Chapter 2:

Banking Activities
Treasury Management
 Financial Institution

In financial economics, a financial institution acts as an agent

that provides financial services for its clients. Financial
institutions generally fall under financial regulation from a
government authority.
 Types of Financial Institutions

Depository Institutions

Non-depository Institutions
 Types of Financial Institutions
Depository Institutions
 Accept deposits from surplus units and provide credit to deficit units
through loan and purchase of securities.
 They accept risk on loans provided.
 They provide the liquidity, size and maturity desired.
 They have more expertise.
 They diversify loans in order to minimize risk.
 Examples: Banks, saving institutions and credit unions. 4
 Types of Financial Institutions

Non-Depository Institutions

 Generate funds from sources other than deposits.

 They sell securities to firms.
 Examples: Mutual funds, finance companies, insurance
companies, pension funds and securities firms.
5
 Banks

A bank is a commercial or state institution that provides

financial services, including issuing money in various
forms, receiving deposits of money, lending money and
processing transactions and the creating of credit.
 1. Central Bank

•A central bank, reserve bank or monetary

authority, is an entity responsible for the monetary
policy of its country or of a group of member states,
such as the European Central Bank (ECB) in the
European Union, the Federal Reserve System in the
United States of America, State Bank in Pakistan.
 1. Central Bank

Its primary responsibility is to maintain the stability of the

national currency and money supply, but more active
duties include controlling subsidized-loan interest rates,
and acting as a “lender of last resort” to the banking sector
during times of financial crisis
 2. Commercial Banks
 A commercial bank accepts deposits from customers and in turn makes loans, even
in excess of the deposits; a process known as fractional-reserve banking. Some
banks (called Banks of issue) issue banknotes as legal tender.
 Commercial banks are the major financial intermediary in any economy. They are
the main providers of credit to the household and corporate sector and operate the
payments mechanism.
 Commercial banks are typically joint stock companies and may be either publicly
listed on the stock exchange or privately owned.
 Commercial banks deal with both retail and corporate customers, have well
diversified deposit and lending books and generally offer a full range of financial
services.
 The largest banks in most countries are commercial banks and they include
household names such as CIMB, Maybank, Hong Leong Bank etc.
 3. Investment Banks

• Investment banks help companies and governments and

their agencies to raise money by issuing and selling
securities in the primary market. They assist public and
private corporations in raising funds in the capital markets
(both equity and debt), as well as in providing strategic
advisory services for mergers, acquisitions and other types
of financial transactions.
 4. Saving Banks

A savings bank is a financial institution whose primary purpose is

accepting savings deposits. It may also perform some other functions.
 Savings banks are similar in many respects to commercial banks
although their main difference (typically) relates to their ownership
features – savings banks have traditionally had mutual ownership,
being owned by their ‘members’ or ‘shareholders’ who are the
depositors or borrowers.
 Also known as Savings and Loans Association (S&Ls or thrifts).
 In Malaysia we have Bank Simpanan Nasional or National Savings
Bank.
 5. Micro Finance Banks

 Microfinance refers to an array of financial services, including

loans, savings and insurance, available to poor entrepreneurs and
small business owners who have no collateral and wouldn't
otherwise qualify for a standard bank loan.
 For the purpose of poverty reduction program, such kind of banks
are working in the different countries with the contribution of
UNO or World Bank.
 6. Islamic Banks

Islamic banking refers to a system of banking or banking

activity that is consistent with Islamic law (Sharia)
principles and guided by Islamic economics.
In particular, Islamic law prohibits usury, the collection
and payment of interest, also commonly called riba in
Islamic discourse.
In Malaysia, example is Bank Islam Malaysia Berhad
(BIMB).
 7. Specialized Banks
 Specialized banks as those banks that specialize in
financing certain economic sectors.
 Most important types are specialized banks, industrial
banks, agricultural banks and banks of real estate.
 Examples are Agrobank and EXIM Bank Malaysia.
 (source: http://www.bnm.gov.my/index.php?
ch=en_fxmm_mo&pg=en_fxmm_fmc&ac=588&lang=en)
 8. Non-banking financial company

