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Banking Fundamentals – Basics of Banking

Safe Harbor Statement

Due care has been taken to make this Presentation as accurate as possible. Certain statements
made in this presentation may not be based on historical information or facts and may be “forward
looking statements” and may be subject to risks and uncertainties that could cause actual results to
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Oracle makes no representation or warranties with respect to the contents hereof and shall not be
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All company and product names are trademarks of the respective companies with which they are
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COPYRIGHT © 2010 Oracle Financial Services Software Limited.

All rights reserved.

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The Financial System

Financial System

“Financial system refers to a set of

complex and closely connected
institutions, agents, practices,
markets, transactions and claims in
the economy”.

The financial system consists of financial institutions,

organized and unorganized financial markets, financial
instruments and services which facilitate transfer of funds.
Procedures and practices adopted in the markets and
financial inter- relationships are also parts for system.
Financial System

Financial
System

Financial Financial Financial Financial

Institution Markets Instruments Services

Banks
Stock Banking,
Mutual Funds Stocks,
Exchange, Insurance,
Insurance co. Bonds, etc etc
OTC, etc
etc
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Financial Institutions
Financial Institution

Financial institutions are business organizations

like banks, mutual funds, insurance companies,
building societies, etc. These specialized
institutions act as mobilizers and depositories of
savings and extend loans and advances to the
public.
Financial Institutions

Financial
Institutions

Non
Intermediar
Regulatory Intermediar Others
y
y

Non-
Banking
Banking
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Financial Markets
Financial Markets

Organizations that facilitate the trade in financial

products. i.e. Stock exchanges facilitate the trade in
stocks, bonds and warrants.

The coming together of buyers and sellers to trade

financial products. i.e. Stocks and shares are traded
between buyers and sellers in a number of ways
including: the use of stock exchanges; directly between
buyers and sellers etc.
Financial Markets

Financial Markets

Organized Un-organized

Secondary
Primary Market
Market

Capital Markets Money Markets

Financial Markets

 Organized Markets:

these are formed under some legal framework, are

monitored in some form, the statistics of their activity
is reported and is publicly available. Typical
examples are stock exchanges, commodity
exchanges, mortgage loan/housing loan companies,
etc.
Financial Markets

 Un-organized Markets:

The coming together of buyers and sellers to trade

financial products.
There are no legal records of such business and, by
and large, these markets are unregulated. Money
lending by pawnbrokers, small lending/community
chits carried out by individuals, etc., come under this
category.
Primary Market

The primary market provides the channel for sale

of new securities. Primary market provides
opportunity to issuers of securities; Government
as well as corporates, to raise resources to meet
their requirements of investment and/or
discharge some obligation.
New issuance of the securities, by way of
 Underwriting
 Initial public offerings (IPO)
 Follow on public issue (FPO)
Secondary Market

Secondary markets are where ‘old’ or ‘issued’

financial assets are traded.
Secondary market refers to a market where
securities are traded after being initially offered to
the public in the primary market and/or listed on
the Stock Exchange. Majority of the trading is
done in the secondary market. Secondary market
comprises of equity markets and the debt
markets.
Primary & Secondary Market

Major Players
 Bankers

 Mutual funds

 Brokers and

 Individual investors.
Important Functions of Financial Markets

Price Discovery Process

Provision of Liquidity

Low Cost of Transaction &

Information to Buyers and
Sellers
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Financial Instruments
Financial Instruments

A financial asset can be in the form of a

claim i.e. it is a loan given to a borrower
for which the lender (asset owner) is paid
interest.
Financial Instruments

Financial Instruments

Primary Secondary

Medium
Short Term Long Term
Term
Financial Instruments

Characteristics
 Liquidity
 Marketability
 Transferability
 Transaction Costs
 Risk of default
 Maturity period
 Call Back
 Buy Back
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Financial Services
Financial Services

Financial services basically mean services

connected with money. The basic service
in most cases remains, borrowing money
from a set of people and lending it to
another.
Financial Services

