a debt obligation. It can also be issued by a third
party or an intermediary.
Example: A
person takes a loan of Rs 2 crore for the types of machinery. So to secure itself
in the case of default by the borrower it asks for mortgaging residential flat
or hypothecating jewellery, which will be termed as collateral security.
RBI has
advised the banks not to obtain any collateral security in case of all priority
sector advances up to Rs. 25000. In other cases, it is left to the mutual
agreement of the borrower with the bank.
When
collateral security is required?
Collateral
security is not required in housing loan, car loan, personal loan etc. It is
required by lenders in corporate loans like cash credit because in cash credit
primary security such as stock and book debts can be sold any time by the
borrower so an additional security in shape of immovable property or some other
assets are taken to secure loan.
What are
collateral free loans?
Loans that
are disbursed without collateral or security, which limit the lender’s exposure
to risk, are called collateral free loans. This facility is provided under
Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), where
micro and small enterprises can be extended loan upto Rs. 1 crore without
security. This scheme was launched to solve the problem of lack of funding that
these enterprises face as well as to boost their development.
Advantages
No
collateral or third party guarantee is required
The
subsidised rate of interest.
Flexible
repayment tenures up to 5 years.
No track
record required.
Quick and
hassle free processing of applications.
Letter of
credit/bill discounting up to 180 days.
Similarly,
MUDRA (Micro Units Development and Refinance Agency) bank provide
collateral-free financial aid up to Rs. 10 lakhs to sole proprietors or
entrepreneurs carrying on Small and Medium enterprises.
**What is an Offshore Banking Unit (OBU)
An
offshore banking unit (OBU) is a bank shell branch, located in another
international financial center (or, in the case of India, a Special Economic
Zone). Offshore banking units (OBUs) make loans in the Eurocurrency market when
they accept deposits from foreign banks and other OBUs. Local monetary
authorities and governments do not restrict OBUs' activities; however, they are
not allowed to accept domestic deposits or make loans to residents of the
country, in which they are physically situated. Overall OBUs can enjoy
significantly more flexibility regarding national regulations.
BREAKING
DOWN Offshore Banking Unit (OBU)
OBUs have
proliferated across the globe since the 1970s. They are found throughout
Europe, as well as in the Middle East, Asia, and the Caribbean. U.S. OBUs are
concentrated in the Bahamas, the Cayman Islands, Hong Kong, Panama, and
Singapore. In some cases, offshore banking units may be branches of resident
and/or nonresident banks; while in other cases an OBU may be an independent
establishment. In the first case, the OBU is within the direct control of a
parent company; in the second, even though an OBU may take the name of the
parent company, the entity’s management and accounts are separate.
Some
investors may, at times, consider moving money into OBUs to avoid taxation
and/or retain privacy. More specifically, tax exemptions on withholding tax and
other relief packages on activities, such as offshore borrowing, are
occasionally available. In some cases, it is possible to obtain better interest
rates from OBUs. Offshore banking units also often do not have currency
restrictions. This enables them to make loans and payments in multiple
currencies, often opening more flexible international trade options.
History of
Offshore Banking Units
The euro
market allowed the first application of an offshore banking unit. Shortly
afterward Singapore, Hong Kong, India, and other nations followed suit as the
option allowed them to become more viable financial centers. While it took
Australia longer to join, given less favorable tax policies, in 1990, the
nation established more supportive legislation.
In the
United States, the International Banking Facility (IBF) acts as an in-house
shell branch. Its function serves to make loans to foreign customers. As with
other OBUs, IBF deposits are limited to non-U.S applicants.
**What Is Positive Pay?
Positive
pay is an automated cash-management service employed to deter check fraud.
Banks use positive pay to match the checks a company issues with those it
presents for payment. Any check considered suspect is sent back to the issuer
for examination. The system acts as a form of insurance for a company against
fraud, losses, and other liabilities. There is generally a charge incurred for
using it, although some banks now offer the service for free.
KEY
TAKEAWAYS
Positive
pay is a fraud-prevention system offered by most commercial banks to companies
to protect them against forged, altered, and counterfeit checks.
The
company provides a list to the bank of the check number, dollar amount, and
account number of each check.
The bank
compares the list to the actual checks, flags any that do not match, and
notifies the company.
The
company then tells the bank whether or not to cash the check.
Understanding
Positive Pay
In order
to protect against forged, altered, and counterfeit checks, the service matches
the check number, dollar amount, and account number of each check against a
list provided by the company. In some cases the payee may also be included on
the list. If these do not match, the bank will not clear the check. When
security checks are not put in place, identity thieves and fraudsters can
create counterfeit checks that may end up being honored.
When the
information does not match the check, the bank notifies the customer through an
exception report, withholding payment until the company advises the bank to
accept or reject the check. The bank can flag the check, notify a
representative at the company, and seek permission to clear the check. If the
company finds only a slight error or other minor problem, it can choose to
advise the bank to clear the check. If the company forgets to send a list to
the bank, all checks presented that should have been included may be rejected.
As banks
may not be responsible for fraudulent checks, companies should review the
institution’s terms and conditions thoroughly.
Reverse
Positive Pay vs. Positive Pay
A
variation on the positive-pay concept is the reverse positive-pay system. This
system requires the issuer to monitor its checks on its own, making it the company’s
responsibility to alert the bank to decline a check. The bank notifies the
company daily about all presented checks and clears the checks approved by the
company.
Typically,
if the company does not respond within a fairly short time, the bank will go
ahead and cash the check. This method, therefore, is not as reliable and
effective as positive pay, but it is cheaper.
What Is Stress Testing?
Stress
testing is a computer simulation technique used to test the resilience of
institutions and investment portfolios against possible future financial
situations. Such testing is customarily used by the financial industry to help
gauge investment risk and the adequacy of assets, as well as to help evaluate
internal processes and controls. In recent years, regulators have also required
financial institutions to carry out stress tests to ensure their capital
holdings and other assets are adequate.
Stress
Testing for Risk Management
Companies
that manage assets and investments commonly use stress testing to determine
portfolio risk, then set in place any hedging strategies necessary to mitigate
against possible losses. Specifically, their portfolio managers use internal
proprietary stress-testing programs to evaluate how well the assets they manage
might weather certain market occurrences and external events.
Asset and
liability matching stress tests are widely used, too, by companies that want to
ensure they have the proper internal controls and procedures in place.
Retirement and insurance portfolios are also frequently stress-tested to ensure
that cash flow, payout levels, and other measures are well aligned.
KEY
TAKEAWAYS
Stress
testing is a computer-simulated technique to analyze how banks and investment
portfolios fare in drastic economic scenarios.
Stress
testing helps gauge investment risk and the adequacy of assets, as well as to
help evaluate internal processes and controls.
Regulations
require banks to carry out various stress-test scenarios and report on their
internal procedures for managing capital and risk.
Regulatory
Stress Testing
Following
the 2008 financial crisis, regulatory reporting for the financial
industry—specifically for banks—was significantly expanded with a broader focus
on stress testing and capital adequacy, mainly due to the 2010 Dodd-Frank Act.
Beginning
in 2011, new regulations in the United States required the submission of
Comprehensive Capital Analysis and Review (CCAR) documentation by the banking
industry. These regulations require banks to report on their internal procedures
for managing capital and carry out various stress-test scenarios.
In
addition to CCAR reporting, banks in the United States deemed too big to fail
by the Financial Stability Board—typically those with more than $50 billion in
assets—must provide stress-test reporting on planning for a bankruptcy
scenario. In the government’s most recent reporting review of these banks in
2018, 22 international banks and eight based in the United States were
designated as too-big-to-fail.
Currently,
BASEL III is also in effect for global banks. Much like the U.S. requirements,
this international regulation requires documentation of banks’ capital levels
and the administration of stress tests for various crisis scenarios.
Stress testing involves running computer
simulations to identify hidden vulnerabilities in institutions and investment
portfolios to evaluate how well they might weather adverse events and market
conditions.
Types of
Stress Testing
Stress
testing involves running simulations to identify hidden vulnerabilities. The
literature about business strategy and corporate governance identifies several
approaches to these exercises. Among the most popular are stylized scenarios,
hypotheticals, and historical scenarios.
In a
historical scenario, the business—or asset class, portfolio, or individual
investment—is run through a simulation based on a previous crisis. Examples of
historical crises include the stock market crash of October 1987, the Asian
crisis of 1997, and the tech bubble that burst in 1999-2000.
A
hypothetical stress test is generally more specific, often focusing on how a
particular company might weather a particular crisis. For example, a firm in
California might stress-test against a hypothetical earthquake or an oil
company might do so against the outbreak of war in the Middle East.
Stylized
scenarios are a little more scientific in the sense that only one or a few test
variables are adjusted at once. For example, the stress test might involve the
Dow Jones index losing 10% of its value in a week.
As for the
methodology for stress tests, Monte Carlo simulation is one of the most widely
known. This type of stress testing can be used for modeling probabilities of
various outcomes given specific variables. Factors considered in the Monte Carlo
simulation, for example, often include various economic variables.
Companies
can also turn to professionally managed risk management and software providers
for various types of stress tests. Moody’s Analytics is one example of an
outsourced stress-testing program that can be used to evaluate risk in asset
portfolios.
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 a 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.
How Bank
Rates Work
The bank
rate in the United States 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 the Interest Rate Spread?
Rate
spreads are important if your business borrows or lends money.
A
difference or spread between two related interest rates occurs in many types of
business or finance transactions. As it relates to your business, a spread
could be relevant if you are borrowing money or if your business involves
lending or arranging for loans for your customers. As it relates to small
business, a rate spread could be an expense or source of profit.
Spreads in
Lending
For any
business that lends money, the interest rate spread is what the company charges
on a loan compared to its cost of money. A bank runs on interest rate spreads,
paying a certain rate on savings and CD deposits and making loans at higher
rates than it pays to savers. Publicly traded financial companies such as banks
often report the net interest rate spread earned on quarterly and annual
financial reports. The World Bank supplies interest rate spread data from countries
around the world showing the difference between the average lending rate and
deposit rate.
Spreads in
Investing
In the
investment world, interest rate spreads are used to evaluate what an investment
is paying compared to a benchmark rate. In the U.S., the benchmark is often the
current rate on a specified U.S. Treasury security. In the bond market, the
rates on corporate bonds will be compared to the 10-year Treasury bond at
different credit ratings. As examples, bonds with a AA credit rating will be
paying a certain spread over the Treasury rate and bonds with a lower rating
such as BB will be paying a higher spread over the Treasury rate.
