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The 1ederal Qlectronic Fund Trans1er Ict 7QFT Ict8 co/ers +ost 7not all8 electronic custo+er
transactions* The Ict does not co/er 3stored /alue5 cards like prepaid telephone cards, +ass
transit passes, and so+e gi1t cards* These Sstored&/alueS cards, as )ell as transactions using
the+, +ay not =e co/ered =y the QFT Ict*
ELECT(O&C F)D T(A!FE(!
QFT o11ers the 1ollo)ing ser/ices to the custo+ers#
Auto*ated Te,,er $a;@ines 1AT$s3
IT-s are electronic ter+inals that let custo+ers =ank al+ost any ti+e* The custo+er generally
inserts an IT- card and enters hisFher ",N to )ithdra) cash, +ake deposits, or trans1er 1unds
=et)een accounts, So+e 1inancial institutions and IT- o)ners charge a 1ee, particularly to
custo+ers )ho donRt ha/e accounts )ith the+ or on transactions at re+ote locations*
Dire;t De+osit
Custo+ers can authorize speci1ic deposits, such as paychecks and Social Security checks, to
their account on a regular =asis*
Dire;t De=its.E,e;troni; Bi,,s "resent*ent
Custo+ers can pre&authorize direct )ithdra)als 7QCS under ,ndian conte4t8 so that recurring
=ills, such as insurance pre+iu+s, +ortgages, and utility =ills, are paid auto+atically*
"a:-=:-"@one !:ste*s
They let custo+ers call their 1inancial institution )ith instructions to pay certain =ills or to trans1er
1unds =et)een accounts* For such transactions, custo+ers need to ha/e an e4plicit agree+ent
)ith their =anks*
"ersona, Co*+uter Banking
Custo+ers do +any =anking transactions through their personal co+puter* For e4a+ple,
custo+ers can /ie) their account =alance, re<uest trans1ers =et)een accounts, and pay =ills
electronically*
7
E/;er+ted 8ro* Federa, Trade Co**ission Ae=site @tt+:..AAA.8t;.go<
Business & ,T -odel . Cards /%*00% "age 20 o1 $00
Foundation Course in Banking
"oint-o8-!a,e Trans8ers
Custo+ers can pay 1or their purchases )ith a de=it card, )hich also +ay also dou=le up as the
IT- card* :e=it card purchase trans1ers +oney & 1airly <uickly & 1ro+ the custo+er;s =ank
account to the storeRs account* So the custo+er should ha/e the re<uired 1unds in hisFher account
=e1ore the use o1 de=it card*
E,e;troni; C@e;k Con<ersion
QCC con/erts a paper check into an electronic pay+ent at the point o1 sale or else)here* ,n a
store, the custo+er can present a check to a store cashier* The check can =e processed through
an electronic syste+ that captures the =anking in1or+ation and the a+ount o1 the check* Gnce
the check is processed, the custo+er signs a receipt authorizing the store to present the check to
the =ank electronically and deposit the 1unds into the store;s account* The custo+er gets a
receipt o1 the electronic transaction and the check is returned to the custo+er* ,t should =e /oided
or +arked =y the +erchant so that it canRt =e used again*
EFT (E')LAT&O!
Dis;,osures
The docu+ents 7usually 1ine print8 supplied =y the issuer o1 the 3access de/ice5 co/er the legal
rights and responsi=ilities regarding an QFT account* Be1ore using QFT ser/ices, the institution
+ust tell the custo+er the 1ollo)ing in1or+ation#
I su++ary o1 custo+er;s lia=ility 1or unauthorized trans1ers*
The telephone nu+=er and address o1 the person to =e noti1ied in
the e/ent o1 an unauthorized trans1er, a list o1 the institutionRs
S=usiness daysS, and the nu+=er o1 days to report suspected
unauthorized trans1ers*
The type o1 trans1ers, 1ees 1or trans1ers, and any li+its on the
1re<uency and dollar a+ount o1 trans1ers*
I su++ary o1 right to recei/e docu+entation o1 trans1ers, to stop
pay+ent on a pre&authorized trans1er, and the procedures to 1ollo)
to stop pay+ent*
"rocedures to report an error on a receipt 1or an QFT or periodic
state+ent and to re<uest +ore in1or+ation a=out a trans1er listed on
the state+ent, and the nu+=er o1 days to report*
I su++ary o1 the institutionRs lia=ility i1 it 1ails to +ake or stop certain
transactions*
Circu+stances under )hich the institution )ill disclose in1or+ation to
third parties concerning custo+er;s account*
Charges 1or using IT-s )here the custo+er does not ha/e an
account*
(e;ei+ts and !tate*ents
The custo+ers are entitled 1or ter+inal receipts and periodic state+ents* Custo+ers are entitled
to a ter+inal receipt )hen they initiate an electronic trans1er, )hether it is an IT- or a point&o1&
sale electronic trans1er* The receipt +ust sho) the a+ount and date o1 the trans1er, and its type,
such as S1ro+ sa/ings to checking*S
Business & ,T -odel . Cards /%*00% "age 50 o1 $00
Foundation Course in Banking
No ter+inal receipts )ould =e issued 1or regularly occurring electronic pay+ents that are pre&
authorized, like insurance pre+iu+s, +ortgages, or utility =ills* ,nstead, these trans1ers )ill
appear on your periodic state+ent*
Custo+ers are also entitled to a periodic state+ent 1or each state+ent cycle in )hich an
electronic trans1er is +ade* The state+ent +ust sho) the a+ount o1 any trans1er, the date o1
credit or de=it to their account, the type o1 trans1er and type o1 account7s8 to or 1ro+ )hich 1unds
)ere trans1erred, and the address and telephone nu+=er 1or in<uiries*
Errors
Custo+ers ha/e !0 days 1ro+ the date a state+ent is recei/ed to noti1y errors to the =ank* The
=est )ay is to noti1y the 1inancial institution =y )ay o1 a certi1ied letter, return receipt re<uested*
9nder 9S 1ederal la), the institution has no o=ligation to conduct an in/estigation i1 the custo+er
+issed out the !0&day deadline*
The 1inancial institution has %0 =usiness days to in/estigate the error* The institution has to
co++unicate the results o1 its in/estigation )ithin three =usiness days a1ter co+pletion and +ust
correct the error )ithin one =usiness day a1ter detecting the error* ,1 the institution needs +ore
ti+e, it +ay take up to 25 days to co+plete the in/estigation & =ut only i1 the +oney in dispute is
returned to the custo+er;s account )ith due noti1ication o1 the credit* It the end o1 the
in/estigation, i1 no error has =een 1ound, the institution +ay take the +oney =ack a1ter sending a
)ritten e4planation*
Lost or !to,en AT$ or De=it Cards
9nlike a credit card, i1 so+eone loses the IT- or de=it card, custo+er can lose +uch +ore* ,1
the custo+er reports the loss o1 an IT- or de=it card to the card issuer =e1ore itRs used )ithout
hisFher per+ission, heFshe canRt =e held responsi=le 1or any unauthorized )ithdra)als*
,1 unauthorized use occurs =e1ore reporting, the lia=ility o1 the custo+er /aries depending on the
delay in reporting the loss to the card issuer*
Within t)o =usiness days . Via=ility li+ited to B50 1or unauthorized
use*
Bet)een $ & !0 days . Via=ility li+ited to B500 =ecause o1 an
unauthorized trans1er*
,1 the loss is not reported )ithin !0 days, the lia=ility has no li+its*
,1 the custo+er 1ailed to noti1y the institution )ithin the ti+e periods allo)ed =ecause o1
e4tenuating circu+stances, such as lengthy tra/el or illness, the issuer +ust reasona=ly e4tend
the noti1ication period* ,n addition, i1 state la) or the indi/idual contract i+poses lo)er lia=ility
li+its, those lo)er li+its apply instead o1 the QFT act li+its*
Li*ited !to+-"a:*ent "ri<i,eges
The QFT Ict does not gi/e the right to the custo+er to stop pay+ent* ,1 a purchase is de1ecti/e or
an order is not deli/ered, itRs up to the custo+er to resol/e the pro=le+ )ith the seller*
The custo+er can stop pay+ent only 1or regular pay+ents out o1 hisFher account to third parties,
such as insurance co+panies* The institution has to =e noti1ied at least three =usiness days
=e1ore the scheduled trans1er*
Ilthough 1ederal la) pro/ides only li+ited rights to stop pay+ent, indi/idual 1inancial institutions
+ay o11er +ore rights or state la)s +ay re<uire the+*
Business & ,T -odel . Cards /%*00% "age 5% o1 $00
Foundation Course in Banking
ELECT(O&C B&LL&' "(E!ETAT&O AD "A%$ET
&ntrodu;tion
Qlectronic Billing "resentation and "ay+ent 7QB""8 is the use o1 electronic +eans, such as e+ail
or a short +essage, 1or rending a =ill*
Ad<antages
The ad/antage o1 QB"" o/er traditional +eans is pri+arily the sa/ings to the operator in ter+s o1
the cost to produce, distri=ute, and collect =ills*
)se in $o=i,e Co**uni;ations
QB"" +ay =e used in lieu o1 a standard paper =ill as a +eans to reduce operational costs* So+e
operators +ay /ie) QB"" as an alternati/e to prepay as so+e operators /ie) prepay ser/ice
strictly as an alternati/e to traditional =illing, =ut it usually has +ost /alue as an alternati/e
+echanis+ 1or =illing post&paid custo+ers* Po)e/er, QB"" can also =e used si+ply as an
in1or+ational tool to in1or+ the custo+er o1 charges le/ied against the account*
Bi,,ing and C@arging to T@ird "arties
QB"" is an e11icient +echanis+ to =ill or in1or+ third parties o1 charges* For e4a+ple, the 1ather
o1 a son in college +ay )ant to kno) ho) +uch the child is spending on +o=ile phone ser/ice
prior to the =ill =eco+ing to high*
"a:ing t@e Bi,,
So+e QB"" syste+s re<uire so1t)are 1or pay+ent )hile others re<uire only standard =ro)ser
so1t)are 1or accesses a )e= site 1or secure pay+ent* Ilternati/ely, the =illing arrange+ent can
=e +ade in ad/ance 1or 1unds to =e auto+atically de=ited 1ro+ a custo+er;s account )ith a
1inancial institution* Po)e/er, the +ore attracti/e +odel 1or +ost )ill =e to ha/e control o/er )hen
the =ill is actually paid, rather than ha/e it =e paid at a predeter+ined date*
Future o8 EB""
QB"" is e4pected to =eco+e an increasingly attracti/e alternati/e as +o=ile operators continue
to search 1or )ays to reduce operational costs* Po)e/er, the e4tent to )hich QB"" is proli1erated
)ill depend entirely on user acceptance and diligence to actually pay 1or =ills in a ti+ely and
7pre1era=ly8 electronic 1ashion*
Business & ,T -odel . Cards /%*00% "age 5$ o1 $00
Foundation Course in Banking
FEDB&(E
Fed)ire is an electronic trans1er syste+ de/eloped and +aintained =y the Federal 6eser/e
Syste+* The syste+ connects Federal 6eser/e Banks and Branches, the Treasury and other
go/ern+ent agencies, and +ore than 0,000 on&line and o11&line depository institutions and thus
plays a key role in 9S pay+ents +echanis+* The syste+ is a/aila=le on&line depository
institutions )ith co+puters or ter+inals that co++unicate directly )ith the Fed)ire net)ork*
These users originate o/er 00 percent o1 total 1unds trans1ers* The re+aining custo+ers ha/e o11&
line access to Fed)ire 1or a li+ited nu+=er o1 transactions*
Fed)ire trans1ers 9*S* go/ern+ent and agency securities in =ook&entry 1or+* ,t plays a signi1icant
role in the conduct o1 +onetary policy and the go/ern+ent securities +arket =y increasing the
e11iciency o1 Federal 6eser/e open +arket operations and helping to keep the +arket 1or
go/ern+ent securities li<uid*
:epository institutions use Fed)ire +ainly to +o/e =alances to correspondent =anks and to send
1unds to other institutions on =ehal1 o1 custo+ers* Trans1ers on =ehal1 o1 =ank custo+ers include
1unds used in the purchase or sale o1 go/ern+ent securities, deposits, and other large, ti+e&
sensiti/e pay+ents*
Fed)ire and CP,"S, a pri/ate§or 1unds trans1er net)ork specializing in international
transactions, handle +ost large&dollar trans1ers* ,n $000, so+e %0' +illion 1unds trans1ers )ith a
total /alue o1 B('0 trillion )ere +ade o/er Fed)ire && an a/erage o1 B(*5 +illion per transaction*
Ill Fed)ire trans1ers are co+pleted on the day they are initiated, generally in a +atter o1 +inutes*
They are guaranteed to =e 1inal =y the Fed as soon as the recei/ing institution is noti1ied o1 the
credit to its account*
9ntil %0'0, Fed)ire ser/ices )ere o11ered 1ree to Federal 6eser/e +e+=er co++ercial =anks*
Po)e/er, the :epository ,nstitutions :eregulation and -onetary Control Ict o1 %0'0 re<uired the
pricing o1 Fed ser/ices, including 1unds and securities trans1ers, and ga/e non+e+=er depository
institutions direct access to the trans1er syste+* To encourage pri/ate§or co+petition, the la)
re<uires the FedRs 1ees to re1lect the 1ull cost o1 pro/iding the ser/ices, including an i+plicit cost
1or capital and pro1ita=ility*
#oA FedAire Borks
Trans1ers o/er Fed)ire re<uire relati/ely 1e) =ookkeeping entries* Suppose an indi/idual or a
pri/ate or go/ern+ent organization asks a =ank to trans1er 1unds* ,1 the =anks o1 the sender and
recei/er are in di11erent Federal 6eser/e districts, the sending =ank de=its the senderRs account
and asks its local 6eser/e Bank to send a trans1er order to the 6eser/e Bank ser/ing the
recei/erRs =ank* The t)o 6eser/e Banks settle )ith each other through the ,nter&district
Settle+ent Fund, a =ookkeeping syste+ that records Federal 6eser/e inter&district transactions*
Finally, the recei/ing =ank noti1ies the recipient o1 the trans1er and credits its account* Gnce the
trans1er is recei/ed, it is 1inal and the recei/er +ay use the 1unds i++ediately* ,1 the sending and
recei/ing =anks are in the sa+e Federal 6eser/e district, the transaction is si+ilar, =ut all o1 the
processing and accounting are done =y one 6eser/e Bank*
OT#E( T(A!FE( !%!TE$!
Clearing Pouse ,nter=ank "ay+ent Syste+ 7CP,"S8 is a pri/ate sector 1unds trans1er net)ork
+ainly 1or international transactions* CP,"S trans1ers are settled on a net =asis at the end o1 the
day, using FedAire 1unds trans1ers to and 1ro+ a special settle+ent account on the =ooks o1 the
eA %ork Fed.
Business & ,T -odel . Cards /%*00% "age 5( o1 $00
Foundation Course in Banking
,n addition to Fed)ire, the Federal 6eser/e Banks pro/ide net settle+ent ser/ices 1or participants
in pri/ate§or pay+ents syste+s, such as check clearing houses, auto+ated clearing house
associations 7ICP8, and pri/ate electronic 1unds trans1er syste+s that nor+ally process a large
nu+=er o1 transactions a+ong +e+=er institutions* et sett,e*ent in<o,<es +osting net de=it
and net ;redit entries +ro<ided =: su;@ organiMations to t@e a;;ounts t@at t@e a++ro+riate
de+ositor: institutions *aintain at t@e Federa, (eser<e.
In auto+ated clearing house processes and deli/ers electronic de=it and credit pay+ents a+ong
participants*
Business & ,T -odel . Cards /%*00% "age 52 o1 $00
Foundation Course in Banking
!)$$A(%
6etail =anking is =anking ser/ices pro/ided 1or indi/iduals* Co++on
ser/ices include .
o Branch Banking
o Custo+er Care
o Teller Ser/ices
o :eposit and Voan "roducts
o Gnline Banking
o Financial Id/isory
IT- =anking has =eco+e increasingly popular o/er the last 1e)
decades
There are +any types o1 Banking Iccounts
o Checking Iccounts
o -oney -arket :eposit Iccounts
o Sa/ings Iccount
o Ti+e :eposits 7Certi1icates o1 :eposit8
o Basic or No Frill Banking Iccounts
Qlectronic =anking, also kno)n as electronic 1und trans1er 7QFT8,
uses co+puter and electronic technology as a su=stitute 1or checks
and other paper transactions*
QFT;s are initiated through de/ices like IT- cards or codes that let
one to access your account* -any 1inancial institutions use IT- or
de=it cards and "ersona, &denti8i;ation u*=ers 1"&s3 8or t@is
+ur+ose.
The 1ederal Qlectronic Fund Trans1er Ict 7QFT Ict8 co/ers +ost 7not
all8 electronic custo+er transactions*
QFT o11ers the 1ollo)ing ser/ices to the custo+ers#
o Auto*ated Te,,er $a;@ines 1AT$s3
o :irect :eposit
o :irect :e=itsFQlectronic Bills "resent+ent
o "ay&=y&"hone Syste+s
o "ersonal Co+puter Banking
o "oint&o1&Sale Trans1ers
o Qlectronic Check Con/ersion
QB"" is an upco+ing +ode o1 transaction in/ol/ing the use o1
electronic +eans, such as e+ail or a short +essage, 1or rending a
=ill*
FedWire is an electronic trans1er syste+ de/eloped and +aintained
=y the Federal 6eser/e Syste+* The syste+ connects Federal
6eser/e Banks and Branches, the Treasury and other go/ern+ent
agencies, and depository institutions and thus plays a key role in 9S
pay+ents +echanis+
C,earing #ouse &nter=ank "a:*ent !:ste* 1C#&"!8 is a pri/ate
sector 1unds trans1er net)ork +ainly 1or international transactions.
C#&"! trans8ers are sett,ed on a net =asis at t@e end o8 t@e da:7
Business & ,T -odel . Cards /%*00% "age 55 o1 $00
Foundation Course in Banking
using Fed)ire 1unds trans1ers to and 1ro+ a special settle+ent
account on the =ooks o1 the eA %ork Fed.
Business & ,T -odel . Cards /%*00% "age 5! o1 $00
Foundation Course in Banking
2.C. CO!)$E( LED&'
Business & ,T -odel . Cards /%*00% "age 5 o1 $00
Foundation Course in Banking
(ETA&L LED&'
6etail Vending is one o1 the +ost i+portant 1unctions per1or+ed =y a =ank* ,t enco+passes the
1ollo)ing#
"ersona, ,oans7 ;onsu*er ,oans
Asset =ased ,oans - auto ,oans7 @o*e ,oans
O+en ended ,oans
Lease7 #ire "ur;@ase
Credit ;ards
"ersona, Loans . Consu*er Loans
"ersonal loans are a+ount =orro)ed =y indi/iduals to co/er their personal e4penses* The details
o1 such e4penses are ne/er o1 any interest to the lenders*
The 1inancer is not interested in the intention o1 the loan*
No security
Short ter+ loans
6ate o1 interest is /ery steep*
,deally should =e used only in case o1 an e+ergency
Ill =anksF1inance co+panies o11er these loans
Voan a+ount is directly linked to =orro)er;s repay+ent capacity*
Asset Based Loans
Such loans are a+ount =orro)ed =y indi/iduals to =uy so+e asset, )hich is hypothecated to the
lender* Thus the lender is 1ully a)are o1 the purpose o1 the loan* The interest rate charged is
lo)er than personal loans =ecause the loan is secured =y the hypothecation o1 the asset to the
lender*
TAo *ain t:+es 5 auto ,oans7 @ousing ,oans
,nterest rate is lo)er as co+pared to "ersonal loans
Pypothecation o1 the Isset to the 1inancer*
6epay+ent through Q-,;s*
Thu+= rules 1or calculation o1 -a4i+u+ loan a+ount
a* Not greater than ( ti+es the yearly inco+e G6
=* The Q-, should =e less than !0 pct o1 the gross +onthly inco+e*
Loan against !e;urities
G/erdra1t 1acility can =e a/ailed against pledge o1 e<uity Shares,
-utual Fund units*
:ra)ing po)er is usually !0&0 A o1 the /alue o1 the pledged
instru+ents*
O+en Ended Loans- se;ured
Business & ,T -odel . Cards /%*00% "age 5' o1 $00
Foundation Course in Banking
Gpen ended loan allo) the =orro)er to =orro) additional a+ount su=Kect to the +a4i+u+ a+ount
less then a set /alue*
Si+ilar to o/erdra1t 1acilities pro/ided =y =anks*
,nterest is calculated on the daily outstanding =alance*
9sually a card 7si+ilar to a Credit Card8 is issued =y the lending
institution*
The lending institution has tie&ups )ith /arious +erchant
esta=lish+ents*
Ilso allo) you to )ithdra) Cash*
,+portant Ter+s?
;. Li*it 1L3 5 *a/ outstanding a,,oAed
d. $argin 1$3 5 +er;entage o8 ,i*it t@at ;an =e draAn
e. Asset <a,ue 1AV3 5 <a,ue o8 under,:ing asset
8. DraAing "oAer 1D"3 - ,oAer o8 L and 11-$3-AV
Q4a+ple#
Vi+it >B %000? -argin > (0A? Isset Malue 7initial8 > B%000
Date Asset Va,ue 1AV3 DraAing "oAer 1D"3
%st Jan $002 B%000 B00
%st Fe= $002 B%!00 B%000
%st -ar $002 B$000 B%000
%st Ipr $002 B500 B(50
Lease . #ire "ur;@ase
Vease is a long&ter+ rental agree+ent 1or the asset, )hile Pire "urchase is allo)s the user to
o)n the asset a1ter all the pay+ents ha/e =een +ade to the lender*
Lease
T)o +ain types . operating, 1inancial
The Financier o)ns the asset*
:epreciation is clai+ed =y the 1inancier*
Ta4 deduction can =e clai+ed 1or the 1ull /alue o1 the rental paid*
Financier takes care o1 +aintenance, insurance etc*
#ire "ur;@ase
The asset is o)ned =y the 1inancier*
Business & ,T -odel . Cards /%*00% "age 50 o1 $00
Foundation Course in Banking
:epreciation can =e clai+ed =y the =orro)er*
Ta4 deduction can =e clai+ed only to the e4tent o1 the interest
repay+ent*
(etai, Lending C:;,e
%* Voan application +anage+ent and processing
6eceipt o1 loanFcard application
Ipplication "rocessing
o :uplicate check
o Negati/e list check
o :ocu+ent Meri1ication
o Calculate loan eligi=ility, ,66, processing 1ees
o Credit scoring
o Field ,n/estigation
o Credit Ippro/al
Dis=urse*ent
o Che<ue issuance
o Credit to account
o "ay+ent to third party
For+ulating the repay+ent schedule*
$* Voan repay+ents and ter+ination
"ost-Dated C@eGues
o ":C;s are collected H their in1or+ation captured*
o Che<ues are presented in clearing on due dates
o BouncedF hold che<ues are +arked 1or 1urther action*
Salary deductions
o Q+ployer )ise receipt =atches are created*
o Q+ployer che<ue details are captured
o "ay+ent receipt is +arked 1or corresponding e+ployees*
:irect receipts
o CashFChe<ue in1or+ation is captured
o Che<ues are cleared in =atches*
Iuto pay+ents F :irect de=its
o Bank )ise recei/a=le =atches are created*
o Short receipts are +arked*
o 6elease receipt =atch to +ark receipts
Xinds o1 repay+ents
o E$& 5 sa*e insta,,*ent a*ount
o Fi/ed "rin;i+a, 5 ;onstant +rin;i+a,7 de;reasing interest a*t
o !te+-u+ 5 +rin;i+a, a*ount in;reases in ste+s
Business & ,T -odel . Cards /%*00% "age !0 o1 $00
Foundation Course in Banking
o !te+-doAn 5 +rin;i+a, a*ount de;reases in ste+s
o Ba,,oon 5 notiona, a*ount initia,,:7 ,arge ,ast +a:*ent
o Bu,,et 5 interest +a:*ent initia,,:7 entire +rin;i+a, at one s@ot
o (ando* 5 s;@edu,e N a*ount o8 insta,,*ents unde;ided
o !+e;ia, +rodu;ts 5 ;o*=ination o8 a=o<e
(* :elin<uencies identi1ication and collections
Case "rocessing
o Categorization o1 cases =ased on prede1ined rules
o Illocation o1 cases to collectors
Standard Cases
o Collector 1ollo)&up 7deskF1ield8
o 6epay+ent =y custo+er
o Che<ue issuance
Q4ception Cases 7deathF1raud etc*8
o ,nitiate process =ased on case speci1ics 7legalFother +eans8
o TrackF1ollo) up the case de/elop+ents till repay+ent
o Case closed
&nterest (ates
Fi/ed (ate o8 &nterest
The rate o1 interest applica=le is guaranteed not to change during the 1i4ed rate period* Borro)er
H =ank protected 1ro+ ad/erse interest rate +o/e+ents*
F,oating (ate o8 &nterest
The rate o1 interest is linked to one o1 the rates pre/ailing in the +arket, 1or e4a+ple it can =e
linked to "L( 1"ri*e Lending (ate3 or L&BO( 1London &nter=ank O88ered (ate3. Borro)er
=ene1its 1ro+ 1alling int* rate, e4posed to up)ard +o/e+ent o1 int* rate*
,+portant ter+s areO Ca+7 8,oor7 ;o,,ar7 =en;@*ark.=ase.an;@or rate7 *ark-u+.s+read rate7
reset date N 8reGuen;:
Submit Proposal
OK
Appraisal
Decision
OK
Disbursement Compliance Conditions for borrower
Monitoring
NO
Repayment Follow -up/Action
Scrutinize
Business & ,T -odel . Cards /%*00% "age !% o1 $00
Foundation Course in Banking
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Cap
Current rate
Base rate
Floor
Co,,atera,
In asset than can =e repossessed =y the lender i1 the =orro)er de1aults* They are o1 the
1ollo)ing types
"ri+ary 7sa+e asset 1or )hich 1inance is taken8
Secondary 7asset =acking the loan di11erent8
C@arge T:+es
"ledge . gold, =ank has possession
Pypothecation . /ehicle, =orro)er has possession
Vien . against =ank deposits
Issign+ent . insurance policies, rights get trans1erred to =ank
Shares & periodic dra)ing po)er calculation
-ortgage . i++o/a=le property
$O(T'A'E!
I loan secured =y the collateral o1 so+e speci1ied real estate property that o=liges the =orro)er
to +ake a predeter+ined series o1 pay+ents* ,1 the =orro)er doesn;t keep up the loan
repay+ents, the lender can repossess the real estate property and sell it in order to get the
+oney =ack*
The rate o1 interest applica=le is lo)er than personal loans and co+para=le to other asset =ased
loans*
To co+pare the cost o1 di11erent -ortgages deals one should look at the A"( 5 Annua,
"er;entage (ates. Ill 1ir+s that <uote an I"6 +ust calculate it in a standard )ay, so one can
co+pare like )ith like* The I"6 1or a loan is a single 1igure, )hich takes into account#
The a+ount o1 interest you are charged
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When and ho) o1ten the interest +ust =e paid
Gther charges . 1or e4a+ple, an arrange+ent 1ee or co+pulsory
pay+ent protection insurance . i1 they +ust =e =ought 1ro+ the
lender as a condition o1 the loan
When and ho) o1ten these charges +ust =e paid
Dinds o8 $ortgages
-ortgages can =e classi1ied =ased on the interest rates deals#
&nterest (ate Dea, #oA it Aorks
Standard /aria=le
rate
The pay+ents go up and do)n as the +ortgage rate changes*
Standard /aria=le
rate )ith cash =ack
Sa+e as a standard /aria=le rate loan & =ut one recei/e a su=stantial
cash su+ 7Q4a+ple (.5A o1 the a+ount =orro)ed8 )hen you take up
the loan*
Base rate tracker
Si+ilar to a standard /aria=le rate +ortgage =ut the interest rate is
guaranteed to =e a set a+ount a=o/e the =ase rate and alters in line
)ith changes in that rate*
Fi4ed interest rate
The pay+ents are set at a certain le/el 1or a set period o1 ti+e . 1or
e4a+ple, one year, t)o years, or 1i/e years* It the end o1 the period,
one is usually charged the lender;s standard /aria=le rate 7or
so+eti+es a ne) 1i4ed rate is o11ered8*
:iscounted interest
rate
The pay+ents are /aria=le, =ut they are set at less than that lender;s
going rate 1or a 1i4ed period o1 ti+e* It the end o1 the period, one is
charged the lender;s standard /aria=le rate*
Capped rate
The pay+ents go up and do)n as the +ortgage rate changes =ut are
guaranteed not to go a=o/e a set le/el 7the @cap;8 during the period o1
the deal*
So+eti+es, they cannot 1all =elo) a set +ini+u+ le/el either 7the
@collar; or @1loor;8* It the end o1 the period, one is charged the lender;s
standard /aria=le rate*
(e+a:*ent $et@ods
(e+a:*ent *ortgage
-onthly pay+ents o/er the agreed nu+=er o1 years 7Called the
+ortgage @ter+;8 goes partly to)ards the interest and partly to)ards
the principal*
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,1 all the +onthly pay+ents agreed )ith the lender are +ade, the
)hole loan )ill =e repaid =y the end o1 the ter+*
-onthly pay+ents could increase i1 interest rates rise*
&nterest-on,: *ortgage
The +onthly pay+ents to the lender co/er only the interest on the
loan* They do not pay o11 any a+ount one has =orro)ed*
Gne usually +akes separate pay+ents into a sa/ings sche+e each
+onth to =uild up a lu+p su+, )hich is then used to pay o11 the
)hole a+ount one has =orro)ed, in one go at the end o1 the
+ortgage ter+ or sooner*
This in/ol/es so+e in/est+ent risk in =uilding up a su+ o1 +oney to
repay the loan*
,t is one;s responsi=ility to sa/e enough +oney to repay the loan at
the end o1 its ter+*
EndoA*ent *ortgage
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To repay an interest&only loan, one can take an endo)+ent policy,
)hich is designed to end at the sa+e ti+e as the +ortgage*
The +oney one pays into an endo)+ent policy is in/ested in stocks
and shares and other in/est+ents* It the end o1 a set nu+=er o1
years 7the policy @ter+;8, the policy @+atures; and one gets a lu+p
su+, )hich is used to repay the +ortgage loan*
In endo)+ent policy pro/ides li1e insurance and so+eti+es other
insurance =ene1its too*
&nterest-on,: *ortgage ;o*=ined Ait@ stake@o,der +ension
Ilongside an interest&only loan, one can +ake pay+ents into a
personal or stakeholder pension* When one start to take the pension
7=et)een age 50 and 58, one can take part o1 the pension 1und as a
ta4&1ree lu+p su+, )hich is used to pay o11 the +ortgage loan*
&*+ortant )! &nstitutions in $ortgage $arket
Freddie $a;7 'innie $aes N Fannie $ae
Federa, ationa, $ortgage Asso;iation 1F$A or Fannie $ae37 'o<ern*ent ationa,
$ortgage Asso;iation 1'$A or 'innie $ae3 and Federa, #o*e Loan $ortgage
Cor+oration 1F#L$C or Freddie $a;3 are all Sse;ondar: *arket ,endersP.