 Non-bank financial companies (NBFCs) also known as a

non-bank or a non-bank bank, are financial institutions that
provide banking services without meeting the legal definition
of a bank, i.e. one that does not hold a banking license.
 Non-bank institutions frequently acts as suppliers of loans
and credit facilities, supporting investments in property,
providing services relating to events within peoples lives such
as funding private education, wealth management and
retirement planning.
 8. Non-banking financial company (con’t)

however they are typically not allowed to take deposits from

the general public and have to find other means of funding
their operations such as issuing debt instruments.
Examples are pension funds and insurance companies.
 9. Investment company
Generally, an "investment company" is a company
(corporation, business trust, partnership, or limited
liability company) that issues securities and is primarily
engaged in the business of investing in securities.
An investment company invests the money it receives
from investors on a collective basis, and each investor
shares in the profits and losses in proportion to the
investor’s interest in the investment company.
 10. Leasing Companies
 A lease or tenancy is the right to use or occupy personal property or
real property given by a lessor to another person (usually called the
lessee or tenant) for a fixed or indefinite period of time, whereby the
lessee obtains exclusive possession of the property in return for
paying the lessor a fixed or determinable consideration (payment).
Types are:
Operating lease
Finance lease
 11. Insurances Companies
 Insurance is a contract, represented by a policy, in which an
individual or entity receives financial protection or reimbursement
against losses from an insurance company. The company pools
clients' risks to make payments more affordable for the insured.
 Insurance companies may be classified as
1. Life insurance companies, which sell life insurance, annuities
and pensions products.
2. Non-life or general insurance companies, which sell other
types of insurance.
 12. Mutual Fund
A mutual fund is an investment vehicle made up of a pool of
funds collected from many investors for the purpose of
investing in securities such as stocks, bonds, money market
instruments and similar assets.
Mutual funds are operated by money managers, who invest
the fund's capital and attempt to produce capital gains and
income for the fund's investors.
A mutual fund's portfolio is structured and maintained to
match the investment objectives stated in its prospectus.
 13. Brokerage Houses
A brokerage firm, or simply brokerage, is a financial
institution that facilitates the buying and selling of financial
securities between a buyer and a seller.
Brokerage firms serve a clientele of investors who trade
public stocks and other securities, usually through the firm's
agent stockbrokers
Stock brokers assist people in investing, online only
companies are called 'discount brokerages', companies with
a branch presence are called 'full service brokerages' or
'private client services.
 Financial Institution Functions

 Financialinstitutions provide a service as intermediaries of the

capital and debt markets.
 Theyare responsible for transferring funds from investors to
companies, in need of those funds.
 The presence of financial institutions facilitate the flow of cash
through the economy.
 To do so, savings accounts are pooled to mitigate the risk brought
by individual account holders in order to provide funds for loans.
Such is the primary means for depository institutions to develop
 Role of a Bank: Transformation
Banks bridge the gap between the needs of lenders and
borrowers by performing a transformation function.
a) Size transformation: Banks collect funds from savers in the
form of small-size deposits and repackage them into larger
size loans.
b)Maturity transformation: Banks transform funds lent for a
short period of time into medium- and long-term loans.
c) Risk transformation: Banks are able to minimise the risk of
individual loans by diversifying their investments, pooling
risks, screening and monitoring borrowers and holding capital 23

and reserves as a buffer for unexpected losses.

 Banking Services & Products
Modern banks offer a wide range of financial services,
including:
1. Payment services
2. Deposit and lending services
3. Investment, pensions and insurance services
4. E-banking
5. Treasury operations 24
 1. Payment services

 A payment system can be defined as any organized arrangement for

transferring value between its participants.
 Facilitates the transfer of ownership of claims in the financial sector.
 These payment flows reflect a variety of transactions: for goods and
services as well as financial assets.
 Payments services can be either paper-based or electronic and an
efficient payments system forms the basis of a well-functioning
financial system. 25
 2. Deposit and Lending Services
• Current or checking accounts that typically pay no (or low) rates of interest
and are used mainly for payments.