Borrowing
for Your Business
If you
want to take out a bank loan for your business, the bank will very likely quote
you a rate that is the prime rate plus a rate spread. The prime rate is used by
many banks as the base rate for commercial and personal loans, with a spread
added to the prime based on the borrower's credit situation. For a business
loan, it is likely that the loan is an adjustable rate loan and the contract
will be written with a rate spread over the prime rate. This means that if the
prime rate increases, so will the rate you pay for your business loan.
Lending to
Customers
If you
provide financing options to help customers of your business buy your products,
you can generate additional profits from interest rate spreads. For example,
you sell golf carts and to promote sales you offer easy financing solutions, To
provide the golf cart loans, you work with a bank which provides you the money
at a 6 percent cost. You write the golf cart finance contracts at 9.9 percent.
When you send the finance contracts to the lender, the bank will calculate the
difference in interest earnings between the 9.9 and 6 percent and send you a
check for the difference, providing additional profit from the sale.
What Is Cost of Funds?
Cost of
funds is a reference to the interest rate paid by financial institutions for
the funds that they use in their business. The cost of funds is one of the most
important input costs for a financial institution since a lower cost will end
up generating better returns when the funds are used for 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 many financial institutions.
[Important:
The cost of funds shows how much interest rates banks and other financial
institutions must pay in order to acquire funds.]
Cost of
Funds
Understanding
the Cost of Funds
For
lenders, such as banks and credit unions, the cost of funds is determined by
the interest rate paid to depositors on financial products, including savings
accounts and time deposits. Although the term is often used with regard to
financial institutions, most corporations are also significantly impacted by
the cost of funds when borrowing.
Cost of
funds and net interest spread are conceptually key ways in which many banks
make money. Commercial banks charge interest rates on loans and other products
that consumers, companies, and large-scale institutions need. The interest rate
banks charge on such loans must be greater than the interest rate they pay to
obtain the funds initially—the cost of funds.
How the
Cost of Funds Are Determined
Sources of
funds that cost banks money fall into several categories. Deposits (often
called core deposits) are a primary source, typically in the form of checking
or savings accounts, and are generally obtained at low rates.
Banks also
gain funds through shareholder equity, wholesale deposits, and debt issuance.
Banks issue a variety of loans, with consumer lending comprising the lion's
share in the United States. Mortgages on property, home equity lending, student
loans, car loans, and credit card lending can be offered at variable,
adjustable or fixed interest rates.
The
difference between the average yield of interest obtained from loans and the
average rate of interest paid for deposits and other such funds (or the cost of
funds) is called the net interest spread, and it is an indicator of a financial
institution’s profit. Akin to a profit margin, the greater the spread, the more
profit the bank realizes. Conversely, the lower the spread, the less profitable
the bank.
Special
Considerations
The
relationship between the cost of funds and interest rates is fundamental to
understanding the U.S. economy. Interest rates are determined in a number of
ways. While open market activities play a key role, so does the federal funds
rate (or “fed fund rate”). According to the U.S. Federal Reserve, the federal
funds rate is “the interest rate at which depository institutions lend reserve
balances to other depository institutions overnight.” This applies to the
biggest, most credit-worthy institutions as they maintain the mandated amount
of reserve required.
Thus, the
fed funds rate is a base interest rate, by which all other interest rates in
the U.S. are determined. It is a key indicator of the health of the U.S.
economy. The Federal Reserve’s Federal Open Market Committee (FOMC) issues the
desired target rate in response to economic conditions as part of its monetary
policy to maintain a healthy economy.
For
instance, during a period of rampant inflation in the early 80s, the fed funds
rate soared to 20%. In the wake of the Great Recession starting in 2007 and the
ensuing global financial crisis, as well as the European sovereign debt crisis,
the FOMC maintained a record low target interest rate of 0% to 0.25% in order
to encourage growth.
Key Takeaways
The cost
of funds is how much banks and other financial institutions must pay in order
to acquire funds.
A lower
cost of funds means a bank will see better returns when the funds are used for
loans to borrowers.
The
difference between the cost of funds and the interest rate charged to borrowers
is one of the main sources of profit for many financial institutions.
What Is Core Capital?
Core
capital refers to the minimum amount of capital that a thrift bank, such as a
savings bank or a savings and loan company, must have on hand in order to
comply with Federal Home Loan Bank (FHLB) regulations. This measure was
developed as a safeguard with which to protect consumers against unexpected
losses.
KEY
TAKEAWAYS
Core
capital is the minimum amount of capital that thrift banks must maintain to
comply with Federal Home Loan Bank regulations.
In
combination with risk-weighted assets, core capital is used to determine Common
Equity Tier1 (CET1) ratios that regulators rely on to define a bank's capital
requirements.
CET1
requirements have become stricter since the financial crisis of 2008.
The
Federal Home Loan Bank regulations require banks to have core capital that
represents a minimum of 2% of the bank's overall assets, which may entail
equity capital (common stock) and declared reserves (retained assets). Created
to ensure that consumers are protected when creating financial accounts, core
capital comprises a substantial portion of Tier 1 capital, which regulators
view as a measure of a bank's financial strength.
Tier 1
capital refers to the ratio of a bank's core equity capital to the entire
amount of risk-weighted assets (total assets, weighted by credit risk) that a
bank owns. The risk-weighted assets are defined by The Basel Committee on
Banking Supervision, a banking supervisory authority created by the central
bank governors from more than a dozen nations.
Banks are
deemed less susceptible to failure if they have more core capital and fewer
risk-weighted assets. On the other hand, regulators consider banks prone to
failure, if the opposite is true.
Tier 1
Example
To better
understand how Tier 1 ratios work, consider the following scenario. Let us
assume that the Friendly Bank, which holds $3 of equity assets, lends $20 to a
customer. Assuming that this loan, which is now itemized as a $20 asset on the
bank's balance sheet, has a risk weighting of 80%. In this case, the Friendly
Bank carries $16 worth of risk-weighted assets ($20 × 80%). Considering its
original $3 equity, the Friendly Bank's Tier 1 ratio is calculated to be $3/$16
or 19%.
According
to the latest figures, the Tier 1 Capital ratio has been set at 4%. Therefore,
the Friendly Bank would presently be compliant with current banking authority
regulations.
Understanding
Core Capital
Following the
financial crisis of 2008, regulators began increasing their focus on banks'
Tier 1 capital, which not only consists of core capital but may also include
nonredeemable, noncumulative preferred equity. This is more stringent than
typical capital ratios, which can also include Tier 2 and lesser-quality
capital. Financial institutions are expected to adhere to the Tier 1 capital
ratios defined in Basel III regulations, which were issued to improve banking
regulation and supervision while mitigating the possibility of a future
financial crisis.
The
increase in capital ratio requirements was established primarily due to the
fact that capital depletion occurred in large quantities at major U.S.
financial institutions. According to studies, twelve institutions had capital
ratio erosion in excess of 300 basis points, and eight such institutions had
capital ratio erosion in excess of 450 basis points.
To ensure
that their capital requirements adhere to Basel III requirements, banks have
undertaken a number of measures, including shedding their non-performing and
risky assets and pruning employee headcounts. Furthermore, some financial
institutions have also merged with well-capitalized entities in a strategic
effort to boost their capital. Such mergers result in a reduction of
risk-weighted assets and increased availability of core capital to both bank
parties involved.
Shell bank
A shell
bank is a term that describes a financial institution that does not have a
physical presence in any country. In order to prevent money laundering,
Subtitle A of the USA PATRIOT Act specifically prohibits such institutions,
with the exception of shell banks that are affiliate of a bank that has a
physical presence in the U.S. or if the foreign shell bank is subject to
supervision by a banking authority in the non-U.S. country regulating the
affiliated depository institution, credit union, or foreign bank. The USA
PATRIOT Act includes specific provisions designed to limit the use of
correspondent accounts for money laundering activity. These provisions are
contained in sections 312, 313 and 319 and involve limitations on shell bank
relationships as well as enhanced due diligence and record keeping
requirements. I like them though. On 2002-11-28, final regulations implementing
section 313 and 319 of the US Patriot Act became effective. The regulations
implement provisions of the BSA that relate to foreign corresponded accounts.
What Is Reputational Risk?
Reputational
risk is a threat or danger to the good name or standing of a business or
entity. Reputational risk can occur in the following ways:
Directly,
as the result of the actions of the company itself
Indirectly,
due to the actions of an employee or employees
Tangentially,
through other peripheral parties, such as joint venture partners or suppliers
In
addition to having good governance practices and transparency, companies need
to be socially responsible and environmentally conscious to avoid or minimize
reputational risk.
KEY
TAKEAWAYS
Reputational
risk is a hidden threat or danger to the good name or standing of a business or
entity and can occur through a variety of ways.
The
biggest problem with reputational risk is that it can literally erupt out of
nowhere and even without warning.
Reputational
risk can pose a threat to the survival of the biggest and best-run companies
and has the potential to wipe out millions or billions of dollars in market
capitalization or potential revenues.
Understanding
Reputational Risk
Reputational
risk is a hidden danger that can pose a threat to the survival of the biggest
and best-run companies. It can often wipe out millions or billions of dollars
in market capitalization or potential revenues and can occasionally result in a
change at the uppermost levels of management.
The
biggest problem with reputational risk is that it can literally erupt out of
nowhere
Reputational
risk can also arise from the actions of errant employees, such as egregious
fraud or massive trading losses disclosed by some of the world's biggest
financial institutions. In an increasingly globalized environment, reputational
risk can arise even in a peripheral region far away from home base.
In some
instances, reputational risk can be mitigated through prompt damage control
measures, which is essential in this age of instant communication and social
media networks. In other instances, this risk can be more insidious and last
for years. For example, gas and oil companies have been increasingly targeted
by activists because of the perceived damage to the environment caused by their
extraction activities.
Example of
Reputational Risk
Reputational
risk exploded into full view in 2016 when the scandal involving the opening of
millions of unauthorized accounts by retail bankers (and encouraged or coerced
by certain supervisors) was exposed at Wells Fargo.
The CEO,
John Stumpf, and others were forced out or fired. Regulators subjected the bank
to fines and penalties, and a number of large customers reduced, suspended, or
discontinued altogether doing business with the bank. Wells Fargo's reputation
was tarnished, and the company continues to rebuild its reputation and its
brand into 2019.