Banks issue loansF+ortgages )ith so+e collateral 1or security* These loansF+ortgages are
=ought =y the 3secondary +arket lenders5 1ro+ the =anks thus 1reeing the+ to turn around and
issue +ortgage to ne) custo+ers*
Their ;ore =usiness ;onsists o8 *ortgage ,oan se;uritiMation* They =u: *ortgages 8ro*
=anks and +oo, t@e* into =onds to =e so,d or @e,d* These co+panies guarantee the
credit)orthiness o1 these =onds, =ut not the interest&rate risk* They @edge t@eir oAn e/+osure
to interest-rate risk t@roug@ deri<ati<e ;ontra;ts.
G1ten +any retail lenders actually recei/e their 1unds 1ro+ a secondary +arket lender* These
secondary lenders ha/e assisted the national +ortgage +arket =y allo)ing +oney to +o/e easily
1ro+ state&to&state* The +o/e+ent o1 loan 1unds helps to a/oid a situation )here +ortgages are
only a/aila=le in certain areas or states* Ilso, the secondary lenders ha/e esta=lished regulations
and guidelines that help the general pu=lic*
A)TO LOA!
Iuto Voans is =asically lending to the indi/idual custo+ers 1or a t)o or 1our )heeler or their
personal use* The 1ollo)ing section descri=es the +ultiple +echanis+s =y )hich the 1inancing 1or
auto loans is nor+ally done*
T:+es o8 Finan;ing $e;@anis*
Dire;t Lending: The Bank or the 1inance co+pany directly lends to
the =uyer or the =orro)er in this case* I nu+=er o1 lending
institutions are o11ering such loans on their )e=sites*
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Dea,er 8inan;ing# This is a type o1 loan a/aila=le through the dealer*
The lending and repay+ents are done =yFto the dealer* Basically the
dealer tells the custo+er ho) +uch do)n pay+ent and +onthly
,nstall+ent is to =e paid against the /ehicle* The e11ecti/e cost to the
custo+er +ost o1 the ti+es is generally +ore than the original price*
Veasing # MehicleF Iuto lease is a contract =et)een the =orro)er and
a auto leasing co+pany* The =orro)er agrees to pay the leasing
co+pany 1or the use o1 the /ehicle 1or a certain a+ount o1 ti+e,
usually $2 to (! +onths* :uring that ti+e the =orro)er agrees to
+ake +onthly lease pay+ents, keep the car in good repair, insure
the car and not dri/e the car +ore +iles that stipulated in the
contract*
T@e De: entities in a ,ease agree*ent are t@e ,essee or t@e ,essor.
Vessee or the =orro)er# The party to )ho+ the /ehicle is leased* ,n a consu+er lease, the lessee
is the consu+er* The lessee is re<uired to +ake pay+ents and to +eet other o=ligations
speci1ied in the lease agree+ent*
Vessor or the lender or the lending institution is the original o)ner o1 the /ehicle or property =eing
leased
The lease can =e closed ended or open ended as de1ined =elo)#
Closed end lease & I lease agree+ent that esta=lishes a non&
negotia=le residual /alue 1or the leased auto and 1ee a+ounts due at
the end o1 the lease ter+*
Gpen Qnd lease & I lease ter+ that re<uires the lessee to pay the
di11erence =et)een residual /alue and 1air +arket /alue at the end o1
the lease ter+ i1 the 1air +arket /alue is lo)er
,n a lease, the 1actors such as the o)nership, up 1ront costs and +onthly pay+ents as against the
direct lending are#
G)nership# Dou do not o)n the /ehicle* Dou get to use it =ut +ust
return it at the end o1 the lease unless you choose to =uy it*
9p&1ront costs# 9p&1ront costs +ay include the 1irst +onthRs pay+ent,
a re1unda=le security deposit, a capitalized cost reduction 7like a
do)n pay+ent8, ta4es, registration and other 1ees, and other
charges*
-onthly pay+ents# -onthly lease pay+ents are usually lo)er than
+onthly loan pay+ents =ecause you are paying only 1or the /ehicleRs
depreciation during the lease ter+, plus rent charges 7like interest8,
ta4es, and 1ees*
The Xey Qntities in an Iuto Voan syste+ are#
Borro)er# is the one )ho needs to useFo)n the auto+o=ile and
approaches a dealerFlender 1or getting 1inancing 1or the sa+e
:ealer# Typically a 1ranchisee o1 the +anu1acturer, in/ol/ed in selling
and deli/ery o1 the /ehicle to the =uyer
Vender# "ro/ides capital to the =orro)er 1or =uying the /ehicle* This
can =e the =ank or the dealer or any 1inancing institution*
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Credit =ureau# Tracks and +aintains credit history o1 =orro)ers and
1or)ard it to lenders during ne) application processing* This is used
1or deciding )hether the loan should =e pro/ided to a custo+er or
not*
Ippraiser# Issesses and esta=lishes the 1air +arket /alue o1 a
collateral o11ered as underlying security to the credit asked 1or*
,nsurer# The ,nsurance co+pany insures the /ehicle o)ner against
speci1ic lia=ilities caused to and 1ro+ the /ehicle during the course o1
its use upon the pay+ent o1 a pre+iu+ and signing o1 a contract
Voan ser/icer# is the one )ho pro/ides /arious ser/ices during the
li1e cycle o1 a loan starting 1ro+ loan origination to loan closure*
!T)DET LOA!
Student Voans are Voans a/ailed =y eligi=le students to pursue graduate and post graduate
studies in 9S SchoolsFCollegesF9ni/ersities* These loans are usually pro/ided =y =anks, Credit
9nions and other 1inancial institutions )hich are guaranteed =y state sponsored Guarantors
T:+es o8 !tudent Loans
Students Voans o11ered can =e categorized =roadly into t)o types#
Federally sponsored loans . These loans are 1ederally insured and
pro/ide protection against de1ault* The depart+ent o1 Qducation
guarantees upto 0'A and e/en %00A in so+e cases
Non&1ederally sponsored loans . These are insured =y the pri/ate
sector and ha/e no go/ern+ent =acking* The guarantee in this case
is only 1ro+ the pri/ate insurers or 1ro+ the reser/es pledged to
securitization
Federally sponsored loans are o1 t)o types
Federal Fa+ily Qducation Voan "rogra+ 7FFQV"8& These loans are
+ade =y 1inancial institutions pri+arily )ith a 1loating rate that is
adKusted once a year* The interest rate is capped at '*$5A and the
Fed su=sidizes the di11erence =et)een the actual loan rate and the
rate cap through Special Illo)ance "ay+ents7SI"8* The rates are
usually speci1ied =y inde4ing the+ to the 9S Treasury =ill rates*
Federal :irect Voan 7F:V"8& )here the depart+ent o1 Qducation
directly pro/ides the loans
FFQV" or the Federal Fa+ily Qducation Voan "rogra+ can 1urther =e di/ided into three types
Federal Sta11ord .Federal Sta11ord loans are the +ost co++on
source o1 education loan 1unds in the 9S* This is a/aila=le to =oth
graduate and undergraduate students* This loan could =e either
su=sidized or unsu=sidized=y the 1ederal go/ern+ent* The interest
rate is a 1loating rate that is inde4ed to the 0% day T&Bill and is
capped at '*$5A* Sa+ple rates o1 during the year $00(&02 )ere
o $*'$A in school, grace and de1er+ent
o (*2$A in repay+ent and 1or=earance
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Federal "V9S & "V9S loans are a/ailed =y the parents o1 a 1ull& or
hal1&ti+e undergraduate student *This re<uires a credit check and
hence the parent +ust ha/e a good credit history and should ha/e
=een a citizen or per+anent resident o1 9S* The loans don;t re<uire
any collateral and the interest pay+ents are ta4 deducti=le*
Consolidation loans & I consolidation loan in/ol/es t)o or +ore
e4isting 1ederally sponsored loans into one single loan* The interest
rate 1or this is deter+ined =y the )eighted a/erage o1 the loan rates
pre/ailing at that ti+e and capped at '*$5A
There are three principal ad/antages
Con/enience . By co+=ining loans the =orro)er is a=le to 1ocus on
repaying one single loan than handle +ultiple loans
,nterest rate . ,n a lo) rate scenario the =orro)er can reduce his
cost o1 =orro)ing =y taking a ne) loan at the lo) pre/ailing lo) rates
6epay+ent . The repay+ent period is e4tended to (0 years and this
reduces the install+ent to paid each +onth
The Xey Qntities in the Student Voan Syste+ are Federal
go/ern+ent, Schools, Venders Ser/icers and guarantors and the
=orro)er*
Federal go/ern+ent# Sponsors and authorizes 1unds 1or grants and
loan progra+s*
School# The school is certi1ied =y the depart+ent o1 education as an
eligi=le school to participate in the FFQV" or F:V" loan progra+s*
Schools are responsi=le 1or deter+ining =orro)er;s eligi=ility,
reco++ends and certi1ies loan a+ounts, +onitors the enroll+ent
status
Venders # are the institutions appro/ed =y the :GQ 1or /oluntary
participation in any or all o1 the FFQV" student loan progra+s*
Typical lenders are usually Banks, credit unions, SHV institutions,
insurance co+panies and other institutions*
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Ser/icer# is an entity )ho collects pay+ents on a loan and per1or+s
other ad+inistrati/e tasks associated )ith +aintaining a loan
port1olio* The nor+al 1unctions include dis=urse loans 1unds, +onitor
loans )hile the =orro)ers are in school, collect pay+ents, process
de1er+ents and 1or=earances, respond to =orro)er in<uiries and
ensuring regulatory co+pliance*
Guarantor is a state agency, )hich guarantees or insures the loan
and is a not&1or&pro1it agency* ,t protects the lenders against loss
due to =orro)er de1ault, death o1 =orro)er, total and per+anent
disa=ility, =ankruptcy, closed school, and ineligi=le =orro)er*
Borro)er # is the student )ho a/ails o1 the loan*
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!)$$A(%
The loans gi/en to retail custo+er co+e under Consu+er Vending*
There are 1our +aKor types o1 Consu+er Vending .
o "ersonal loans
o -ortgages
o Iuto Voans
o Student Voans
"ersonal loans nor+ally ha/e the highest interest rates charge )hile
+ortgages ha/e the lo)est*
6etail lending cycle includes &
o Voan application +anage+ent and processing
o Voan repay+ents and ter+ination
o :elin<uencies identi1ication and collections
Types o1 interest rates
o Fi4ed interest rate
o Fle4i=le interest rate
o Py=rid interest rates
-ortgages are Voans gi/en to consu+ers 1or the purpose o1
purchase, construction or repair o1 real estate*
Iuto loans are loans 1inanced 1or /ehicles 1or personal use
Student loans are loans pro/ided to eligi=le students to pursue
graduate and post graduate studies in 9S
SchoolsFCollegesF9ni/ersities
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2.4. CO$$E(C&AL AD B#OLE!ALE BAD&'
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CO("O(ATE LED&'
CO("O(ATE LED&'
Corporate Vending re1ers to /arious 1or+s o1 loans e4tended =y =anks to corporate =odies like
proprietorship, partnership, pri/ate li+ited co+panies or pu=lic li+ited co+panies* Banks lend to
such entities on the strength o1 their =alance sheet and =usiness cash 1lo)s* Corporate loans are
pro/ided =y =anks 1or /arious purposes like ne) proKects, capacity e4pansion or plant
+odernization, daily cash 1lo) re<uire+ents 7)orking capital8 etc* :epending on the nature o1 the
re<uire+ent, loans +ay =e long&ter+ or short&ter+ in nature*
Voans can =e either secured or unsecured in nature* ,n case o1 secured loans, i1 the corporate
de1aults on pay+ent o1 principal or interest on the loan, the =ank can take possession o1 the
security and sell o11 the sa+e to +eet principal or interest pay+ent on the loan* Security is usually
in the 1or+ o1 land, =uildings, plant and +achinery, physical stock o1 the ra) +aterial, goods 1or
sale etc*
CO("O(ATE LED&' "(OCE!!
The 1ollo)ing is the typical stages in a corporate lending process#
Corporate approaches the relationship +anager o1 the =ank )ith a
re<uest 1or a loan* The corporate pro/ides details like# past 1inancial
state+ents, details o1 the loan re<uire+ent, cash 1lo) proKection 1or
the period o1 the loan, details o1 the security =eing pro/ided etc*
:epending on the loan type and =ank re<uire+ents, /arious other
in1or+ation )ould need to =e pro/ided =y the corporate*
The concerned di/ision o1 the =ank prepares the detailed analysis o1
the corporate 1inancial state+ents* I detailed study is also done on
the corporate;s products, +arket seg+ent, co+petitors etc to
ascertain the strength o1 the corporate;s =usiness* I report is
prepared to capture the a=o/e details*
Based on the a=o/e report, the concerned di/ision o1 the =ank
assigns a rating to the corporate* The rating captures /arious 1actors
like strength o1 =usiness, 1inancial state o1 the corporate, a=ility to
repay the loan =ased on cash 1lo) proKections, pro+oter =ackground
etc*
I co++ittee o1 the =ank e/aluates the loan proposal and decides to
sanctionFreKect the sa+e*
Gnce sanctioned, the =ank pro/ides a sanction letter to the corporate
pro/iding details o1 the loan ter+s and conditions*
I1ter the corporate accepts the sa+e, a loan agree+ent is signed
=et)een the =ank and the corporate* The loan agree+ent captures
/arious conditions o1 the loan like repay+ent +ode, repay+ent
period, interest paya=le, security pro/ided, other conditions etc* The
loan =eco+es @co++itted; at this stage*
The =ank dis=urses the re<uired a+ount under the loan co++itted*
This a+ount is called the @dis=ursed a*ountQ under the loan* 'i<e
t@e *one:
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Foundation Course in Banking
,nterest is usually paid on the dis=ursed a+ount o1 the loan* ,n so+e cases, a no+inal interest i1
also paya=le on the co++itted a+ount o1 the loan* Ilso, in +ost cases, the corporate )ould ha/e
to pay a certain a+ount as processing 1ees 1or the loan* This )ould co/er the =ank;s o/erhead
costs in the loan process*
CO("O(ATE C(ED&T (AT&'
Be1ore sanctioning a loan to a corporate, the =ank does a detailed assess+ent o1 its 1inancials
and =usiness strength as discussed in the earlier section* This process ends )ith the =ank
assigning a rating to the corporate 1or the loan 1acility*
6atings are usually speci1ied in alphanu+eric ter+inologies* 6ating le/els +ight /ary 1ro+ III
7highest8, IIE, II& to de1ault ratings like :* 6ating ter+inologies +ight /ary across =anks and
across /arious loan tenures* The rating le/el speci1ies a certain pro=a=ility o1 de1ault o1 the loan* ,t
also takes in to account the protection o11ered =y the security o1 the loan*
For corporates )ith higher ratings, =anks pro/ide loans at lo)er interest rates and /ice /ersa* ,n
+ost cases, =anks do a rating process 1or each o1 its corporate clients at the end o1 say, e/ery
year or e/ery <uarter* This helps =anks to continuously track the 1inancials and +arket position o1
the corporate*
Credit en@an;e*ents
Credit enhance+ent is a +echanis+ used to increase the original rating o1 a loan 1or a corporate*
Credit enhance+ents can =e in the 1or+ o1 pledge o1 shares, cash collateral, corporate or =ank
guarantees etc*
E/a*+,e:
I corporate rated BB 7lo) rating8 re<uires a loan o1 9S: 5*0 +illion 1ro+ a =ank* To enhance the
loan rating and thus reduce interest paya=le on the loan, the pro+oters pledges their share
holding in the co+pany )ith the =ank* Thus, )hene/er there is a de1ault on repay+ent o1 the
loan, the =ank has the right to sell the shares in the +arket* Based on the historic /olatility o1 the
shares and the current +arket /alue o1 9S: !*0 +n, the =ank upgrades the rating o1 the loan to
BBBE*
T%"E! OF LOA!
Ter* ,oans
These loans can either =e short ter+ loans or long ter+ loans*
Vong&ter+ loans are e4tended 1or purposes like ne) proKects, capacity e4pansion or plant
+odernization* These loans are usually repaya=le o/er a $& year period a1ter an initial
+oratoriu+ period 7period during )hich loan repay+ents are not re<uired8 to help the corporate
co+plete i+ple+entation o1 the proKect =e1ore re/enue generation takes place*
E/a*+,e
On A+ri, 157 20047 ATNT =orroAs a ter* ,oan o8 )!D 200 *i,,ion 8ro* Citi=ank 8or 8unding
t@eir &T *oderniMation +roRe;t a;ross t@e nation. T@e ,oan is re+a:a=,e in 1I Guarter,:
insta,,*ents starting A+ri, 157 20057 a8ter an initia, *oratoriu* o8 4 Guarters. T@e interest
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+a:a=,e Aou,d =e L&BO(20.5S +a:a=,e Guarter,:. T@e ,oans Aou,d =e se;ured =: ATNT
eGui+*ent at t@eir #?7 Aort@ )!D C00 *n.
Short ter+ loans are e4tended usually 1or +eeting )orking capital re<uire+ents* The loans can
=e repaya=le in /arious tenures starting 1ro+ a )eek to as long as % year* The loans are either
repaya=le in 1i4ed install+ents or in one =ullet install+ent at the end o1 the period* ,n so+e cases,
short ter+ loans are =acked =y pro+issory notes )hich are legal instru+ents that guarantee
pay+ent o1 a certain a+ount on a speci1ied due date*
Cor+orate =onds
Corporate =onds are used 1or the sa+e purpose as ter+ loans, =ut the loan is =acked =y a
trans1era=le instru+ent )hich guarantees pay+ent 1ro+ the corporate as per speci1ied
conditions* Thus, corporate =onds are trada=le and =anks can sell the+ to a third party )ho
recei/es the right to get pay+ents 1ro+ the corporate* Bonds are rated depending on the rating o1
the corporate and depending on the rating, the +arket de+ands /arying a+ounts o1 interest* I
certain class o1 =onds called Kunk =onds is issued =y corporates )ith /ery lo) credit ratings and
carries /ery high rates o1 interest*
Borking Ca+ita,
For any =usiness, there )ould =e current assets in the 1or+ o1 cash, recei/a=les, ra) +aterial
in/entory, goods 1or sale in/entory etc )hile there )ould =e current lia=ilities in the 1or+ o1
paya=les and other short ter+ lia=ilities* "art o1 the current assets )ould =e 1unded through
current lia=ilities )hile the rest )ould ha/e to =e 1unded through a +i4ture o1 short ter+ and long
ter+ loans* Is per nor+s, $5A o1 the )orking capital gap )ould ha/e to =e 1unded =y long ter+
sources like e<uity or ter+ loans )hile the rest 5A can =e 1unded through short ter+ loans and
o/erdra1t li+its*
Banks conduct a detailed assess+ent o1 the current assets and lia=ilities 1or a corporate and
arri/e at a suita=le )orking capital li+it* For purpose o1 calculating li+its, =anks typically include
only recei/a=les )hich are less than ! +onths old* Ilso )ithin the speci1ied li+it, =anks keep
re/ie)ing the current asset and current lia=ility position o1 a co+pany to arri/e at the dra)ing
po)er 1or each +onth* Corporates are allo)ed to =orro) up to the )orking capital li+it or the
dra)ing po)er, )hiche/er is lo)er*
G/erdra1t li+its are e4tended to help the corporate +anage the day&to&day cash 1lo) needs o1 the
=usiness* The =ank +akes a/aila=le a certain su+ o1 +oney 1or a period o1 ti+e 7say, 9S: $0*0
+illion 1or a period o1 % year8* There )ould =e a separate account called the o/erdra1t account
created to +onitor )ithdra)als under this loan* Whene/er the corporate has a de1icit in its +ain
=usiness account, it can dra) +oney 1ro+ the o/erdra1t account 7up to the li+it o1 9S: $0*0
+illion8* ,t can also put =ack +oney in the o/erdra1t account as and )hen they ha/e surpluses in
the =usiness account* ,nterest is calculated =y the =ank on the /arious end&o1&day de1icits in the
o/erdra1t account and is usually paya=le =y the corporate at the end o1 e/ery +onth*
Lines o8 ;redit
These are short ter+ loans sanctioned 1or a 1i4ed /alidity period, allo)ing the corporate to dra)
the loan as and )hen re<uired )ithin the /alidity period and repay the loan a1ter a certain period
7repay+ent period8* ,nterest is either repaya=le in certain inter/als or in one =ullet install+ent at
the end o1 the repay+ent period* ,n +any cases, the lines o1 credit are o1 a re/ol/ing nature* The
sa+e is e4plained /ia the e4a+ple pro/ided =elo)#
Business & ,T -odel . Cards /%*00% "age 2 o1 $00
Foundation Course in Banking
E/a*+,e
Citi=ank sanctions a line o1 credit o1 9S: %0*0 +n to ITHT, /alid 1or a period o1 ( years* Within
the ( year period, ITHT can =orro) any a+ount at any point o1 ti+e, such that the cu+ulati/e
outstanding is =elo) 9S: %0*0 +n on any date* Qach o1 these =orro)als are repaya=le )ith
interest at the end o1 (0 days 1ro+ the date o1 =orro)al* Since ITHT can thus @re/ol/e; the li+it
any nu+=er o1 ti+es )ithin the speci1ied li+it and /alidity period, these are called re/ol/ing lines
o1 credit*
Bi,, dis;ounting
Bill discounting is another 1or+ o1 )orking capital 1inancing* I =ill 7Bill o1 Q4change8 is a 1inancial
instru+ent =y )hich one party pro+ises to pay the other party a certain a+ount o1 +oney on a
speci1ied due date* This is trans1era=le and the 1inal holder o1 the =ill holds the right to recei/e the
pay+ent 1ro+ the concerned party* The corporate )ould ha/e =ills o1 e4change )hich are dra)n
on their dealers, )hich entitle the corporate to recei/e certain a+ounts o1 +oney 1ro+ the dealer
a1ter a pre&de1ined credit period* The corporate can then trans1er the =ill to the =ank and get a
discounted a+ount up1ront* The =ank collects the interest on the =ill a+ount 1or the speci1ied
period up1ront in this process called =ill discounting* Gn the due date, the =ank collects the
pay+ent 1ro+ the concerned party directly*
Co**er;ia, "a+er
Co++ercial "aper 7C"s as co++only kno)n8 is an instru+ent =y )hich a corporate =orro)s
+oney 1ro+ =anks 1or short periods o1 ti+e* I C" =inds the corporate to +ake a pay+ent e<ual
to the 1ace /alue o1 the C" to the issuing =ank on a speci1ied due date* ,n this sense, a C" is like
a short ter+ unsecured loan* Po)e/er, a C" is trada=le in the +arket . the =ank can sell the C"
to a third party* For this reason, =anks charge lesser interest on C"s than nor+al short ter+
loans* Po)e/er, since C"s are unsecured and are to =e trada=le in the +arket, =anks pro/ide C"
lending to only highly rated corporates*
Leasing
Veasing is another 1or+ o1 =ank 1inancing* ,n leasing, the =ank purchases real estate, e<uip+ent,
or other 1i4ed assets on =ehal1 o1 the corporate and grants use o1 the sa+e 1or a speci1ied ti+e to
the corporate in e4change 1or pay+ent, usually in the 1or+ o1 rent* The o)ner o1 the leased
property is called the lessor, the user the lessee* Vease pay+ents 7)hich include principal and
interest pay+ents usually8 can =e sho)n =y corporates as operating e4penses and hence leases
are used =y so+e corporates as a su=stitute 1or loans to get =etter ta4 =ene1its*
!u++,ier and dea,er ,oans
These are short ter+ loans pro/ided =y =anks to suppliers and dealers o1 large co+panies*
These loans usually ha/e conditions )hich ensure that there is su11icient support 1ro+ the
corporate in case the supplier or a dealer de1aults* Thus, using the support 1ro+ the corporate,
the suppliersFdealers can =orro) +oney 1ro+ the =ank at a lo)er rate o1 interest than other)ise
possi=le* Such loans help the corporates to de/elop a stronger =ase o1 suppliers and dealers,
)hich o1ten helps the+ in i+pro/ing their =usiness*
Business & ,T -odel . Cards /%*00% "age 5 o1 $00
Foundation Course in Banking
Asset !e;uritisation ,oans
Isset Securitisation loans are loans )hich are =acked =y speci1ied 1uture cash 1lo)s or other
assets o1 the corporate* These loans help corporates to release e4cess cash 1lo)s 1ro+ e4isting
recei/a=les or 1uture recei/a=les*
E/a*+,e
Citi=ank pro/ides a loan o1 9S: $50*0 +n to 6oyal :utch Shell, securitizing cash 1lo)s 1ro+
1uture +onthly sale o1 oil e4plored 1ro+ its speci1ied o11shore rig* ,n this case, there )ould =e a
+echanis+ to ensure that +oney 1ro+ +onthly sale o1 oil e4plored 1ro+ the speci1ied rig 1or the
period o1 the loan )ould =e used to ser/ice pay+ent o1 interest and principal o1 the loan to
Citi=ank* Citi=ank )ould do a detailed assess+ent o1 oil e4ploration potential, study oil prices and
ensure proper cash 1lo) trapping +echanis+s =e1ore dis=ursing the loan to 6oyal :utch Shell*
CLA!!&F&CAT&O OF LOA! B% T#E BAD
1. C,assi8i;ation o8 DraAn Loans
Voans are classi1ied and accounted 1or as 1ollo)s#
A;;rua,TLoans that +anage+ent has the intent and the a=ility to hold 1or the 1oreseea=le 1uture
or until +aturityFloan payo11* Iccrual loans are reported on the =alance sheet at the principal
a+ount outstanding, net o1 charge&o11s, allo)ance 1or loan losses, unearned inco+e, and any net
de1erred loan 1ees*
#e,d-8or-sa,eZVoan or loan port1olios that +anage+ent intends to sell or securitize*
TradingZVoans )here +anage+ent has the a=ility and intent to trade or +ake +arkets 7i*e*,
sellFhedge the credit risk*8 Voans held 1or trading purposes are included in Trading Issets and are
carried at 1air /alue, )ith the gains and losses included in Trading 6e/enue pro/ided that the
criteria outlined in this policy are +et*
2. C,assi8i;ation o8 )ndraAn Loan Co**it*ents
Voan co++it+ents are generally classi1ied as accrual and recorded o11&=alance sheet*
:i11erences =et)een loan and co++it+ent are as 1ollo)s? &
Loans are re8,e;ted in t@e asset side o8 t@e =ankQs =a,an;e s@eet. Co**it*ents are
Uo88-=a,an;e s@eetQ ite*s and are re8,e;ted in t@e ;ontingent asset side o8 t@e =a,an;e
s@eet.
The a+ount o1 the loan that is dis=ursed is credited to the account o1 the =orro)er* ,n
case o1 a co++it+ent, there is no dis=urse+ent or credit to a =orro)er;s account*
The 1ee charged on a loan is a 1unction o1 the dis=ursed a+ount* The 1ee charged on
co++it+ent is a 1unction o1 the a+ount o1 co++it+ent that is not utilized*
Business & ,T -odel . Cards /%*00% "age ! o1 $00
Foundation Course in Banking
C(ED&T DE(&VAT&VE!
Credit deri/ati/es are 1inancial contracts that trans1er credit risk 1ro+ one party to another,
1acilitating greater e11iciency in the pricing and distri=ution o1 credit risk a+ong +arket players*
E/a*+,e
The holder o1 a de=t security issued =y WDT Corp* enters into a contract )ith a deri/ati/es dealer
)here=y he )ill +ake periodic pay+ents to the dealer in e4change 1or a lu+p su+ pay+ent in the
e/ent o1 de1ault =y WDT Corp* during the ter+ o1 the deri/ati/es contract* Is a result o1 such a
contract, the in/estor has e11ecti/ely trans1erred the risk o1 de1ault =y WDT Corp* to the dealer* ,n
+arket parlance, the corporate =ond in/estor in this e4a+ple is the =uyer o1 protection, the dealer
is the protection seller, and the issuer o1 the corporate =ond is called the re1erence entity*
)ses o8 Credit Deri<ati<es
Vike any other deri/ati/e instru+ent, credit deri/ati/es can =e used either to take on +ore risk or
to a/oid 7hedge8 it* I +arket player )ho is e4posed to the credit risk o1 a gi/en corporation can
hedge such an e4posure =y =uying protection in the credit deri/ati/es +arket* Vike)ise, an
in/estor +ay =e )illing to take on that credit risk =y selling protection and thus enhance the
e4pected return on his port1olio*
Credit deri/ati/es can =e used to create positions that can other)ise not easily =e esta=lished in
the cash +arket* For instance, consider an in/estor )ho has a negati/e /ie) on the 1uture
prospects o1 a gi/en corporation* Gne strategy 1or such an in/estor )ould =e to short the =onds
issued =y the corporation, =ut the corporate repo +arket 1or taking short positions in corporates is
not )ell de/eloped* ,nstead, the in/estor can =uy protection =y )ay o1 credit de1ault s)ap* ,1 the
corporation de1aults, the in/estor is a=le to =uy the de1aulted de=t 1or its reco/ery /alue in the
open +arket and sell it to its credit deri/ati/es counterparty 1or its 1ace /alue*
Banks use credit deri/ati/es =oth to di/ersi1y their credit risk e4posures and to 1ree up capital
1ro+ regulatory constraints* Is an e4a+ple, consider a =ank that )ants to di+inish its e4posure
to a gi/en client, =ut does not )ant to incur the costs o1 trans1erring loans +ade to that client to
another =ank* The =ank can, )ithout ha/ing to noti1y its client, =uy protection against de1ault =y
the client in the credit deri/ati/es +arket# Q/en though the loans re+ain on the =ankRs =ooks, the
associated credit risk has =een trans1erred to the =ankRs counterparty in the credit deri/ati/e
contract*
The a=o/e e4a+ple can also =e used to illustrate =anksR usage o1 credit deri/ati/es to reduce
their regulatory capital re<uire+ents* 9nder current Basle standards, 1or a corporate =orro)er,
the =ank is generally re<uired to hold ' percent o1 its e4posure as a regulatory capital reser/e*
Po)e/er, i1 its credit deri/ati/es counterparty happens to =e a =ank located in an GQC: country,
and the =ank can de+onstrate that the credit risk associated )ith the loans has =een e11ecti/ely
trans1erred to the GQC: =ank, then the =ankRs regulatory capital charge 1alls 1ro+ ' percent to
%*! percent*
E/a*+,e
Vet us /isualize a =ank, say Bank I )hich has specialized itsel1 in lending to the o11ice
e<uip+ent seg+ent* Gut o1 e4perience o1 years, this =ank has ac<uired a specialized
kno)ledge o1 the e<uip+ent industry* There is another =ank, Bank B, )hich is, say,
specialized in the cotton te4tiles industry* Both these =anks are specialized in their o)n
seg+ents, =ut =oth su11er 1ro+ risks o1 port1olio concentration* Bank I is concentrated in the
o11ice e<uip+ent seg+ent and =ank B is 1ocused on the te4tiles seg+ent* 9nderstanda=ly,
=oth the =anks should di/ersi1y their port1olios to =e sa1er*
Gne o=/ious option 1or =oth o1 the+ is# Bank I should in/est in an unrelated port1olio, say
te4tiles* Ind Bank B should in/est in a port1olio in )hich it has not in/ested still, say, o11ice
e<uip+ent* :oing so )ould in/ol/e ine11iciency 1or =oth the =anks# as Bank I does not kno)
enough o1 the te4tiles seg+ent as =ank I does not kno) anything o1 the o11ice e<uip+ent
seg+ent*
Pere, credit deri/ati/es o11er an easy solution# =oth the =anks, )ithout trans1erring their
port1olio or reducing their port1olio concentration, could =uy into the risks o1 each other* So
=ank B =uys a part o1 the risks o1 the port1olio that is held =y Bank I, and /ice /ersa, 1or a 1ee*
Both continue to hold their port1olios, =ut =oth are no) di/ersi1ied* Both ha/e di/ersi1ied their
Business & ,T -odel . Cards /%*00% "age o1 $00
Foundation Course in Banking
T:+es o8 Credit Deri<ati<es
Credit deri/ati/es can =e classi1ied in t)o +ain groups# Single na+e instru+ents are those that
in/ol/e protection against de1ault =y a single re1erence entity* -ulti&na+e credit deri/ati/es are
contracts that are contingent on de1ault e/ents in a pool o1 re1erence units*
Business & ,T -odel . Cards /%*00% "age ' o1 $00
Foundation Course in Banking
T(EA!)(% !E(V&CE!
