CHAPTER 3

COMMERCIAL BANK

TOPICS
Roles

and functions of
commercial bank
List of commercial banks in
Malaysia
Flows of funds: sources and uses
Commercial bank current issues:
merger and consolidation
Issues, concept and differences
between conventional bank and
Islamic bank

LEARNING OBJECTIVES
To

explain the definition of

commercial banks
To discuss the role and functions of
commercial banks
To explain the management and
services offered by commercial banks
To identify the flow of funds in the
commercial banks
To discuss the major issues related to
commercial banks in Malaysia

Commercial Banks
Commercial

banks are the largest group of financial

institutions in terms of total assets
Key financial intermediary because they serve all types of
surplus and deficit units

Major

assets - loans
Major liabilities are depositsdepository institutions
Perform services essential to financial markets
play a key role in the transmission of monetary policy
provide payment services
provide maturity intermediation
Banks

are regulated to protect against disruptions to

the services they perform

Commercial banks
Act

Excess cash

as a financial intermediary

Financial
intermediary

Financial
Institution

Need cash

Commercial Bank Assets

Cash

and balances due from other depository

institutions
Investment securities
short-term securities (e.g, Treasury bills and fed funds sold)
long-term securities (e.g., Treasury bonds, munis, MBSs)
Loans

commercial and industrial

real estate
consumer
other loans

Unearned

income and allowance for loan and lease

losses
Other assets (e.g., fixed assets, goodwill, etc.)

Commercial Bank Liabilities

Core

deposits

demand deposits
savings deposits
certificates of deposits
Other

deposits

wholesale certificates of deposits

negotiable instruments traded in secondary
markets
brokered deposits

Main Function of commercial

banks
1.

Receiving Deposits:
This is the main function of commercial banks to collect
savings of individuals and firms. They offer different types of
deposits for the facility of the customers.
Current Account or Demand Deposits:
Any amount can be withdrawn from this account any time without any
notice. No interest is allowed on this type of account.
Saving Account:
The saving account carries lower rate of interest.
Fixed Deposit (time deposit):
Amount cannot be withdrawn before the fixed future date in this type
of deposit. High interest is allowed in fixed deposit which is different
according to period, the longer the period the higher the rate of
interest offered.

Main Function of commercial banks

2.

Advancing Loans:
This is the important function of the
commercial bank. Credit is given to the
people in different ways.
a) Making Loans:
There are three types of loans given to borrowers.
i. Short Term Loans:
These loans are advanced for the period of six
months to one year. High Interest rate is charged
on this type of accounts.
ii. Medium Term Loans:
Loans from one to five years are called medium
term loans.
iii: Long Term Loans:
Loans which are advanced for the period, more
than ten years are long term loans.

Main Function of commercial

banks
b)Bank Overdraft:
Banks allows their trustful
customers to withdraw more than
the deposit they have in their
current accounts. Bank charges
interest on overdraft.
c)Cash Credit:
An arrangement whereby the bank allows
the borrower to withdraw amount up to a
specified limit. The interest is charged on
the amount withdrawn.

Secondary functions
Issuing

letters of credit, travellers cheques, circular notes

etc.
Undertaking safe custody of valuables, important
documents, and securities by providing safe deposit vaults
or lockers;
Providing customers with facilities of foreign exchange.
Transferring money from one place to another; and from
one branch to another branch of the bank.
Standing guarantee on behalf of its customers, for making
payments for purchase of goods, machinery, vehicles etc.
Collecting and supplying business information;
Issuing demand drafts and pay orders; and,
Providing reports on the credit worthiness of customers.

Retail Banking services

Automated
Automated teller
teller machines
machines (ATMs)
(ATMs)

Point-of-sale
Point-of-sale (POS)
(POS) debit
debit cards
cards

Preauthorized
Preauthorized debits
debits and
and credits
credits

Paying
Paying bills
bills via
via telephone
telephone

Online
Online banking
banking

Smart
Smart cards
cards (stored-value)
(stored-value) cards
cards

Internet
Internet banking
banking

complements
complements existing
existing business
business for
for already
already
existing
existing banks
banks
some
some new
new internet-only
internet-only banks
banks have
have no
no brick
brick
and
and mortar
mortar

Flow of funds: sources of

funds
Deposit

Accounts

Transaction deposits
Savings deposits
Time deposits
Money market deposit accounts

Borrowed

funds

Federal funds purchased (borrowed)

Borrowing from the Federal Reserve Bank
Repurchase agreements
Eurodollar borrowings

Long-term

sources of funds

Bonds issued by the bank

Bank capital

Flow of funds: sources of

funds
Transaction

Deposits

Demand deposit account or checking account

Small min balance and no interest

Negotiable order of withdrawal (NOW) account

Pays interest and provide checking services
Require larger min balance

Savings

Deposits

No check writing
No required min balance
Time

deposits

Cannot be withdrawn until specified maturity date

Certificate of deposits (CD)
No secondary market
Requires a specified min amount of funds for a specified period of time

Negotiable Certificate of Deposits (NCD)