Compare Branch Banking VS Unit Banking
|
BASIS FOR COMPARISON
|
UNIT BANKING
|
BRANCH BANKING
|
|
Meaning
|
Unit
banking is that system of banking in which there is a single small banking
company, that provides financial services to the local community.
|
Branch
banking is a banking method wherein a bank operates in more than one place to
provide banking services to customers, through its branches.
|
|
Local economy
|
Affected
by the ups and downs of the local economy.
|
It is
not affected by the ups and downs of the local economy.
|
|
Independence
of operations
|
More
|
Comparatively
less
|
|
Supervision
Cost
|
Low
|
Comparatively
high
|
|
Financial
Resources
|
Limited
financial resources
|
Large
pool of financial resources
|
|
Competition
|
No or
little within the bank
|
Exist
between the bank branches
|
|
Rate of
interest
|
Not
fixed, as the bank has its own policies and norms.
|
Fixed by
the head office, and directed by the central bank.
|
|
Decision
making
|
Quick
|
Time
Consuming
|
What Is a Smurf or Structuring?
A smurf is
a money launderer or someone who seeks to evade scrutiny from government
agencies by breaking up a transaction involving a large amount of money into
smaller transactions below the reporting threshold. Smurfing involves
depositing illegally gained money into bank accounts for under-the-radar
transfer in the near future.
How a
Smurf Works
To prevent
money laundering by criminals involved in illegal activities, such as drugs and
extortion, countries such as the United States and Canada require a currency
transaction report to be filed by a financial institution handling any
transaction exceeding $10,000 in cash. Therefore, a criminal group with $50,000
in cash for laundering may use several smurfs for depositing anywhere from
$5,000 to $9,000 in a number of accounts geographically dispersed.
"Smurf" is a colloquial term for a
money launderer, someone who deposits illegally gained money into bank accounts
for under-the-radar transfer in the near future. Smurfing is an illegal
activity that can have serious consequences.
Smurfing
happens in three stages, placement, layering, and integration. In the placement
stage, where the criminal is relieved of guarding large amounts of illegally
obtained cash by placing it into the financial system. For example, a smurf may
pack cash in a suitcase and smuggle it to another country for gambling, buying
international currency, or other reasons.
During the
layering stage, illicit money is separated from its source by a sophisticated
layering of financial transactions that obscures the audit trail and breaks the
link to the original crime. For example, a smurf moves funds electronically
from one country to another, then divides the money into investments placed in
advanced financial options or overseas markets.
The integration
stage is when the money is returned to the criminal. Although there are
numerous ways of getting the money back, funds must appear to come from a
legitimate source, and the process must not draw attention. For example,
valuables such as property, artwork, jewelry, or high-end automobiles may be
purchased and given to the criminal.
An Example
of Smurfing
One way
criminals move money internationally is known as “cuckoo smurfing.” Say a New
York criminal owes a London criminal $9,000, and a London merchant owes a New
York supplier $9,000.
The London
merchant goes to London Bank and deposits $9,000, with instructions to transfer
the money to the New York supplier’s bank.
The London
banker, working with the New York criminal, instructs the New York criminal to
deposit $9,000 in the New York supplier’s bank account.
The London
banker then transfers $9,000 from the London merchant’s account to the London
criminal’s account.
The London
merchant and the New York supplier do not know the funds were never directly
transferred. All they know is that the London merchant paid $9,000 and the New
York supplier received $9,000. However, if caught, the London banker could face
serious consequences.
What is a Lien
A lien is
a legal right granted by the owner of property, by a law or otherwise acquired
by a creditor. A lien serves to guarantee an underlying obligation, such as the
repayment of a loan. If the underlying obligation is not satisfied, the
creditor may be able to seize the asset that is the subject of the lien.
BREAKING
DOWN Lien
Once
executed, a lien becomes the legal right of a creditor to sell the collateral
property of a debtor who fails to meet the obligations of a loan or other
contract. The property that is the subject of a lien cannot be sold by the
owner without the consent of the lien holder. A floating lien refers to a lien
on inventory, or other unfixed property.
Practical
Examples of Liens
A lien is
often granted when an individual takes out a loan from a bank to purchase an
automobile. The individual purchases the vehicle and pays the seller using the
funds from the bank, but grants the bank a lien on the vehicle. If the
individual does not repay the loan, the bank may execute the lien, seize the
vehicle, and sell it to repay the loan. If the individual does repay the loan
in full, the lien holder (the bank) then releases the lien, and the individual
owns the property free and clear of any liens.
Another
type of lien is a mechanic's lien, which can be attached to real property if
the property owner fails to pay a contractor for services rendered. If the
debtor never pays, the property can be auctioned off to pay the lien holder.
Liens and
Taxes
There are
also several statutory liens, meaning liens created by laws, as opposed to
those created by a contract. These liens are very common in the field of
taxation, where laws often allow tax authorities to put liens on the property
of delinquent taxpayers. For example, municipalities can use liens to recover
unpaid property taxes.
In the
United States, if a taxpayer becomes delinquent and does not demonstrate any
indication of paying owed taxes, the IRS may place a legal claim against a
taxpayer's property, including his home, vehicle and bank accounts. A federal
tax lien has precedence over all other creditors' claims, and can lead to a
sheriff's sale. It also affects the taxpayer's ability to sell existing assets
and to obtain credit. The only way to release a federal tax lien is to fully
pay the tax owed or to reach a settlement with the IRS. The IRS has the
authority to seize the assets of a taxpayer who ignores a tax lien.
What Is a Set-Off Clause?
A set-off
clause is a legal clause that gives a lender the authority to seize a debtor's
deposits when they default on a loan. A set-off clause can also refer to a
settlement of mutual debt between a creditor and a debtor through offsetting
transaction claims. This allows creditors to collect a greater amount than they
usually could under bankruptcy proceedings.
KEY
TAKEAWAYS
Set-off
clauses are written into legal agreements to protect the lender.
A set-off
clause allows the lender to seize assets belonging to the borrower, such as
bank accounts, in the event of a default.
Set-off
clauses are also used by manufacturers and other sellers of goods to protect
them from a default by a buyer.
How a
Set-Off Clause Works
Set-off
clauses give the lender the right of setoff—the legal right to seize funds from
the debtor or a guarantor of the debt. They are part of many lending
agreements, and can be structured in various ways. Lenders may elect to include
a set-off clause in the agreement to ensure that, in the event of default, they
will receive a greater percentage of the amount that's owed them than they
might otherwise. If a debtor is unable to meet an obligation to the bank, the
bank can seize the assets detailed in the clause.
Set-off
clauses are most commonly used in loan agreements between lenders, such as
banks, and their borrowers. They may also be used in other kinds of
transactions where one party faces a risk of payment default, such as a
contract between a manufacturer and a buyer of its goods. The Truth in Lending
Act prohibits set-off clauses from applying to credit card transactions; this
protects consumers who decline to pay for defective merchandise purchased with
their cards, using what's known as a chargeback.
Examples
of Set-Off Clauses
A lending
set-off clause is often included in a loan agreement between a borrower and the
bank where they hold other assets, such as money in a checking, savings, or
money market account, or a certificate of deposit. The borrower agrees to make
those assets available to the lender in the case of default. If assets are held
at that lender, they can be more easily accessed by the lender to cover a
defaulted payment. But a set-off clause may also include rights to assets held
at other institutions. While those assets are not as readily accessible to the
lender, the set-off clause does give the lender contractual consent to seize
them if a borrower defaults.
A set-off
clause might be also part of a supplier agreement between the supplier, such as
a manufacturer, and a buyer, such as a retailer. This type of clause can be
used in place of a letter of credit from a bank and gives the supplier access
to deposit accounts or other assets held at the buyer's financial institution
if the buyer fails to pay. With a set-off clause, the seller can obtain payment
equivalent to the amount that's owed them under the supplier agreement.
Borrowers
should be aware that agreeing to a set-off clause might mean having to forfeit
more of their assets than they would in a bankruptcy proceeding.
Benefits
of Set-Off Clauses
Set-off
clauses are used for the benefit of the party at risk of a payment default.
They give the creditor legal access to a debtor’s assets at either the lender's
financial institution or another one where the debtor has accounts. Before
signing a contract with a set-off clause, borrowers should be aware that it may
result in the loss of assets they would have been able to retain through other
means of debt settlement, such as bankruptcy.
What Is Asset/Liability Management?
Asset/liability
management is the process of managing the use of assets and cash flows to
reduce the firm’s risk of loss from not paying a liability on time.
Well-managed assets and liabilities increase business profits. The
asset/liability management process is typically applied to bank loan portfolios
and pension plans. It also involves the economic value of equity.
Understanding
Asset/Liability Management
The
concept of asset/liability management focuses on the timing of cash flows
because company managers must plan for the payment of liabilities. The process
must ensure that assets are available to pay debts as they come due and that
assets or earnings can be converted into cash. The asset/liability management
process applies to different categories of assets on the balance sheet.
[Important:
A company can face a mismatch between assets and liabilities because of
illiquidity or changes in interest rates; asset/liability management reduces
the likelihood of a mismatch.]
Factoring
in Defined Benefit Pension Plans
A defined
benefit pension plan provides a fixed, pre-established pension benefit for
employees upon retirement, and the employer carries the risk that assets
invested in the pension plan may not be sufficient to pay all benefits.
Companies must forecast the dollar amount of assets available to pay benefits
required by a defined benefit plan.
Assume,
for example, that a group of employees must receive a total of $1.5 million in
pension payments starting in 10 years. The company must estimate a rate of
return on the dollars invested in the pension plan and determine how much the
firm must contribute each year before the first payments begin in 10 years.
Examples
of Interest Rate Risk
Asset/liability
management is also used in banking. A bank must pay interest on deposits and
also charge a rate of interest on loans. To manage these two variables, bankers
track the net interest margin or the difference between the interest paid on
deposits and interest earned on loans.
Assume,
for example, that a bank earns an average rate of 6% on three-year loans and
pays a 4% rate on three-year certificates of deposit. The interest rate margin
the bank generates is 6% - 4% = 2%. Since banks are subject to interest rate
risk, or the risk that interest rates increase, clients demand higher interest
rates on their deposits to keep assets at the bank.