T@e Treasur: !er<i;es de+art*ent is ;on;erned Ait@ *anaging t@e 8inan;ia, risks o8 t@e
=ank. Pence, the treasurerRs Ko= is to understand the nature o1 these risks, the )ay they interact
)ith the =usiness, and to +ini+ize or to o11set the+* ,n +any cases, the treasury ser/ices
depart+ent also pro/ides cash +anage+ent solutions 1or custo+ers o1 the =ank* The Treasury
ser/ices depart+ent o1 a =ank per1or+s the 1ollo)ing 1unctions#
-anaging the cash position o1 the =ank, +anaging li<uidity and
associated risks
Fore4 ser/ices# pro/ides 1ore4 ser/ices to corporates, enters in to
deals )ith +ultiple counterparties to +aintain a risk&+anaged
position 1or the =ank*
6isk +anage+ent ser/ices# pro/ides risk +anage+ent products like
s)aps, options etc to corporates and enters in to +ultiple deals )ith
/arious counterparties to +aintain a risk&+anaged position 1or the
=ank*
Conducts research on /arious +arket 1actors, +onitors interest rate
and econo+ic scenario etc
Cash -anage+ent ser/ices 1or corporates . +anaging collections
and pay+ents
Typically, the treasury has a 1ront o11ice desk )hich enters in to trades 7in 1ore4, +oney +arkets,
e<uity, treasury securities etc8 )ith /arious +arket participants and a +iddle o11iceF=ack o11ice
desk )hich +onitors positions and pro/ides operational support*
-ost large in/est+ent =anks pro/ide Treasury Ser/ices to their clients* Treasury do+ain
includes
Fi/ed &n;o*e : In in/est+ent that pro/ides a return in the 1or+ o1
1i4ed periodic pay+ents and e/entual return o1 principle at +aturity*
9nlike a /aria=le&inco+e security )here pay+ents change =ased on
so+e underlying +easure, such as short&ter+ interest rates, 1i4ed&
inco+e securities pay+ents are kno)n in ad/ance*
$one: $arkets # The +oney +arket is a su=section o1 the 1i4ed
inco+e +arket* The di11erence =et)een the +oney +arket and the
1i4ed inco+e +arket is that the +oney +arket specializes in /ery
short&ter+ de=t securities 7de=t that +atures in less than one year8*
-oney +arket in/est+ents are also called cash in/est+ents
=ecause o1 their short +aturities* So+e o1 the popular +oney
+arket instru+ents include Certi1icates o1 :eposit 7C:8, Co++ercial
"aper 7C"8, Treasury Bills 7T&Bills8
Foreign E/;@ange # The +arket 1or =uying and selling o1 currencies
is called the Foreign Q4change +arket 7FW 8* ,t is a $2 hour non&stop
+arket* So+e o1 the +aKor Currency traded include . The 9S
:ollar 79S:8, The Japanese Den 7J"D8, The Quro 7Q968, The Great
Britain "ound 7GB"8, The S)iss Frank 7CPF8* FW rates e4press the
/alue o1 one currency in ter+s o1 another currency* They in/ol/e
o The co++odity currency & the currency =eing priced, usually % unit or a 1i4ed a+ount o1
currency*
o The ter+s currency & the currency used to e4press the price o1 the co++odity, in
/arying a+ounts o1
Business & ,T -odel . Cards /%*00% "age 0 o1 $00
Foundation Course in Banking
OTC Deri<ati<es : G/er the counter 7GTC8 +arkets are a 1or+ o1
Secondary +arkets* World o/er Secondary +arkets are classi1ied
as Visted and GTC* Visted +arkets typically are e4changes )here a
security is listed and traded* I decentralized +arket o1 securities not
listed on a e4change )here +arket participants trade o/er the
telephone, 1acsi+ile or electronic net)ork instead o1 a physical
trading 1loor or electronic order +atching syste+s* There is no
central e4change or +eeting place 1or this +arket* Typically
Currency instru+ents are traded GTC* I deri/ati/e contract deri/es
its /alue =ased on the /alue o1 so+e =asic underlying* The
underlying +ay =e any instru+ent like a =ond, a stock or a +arket
inde4, currency or interest rates* So+e o1 the instru+ents traded
GTC include
o ForAard (ate Agree*ent 1F(A3 & I contract that deter+ines the rate o1 interest,
or currency e4change rate, to =e paid, or recei/ed, on an o=ligation =eginning at a so+e
1uture start date* ,t is also re1erred to as Future 6ate Igree+ent*
o &nterest (ate !Aa+ 1&(!8 & I deal =et)een =anks or co+panies )here =orro)ers s)itch
1loating&rate loans 1or 1i4ed rate loans in another country* These can =e either the sa+e
or di11erent currencies* The +oti/e +ay =e the co+petiti/e ad/antage o1 one co+pany to
ha/e access to lo)er 1i4ed rates than another co+pany* The other co+pany +ay =e
co+petiti/ely placed to ha/e access to lo)er 1loating rates* I s)ap )ould =e =ene1icial
to =oth* The s)ap is +easured =y its notional principal*
FF O+tions : Fore4 Gptions gi/e the holder the right to =uy or sell a
currency in ter+s o1 another currency at a particular rate on a
particular date or )ithin a period o1 ti+e* The option to =uy is called
as a Call Gption and the option to sell is called as a "ut Gption*
EGuit: O+tions . These are si+ilar to FW options the only di11erence
is the underlying* The underlying in case o1 Q<uity Gptions are
stocks or stock +arket indices* When the underlying is a stock
+arket inde4 the ter+ used is ,nde4 Gption and the ter+ used to
re1er options on indi/idual stocks is Stock Gption
Credit Deri<ati<es - "ri/ately held negotia=le =ilateral contracts that
allo) users to +anage their e4posure to credit risk* Credit
:eri/ati/es are 1inancial assets like 1or)ard contracts, s)aps, and
options 1or )hich the price is dri/en =y the credit risk o1 econo+ic
agents 7pri/ate in/estors or go/ern+ents8* For e4a+ple, a =ank
concerned that one o1 its custo+ers +ay not =e a=le to repay a loan
can protect itsel1 against loss =y trans1erring the credit risk to another
party )hile keeping the loan on its =ooks*
Fun;tions o8 t@e Treasur: $anager
Qnsure a/aila=ility o1 1unds . In integrated treasury typically )ould
include de=t +arket, +oney +arket and 1ore4 transactions* Treasury
+anager needs to ensure that ade<uate 1unds are a/aila=le to co/er
the settle+ent o=ligations o1 the said transactions*
-anage all 1oreign currency transactions 1or the =ank
-anage /arious risks#
o Vi<uidity . 6isk o1 asset and lia=ility cash 1lo) +is+atch* I =ank +ay not ha/e ade<uate
1unds 1or the settle+ent o1 its transactions or to pay its custo+ers =ecause o1
+is+atches in the tenor o1 its recei/a=les
Business & ,T -odel . Cards /%*00% "age '0 o1 $00
Foundation Course in Banking
o ,nterest rate . 6isk due to /olatility o1 interest rates* I =ank +ay ha/e =orro)ed at
1loating rates o1 interest and lent at 1i4ed rate o1 interest and the interest rates +o/es up
o Currency . 6isk due to /olatility in e4change rates* I =ank +ay ha/e its pay+ent
o=ligations in a currency say 9S: and the rate to purchase the said currency goes up
Co++odity . 6isk due to /olatility in co++odity prices* I =ank +ay
ha/e an o=ligation to deli/er a co++odity in the 1uture and the price
o1 the co++odity +o/es up
Cash -anage+ent Ser/ices & C-S is a ser/ice pro/ided =y =anks to
its corporate clients 1or a 1ee to reduce the 1loat on collections and to
ease the =ulk pay+ent transactions o1 the client* The three ele+ents
o1 C-S are#
o 6ecei/a=les -anage+ent .Pelps the co+pany to +anage collection o1 its sale proceeds
1ro+ re+ote upcountry regions
o "aya=les -anage+ent . Pelps the co+pany to +anage its pay+ents to its regular
suppliers )ithout keeping nu+erous =ank accounts 1or /arious locations and then
reconciles the+ periodically in a highly +anual F paper&=ased en/iron+ent
o Vi<uidity -anage+ent . Pelps the co+pany =y ensuring direct and instant access to its
=ank accounts* ,t should not happen that a co+pany has e4cess 1unds in one =ank
account and it needs to pay through another =ank account )here there are no 1unds
-anaging Vi<uidity H ,nterest 6ate risks
o Isset Via=ility -anage+ent . I =ank;s assets and lia=ilities need to necessarily +atch*
,1 they don;t the =ank +ay ha/e li<uidity pro=le+s )hich )ould endanger its sol/ency*
The long ter+ assets should not =e 1inanced =y short ter+ sources o1 1unds* The =ank
)ould not =e a=le to ser/e its lenders i1 the ti+ings o1 its in1lo)s do not +atch its
out1lo)s* I =ank typically uses +athe+atical tools like :uration, Gap Inalysis to 1ind out
+is+atches and take correcti/e actions
E/a*+,e
I =ank =orro)s 9S: %00-- at (*00A 1or one year
The =ank uses this =orro)ed +oney to lend to a highly&rated =orro)er 1or 5 years at (*$0A*
For si+plicity, assu+e interest rates are annually co+pounded and all interest accu+ulates to the
+aturity o1 the respecti/e o=ligations* The net transaction appears pro1ita=leZthe =ank is earning
a $0 =asis point spreadZ=ut it entails considera=le risk*
It the end o1 one year, the =ank )ill ha/e to 1ind ne) 1inancing 1or the loan, )hich )ill ha/e 2
+ore years =e1ore it +atures* Issu+e interest rates are at 2*00A at the end o1 the 1irst year*
The Bank )ill no) ha/e to pay a higher rate o1 interest 72*00A8 on the ne) 1inancing than the
1i4ed (*$0 it is earning on its loan* ,t is going to =e earning (*$0A on its loan and paying
2*00A on its 1inancing*
The pro=le+ in this si+ple e4a+ple )as caused =y a +aturity +is+atch =et)een assets and
lia=ilities* Is long as interest rates e4perienced only +odest 1luctuations, losses due to asset&
lia=ility +is+atches are s+all or tri/ial* Po)e/er, in a period o1 /olatile interest rates, the
+is+atches )ould =eco+e serious*
Business & ,T -odel . Cards /%*00% "age '% o1 $00
Foundation Course in Banking
The treasury asset-,ia=i,it: *anage*ent 1AL$3 group assesses asset&lia=ility risk and all =anks
ha/e IV- co++ittees co+prised o1 senior +anagers to address the risk* Techni<ues 1or
assessing asset&lia=ility risk ca+e to include gap analysis, duration analysis and scenario
analysis* 'a+ ana,:sis ,ooks at a*ount o8 assets and ,ia=i,ities in <arious *aturit: =u;kets
A@i,e Duration ana,:sis ,ooks at Aeig@ted a<erage *aturit: o8 ;as@ 8,oAs to ;o*+are
assets and ,ia=i,ities. Since li<uidity +anage+ent is closely linked to asset&lia=ility
+anage+ent, assess+ent and +anage+ent o1 li<uidity risk is also a 1unction o1 IV-
depart+ents and IV- co++ittees* IV- strategies o1ten include securitization, )hich allo)s 1ir+s
to directly address asset&lia=ility risk =y re+o/ing assets or lia=ilities 1ro+ their =alance sheets*
This not only eli+inates asset&lia=ility risk? it also 1rees up the =alance sheet 1or ne) =usiness*
,nterest rate risk +anage+ent
o -anage risks due to /olatility o1 interest rates & :e+and and supply o1 +oney go on
changing 1ro+ ti+e to ti+e +aking interests rates /olatile* I =ank +ay ha/e accepted
deposits at a 1i4ed rate o1 interest historically* Po)e/er current +arket rates +ay =e
lo)er )hen it )ishes to lend* The =ank;s port1olio /alue o1 in/est+ents in =onds and
treasury also /aries in/ersely )ith the interest rates* I higher interest rate di+inishes the
/alue o1 a =ank;s port1olio and /ice /ersa* ,nstru+ents like interest rate s)aps and
currency s)aps help to address ,nterest 6ate risks
Causes o8 interest rate risk
The causes o1 interest rate risk +ight /ary#
(e+ri;ing risk: The pri+ary 1or+ o1 interest rate risk arises 1ro+
ti+ing di11erences in the +aturity 71or 1i4ed rate8 and repricing 71or
1loating rate8 o1 =ank assets, lia=ilities and o11&=alance&sheet 7GBS8
positions* For instance, a =ank that 1unded a long&ter+ 1i4ed rate
loan )ith a short&ter+ deposit could 1ace a decline in =oth the 1uture
inco+e arising 1ro+ the position and its underlying /alue i1 interest
rates increase*
%ie,d ;ur<e risk: Dield cur/e risk arises )hen unanticipated shi1ts o1
the yield cur/e 7a plot o1 in/est+ent yields against +aturity periods8
ha/e ad/erse e11ects on a =ankRs inco+e or underlying econo+ic
/alue* Dield cur/es can shi1t parallel or change in steepness, posing
di11erent risks* For instance, the underlying econo+ic /alue o1 a long
position in %0&year go/ern+ent =onds hedged =y a short position in
5&year go/ern+ent notes could decline sharply i1 the yield cur/e
steepens, e/en i1 the position is hedged against parallel +o/e+ents
in the yield cur/e*
Basis risk: Basis risk arises 1ro+ i+per1ect correlation in the
adKust+ent o1 the rates earned and paid on di11erent instru+ents )ith
other)ise si+ilar repricing characteristics* For e4a+ple, a strategy o1
1unding a one year loan that reprices +onthly =ased on the one
+onth 9*S* Treasury Bill rate, )ith a one&year deposit that reprices
+onthly =ased on one +onth Vi=or, e4poses the institution to the risk
that the spread =et)een the t)o inde4 rates +ay change
une4pectedly*
O+tiona,it:: In additional and increasingly i+portant source o1
interest rate risk arises 1ro+ the options e+=edded in +any =ank
assets, lia=ilities and GBS port1olios* Gptions +ay =e stand alone
Business & ,T -odel . Cards /%*00% "age '$ o1 $00
Foundation Course in Banking
instru+ents such as e4change&traded options and o/er&the&counter
7GTC8 contracts, or they +ay =e e+=edded )ithin other)ise
standard instru+ents* They include /arious types o1 =onds and notes
)ith call or put pro/isions, loans )hich gi/e =orro)ers the right to
prepay =alances, and /arious types o1 non&+aturity deposit
instru+ents )hich gi/e depositors the right to )ithdra) 1unds at any
ti+e, o1ten )ithout any penalties* ,1 not ade<uately +anaged, the
asy++etrical payo11 characteristics o1 instru+ents )ith optionality
1eatures can pose signi1icant risk particularly to those )ho sell the+,
since the options held, =oth e4plicit and e+=edded, are generally
e4ercised to the ad/antage o1 the holder and the disad/antage o1 the
seller*
$anaging interest rate risk
Bank treasuries +easure interest rate sensiti/ity o1 securities 7assets or lia=ilities8 through
:uration analysis* :uration is a +athe+atical concept )hich can =e used to +easure the
sensiti/ity o1 a 1inancial instru+ent;s price to changes in interest rate* Gn the =asis o1 duration
analysis, =anks can increaseFdecrease holdings o1 long ter+ and short ter+ securities in
response to anticipated changes in interest rate*
Banks also use deri/ati/e instru+ents like interest rate s)aps and options to +anage interest
rate risks 7I deri/ati/e is a generic ter+ o1ten used to categorize a )ide /ariety o1 1inancial
instru+ents )hose /alue 3depends on5 or is 3deri/ed 1ro+5 the /alue o1 an underlying asset,
re1erence rate or inde48* So+e o1 the+ are#
o &nterest (ate !Aa+: In agree+ent to e4change net 1uture cash 1lo)s* ,n
its co++onest 1or+, the 1i4ed&1loating s)ap, one counterparty pays a 1i4ed rate
and the other pays a 1loating rate =ased on a re1erence rate, such as Vi=or*
There is no e4change o1 principal* The interest rate pay+ents are +ade on an
agreed notional a+ount*
o ForAard (ate Agree*ent 1F(A3: I F6I allo)s purchasers F sellers to 1i4
the interest rate 1or a speci1ied period in ad/ance* Gne party pays 1i4ed, the other
an agreed /aria=le rate* -aturities are generally out to t)o years and are priced
o11 the underlying yield cur/e* The transaction is done in respect o1 an agreed
no+inal a+ount and only the di11erence =et)een contracted and actual rates is
paid*
o &nterest (ate 'uarantee: In option on a 1or)ard rate agree+ent 7F6I8,
also kno)n as a F6Ition* "urchasers ha/e the right, =ut not the o=ligation, to
purchase a F6I at a predeter+ined strike* Caps and Floors are strips o1 interest
rate guarantees*
o !Aa+tion: In option to enter an interest rate s)ap* I payer s)aption gi/es
the purchaser the right to pay 1i4ed 7recei/e 1loating8, a recei/er s)aption gi/es
the purchaser the right to recei/e 1i4ed 7pay 1loating8*
Fore/ $anage*ent . Si+ilar to interest rates, the 1ore4 rates o1
countries )ho ha/e not pegged their currencies /ary 1ro+ ti+e to
ti+e* This e4poses its +arket participants to risk o1 ad/erse
+o/e+ents o1 e4change rates* FW For)ards and Fore4 Gptions
pro/ide a +eans o1 reducing e4change rate risks =y entering into
contracts at 1i4ed rates there=y +aking the outco+e predicta=le
Business & ,T -odel . Cards /%*00% "age '( o1 $00
Foundation Course in Banking
Foreign e4change is essentially a=out e4changing one currency 1or another* Fore4 rates =et)een
t)o currencies at any point o1 ti+e are in1luenced =y a /ariety o1 1actors like state o1 the econo+y,
interest rates H in1lation rate, e4change rate syste+s 71i4edF1loating8, te+porary de+and&supply
+is+atches, 1oreign trade position etc*
Foreign e4change e4posures 1or a 1inancial entity arise 1ro+ +any di11erent acti/ities* I co+pany
)hich =orro)s +oney in a 1oreign currency is at risk )hen the local currency depreciates /is&[&/is
the 1oreign currency* In e4porter )ho sells its product in 1oreign currency has the risk that i1 the
/alue o1 that 1oreign currency 1alls then the re/enues in the e4porterRs ho+e currency )ill =e
lo)er* In i+porter )ho =uys goods priced in 1oreign currency has the risk that the 1oreign
currency )ill appreciate there=y +aking the cost in local currency greater than e4pected*
Generally the ai+ o1 1oreign e4change risk +anage+ent is to sta=ilise the cash 1lo)s and reduce
uncertainty 1ro+ 1inancial 1orecasts*
Since a =ank is usually a counter party to the a=o/e transactions, it 1aces si+ilar 1ore4 6isk )hen
the re/erse happens*
Basi;s o8 8ore/
Currencies are <uoted in one o1 the t)o )ays#
:irect Uuotation 7% 9S: > ,N6 25*$!8 H
,ndirect Uuotation 7,N6 %00 > 9S: $*$%8*
@:irect; or @,ndirect; are al)ays /is&[&/is the 9S dollar percepti/e* ,n practice, all currencies e4cept
the British "ound are <uoted in the direct <uotation +ethod* Since rates 1or all currencies are
<uoted /is&[&/is the 9S dollar, cross currency rates 7e4a+ple# ,N6FQuro8 )ould =e o=tained =y
co+=ining the t)o pri+ary currency <uotes /is&[&/is the 9S dollar*
Ilso, <uotes usually ha/e t)o parts# the =id rate 7rate at )hich the =ank )ill purchase 9S dollars
against ho+e currency in case o1 direct <uotes8 and the ask rate 7rate at )hich the =ank )ill sell
9S dollars against ho+e currency in case o1 direct <uotes8* The =id rate )ill al)ays =e lesser
than the ask rate to co/er 1or operational charges and pro1it +argins o1 the =anks* Q4a+ples are#
,N6F9S: <uote# 25*$!F*(! 7here, 0*0% is the s+allest count, re1erred
to as one @pip;8
Q96F9S: <uote# %*$25'F*$2!% 7here, 0*000% is the s+allest count,
re1erred to as one @pip;8
While the deri/ed cross currency rate )ould =e#
,N6FQuro <uote# 725*$!C%*$2!%8F 725*(!C%*$25'8 > 5!*20F*5%
Foreign currency deals in a particular currency necessary ha/e to =e settled in the ho+e nation o1
the currency* Pence, =anks taking part in international transactions need to +aintain accounts in
/arious countries to ena=le transacting in those currencies* These accounts are o1 +ultiple types#
Nostro 7GurF+y account )ith you8# Current account +aintained =y
one =ank )ith another =ank a=road in the latter;s ho+e currency
Mostro 7Their account )ith +eFus8# Current account +aintained in the
ho+e currency =y one =ank in the na+e o1 another =ank =ased
a=road
Typically, =anks @a<e <ostro.nostro a;;ounts Ait@ *u,ti+,e 8oreign =anks.
!+ot and ForAard Foreign E/;@ange Contra;ts
Business & ,T -odel . Cards /%*00% "age '2 o1 $00
Foundation Course in Banking
The +ost =asics tools o1 1ore4 risk +anage+ent are RspotR and R1or)ardR contracts* These are
contracts =et)een end users and 1inancial institutions that speci1y the ter+s o1 an e4change o1
t)o currencies* ,n any 1ore4 contract there are a nu+=er o1 /aria=les that need to =e agreed upon
and they are#
The currencies to =e =ought and sold & in e/ery contract there are
t)o currencies the one that is =ought and the one that is sold
The a+ount o1 currency to =e =ought or sold
The date at )hich the contract +atures
The rate at )hich the e4change o1 currencies )ill occur
The e4change rates ad/ertised either in the ne)spapers 7and that +entioned a=o/e8 or on the
/arious in1or+ation ser/ices assu+e a deal )ith a +aturity o1 t)o =usiness days ahead & a deal
done on this =asis is called a spot deal* ,n a spot transaction the currency that is =ought )ill =e
recei/a=le in t)o days )hilst the currency that is sold )ill =e paya=le in t)o days* This applies to
all +aKor currencies )ith the e4ception o1 the Canadian :ollar*
-ost +arket participants )ant to e4change the currencies at a ti+e other than t)o days in
ad/ance =ut )ould like to kno) the rate o1 e4change no)* This is done through a 1or)ard
contract to e4change the currencies at a speci1ied e4change rate at a speci1ied date* ,n
deter+ining the rate o1 e4change in si4 +onths ti+e there are t)o co+ponents#
the current spot rate
the 1or)ard rate adKust+ent
The spot rate is si+ply the current +arket rate as deter+ined =y supply and de+and* The
1or)ard rate adKust+ent is a slightly +ore co+plicated calculation that in/ol/es the interest rates
o1 the currencies in/ol/ed*
ForAard rate 1Lo;a, ;urren;:.)!D3 9 !+ot rate -112 interest rate in )!3 . 112 ,o;a, interest
rate37 )ith interest rates adKusted 1or the period o1 the 1or)ard rate* The concept =ehind this
e<uation is that i1 you de1er the /alue date o1 a spot transaction each party )ill ha/e the 1unds
that they )ould ha/e paid to in/est* The di11erence =et)een a 1ore4 spot rate and the 1or)ard rate
1or a particular tenure is called the 1or)ard pre+iu+ 1or that tenure* Currencies can ha/e 1or)ard
pre+iu+s or 1or)ard discounts /is&[&/is the 9S dollar*
Fore4 risk can also =e co/ered through 1ore4 1uture contracts* Futures are e4actly si+ilar to
1or)ards, e4cept 1or the 1act that these deals are =rokered through an e4change, non&
custo+iza=le 7only standard deals a/aila=le8 and hence, not prone to counter&party risk*
Bi8ur;ation o8 A,, *aRor *arkets 1EGuities7 Bond7 FF7 Deri<ati<es3
S+all and Varger Grders . Q<uity +arkets are characterized =y
s+aller orders as co+pared to the +arkets 1or other 1inancial
instru+ents =ecause o1 +ore retail participation
Vi<uidity . Q4change traded instru+ents are +ore li<uid
,n/estor "ro1ile . Q<uity +arkets ha/e a +ore retail in/estor pro1ile
as co+pared to +arkets 1or other 1inancial instru+ents
6outing . :eals in the Q<uity +arkets are routed to +ultiple
destinations )here as deals in 1ore4 as )ell as de=t +arkets are
3+atched5 internally
"u=lic /Fs "ri/ate & -arkets 1or e<uities are listed )hereas certain
:eri/ati/es are GTC
Business & ,T -odel . Cards /%*00% "age '5 o1 $00
Foundation Course in Banking
Treasur: a++,i;ations seg*ents N <endors
Treasury -anage+ent Syste+s . ,nter&=ank
Cross&Isset Trading and 6isk
Sungard F Front Irena & F6GNT I6QNI is the de1initi/e integrated
solution 1or sales, trading and risk +anage+ent, operations and
distri=ution across +ultiple asset classes* ,ts rich 1unctionality
ena=les traders to +ake critical decisions )ith assurance* ,t is
1le4i=le across a range o1 =usiness areas gi/es )hich gi/es traders a
co+petiti/e edge in trading acti/ities*
Su++it & Su++it is a core solution 1or treasury +anage+ent 1or
=oth 1inancial and corporate institutions* Su++it;s trading
applications interact )ith operations and risk +anage+ent plat1or+s
to pro/ide a straight&through&processing solution* This allo)s 1ront to
=ack +anage+ent o1 all products )ithin 1our pri+ary =usiness areas
/iz Treasury, Fi4ed ,nco+e, :eri/ati/es and Co++ercial lending
Calypso & Calypso Technologies the )orld;s leading so1t)are
pro/ider o1 credit deri/ati/es, cross
asset trading, risk +anage+ent, and processing* ,t o11ers a 1ront&to&
=ack o11ice syste+ that allo)s traders 1le4i=ility to plug in their o)n
products*
Wall Street Syste+s & Wall Street Syste+s deli/ers single&ser/er,
enterprise&)ide solutions to the )orldRs leading 1inancial institutions
and corporations The Wall Street Syste+ 1inancial trading and
treasury engine pro/ides a +ulti&entity, +ulti¤cy, +ulti&asset
class en/iron+ent )hich supports all 1ront, +iddle and =ack o11ice
operations*
Treasury Sales . Bank to Custo+er
Single&=ank plat1or+
Cognotec . Cognotec is the )orldRs leading pro/ider o1 auto+ated
trading solutions to 1inancial enterprises across the glo=e* They
pro/ide 1ore4 dealing solutions* They ha/e partnered )ith )orld&
leading technology pro/iders, +ulti&=ank plat1or+s and industry
organizations*
,ntegral & ,ntegral is at the 1ore1ront o1 the eFW +arket in de/eloping
ne), highly inno/ati/e products* ,ntegral is the pro/ider o1 integrated
electronic trading syste+s, o11ering intuiti/e and inno/ati/e products
that auto+ate and strea+line the entire trading cycle*
-ulti&=ank plat1or+
6euters 6QT & 6euters Qlectronic Trading pro/ides a
co+prehensi/e FW and +oney +arkets trading solution 1or =anks** ,t
includes Iuto+ated :ealing, an internet =ased FW and +oney
+arket auto+ated dealing capa=ility, to ena=le the BankRs dealing
roo+ to price, e4ecute, con1ir+ and +anage FW and +oney +arket
trading*
Business & ,T -odel . Cards /%*00% "age '! o1 $00
Foundation Course in Banking
CA!# $AA'E$ET
Cas@ $anage*ent !er<i;e 1C$!3 is a ser/ice pro/ided =y =anks to its clients 1or a 1ee to
reduce the 1loat on collections and to ease the =ulk pay+ent transactions o1 the client* Varge
Corporations like G- or Ford need to +anage cash )ell since they ha/e#
"ay+ents to +ultiple parties at /arious locations . "ay+ents need to
=e +ade to suppliers across the country* Typically these ha/e
suppliers across the country to reduce dependence on one or a 1e)
suppliers
Collections 1ro+ +ultiple parties at /arious locations & Po) does a
co+pany collect its sale proceeds 1ro+ re+ote upcountry regionsL
-ultiple =anking accounts at /arious locations
o Qnsure local de1icits and surpluses are +anaged . I corporate +ay =e paying its
e+ployees salaries out o1 one =ank account )hereas it +ay =e =anking its recei/a=les in
another =ank account another location leading to surpluses and de1icits in their =ank
accounts
o Qnsure net surplus is in/ested properly . ,1 a corporate is una=le to identi1y surpluses, a
corporate +ay risk keeping +oney idle leading to loss o1 interest inco+e i1 it does not
prudently in/est its net surpluses leading to
o 6educe operational costs associated )ith pay+ents H collections . I C-S )ould help
opti+ize )asted operational cost on pay+ents and collections
Cash -anage+ent solutions help corporations#
o :e/ise an e11ecti/e account H in/est+ent strategy to +anage surpluses and de1icits .