Banking
Insurance
Consumer Finance
Stock Broking
Investment Funds
Foreign Exchange services
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Central Banking
Central Banking - Roles & Functions
 Issue and management of currency
 Bankers to the Government
 Banker’s Bank
 Regulation of credit
 Supervise and control commercial banks
 Lay down and conduct monetary policy
 Open Market Operations:
 Bank Rate/Discount Rate Mechanism
 Reserve Requirements

 Exchange Control
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Bank
Banking

'Banking' as defined under Section 5 (b) of the

Banking Regulations Act, 1949 is the business of
"accepting deposits of money from the public
for the purpose of lending or investment".
These deposits are "repayable on demand or
otherwise, and withdrawable by a cheque,
draft, order or otherwise".
Bank

A bank is a business which provides financial

services for profit. Traditional banking services
include receiving deposits of money, lending
money and processing transactions. Many banks
offer ancillary financial services to make additional
profit; for example: selling insurance products,
investment products or stock broking.
Banking Services

Some of the Important banking service are:

 Withdrawals & Payments
 Deposits
 Mortgages
 Loans
 Trade Finance
 Investment Funds
 Foreign Currency
 Funds transfer
 Locker facilities
 Clearing services
Account Types – by Periodicity of Flow

Type Long term Long Term Short Term Short Term

Inflow Outflow Inflow Outflow
Real Asset
Personal Asset Liability
Nominal Income Expenditure

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 Debit - Credit
• Simple Thumb Rules to remember which accounts to credit and
which to debit:
• Personal accounts:
– Debit: the receiver;
– Credit: the giver
• Real/Asset Accounts:
– Debit: what comes in;
– Credit: what goes out
• Nominal/Expense Accounts:
– Debit: all expenses/losses;
– Credit: all income/gains

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 Examples

• when you pay rent with cash: you increase rent (expense) by
debiting, and decrease cash (asset) by credit.
• when you receive cash for a sale: you increase cash (asset) by
debiting, and increase sales (revenue) by credit.
• when you buy equipment (asset) with cash: You increase
equipment (asset) by debiting, and decrease cash (asset) by
credit.
• when you borrow with a cash loan: You increase cash (asset)
by debiting, and increase loan (liability) by credit.
• When you Pay salary with cash: you increase salary (expenses)
by debiting, and decrease cash (asset) by credit.

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 Types of Banking Services

BANKING

RETAIL CORPORATE PRIVATE INVESTMENT

Retail Banking: Providing service to individuals and small businesses

Corporate Banking: Providing services to large business entities

Private Banking: Providing wealth management services to High Net-worth Individuals

Investment Banking: Providing financial market related services

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Customer
Customer

No statutory definition exists for customer.

The relationship of banker and customer does not

come into existence unless both parties intend to
enter into it.

If someone opens some sort of an account, - a

current, savings or deposit account, then he
becomes a customer of the bank.
Customer
Based on important judicial pronouncements:
• a customer is one who maintains a deposit account with the bank
• duration of the account is immaterial
• state of the account, i.e., whether it is in debit or credit, is immaterial
• banker-customer relationship would exist between two banks if one has the account
with the other, and cheques etc., are collected through that account
• merely visiting a bank frequently for purchasing a draft or for encashing a cheque
etc., does not confer on the visitor the status of a customer i.e., maintenance of a
deposit account is a sine qua non of the eligibility criterion for a customer
• a customer of one branch does not automatically become a customer of another
branch of the same bank where he does not maintain an account
• even an agreement to open an account would make a prospective depositor a
customer of the bank.
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Account Opening
Account Opening

A bank exercises caution before opening

an account and providing full banking
facilities. Normally, a banker will not open
an account on mere request from a
stranger. Banks call for a satisfactory
introduction of new customers
Account Opening

Internationally, new norms are being adopted that would mandate

commercial bankers to “know and keep knowing” their customers and
their background on an on-going basis.
Account Opening – Money Laundering