The Asset
Coverage Ratio
An
important ratio used in managing assets and liabilities is the asset coverage
ratio which computes the value of assets available to pay a firm’s debts. The
ratio is calculated as follows:
Asset
Coverage Ratio= (BVTA−IA)−(CL−STDO) / (Total Debt Outstanding)
where:
BVTA=book value
of total assets
IA=intangible
assets
CL=current
liabilities
STDO=short
term debt obligations
Tangible
assets, such as equipment and machinery, are stated at their book value, which
is the cost of the asset less accumulated depreciation. Intangible assets, such
as patents, are subtracted from the formula because these assets are more
difficult to value and sell. Debts payable in less than 12 months are
considered short-term debt, and those liabilities are also subtracted from the
formula.
The coverage
ratio computes the assets available to pay debt obligations, although the
liquidation value of some assets, such as real estate, may be difficult to
calculate. There is no rule of thumb as to what constitutes a good or poor
ratio since calculations vary by industry.
Key
Takeaways
Asset/liability
management reduces the risk that a company may not meet its obligations in the
future.
The
success of bank loan portfolios and pension plans depend on asset/liability
management processes.
Banks
track the difference between the interest paid on deposits and interest earned
on loans to ensure that they can pay interest on deposits and to determine what
a rate of interest to charge on loans.
[Fast
Fact: Asset/liability management is a long-term strategy to manage risks. For
example, a home-owner must ensure that they have enough money to pay their
mortgage each month by managing their income and expenses for the duration of
the loan.]
What is a Classified Loan?
A
classified loan is any bank loan that is in danger of default. Classified loans
have unpaid interest and principal outstanding, and it is unclear whether the
bank will be able to recoup the loan proceeds from the borrower. Banks usually
categorize such loans as adversely classified assets on their books.
Classified
loans have failed to meet acceptable credit standards, according to bank
examiners. The credit quality has essentially declined since initial approval.
This type of loan has a high rate of borrower default and can raise the cost of
borrowing money for the bank's other customers.
Classified
loans have a high rate of borrower default and can raise the cost of borrowing
for a bank's other customers.
The Whys
and Hows of Credit Analysis
To
determine the creditworthiness of a borrower and thus the quality of a loan,
many banks will undertake a credit analysis. A credit analysis focuses on the
ability of an entity, such as an individual or a company, to meet its debt
obligations. Lenders will generally work through the five C's to determine credit
risk, looking into an applicant's:
Credit
history
Capacity
to repay
Capital
Conditions
and terms of the loan
Collateral
(In a mortgage transaction, for example, collateral is the house, which the
party purchases with the funds from the mortgage. If payments on this debt
cease, the lender can take possession of the house through a process called
foreclosure.)
Credit
analysis is a form of due diligence, which often relies on liquidity and
solvency ratios. Liquidity measures the ease with which an individual or
company can meet its financial obligations with the current assets available to
them, while solvency measures ability to repay long-term debts. A credit
analyst may use the following specific liquidity ratios to determine short-term
vitality: current ratio, quick ratio or acid test, and cash ratio. Solvency
ratios might entail the interest coverage ratio.
Classified
Loans and High-Yield Bonds
A
classified loan and a high-yield bond are similar in that both may have reduced
credit ratings. High-yield bonds are also called junk bonds in contrast with
investment-grade corporate bonds, Treasury bonds and municipal bonds. Given
classified loans’ higher risk of default, they often pay a higher yield than
investment grade bonds. Issuers of high-yield debt tend to be startup companies
or capital-intensive firms with high debt ratios.
A bond
yield is the amount of return an investor realizes on a bond. Several types of
bond yields exist, including nominal yield, which is the interest paid divided
by the face value of the bond, and current yield, which equals annual earnings
of the bond divided by its current market price.
What Is a Loan Loss Provision?
A loan
loss provision is an expense set aside as an allowance for uncollected loans
and loan payments. This provision is used to cover a number of factors
associated with potential loan losses, including bad loans, customer defaults,
and renegotiated terms of a loan that incur lower than previously estimated
payments. Loan loss provisions are an adjustment to loan loss reserves and are
also known as valuation allowances.
How a Loan
Loss Provision Works
Banking
industry lenders generate revenue from the interest and expenses they receive
from lending products. Banks lend to a wide range of customers, including consumers,
small businesses, and large corporations. Lending standards and reporting
requirements are constantly changing, and constraints have been rigorously
tightening since the height of the 2008 financial crisis. Improved regulations
for banks resulting from the Dodd-Frank Act have focused on increasing the
standards for lending, which have required higher credit quality borrowers and
also increased the capital liquidity requirements for the bank.
Despite
these improvements, banks still have to account for loan defaults and expenses
that occur as a result of lending. Loan loss provisions are a standard
accounting adjustment made to a bank’s loan loss reserves included in the
financial statements of banks. Loan loss provisions are consistently made to incorporate
changing projections for losses from the bank’s lending products. While
standards for lending have greatly improved, banks still experience late loan
payments and loan defaults.
Loan Loss
Reserves in Accounting
Loan loss
reserves are typically accounted for on a bank’s balance sheet, which can
increase by the amount of the loan loss provision or decrease by the amount of
net charge-offs each quarter.
Loan loss
provisions are constantly made to update estimates and calculations based on
statistics for the bank’s customer defaults. These estimates are calculated
based on average historical default rates by different levels of borrowers.
Credit losses for late payments and collection expenses are also included in
loan loss provision estimates and are calculated using a similar methodology,
which takes into account the previous payment statistics of a bank’s credit
clients.
Overall,
by setting aside loan loss reserves and constantly updating estimates through
loan loss provisions, banks can ensure they are presenting an accurate
assessment of their overall financial position. This financial position is
often released publicly through the bank’s quarterly financial statements.
Many
analysts believe that the global economy is entering a period of strong new
growth, especially in emerging markets. Asia, for example, is now responsible
for a third of the world’s GDP, while Africa has seven out of ten of the
planet’s fastest-growing economies. And South America’s middle class is
expanding by leaps and bounds. For Canadian businesses seeking growth, such
developments are very promising. At the same time, though, these new markets
can be risky for the unprepared. The single most serious hazard is not getting
paid, for reasons that can range from a customer’s bankruptcy to a government’s
imposition of currency controls. Make sure you get paid during international
trade Your first line of defence against this danger is to effectively manage
credit risk. If you’re clearly aware of your foreign customers’ creditworthiness,
as well as local political and economic conditions that may affect their
ability to pay, protecting your receivables will be a lot easier. Here are
seven basic ways to lower the risk of not getting your money.
1. Thoroughly check a new customer’s credit
record.
Finding
foreign corporate information can be tricky, especially for emerging markets.
Local consulting firms may be able to help, and you can also get assistance
from the Canadian Trade Commissioner Service office.
2. Use that first sale to start building
the customer relationship.
Your
number-one tool for managing a customer’s credit risk is building a long-term,
trusted relationship. This can obviously take years to fully achieve. But start
laying the groundwork by discussing your credit terms with a new customer
before you extend credit. This will help you gauge the customer’s attitudes to
credit, and ensure that they clearly understand what you expect of them. Also
consider using a “master sales agreement” with a new customer, rather than
relying on purchase orders to set out credit terms.
3. Establish credit limits.
To set a
credit limit for a new customer, you can use tools such as: Credit-agency
reports, which can provide comprehensive information about a company’s
financial history. Bank reports, which should give details of the bank’s
relationship with the company, the company’s borrowing capacity and its level
of debt. Audited financial statements, which can provide a good view of the
business’s liquidity, profitability and cash flow.
4. Make sure the credit terms of your
sales agreements are clear.
A sales
agreement that includes well-worded, comprehensive terms of credit will
minimize the risk of disputes and improve your chances of getting paid in full
and on time.
5. Use credit and/or political risk
insurance.
The
Receivables Insurance Association of Canada provides useful information about
insuring your company against non-payment. If you decide to insure, EDC offers
a full suite of insurance products that can protect you against non-payment,
contract cancellation, breach of contract, expropriation, currency
restrictions, political violence and more. Titan Building nails down its
receivables Ottawa-based Titan Building Products manufactures deck-building
components and materials, which it sells in Canada and abroad. A brush with a
non-paying customer, however, cost company president Richard Bergman some
sleepless nights. As a result, Titan now takes customer deposits upfront and
insures the remainder of the sale with EDC credit insurance. It’s a very
flexible solution because the company can insure only those sales that might
involve extra risk. Moreover, says Bergman, “for a small business like Titan,
the insurance fee is very cost-effective.
6. Use factoring.
To do this,
you sell your receivable to a factoring company for its cash value, minus a
discount. This gives you your money immediately because you don’t have to wait
for payment—the customer will pay the factoring company instead of you. But
make sure the factoring is on a “non-recourse” basis, which means you’re not
liable if the customer defaults.
7. Develop a standard process for
handling overdue accounts.
Your
chances of collecting on a delinquent account are highest in the first 90 days
after the due date. If you have an established routine for dealing with late
accounts, you can start the collection process as soon as you know there’s a
problem.
What Is a Beneficial Owner?
A
beneficial owner is a person who enjoys the benefits of ownership even though
the title to some form of property is in another name. It also means any
individual or group of individuals who, either directly or indirectly, has the
power to vote or influence the transaction decisions regarding a specific
security, such as shares in a company.
Beneficial
Owner Explained
For
example, when shares of a mutual fund are held by a custodian bank or when
securities are held by a broker in street name, the true owner is the
beneficial owner, even though, for safety and convenience, the bank or broker
holds the title. Beneficial ownership may be shared among a group of
individuals. If a beneficial owner controls a position of more than 5%, it must
file Schedule 13D under Section 12 of the Securities Exchange Act of 1934.
Beneficial
ownership is distinguished from legal ownership. In most cases, the legal and
beneficial owners are one and the same, but there are some cases, legitimate
and sometimes not-so legitimate, where the beneficial owner of a property may
wish to remain anonymous.
Funded & Non-Funded Loan: Definition, Uses etc.
What is
Funded Facility/Loan?
Funded
Facilities are the loan where the bank or other financial institution provides
real cash (not a commitment) to their client. Bank overdraft, Overnight lending
facility, Cash Finance, Running Finance, Financing against Defence saving
certificates or other marketable securities, Project Financing, etc are the
goods examples of the funded facility. In a Funded facility the banks, Non-Bank
financial institution or other institution who is provided finance to its
client, lend to its client with real cash, not commitment.
In a
Funded Facility, Fixed Charges and Floating Charges (security for the loan)
will be needed. After getting sufficient security from the client, the bank
will disburse the fund.