"ooling, Netting, Tero&=alance structures
o Auto*ate ;o,,e;tions and +a:*ents +ro;ess 8,oAs
o Gutsource collections and pay+ents ad+inistration H reconciliation
E/a*+,e
Consider a consu+er goods co+pany in -id&)est 9S, )ith dealerships spread through %$ states*
The co+pany has a +anu1acturing 1acility in -ichigan and 2 depots, one each in Ghio, -ichigan,
,llinois and Te4as* The co+pany transports goods to the 2 depots )hich ser/es the respecti/e
local dealers and in so+e cases dealers in neigh=oring states* Ill the depots are treated as
independent cost centers, )ith sales 1ro+ respecti/e regions and salaries and general e4penses
1or these regions +arked to the depot concerned* Collections 1ro+ dealers in /arious locations
are +anaged =y local sales tea+s, one tea+ 1or each state* The co+pany )ants to#
Qnsure daily +onitoring o1 collections 1ro+ /arious states
S)eep all local collections daily to a central =ank account at -ichigan
Qnsure that local accounts do not re+ain in de=it )hen the central account is in credit*
"ro/ide 1acility 1or te+porary intra&day o/erdra1t 1or the local accounts
Qnsure that surplus +oney in the central account is in/ested in an opti+al 1ashion )hile
allo)ing su11icient li<uidity
Ill pay+ents 1ro+ local accounts a=o/e B%0,000 re<uire an appro/al 1ro+ the CFG sitting in
-ichigan
Business & ,T -odel . Cards /%*00% "age ' o1 $00
Foundation Course in Banking
This is a typical case )here the co+pany needs the ser/ices o1 a =ank to +anage its cash
collections and pay+ents* The co+pany needs =oth cash +anage+ent 1acilities and -,S o1
collections and pay+ents that can allo) it to track re/enue and e4penses in the +anner re<uired*
Co+panies rarely 1ail =ecause they are insol/ent* They do 1ail =ecause they are illi<uid*
Co+panies +ust 1ocus on precise )orking capital +anage+ent as a critical co+ponent o1
treasury strategy* Co+panies re<uire#
rich in1or+ation, to parallel the co+pany;s cash 1lo) cycle
glo=al cash concentration, through pooling +echanis+s
auto+ated internal 1unding +echanis+s 1or de1icit positions
,n/est+ent options to +atch indi/idual pro1iles 1or li<uidity, risk and
return*
So+e o1 the o11erings in Cash -anage+ent Ser/ices are &
"a:*ent . Dis=urse*ent O88erings
"ay+ent ser/ice 1or corporationsFretail custo+ers
o Banks process pay+ents on =ehal1 o1 corporations . C-S pro/ides its custo+ers the
pay+ent processing ser/ices )hich help corporations to reduce ad+inistrati/e hassles
and costs in doing so*
o ,nstru+ents & ChecksFde+and dra1tsF Qlectronic Fund Trans1er 7QFT8 help in processing
pay+ents
"ay+ent ,nitiation
o -anual instruction . Banks can act on +anual instructions gi/en =y the corporations to
their =ankers 1or processing pay+ents* They typically take the 1or+ o1 che<ues or dra1ts
o FloppyFQlectronic +edia instructions . I list o1 =ene1iciaries and the corresponding
a+ounts are gi/en in either a 1loppy or an other electronic +edia to their =anks in the
re<uired 1or+ats )hich are used =y the =anks 1or processing pay+ents
o Qlectronic =anking applications . Qlectronic applications like QCS F QFT or indi/idual
=ank speci1ic so1t)are packages can =e +ade use o1 =y corporations to e11ect trans1ers
Bulk pay+ents
C-S is /ery =ene1icial 1or processing repetiti/e F =ulk pay+ents in the nature listed =elo)*
Qcono+ies o1 scale and reduction o1 ad+inistrati/e and related costs can =e gained =y
corporations
o "ayroll processing
o :i/idend )arrants
o 6ede+ptions
Co,,e;tions !er<i;es
Collect 1unds around the glo=e . C-S pro/ides accurate and ti+ely
collection o1 recei/a=les )orld)ide
Funds are credited to the cash +anage+ent account
o Vocal collections . 6e1er to collections 1ro+ suppliers F de=tors )ho issue local che<ues
o Gutstation collections & 6e1er to collections 1ro+ custo+ers not in the =ase location o1
the corporation
Business & ,T -odel . Cards /%*00% "age '' o1 $00
Foundation Course in Banking
Banks ha/e responded to the call 1or e/ol/ed cash +anage+ent concepts* Iccelerating accounts
recei/a=le and strea+lining accounts paya=le /ia a single =anking syste+ inter1ace pro/ide the
stepping stone to achie/e opti+al cash 1lo) +anage+ent* So+e =anks also pro/ide aligned cash
+anage+ent )ith li<uidity and in/est+ent o11erings* They do so =y#
de/eloping opti+al account structures
applying cash concentration techni<ues like pooling and s)eeping
pro/iding in/est+ent /ehicles to +a4i+ize cash 1lo)s
i+ple+enting 1oreign e4change and interest rate e4posure netting
syste+s
Qsta=lishing regional treasury and shared ser/ice centers*
The 1inal o=Kecti/e o1 +ost o1 these cash +anage+ent solutions is to e11ecti/ely outsource the
corporate;s recei/a=les and paya=les process and ensure the =est possi=le li<uidity and short
ter+ in/est+ent +anage+ent strategy* -oreo/er, increasingly, cash +anage+ent 7=oth
pay+ents and collections8 are +o/ing o/er to a )e=&=ased en/iron+ent )here the corporate can
+anage his recei/a=les, paya=les and li<uidity position online* ,n +any cases, there is al+ost&
co+plete integration =et)een the =ank and the co+pany;s supply chainFQ6" syste+ )hich
+anages collection and pay+ents data internally* So+e o1 the co++on +ethods used 1or cash
+anage+ent are descri=ed =elo)*
C@eGue Co,,e;tions 5 Lo;k Bo/ ser<i;e
There are possi=ilities 1or opti+izing and strea+lining a co+pany;s inco+ing pay+ent 1lo)s* The
+ost co++on collection +echanis+ is a Che<ues lock =o4 ser/ice . a collecting ser/ice )hich
ena=les co+panies to collect and settle che<ues locally 7,n a typical case, each o1 the corporate;s
de=tors )ould send che<ues along )ith accepted in/oices to a designated post =o4, hence the
lock =o4 na+e8* Banks undertake to collect che<ues at /arious pre&de1ined locations on =ehal1 o1
the custo+er, send the+ 1or clearing and credit the a+ount s to a speci1ied custo+er account*
Gnce the che<ues are collected =y the =ank through person, courier or deli/ered =y the co+pany
representati/e#
the che<ues are sorted and =atched
post dated che<ues are kept 1or processing on the /alue date
the i+age o1 the che<ues and the re+ittance ad/ices are captured
and sent to the corporate
che<ues are sent 1or clearing, i1 re<uired
realized che<ues are tallied and a+ounts credited to the corporate;s
=ank account
the in1or+ation on che<ues collected is trans+itted to the corporate
1or electronic reconciliation
,n enhanced /ersions o1 this 1acility, the =ank +anage the recei/a=le =ooks o1 the corporate &
+anaging collections, +onitoring recei/a=les ageing and pro/iding reconciled collection reports
)hich can =e directly uploaded to corporate in1or+ationFsupply chain syste+s*
>ero =a,an;e stru;ture - "oo,ing
"ooling allo)s a co+pany or se/eral co+panies =elonging to the sa+e group pro1it 1ro+ e11icient
li<uidity +anage+ent, centralized treasury and credit&line +anage+ent and opti+ization o1
interest results* Banks o11er =oth do+estic and cross =order zero =alancing )here=y all /alue
=alances o1 a set o1 RparticipatingR accounts are centralized at the end o1 each day in one central
Business & ,T -odel . Cards /%*00% "age '0 o1 $00
Foundation Course in Banking
account* Thus the participating accounts )ill not =ear any credit or de=it interest, and all =alances
are concentrated in the central account ena=ling opti+al +anage+ent o1 your cash position*
etting
Netting is the 1unda+ental +ethod 1or centralising and o11setting intra co+pany and third party
pay+ents* Netting not only signi1icantly reduces pay+ent 1lo)s and costs, =ut also pro/ides
in/alua=le +anage+ent in1or+ation* Banks o11er =oth do+estic and cross&=order netting
solutions*
C,earing ser<i;es
Banks o11er clearing ser/ices to other =anks* ,n such cases, a =ank )ith strong local =ranch
co/erage o11ers to participate in clearing arrange+ents on =ehal1 o1 other =anks )ith no physical
presence at these locations* Ilso clu==ed under correspondent =anking ser/ices, this 1acility
pri+arily helps use the =ranch net)orks o1 /arious =anks on a co+pli+entary =asis*
eA A;t - C@e;k 21
The Check Clearing 1or the $%st Century Ict 7Check $%8 )as signed into la) on Gcto=er $',
$00(, and =eca+e e11ecti/e on Gcto=er $', $002* The la) 1acilitates check truncation =y
creating a ne) negotia=le instru+ent called a su=stitute check, )hich per+its =anks to
truncate original checks, to process check in1or+ation electronically, and to deli/er su=stitute
checks to =anks that )ant to continue recei/ing paper checks* I su=stitute check is the legal
e<ui/alent o1 the original check and includes all the in1or+ation contained on the original
check* The la) does not re<uire =anks to accept checks in electronic 1or+ nor does it re<uire
=anks to use the ne) authority granted =y the Ict to create su=stitute checks*
o Qlectronic trans+ission o1 che<ues =y Check i+aging & Banks 1ind that e4changing
electronic i+ages o1 checks )ith other =anks is 1aster and +ore e11icient than physically
transporting paper checks* To address this need, Check $% allo)s a =ank to create and
send a su=stitute check that is +ade 1ro+ an electronic i+age o1 the original check*
o Faster F e11icient che<ue realization . Since the electronic i+age o1 the che<ue can =e
<uickly trans+itted electronically, ti+e re<uired 1or transporting the physical paper
che<ues is greatly reduced there=y e11ecting 1aster che<ue realizations
DEVELO"$ET! & T(EA!)(% N CA!# $AA'E$ET
Asset !e;uritisation
Financial institutions and =anks need to raise 1resh capital to 1und continuous asset gro)th and
port1olio +anage+ent* This has =eco+e a +aKor challenge 1or +any 1inancial institutions and
=anks due to tough capital +arket conditions and other +arket related 1actors* Isset
securitisation can o11er an alternati/e cost e11icient 1inancing tool, ena=ling the+ to =etter +anage
li<uidity and 1unding re<uire+ents*
Isset securitisation transactions ha/e one =asic concept# the identi1ication and isolation o1 a
separa=le pool o1 assets that generate re/enue strea+s independently 1ro+ the originating entity*
The securities issued on these assets are then sold to in/estors )ho =ase their returns
e4clusi/ely on the underlying assets; per1or+ance* The structure is illustrated =elo)#
Business & ,T -odel . Cards /%*00% "age 00 o1 $00
Foundation Course in Banking
Ill these entities need not =e present in e/ery transaction* The nu+=er o1 entities depends on the
co+ple4ity o1 the transaction* In e4a+ple )ould help understand the concept =etter*
E/a*+,e
Bank o1 I+erica 7Griginator8 has 5000 ho+e loans totaling +ore than B!00 +illion* The indi/idual
loans are o1 /arious credit pro1iles and /arious repay+ent periods* Bank o1 I+erica is
constrained =y lack o1 1unds and )ishes to sell o11 its loans to raise +oney* Thus, it decides to
@sell; a=out $000 ho+e loans totaling B$00 +illion* The steps 1ollo)ed are sho)n =elo)#
Bank o1 I+erica conducts an internal study o1 the port1olio and ascertains that the a/erage
+aturity o1 the pool o1 loans is a=out %$ years and the a/erage credit rating )ould =e II&* ,t
realizes that historically %0A o1 the total ho+e loan o)ners de1ault* So it )ould only realize
B%'0 +illion instead o1 B$00 +illion*
Bank o1 I+erica )ants to enhance the rating so that it can @sell; the loans at a =etter price* ,t
decides to pro/ide a cash security o1 B%0 +illion 7Credit enhance+ent8 in the scenario o1 any
repay+ent de1ault =y ho+e loan =orro)ers*
Bank o1 I+erica appoints Credit rating agency W )hich analyses the pool o1 loans, and taking
into account the cash security pro/ided rates it IIE*
Bank o1 I+erica @sells; the pool o1 housing loans a+ounting to B$00 +illion to a independent
1ir+, "le4us S"M Vtd*
Backed =y these ho+e loan;s 1uture cash 1lo)s, "le4us S"M Vtd* issues de=t certi1icates 1or
B$00 +illion to in/estors* "le4us pays =ack the in/estors the +oney 1ro+ the repay+ents
done =y the ho+e loan =orro)ers*
"le4us S"M Vtd* pays B%0' +illion to Bank o1 I+erica a1ter deducting ser/ice charges to
co/er operational costs*
Fro+ no) on, all Q-, repay+ents on these ho+e loans +ade =y retail in/estors )ould 1lo)
through "le4us S"M Vtd and then reaches the in/estors*
The a=o/e e4a+ple captures the gist o1 any securitisation transaction, =ut there are a lot o1
structuring issues and legal and regulatory challenges in/ol/ed in any such transaction*
Business & ,T -odel . Cards /%*00% "age 0% o1 $00
Foundation Course in Banking
Fannie -ae and Ginnie -ae are e4a+ples o1 institutions specializing in securitisation
transactions o1 +ortgage loans 1or 9S =anks* They help 9S =anks in ha/ing enough 1resh 1unds
1or ho+e loan dis=urse+ents*
(ea, Ti*e 'ross !ett,e*ent 1(T'!3
The current pay+ent syste+ in/ol/es settle+ent o1 pay+ents on a @settle+ent day; and interest is
in/aria=ly co+puted to accrue on a daily =asis* Q/en in the )holesale +arkets 1or 1oreign
e4change and +oney +arkets contracts, @spot; transactions +ean t)o&=usiness days* Settle+ent
1or clearing che<ues presented to the clearing houses takes place on a netting =asis at a
particular ti+e either sa+e day or on the ne4t day* This syste+ gi/es rise to risks such as credit
risk, li<uidity risk, legal risk, operational risk and syste+ic risk*
6TGS is a syste+ pro/ides online settle+ent o1 pay+ents =et)een 1inancial institutions* ,n this
syste+ pay+ent instructions =et)een =anks are processed and settled indi/idually and
continuously throughout the day* This is in contrast to net settle+ents )here pay+ent instructions
are processed throughout the day =ut inter&=ank settle+ent takes place only a1ter)ards typically
at the end o1 the day* "articipant =anks )ill ha/e to +aintain a dedicated 6TGS settle+ent
account )ith the central =ank 1or out)ard and in)ard 6TGS pay+ents*
6TGS syste+s do not create credit risk 1or the recei/ing participant =ecause they settle each
pay+ent indi/idually, as soon as it is accepted =y the syste+ 1or settle+ent*
6TGS syste+ can re<uire relati/ely large a+ounts o1 intraday li<uidity =ecause participants need
su11icient li<uidity to co/er their outgoing pay+ents*
Continuous Linked !ett,e*ent 1CL!3
The a/erage daily turno/er in glo=al 1ore4 transactions stand at al+ost 9S: $ trillion, )ith
participants in the +arket spread across /arious geographies and ti+e zones* Po)e/er, the
di11erence in ti+e zones and hence lack o1 synchronization o1 transactions has resulted in
considera=le a+ount o1 syste+atic risk* Typically, one leg o1 a 1ore4 trade is a11ected at one point
o1 ti+e and there )ould =e a delay =e1ore the other leg is e4ecuted =ecause o1 ti+e&zone
di11erences* ,n such a situation, there is a heightened risk o1 one party de1aulting*
CVS eli+inates this @te+poral; settle+ent risk, +aking sa+e&day settle+ent =oth possi=le and
1inal* This is +ade possi=le =y le/eraging on the 1act that there are signi1icant o/erlaps =et)een
the +ain ti+e zones* CVS pro/ides a speci1ic ti+e )indo) in )hich /arious settle+ent ti+e zones
can interact and pass settle+ent +essages* The CVS syste+ consists o1 the 1ollo)ing entities#
CL! Bank: The CVS =ank is the central node 1or the CVS syste+*
CVS Bank is o)ned =y nearly 0 o1 the )orld;s largest 1inancial
groups throughout the 9S, Qurope and Isia "aci1ic, )ho are
responsi=le 1or +ore than hal1 the /alue trans1erred in the )orldRs FW
+arket*
!ett,e*ent $e*=ers: They are shareholders o1 the CVS =ank, )ho
can each su=+it settle+ent instructions directly to CVS Bank and
recei/e in1or+ation on the status o1 their instructions* Qach
Settle+ent -e+=er has a +ulti¤cy account )ith CVS Bank,
)ith the a=ility to +o/e 1unds* Settle+ent -e+=ers ha/e direct
access and input deals on their o)n =ehal1 and on =ehal1 o1 their
custo+ers* They can pro/ide a =randed CVS ser/ice to their third&
party custo+ers as part o1 their agree+ent )ith CVS Bank*
Business & ,T -odel . Cards /%*00% "age 0$ o1 $00
Foundation Course in Banking
)ser $e*=ers: 9ser -e+=ers can su=+it settle+ent instructions
1or the+sel/es and their custo+ers* Po)e/er, 9ser -e+=ers do not
ha/e an account )ith CVS Bank* ,nstead they are sponsored =y a
Settle+ent -e+=er )ho acts on their =ehal1* Qach instruction
su=+itted =y a user +e+=er +ust =e authorized =y a designated
Settle+ent -e+=er* The instruction is then eligi=le 1or settle+ent
through the Settle+ent -e+=erRs account*
T@ird +arties: Third parties are custo+ers o1 settle+ent and user
+e+=ers and ha/e no direct access to CVS* Settle+ent or user
+e+=ers +ust handle all instructions and 1inancial 1lo)s, )hich are
consolidated in CVS*
ostro agents: These agents recei/e pay+ent instructions 1ro+
Settle+ent -e+=ers and pro/ide ti+e&sensiti/e 1und trans1ers to
Settle+ent -e+=ersR accounts at CVS Bank* They recei/e 1unds
1ro+ CVS Bank, 9ser -e+=ers, third parties and others 1or credit to
the Settle+ent -e+=er account*
The =ene1its o1 the CVS syste+ are +any#
Traders can e4pand their FW =usiness )ith counterparty =anks
)ithout increasing li+its*
Treasury +anagers ha/e +ore certainty a=out intraday and end&o1&
day cash positions*
Glo=al settle+ent can rationalize nostro accounts and le/erage
+ulti¤cy accounts*
The /olu+e and o/erall /alue o1 pay+ents is reduced, as are cash&
clearing costs*
Costly errors are +ini+ized and any pro=le+s can =e resol/ed 1ast*
Auto*ated C,earing #ouse 8a;i,ities 1AC#3
ICP transactions are electronic clearing transactions in )hich in1or+ation a=out de=its and
credits are passed across the clearing syste+ through electronic data 1iles rather than physical
instru+ents like che<ues, dra1ts etc* ICP electronic transactions are distinguished 1ro+ )ire
trans1ers in that they are high /olu+e, regularly scheduled, usually =et)een the sa+e parties,
and are initiated /ia speci1ically 1or+atted electronic 1iles* Such transactions +ust usually =e
initiated one to t)o days prior to the settle+ent date, since they are =atch processed and not 1or
i++ediate pay+ent* The +ost co++on ICP pay+ent applications are#
:irect deposit o1 payroll, )here the =ank de=its the corporate
account and credits e+ployee accounts on the =asis o1 a electronic
1ile trans+ittedFpro/ided =y the corporate
Corporate :is=urse+ent Ser/ice, )here the =ank de=its a clientRs
account to initiate pay+ents to /endors on their =ehal1
Corporate Collection Ser/ice, )here the =ank ena=les it;s clients to
collect pay+ents and re+ittance data 1ro+ /endors or trading
partners*
Collection o1 consu+er pay+ents o/er the telephone, through the
,nternet or /ia check&to&ICP con/ersion*
Business & ,T -odel . Cards /%*00% "age 0( o1 $00
Foundation Course in Banking
ICP Iccounts 6ecei/a=le Check Con/ersion ena=les con/erting
checks collected at a lock=o4 or re+ittance&processing center to
ICP electronic de=its, speeding pay+ent collections and i+pro/ing
1unds a/aila=ility*
These ser/ices allo) the custo+er to increase transaction speed and i+pro/e accuracy and ease
o1 reconciliation =y electronic +eans and a/oidance o1 physical instru+ents and clearing delays*
ICP has =een an area o1 /ery strong gro)th, )ith o/er '*5 =illion transactions =eing e11ected
through this route in $00$* Po)e/er, se/eral security issues re+ain to =e resol/ed in this area*
Business & ,T -odel . Cards /%*00% "age 02 o1 $00
Foundation Course in Banking
T(ADE F&ACE
The +ain o=Kecti/e o1 trade 1inance is to 1acilitate transactions* There are +any 1inancing options
a/aila=le to 1acilitate international trade such as pre&ship+ent 1inance to produce or purchase a
product, and post&ship+ent 1inance o1 the recei/a=les*
"(E !#&"$ET LOA!
Banks pro/ide "re&ship+ent 1inance & )orking capital 1or purchase o1 ra) +aterials, processing
and packaging o1 the e4port co++odities*
"O!T !#&"$ET LOA!
"ost&ship+ent 1inancing assists e4porters to =ridge their li<uidity needs )here e4ports are +ade
under de1erred pay+ent =asis* I typical e4a+ple o1 post&ship+ent 1inancing is =ills discounting*
Bills discounting 1acility ser/es to pro/ide li<uidity to an e4porter =y ad/ancing hi+Fher a portion
o1 the 1ace /alue o1 a trade =ill dra)n =y the e4porter, accepted =y the =uyer and endorsed to the
Bank*
,n co+petiti/e supply situations, 1a/ora=le ter+s o1 pay+ent o1ten ensure that the order is
)on* In e4porter usually )ants to get paid as <uickly as possi=le and an i+porter )ill )ant to pay
as late as possi=le . pre1era=ly a1ter they ha/e sold the goods* Trade 1inance is o1ten re<uired to
=ridge these t)o disparate o=Kecti/es*
FACTO(! & C#OO!&' T#E $ODE OF F&AC&'
Costs: The cost o1 di11erent 1inancing +ethods can /ary, =oth in
ter+s o1 interest rates and 1ees* These costs )ill i+pact the /ia=ility
o1 a transaction
Ti*e Fra*e: :epending on the need, short, +ediu+ and long&ter+
1inance 1acilities +ay =e a/aila=le* The di11erent possi=ilities should
=e e4plored )ith the 1inance pro/ider prior to concluding a
transaction* Vong&ter+ re<uire+ents should also =e considered to
ensure 1ees are not =eing paid out on a re/ol/ing 1acility that could
=e sa/ed =y using a di11erent 1inancing structure
(isk Fa;tors: The nature o1 the product or ser/ice, the =uyers;
credit rating and countryFpolitical risks can all a11ect the security o1 a
trading transaction* ,n so+e cases it )ill =e necessary to o=tain
e4port insurance or a con1ir+ed letter o1 credit* ,ncreased risks )ill
nor+ally correspond to increased cost in a transaction and )ill
Uuestion
"re&ship+ent 1inance is li<uidated only through realizations o1 e4port =ills or a+ounts recei/ed
through e4port incenti/es* "re ship+ent 1inance should not nor+ally re+ain outstanding
=eyond the original stipulated ship+ent date* ,n case it re+ains outstanding, can the non&
adKusted a+ount =e then trans1erred as post ship+ent 1inanceL
Business & ,T -odel . Cards /%*00% "age 05 o1 $00
Foundation Course in Banking
nor+ally +ake the 1unding o1 a particular transaction, harder to
o=tain
'o<ern*ent 'uarantee "rogra*s: These can so+eti+es =e
o=tained )here there is so+e <uestion o/er the e4porter;s a=ility to
per1or+ or )here increased credit is needed* ,1 o=tained, these +ay
ena=le a lender to pro/ide +ore 1inance than their usual under)riting
li+its )ould per+it*
E/+ortersQ Funds: ,1 the e4porter has su11icient resources, heFshe
+ay =e a=le to e4tend credit )ithout the need 1or third party
1inancing* Po)e/er, an esta=lished trade 1inance pro/ider, o11ers
other =ene1its like e4pert credit /eri1ication and risk assess+ent as
)ell as an international net)ork o1 o11ices and sta11 to ensure that the
transaction is co+pleted sa1ely and satis1actorily
B&LL OF LAD&'
I =ill o1 lading or BGV is#
I contract =et)een a carrier and a shipper 1or the transportation o1
goods*
I receipt issued =y a carrier to a shipper 1or goods recei/ed 1or
transportation*
Q/idence o1 title to the goods in case o1 a dispute*
The BGV grants the carrier the right to su=&contract its o=ligations on any ter+s and )ould =ind a
shipper e/en i1 it +eant that the shipperRs goods could =e detained and sold =y the su=&
contractor*
C(ED&T C#ECD
,nsuring pay+ent starts long =e1ore a contract is signed* The seller, or his representati/e,
per1or+s @due diligence; or a reasona=le assess+ent o1 the risks posed =y the potential =uyer*
The sources o1 in1or+ation include#
Cha+=ers o1 co++erce, Business Bureaus or their e<ui/alents
Credit rating ser/ices such as T6W and :un H Bradstreet )hich
ha/e international a11iliates
Trade associations and trade pro+otion organizations
Freight 1or)arders, =rokers, and =anks
:irect re1erences 1ro+ the =uyer
"A%$ET $ET#OD!
Gnce accepta=le risks ha/e =een deter+ined then the +ost appropriate pay+ent +ethod can =e
selected* The +ost co++on pay+ent +ethods are descri=ed =elo)#
Cash in ad/ance
Vetter o1 credit
:ocu+entary collection
Gpen account or credit
Counter&trade or Barter
Business & ,T -odel . Cards /%*00% "age 0! o1 $00
Foundation Course in Banking
CA!# & ADVACE
Cash in ad/ance is risk&1ree e4cept 1or potential non&deli/ery o1 the goods =y the seller* ,t is
usually a )ire trans1er or a check* Ilthough an international )ire trans1er is +ore e4pensi/e, it is
o1ten pre1erred =ecause it is speedy and does not =ear the danger o1 the check not =eing
honored* The check can =e at a disad/antage i1 the e4change rate has changed signi1icantly =y
the ti+e it arri/es, clears and is credited* Gn the other hand, the check can +ake it easier to shop
1or a =etter e4change rate =et)een di11erent 1inancial institutions*
For )ire trans1ers the seller +ust pro/ide clear routing instructions in )riting to the =uyer or the
=uyer;s agent* These include#
Full na+e, address, telephone, and tele4 o1 the seller;s =ank
Bank;s SW,FT andFor IBI nu+=ers
Seller;s 1ull na+e, address, telephone, type o1 =ank account, and
account nu+=er*
CO$$E(C&AL LETTE( OF C(ED&T
The letter o1 credit 7VC8 allo)s the =uyer and Seller to contract a trusted inter+ediary 7a =ank8
that )ill guarantee 1ull pay+ent to the seller pro/ided that he has shipped the goods and
co+plied )ith the ter+s o1 the agree+ent*
Features
The VC ser/es to e/enly distri=ute risk =et)een =uyer and seller*
The seller is assured o1 pay+ent )hen the conditions o1 the VC are
+et and the =uyer is reasona=ly assured o1 recei/ing the goods
ordered* This is a co++on 1or+ o1 pay+ent, especially )hen the
contracting parties are un1a+iliar )ith each other*
Since =anks deal )ith docu+ents and not )ith products, they +ust
pay an VC i1 the docu+ents are presented =y the seller in 1ull
co+pliance )ith the ter+s, e/en i1 the =uyer ne/er recei/es the
goods* Goods lost during ship+ent or e+=argoed are so+e
e4a+ples* ,ra< 1or e4a+ple, ne/er recei/ed goods that )ere shipped
=e1ore its e+=argo =ut the VCs had to =e paid any)ay*
VCs are typically irre/oca=le, )hich +eans that once the VC is
esta=lished it cannot =e changed )ithout the consent o1 =oth parties*
There1ore the seller, especially )hen ine4perienced, ought to present
the agree+ent 1or an VC to an e4perienced =ank or 1reight 1or)arder
so that they can /eri1y i1 the VC is legiti+ate and i1 all the ter+s can
=e reasona=ly +et* I trusted =ank, other than the issuing or =uyer;s
=ank can guarantee the authenticity o1 the docu+ent 1or a 1ee*
Disad<antages
,1 there are discrepancies in the ti+ing, docu+ents or other
re<uire+ents o1 the VC the =uyer can reKect the ship+ent* I reKected
ship+ent +eans that the seller +ust <uickly 1ind a ne) =uyer,
Business & ,T -odel . Cards /%*00% "age 0 o1 $00
Foundation Course in Banking
usually at a lo)er price, or pay 1or the ship+ent to =e returned or
disposed*
Gne o1 the +ost costly 1or+s o1 pay+ent guarantee . 9sual cost is
0*5A to %A* So+eti+es, the costs can go up to 5 percent o1 the total
/alue*
VCs take ti+e to dra) up and usually tie up the =uyer;s )orking
capital or credit line 1ro+ the date it is accepted until 1inal pay+ent,
reKection 1or nonco+pliance, e4piration or cancellation 7re<uiring the
appro/al o1 =oth parties8
The ter+s o1 an VC are /ery speci1ic and =inding* Statistics sho)
that appro4i+ately 50A o1 su=+issions 1or VC pay+ent are reKected
1or 1ailure to co+ply )ith ter+s* For e4a+ple, i1 one o1 the re<uired
docu+ents is inco+plete or deli/ered late, then pay+ent )ill =e
)ithheld e/en i1 all other conditions are 1ul1illed and the ship+ent
recei/ed in per1ect order* The =uyer can so+eti+es appro/e the
release o1 pay+ent i1 a condition is not 1ul1illed? =ut changing ter+s
a1ter the 1act is costly, ti+e consu+ing and so+eti+es i+possi=le*
T@e *e;@anis*
9sually, 1our parties are in/ol/ed in any transaction using an VC#
1. Bu:er or A++,i;ant
The =uyer applies to his =ank 1or the issuance o1 an VC* ,1 the =uyer does not ha/e a credit
arrange+ent )ith this issuing =ank then he +ust pay in cash or other negotia=le securities*
2. &ssuing =ank
The issuing or applicant;s =ank issues the VC in 1a/or o1 the =ene1iciary 7Seller8 and routes
the docu+ent to the =ene1iciary;s =ank* The applicant;s =ank later /eri1ies that all the ter+s,
conditions, and docu+ents co+ply )ith the VC, and pays the seller through his =ank*
C. Bene8i;iar:Qs =ank
The seller;s or =ene1iciary;s =ank /eri1ies that the VC is authentic and noti1ies the =ene1iciary*
,t, or another trusted =ank, can act as an ad/ising =ank* The ad/ising =ank is used as a
trusted =ridge =et)een the applicant;s =ank and the =ene1iciary;s =ank )hen they do not
ha/e an acti/e relationship* ,t also 1or)ards the =ene1iciary;s proo1 o1 per1or+ance and
docu+entation =ack to the issuing =ank* Po)e/er, the ad/ising =ank has no lia=ility 1or
pay+ent o1 the VC* The =ene1iciary, or his =ank, can ask an ad/ising =ank to con1ir+ the VC*
The con1ir+ing =ank charges a 1ee to ensure that the =ene1iciary is paid )hen he is in
co+pliance )ith the ter+s and conditions o1 the VC*
4. Bene8i;iar: or !e,,er
The =ene1iciary +ust ensure that the order is prepared according to speci1ications and
shipped on ti+e* Pe +ust also gather and present the 1ull set o1 accurate docu+ents, as
re<uired =y the VC, to the =ank*
Business & ,T -odel . Cards /%*00% "age 0' o1 $00
Foundation Course in Banking
Letter O8 Credit Diagra*
K
%* Buyer and seller agree on a co++ercial transaction*
$* Buyer applies 1or a letter o1 credit*
(* ,ssuing =ank issues the letter o1 credit 7VC8
2* Id/ising =ank ad/ises seller than an VC has =een opened in his or her 1a/or* Seller sends
+erchandise and docu+ents to the 1reight 1or)arder*
5* Seller sends copies o1 docu+ents to the =uyer*
!* Freight 1or)arder sends +erchandise to the =uyer;s agent 7custo+s =roker8*
* Freight 1or)arder sends docu+ents to the ad/ising =ank*
'* ,ssuing =ank arranges 1or ad/ising =ank to +ake pay+ent*
0* Id/ising =ank +akes pay+ent a/aila=le to the seller*
%0* Id/ising =ank sends docu+ents to the issuing =ank*
%%* Buyer pays or takes loan 1ro+ the issuing =ank*
%$* ,ssuing =ank sends =ill o1 lading and other docu+ents to the custo+s =roker*
%(* Custo+s =roker 1or)ards +erchandise to the =uyer*
Vetters o1 credit can =e 1le4i=le* So+e VC /ariations include# 6e/ol/ing, Negotia=le, Straight, 6ed
Clause, Trans1era=le, and 6estricted* But perhaps the sa1est type o1 letter o1 credit 1ro+ the
seller;s point o1 /ie), is the Stand=y letter o1 credit*
8
Letter o8 Credit Diagra* and t@e 14 ste+s @a<e =een re+rodu;ed 8ro* AAA.Ae=.Aor,d=ank.org
Business & ,T -odel . Cards /%*00% "age 00 o1 $00
Foundation Course in Banking
E/a*+,e
An Asian Bu:er 8ro* a !Aedis@ E/+orting ;o*+an: stated A@en @e ;on<in;ed t@e
E/+orter to se,, to t@e* on o+en a;;ount ter*s. T@e Asian Bu:er o=tained I0 da:s ;redit7
A@i;@ Aas to =e ;a,;u,ated 8ro* t@e date o8 t@e in<oi;e. T@e <a,ue o8 t@e order Aas )!D
1007 000 and t@e goods Aere dis+at;@ed and in<oi;ed =: t@e !Aedis@ E/+orter on t@e 15t@
Vu,: 200C.
