Commercial Bank Operations
Broad Learning Goals of This Chapter
Definition of Commercial Bank and its Balance Sheet Composition
Different Liability Components of Commercial Banks
Different Asset Components of Commercial Banks
Common Risk Faced by Commercial Banks
Commercial Banks and their
Balance Sheet Composition
Definition of Commercial Banks
Give Take Deposits
Loans
Get back money with Return the money with
interest interest
Deficit Surplus Unit
Unit
Interest Charged on Loan > Interest Paid on Deposit
The more the difference the more profit banks make.
Commercial
Banks in
Bangladesh
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A Real Balance
Sheet (Liability
Component
Only)
BRAC BANK
ANNUAL REPORT
2021
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Bank 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 banks
• Repurchase agreements
• Eurodollar borrowings
Long-Term Sources of Funds
• Bonds issued by the bank
• Bank capital
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Bank Sources of Funds
Current Deposit Account/demand deposit account
• Depositing and withdrawing money any time using checks or online
• A conventional demand deposit account requires a small minimum balance
• Does not usually pay any interest for the deposited amount
• Suitable for business people who need to make multiple payments, receipts, and other
transactions daily
• Minimum Balance, Overdraft facility
Source: Website of Trust Bank Limited
Bank Sources of Funds
2. Saving Deposit Account
• Allow limited transactions especially for
withdrawal (though unlimited withdrawal is also
possible now)
• Customer can deposit money anytime they want
• Earn modest interest on the deposited amount
• No check writing facility
• Suitable for people who are salaried employees or
have a monthly income
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Bank Sources
of Funds
•3. Special Notice Account
(SND)
•Advance notice is
required for withdrawal
•Attractive interest is paid
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Bank Sources of Funds
Popularly known as “FDR (Fixed Deposit
Receipt)” or Certificates of Deposit
A specified minimum amount of funds to be
deposited for a specified period of time
Normally the fund can not be withdrawn
4. Fixed before the maturity without incurring a
Deposit/Term penalty
Deposit Banks pay the highest interest on this deposit
• Negotiable Certificates of Deposit — Have a
specified maturity and require a minimum
deposit. Maturities are typically short-term,
and the minimum deposit is $100,000. A
secondary market for NCDs does exist.
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Bank Sources of Funds
•Money Market Deposit Accounts
• Differ from conventional time deposits in
that they do not specify a maturity.
• Provide limited check-writing ability,
require a larger minimum balance, and
offer a higher yield.
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Bank Sources of Funds
• 5. Borrowings from Other Banks/FIs
• Commercial Banks are always in transaction with other Banks as well as Financial
Institutions (Fis).
• They can take both short and long term loan from one another (if needed)
Call Money:
• A short term loan which has to be paid immediately in full whenever the lender demands.
So this call money does not have a fixed payment date time term loans. So the lender
does not have to provide prior notice to the borrower when he/she needs money back
with interest. Normally ranges from 1 to 14 days.
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• Federal Funds Purchased
Bank Sources • Represent a liability to the borrowing bank and an
asset to the lending bank. (typically for one to seven
of Funds days)
• Intent is to correct short-term fund imbalances by
banks.
• The interest rate charged in the federal funds market is
called the federal funds rate.
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Bank Sources of Funds
Borrowing from the Federal Reserve Banks
• The Federal Reserve banks regulate certain activities of banks and provide short-term
loans to banks.
• Often referred to as borrowing at the discount window.
• The interest rate charged is the primary credit lending rate.
• Mainly used to resolve a temporary shortage of funds.
Repurchase Agreements
• Represents the sale of securities with an agreement to repurchase the securities at a
specified date and price.
• Occur through a telecommunications network connecting large banks.
Bank Sources of Funds
Bank Capital/Stockholders’ Equity:
Funds acquired by issuance of stock or retaining profits (earnings)
Unlike other sources, banks have no obligation to pay out these
funds in the future
A bank must have enough capital to bear the operating losses
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Bonds Issued by the Bank
• Banks own fixed assets such as land,
Bank buildings, and equipment which are
Sources of usually financed with long-term sources
such as the issuance of bonds.
Funds • Common purchasers of these bonds are
households and various financial
institutions.
A Real Balance
Sheet (Asset
Component Only)
•BRAC BANK ANNUAL REPORT
2021
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Bank Uses of Funds
• Reserve (Cash in Hand + Cash balance held with Bangladesh Bank):
• Banks must keep a certain percentage of their deposit in a Bangladesh Bank account
• They also keep cash in their volt to entertain withdrawal requests made by the depositors
• Unlike investments, cash does not give income to the Banks
• Money kept with the central bank as a reserve requirement also does not provide any interest
• Hence, commercials banks do not want to keep excess cash
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Bank Uses of Funds
Deposit with other banks or Financial Institutions (FIs):
•Sometimes commercial banks also keep deposits to other
banks or financial institutions if they have idle money and
not better investment/credit opportunities. They can keep
term deposits with other banks as well
Call Money:
A commercial bank with sudden excess funds can
lend the money to other banks at a call money rate.
It can ask for repayment of the loan with interest any
day without any prior notice.
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Bank Uses of Funds
Investment in securities:
Banks can also buy both
• Government Bonds: Treasury Bills and Treasury Bonds.
• Corporate Bonds: Bonds issued by other company
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Cash Reserve Ratio (CRR) &
Statutory Liquidity Ratio (SLR)
Suppose a commercial bank has total 100 crore in demand and term deposit. According
to Bangladesh Bank’s regulation it must keep 4 crore in CRR and 13 crore in SLR.