Some
example of funded facility are clarified in below:
1) Working
Capital Loan:
The
duration of a working capital loan would be less than 1 year. But where the
gestation period of a working capital loan is longer, the duration of loan
would be longer too.
2)
Overdraft Facility:
Revolving loan against current Accounts is
considered as Overdraft. This is the unsecured facility where the bank doesn’t
want any collateral from the client. In this facility allows a borrower to
overdraw funds beyond available up to an agreed limit. Interest is payable only
on the money used for the duration of withdrawal compounded daily.
3) Cash
Credit Facility (CC):
Cash
Credit Facility (CC) is provided by the bank against the inventory and
receivable balance of the client. The interest is usually linked to a benchmark
rate and decided periodically. This is a Secured loan.
4) Demand
Loan:
Demand
Loan is a short term revolving loan facility which is disbursed against the
working capital requirements of the company. The interest rate is determined
according to its current interest rate. A demand loan is a popular mode of
finance which is common in a large and medium company which have large working
capital requirements, unlike CC.
5) Trade
Finance:
This is
one kind of Working Capital Loan where the bank provides the loans to the
seller to bridge his funding requirements till he gets paid.
6) Pre –
Shipment Loans:
This is
also a working capital loan to purchase raw materials, for packaging of export
commodities. Most popular form of pre-shipment finance is packing credit where
the exporter gets a concessional interste rate.
7) Others:
Post
shipment finance, Bill discounting, Factoring etc. are also the goods example
of funded facility.
Non-Funded
Facility/Loan
Non –
Funded Facility means that fund which is not provided in real cash, rather
Banks committed to the third party to pay their amount if the client failed to
do so. Non-Funded Facilities are:
Bank
Guarantee:
Under
this, the bank agrees to discharge any liability to the third party in the
event of failure by the customer to discharge their liabilities. There can be
many types of guarantees like performance guarantee, deferred payment guarantee
and so on.
Letter of
Credit:
In this
respect, the bank committed to the beneficiary on behalf of its client that the
bank will make the payment if the client fails to do so.
In case of
default by the client, Bank has to repay the amount converting the non-funded
exposure to funded exposure (forced loan).
Relationship between Banker and Customer
The
relationship between banker and Customer are categorized into three;
Relationship
as debtor and creditor.
Banker as
a trustee.
Banker as
an agent.
Other
special relationship with the customer, obligations of a banker
Relationship
as Debtor and Creditor
On the
opening of an account, the banker assumes the position of a debtor. A depositor
remains a creditor of his banker so long as his account carries a credit
balance.
The
relationship with the customer is reserved as soon as the customer account is
overdrawn.
Banker
becomes a creditor of the customer who has taken a loan from the banker and
continues in that capacity fills the loan is repaid.
Banker as
a Trustee
Ordinally
a banker is a debtor of his customer in the report of the deposit made by the
letter but in certain circumstances, he acts as trustee also.
A trustee
hold holds money or asset and performs certain functions for the benefit of
some other person called the beneficiary.
For
example; If the customer deposits securities or other values with the banker
for the safe custody, the letter acts as a trustee of his customer.
Banker as
an Agent
A banker
acts as an agent of his customer and performs a number of agency functions for
the conveniences of his customer.
For
example, he buys or sells securities on behalf of his customer, collects
check/cheques on his behalf and makes payment of various dues of his customer.
Special
relationship with customer/obligation of a banker:
Through
the primary relationship between a banker and his customer is that of a debtor
and a creditor or vice versa, the special features of this relationship as a
note above impose the following additional obligations on the banker.
The
obligation to honor the Check/Cheques
The
deposit accepted by a banker is his liabilities repayable on demand or
otherwise. The banker is therefore under a statutory obligation to honor his
customer’s check/cheque in the usual course.
According
to section 31 of the negotiable instruments. Act 1881 the banker is bound to
honor his customer’s check/cheque provided by following conditions are
fulfilled:
Availability
of sufficient funds of the customer.
The
correctness of the check/cheque.
Proper
presentation of the check/cheque.
A
reasonable time for collection.
Proper
drawing of the check/cheque.
The
obligation to maintain the secrecy of the customer accounts
The banker
is an obligation to take the utmost care in keeping secrecy about the account
of his customer.
By keeping
secrecy is that the account books of the bank will not be thrown open to the
public or government, officials if the following reasonable situation does not
occur,
Discloser
of information required by law.
Discloser
permitted by bankers’ practice and wages. The practice and wages are customary
amongst bankers permit disclosure of certain information and the following
circumstances.
With
express or implied consent of the customer.
Banker
reference.
Duty to
the public to disclose.
Politically exposed person (PEP)
In
financial regulation, a politically exposed person (PEP) is one who has been
entrusted with a prominent public function. A PEP generally presents a higher
risk for potential involvement in bribery and corruption by virtue of their
position and the influence that they may hold. The terms politically exposed
person and senior foreign political figure are often used interchangeably,
particularly in international forums. Foreign official is a term for
individuals deemed as government persons under the Foreign Corrupt Practices
Act or FCPA, and although definitions are similar to PEP, there are quite a few
differences and should not be used interchangeably. The term PEP is typically
used referring to customers in the financial services industry, while 'foreign
official' refers to the risks of third party relationships in all industries.
False positive
In fraud
detection, a “false positive” occurs when something innocent is wrongly deemed
suspicious. Credit card holders encounter false positives most often occurs
when a cardholder accidentally trips the card issuer’s fraud detection system.
Card issuers have developed sophisticated, automated fraud detection systems
that work by detecting activities and patterns associated with fraud, but these
systems don’t work perfectly. False positives can cause a cardholder’s
transaction to be denied or an account locked down.
What Is Trust Receipt?
A trust
receipt is a notice of the release of merchandise to a buyer from a bank, with
the bank retaining the ownership title of 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.
KEY
TAKEAWAYS
A trust
receipt is a notice of the release of merchandise to a buyer from a bank, with
the bank retaining the ownership title of 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 trust
receipt serves as a promissory note to the bank that the loan amount will be
repaid upon sale of the goods.
How Trust
Receipts Work
A trust
receipt is a financial document attended to by a bank and a business that has
received delivery of goods but cannot pay for the purchase until after the
inventory is sold. In most cases, the company's cash flow and working capital
may be tied up in other projects and business operations.
In the
normal course of running a trade business, companies purchase goods for their
inventories from vendors or wholesalers to resell to consumers or to
manufacture goods. These goods may either be purchased locally or imported from
other companies. When these companies receive the merchandise, they are also
billed by the seller or exporter for the goods purchased. In the event that the
firm does not have the required cash on hand to settle the bill, it may obtain
financing from a bank via a trust receipt.
The trust
receipt serves as a promissory note to the bank that the loan amount will be
repaid upon sale of the goods. The bank pays the exporter on its end or issues
the seller (or seller’s bank) a letter of credit guaranteeing payment for the
merchandise. The lender, however, retains the title to the merchandise as
security. The customer or borrower is required to keep the goods separate from
its other inventory and, in effect, holds and sells the goods as a trustee for
the bank.
Although
the bank has a security interest in the goods under the standard terms of a
trust receipt, the customer takes possession of the goods and may do what he
wants with them as long as he does not violate the terms of his contract with
the bank. If he decides to terminate the bank’s security interest and tie to
the inventory, he may tender the amount advanced on the goods, giving him total
ownership of the goods.
Due diligence
Due
diligence is an investigation or audit of a
potential investment or product to confirm all facts, that might include the
review of financial records. Due diligence refers to the research done before
entering into an agreement or a financial transaction with another party.
Investors
perform due diligence before buying a security from a company. Due diligence
can also refer to the investigation a seller performs on a buyer that might
include whether the buyer has adequate resources to complete the purchase.
Enhanced due diligence (EDD)
Enhanced
due diligence (EDD) is a more comprehensive set of procedures for customers
with a higher risk profile, either through sources of origin or transactions
that exhibit irregular behaviour. The USA PATRIOT Act dictates that
institutions "shall establish appropriate, specific, and, where necessary,
enhanced, due diligence policies, procedures, and controls that are reasonably
designed to detect and report instances of money laundering through those
accounts."[11] US regulations require that EDD measures are applied to
account types such as private banking, correspondent account, and offshore
banking institutions. Because regulatory definitions are neither globally
consistent nor prescriptive, financial institutions are at risk of being held
to differing standards dependent upon their jurisdiction and regulatory
environment. An article published by Peter Warrack in the July 2006 edition of
ACAMS Today (Association of Certified Anti-Money Laundering Specialists)
suggests the following:
A
rigorous and robust process of investigation over and above (KYC) procedures,
that seeks with reasonable assurance to verify and validate the customer's
identity; understand and test the customer's profile, business and account
activity; identify relevant adverse information and risk; assess the potential
for money laundering and/or terrorist financing to support actionable decisions
to mitigate against financial, regulatory and reputational risk and ensure
regulatory compliance.
What Is a Suspicious Activity Report (SAR)?
A
Suspicious Activity Report (SAR) is a tool provided under the Bank Secrecy Act
(BSA) of 1970 for monitoring suspicious activities that would not ordinarily be
flagged under other reports (such as the currency transaction report). The SAR
became the standard form to report suspicious activity in 1996.
Suspicious
Activity Reports can cover almost any activity that is out of the ordinary. An
activity may be included in the Suspicious Activity Report if the activity
gives rise to a suspicion that the account holder is attempting to hide
something or make an illegal transaction.
Currency Transaction Report (CTR)
A currency
transaction report is a bank form used in the United States to help prevent money
laundering. The form must be filled out by a bank representative who has a
customer requesting to deposit or withdraw a currency transaction greater than
$10,000.
Breaking
Down Currency Transaction Report (CTR)
The Bank
Secrecy Act initiated the currency transaction report in 1970. However, not all
transactions greater than $10,000 need to reported with a CTR. Recent
legislation has identified certain groups known as "exempt persons."
The three
categories of "exempt persons" are:
1. Any
bank in the United States.
2.
Departments or agencies that fall under federal, state, or local governments,
including any organization that exercises government authority.
3. Any
corporation whose stock is traded on the NYSE, Nasdaq and American Stock
Exchange (excluding stocks listed on the Emerging Company Marketplace and under
the Nasdaq Small-Cap Issues heading).