T@e +a:*ent 8ro* Asia Aas due on t@e 14t@ !e+t 200C. T@e +a:*ent e<entua,,: arri<ed on
t@e 21st o< 200C7 o<er tAo *ont@s ,ate. T@e de,a: in +a:*ent ;ost t@e E/+orter )!D 1J00
as it resu,ted in @is a;;ount =eing o<erdraAn =: t@is a*ount 8or IK da:s at LS +er annu*.
What if confirmed Letter of Credit had been required?
,1 S)edish Q4porter had insisted on recei/ing a con1ir+ed Vetter o1 Credit through Illied S)edish
Banks plc* The 1ollo)ing costs 7appro4i+ations8 )ould ha/e applied#
Con1ir+ation Fee 9S: B$50
Icceptance Co++ission 7\ %*5A pa 1or !0 days8 9S: B$50
Negotiation F "ay+ent Fee 9S: B%50
Gut o1 "ocket Q4penses 7esti+ate8 9S: B!0
Total Vetter o1 Credit Cost 9S: B%0
,nterest Cost as a result o1 late pay+ent 9S: 7B%,008
Bene1it o1 using Vetter o1 Credit 9S: B000
Ad<antages o8 Letter o8 Credit
I Guarantee o1 pay+ent on the due date 1ro+ Illied S)edish Banks*
7"ro/ided the ter+s and conditions o1 the Vetter o1 Credit )ere
co+plied )ith8*
I de1initi/e date 1or the receipt o1 1unds, particularly i+portant 1or
de/ising proper currency hedging strategies*
The opportunity to recei/e the pay+ent in ad/ance o1 the due date
through non&recourse discounting o1 the recei/a=le*
Business & ,T -odel . Cards /%*00% "age %00 o1 $00
Foundation Course in Banking
Ilso note that the costs incurred in chasing the de=t 1ro+ the Isian =uyer has not =een
accounted 1or the ,rish Q4porter* ,n addition i1 the Q4porter had sold his 1oreign currency
recei/a=le on a 1or)ard =asis to his =ank 1or the original due date, they +ay ha/e incurred a
1urther cost in canceling or rearranging the 1or)ard contract* Vetters o1 Credit pro/ide real and
tangi=le =ene1its to co+panies* ,n this case the S)edish e4porter only lost 9SB %00* G1 course i1
the Isian =uyer had not paid at all they )ould ha/e lost the )hole 9S: %00,000
The stand=: LC is like a =ank guarantee* ,t is not used as the pri+ary pay+ent +ethod =ut as a
1ail sa1e +ethod or guarantee 1or long&ter+ proKects* This VC pro+ises pay+ent only i1 the =uyer
1ails to +ake an arranged pay+ent or 1ail to +eet pre&deter+ined ter+s and conditions* Should
the =uyer de1ault, the seller +ust then apply to the =ank 1or pay+ent & a relati/ely si+ple process
)ithout co+plicated docu+entation* Since the stand=y VC can re+ain /alid 1or years 7Q/ergreen
Clause8 it eli+inates the cost o1 separate VCs 1or each transaction )ith a regular client*
Ba;k to Ba;k LC allo)s a seller to use the VC recei/ed 1ro+ his =uyer as collateral )ith the =ank
to open his o)n VC to =uy inputs necessary to 1ill his =uyer;s order*
DOC)$ETA(% COLLECT&O
The seller sends a dra1t 1or pay+ent )ith the related shipping docu+ents through =ank channels
to the =uyer;s =ank* The =ank releases the docu+ents to the =uyer upon receipt o1 pay+ent or
pro+ise o1 pay+ent* The =anks in/ol/ed in 1acilitating this collection process ha/e no
responsi=ility to pay the seller should the =uyer de1ault unless the dra1t =ears the a/al 7ad
/alute+8 o1 the =uyer;s =ank* ,t is generally sa1er 1or e4porters to re<uire that =ills o1 lading =e
3+ade out to shipper;s order and endorsed in =lank5 to allo) the+ and the =anks +ore 1le4i=le
control o1 the +erchandise*
:ocu+entary collection carries the risk that the =uyer )ill not or cannot pay 1or the goods upon
receipt o1 the dra1t and docu+ents* ,1 this occurs it is the =urden o1 the seller to locate a ne)
=uyer or pay 1or return ship+ent* :ocu+entary collections are /ia=le only 1or ocean ship+ents,
as the =ill o1 lading 1or ocean 1reight is a /alid title to the goods and is a negotia=le docu+ent
)hereas the co+para=le air)ay =ill is not negotia=le as an o)nership title*
Dra8ts
I dra1t 7so+eti+es called a =ill o1 e4change8 is a )ritten order =y one party directing a second
party to pay a third party* :ra1ts are negotia=le instru+ents that 1acilitate international pay+ents
through respected inter+ediaries such as =anks =ut do not in/ol/e the inter+ediaries in
guaranteeing per1or+ance* Such dra1ts o11er +ore 1le4i=ility than VCs and are trans1era=le 1ro+
one party to another* There are t)o =asic types o1 dra1ts# sight dra1ts and ti+e dra1ts*
!ig@t Dra8t
I1ter +aking the ship+ent the seller sends a sight dra1t, through his =ank to the =uyer;s =ank,
acco+panied =y agreed docu+entation such as the original =ill o1 lading, in/oice, certi1icate o1
origin, phyto&sanitary certi1icate, etc* The =uyer is then e4pected to pay the dra1t )hen he sees it
and there=y recei/e the docu+entation that gi/es hi+ o)nership title to the goods that )ere
shipped* There are no guarantees +ade a=out the goods other than the in1or+ation a=out
<uantities, date o1 ship+ent, etc* )hich appears in the docu+entation* The =uyer can re1use to
accept the dra1t there=y lea/ing the seller in the unpleasant position o1 ha/ing shipped goods to a
destination )ithout a =uyer* There is no recourse )ith the =anks since their responsi=ility ends
)ith the e4change o1 +oney 1or docu+ents*
Business & ,T -odel . Cards /%*00% "age %0% o1 $00
Foundation Course in Banking
Ti*e Dra8ts.BankersW a;;e+tan;es
BankersW a;;e+tan;es are negotia=le instru+ents 7ti+e dra1ts8 dra)n to 1inance the e4port,
i+port, do+estic ship+ent or storage o1 goods* ,t de+ands pay+ent a1ter a speci1ied ti+e or on a
certain date a1ter the =uyer accepts the dra1t and recei/es the goods* I =ankersR acceptance is
SacceptedS )hen a =ank )rites on the dra1t its agree+ent to pay it at +aturity* I =ank +ay accept
the dra1t 1or either the dra)er or the holder*
In ordinary acceptance is a dra1t or =ill o1 e4change order to pay a speci1ied a+ount o1 +oney at
a speci1ied ti+e* I dra1t +ay =e dra)n on indi/iduals, =usinesses or 1inancial institutions*
In acceptance doesnRt reduce a =ankRs lending capacity* The =ank can raise 1unds =y selling the
acceptance* Ne/ertheless, the acceptance is an outstanding lia=ility o1 the =ank and is su=Kect to
the reser/e re<uire+ent unless it is o1 a type eligi=le 1or discount =y the Federal 6eser/e Bank*
#%B(&D $ET#OD!
,n practice, international pay+ent +ethods tend to =e <uite 1le4i=le and /aried* Fre<uently,
trading partners )ill use a co+=ination o1 pay+ent +ethods* For e4a+ple# the seller +ay re<uire
that 50A pay+ent =e +ade in ad/ance using a )ire trans1er and that the re+aining 50A =e
+ade =y docu+entary collection and a sight dra1t*
O"E ACCO)T
Gpen account +eans that pay+ent is le1t open to an agreed&upon 1uture date* ,t is one o1 the
+ost co++on +ethods o1 pay+ent in international trade and +any large co+panies )ill only =uy
on open account* "ay+ent is usually +ade =y )ire trans1er or check* This can =e a /ery risky
+ethod 1or the seller, unless he has a long and 1a/ora=le relationship )ith the =uyer or the =uyer
has an e4cellent credit rating* Still, there are no guarantees and collecting delin<uent pay+ents is
di11icult and costly in 1oreign countries especially considering that this +ethod utilizes 1e) legally
=inding docu+ents* Contracts, in/oices, and shipping docu+ents )ill only =e use1ul in securing
pay+ent 1ro+ a recalcitrant =uyer )hen his country;s legal syste+ recognizes the+ and allo)s
1or reasona=le settle+ent o1 such disputes*
OT#E( "A%$ET $ET#OD!
Consign*ent
The consign+ent +ethod re<uires that the seller ship the goods to the =uyer, =roker or distri=utor
=ut not recei/e pay+ent until the goods are sold or trans1erred to another =uyer* So+eti+es e/en
E/a*+,e
Banker;s Icceptances sell at a discount 1ro+ the 1ace /alue#
Face /alue o1 Bankers Icceptance B%,000,000
-inus $A per annu+ co++ission 1or one year &B$0,000
I+ount recei/ed =y e4porter in one year B0'0,000
Business & ,T -odel . Cards /%*00% "age %0$ o1 $00
Foundation Course in Banking
the price is not pre&1i4ed and )hile the seller can /eri1y +arket prices 1or the sale date or hire an
inspector to /eri1y the standard and condition o1 the product, he ulti+ately has /ery little recourse*
Credit Card
So+e =anks o11er =uyers special lines o1 credit that are accessi=le /ia credit card to 1acilitate
e/en su=stantial purchases* ,t is con/enient 1or =oth parties & =ut the seller should con1ir+ the
=ank charges and also =ear in +ind that the la)s that go/ern do+estic credit card transactions
di11er 1ro+ those go/ern international use*
Counter-trade and Barter
Counter&trade or =arter is +ost o1ten used )hen the =uyer lacks access to con/erti=le currency or
1inds that rates are un1a/ora=le or can e4change 1or products or ser/ices desira=le to the seller*
Counter&trade indicates that the =uyer )ill co+pensate the seller in a +anner other than trans1er
or +oney or products*
Fa;toring
Factoring is a discounting +ethod )ithout re;ourse* ,t is an outright sale o1 e4port accounts
recei/a=le to a third party, 7the 1actor8 )ho assu+es the credit risk* The 1actor +ay =e a 1actoring
house or a depart+ent o1 a =ank* The ad/antage to the e4porter is the re+o/al o1 contingent
lia=ilities 1ro+ its =alance sheet, i+pro/ed cash 1lo) and eli+ination o1 =ad de=t risk*
Factoring is 1or short&ter+ recei/a=les 7under 00 days8 and is +ore related to recei/a=les against
co++odity sales*
For8aiting
The e4porter sells accounts recei/a=les to a 1or1aiter on a 3non-re;ourse discount5 =asis, and
the e4porter e11ecti/ely passes all risks associated )ith the 1oreign de=t to the 1or1aiter* The
1or1aiter +ay =e a 1or1aiting house or a depart+ent o1 a =ank* The =ene1its are sa+e as 1actoring &
+a4i+ize cash 1lo) and eli+inate the pay+ent risk* ,t is a 1le4i=le 1inance tool that can =e used in
short, +ediu+ and long&ter+ contracts*
For1aiting can =e 1or recei/a=les against )hich pay+ents are due o/er a longer ter+, o/er 00
days and e/en up to 5 years*
Business & ,T -odel . Cards /%*00% "age %0( o1 $00
Foundation Course in Banking
FO(E&' C(ED&T &!)(ACE )DE(B(&TE(! AD B(ODE(!
The purpose o1 1oreign credit insurance is to insure repay+ent o1 e4port credit against
nonpay+ent due to political andFor co++ercial causes* ,t insures co++ercial risks o1
nonpay+ent =y i+porters =ecause o1 insol/ency or other =usiness 1actors and political risks o1
)ar, e4propriation, con1iscation, currency incon/erti=ility, ci/il co++otion, or cancellation o1
i+port per+its*
T#E BADE(! A!!OC&AT&O FO( FO(E&' T(ADE 1BAFT3
The Bankers Issociation 1or Foreign Trade 7BIFT8 is a collection o1 =anking institutions,
dedicated to pro+oting I+erican e4ports, international trade, and 1inance and in/est+ent
=et)een 9*S* 1ir+s and their trading partners* BIFT has set up a trade 1inance data=ase )ith a
grant 1ro+ the 9*S* :epart+ent o1 Co++erce* The data=ase ser/es as an essential resource 1or
assisting e4porters seeking trade 1inance and =anks that pro/ide 1inancial ser/ices*
E/a*+,e
In Isian ,+porter )ants to purchase +achinery that he is un)illing or una=le to pay 1or in
cash until that +achinery =egins to generate inco+e*
It the sa+e ti+e, the e4porter )ants i++ediate pay+ent in 1ull in order to +eet his on&going
=usiness co++it+ents
For1aiting solution )orks as 1ollo)s
%* Co++ercial contracts are negotiated su=Kect to 1inance?
$* The i+porter arranges 1or an ,rre/oca=le Vetter o1 Credit to =e issued or 1or a series o1
"ro+issory Notes or Bills o1 Q4change to =e dra)n in 1a/our o1 the e4porter )hich the
i+porter arranges to ha/e guaranteed =y his local =ank?
(* The e4porter contacts the discounting =ank 7the 1or1aiter8 1or a rate o1 discount )hich
is then agreed?
2* The goods are shipped?
5* The notes or =ills are sent )ith shipping docu+entation and in/oices to the
discounting =ank /ia the e4porter 7)ho endorses the notes or =ills S)ithout recourseS
to the order o1 the discounting =ank8?
!* The discounting =ank purchases the guaranteed notes or =ills 1ro+ the e4porter at the
agreed rate*
(esu,t# the e4porter recei/es pay+ent in 1ull i++ediately a1ter shipping 7against
presentation o1 satis1actory docu+entation to the 1or1aiter8? the i+porter gets his goods
and can pay 1or the+ in install+ents o/er ti+e? and the 1or1aiter has title to an asset )hich
he +ay retain as an in/est+ent*
Business & ,T -odel . Cards /%*00% "age %02 o1 $00
Foundation Course in Banking
&TE(AT&OAL "A%$ET &!T()$ET! CO$"A(&!O C#A(T
L
9
T@e a=o<e X&nternationa, "a:*ents Co*+arison C@artY is re+rodu;ed 8ro* )! De+art*ent o8
Agri;u,ture Ae=site - www.ams.usda.go! "ub.
Business & ,T -odel . Cards /%*00% "age %05 o1 $00
Foundation Course in Banking
2.5. CA(D! AD "A%$ET!
Business & ,T -odel . Cards /%*00% "age %0! o1 $00
Foundation Course in Banking
C(ED&T CA(D!
The 9*S* pay+ents industry has undergone a signi1icant shi1t in recent years* Check usage is
declining )hile the adoption o1 electronic pay+ent 1or+s is gro)ing* :uring calendar year $00(,
22*5 =illion electronic pay+ents )ere originated in the 9nited States )ith a /alue o1 B$*2 trillion*
This represents a CIG6 o1 (*'A since $000, )hich is t)ice the real G:" gro)th 7%*0A8*
Non&cash "ay+ent instru+ents in the 9S can =e classi1ied as 1ollo)s#
C@e;k-=ased "a:*ents
9ntil recently, checks )ere the +ost used pay+ent instru+ent in the 9S* To)ards the end o1
$002, Cards&=ased pay+ent instru+ents ha/e o/ertaken the+* Their popularity has =een due to
their ease o1 use at the point o1 sale, 1or =ill pay+ents, and 1or person&to&person pay+ents* The
latest de/elop+ent in this pay+ent instru+ent is the introduction o1 Check $% Ict, )hich is
related to the truncation o1 checks to electronic 1or+* I recent study =y Federal 6eser/e indicates
that )hile checks paid decreased =y o/er 5 =illion 1ro+ $000 to $00(, the nu+=er o1 electronic
pay+ent transactions increased =y o/er %( =illion* ,t is esti+ated that =e1ore the end o1 the
decade credit cards and de=it cards )ill indi/idually e4ceed the nu+=er o1 paid checks*
Cards-=ased "a:*ents
:e=it
:e=it cards ena=le the holder to +ake purchases and to charge those purchases directly to a
current account at the =ank issuing the pay+ent card* :e=it cards are either on&line 7",N&=ased8
or o11&line 7Signature&=ased8* Gn&line de=it cards ha/e =een a/aila=le 1or se/eral decades and
ha/e seen tre+endous gro)th since the early %000;s* G11&line de=it cards are a +ore recent
inno/ation and consu+ers are increasingly using the+ at +erchant locations that accept
=ankcards* G1 all cards&=ased pay+ents, de=it has seen the highest gro)th*
IT-
Financial institutions issue IT- cards to consu+ers to pro/ide on&line access to account
in1or+ation and to allo) consu+ers to +ake )ithdra)als and deposits at IT-s* -any 1inancial
institutions no) o11er IT- cards that can also =e used as de=it cards 1or "GS transactions at
participating retailers*
Credit
These include general&purpose credit cards and pri/ate&la=el credit cards 7discussed later8*
Co+pared to other electronic pay+ent instru+ents, credit cards ha/e sho)n a relati/ely
+oderate gro)th since $000*
Chip Cards
These cards ha/e the capa=ility to store 1unds electronically in an e+=edded chip, )hich updates
the 1unds a/aila=le data as transactions are +ade* While "repaid cards are =est kno)n 1or their
use as a gi1t card, they are increasingly used 1or payroll, incenti/es, insurance, re1unds and other
purposes* So+e stored /alue cards +ay also =e s+art cards i1 they contain an integrated
+icrochip* The integrated chip can store /alue and per1or+ other 1unctions, such as consu+er
authentication, health care progra+s, go/ern+ent&1unded =ene1its progra+s, transportation
ser/ices, etc* The chip +ight also contain consu+er pre1erences and loyalty progra+ in1or+ation
1or +arketing purposes*
Auto*ated C,earing #ouse 1AC#3
In ICP transaction is a =atch&processed, /alue&dated electronic 1unds trans1er =et)een
originating and recei/ing 1inancial institutions* ICP pay+ents are used in a /ariety o1 pay+ent
en/iron+ents* Griginally, consu+ers pri+arily used the ICP 1or paycheck direct deposit* No),
Business & ,T -odel . Cards /%*00% "age %0 o1 $00
Foundation Course in Banking
they increasingly use the ICP 1or =ill pay+ents 7o1ten re1erred to as direct pay+ents8, corporate
pay+ents 7=usiness&to&=usiness8, and go/ern+ent pay+ents 7e*g*, ta4 re1unds8, and electronic
check present+ent* There are t)o national ICP operators . Qlectronic "ay+ent Net)orks, a
pri/ate processor )ith a (0A +arket share )hile the rest o1 the +arket is ser/ed =y the Federal
6eser/e Banks*
E*erging "a:*ents
Gnline Bill "ay 7QB"", Q,""8
Gnline ser/ices that ena=le custo+ers to recei/e, re/ie), and e4ecute pay+ent o1 their =ills o/er
the ,nternet*
"erson&to&"erson "ay+ents 7"$"8
Gn&line "$" pay+ents, or e&+ail pay+ents, use e4isting retail pay+ent net)orks to pro/ide an
electronically initiated trans1er o1 /alue 1ro+ one indi/idual to another*
,nternet Currencies F :igital Cash F e&Wallets
Si+ilar to "$" pay+ents, indi/iduals can trans1er electronic cash /alue to other indi/iduals or
=usinesses* -ost electronic cash applications e4ist on the ,nternet* Consu+ers can use the cash
pay+ent instru+ents 1or purchases at retailers; We= sites or they can trans1er cash to other
indi/iduals through e&+ail* ,ndi/iduals use a credit card or signature&=ased de=it card nu+=er to
pre&1und the We= certi1icate or electronic account, and recipients redee+ the /alue )ith the
,ssuer*
Qlectronic Bene1its Trans1er 7QBT8
Qlectronic syste+ that allo)s a recipient to authorize trans1er o1 hisFher go/ern+ent =ene1its 1ro+
a Federal account to a retailer account to pay 1or products recei/ed* QBT is currently used to
issue 1ood sta+ps and other =ene1its in the 9S*
'eneri; Fra*eAork 8or "a:*ent &nstru*ents
The diagra+ =elo) depicts the co++on +odel on )hich +ost pay+ent syste+s are =ased**
While the 1lo) o1 1unds, in1or+ation, and data are di11erent, in +ost cases, the set o1 participants
are si+ilar* The initiator o1 the pay+ent 7payer8 is typically a consu+er and the recipient o1 the
pay+ent 7payee8, typically a +erchant* The payer and the payee are sho)n to ha/e a
relationship )ith their respecti/e 1inancial institutions* The pay+ent net)ork routes the
transactions =et)een the 1inancial institutions
Credit Card $arket O<er<ieA
Financial Institution
orThirdparty
Network
Financial Institution
orThirdparty
Payer
Payee
Four Corner PaymentSystemModel
Goods/ Services
PresentNon -cashPaymentinstrument
Solidlineindicatesflowof information
Financial Institution
orThirdparty
Financial Institution
orThirdparty
Network Network
Financial Institution
orThirdparty
Financial Institution
orThirdparty
Payer
Payee
Four Corner PaymentSystemModel
Goods/ Services
PresentNon -cashPaymentinstrument
Solidlineindicatesflowof information
Business & ,T -odel . Cards /%*00% "age %0' o1 $00
Foundation Course in Banking
Credit card acti/ities in the 9S represent +ore than $5 =illion indi/idual transactions purchasing
B%* trillion dollars in products and ser/ices e<ualing +ore than %0A o1 G:"* There are %*$ =illion
credit cards 7including store and gas credit cards8 in circulation in the 9S held =y o/er %!0 +illion
indi/iduals* The a/erage household possesses %2*$ credit cards )ith an a/erage household
credit =alance o1 B0,250 in $00(
%0
* Credit card 1ees paid =y consu+ers e4ceed B%5 =illion*
I Credit card is a type o1 a pay+ent card product* I pay+ent card product is a set o1
entitle+ents* ,t allo)s the client to access the 1eatures the pro/ider 7e*g*, 1inancial institution8
attaches to the card*
I sa+ple o1 possi=le pay+ent card entitle+ents is sho)n =elo)#
Access +on#enience Affora/ility
+reit <orl;ie acce'tance 5nterest rate
"e'osits 3& hour a#aila/ility Fees
Merchants -orta/ility Benefits
ATMs Monthly statements -ayment terms
To create an actual pay+ent card product, these entitle+ents are grouped together to appeal to a
target seg+ent . consu+er or =usiness* I card is issued to a cardholder and usually displays
cardholder na+e, account nu+=er, e4piration date, location acceptance logos 7e*g*,
MisaF-asterCard8 and issuing organization* -ost cards are plastic )ith a +agnetic stripe* So+e
o1 the ne) cards contain chips that store in1or+ation such as additional custo+er in1or+ation and
stored /alue* I card usually is linked to so+e type o1 1inancial account 7e*g*, credit card to a credit
line and a de=it card to a checkingFsa/ings account8*
Credit Cards
I credit card indicates that the holder has =een granted a line o1 credit ena=ling the cardholder to
+ake purchases andFor dra) cash up to a pre&arranged a+ount* ,nterest is charged on the
a+ount o1 the unpaid credit =alance and cardholders are o1ten charged an annual user 1ee*
The do+inant pay+ent card types that are in use at this ti+e in de/eloped =anking en/iron+ents
are those e+ploying the use o1 3+agnetic stripe5 technology* "art o1 the reason 1or this is the
relati/ely lo)er cost o1 "oints&o1&Sale 7"GS8 ter+inals and the 1or+ation o1 )ell&esta=lished
speci1ications that allo)s these +agnetic&stripe cards to =e used in /irtually any card&=ased "GS
de/ice )orld)ide* The production costs o1 the stripe card are also lo)* Idditionally, ad+inistrati/e
support re<uire+ents are )ell de/eloped*
Po)e/er, s+art cards, introduced a decade ago, are +aking signi1icant inroads in so+e countries
)here, in addition to, regulated pilots =eing undertaken so+e signi1icant sche+es are already in
place* These plastic cards, )hich are e+=edded )ith a co+puter chip, o11er a nu+=er o1
signi1icant =ene1its to 1inancial institutions, retailers, and cardholdersZranging 1ro+ i+pro/ed
security to a host o1 inno/ati/e ne) 1eatures*
But )hile s+art card usage has =een rapidly increasing thanks to a di/erse set o1 applications
1ro+ )ireless telephones to loyalty progra+s, the predicted +ass +igration o1 pay+ent
applications 1ro+ con/entional +agnetic&stripe cards to s+art cards has not yet +aterialized* Gne
o1 the =iggest hurdles, until no), has =een the lack o1 uni/ersally accepted speci1ications 1or
s+art card =ased pay+ents? ho)e/er, consensus on Q-M 7Quropay F -asterCard F Misa8
speci1ications 1or s+art cards is no) set to change this situation and s+art cards are poised to
challenge the $E =illion +agnetic&stripe cards in circulation around the glo=e*
Credit Card $arket 5 $aRor Business Entities and t@eir A;ti<ities
&ssuer: Polds contractual agree+ents )ith and issues cards to cardholders* The key
acti/ities o1 an issuer can =e represented in the 1ollo)ing +anner .
!
Source" #ilson $eport
Business & ,T -odel . Cards /%*00% "age %00 o1 $00
Foundation Course in Banking
A;Guirer: :oes =usiness )ith +erchants ena=ling the+ to accept credit cards* Ic<uirers =uy
7ac<uire8 the +erchantRs sales slips and credit the ticketsR /alue to the +erchantRs account*
Ic<uirer;s key acti/ities can =e su++arized as .
:ue to high 1actors such as high /olu+es and lo) pro1it +argins, +ost 9S =anks ha/e sold
their ac<uirer =usinesses to non&=anking entities that specialize in this 1ield* Follo)ing are the
,nco+e and Q4pense sources in an Ic<uirer =usiness .