Cash Reserve Ratio (CRR) Statutory Liquidity Ratio (SLR)
• Cash balance held with • Components of SLR: Cash
Bangladesh Bank or its agent held inside the bank, Gold,
bank Government Securities, and
• 4% of total demand and term Excess Reserve.
deposit • 13% of total demand and term
deposit
Bank Uses of Funds
4 Loans and Advances:
•A. Business Loans:
Term Loans: These are loans taken typically to finance the purchase of
fixed assets such as land, buildings, machinery, etc. Loans can range
from 2 years to 10 years.
•loan
The asset purchased with the loan amount can act as collateral of the
Working capital loan: (sometimes called a self-liquidating loan) —
Designed to support ongoing business operations
Restrictive Covenants: Specific conditions imposed by the bank to
protect it from loan default.
Fix maximum level of dividend is allowed, No new loan can be taken
before the existing one ends
Repayment method:
-Equal Installments which contain both interest and principal payments.
(More Popular)
-Balloon Payments: Loan as bullet loans where the principal is paid only
at the end of maturity. (Riskiness?) 23
Bank Uses of Funds
• A2: Direct Lease Loan (An alternative to Term Loans):
• -Rather than buying the asset the business rent the asset from
the bank. The bank remains the owner of the asset.
• -Hence, the bank can charge depreciation and get tax advantage.
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Bank Uses of Funds
• A3: Informal Line of Credit:
• Business can borrow up to specified amount for specified period of time.
Useful for firms that have unpredictable need for funds/cashflows for their business.
Interest rate (adjustable) charged on the fund depends on prevailing market condition.
• Banks do not have any legal obligation to supply funds when needed. (What about the reputation?)
• A4: Revolving Credit Loan:
• Banks have legal obligation/commitment to supply maximum amount for a specified time when needed.
• Commitment fees are charged on the unused limit.
•
.
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Bank Uses of Funds
B. Consumer Loans:
B1: Installment Loans:
These loans are taken to finance the purchase of personal car or other assets. These loans are taken to fulfill
personal needs.
Repayments are usually made in monthly equal installments throughout the loan terms.
Loans may be secured or unsecured.
B2: Real Estate/Home Loans:
Bank Uses of For purchasing new flat, constructing a house or
Funds renovating existing home
Term ranges from 1 year to 25 years
Like car loan, this loan is backed by the asset purchased
Maximum amount 20 Million
Go through the Subprime mortgage crisis
(2007-08) from your text book to understand
the risk involved with Real Estate Loans
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Bank Uses of Funds
• B3: Credit Cards: A credit card is one type of loan from the bank and these cards are used
to make payments for goods and services on credit. Here, not the merchant but the bank
is providing you the credit opportunity.
• Each month the bank will provide you with a statement of your usage and provide you
some time to repay the full balance without any interest.
• In return banks charge a very high-interest rate (the highest among all consumer loans).
Banks also charge a fixed annual fee against credit cards.
• Each credit cards have a credit limit (Maximum amount you can owe the bank) based on
income and employment profile
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Common Risks Faced by Commercial Banks
Credit Risk/Default Risk:
The likelihood that the borrower will not pay the promised interest and
principal.
Higher the probability, higher the interest rate is charged.
Banks make some group and categorize people and business
organizations and attach probability of defaults accordingly.
YouTube video link: https://www.youtube.com/watch?v=PkxxMyYKD4o
(1st 8 Minute only)
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Common Risks Faced by Commercial
Banks
Interest Rate Risk:
is the potential loss due to movements in interest rates.
This risk arises because bank assets (loans and bonds) usually have a significantly
longer maturity
This risk than bank liabilities
can be conceptualized in two (deposits).
ways. First, if interest rates rise, the value of
the longer-term assets will tend to fall more than the value of the shorter term
liabilities, reducing the bank’s equity. Second, if interest rates rise, the bank will be
forced to pay higher interest rates on its deposits well before its longer-term loans
mature and it is able to replace those loans with loans that earn higher interest
rates.
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Common Risks Faced by Commercial
Banks
Foreign Exchange Risk:
is the risk that the value of the bank’s assets or liabilities changes due to
currency exchange rate fluctuations.
Banks buy and sell foreign exchange on behalf of their customers (who need
foreign currency to pay for their international transactions or receive foreign
currency and want to exchange it to their own currency)
and they also hold assets and liabilities in different currencies on their own
balance sheets.
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Common Risks Faced by Commercial
Banks
Liquidity Risk:
Liquidity risk is the risk that a bank may not be able to meet its obligations to
repay deposits and other funding, or to continue financing its assets.
The simplest way to lower this risk is to always hold sufficient cash to meet
demands. However, this is not optimal when organizations seek to make a profit
or expand operations.
This risk is more severe for companies which have a balance sheet that is too
focused on illiquid assets.
Commercial banks plan their cashflows properly to mitigate the liquidity risk.
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Common Risks Faced by Commercial
Banks
Operational Risk:
Operational risk is the risk of loss resulting from inadequate or failed internal
processes, people, and systems or from external events.
Some examples include:
Cybersecurity Risk: Weaknesses in firms’ IT infrastructure may result in loss of
clients money.
Internal and External Fraud: Forgery, bribes, theft, check fraud, theft, hacking,
system breaches, money laundering, data theft etc.
Business Disruptions and Systems Failures: Hardware or software system
failures, and power failures may lead to serious obstacle in business and