KYC
KYC means
Know Your Customer. It is a part of our account opening form printed by our
Bank as per guidelines of Bangladesh Bank. It is compulsorily to be filled duly
signed by all the deposit & investment clients. This part of account
opening form contains the particulars, i.e. Name, Present address, Permanent
address, business/service address, source of income, nature of business,
Monthly/Yearly income, Telephone/Mobile no of
present/permanent/business/service addresses, relationship with the introducer,
expected amount & number of transaction in cash & other modes in a
month etc. Bankers could segregate the accounts riskwise through KYC as per
guidelines of Bangladesh Bank.
CTR
CTR means
Cash Transaction Report. It is a monthly statement form introduced by
Bangladesh Bank if Tk. Ten lac & above credited or debited by one or more
vouchers in an account in a day, to submit the same to them by the branches
through the Head Office of their Banks. This statement contains the date,
Account no, name of the account, number of debit/credit vouchers of the day,
amount credited/debited etc. This statement could generate by our computer.
Anti Money Laundering unit of branches should observe the CTR statements
whether any doubtful transactions are happened or not and they should put their
comments upon the statement.
STR
STR means Suspicious Transaction Report. As per
Bangladesh Bank Anti Money Laundering circular no.2 a quarterly statement
designed by Bangladesh Bank to detect Money Laundering crimes. Branches of all
Banks in Bangladesh prepare the statement at the end of the quarter which
contains the full particulars of suspicious transacted account detected at the
branch during the quarter. Head Office collect the statement from branches and
submit a consolidated statement to Bangladesh Bank with their comments duly
scrutinized/verified/inspected.
KYC - Know Your Customer (Banking) and KYE
KYE and
KYC are crucial processes for any organization as a part of their
candidate/employee onboarding process. However, it is important to know the
difference between each individual process.
Where KYE
is specifically centered towards gaining knowledge about the employee,
surrounding their capabilities, skill sets, expertise, and even their
shortcomings. Know Your Employee also includes, future career aspirations,
direction.
Whereas
KYC is a process of getting to know about a customer’s activities and nature
through a risk-based approach to due diligence practices. Which includes
getting to know about a customer’s source of income and customer profile that
it represents.
KYC is a
mandatory process that regulated institutions have to fulfill in order to be
compliant to globally mandated anti-money laundering regulations. In order to
vet customers, through identity proofing and subsequent identity verification.
Whereas KYE is more of an ‘In-organization development’ program.
A normal
flow would be an individual undergoing KYC first and then having KYE done, once
he or she is hired/employed at the respective institution. When an organization
sees the best fit.
RTGS
Real-time
gross settlement (RTGS) is the continuous process of settling payments on an
individual order basis without netting debits with credits across the books of
a central bank (e.g., bundling transactions). Once completed, real-time gross
settlement payments are final and irrevocable.
KEY
TAKEAWAYS
Real-time
gross settlement (RTGS) is the continuous process of settling interbank
payments on an individual order basis across the books of a central bank—as
opposed to netting debits with credits at the end of the day.
Real-time
gross settlement is generally employed for large-value interbank funds
transfers.
RTGS
systems are increasingly used by central banks worldwide and can help minimize the
risk to high-value payment settlements among financial institutions.
How
Real-Time Gross Settlement (RTGS) Works
Real-time
gross settlement is a system that is generally used for large-value interbank
funds transfers. These often require immediate and complete clearing and are
usually organized by a country’s central bank.
Real-time
gross settlement lessens settlement risk overall, as interbank settlement
usually occurs in real time throughout the day—instead of simply all together
at the end of the day. This eliminates the risk of a lag in completing the
transaction. (Settlement risk is often called delivery risk.) RTGS can often
incur a higher charge than processes that bundle and net payments.
National Payment Switch Bangladesh (NPSB)
National Payment
Switch Bangladesh (NPSB) is an electronic platform, started its operation on 27
December 2012 with a view to attain interoperability among schedule banks for
card based/online retail transactions. At present, NPSB is processing interbank
Automated Teller Machines (ATM), Point of Sales (POS), Internet Banking Fund
Transfer (IBFT) transactions.
Automated Teller Machines (ATM):
There are
53 Banks operating card business in the country. Among 53 banks 51 banks are
interoperable for ATM transactions through NPSB. That is, a cardholder of any
bank from these 51 NPSB member banks can use ATM of all other banks throughout
the country. Cardholders are getting banking services like cash withdrawal,
mini statement and balance inquiry for 24/7 from almost all ATMs in the
country. As a result, Long queues at cash counter of banks are decreasing.
Moreover, banks yet to install ATM and POS can issue cards to their clients. A
cardholder has to pay 15 taka per transaction (including VAT) for Cash
Withdrawal and 5 taka (including VAT) for each Mini Statement or Balance
Inquiry using other Bank's ATM.
Point of Sales (POS):
48 banks
are presently interoperable for POS transactions through NPSB. Cardholders from
those banks can use POS of all NPSB member banks in different merchant outlets
for their retail purchases. The necessity for holding cash is reducing very
fast due to large acceptance of cards at POS of NPSB member banks. Cardholders
need not to pay any extra charges for their retail purchases using other bank's
POS under NPSB.
Internet Banking Fund Transfer (IBFT):
NPSB is
also processing Internet Banking Fund Transfer (IBFT) transactions of 6 banks.
An account/card holder of an IBFT member banks can transfer funds (account to
account/card and card to card/account) to other Banks through internet banking.
The daily transaction for a customer will be five times and a total of Tk
2,00,000(two lac). Each transaction will be maximum Tk. 50,000 (fifty
thousand). Banks will ensure two factor authentications for internet banking to
maintain security. Banks can provide services like utility bill payment, credit
card bill payment, installments payment of loan, insurance premium payment etc.
to their customers through internet banking from home or office.
The
Central Bank is ensuring continuous effort to tighten the security of NPSB
adapting International Standards and Best Practices of card based payment. A
safe, secure and efficient retail payment system always involves active
participation from all stakeholders (Banks, customers, government). Therefore,
the Central Bank is in the pledge to step forward with altogether.
Payment
systems in BB
(a)
Bangladesh Automated Cheque Processing Systems (BACPS)
Since
inception in October, 2010 BACPS is the only state-of-the art cheque clearing
facility. It uses the Cheque Imaging and Truncation (CIT) technology for
electronic presentment and payment of paper-based instruments (i.e. cheque, pay
order, dividend & refund warrants, etc). BACPS operates in a batch
processing mode. Transactions received from the banks during the day are
processed and settled at a pre-fixed time. Under BACPS umbrella High Value (HV)
Cheque Clearing (Cheque amounting Tk. 5,00,000 or above) and Regular Value (RV)
Cheque clearing are operated. At present HV presentment cutoff time is at 12:00
and the return cutoff is at 15:00 while for RV clearing presentment cut off
time is at 12:30 and return cut off is at 17:00.
BACPS
Operating Rules and Procedures
Draft of
Bangladesh Automated Cheque Processing System (BACPS), Operating Rules and
Procedures.
Transaction
Trend
(b)
Bangladesh Electronic Funds Transfer Network (BEFTN)
Incepted
in February 2011, BEFTN was country's first paperless electronic inter-bank
funds transfer system. It facilitates both credit and debit transactions, as a
lead over cheque clearing system. This network can handle credit transfers such
as payroll, foreign and domestic remittances, social security payments, company
dividends, bill payments, corporate payments, government tax payments, social security
payments and person to person payments. At the same way it accommodates debit
transactions like utility bill payments, insurance premium payments,
Club/Association payments, EMI payment etc. Most of Govt. salary, social
benefits, all social safety net payments and other government payments are
processed through BEFTN.
(c)
National Payment Switch Bangladesh (NPSB)
Operational
since 2012, NPSB is meant for establishing interoperability among participating
banks for their account and card based transactions. Currently, it caters
interbank Automated Teller Machines (ATM), Point of Sales (POS) and Internet
Banking Fund Transfer (IBFT) transactions while the Mobile Financial Services
interoperability is under active consideration. 51 Banks are now interconnected
through NPSB for their ATM transactions. Currently, three types of interbank
ATM transaction (i.e. cash withdrawal, balance enquiry and mini statement)
could be done through NPSB. As of October 2018, 50 banks are interoperable for
POS transactions and 19 banks are interconnected for their IBFT transactions.
There is transaction limit for IBFT. The maximum value of each transaction is
50,000 and the frequency is maximum 5 times a day and not more than 2,00,000
taka per day. It is mandatory for the participating banks to ensure Two Factor
Authentications (2FA) for any online/e-commerce/interbanking/card not present
transactions.
(d) Real
Time Gross Settlement System (RTGS)
To
facilitate real time settlement of high value time critical payments BB introduced
Bangladesh Real Time Gross Settlement (BD-RTGS) system during October 2015. It
opened a new dimension for the banks and for the corporate to settle their
payments instantly, at the same time individual customers are also availing
this service for settling their large value transactions. Out of 11,000
scheduled bank branches 7,000 are connected till June 2018 with BD-RTGS system
and the number is increasing gradually.
REGULATION,
POLICY AND LICENSING
a) Legal
and Regulatory Function
Proper
legal and regulatory framework is important to ensure smooth functioning of the
payment and settlement system. The legal basis for Bangladesh bank to promote a
safe secure payment system is lies in the Bangladesh Bank Order 1972.
Side-by-side Payment Systems Department issues regulation and publishes systems
rules, which among other defines roles and responsibilities of the participants
of specific payment systems. Bangladesh Bank has also initiated process to
enact a National Payment Systems Act.
Mobile Financial Services (MFS)
Bangladesh
Bank has introduced efficient off-branch Mobile Financial Services (MFS) during
2011 in Bangladesh as the country acquired an omnipresent mobile phone network
experienced, large number of mobile phone users and improved IT infrastructure.
Within seven years, this exponentially growing Bank-Led model of MFS has become
the largest MFS market in the world.
Bangladesh
Bank permits Cash in, Cash out, Person to Person (P2P), Person to Business
(P2B), Business to Person (B2P), Person to Government (P2G) and Government to
Person (G2P) payment services through MFS domestically. No cross border money
transfer is allowed under this service. However, local disbursement of inward
foreign remittance comes through banking channel is permitted. Any adult can
open MFS account with any provider at an agent point or bank branch with a
photo and legal identification. Having more than one MFS account by one person
with the same provider is not permitted.
Payment Service Provider (PSP) and Payment System
Operator (PSO)
According
to "Bangladesh Payment and Settlement Systems Regulation-2014
(BPSSR-2014)" Payment Systems Department (PSD) issues license in two broad
criteria- Payment Service Provider (PSP) and Payment System Operator (PSO).