,nco+e#
-erchant discount 7%.2A o1 transaction /alue8
"rocessing 1ees 7B 0*$0 . B 0*20 per transaction8
-onthly +ini+u+ 1ees
Custo+er ser/ice 1ees
"GS Q<uip+ent salesFser/ice
Q4pense#
,nterchange 1ees paid to ,ssuer
Business & ,T -odel . Cards /%*00% "age %%0 o1 $00
Foundation Course in Banking
,SGF-S" 1ees
:ata processing H Co++unications e4penses
6isk -anage+ent
Vosses on -erchant Charge=acks H Fraud
"ro;essor 1T@ird "art: Entities3# "ro/ides credit card processing, =illing, reporting and
settle+ent, and operational ser/ices to the ,ssuerFIc<uirer* The Card "rocessing +arket is a
highly concentrated +arket )ith players like First :ata and TSDS processing +ore than hal1
o1 all 9S card transactions* The t)o +ain ser/ices that the Third "arty "rocessors o11er are
,ssuing Ser/ices and Ic<uiring Ser/ices &
,ssuing ser/ices
Functions# -ost acti/ities o1 card ,ssuers
,nco+e > Transaction "rocessing 1ees E So1t)are Vicensing H -aintenance
Q4pense > :ata processing H Co++unications e4pense
Ic<uiring ser/ices
Functions# -ost acti/ities o1 card Ic<uirers
,nco+e > -erchant 1ees E "rocessing 1ees E ,SGF-S" 1ees
Q4pense > :ata processing H Co++unications e4pense E Vosses on
Charge=acks E :epreciation
&nde+endent !a,es OrganiMation 1&!O3# In outside co+pany 7not -asterCardFM,SI
+e+=er, non&=ank8 that o11ers +erchant accounts and +ay process credit card transactions
1or a transaction 1ee* ,SGs enter into a contract )ith Ic<uiring =anks to o11er =ankcard
ac<uiring ser/ices, through registered or unregistered sales agents or e+ployees
Asso;iation# In organization o)ned =y +e+=ers, )hich ser/ices and o=tains processing
ser/ices 1or +e+=ers* -e+=ers include co++ercialFretail =anks, credit unions etc* Follo)ing
are 1e) +ain characteristics o1 Issociation &
Vicense +e+=ers 7,ssuers, Ic<uirers8 to issue H accept pay+ent cards
Po)e/er, associations the+sel/es do NGT issue cards F set card 1ees F set credit
li+its F set interest rates, or solicit +erchants F set discount rates
Ser/e as the ner/e center connecting the issuing H ac<uiring sides
"ro/ide the interchange syste+s to trans1er data and 1unds =et)een +e+=ers
7transaction processing . MisaNet, BankNet8
G11er a /ariety o1 product progra+s and ser/ices to i+pro/e +e+=er pro1ita=ility and
+ini+ize +e+=er risk
Q*g* @Meri1ied =y Misa;, SQT
,+ple+ent rules and regulations that go/ern the interchange o1 transactions =et)een
+e+=ers
9ndertake =rand ad/ertising and pro+otional ca+paigns
I card Issociation &
"ro<ide T@ese Fun;tions Do ot "ro<ide T@ese Fun;tions
Business & ,T -odel . Cards /%*00% "age %%% o1 $00
Foundation Course in Banking
6eco++end, +onitor H pro/ide support ser/ices
o Byla)s
o Gperating rules H regulations
Brand ad/ertising H pro+otional ca+paigns
Iuthorization H settle+ent syste+s
SecurityF6isk +anage+ent
Issess+ent H 1ee =ased ser/ices
:e/elop ne) products H ser/ices
,ssue cards
Set credit li+its
Set card 1ees
Set interest rates
Solicit +erchants
Set discount rates
$er;@ant# I retailer, or any other person, 1ir+, or corporation that, according to a -erchant
Igree+ent, agrees to accept credit cards, de=it cards, or =oth, )hen properly presented*
Card@o,der# The person to )ho+ a 1inancial transaction card is issued or an additional
person authorized to use the card
Business & ,T -odel . Cards /%*00% "age %%$ o1 $00
Foundation Course in Banking
The 1ollo)ing diagra+ depicts typical acti/ities in transaction processing using a card
in/ol/ing all the entities descri=ed a=o/e &
Foundation Course in Banking
The 1ollo)ing ta=le sho)s lists the description o1 the /arious entities in/ol/ed in a Credit card
processing
Entit: Des;ri+tion
,ssuing Bank
This is a =ank F 1inancial institution that issues a credit product
Cardholder
Iccount
Cardholder port1olio account is created )hen a credit application is
appro/ed*
Business "ort1olio
Iccount
This de1ines the processing rules 1or all the accounts under a =usiness
/enture o1 the sa+e card o11ering type* This entity +ay hold =illing rules,
auth li+its, collection strategies, and other properties that can =e de1ined
at this le/el* Q4a+ples o1 Business port1olio account +ay include Chase
Misa Classic, Chase Misa Gold, etc
Card "roduct
,denti1ies the di11erent card types that the Credit syste+ supports*
Q4a+ples +ay =e proprietary cards, Misa, -asterCard
Iuthorization
Qngine
Iuthorization engines are used to authorize credit transactions* The
authorization engine uses the account in1or+ation, +erchant in1or+ation,
and other related in1or+ation to appro/e F decline F re1er an authorization
transaction* There can =e +ore than one authorization engines 1or a
=usiness port1olio*
Credit Bureau
"ro/ides credit scores that are used =y ,ssuers to process card
applications
Collection Igency
Third party to )ho+ ,ssuer outsources the cardholder collection acti/ities
,ssuer "rocessor
In outside co+pany )ith )hich the ,ssuer contracts to pro/ide cardholder
transaction processing acti/ities*
,ssuer Clearing
Bank
Bank designated =y the ,ssuer to recei/e the ,ssuer;s daily net settle+ent
ad/ise+ent* The clearing =ank 7+ay =e the ,ssuer itsel18 )ill also conduct
1unds trans1er acti/ities )ith the net settle+ent =ank and +aintain the
,ssuer;s clearing account*
Ic<uirer
This is a =ank F 1inancial institution that ac<uires +erchant transactions
Ic<uirer Clearing
Bank
Bank designated =y Ic<uirer to recei/e the Ic<uirer;s daily net settle+ent
ad/ise+ent* The clearing =ank 7+ay =e the Ic<uirer itsel18 )ill also
conduct 1unds trans1er acti/ities )ith the net settle+ent =ank and +aintain
the Ic<uirer;s clearing account*
Ic<uirer "rocessor
In outside co+pany )ith )ho+ the Ic<uirer contracts to pro/ide
+erchant processing ser/ices
-erchant Iccount
I +erchant account is created )hen a +erchant application is appro/ed*
I +erchant account is necessary 1or a +erchant to accept pay+ent =y
Foundation Course in Banking
credit card
Clearing 1ile
Contains present+ents and other 1inancial +essages that need to =e
+atched )ith corresponding authorizations
Funding 1ile
This 1ile is 1or ena=ling +e+=er settle+ent
Transa;tion T:+es
Entit: Transa;tion T:+e (e*arks
Cardholder
transactions
"urchase
IuthorizationFMeri1ica
tion
"reauthorization
-erchandise return
Triggered =y the cardholder*
IuthorizationFMeri1ication is the de1ault
transaction type* ,1 no type is indicated
)hen su=+itting transactions to the
gate)ay, the gate)ay )ill assu+e that the
transaction is o1 the type
Syste+
Generated
Transactions
6e/ersal
This transaction is an action on a pre/ious
transaction and is used to cancel the
pre/ious transaction and ensure it does not
get sent 1or settle+ent*
Q4ception
Transactions
IdKust+ent
Charge=ack H
Charge=ack 6e/ersal
6epresent+ent
9sed to correct errors that occur at point o1
transaction or in a participant;s syste+
Gthers
Id+inistrati/e
Net)ork
6econciliation
File -aintenance
Fee transactions
These are routine transactional acti/ities to
ensure co+pletion o1 the /arious acti/ities
in/ol/ed in a transaction processing cycle
C@arge=a;k N C@arge=a;k (e<ersa,s 5
It any ti+e 7currently li+ited to !0 days a1ter state+ent date8, cardholder +ay contact the ,ssuer
to <uestion )hether a transaction is legiti+ate and re<uest a copy o1 the transaction 1ro+ the
+erchant* ,1 the cardholder does not recei/e a copy o1 transaction, she +ay re<uest a
charge=ack . a 1inancial re/ersal o1 the transaction* Q/en i1 the retrie/al re<uest is 1ul1illed,
cardholder still +ay re<uest the ,ssuer to initiate a charge=ack* Po)e/er, i1 the +erchant disputes
the charge=ack, the disputed transaction is dealt )ith through a de1ined dispute process*
Follo)ing diagra+ depicts the process o1 charge=ack and charge=ack re/ersal
Foundation Course in Banking
$aRor ",a:ers
The 1ollo)ing ta=le sho)s so+e o1 the leading 9S card organizations and their respecti/e roles in
the Credit card industry#
Leading )! $arket Card OrganiMations
Banks on-Banks Asso;iation .
OrganiMation
Citigroup
7,ssuer8
-BNI I+erica
7,ssuer8
J"-organ Chase F
Bank Gne
7Ic<uirer H ,ssuer8
Bank o1 I+erica
7Ic<uirer H ,ssuer8
Capital Gne
7,ssuer8
Wells Fargo
7Ic<uirer H ,ssuer8
Wacho/ia
7,ssuer8
First :ata Corp 7"rocessor8
TSDS 7"rocessor8
Mital 7Ic<uirer H "rocessor8
I+erican Q4press 7Ic<uirer, Card
Grganization H ,ssuer8
:isco/er 7Ic<uirer, Card Grganization
H ,ssuer8
:iners Clu= 7Card Grganization H
,ssuer8
Q<ui1a4 7"rocessor8
Sears 7 Ic<uirer, Card Grganization H
,ssuer8
GQ Card Ser/ices 7"rocessor8
9S Go/ern+ent 7Ic<uirer H ,ssuer8
Misa
7Card
Issociation,
"rocessor8
-asterCard
7Card
Issociation,
"rocessor8
JCB 7Card
Issociation8
Foundation Course in Banking
!)$$A(%
Cards are one o1 the +ost )idely used +echanis+s 1or transactions
)orld )ide* There are se/eral types o1 cards used .
o :e=it cards
o IT- cards
o Credit cards
o Chip cards
o S+art cards
ICP ena=les =atch&processed, /alue&dated electronic 1unds trans1er
=et)een originating and recei/ing 1inancial institutions*
Q+erging pay+ents syste+s are .
o Gnline Bill "ay+ent 7QB"", Q,""8
o "erson to "erson "ay+ents 7"$"8
o ,nternet currencies, digital cash, e&Wallet
o Qlectronic Bene1it Trans1er 7QBT8
There are /arious entities in/ol/ed in the credit card transaction
processing cycle &
o ,ssuer
o Ic<uirer
o Third party "rocessor
o ,ndependent Sales organization
o Issociation
o -erchant
o Card holder
Charge=ack and Charge=ack re/ersals are legiti+ate )ays to cancel
the credit card transactions )ithin a li+ited ti+e 1ra+e
Foundation Course in Banking
2.I. &VE!T$ET $AA'E$ET
Foundation Course in Banking
"(&VATE BAD&' . BEALT# $AA'E$ET
"ri/ate Banking co/ers =anking ser/ices, including lending and in/est+ent +anage+ent, "ri/ate
=anking pri+arily is a credit ser/ice, and is less dependent on accepting deposits than retail
=anking*
The Federal 6eser/e Super/isory Vetter de1ines pri/ate =anking as personalized ser/ices such
as +oney +anage+ent, 1inancial ad/ice, and in/est+ent ser/ices 1or high net )orth clients*
Ilthough high net Aort@ is not de8ined7 it is genera,,: taken at a @ouse@o,d in;o*e o8 at
,east B%00,000 or net )orth greater than B500,000* Varger pri/ate =anks o1ten re<uire e/en
higher thresholds & Se/eral no) re<uire their ne) clients to ha/e at least B% +illion o1 in/esta=le
assets* Is per the World Wealth 6eport $00% =y -errill Vynch F Cap Ge+ini, there are currently
o/er *$ +illion +illionaires in the )orld )ith a co+=ined asset =ase e4ceeding 9SB $ trillion
)hich is proKected to gro) to o/er 9SB 25 trillion =y the end o1 $005*
CL&ET !E(V&CE!
I typical pri/ate =anking di/ision o1 a large =ank )ould o11er the 1ollo)ing 1inancial ser/ices to its
"ri/ate clients#
&n<est*ent $anage*ent and Ad<i;e
I client relationship -anager understands the client;s li<uidity, capital and in/est+ent needs* Pe
stri/es to de/elop an integrated approach to +anage client in/est+ents and capital +arkets
trading* Iccess to specialist ad/ice and e4tensi/e research is a key 1eature o1 pri/ate =anking*
!e,8-dire;ted or non-dis;retionar:# This is largely in/est+ent ad/isory in )hich the =ank o11ers
in/est+ent reco++endations =ased on the Client;s appro/al* The client +ay choose to ignore
this*
Dis;retionar:# ,n this case, the =ank;s port1olio +anagers +ake in/est+ent decisions on =ehal1
o1 the custo+er*
(isk $anage*ent
Stri/es to reduce e4posures 1or its clients across the )orld through a /ariety o1 hedging tools,
taking positions in deri/ati/e +arkets etc
LiGuidit:
-anage+ent o1 a Client;s li<uidity 7cash etc8 needs through short&te+ credit 1acilities, 1le4i=le
cash +anage+ent ser/ices etc* In e4clusi/e cash +anage+ent ser/ice )ith SsAee+S 1acility is a
"ri/ate Banking 1eature* The s)eep auto+atically trans1ers e4cess 1unds o/er a pre&deter+ined
li+it out o1 your current account into a higher yielding reser/e account, opti+izing your return on
short&ter+ cash* Funds are on call so they re+ain easy to access*
!tru;tured Lending
"ro/ides tailored lending to pro/ide long&ter+ li<uidity to clients, or in/est+ent capital
Foundation Course in Banking
En@an;ed =anking 8a;i,ities
"ri/ate clients enKoy a /ariety o1 e4clusi/e =anking ser/ices such as#
,nsurance
Foreign e4change transactions
Iuto+atic credit entitle+ents etc
&ssuer Ca+ita, 8or*ation
"ro/iding clients )ith access to in/est+ent =anking and other institutional ser/ices
"ri/ate Bankers are high&end relationship +anagers, as )ell as +oney +anagers and ad/isors*
"ri/ate clients trade in larger /olu+es, the 1ees and co++issions are larger*
Changes in the regulatory en/iron+ent ha/e rede1ined the co+petiti/e landscape o1 )ealth
+anage+ent =y allo)ing in/ol/e+ent o1 =anks in insurance acti/ities* I success1ul )ealth
+anager +ust harness and deploy not Kust the standard acti/ities o1 e<uity and 1i4ed inco+e
in/est+ent +anage+ent, =ut a plethora o1 other products and ser/ices# ta4 and estate planning,
insurance products, 20%7k8 rollo/ers, and +ore*
-ost pri/ate =anks segregate their clients =ased on net )orth, in/esti=le assets, age etc* For
e4a+ple, one classi1ication could =e =et)een young a11luent and retired a11luent*
"ri/ate =anking clients typically de+and higher returns on their in/est+ent, and as a result =anks
o11ering these ser/ices are hea/ily dependent on e11icient "ort1olio Inalysis and Isset Illocation
techni<ues to achie/e this* The conse<uent in/est+ent in technology is also /ery high*
"ri/ate =anking is a 1ee&dri/en =usiness* Banks o11ering these ser/ices charge anything =et)een
%&2 A 1or their ser/ice, depending on the nature o1 the ser/ice rendered* 6eturn on e<uity 1or
=anks o11ering these ser/ices could =e as high as $5A*
CO$$O "(&VATE BAD&' "(OD)CT!
"ersona, &n<est*ent Co*+anies 1"&Cs3
I ",C is a shell co+pany set up =y a "ri/ate Bank;s o11shore di/ision 7e*g* trust di/ision8 1or a
client, usually in a ta/ @a<en ,ike t@e Ca:*an &s,ands* The ",C has its o)n legal entity and the
in/estor enKoys con1identiality as )ell as ta4 =ene1its* There is su=stantial startup 1ee in/ol/ed 1or
these, and =anks charge annual ad+inistration 1ees*
"a:a=,e T@roug@ A;;ount 1"TA3
"TIs are transaction deposit accounts that allo) =anks in one country to o11er their 1oreign clients
o1 a 1oreign =ank, such ser/ices as check&)riting* The 1oreign =ank in this case plays the role o1 a
correspondent =ank* These accounts usually ha/e a high transaction /olu+e and attract dollar
deposits 1ro+ the 1oreign custo+ers*
Foundation Course in Banking
#edge Funds
This is a pri/ate in/est+ent partnership, and is usually run =y "ri/ate Banks* Pedge 1unds are
highly speculati/e and they use a /ariety o1 techni<ues such as le/erage, short&selling, and use o1
deri/ati/es* Se/eral hedge 1unds also utilize so+e 1or+ o1 ar=itrage, such as those )here they
can take ad/antage o1 +o/e+ents e4pected to occur in the stock price o1 t)o co+panies
undergoing a +erger or other si+ilar e/ent* ,n +ost cases, in/estors in a hedge 1und need to =e
duly accredited*
B#O OFFE(! "(&VATE BAD&' !E(V&CE!E
-ost Banks ha/e separate di/isions o11ering dedicated pri/ate =anking ser/ices* There +ay =e
Qdge Corporations or Foreign su=sidiaries o1 large national =anks as )ell, )hich o11er these
ser/ices*
The large Quropean =anks like 9BS, Credit Suisse are industry leaders* There are a nu+=er o1
standalone "ri/ate Banks as )ell* ,n =anks such as -ellon and Bank Gne, "ri/ate Banking takes
place in the Trust or &n<est*ent $anage*ent di/ision* -any =anks o11er "ri<ate C,ient
!er<i;es 7"CS8 to clients in other countries as )ell, through 1oreign su=sidiaries, or e/en
a11iliated =anks*
B#% '(OB "(&VATE BAD&' B)!&E!!E
-ost pri/ate =anks target return on e<uity o1 at least $5A )hich is
considera=ly higher than that o1 the a/erage co++ercial =ank*
Gpportunities 1or o11&=alance sheet inco+e are an additional
incenti/e* 9nlike depository accounts, securities and other
instru+ents held in the clients; in/est+ent accounts are not re1lected
on the =alance sheet o1 the institution =ecause they =elong to the
client*
#ow hae aerage hedge fund returns $erformed is%a%is market &ee&s?
3-ulti=illion dollar Uuantu+ Fund +anaged =y the legendary George Soros, 1or instance,
=oasted co+pound annual returns e4ceeding (0A 1or +ore than a decade*5
3G11 Shore Pedge Funds# Sur/i/al and "er1or+ance# %0'0&%005,S a study =y Dale and ND9
Stern econo+ists, indicates that, during that si4&year period, the a/erage annual return 1or
o11shore hedge 1unds )as %(*!A, )hereas the a/erage annual gain 1or the SH" 500 )as
%!*5A* Q/en )orse, the rate o1 closure 1or 1unds rose to o/er $0A per year, so choosing a
long&ter+ hedge 1und is trickier e/en than choosing a stock in/est+ent*
're hedge funds not immune to risk?
Ved =y Wall Street trader John -eri)ether and a tea+ o1 1inance )izards and "h*:s, Vong
Ter+ Capital -anage+ent i+ploded in the late %000s* ,t nearly sank the glo=al 1inancial
syste+ and had to =e =ailed out =y Wall StreetRs =iggest =anks* ,n $000 George Soros shut
do)n his Uuantu+ Fund a1ter sustaining stupendous losses*
Foundation Course in Banking
Po)e/er, the institution can earn su=stantial 1ees 1or +anaging client
assets or per1or+ing other cash +anage+ent and custodial ser/ices*
To gro), pri/ate =anks need to lure ne) )ealthy in/estors a)ay
1ro+ direct in/esting or 1ro+ in/esting )ith +aKor +utual 1unds such
as Fidelity or -errill Vynch*
CO(E F)CT&O! & "(&VATE BAD&'
Sales and -arketing F Client "rospecting
Client -anage+ent, Ser/icing and deli/ery
Financial "lanning
"ort1olio Inalysis and Gpti+ization
-arket Icti/ities
6esearch
Co+pliance controls*
"(&VATE BAD&' BO(DFLOB
The high&le/el process 1lo) 1or pri/ate =anking is sho)n =elo)* The roles and responsi=ilities o1
the /arious players are outlined =elo)#
Client 6epresentati/e#
Ser/icing specialist
-iddle o11ice
Back o11ice
Foundation Course in Banking
Foundation Course in Banking
The diagra+ =elo) sho)s the /arious depart+ents in the "ri/ate Banking di/ision o1 a =ank*
Foundation Course in Banking
&VE!T$ET $AA'E$ET
,n/est+ent -anage+ent can =e de1ined as the process o1 +anaging +oney, )hich includes
in/est+ents such as real estate, 1inancial instru+ents such as stock, +utual 1und, =onds or
e<uip+ent that has +onetary /alue that could =e realized i1 sold* Mery o1ten, ter+s such as
+oney +anage+ent, asset +anage+ent etc* are used interchangea=ly*
&VE!T$ET $AA'E$ET 'OAL!
,n/est+ent -anage+ent ai+s at the 1ollo)ing goals#
-anage in/estors +oney e11iciently and cost e11ecti/ely
Generate superior in/est+ent returns
&n<esting 'oa, 9lti+ate o=Kecti/e is to deli/er e<uity type returns
)ith lesser /olatility risk and achie/e capital preser/ation
,n achie/ing the a=o/e goals, an ,n/est+ent -anager uses the 1ollo)ing approachesFprinciples#
Asset $i/ is the pri+ary deter+inant o1 port1olio return, opti+u+
port1olios are designed using asset allocation tools
&nternationa, Di<ersi8i;ation - ,n/est+ent in )orld )ide stocks
reduces risk and i+pro/es returns
!;reens.Fi,ters - Mariety o1 <uantitati/e and <ualitati/e screens to
identi1y candidate in/est+ents, inter/ie)s )ith 1und +anagers prior
to in/esting and continuous due diligence*
Ca+ita, +reser<ation & "reser/e the )ealth o1 in/estors and ensure
erosion 1ree in/est+ent
A,ternati<e &n<est*ents - ,n/esting in hedge 1und and 1utures to
ha/e strong returns* These assets generally earn returns consistent
)ith those o1 e<uities* By co+=ining alternati/e in/est+ents )ith
e<uities, the asset +anager can generate superior returns )hile
reducing the ups and do)ns o1 the port1olio*
,n/est+ent +anage+ent ser/ices are usually o11ered =y 1ir+s that
specialize in +anaging an in/estor;s +oney* These 1ir+s e+ploy
indi/iduals kno)n as port1olio +anagers )ho are responsi=le 1or
taking the decision on )hich type o1 assets to in/est it to =est suit the
in/estors needs*
T#E &VE!T$ET "(OCE!!
-aking in/est+ent decisions is not an easy task and re<uires
specialized skills and ser/ices and in/ol/es a nu+=er o1 =usiness
processes*
The diagra+ =elo) depicts so+e o1 the key stepsFprocess in/ol/ed
in the in/est+ent +anage+ent li1e&cycle*
Foundation Course in Banking
Foundation Course in Banking
&VE!T$ET $AA'E$ET C%CLE
" o r t 1 o l i o
- a n a g e + e n t
- o n i t o r i n g
a n d
6 e p o r t i n g
, n / e s t + e n t
G p e r a t i o n s
T r a d i n g
6 e s e a r c h
a n d
I n a l y s i s
Q 4 t e r n a l
, n 1 o r + a t i o n
" r o / i d e r s
B r o k e r s a n d
T r a d i n g
N e t ) o r k s
C l e a r i n g a n d
S e t t l e + e n t
C u s t o d i a n s
- a r k e t a n d I n a l y t i c a l
: a t a
" r i c e s
T r a d e G r d e r s
T r a d e s
S e t t l e + e n t s
T r a d i n g
: a t a
Foundation Course in Banking
(E!EA(C#
6esearch is one o1 the pri+ary inputs to)ards deciding )hat kind o1 asset or 1inancial instru+ent
to in/est in* ,t in/ol/es per1or+ing a /ariety o1 <ualitati/e and <uantitati/e analysis to deter+ine
the ideal port1olio +i4* Pis includes an in depth analysis a=out the institution issuing the
instru+ent, esti+ating 1uture gro)th, industry analysis, trend analysis o1 historical prices etc*
So+e o1 the pre&re<uisites 1or per1or+ing +eaning1ul research to aid in/est+ent decision +aking
are as 1ollo)s#
(esear;@ tea*
The 1irst step is to put together a dedicated research tea+* ,t is critical that the tea+ +e+=ers not
only understand the 1inancial +arket dyna+ics =ut also ha/e kno)ledge on -odel =uilding and
Qcono+etrics* The success o1 the research tea+ is usually e/aluated relati/e to a =ench+ark
return*
Data
The research tea+ +ust ha/e easy access to a /ariety o1 data* The collection and +aintenance
o1 the data=ase is /ery i+portant* Tactical decisions need to =e +ade <uickly as ne) data keeps
pouring in* ,t is =est to in/est in a data=ase syste+ that takes the ne) data and auto+atically
runs the <uantitati/e analyses*
Co*+uting
While +ost top&do)n data +anage+ent e4ercises can =e handled )ithin Q4cel, the =otto+ up
proKects are not 1easi=le )ithin a spreadsheet* The =otto+&up proKects +ay include up to %0,000
securities along )ith /ectors o1 attri=utes 1or each security*
A!!ET ALLOCAT&O
"assi<e A++roa;@
The port1olio +anager has to decide on the +i4 o1 assets that +a4i+izes the a1ter&ta4 returns
su=Kect to the risk and cash 1lo) constraints* Thus the in/estor;s characteristics deter+ine the
right +i4 1or the port1olio* ,n co+ing up )ith the +i4, the asset +anager uses di/ersi1ication
strategies? asset classes tend to =e in1luenced di11erently =y +acro econo+ic e/ents such as
recessions or in1lation* :i/ersi1ying across asset classes )ill yield =etter trade o11s =et)een risk
and return than in/esting in any one risk class* The sa+e o=ser/ation can =e +ade a=out
e4panding port1olios to include =oth do+estic and 1oreign assets*
A;ti<e A++roa;@
"ort1olio +anagers o1ten de/iate 1ro+ the passi/e +i4 =y using 3-arket ti+ing5* To the e4tent that
port1olio +anagers =elie/e that they can deter+ine )hich +arkets are likely to go up +ore than
e4pected and )hich less than e4pected, they )ill alter the acti/e&passi/e +i4 accordingly* Thus, a
port1olio +anager )ho =elie/es that the stock +arket is o/er /alued and is ripe 1or a correction,
)hile real estate is under /alued, +ay reduce the proportion o1 the port1olio that is allocated to
e<uities and increase the proportion allocated to real estate* -arket strategists at all o1 the +aKor
in/est+ent 1ir+s in1luence the asset allocation decision*
Foundation Course in Banking
There ha/e =een 1e)er success1ul +arket ti+ers than success1ul stock pickers* This can =e
attri=uted to the 1act that it is 1ar +ore di11icult to gain a di11erential ad/antage at +arket ti+ing
than it is at stock selection* For instance, it is unlikely that one can ac<uire an in1or+ational
ad/antage o/er other in/estors at ti+ing +arkets* But it is still possi=le, )ith su11icient research
and pri/ate in1or+ation, to get an in1or+ational ad/antage at picking stocks* -arket ti+ers
contend that they can take e4isting in1or+ation and use it +ore creati/ely or in =etter +odels to
arri/e at predictions 1or +arkets, =ut such approaches can =e easily i+itated*
A""(OAC#E! TO A!!ET ALLOCAT&O
Fund +anagers generally adopt an indi/idual in/est+ent +anage+ent style* The 1ollo)ing are
the t)o <uantitati/e approaches to tactical glo=al asset +anage+ent#
To+ DoAn A++roa;@
The Stop do)nS in/estor =egins =y looking at the 3=ig picture5 & econo+y or =road trends in
society to identi1y indi/idual countries and then sectors that )ill =ene1it 1ro+ the pre/ailing
conditions* For e4a+ple, a Stop do)nS in/estor +ight say that since the huge =a=y&=oo+er
generation is aging and +o/ing to)ard retire+ent, co+panies that pro/ide products and ser/ices
to older people should =ene1it 1ro+ that trend* This +ight lead to =uying phar+aceutical stocks or
health care shares or, stocks o1 insurers that pro/ide retire+ent annuities*
I Stop do)nS in/estor +ay also +ake in/est+ents =ased on )hat he or she thinks lies ahead 1or
the econo+y* So, 1or e4a+ple, i1 a Stop do)nS in/estor =elie/ed that a resurgent econo+y +ight
re&ignite in1lation 1ears, then he or she +ight consider =uying gold or natural resource stocks, or
Kettisoning long&ter+ =onds in 1a/or o1 Treasury =ills* So a Stop do)nS in/estor starts )ith a
concept and then looks 1or stocks that are co+pati=le )ith it*
Then they )ork syste+atically do)n 1ro+ this /ery =road perspecti/e translating these top&do)n
/ie)s into +ore speci1ic econo+ic and +arket 1orecasts* This is an analytical process? trying to
identi1y those pro1ound structural changes in glo=al econo+ies and societies, seeing )hat e11ects
are likely to 1ilter do)n and in ti+e a11ect the /alue o1 ordinary in/est+ents*
In illustrati/e +odel o1 3top do)n5 approach )ill look as 1ollo)s#
Build country&=y&country 1orecasting +odels =ased on =ench+ark
return
Malidation o1 +odels
Forecast out o1 sa+ple returns
Sort country returns
,n/est in port1olio o1 highest e4pected return countries
,n1or+ation in =oth the /olatility and correlation is used in
deter+ining opti+al port1olio )eights
SPedgeS strategies are also possi=le* This in/ol/es taking long positions in the highest e4pected
returns countries and short positions in the lo)est e4pected returns countries*
Botto* )+ A++roa;@
The idea is to select indi/idual securities* Fro+ a /ariety o1 +ethods, 1orecasted )inners are
purchased and 1orecasted losers are sold* 3Botto+ upS in/estor )ould try to 1ind in/est+ents that
Foundation Course in Banking
are attracti/e =ecause o1 so+ething particular to the+ && i*e*, their terri1ic gro)th potential, say, or
the 1act that their assets are selling 1or less than their intrinsic )orth* So an in/estor )ho practices
the S=otto+ upS approach +ight screen through a long list o1 stocks to 1ind ones that look like a
=uy on the =asis o1 their 1unda+entals*
"O(TFOL&O EFEC)T&O
There are +any indi/idual strategies that +ay sho) pro+ise in ter+s o1 =eating the +arket*
Po)e/er, /ery 1e) port1olio +anagers actually acco+plish the sa+e o=Kecti/e* Gne /ery
i+portant reason is the 1ailure on the part o1 +ost studies to 1actor in =oth the di11iculties and the
costs associated )ith e4ecuting strategies*
There are three di+ensions to port1olio e4ecution#
Cost o8 e/e;ution
There are three co+ponents to this cost*
Bid&ask spread, )hich leads in/estors to =uy at a high price and sell at a lo)er price* For lo)&
priced stocks, this cost can =e as high as $0A o1 the price o1 the stock*
"rice i+pact that in/estors ha/e )hen they trade, pushing the price up as they =uy and do)n as
they sell* ,n illi<uid +arkets, this cost can =e signi1icant especially 1or large trades*
Ta4 i+pact associated )ith trading, )hich =eco+es a 1actor )hen )e consider the o=Kecti/e in
port1olio +anage+ent is +a4i+izing a1ter&ta4 returns*
When considered in aggregate, the trading costs )ill )ork out to =e high* The trading costs )ill
/ary )idely across di11erent in/est+ent strategies, depending upon the trading 1re<uency and
urgency associated )ith each strategy*
Trading s+eed
The need to trade 1ast and the desire to keep transactions costs lo) )ill co+e into con1lict*
,n/estors )ho are )illing to accept trades spread out o/er longer periods )ill generally =e a=le to
ha/e +uch lo)er trading costs than in/estors )ho need to trade <uickly* Vong ter+ /alue
in/estors )ill =e less a11ected =y trading costs than short ter+ in/estors trading on in1or+ation*
"ort8o,io (isk $anage*ent
"ort1olio risk characteristics change o/er ti+e and it is the port1olio +anager;s Ko= to keep the
port1olio risk at desired le/els at +ini+u+ costs* The deri/ati/es +arkets pro/ide port1olio
+anagers )ith additional tools that can =e used to hedge risk and add to returns o/er ti+e*
&VE!T$ET "#&LO!O"#&E!