• Money laundering is said to be an attempt to give apparent legitimacy

to illegally obtained funds.
• Banks should frame their KYC policies incorporating the following four
key elements:
• Customer Acceptance Policy;
• Customer Identification Procedures;
• Monitoring of Transactions; and
• Risk management.
 KYC – Documents that may be obtained

Accounts of Documents
Individuals
•Legal name (i) Passport
and any other (ii) PAN card
names used (iii) Voter’s Identity Card
(iv) Driving license
(v) Identity card (subject to the bank’s satisfaction)
(vi) Letter from a recognized public authority or public servant
verifying the identity and residence of the customer to the
satisfaction of bank

•Correct (i) Telephone bill

permanent (ii) Bank account statement
address (iii) Letter from any recognized public authority
(iv) Electricity bill
(v) Ration card
(vi) Letter from employer (subject to satisfaction of the bank)
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Types of Customer Accounts

Type of Customer Accounts

 Individuals
 Joint accounts – E or S, F or S, Joint.
 Minors – no O/D allowed, age > 10 yrs
 Partnership accounts
 Companies
 Associations, Committees, Societies, etc – No O/D allowed
 Trust accounts
 Executors and Administration
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Account Operations
Deposits

 Current Deposit: Payable on demand

 Savings Deposit: Payable on demand

 Term / Time / Fixed Deposit: Payable at a fixed future date.

Transaction Accounts

Most common of transaction accounts in a bank are current and

savings account

Current Account : Current Account is ideally suited for business or

individuals who have large number of transactions to be put through
the account. There are no restrictions on the number of transactions,
or on cheques used by the customer.

Savings Account : Savings accounts are special type of deposit

accounts that are intended primarily for small savers and individuals.
Interest rate is linked to money market interest rates.
Deposit Accounts

When an amount is placed in a bank by a

customer with instructions to hold it for a
specific period, say 6 months, 1 year, 5 years,
etc., at a given rate of interest, it is known as a
deposit account.

The bank gives a receipt marked ‘not

transferable’ and acknowledges the amount,
period and interest terms. The deposit is
payable usually only on maturity and on
production of the receipt duly signed by the
customer.
Deposit Accounts

Short-term and Long-term deposits

Short-term generally means, the tenor of the deposit is from 7 days

to 90 days. Anything more than that is treated as term deposits or
long-term deposits

Recurring deposits

Recurring deposits, under which a fixed amount is deposited at

regular intervals for a fixed term and the repayment of principal and
accumulated interest is made at the end of the term.
Sweep Facility
E.g.: When a $20,000 is placed for 1 year @ 7% p.a. and the customer wants to
withdraw in the 4th month, normal option would be to uplift the deposit. By doing so, he
would be penalized on the interest rate for the entire deposit for $20,000. After utilizing
the required amount i.e. $6,000, he has to open a fresh deposit for $14,000, perhaps at
a different rate of interest - rate prevailing on the date of breakage of deposit.

Banks innovated by allowing a deposit to be withdrawn prematurely on demand in small

portions or clusters.
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The Clearing System

The Clearing System

All crossed cheques drawn on other banks have to pass through

the clearing system. It is mandatory in most countries that
cheques have to be physically presented to the paying banker.
The Clearing System

Bank of
Baroda

SCG Canara
ICLG
Bank
CLEARING OCLG
HOUSE

Dena
Bank

Syndicate
Bank
Magnetic Ink Character Recognition (MICR)

In all-important cities in India, clearing is done through MICR process.

The relevant information is printed / encoded on the bottom of the
cheques in magnetic ink (MICR Band).

The code signifies the

 Place (Mumbai, Delhi, etc.)

 The Bank,

 The Branch
MICR Clearing
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Remittance and Payment

Systems
Mechanism of remittance
An example of the remittance process

Correspondent Bank

Chase Manhattan Bank

TT for US $ New York Issues PO for
10000 US $ 10000
less
Debits US $ charges
10000

Federal Bank Bank of America

Alwaye New York
Remittance networks

 SWIFT (Society for Worldwide Interbank

Financial Telecommunication)

 Large Value Transfer Systems (LVTS) and link

with local clearing system
 Thank You
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