It gives PSP
license to the company who facilitates payment(s) or payment processes directly
to the customers and settling their transactions through a scheduled bank or
financial institution; for example E-wallet, Mobile Wallet etc. Besides, PSD
gives PSO license to the company who operates a settlement system for payment
activities between/among participants of which the principal participant must
be a scheduled bank or financial institution; such as payment gateway, payment
aggregator etc. PSD reviews the market demand, business rational, regulatory
requirements, risk management systems, settlement systems, eligibility criteria
and others according to BPSSR-2014 for considering the application of license
of PSP or PSO.
List of
Authorized PSP and PSO:
8. IT Consultants Ltd (PSO)
9. SSL Commerz Ltd (PSO)
10. ShurjoMukhi Ltd (PSO)
11. iPay Systems Ltd (PSP)
12. D Money Bangladesh Ltd (PSP)
BFIU
Overview
of Bangladesh Financial Intelligence Unit
Bangladesh Financial Intelligence Unit
(BFIU) is the central agency of Bangladesh responsible for analyzing Suspicious
Transaction Reports (STRs), Cash Transaction Reports (CTRs) & information
related to money laundering (ML) /financing of terrorism (TF) received from
reporting agencies & other sources and disseminating information/intelligence
thereon to relevant law enforcement agencies. BFIU has been entrusted with the
responsibility of exchanging information related to money laundering and
terrorist financing with its foreign counterparts. The main objective of the
BFIU is to establish an effective system for prevention of money laundering,
combating financing of terrorism and proliferation of weapons of mass
destruction.
BFIU was established in June 2002, in
Bangladesh Bank (Central bank of Bangladesh) named as 'Anti Money Laundering Department'.
To enforce and ensure the operational independence of FIU, Anti Money
Laundering Department has been transformed as the Bangladesh Financial
Intelligence Unit (BFIU) in 25 January, 2012 under the provision of Money
Laundering Prevention Act, 2012 and has been bestowed with operational
independence. BFIU has also achieved the membership of Egmont Group in July,
2013. Legal Framework: BFIU works under the provisions of Money Laundering
Prevention Act, 2012 and Anti-Terrorism Act, 2009 (including amendments in
2013).
Mission
Putting in
place effective legal, administrative and judicial arrangements for prevention
of money laundering, terrorist & proliferation financing and other related
offences; through-
Continual
upgrading of AML/CFT legal and regulatory frameworks in line with the needs of
evolving circumstances;
Maintaining
broad based awareness of AML/CFT issues amongst regulators, law enforcers,
reporting entities and the general people through workshops, seminars, public
campaigns and so forth;
Developing
human resources and required infrastructures of BFIU for effective intelligence
management;
Building
and strengthening of detecting and reporting capacities in the reporting
entities in different sectors for ensuring better compliance;
Deepening
liaisons between BFIU, law enforcement and judiciary authorities for expediting
investigation, trial and adjudication of ML/TF offences; and
Strengthening
contact and liaison with foreign FIUs for better information exchange in ML/TF
offences; with regional and global bodies for sharing relevant experiences and
upgrading AML/CFT best practices and standards.
What Is Electronic Commerce (e-commerce)?
Electronic
commerce or e-commerce (sometimes written as eCommerce) is a business model
that lets firms and individuals buy and sell things over the internet.
E-commerce operates in all four of the following major market segments:
Business
to business
Business
to consumer
Consumer
to consumer
Consumer
to business
E-commerce,
which can be conducted over computers, tablets, or smartphones may be thought
of like a digital version of mail-order catalog shopping. Nearly every
imaginable product and service is available through e-commerce transactions,
including books, music, plane tickets, and financial services such as stock
investing and online banking. As such, it is considered a very disruptive
technology.
KEY
TAKEAWAYS
E-commerce
is the buying and selling of goods and services over the internet.
E-commerce
can be a substitute for brick-and-mortar stores, though some businesses choose
to maintain both.
Almost
anything can be purchased through e-commerce today.
[E-commerce lets firms and individuals conduct
business over the Internet.]
Electronic
Commerce
Understanding
Electronic Commerce (e-commerce)
E-commerce
has helped businesses establish a wider market presence by providing cheaper
and more efficient distribution channels for their products or services. For
example, the mass retailer Target has supplemented its brick-and-mortar
presence with an online store that lets customers purchase everything from
clothes to coffeemakers to toothpaste to action figures.
By
contrast, Amazon launched its business with an e-commerce-based model of online
sales and product delivery. Not to be outdone, individual sellers have
increasingly engaged in e-commerce transactions via their own personal
websites. Finally, digital marketplaces such as eBay or Etsy serve as exchanges
where multitudes of buyers and sellers come together to conduct business.
The
Advantages and Disadvantages of Electronic Commerce
E-commerce
offers consumers the following advantages:
Convenience.
E-commerce can occur 24 hours a day, seven days a week.
Increased
selection. Many stores offer a wider array of products online than they carry
in their brick-and-mortar counterparts. And many stores that solely exist
online may offer consumers exclusive inventory that is unavailable elsewhere.
E-commerce
carries the following disadvantages:
Limited
customer service. If you are shopping online for a computer, you cannot simply
ask an employee to demonstrate a particular model's features in person. And
although some websites let you chat online with a staff member, this is not a
typical practice.
Lack of
instant gratification. When you buy an item online, you must wait for it to be
shipped to your home or office. However, retailers like Amazon make the waiting
game a little bit less painful by offering same-day delivery as a premium
option for select products.
Inability
to touch products. Online images do not necessarily convey the whole story
about an item, and so e-commerce purchases can be unsatisfying when the
products received do not match consumer expectations. Case in point: an item of
clothing may be made from shoddier fabric than its online image indicates.
What Is Return on Equity – ROE?
Return on
equity (ROE) is a measure of financial performance calculated by dividing net
income by shareholders' equity. Because shareholders' equity is equal to a
company’s assets minus its debt, ROE could be thought of as the return on net
assets.
ROE is
considered a measure of how effectively management is using a company’s assets
to create profits.
Formula
and Calculation for ROE
ROE is
expressed as a percentage and can be calculated for any company if net income
and equity are both positive numbers. Net income is calculated before dividends
paid to common shareholders and after dividends to preferred shareholders and
interest to lenders.
Return on
Equity= Net Income/Average Shareholders’ Equity
Net Income
is the amount of income, net of expense, and taxes that a company generates for
a given period. Average Shareholders' Equity is calculated by adding equity at
the beginning of the period. The beginning and end of the period should
coincide with that which the net income is earned.
Net income
over the last full fiscal year, or trailing 12 months, is found on the income
statement—a sum of financial activity over that period. Shareholders' equity
comes from the balance sheet—a running balance of a company’s entire history of
changes in assets and liabilities.
It is
considered the best practice to calculate ROE based on average equity over the
period because of this mismatch between the two financial statements. Learn
more about how to calculate ROE.
What Is Return on Assets—ROA?
Return on
assets (ROA) is an indicator of how profitable a company is relative to its
total assets. ROA gives a manager, investor, or analyst an idea as to how
efficient a company's management is at using its assets to generate earnings. Return
on assets is displayed as a percentage.
KEY
TAKEAWAYS
Return on
Assets (ROA) is an indicator of how well a company utilizes its assets, by
determining how profitable a company is relative to its total assets.
ROA is
best used when comparing similar companies or comparing a company to its
previous performance.
ROA takes
into account a company’s debt, unlike other metrics, such as Return on Equity
(ROE).
The Basics
of Return on Assets—ROA
Businesses
(at least the ones that survive) are ultimately about efficiency: squeezing the
most out of limited resources. Comparing profits to revenue is a useful
operational metric, but comparing them to the resources a company used to earn
them cuts to the very feasibility of that company's’ existence. Return on assets
(ROA) is the simplest of such corporate bang-for-the-buck measures.
ROA is
calculated by dividing a company’s net income by total assets. As a formula, it
would be expressed as:
Higher ROA
indicates more asset efficiency.
For
example, pretend Spartan Sam and Fancy Fran both start hot dog stands. Sam
spends $1,500 on a bare-bones metal cart, while Fran spends $15,000 on a zombie
apocalypse-themed unit, complete with costume. Let's assume that those were the
only assets each deployed. If over some given time period Sam had earned $150
and Fran had earned $1,200, Fran would have the more valuable business but Sam
would have the more efficient one. Using the above formula, we see Sam’s
simplified ROA is $150/$1,500 = 10%, while Fran’s simplified ROA is $1,200/$15,000
= 8%.
Return On
Assets (ROA)
The
Significance of Return on Assets—ROA
Return on
assets (ROA), in basic terms, tells you what earnings were generated from
invested capital (assets). ROA for public companies can vary substantially and
will be highly dependent on the industry. This is why when using ROA as a
comparative measure, it is best to compare it against a company's previous ROA
numbers or against a similar company's ROA.
The ROA
figure gives investors an idea of how effective the company is in converting
the money it invests into net income. The higher the ROA number, the better,
because the company is earning more money on less investment.
Remember
total assets is also the sum of its total liabilities and shareholder's equity.
Both of these types of financing are used to fund the operations of the
company. Since a company's assets are either funded by debt or equity, some
analysts and investors disregard the cost of acquiring the asset by adding back
interest expense in the formula for ROA.
In other
words, the impact of taking more debt is negated by adding back the cost of
borrowing to the net income and using the average assets in a given period as
the denominator. Interest expense is added because the net income amount on the
income statement excludes interest expense.
The return on revenue (ROR)
The return
on revenue (ROR) is a measure of profitability that compares net income of a
company to its revenue. This is a financial tool used to measure the
profitability performance of a company. Also called net profit margin.
The return
on revenue (ROR) is tool for measuring the profitability performance of a
company from year to year. This ratio compares the net income and the revenue.
The only difference between net income and revenue is the expenses. An increase
in ROR is means that the company is generating higher net income with lesser
expenses.
This ratio
can help the management in controlling the expenses. It can give indications of
rising expenses. If a decrease in return on revenue is observed, the management
should know that the expenses are not being managed as efficiently as in the
past. The management should find out why the expenses are rising and then take
steps to reduce them. An increase in the ROR is an indication that the expenses
of the company are being facilitated efficiently. These insights can help to
see a clearer picture of the expenses and it can help to control expenses.