"ort1olio -anagers 1ollo) di11erent in/est+ent philosophies* So+e e4a+ples are#
"assi<e Di<ersi8i;ation
So+e "ort1olio -anagers =elie/e that +arkets are e11icient? e/en i1 they are ine11icient, the cost o1
e4ploiting the ine11iciency is +ore the returns that can =e earned* Pence, they are )illing to
accept +arket returns* They try to construct port1olios that rese+=le the +arket inde4, o1ten
inde4ing to =roadest possi=le indices*
Foundation Course in Banking
"assi<e Va,ue &n<esting
-arkets syste+atically under/alue certain co+panies* "ort1olio -anagers identi1y such
co+panies )ith para+eters like lo) "Q, Pigh di/idend yield, lo) "rice to Book Malue, lo)
"riceF6eplace+ent Malue etc* The leading e4a+ples are the likes o1 "eter Vynch and Warren
Bu11et* Such "ort1olio -anagers ha/e long ti+e horizons, lo) turno/er 7i*e*8 =uying and selling,
and transactions costs
$o*entu* &n<esting
-arkets tend to stay in trends# i1 prices ha/e gone up 7do)n8 <uickly, they )ill tend to keep going
up 7do)n8* "ort1olio -anagers )ho su=scri=e to this school, use price +o+entu+ indicators,
relati/e strength indicators and charts* They ha/e short ti+e horizons and speedy e4ecution
styles*
$arket Ti*ing
,t is possi=le to 1orecast the direction o1 +arkets 7i*e* to ti+e +arkets8 using identi1ied /aria=les
like +arket ti+ing +odelsFindicators* Such "ort1olio -anagers usually take large =ets on the
+arket 7in either direction8, atte+pt tactical Isset Illocation in sectors, and use Pedge 1unds
7selling o/er/alued and =uying under/alued asset classes8* In e4a+ple )ould =e George Soros
and his Uuantu+ Fund*
Contrarian &n<esting
-arkets tend to correct the+sel/es? i1 prices ha/e gone up 7do)n8 <uickly, they )ill tend to go
do)n 7up8* ,1 in/estors are too =ullish 7=earish8, stocks are +ore likely to go do)n 7up8* Such
"ort1olio -anagers ha/e usually short ti+e horizons, are )illing to hold unpopular in/est+ents
and use specialist short sales*
&VE!T$ET $AA'E$ET VA(&AT!
Ilthough )e ha/e seen the generic de1inition and a typical in/est+ent +anage+ent process 1lo)
there are a nu+=er o1 /ariants in in/est+ent +anage+ent that ha/e e/ol/ed o/er the years to
address speci1ic needs o1 ,n/estors* This section 1ocuses on so+e o1 the in/est+ent options that
are a/aila=le to in/estors*
E/a*+,e# ,n the +iddle o1 -arch this year, the )ar )ith ,ra< )as Kust starting* The SI6S
epide+ic )as raging across Isia* Tra/ellers, )hether 1or =usiness or pleasure, )ere staying
at ho+e in 1ear o1 terroris+ . )hether in the guise o1 che+ical or =iological )ar1are, or old
1ashioned high e4plosi/es* The airline, touris+, and hotel industries )ere )arning o1 the )orst
conditions in li/ing +e+ory* The FTSQ %00 inde4 1ell to an eight&year lo) o1 (,(00*
The contrarians, +ean)hile, )ere ru==ing their hands )ith glee*
Guess )hatL ,1 you had in/ested then, at the pit o1 +isery you )ould ha/e +ade $ per cent
in around three +onths to the +iddle o1 June*
Foundation Course in Banking
&!T&T)T&OAL A!!ET $AA'E$ET
,nstitutional +oney +anagers are independent 1inancial ad/isory 1ir+s organized and licensed
under the Security and Q4change Co++ission or Banking Va)sR o/ersight agency o1 the country*
,nstitutional Isset -anage+ent ser/ice can =e =oth Id/isory or Fund handling and in/esting on
=ehal1 o1 the custo+er*
,nstitutional +oney +anagers are distinguished =y the 1act that#
They are under greater regulatory scrutiny 1ro+ =oth state and
1ederal authorities
They pro/ide e4clusi/e ser/ice to their clientele )ho are typically
institutions ha/ing port1olios in e4cess o1 se/eral +illion dollars*
They are /ery selecti/e in the clientele they ser/ice and 1irst do an
independent analysis o1 that clientRs 1inancial needs, goals,
o=Kecti/es, and risk tolerance*
They charge co+petiti/e 1ees due to the 1act that their clients entrust
+illions o1 dollars to the+ 1or in/esting* Iccordingly they are under
greater scrutiny to pro/ide attracti/e per1or+ance returns*
Ill +aKor international =anks o11er asset +anage+ent ser/ices* So+e key players include#
-organ Stanley
Bankers Trust
Boston "artners
"aci1ic ,n/est+ent -anage+ent Co* 7",-CG8
$)T)AL F)D!
I +utual 1und is a 1und that pools together +oney 1ro+ +any in/estors and in/ests it on =ehal1 o1
the group, in accordance )ith a stated set o1 o=Kecti/es* -utual 1unds raise the +oney =y selling
shares o1 the 1und to in/estors that includes indi/iduals and institutions, +uch like any other
co+pany can sell stock in itsel1 to the pu=lic* These 1unds take the proceeds o1 the +oney 1ro+
the sale o1 the shares and in/est it in other instru+ents like =onds, stocks etc* ,n return 1or the
+oney they gi/e to the 1und )hen purchasing shares, shareholders recei/e an e<uity position in
the 1und and, in e11ect, in each o1 its underlying securities* For +ost +utual 1unds, shareholders
are 1ree to sell their shares at any ti+e, although the price o1 a share in a +utual 1und )ill
1luctuate daily, depending upon the per1or+ance o1 the securities held =y the 1und*
No) you +ust =e )ondering that )hy do people =uy +utual 1unds )hen they can directly =uy the
instru+ents that these +utual 1unds in/est in* a1ter all )hat is the need o1 ha/ing a +iddle+anL
There are nu+erous reasons 1or in/esting in the +utual 1und* They are#
Diversi'ication2 With a +utual 1und one can di/ersi1y the in/est+ent =oth across co+panies
and across asset classes* When so+e assets are 1alling in price, others are likely to =e rising,
so di/ersi1ication results in less risk than i1 you purchased Kust one or t)o in/est+ents*
Liquidity2 -ost +utual 1unds are li<uid and it is easy to sell the share o1 a +utual 1und*
Low Invest(ent "ini(u(s2 Gne doesn;t need to =e )ealthy to in/est in +utual 1unds* -ost
+utual 1unds )ill allo) you to =uy into the 1und )ith as little B%,000 or B$,000*
Foundation Course in Banking
Convenience2 When you o)n a +utual 1und, you donRt need to )orry a=out tracking the
dozens o1 di11erent securities in )hich the 1und in/ests? rather, all you need to do is to keep
track o1 the 1undRs per1or+ance*
Low &ransaction Costs2 -utual 1unds are a=le to keep transaction costs lo) =ecause they
=ene1it 1ro+ reduced =rokerage co++issions 1or =uying and selling large <uantities o1
in/est+ents at a single ti+e*
3egulation2 -utual 1unds are regulated stringently =y the go/ern+ent* Thus this reduces the
risk 1or the end in/estor*
#ro'essional "anage(ent2 -utual 1unds are +anaged =y a tea+ o1 pro1essionals, )hich
usually includes one +utual 1und +anager and se/eral analysts*
So +utual 1unds are 1ull o1 =ene1its* No) you +ust =e )ondering i1 the +utual 1und )hat the
disad/antages o1 +utual 1unds are* There are plenty o1 disad/antages#
Fees and E)penses2 -ost +utual 1unds charge +anage+ent and operating 1ees that pay 1or
the 1undRs +anage+ent e4penses 7usually around %*0A to %*5A per year8* -oreo/er a 1e)
+utual 1unds charge high sales co++issions*
#oor #er'or(ance2 -utual 1unds do not guarantee a 1i4ed or high return* Gn an a/erage +ore
than hal1 o1 the +utual 1unds 1ail to do =etter than the +arket returns*
Loss o' Control2 The +utual 1und +anagers are the people )ho decide upon the strategy to
in/est* Thus the in/estor loses the control o1 his +oney to the 1und +anager*
Ine''iciency o' Cas 3eserves2 Nor+ally a -utual 1und +aintains a large cash reser/e to
pro/ide protection against si+ultaneous )ithdra)als* This pro/ides in/estors )ith li<uidity,
=ut due to the large cash reser/e the +utual 1unds do not in/est all cash in asset and thus
pro/ide in/estor )ith lo)ered returns*
T:+es o8 *utua, 8unds
-utual 1unds co+e in +any /arieties* For e4a+ple, there are inde4 1unds, stock 1unds, =ond
1unds, +oney +arket 1unds*
(nde) funds
S,nde4 1undS descri=es a type o1 +utual 1und or 9nit ,n/est+ent Trust 79,T8 )hose in/est+ent
o=Kecti/e typically is to achie/e the sa+e return as a particular +arket inde4, such as the SH"
500 Co+posite Stock "rice ,nde4, the 6ussell $000 ,nde4, or the Wilshire 5000 Total -arket
,nde4*
Stock funds
SStock 1undS and Se<uity 1undS descri=e a type o1 in/est+ent co+pany 7+utual 1und, closed&end
1und, 9nit ,n/est+ent Trust 79,T88 that in/ests pri+arily in stocks or Se<uitiesS* The types o1
stocks in )hich a stock 1und )ill in/est )ill depend upon the 1und;s in/est+ent o=Kecti/es,
policies, and strategies* For e4a+ple, one stock 1und +ay in/est in +ostly esta=lished, S=lue
chipS co+panies that pay regular di/idends )hereas another stock 1und +ay in/est in ne)er,
technology co+panies that pay no di/idends =ut that +ay ha/e +ore potential 1or gro)th*
*ond funds
SBond 1undS and Sinco+e 1undS are ter+s used to descri=e a type o1 in/est+ent co+pany 7+utual
1und, closed&end 1und, or 9nit ,n/est+ent Trust 79,T88 that in/ests pri+arily in =onds or other
types o1 de=t securities* The securities that =ond 1unds hold )ill /ary in ter+s o1 risk, return,
duration, /olatility, and other 1eatures*
Money market funds
Foundation Course in Banking
I +oney +arket 1und is a type o1 +utual 1und that is re<uired =y la) to in/est in lo)&risk
securities* These 1unds ha/e relati/ely lo) risks co+pared to other +utual 1unds and pay
di/idends that generally re1lect short&ter+ interest rates* 9nlike a S+oney +arket deposit accountS
at a =ank, +oney +arket 1unds are not 1ederally insured*
-oney +arket 1unds typically in/est in go/ern+ent securities, certi1icates o1 deposits, co++ercial
paper o1 co+panies, and other highly li<uid and lo)&risk securities* While in/estor losses in
+oney +arket 1unds ha/e =een rare, they are possi=le*
et Asset Va,ue
Net asset /alue,S or SNIM,S o1 an in/est+ent co+pany or a +utual 1und is the co+panyF1und;s
total assets +inus its total lia=ilities* For e4a+ple, i1 an in/est+ent co+pany has securities and
other assets )orth B%00 +illion and has lia=ilities o1 B%0 +illion, the in/est+ent co+pany;s NIM
)ill =e B00 +illion* Because an in/est+ent co+pany;s assets and lia=ilities change daily, NIM )ill
also change daily* NIM +ight =e B00 +illion one day, B%00 +illion the ne4t, and B'0 +illion the
day a1ter*
The in/est+ent co+panyF1und calculates the NIM o1 a single share 7or the Sper share NIMS8 =y
di/iding its NIM =y the nu+=er o1 shares that are outstanding*
So+e o1 the leading co+panies that o11er +utual 1unds are#
Fidelity ,n/est+ents
Mangaurd
,NG :irect
-ellon
!E"A(ATEL% $AA'ED ACCO)T!
I separately +anaged account is a port1olio o1 securities o)ned directly =y the in/estor and
+anaged =y pro1essional +oney +anager in lieu o1 an asset&=ased 1ee* S-I or the separately
+anaged accounts pro/ides the indi/idual in/estors the sa+e <uality o1 ser/ice as o11ered to
institutional in/estors*
Separately +anaged accounts help in/estors =uild and +anage their )ealth =y 1ocusing on the
in/estorRs indi/idual in/est+ent goals, ti+e horizon, and risk tolerance* To deter+ine these, a risk
pro1ile <uestionnaire is used* Clients recei/e a personalized ,n/est+ent "olicy State+ent that
outlines goals and the in/est+ent /ehicles necessary to help achie/e the+* Fro+ there, the
1inancial consultant chooses an asset allocation strategy that is used as a road +ap to achie/e
o=Kecti/es* The 1inancial consultant then reco++ends the in/est+ent +anagers =est suited to
+anage the o/erall port1olio* Vastly, ongoing +onitoring and re/ie) o1 the port1olio takes place at
=oth the 1inancial consultant and in/est+ent +anager le/el*
De: Features
The key 1eatures o1 S-I are &#
Direct ownersip# The port1olio is held in a personal account rather than held as a part o1
1und, there=y gi/ing direct control to the in/estors*
E)clusivity2 The arrange+ent gi/es e4clusi/ity to the in/estor as in/est+ent pre1erence,
o=Kecti/es and ta4 lia=ility are not necessarily shared across a pool o1 in/estors
Custo(i4ation2 The security to =e held and the in/est+ent pattern can =e custo+ized to
indi/idual needs* e*g* a custo+er +ay not )ant to in/est in those co+panies that are in
Foundation Course in Banking
to=acco =usiness* The port1olio can =e custo+ized to cater to his indi/idual needs and
pre1erences*
&a) advantages2 ,n the case o1 traditional +utual 1unds, indi/idual ta4es are not an issue*
Po)e/er, in case o1 S-I ta4 ad/antages to in/estor results 1ro+ ta4 loss har/esting strategy
Ad<antages and Disad<antages
Separately +anaged accounts pro/ide the client )ith the 1ollo)ing =ene1its#
The in/estors get access to top ,n/est+ent +anagers at an a11orda=le rate that they
)ould ha/e =een di11icult other)ise*
The 1ee structure is asset =ased and not co++ission =ased )hich o11er a signi1icant
/alue to the custo+er*
The client is relie/ed o1 port1olio +anage+ent 1unctionality and he can concentrate on
other +atters*
The client gets =etter ta4 planning =ecause o1 the ta4&har/esting ele+ent in S-I*
The transactions and the operations are +ore transparent to the custo+er as co+pared
to traditional +utual 1und*
The client gets custo+ized reports a=out his port1olio*
Disad<antages
There is no re<uire+ent 1or the reporting o1 the holding and there is no speci1ic go/erning
regulation unlike the +utual 1unds
There is no =oard in case o1 S-I, one hires the +anager to +anage the asset and there is
no =oard to sue i1 so+ething goes )rong
Closing an S-I )ould re<uire +o/ing the indi/idual;s security to another +anager, )hich is
a co+plicated and ti+e consu+ing e4ercise*
,t is di11icult to 1ind an appropriate co+para=le to =ench+ark the per1or+ance o1 S-I*
Di88eren;e =etAeen !$A and $utua, Funds
The key di11erence =et)een a +utual 1und and an S-I is that an S-I o11ers in/estors a
custo+ized approach to in/esting, rather than a generic product* 9sually, the process =egins )ith
an assess+ent =y an ad/iser o1 the indi/idual;s 1inancial needs and goals* The ad/iser can then
reco++end a /ariety o1 port1olio strategy options, )hich are custo+ized to +eet each in/estor;s
needs* Gnce the strategy has =een agreed, a pro1essional port1olio +anager =uys and sells
stocks and =onds in the port1olio on the in/estor;s =ehal1* The 1inancial ad/iser then keeps a
close eye on the port1olio;s per1or+ance*
Is the port1olio is tailored to +eet =oth long& and short&ter+ cash needs, an S-I, unlike a +utual
1und, can take into account personal in/est+ent pre1erences, such as not in/esting in particular
stocks 1or personal, social or en/iron+ental reasons* For e*g* an in/estor +ay speci1y that hisFher
port1olio should not contain any stock =elonging to TGBICCG co+panies*
Ilso unlike +utual 1unds, the in/estor has direct o)nership o1 the stocks and =onds )ithin the
port1olio* This can 1acilitate ta4 +anage+ent strategies*
Foundation Course in Banking
So+e o1 the leading in/est+ent +anagers o11ering S-I ser/ices are#
-errill Vynch ,n/est+ent -anage+ent
Brandes ,n/est+ent "artners
Nu/een ,n/est+ents
Illiance Capital
-organ Stanley ,n/est+ent -anage+ent
#ED'E F)D!
Pedge 1unds are /ery si+ilar to +utual 1unds e4cept that they are targeted at Pigh Net)orth
indi/iduals as e4plained in the pre/ious chapter* Pedge 1unds are e4e+pt 1ro+ +any o1 the rules
and regulations go/erning other +utual 1und )hich allo)s the+ to acco+plish aggressi/e
in/esting goals* They are restricted =y la) to no +ore than %00 in/estors per 1und, and as a result
+ost hedge 1unds set e4tre+ely high +ini+u+ in/est+ent a+ounts, ranging any)here 1ro+
B$50,000 to o/er B% +illion* Is )ith traditional +utual 1unds, in/estors in hedge 1unds pay a
+anage+ent 1ee? ho)e/er, hedge 1unds also collect a percentage o1 the pro1its 7usually $0A8*
"E!&O F)D! 1401k7 &(A3
"ension 1unds are the 1unds launched to +eet retire+ent sa/ings o1 indi/iduals so as to pro/ide a
steady inco+e to the+ a1ter retire+ent* Since conser/ation o1 inco+e is o1 ut+ost i+portance 1or
a pension 1und their in/est+ent strategy 1ocuses on long ter+, sa1er instru+ents* ,n/est+ent in
pension 1unds also o11ers ta4 =ene1its*
Foundation Course in Banking
!)$$A(%
"ri/ate Banking co/ers personalized ser/ices such as +oney
+anage+ent, 1inancial ad/ice, and in/est+ent ser/ices 1or high net
)orth clients* Pigh net )orth is generally taken at a household
inco+e o1 at least B%00,000 or net )orth greater than B500,000*
Varger pri/ate =anks o1ten re<uire e/en higher thresholds o1 at least
B% +illion o1 in/esta=le assets
I typical pri/ate =anking di/ision o1 a large =ank )ould o11er 1inancial
ser/ices like#
o ,n/est+ent -anage+ent and Id/ice
o 6isk -anage+ent
o Vi<uidity -anage+ent
o Structured Vending
o Qnhanced =anking 1acilities
o ,ssuer Capital 1or+ation
Core 1unctions in pri/ate =anking include the 1ollo)ing#
o Sales and -arketing F Client "rospecting
o Client -anage+ent, Ser/icing and deli/ery
o Financial "lanning
o "ort1olio Inalysis and Gpti+ization
o -arket Icti/ities
o 6esearch
o Co+pliance controls
"ri/ate Banking Front G11ice co/ers 1unctions like Sales H Client
prospecting, Contact -anage+ent, Iccount Iggregation and
Financial Id/isory ser/ices*
"ri/ate Banking -iddleFBack G11ice co/ers 1unctions like Isset
Illocation, 6esearch, "ort1olio Inalysis, 6isk -anage+ent, Trade
"rocessing, Co+pliance and :ocu+entation
Order Books
In order =ook is a placeholder 1or e/ery order entered into the syste+* Is and )hen /alid orders
are entered or recei/ed =y the trading syste+, they are 1irst nu+=ered, ti+e sta+ped and then
scanned 1or a potential +atch* ,1 a +atch is not 1ound, then the orders are stored in the =ooks as
per the priceFti+e priority* "rice priority +eans that i1 t)o orders are entered into the syste+, the
order ha/ing the =est price gets the higher priority* Ti+e priority +eans i1 t)o orders ha/ing the
sa+e price is entered, the order that is entered 1irst gets the higher priority* Best price 1or a sell
order is the lo)est price and 1or a =uy order, it is the highest price
Order $at;@ing
The =uy and sell orders are +atched =ased on the +atching priority* The =est sell order is the
order )ith the lo)est price and a =est =uy order is the order )ith the highest price* The
un+atched orders are <ueued in the syste+ =y the 1ollo)ing priority#
!TO" LO!! $ATC#&'
Ill stop loss orders entered are stored in the stop loss =ook* These orders can contain t)o prices*
Trigger "rice* ,t is the price at )hich the order gets triggered 1ro+ the
stop loss =ook*
Vi+it "rice* ,t is the price 1or orders a1ter the orders get triggered
1ro+ the stop loss =ook* ,1 the li+it price is not speci1ied, the trigger
price is taken as the li+it price 1or the order* The stop loss orders are
prioritised in the stop loss =ook )ith the +ost likely order to trigger
1irst and the least likely to trigger last* The priority is sa+e as that o1
the regular lot =ook*
The stop loss condition is +et under the 1ollo)ing circu+stances#
Sell Grder & I sell order in the stop loss =ook gets triggered )hen the
last traded price in the nor+al +arket reaches or 1alls =elo) the
trigger price o1 the order*
Foundation Course in Banking
Buy Grder & I =uy order in the stop loss =ook gets triggered )hen the last traded price in the
nor+al +arket reaches or e4ceeds the trigger price o1 the order* When a stop loss order )ith ,GC
condition is there, the order is released in the +arket a1ter it is triggered* Gnce triggered, the
order scans the counter order =ook 1or a suita=le +atch to result in a trade or else is cancelled =y
the syste+*
1.1.5 Trade E/e;ution
The trade e4ecution is carried out on a stock e4change a1ter an order is placed* Grder
+odi1ication andFor order cancellation is re<uired to handle any a=nor+ality* In order in entered
into the trading syste+ =y the =rokers and they speci1y the in1or+ation regarding the trade
details* The trade details typically contain in1or+ation like security Na+e, Uuantity, "rice, Grder
:uration etc* The order is entered into the order =ook and gets e4ecuted as per the ti+e and
price condition as speci1ied in the order* The order +atching 1or the e4ecution takes place in the
stock e4change* The order +odi1ication and order cancellation takes place =e1ore the order gets
e4ecuted i*e* i1 the order is there in the order =ooks o1 the e4change and is )aiting to =e e4ecuted
the re<uest 1or order +odi1ication is entertained =y the stock e4change* The stock e4change
prepares a NGQ 7Note o1 Q4ecution8 )ith the trade details and sends it across to the BrokerF
:ealer and to the clearing corporation gi/ing details o1 the trade* The date the trade is e4ecuted is
kno)n as the Trade :ate, and is re1erred as 5T3 or TE0*
The order e4ecution process 1or a custo+er sell order 7indi/idual in/estor placing order through a
=roker8 goes through the 1ollo)ing cycle#
Custo+er places a sell order through the ,nternet or to the account
e4ecuti/e o1 the =rokerage group*
The account e4ecuti/e sends the order to its corresponding 1loor
=roker or to its trading desk*
The order e4ecution takes place on the 1loor o1 the e4change such
as on NDSQ, I-QW etc*
The e4change sends a Noti1ication o1 sell to the Fir+;s
representati/e on the e4change as )ell as the trading desk o1 the
=rokerage group**
The Fir+;s representati/e on the e4change 1loor send a noti1ication
o1 the sell to the 1loor =roker )hich is then +atched )ith the counter
party =roker*
The trade e4ecution results in identi1ying the 1ollo)ing trade co+ponents#
Trade :ate
Trade Ti+e
Malue :ate
Gperation
Uuantity
Security
"rice
Foundation Course in Banking
1.1.I Trade Enri;@*ent
The process o1 trade enrich+ent in/ol/es the selection, calculation and attach+ent to a trade o1
rele/ant in1or+ation necessary 1or e11iciently ser/icing the clients* The trade co+ponents, )hich
re<uire enrich+ent, are#
Calculation o1 cash /alue# The cash /alue calculation is done
keeping the trade co+ponents in consideration*
Counter party Trade con1ir+ation re<uire+ent# The trade details
needs to =e enriched to deter+ine i1 the counter party needs the
trade con1ir+ation and i1 at all it needs the trade con1ir+ation, the
1or+at in )hich the con1ir+ation )ould =e send across to the+*
Selection o1 custodian details# The client +ight ha/e +ultiple
accounts )ith +ultiple or single custodian* The in/estor )ould send
the custodian details at )hich the settle+ent )ould take place* The
trade details are enriched )ith the account nu+=er o1 the custodian,
)hich )ill handle the cashF securities settle+ent*
-ethod o1 Transaction reporting# The transaction reporting depends
upon the security group as )ell as the country in )hich the
transaction has occurred* For e*g* the 9X e<uities +ay re<uire one
+ethod o1 reporting )hereas the international =onds )ould re<uire
another +ethod*
1.1.J Trade Va,idation
Trade /alidation is a process o1 checking the data contained in the 1ully enriched trade, in order to
reduce the possi=ility o1 erroneous in1or+ation =eing sent to the client 7in case o1 institutional
client8 also the )rong trade related in1or+ation can lead to delay in the settle+ent or e/en in
settle+ent 1ailure* The =asic trade related in1or+ation that are /alidated are 1ollo)ing#
Trade :ate
Trade Ti+e
Malue :ate
Gperation
Uuantity
Security
"rice
Trade Cash Malue
-ethods o1 Trade Malidation# The /alidation o1 trade can =e e11ected +anually or auto+atically
according to the a/aila=ility o1 the syste+*
-anual Trade Malidation
Iuto+atic Trade Malidation
1.1.K Trade C,earing
Clearing process signi1ies the e4ecution o1 indi/idual o=ligations )ith respect to a =uyer and
seller* Gnce the ter+s o1 a securities transaction ha/e =een con1ir+ed, the respecti/e o=ligations
o1 the =uyer and seller are esta=lished and agreed* This process is kno)n as clearance and
Foundation Course in Banking
deter+ines e4actly )hat the counter parties to the trade e4pect to recei/e* Clearance is a ser/ice
nor+ally pro/ided =y a Clearing Corporation 7CC8*
Clearance can =e carried out on a gross or net =asis* When clearance is carried out on a gross
=asis, the respecti/e o=ligations o1 the =uyer and seller are calculated indi/idually on a trade&=y&
trade =asis* When clearance is carried out on a net =asis, the +utual o=ligations o1 the =uyer and
seller are o11set yielding a single o=ligation =et)een the t)o counter parties* Iccordingly,
clearance on a net =asis reduces su=stantially the nu+=er o1 securitiesFpay+ent trans1ers that
re<uire to =e +ade =et)een the =uyer and seller and li+its the credit&risk e4posure o1 =oth
counter parties*
ETT&' "(OCE!!
The Settle+ent process 1or the securities is e4pensi/e as +o/ing securities and +oney in/ol/es
costs* Since a gi/en trader +ay engage in dozens or e/en hundreds o1 trades each day, these
costs soon add up* Gne )ay to reduce these costs is through netting*
For e4a+ple, suppose you sold the shares to S+ith =ecause you e4pected the price o1 GQ to 1all
Say an hour later the price does 1all to 5 and you =uy the shares =ack at that price* By
coincidence, you =uy the+ 1ro+ S+ith* Dou and S+ith could sa/e a lot o1 transaction costs i1 you
netted the t)o transactions . your earlier sale and your later repurchase* Net, S+ith o)es you
%0,000 4 7B'0 & B58 > B50,000* i1 S+ith Kust pays you this a+ount, no securities and a lot less
+oney need change hands*
Dou could e4tend this idea =eyond Kust netting pairs o1 speci1ic transactions to a general =ilateral
netting arrange+ent )ith S+ith* Dou could keep a running ta= o1 your trading in GQ shares o/er
a period o1 ti+e, and Kust settle your net position at the end o1 the period* Dou could sa/e e/en
+ore i1 you engaged in +ulti&issue netting . netting your trade in all securities*
Continuous et !ett,e*ent
The Continuous Net Settle+ent 7CNS8 Syste+ is an auto+ated =ook&entry accounting syste+
that centralizes the settle+ent o1 co+pared security transactions and +aintains an orderly 1lo) o1
security and +oney =alances* Throughout the CNS processing cycles, the syste+ generates
reports that pro/ide participants )ith a co+plete record o1 security and +oney +o/e+ents and
related in1or+ation* CNS pro/ides clearance 1or e<uities, corporate =onds, 9nit ,n/est+ent Trusts
and +unicipal =onds that are eligi=le at The De+ositor: Trust Co*+an: 1DTC8* :TC is an
institution that pro/ides depository ser/ices in 9S*
C,earing "ro;ess
The process o1 clearing is e4plained in the 1ollo)ing e4a+ple#
I deal is struck =et)een )ith S+ith and you on -onday* That night your =ack&o11ice people and
S+ith;s each send electronic noti1ication o1 the trade to the co+puter o1 t@e ationa, !e;urities
C,earing Cor+oration 1!CC3.