Offer by some large banks to corporations
Secondary market exists

Flow of funds: sources of

funds
Money

Market Deposit Accounts

Do not specify maturity

More liquid than CDs and offer lower interest than
CD
Limited check writing ability, larger min balance
and higher yield compared to NOW
Federal

Funds purchased

A liability to the borrowing bank, an asset to the

lending bank
Loans are for 1-7 days
To correct short-term fund imbalances
Interest charged=federal funds rate, which
depends on demand and supply

Flow of funds: sources of

funds
Borrowing

from the Federal Reserve Banks

Short term loans

Referred to as borrowing at the discount window
Interest = primary credit lending rate
The central bank as the lender of the last resort
To resolve temporary shortage of funds

Repurchase

Agreements

Represents the sale of securities by one party to

another with an agreement to repurchase the
securities at a specified date and price
A short term source of fund
The securities serve as a collateral, less risky

Flow of funds: sources of

funds
Eurodollar

Borrowings

Borrow dollars from banks outside US that

accept dollar-denominated deposits
Bonds

issued by the bank

Used to finance fixed asset such as land,

building etc.
Bank

capital

Through the issuance of stocks or

retained earnings which represents equity
No obligation to pay out funds

Flow of funds: uses of

funds
Cash
Bank

loans
Investment in securities
Federal funds sold (loaned out)
Repurchase agreement
Eurodollar loans
Fixed assets

Flow of funds: uses of

funds

Cash

As reserve for the purpose of SRR

controlling the money supply
To maintain liquidity hold necessary amount
Bank

loans

Main use
Type of business loans
Working capital loan to support ongoing business
operations
Term loans to finance the purchase of fixed assets
such as machinery

Speciffed period of time and specified purpose

The asset purchased may serve as collateral
Can be 2, 5 or 10 years
May impose protective covenants to protect the banks from

Flow of funds: uses of

funds
Type

of Business Loans

Direct lease loan

The bank purchase the assets and lease them to the
firm
Avoid having more debt on firms balance sheet

Informal line of credit

To borrow up to a specified amount within a
specified period of time
Do not know precisely when they need the fund

Revolving credit loan

Obligates the bank to offer up to some specified
max amount of funds over a specified period of time
Charges a commitment fee on any unused funds

Flow of funds: uses of

funds
Prime

Rate
What Does Prime Rate Mean?
The interest rate that commercial banks charge their most
credit-worthy customers. Generallya bank's best
customersconsist of large corporations. The prime interest
rate, or prime lending rate, is largely determined by the
federal funds rate, which is the overnight rate which banks
lend to one another. The prime rate is also important for retail
customers, as the prime rate directly affects the lending rates
which are available for mortgage, small business and personal
loans.
Investopedia explains Prime Rate
Default risk is themain determinerof the interest rate abank
will charge a borrower. Because a bank's best customers have
little chance of defaulting, the bank can charge them a rate
that is lower thanthe rate that would be charged to a
customer who has a higher likelihood of defaulting ona loan.

Flow of funds: uses of

funds
Loan

Participation

Pooling of funds by several banks to

cater the need of a large corporation
who wish to borrow a larger amount
One bank will be the lead bank who
prepares the documents etc.
Loan syndication
Loans

supporting leveraged buyouts

Loans to support the purchase of equity

of another business

Flow of funds: uses of

funds
Types of Consumer Loans

Installment loans eg. purchase car, involve periodic

payments
Credit card

Real estate loans

Mortgage loans of typical 15-30 years

Investment

in securities

More liquid compared to loans

Federal

Funds sold

Interbank lending and borrowing

Repurchase

agreements
Eurodollar loans
Fixed assets

Risks associated with

commercial banks

Commercial
Commercial banks
banks face
face unique
unique risks
risks

because
because of
of their
their asset
asset structure
structure

credit
credit (default)
(default) risk
risk is
is the
the risk
risk that
that loans
loans
are
are not
not repaid
repaid
liquidity
liquidity risk
risk is
is the
the risk
risk that
that depositors
depositors will
will
demand
demand more
more cash
cash than
than banks
banks can
can
immediately
immediately provide
provide
interest
interest rate
rate risk
risk is
is the
the risk
risk that
that interest
interest
rate
rate changes
changes erode
erode net
net worth
worth
credit,
credit, liquidity,
liquidity, and
and interest
interest rate
rate risk
risk all
all
contribute
contribute to
to aa commercial
commercial banks
banks level
level of
of
insolvency
insolvency risk
risk

Commercial banks in
malaysia
Currently, there are 23 commercial banks in
Malaysia, 9 L, 14 F (www.bnm.gov.my)

Affin Bank Bhd

Alliance Bank Malaysia Bhd
AmBank (M) Bhd
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Malayan Banking Bhd
Bank of China (Malaysia) Bhd
Bank of Tokyo-Mitsubishi UFJ (Malaysia) Bhd
CIMB Bank Bhd
Citibank Bhd
RHB Bank Bhd
EON Bank Bhd
Hong Leong Bank Bhd..