Calculation
(formula): The return on revenue (ROR) is calculated by dividing the net income
by the revenue. This can be expressed in the following formula.
Return on
Revenue (ROR) = Net Income / Revenue
Both of
these figures can be found in the income statement. Net income is also
sometimes referred to as profit after tax.
What Is Value at Risk (VaR)?
Value at
risk (VaR) is a statistic that measures and quantifies the level of financial
risk within a firm, portfolio or position over a specific time frame. This
metric is most commonly used by investment and commercial banks to determine
the extent and occurrence ratio of potential losses in their institutional
portfolios.
Risk
managers use VaR to measure and control the level of risk exposure. One can
apply VaR calculations to specific positions or whole portfolios or to measure
firm-wide risk exposure.
VaR
modeling determines the potential for loss in the entity being assessed and the
probability of occurrence for the defined loss. One measures VaR by assessing
the amount of potential loss, the probability of occurrence for the amount of
loss, and the timeframe.
For
example, a financial firm may determine an asset has a 3% one-month VaR of 2%,
representing a 3% chance of the asset declining in value by 2% during the
one-month time frame. The conversion of the 3% chance of occurrence to a daily
ratio places the odds of a 2% loss at one day per month.
Investment
banks commonly apply VaR modeling to firm-wide risk due to the potential for
independent trading desks to unintentionally expose the firm to highly
correlated assets.
Using a
firm-wide VaR assessment allows for the determination of the cumulative risks
from aggregated positions held by different trading desks and departments
within the institution. Using the data provided by VaR modeling, financial
institutions can determine whether they have sufficient capital reserves in
place to cover losses or whether higher-than-acceptable risks require them to
reduce concentrated holdings.
What is Capital Adequacy Ratio – CAR?
The
capital adequacy ratio (CAR) is a measurement of a bank's available capital
expressed as a percentage of a bank's risk-weighted credit exposures. The
capital adequacy ratio, also known as capital-to-risk weighted assets ratio
(CRAR), is used to protect depositors and promote the stability and efficiency
of financial systems around the world. Two types of capital are measured: tier-1 capital, which can absorb losses without a
bank being required to cease trading, and tier-2 capital, which can absorb losses in the event
of a winding-up and so provides a lesser degree of protection to depositors.
Calculating CAR
The
capital adequacy ratio is calculated by dividing a bank's capital by its risk-weighted
assets. The capital used to calculate the capital adequacy ratio is divided
into two tiers.
CAR = Tier 1 Capital = Tier 2
Capital / (Risk Weighted Assets)
What Is Earnings Per Share?
Earnings
per share (EPS) is the portion of a company’s profit that is allocated to each
outstanding share of common stock, serving as an indicator of the company’s
financial health. In other words, earnings per share is the portion of a
company's net income that would be earned per share if all the profits were paid
out to its shareholders. EPS is used typically by analysts and traders to
establish the financial strength of a company, and is often considered to be
one of the most important variables in determining a stock’s value. In fact, it
is sometimes known as "the bottom line" – the final statement, both
literally and figuratively, of a firm's worth.
What Is a Cryptocurrency?
A
cryptocurrency is a digital or virtual currency that is secured by
cryptography, which makes it nearly impossible to counterfeit or double-spend.
Many cryptocurrencies are decentralized networks based on blockchain
technology—a distributed ledger enforced by a disparate network of computers. A
defining feature of cryptocurrencies is that they are generally not issued by
any central authority, rendering them theoretically immune to government
interference or manipulation.
KEY
TAKEAWAYS
A
cryptocurrency is a new form of digital asset based on a network that is
distributed across a large number of computers. This decentralized structure
allows them to exist outside the control of governments and central
authorities.
The word
“cryptocurrency” is derived from the encryption techniques which are used to
secure the network.
Blockchains,
which are organizational methods for ensuring the integrity of transactional
data, is an essential component of many cryptocurrencies.
Many
experts believe that blockchain and related technology will disrupt many
industries, including finance and law.
Cryptocurrencies
face criticism for a number of reasons, including their use for illegal
activities, exchange rate volatility, and vulnerabilities of the infrastructure
underlying them. However, they also have been praised for their portability,
divisibility, inflation resistance, and transparency.
How
Cryptocurrency Works
Cryptocurrencies
are systems that allow for the secure payments online which are denominated in
terms of virtual "tokens," which are represented by ledger entries
internal to the system. "Crypto" refers to the various encryption
algorithms and cryptographic techniques that safeguard these entries, such as
elliptical curve encryption, public-private key pairs, and hashing functions.
Types of
Cryptocurrency
The first
blockchain-based cryptocurrency was Bitcoin, which still remains the most
popular and most valuable. Today, there are thousands of alternate
cryptocurrencies with various functions and specifications. Some of these are
clones or forks of Bitcoin, while others are new currencies that were built
from scratch.
Bitcoin
was launched in 2009 by an individual or group known by the pseudonym
"Satoshi Nakamoto.” As of Nov. 2019, there were over 18 million bitcoins
in circulation with a total market value of around $165 billion.
Some of
the competing cryptocurrencies spawned by Bitcoin’s success, known as
"altcoins," include Litecoin, Peercoin, and Namecoin, as well as
Ethereum, Cardano, and EOS. Today, the aggregate value of all the
cryptocurrencies in existence is around $245 billion—Bitcoin currently
represents more than 65% of the total value.
Magnetic Ink Character Recognition (MICR) Line?
Magnetic
ink character recognition (MICR) is the line of numbers that appears at the
bottom of a check. The MICR line is a group of three numbers, which are the
check number, account number, and bank routing number. The MICR number includes
the magnetic ink character recognition line that’s printed using technology
that allows certain computers to read and process the printed information.
KEY
TAKEAWAYS
Magnetic
ink character recognition is the line on the bottom of a personal check that
includes the account, routing, and check numbers.
MICR
numbers are readable by individuals and computers, where its special font helps
limit check fraud.
MICR
benefits include quickly facilitating routing information and making it
difficult to alter checks.
How the
Magnetic Ink Character Recognition (MICR) Line Works:
The MICR
number is used mainly by the banking industry. A benefit of MICR over other
computer-readable information such as bar codes is that humans are able to read
MICR numbers. The two MICR fonts that are used worldwide are E-13B and CMC-7.
These unique fonts are used to help computers recognize the characters and
limit check fraud.
The MICR
number allows computers to rapidly internalize a check number, routing number,
account number, and other numbers or information from printed documents, such
as a personal check. The MICR number, which is sometimes confused with just the
account number, is printed with magnetic ink or toner on a check, usually in
one of two major MICR fonts. The magnetic ink allows the computer to read the
characters on a check even if they have been covered with signatures,
cancellation marks, or other marks.
Trade-Based Money Laundering (TBML)
According
to the International Narcotics Control Strategy Report (INCSR) hundreds of
billions of dollars are laundered annually by way of Trade-Based Money
Laundering (TBML). It is one of the most sophisticated methods of cleaning
dirty money, and trade-based money laundering red flags are among the hardest
to detect.
By
definition, TBML is the process by which criminals use a legitimate trade to
disguise their criminal proceeds from their unscrupulous sources. The crime
involves a number of schemes in order to complicate the documentation of
legitimate trade transactions; such actions may include moving illicit goods,
falsifying documents, misrepresenting financial transactions, and under- or
over-invoicing the value of goods.
The burden
falls on compliance officers to stay current on emerging schemes and updated
AML technology to detect and prevent criminal activity.
ACAMS is
committed to providing the tools and resources for professionals in the field
to stay on top of current trends and schemes. Bookmark this page for updated
information on best practices, relevant “red flags,” industry guidance, and
recent articles and resources covering all angles of TBML.
Trade-Based
Money Laundering Examples and Red Flags
There are
several red flags indicating potential TBML, according to the U.S. Immigration
and Customs Enforcement (ICE):
1. Payments to a vendor by unrelated
third parties
2. False reporting, such as commodity
misclassification, commodity over- or under-valuation
3. Repeated importation and exportation
of the same high-value commodity, known as carousel transactions
4. Commodities being traded that do not
match the business involved
5. Unusual shipping routes or
transshipment points
6. Packaging inconsistent with the
commodity or shipping method
7. Double-invoicing
What Is Basel II?
Basel II
is a set of international banking regulations put forth by the Basel Committee
on Bank Supervision, which leveled the international regulation field with
uniform rules and guidelines. Basel II expanded rules for minimum capital
requirements established under Basel I, the first international regulatory
accord, and provided the framework for regulatory review, as well as set
disclosure requirements for assessment of capital adequacy of banks. The main
difference between Basel II and Basel I is that Basel II incorporates credit
risk of assets held by financial institutions to determine regulatory capital
ratios.
Basel II
is a second international banking regulatory accord that is based on three main
pillars: minimal capital requirements, regulatory supervision, and market
discipline. Minimal capital requirements play the most important role in Basel
II and obligate banks to maintain minimum capital ratios of regulatory capital
over risk-weighted assets. Because banking regulations significantly varied
among countries before the introduction of Basel accords, a unified framework
of Basel I and, subsequently, Basel II helped countries alleviate anxiety over
regulatory competitiveness and drastically different national capital
requirements for banks.
What Is Basel III?
Basel III
is an international regulatory accord that introduced a set of reforms designed
to improve the regulation, supervision and risk management within the banking
sector. The Basel Committee on Banking Supervision published the first version
of Basel III in late 2009, giving banks approximately three years to satisfy
all requirements. Largely in response to the credit crisis, banks are required
to maintain proper leverage ratios and meet certain minimum capital
requirements.
Basel III
is part of the continuous effort to enhance the banking regulatory framework.
It builds on the Basel I and Basel II documents, and seeks to improve the
banking sector's ability to deal with financial stress, improve risk
management, and strengthen the banks' transparency. A focus of Basel III is to
foster greater resilience at the individual bank level in order to reduce the risk
of system-wide shocks.
·
Basel
III is an international regulatory accord that introduced a set of reforms
designed to improve the regulation, supervision and risk management within the
banking sector.
·
Basel
III is part of the continuous effort to enhance the banking regulatory
framework.
·
Basel
III was published in 2009, largely in response to the credit crisis associated
with the Great Recession.
more important topics:
Legacy Account
Mutual Evaluation
Credit Deposit Ratio
Different types of Account
Credit Documentation
Recover Classified Loans
Self-Assessment Report
Fake Account
Project Appraisal and its technical aspect
AD Ratio for Islamic Banks
Face value of lending risky?
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