Foundation Course in Banking
The NSCC co+puter checks the t)o 3con1ir+s5 against each other* ,1 they +atch, the trade is
3co+pared5* NSCC con1ir+s to each o1 you on Tuesday +orning, )ith instructions 1or settle+ent
the sa+e Thursday* ,1 the trade does not co+pare, you are =oth noti1ied and you can sort things
out and resu=+it the trade =e1ore the settle+ent date*
Gn Wednesday, the day =e1ore the settle+ent, NSCC interposes itsel1 =et)een the t)o parties to
the transaction* That is, instead o1 the original deal =et)een you and S+ith, there are no) t)o
deals . one =et)een you and NSCC and the other =et)een NSCC and S+ith* Dou no) ha/e a
deal to sell %0,000 shares o1 GQ to NSCC at '0, and S+ith has a del to =uy the+ 1ro+ NSCC at
the sa+e price* Dou recei/e a notice to deli/er the shares to NSCC? S+ith recei/es a notice to
+ake pay+ent* By interposing itsel1 in this )ay, NSCC is guaranteeing settle+ent to =oth o1 you*
Whether or not S+ith pays up, you )ill get your +oney on ti+e* Whether or not you deli/er the
shares, S+ith )ill get %0,000 shares o1 GQ on Thursday*
The auto+ated co+parison is an i+portant 1unction o1 the clearing corporation =ecause it
ena=les the participant to ensure that the trade details agree )ith those o1 counter party prior to
settle+ent*
1.1.L Trade A88ir*ation.Con8ir*ation
The trade a11ir+ationFcon1ir+ation process occurs )hen a depository 1or)ards the selling =roker;s
con1ir+ation o1 the transaction to the =uyer;s custodian* The custodian re/ie)s the trade
instructions 1ro+ the depository and +atches the in1or+ation to instructions 1or the trade recei/ed
1ro+ its custo+er* ,1 the instructions +atch, the custodian a11ir+s the trade* ,1 the instructions do
not +atch, then the custodian )ill 5:X5 7don;t kno), or reKect8 the trade or )ill instruct the selling
=roker ho) to handle the +is+atch* The a11ir+ationFcon1ir+ation process is generally co+pleted
=y TE% in a nor+al TE( settle+ent cycle* Gn day TE$, depositories send settle+ent instructions
to the custodian =ank a1ter a11ir+ation and prior to settle+ent date* The instructions contain the
details o1 the trade that has =een a11ir+ed and agreed to =y the parties in the trade* Custodians
)ill +atch the settle+ent instructions to their records and prepare instructions to send 1unds or
e4pect 1unds 1ro+ the depository on TE( o1 the settle+ent cycle*
The 1ollo)ing +edia is used 1or the trans+ission o1 trade con1ir+ationFa11ir+ation
Fa4#
Tele4
S*W*,*F*T
e&+ail
"aper
1.1.10 Trade !ett,e*ent Fai,ure
Trade settle+ent is the act o1 =uyer and seller e4changing securities and cash on or a1ter the
/alue date in accordance to the contractual agree+ent* Settle+ent is success1ul )hen the seller
is a=le to deli/er the securities and =uyer is a=le to pay the cash it o)ns to the seller* ,n so+e
cases the settle+ent 1ails pri+arily =ecause the seller )as a)aiting the deli/ery o1 securities 1ro+
its purchase and there1ore could not deli/er the securities to the =uyer*
Foundation Course in Banking
,t is +andatory no) days to settle trade on the /alue date and )hene/er there is a settle+ent
1ailure the authority i+poses penalties to the party concerned*
Causes o8 !ett,e*ent Fai,ure
Non.-atching settle+ent instruction
,nsu11icient Securities
,nsu11icient Cash
1.1.11 Trade !ett,e*ent
Trade settle+ent is the act o1 =uyer and seller e4changing securities and cash on or a1ter the
/alue date in accordance to the contractual agree+ent* Settle+ent is success1ul )hen the seller
is a=le to deli/er the securities and =uyer is a=le to pay the cash it o)ns to the seller* There are
di11erent settle+ent +ethods depending upon the pay+ent +echanis+, security types etc*
,n +ost o1 the +arkets the settle+ent is done on a rolling =asis* ,n a 6olling Settle+ent, all trades
outstanding at end o1 the day ha/e to =e settled, )hich +eans that the =uyer has to +ake
pay+ents 1or securities purchased and seller has to deli/er the securities sold* For instance, 9SI
and 9X 1ollo) a TE( syste+ )hich +eans that a transaction entered into on :ay % has to =e
settled on the :ay % E ( )orking days, )hen 1unds pay in or securities pay out takes place*
!ETTLE$ET T%"E!
The settle+ent process has e/ol/ed o/er the period* Traditionally the settle+ent used to take
place )ith the physical deli/ery o1 the shares, =ut )ith ad/ent o1 Certi1icate ,++o=ilization the
Book Qntry settle+ent syste+ has e/ol/ed*
"hysical Settle+ent
Book Qntry Settle+ent
!ETTLE$ET "E(&OD
The settle+ent period is the ti+e =et)een the e4ecution o1 the trade and the settle+ent o1 trade*
,t is ti+e allo)ed =e1ore the securities sold +ust =e deli/ered to the =uyer* The settle+ent
periods depend upon the type o1 the securities traded* Ippendi4 C has the list o1 the settle+ent
period 1or di11erent types o1 security*
!ETTLE$ET "(OCE!!
Trade settle+ent occurs )hen securities and +oney are e4changed to co+plete the trade*
Settle+ent occurs on TE( in a TE( settle+ent cycle* Settle+ent o1 a securities transaction
in/ol/es the deli/ery o1 the securities and the pay+ent o1 1unds =et)een the =uyer and seller*
The pay+ent o1 1unds is e11ected in the settle+ent syste+ /ia a =ankingFpay+ents syste+* I
depository typically carries out the deli/ery o1 securities* I trade is not declared settled until =oth
71unds and securities8 trans1ers are 1inal*
Foundation Course in Banking
1.1.12 Trade A;;ounting N (e;on;i,iation
Trade accounting and 6econciliation is the internal control process used =y custodians to
+anage trade transactions* ,n this process, the custodian deter+ines that the custo+er;s
account has the necessary securities on hand to deli/er 1or sales, that the custo+er;s
account has ade<uate cash or 1orecasted cash 1or purchases* ,t +aintains the records o1
trades internally and tries to +atch it )ith outside )orld* ,t tries to +atch the positions =y
co+paring positions o1 trades 7Gpen and settled =oth8*
1.1.1C (isks asso;iated Ait@ Trading N !ett,e*ent
There are +ultiple risk associated )ith the trade e4ecution process *The 1ollo)ing e4a+ple
discusses the risk associated )ith the trading process 1ro+ the point o1 /ie) o1 a =roker
associated )ith a e4change*
Is a =roker on the 1loor o1 the Stock Q4change and you ha/e Kust agreed )ith S+ith, another
=roker, to sell hi+ %0,000 shares o1 GQ at '0* To e4ecute this transaction, you need to trans1er
o)nership o1 the shares to S+ith, and S+ith needs to trans1er the cash to you* ,n reality, once
you and S+ith agree on the ter+s, e4ecution is handed o/er to others in the 3=ack o11ice5* The
length o1 the process /aries 1ro+ +arket to +arket*
"rincipal 6isk
6eplace+ent 6isk
Vi<uidity 6isk
Gperational 6isk
Syste+ic 6isk
1.1.14 Bork F,oAs O8 Trading and !ett,e*ent
The 1ollo)ing e4a+ple discusses ho) a typical e<uity trade takes place#
Foundation Course in Banking
Trade Date 1T3:
Step %# The transaction =egins )ith the in/estor )ishing to in/est in e<uity* Pe contacts his =roker
7=uy side8 )ith an order to =uy and si+ilarly an in/estor contacts his =roker 7sell side8 to sell the
securities*
Step $# The =rokers place trade re<uest on the e4change*
Step (# The trade e4ecution takes place in the e4change as per the conditions speci1ied in the
order* The e4change prepares a NGQ 7Notice o1 Q4ecution8 and sends out to the Brokers and the
clearing corporation*
Step 2# The clearing corporation recei/es the +atched instruction i*e* the trade details 7<uantity,
price etc8 1ro+ the e4change* The trade details are entered into the Continuous net settle+ent
syste+ to o=tain the net positions 1or a =roker at the end o1 the day* The clearing corporation
prepares a contract sheet )ith end o1 day positions 1or =roker and sends it across to the
depository*
Step 5# The Brokers sends a con1ir+ation to the client a=out the trade details and the clients in
turn in1or+ their custodians a=out the receiptFdeli/ery o1 shares*
Foundation Course in Banking
-rade .ate /0!1 2-/0!13
Step %# The =roker recei/es trade details 1ro+ the clearing corporation and it enriches it )ith the
1ees, co++ission and other ta4 related details and send across the con1ir+ation to the client*
Step $# The client prepares an I11ir+ation order and sends it across to the custodians a=out the
possi=le pay inFout o1 securities and 1unds*
Step (# The clearing corporation prepares a 1inal pay inFpay out details =ased on the a11ir+ation
recei/ed 1ro+ the client and send it across to the depository*
Step 2# The custodians also con1ir+ )ith the depository a=out the pay inF pay out details a=out
the 1unds and securities*
Foundation Course in Banking
Trade date 2 C1T2C3
Step %# "ay ,n o1 securities# Clearing corporation ad/ises depository to de=it account o1 sell side
custodian and credit its account and the depository does it
Step $#"ay in o1 1unds 7Clearing corporation ad/ises clearing =anks to de=it account o1 =uy side
custodian and credit its account and the clearing =ank does it8
Step (#"ay Gut o1 securities 7Clearing corporation ad/ises depository to credit account o1 =uy
side custodian and de=it its account and depository does it8
Step 2# "ay Gut o1 1unds 7Clearing corporation ad/ises clearing =anks to credit account o1 sell
side custodian and de=it its account and clearing =anks does it8
Step 5# The custodian % con1ir+s the receipt o1 shares to the =uying client*
Step !# The custodian $ con1ir+s the deli/ery o1 shares to the selling client*
A!!ET !E(V&C&'
Isset ser/icing is a 5core3 ongoing ser/ice pro/ided =y custodians* This ser/ice includes
collecting di/idends and interest pay+ents, processing corporate actions and applying 1or ta4
relie1 1ro+ 1oreign go/ern+ents on =ehal1 o1 custo+ers*
Foundation Course in Banking
1.1.15 Cor+orate A;tions
I corporate action is an e/ent related to capital reorganization or restructure a11ecting a
shareholder* Custodians are responsi=le 1or +onitoring corporate actions 1or the securities they
hold under custody* Gnce the Custodian gets noti1ied o1 a corporate action, it identi1ies the
accounts that hold the security* ,1 the account holder has a speci1ied ti+e to decide )hether to
accept the corporate action, the custo+er should =e pro+ptly contacted* The custodians ha/e a
process to +onitor the corporate action to ensure that the custo+er has gi/en a co+plete
response =y the due date* When a custo+er;s instructions are recei/ed, the custodian sends the
instructions to the co+pany 1or e4ecution* The custodian +onitors the status o1 the action to
ensures ti+ely settle+ent* The custodian;s procedures 1or corporate actions also include
docu+entation o1 all custo+er directions*
1.1.15.1 Business "ro;ess o8 Cor+orate A;tion "ro;essing
6ecei/ing Corporate Iction# The in1or+ation regarding the corporate action is recei/ed 1ro+ a
nu+=er o1 e4ternal sources* Is the sa+e corporate action data is supplied =y +any di11erent
sources, a hierarchy o1 sources is +aintained to prioritize the o=tained data*
-aintaining Corporate Iction# The Corporate actions are classi1ied as either +andatory or
/oluntary
-andatory Ictions
,t is a type o1 corporate action )here)ith the shareholders are not
gi/en the option to conditionalize their tender* e*g* stock splits,
+ergers and ac<uisitions, li<uidations, =ankruptcies, reorganizations,
rede+ption;s, =onus issues etc
Moluntary action
,t is a type o1 corporate action )here)ith the shareholders are gi/en
the option to conditionalize their tender* They include rights o11ers,
tender o11er, purchase order, e4change order etc*
Noti1ication o1 Corporate Iction# The noti1ication is generated 1or the client o1 Moluntary and
-andatory Corporate Ictions* The noti1ication process ensures that the client recei/es the
in1or+ation o1 the corporate action* -aintaining 6esponse o1 Corporate Iction# The corporate
action response is +aintained 1or /oluntary corporate action responses against e4piration dates
on a daily =asis until the client responds )ith instructions*
"rocessing o1 Corporate Iction #,n this stage the "rocessing o1 corporate action is done to update
the records o1 the =anks* Is per the 1eed=ack recei/ed 1ro+ the client in case o1 /oluntary
actions, the records 1or the client are updated in the records o1 the =anks* I si+ilar +ethod is
1ollo)ed 1or the +andatory types o1 corporate action*
1.1.1I &n;o*e "ro;essing
Custodians are responsi=le 1or collecting inco+e pay+ents recei/ed 1ro+ the assets held under
custody* The inco+e pay+ents typically take the 1or+ o1 di/idends on e<uity securities and
interest on =onds and cash e<ui/alents* Custodians calculate the proKected pay+ents and in1or+
the custo+ers accordingly in ad/ance* This ena=les the custo+ers to plan in/est+ent decisions
Foundation Course in Banking
and use the proceeds e11ecti/ely* The =ank;s internal controls 1or inco+e collection also include
an inco+e +ap procedure that details each client;s e4pected inco+e 1ro+ a particular security*
Contractual inco+e pay+ents are posted to the custo+er;s account on the date they are due
rather than the date they are recei/ed =y the custodian )hereas the actual inco+e pay+ents are
posted to the custo+er;s account on the date they are recei/ed =y the custodian
1.1.1I.1 Business +ro;ess o8 &n;o*e "ro;essing
6ecei/ing Corporate Innounce+ent# The custodians are dependent on e4ternal /endors to
recei/e corporate action in1or+ation* These /endors are specialized in pro/iding in1or+ation
across the glo=e* So+e o1 the co++on /endor 1eeds used are 1ro+ JJ Xenny, :TC, Telekurs,
and 6euters etc* The in1or+ation collected is announce+ents regarding interest 7coupon8
pay+ents 1or registered =onds, di/idend pay+ent 1or e<uities, inco+e pay+ent 1or I:6
securities, +utual 1unds, pri/ate place+ent securities etc*
Generating "ay+ent G=ligation# I pay+ent o=ligation is lia=ility o)ned =y a client* The pay+ent
o=ligation 1or a client is generated 1ro+ the data regarding the corporate announce+ent* The
pay+ent o=ligation is generated 1or the pending pay+ents that are due to the client* Ilso the
cash proKection 1or the client depending upon corporate announce+ents is calculated*
Iccount -aintenance# :etails regarding the trade are tracked and the corresponding account is
updated* The trade details are +aintained and the details regarding the transaction are captured
and recorded*
"ay+ent Settle+ent# The pay+ent settle+ent stage enco+passes entire process o1 "ay+ent
receipt, pay+ent reconciliation, and pay+ent re/ersal
1.1.1J "ro/: Voting
Custodians pro/ide pro4y&/oting ser/ice to clients )ho )ant to e4ercise their rights as
shareholders o1 a co+pany during the general +eetings* ,1 personal attendance is not possi=le,
the shareholder +ay appoint a representati/e to attend the +eeting and /ote =y pro4y* I
custodian helps in/estor to e4ercise their /otes =y pro/iding a pro4y /oting ser/ice 1or all +anner
o1 general +eetings )here/er this ser/ice is a/aila=le*
1.1.1J.1 Business "ro;ess &n<o,<ed in "ro/: !er<i;es
6ecei/ing Corporate Innounce+ent# The corporate announce+ent regarding the agenda o1
General Body -eeting or Q4traordinary General Body -eeting is captured 1ro+ e4ternal /endors*
Noti1ication to Client# The custodians noti1y the clients a=out the pro4y ser/ices =y pro/iding the
details o1 the corporate announce+ent*
-aintaining 6esponse o1 Client# The client;s response to the corporate announce+ent is
+aintained on a daily =asis until the client responds )ith instructions* The client response is
typically o=tained 1ro+ either e+ail, 1a4 etc* The response is typically like recei/ing client
authorization to represent hi+ at the +eeting and /ote on his =ehal1*
Foundation Course in Banking
1.1.1K Ta/ "ro;essing
Custodians pro/ide ser/ices to +ini+ize 1oreign )ithholding ta4es or reclai+ ta4es )ithheld 1or
their custo+ers* The ta4 treaties =et)een countries o1ten reduce )ithholding ta4es and e4e+pt
capital gains 1ro+ ta4es* The purpose o1 ta4 treaties is to reduce the possi=ility o1 dou=le ta4ation
on inco+e earned in 1oreign countries* ,n addition, so+e countries pro/ide reduced ta4
)ithholding rates 1or certain types o1 in/est+ents 7go/ern+ent =onds, 1or e4a+ple8 or 1or certain
types o1 in/estors 7in/estors e4e+pt 1ro+ ta4ation in their ho+e country, 1or e4a+ple8* Ta4 treaty
=ene1its +ay pro/ide 1or reduced )ithholding ta4 at the ti+e the interest or di/idend is paid 73relie1
at source58, )hile other treaties +ay re<uire the in/estor to 1ile 1or a re1und a1ter the 1act
73reclai+58* Custodian 1iles a 1or+ or state+ent on =ehal1 o1 the client, certi1ying the in/estor;s ta4
status and country o1 residence 1or ta4 purposes* I custodian keeps track o1 the ta4 rates 1or
each o1 the countries in )hich it pro/ides custody* :i/idends, interest, and capital gains +ay all
=e ta4ed at di11erent rates* The custodian also +aintains in1or+ation a=out the ta4 treaties )ithin
its custody net)ork, and )hether its custo+ers <uali1y 1or relie1 under the treaty*
1.1.1K.1 Business "ro;ess o8 Ta/ #and,ing
-aintaining Ta4 ,n1or+ation# The ta4 related in1or+ation like standard ta4 rates, e4e+ptions and
reductions a/aila=le under local la) are +aintained* The details speci1ying the reduced rates
a/aila=le =y /irtue o1 dou=le ta4ation treaties are +ade a/aila=le to the client* The +arket ta4
reports, su++arizing local ta4es 1or each +arket are pro/ided to the client*
Ta4 Calculation# The ta4 calculation process captures trade details and applies the corresponding
ta4 rates 1or co+putation o1 the ta4*
Ta4 6ecla+ation# The ta4 recla+ation process is used to reclai+ the e4tra ta4 paid =y the client*
,t can =e o1 t)o types#
Contractual Ta4 6eclai+s# ,n this kind o1 recla+ation the clientRs cash account is credited )ith
entitle+ents to ta4 relie1 according to a pre&deter+ined schedule o1 ti+e&1ra+es, in place o1 )hen
the ta4 re1und +onies are recei/ed* The contractual ti+e 1ra+e +ay =e @n; +onths a1ter the
inco+e pay date 7)here the /alue o1 n /aries according to the +arket concerned8 or pay+ent
+ay =e +ade, less a discount, )ith inco+e pay+ent* This can greatly assist clients in +anaging
a/aila=le 1unds*
Non&contractual Ta4 6eclai+s# ,n this type )here ta4 relie1 is not o=tained at source, the e4cess
ta4 )ithholding is reclai+ed* The =ank prepares the re<uired reclai+ 1or+ and co+pletes the
associated reclai+ process, pursuing ite+s as appropriate and reporting their status to clients*
Cas@ !Aee+
Cash s)eep is a /alue added ser/ice pro/ided =y custodian =anks to its custo+ers* This ser/ice
ensures that the surplus cash in custo+ers; accounts are e11ecti/ely in/ested in short&ter+
in/est+ent 1unds i*e* ST,F 7+ay =e as short as an o/ernight 1und8 to generate additional returns*
The s)eep can =e done intra&day =ased on proKected earnings o1 the particular account or end&
o1&day =ased on actual surplus cash in the account* The ST,Fs in/est +oney in +oney +arket or
euro dollar :eposit*
(isks Asso;iated Ait@ Custod: !er<i;es
-any =anks currently o11er custodian ser/ices* The pri+ary risks associated )ith custody
ser/ices are# transaction, co+pliance, credit strategic and reputation*
Transaction 6isk
Foundation Course in Banking
Co+pliance 6isk
Credit 6isk
Strategic 6isk
6eputation 6isk
Foundation Course in Banking
2.10. CO("O(ATE !E(V&CE!
Foundation Course in Banking
BEEF&T! AD$&&!T(AT&O
Q+ployee =ene1it plans are esta=lished or +aintained =y an e+ployer or =y an e+ployee
organization 7such as a union8, or =oth, that pro/ides retire+ent inco+e or de1ers inco+e until
ter+ination o1 co/ered e+ploy+ent or =eyond* There are a nu+=er o1 types o1 retire+ent plans,
including the 20%7k8 plan and the traditional pension plan, kno)n as a de1ined =ene1it plan*
The Q+ployee 6etire+ent ,nco+e Security Ict 7Q6,SI8 co/ers +ost pri/ate sector pension
plans* I+ong other things, Q6,SI pro/ides protections 1or participants and =ene1iciaries in
e+ployee =ene1it plans, including pro/iding access to plan in1or+ation* Ilso, those indi/iduals
)ho +anage plans 7and other 1iduciaries8 +ust +eet certain standards o1 conduct under the
1iduciary responsi=ilities speci1ied in the la)*
The Q+ployee Bene1its Security Id+inistration 7QBSI8 o1 the :epart+ent o1 Va=or is responsi=le
1or Id+inistering and en1orcing these pro/isions o1 Q6,SI* Is part o1 carrying out its
responsi=ilities, the agency pro/ides consu+er in1or+ation on pension plans, as )ell as
co+pliance assistance 1or e+ployers? plan ser/ice pro/iders, and others to help the+ co+ply
)ith Q6,SI*
The pri+ary e+ployee =ene1its are
:e1ined Bene1its
:e1ined Contri=ution
Pealth and Wel1are
DEF&ED BEEF&T!
:e1ined Bene1it plans are the oldest retire+ent plans that e4ist in the "ension ,ndustry* They
pro+ise to pay a speci1ied =ene1it at retire+ent age* They de1ine the a+ount o1 retire+ent inco+e
to =e paid* The actual +onthly 7or annual8 =ene1it is calculated using a speci1ic 1or+ula stated in
the plan docu+ent* The =ene1it is usually paid at a speci1ied ti+e such as attain+ent o1 age !5*
I :e1ined Bene1it "lan is an e+ployer&sponsored retire+ent plan in )hich retire+ent =ene1its are
=ased on a 1or+ula indicating the e4act =ene1it that one can e4pect upon retiring* ,n/est+ent risk
is =orne =y the e+ployer and port1olio +anage+ent is entirely under the control o1 the co+pany*
There are restrictions on )hen and ho) participant can )ithdra) these 1unds )ithout penalties*
I pri/ate de1ined =ene1it plan is typically not contri=utory i*e* there are usually no e+ployees
contri=utions, no indi/idual accounts are +aintained 1or each e+ployee* The e+ployer +akes
regular contri=utions to the entire plan to 1und the 1uture =ene1its o1 the entire cohort o1
participants* The e+ployer, rather than the participant, =ears the in/est+ent risk* 9sually, the
pro+ised =ene1it is tied to the e+ployeeRs earnings, length o1 ser/ice, or =oth*
I :e1ined Bene1it plan pro/ides a guaranteed le/el o1 =ene1its on retire+ent and the cost is
unkno)n 1or the e+ployer* ,1 the plan assets earn less than e4pected, the e+ployer +ust +ake
larger contri=utions to ensure that the plan )ill ha/e su11icient 1unds to pay pro+ised =ene1its* ,1
the plan assets earn +ore than e4pected, the e+ployerRs contri=utions )ill decrease*
De8ined Contri=ution
Foundation Course in Banking
I :e1ined Contri=ution "lan is a type o1 retire+ent plan that sets aside a certain a+ount o1
+oney each year 1or an e+ployee* The a+ount to =e contri=uted to each participantRs account
under the plan each year is de1ined 7=y either a 1i4ed 1or+ula or =y gi/ing the e+ployer the
discretion to decide ho) +uch to contri=ute each year8* The size o1 a participantRs =ene1it )ill
depend on#
The a+ounts o1 +oney contri=uted to the indi/idualRs account =y the
e+ployer and, perhaps, =y the e+ployee as )ell?
The rate o1 in/est+ent gro)th on the principal?
Po) long the +oney re+ains in the plan 7in +ost cases, the
e+ployee, upon retire+ent, has the option o1 either recei/ing the
pay+ent in a lu+p su+ or =y taking partial pay+ents on a regular
=asis )hile the =alance continues to earn interest8? and
Whether the 1or1eitures o1 participants )ho lea/e =e1ore they are 1ully
/ested can =e shared a+ong the re+aining participants as a re)ard
to long&ter+ e+ployees*
Since =ene1its accu+ulate on an indi/idual =asis, these plans are so+eti+es re1erred to as
Sindi/idual account plans*S ,n these plans, unlike in de1ined =ene1it plans, the risk 7and re)ard8 o1
in/est+ent e4perience is =orne =y the participant* :e1ined contri=ution plans can per+it, and
so+eti+es re<uire, that e+ployees +ake contri=utions to the plan on either a pre&ta4 =asis 7as in
a 20%7k8 plan8 or an a1ter&ta4 =asis 7as in a thri1t plan8* They +ay also, =ut are not re<uired to,
per+it e+ployees to decide ho) the +onies contri=uted into their accounts )ill =e in/ested*
:e1ined contri=ution plans ha/e gained popularity as e+ployers ha/e =egun to ask their
e+ployees to share responsi=ility 1or their retire+ent* The +ain purpose o1 a de1ined contri=ution
plan is to pro/ide an in/est+ent /ehicle 1or e+ployees to accu+ulate retire+ent inco+e*
Defined Benefit Plan Defined Contribution Plan
The employer funds it. Employee and employer contributions
are allocated to individual participants
The employer bears the investment
ris !the potential for investment
"ain or loss#.
The participant bears the investment
ris.
$t is "enerally difficult to
communicate.
$t is easier to communicate.
The final benefit is defined as it is
formula driven tain" definite
parameters !lie salary% number of
years of service etc.# as input data
The final retirement benefit is unnown
as it is decided by the performance of
participant selected investment funds.
The benefit is e&pressed as an
annuity !a specified annual or
monthly payment to a pensioner
over a specified period of time or
based on life e&pectancy# payable at
normal retirement a"e% usually a"e
The benefit is e&pressed as an account
balance.
Foundation Course in Banking
'(.
The 1ollo)ing plans are designated as de1ined contri=ution plans#
"ro1it Sharing "lans
Cash Gr :e1erred Irrange+ents Gr 20%7k8 "lans
Stock Bonus "lans Ind Q+ployee Stock G)nership "lans
Si+pli1ied e+ployee pensions 7SQ"8
Ta4 Sheltered Innuities Gr 20(7=8 Irrange+ents
Business entities in/ol/ed in the :e1ined Contri=ution "ension Id+inistration process ha/e
strong interdependency in&ter+s o1 1lo) o1 in1or+ation, 1und and assets 7stocks8*
The diagra+ =elo) depicts the +ain entities in the plan ad+inistration =usiness and their
relations )ith each other*
Fig 2.1
Sponsor delegates responsi=ilities to plan ad+inistrator
Foundation Course in Banking
"articipant contri=utes 1or the plan to the sponsor*
Trust o)ns the 1unds o1 the plan contri=uted =y the sponsor and the
participants and delegates +anage+ent o1 the sa+e to ,n/est+ent
-anager
Trust and plan ad+inistrator su=+it co+pliance reports to Federal
Igencies )hich in turn )ould <uali1y the plan*
"articipants direct the ,n/est+ent +anager on their in/est+ent
pre1erences*
6ecord Xeepers pro/ide in1or+ation on "articipant, plan and account
in1or+ation to "lan Id+inistrators, trustee, Sponsor and "articipant*
Follo)ing diagra+ e4plains the =asic processes in/ol/ed in =ene1its ad+inistration
Foundation Course in Banking
#EALT# AD BELFA(E
,n the early days )hen the Social Security )as adopted, Pealth insurance )as taken care =y
pri/ate sectors* Vater the escalating health costs and )age 1reezes o1 the post WW ,, era,
pro+pted +any co+panies to o11er non&cash re)ards in the 1or+ o1 Pealth care =ene1its* The
challenges due to co+petiti/e =ene1its 1or +aintaining the 1iscal responsi=ility and changes in ta4
code +ade the e+ployers to o11er greater =ene1it choices )ith certain ta4 incenti/es*
Pealth and Wel1are =ene1it plans can =e either :e1ined&Bene1it or :e1ined Contri=ution plans*
:e1ined Bene1it health and )el1are plans speci1y a deter+ina=le =ene1it, )hich +ay =e in the 1or+
o1 rei+=urse+ent to the co/ered plan participant or a direct pay+ent to pro/iders or third party
insurers 1or the cost o1 speci1ied ser/ices* Q/en )hen a plan is 1unded pursuant to agree+ents
that speci1y a 1i4ed rate o1 e+ployer contri=ution, it cannot =e a :e1ined =ene1it health and
)el1are plan*
:e1ined Contri=ution health and )el1are plans on the other hand +aintain an indi/idual account
1or each plan participant* The =ene1its a plan participant )ill recei/e are li+ited to the a+ount
contri=uted to the participant;s account, e4perience, e4penses etc* Pealth and Wel1are plans
generally are su=Kect to certain 1iduciary, reporting and other re<uire+ents o1 the Q6,SI
7Q+ployee 6etire+ent ,nco+e Security Ict, %028*
Categories o8 @ea,t@ and Ae,8are +,ans
Pealth Care
o -edical
o "rescription drug
o Beha/ioral health
o :ental
o Mision
o Vong&ter+ care
:isa=ility ,nco+e
o Sick lea/e
o Short&ter+ disa=ility
o )on" term disability
Sur/i/or Bene1its
o Term life
Foundation Course in Banking
C. (ECET DEVELO"$ET!
Foundation Course in Banking
(ECET DEVELO"$ET!
)!A "AT(&OT ACT
11
9S Go/ern+ent passed the 9niting and Strengthening I+erica =y "ro/iding Ippropriate Tools
6e<uired to ,ntercept and G=struct Terroris+ 79SI "IT6,GT Ict8 in response to the terrorists;
attacks o1 Septe+=er %%, $00%* The key 1eatures are#
The Ict gi/es 1ederal o11icials greater authority to track and intercept
co++unications, =oth 1or la) en1orce+ent and 1oreign intelligence
gathering*
,t /ests the Secretary o1 the Treasury )ith regulatory po)ers to
co+=at corruption o1 9*S* 1inancial institutions 1or 1oreign +oney
laundering purposes*
,t seeks to 1urther close our =orders to 1oreign terrorists and to detain
and re+o/e those )ithin 9S =orders*
,t creates ne) cri+es, ne) penalties, and ne) procedural
e11iciencies 1or use against do+estic and international terrorists*
The anti +oney laundering rules are /ery i+portant 1ro+ a =anking point o1 /ie)* They are
descri=ed in greater detail later in the chapter*
Cri*ina, &n<estigations: Tra;king and 'at@ering Co**uni;ations
Federal co++unications pri/acy la) currently 1eatures a three tiered syste+, erected 1or the dual
purpose o1 protecting the con1identiality o1 co++unications )hile ena=ling authorities to identi1y
and intercept cri+inal co++unications* The 1irst le/el prohi=its electronic ea/esdropping on
telephone con/ersations, 1ace&to&1ace con/ersations, or co+puter and other 1or+s o1 electronic
co++unications in +ost instances* Po)e/er, in serious cri+inal cases, la) en1orce+ent o11icers
+ay seek a court order authorizing the+ to secretly capture con/ersations on a statutory list o1
o11enses 1or the per+itted duration*
The ne4t tier o1 pri/acy protection co/ers telephone records, e&+ail held in third party storage,
and the like* The la) per+its la) en1orce+ent access, ordinarily pursuant to a )arrant or court
order or under a su=poena in so+e cases* There is also a procedure that go/erns court orders
appro/ing the go/ern+ent;s use o1 trap and trace de/ices and pen registers, a secret 3caller id5,
)hich identi1y the source and destination o1 calls +ade to and 1ro+ a particular telephone*
Foreign &nte,,igen;e &n<estigations
The Ict eases so+e o1 the restrictions on 1oreign intelligence gathering )ithin the 9nited States,
and a11ords the 9*S* intelligence co++unity greater access to in1or+ation unearthed during a
cri+inal in/estigation, =ut it also esta=lishes and e4pands sa1eguards against o11icial a=use* ,t
per+its 3ro/ing5 sur/eillance 7court orders o+itting the identi1ication o1 the particular instru+ent,
1acilities, or place )here the sur/eillance is to occur )hen the court 1inds the target is likely to
th)art identi1ication8*
$one: Laundering