• Time or savings deposits involve depositing funds for a set period of time for
a pre-determined or variable rate of interest. Deposits that can be withdrawn
on demand pay lower rates than those deposited in the bank for a set period.

• Consumer loans and mortgages. Consumer loans can be unsecured (no

collateral is requested; short to medium time period) or secured on property
26
and interest rates are mainly variable (but can be fixed).
 3. Investment, Pensions and Insurance Services
• Investment products offered include various securities-related products including mutual
funds (known as unit trusts), investment in company stocks and various other securities-related
products (such as savings bonds).
• Pensions and insurance services
• Pension services provide retirement income (in the form of annuities) to those contributing
to pension plans.

• Insurance products protect individuals (policyholders) from various adverse events.

Policyholders pay regular premiums and the insurer promises compensation if the specific
insured event occurs.

• Two types of insurances are life insurance and general insurance.

 4. E-banking

Rapid technological progress and financial market

development.
Increasing proportion of the volume and value of domestic and
cross-border retail payments.
Mainly, we can refer to two categories of payment products:
• E-money includes reloadable electronic money instruments in the
form of stored value cards and electronic tokens stored in
computer memory.
• Remote payments are payment instruments that allow (remote) 28

access to a customer’s account.

 5. Treasury operations

Buying and selling of bullion. Foreign exchange

Acquiring, holding, underwriting and dealing in shares,
debentures, etc.
Purchasing and selling of bonds and securities on behalf of
constituents.
The banks can also act as an agent of the Government or local
authority. They insure, guarantee, underwrite, participate in
managing and carrying out issue of shares, debentures, etc.
 Common Banking Products Available
Credit Card: Credit Card is “post paid” or “pay later” card that draws from a credit
line-money made available by the card issuer (bank) and gives one a grace period to
pay. If the amount is not paid full by the end of the period, one is charged interest
Debit Cards: Debit Card is a “prepaid” or “pay now” card with some stored value.
 Debit Cards quickly debit or subtract money from one’s savings account, or if one
were taking out cash.
 Every time a person uses the card, the merchant who in turn can get the money
transferred to his account from the bank of the buyers, by debiting an exact
amount of purchase from the card.
 To get a debit card along with a Personal Identification Number (PIN).
Automatic Teller Machine: The ATM’s are used by banks for making the
customers dealing easier. ATM card is a device that allows customer who
has an ATM card to perform routine banking transaction at any time without
interacting with human teller. It provides exchange services. This service
helps the customer to withdraw money even when the banks ate closed. This
can be done by inserting the card in the ATM and entering the Personal
Identification Number and secret Password. It allows the customers:
 To transfer money to and from accounts.
 To view account information.
 To order cash.
 To receive cash.
Electronic Funds Transfer (EFT):. The system called electronic
fund transfer (EFT) automatically transfers money from one
account to another.
This system facilitates speedier transfer of funds electronically
from any branch to any other branch.
Telebanking: Telebanking refers to banking on phone services.
A customer can access information about his/her account
through a telephone call and by giving the coded Personal
Identification Number (PIN) to the bank. Telebanking is
extensively user friendly and effective in nature.
Mobile Banking: A new revolution in the realm of e-banking is the emergence
of mobile banking.
 On-line banking is now moving to the mobile world, giving everybody with a
mobile phone access to real-time banking services, regardless of their location.
 It provides a new way to pick up information and interact with the banks to
carry out the relevant banking business.

Internet Banking: Internet banking involves use of internet for delivery of

banking products and services.
 In internet banking, any inquiry or transaction is processed online without any
reference to the branch (anywhere banking) at any time.