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Banking Course Material - Bala

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    Part I - Banking

    Introduction

    WHAT IS A BANK AND WHAT IS BANKING?

    The present day banking has its origin in U.K. Their early role was to safe keep the moneydeposited by the local citizens and charge them a small fee for the same. Slowly thebankers started realising that they could use this money by lending it to those whoneeded it. That was the beginning of "deposit" and "loan". Thus "financial intermediary"was born - "financial intermediary" simply meaning that money flows through them fromthe "money-surplus" units to "money-needed" units.

    The depositors would be paid certain amount and the borrowers of this money would becharged certain amount, called "interest". There would obviously be difference betweenthe amount of interest paid to depositors and the amount of interest recovered from theborrowers. This would be the profit for the financial intermediary, which is a bank. This isthe foundation for today's "retail banking".

    With the growth in commerce, first within a country and then globally, banking startedtranscending first the regional boundaries and then the national boundaries. That is how"international banking" started. Even today, international banking caters to "internationaltrade" to a major extent.

    While primarily the banking function revolved around acceptance of deposits and grantingof loans, the customers started feeling the need for other services. These services were:remittance of funds from one place to another place, purchase of securities on behalf ofits customers, safe custody of important documents, safe deposit vault services etc.Thus slowly the services extended by banks went on expanding. Today in India, anymedium sized or large commercial bank extends the following services:

    Acceptance of deposits of various kinds deposits that can be withdrawn on demandlike Savings/Current Accounts or those deposits that have a fixed maturity date, like,

    Fixed Deposit Accounts, Recurring Deposit Accounts etc. Extending loans to borrowers in the form of Loans and Overdraft (This overdraft

    facility in India is called "Cash Credit" facility in the case of business enterprises)

    Extending financial assistance to exports on soft terms

    Remittance of funds from one place to another place by various modes like MailTransfer (M.T.), Telegraphic Transfer (T.T.), Demand Drafts (D.D.), Electronic FundTransfer (E.F.T.) etc.

    Collection of bills for commercial transactions tendered by its customers facilitatingcommerce within the country as well as outside the country.

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    Safe custody services for safe keeping of important documents

    Safe Deposit Vault services (SDV) for personal safe keeping of documents, cash,jewellery etc.

    Foreign exchange transactions involving import/export of goods and remittance of

    foreign exchange (both outward and inward) Issuing letters of undertaking to suppliers of goods and/or services through their

    bankers which are called Letters of Credit (L/C)

    Issuing Bank Guarantees on behalf of its customers in favour of various beneficiariesincluding Government Agencies (B/G)

    Obtaining credit reports from other Banks and specialised Credit Agencies oncustomers (both within India and outside India) as well as providing Credit Informationabout its customers to other Credit Agencies.

    Doing Government business, like payment of pension, collection of direct tax (like

    income tax) and indirect taxes (like excise duty). Extending Counselling Services to its customers on International Trade, Loan

    Arrangements (Syndication), when to come out with public issue of equity shares etc.

    Extending cash withdrawal facilities through Automated Teller Machines/Any TimeMoney (ATMs).

    Carrying out standing instructions of customers for receipt of payments (amountcredited to customers accounts) and making of payments (amount debited to thecustomers accounts).

    Issue of International Money Orders (IMO), Travellers Cheques (TC), both in Indian

    Rupee and Foreign Currency to travellers, exchanging Indian Rupee for ForeignCurrency Travellers cheques from foreign tourists/visitors, issue of Foreign Currencyto those who travel abroad/exchanging foreign currency for Indian Rupee , payment toInternational Credit Card Agencies, issue of Credit Cards to domestic customers etc.

    Acceptance of deposits from non-resident Indians

    Arrangement of international finance to its customers as well as managing issue ofGlobal Depository Receipts (GDR)/American Depository Receipts (ADR)/ Euro-Bondsetc.

    Investment in Govt. securities, shares of blue chip companies etc. for its own portfolio.

    Extending custodial services (please refer to chapter on banking terms)

    DIFFERENCE BETWEEN RETAIL BANKING AND WHOLESALE BANKING

    Wholesale banking typically involves a small number of very large customers such as bigcorporations and governments, whereas retail banking consists of a large number of smallcustomers who consume personal banking and small business services. Wholesale bankingis largely inter-bank; banks use the inter-bank markets to borrow from or lend to otherbanks/large customers, to participate in large bond issues and to engage in syndicatedlending. Retail banking is largely intra-bank; the bank itself makes many small loans.

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    Most of the Indian public sector banks practise retail banking, while the concept ofwholesale banking is slowly being practised by them. On the other hand, most of thewell-established foreign banks in India and the recent private sector banks practise

    wholesale banking alongside retail banking.

    As a result of this difference, the composition of income for a public sector bank and awell-established private sector bank is different. While a major portion of the income forlarge public sector banks is from lending operations, in the case of any private sector bankin India, the amount of non-operating income (other than interest income) is substantiallyhigher. The composition of other income is - commission on bills/guarantees/letters ofcredit, counselling fees, syndication fees (arrangement for loans), credit report fees, loanprocessing fees, correspondent bank charges (please see next chapter for the meaning ofcorrespondent bank) etc. Internationally also, in the case of any bank, the non-interest

    income is substantially more than interest income. This is considered as a healthy sign, asthe investment required for earning non-interest income is negligible. Non-interestincome is from activities, which are not fund based but fee-based. Hence very littlecapital is required to carry on such activities.

    Note: The significance of important banking terms used in the course material isexplained in the next chapter. "Global banking" activities are an extension of variousactivities listed above into the international market. Global banking primarily consists oftrade in international banking services and establishment of branches and subsidiaries in

    foreign countries.

    WHAT IS A SCHEDULED BANK IN INDIA?

    In India, the Central Banking Authority is the Reserve Bank of India (RBI); it is alsoreferred to as the "Apex Bank". It functions under an act called The Reserve Bank ofIndia Act, 1934. All the banks and other financial institutions operating in India comeunder the monitoring and control of RBI. RBI controls the banking sector in India throughan act called "The Banking Regulations Act". In the past, when there were very few banks,RBI used to include all the "scheduled" banks in its Schedule. Nowadays, when the numberof banks has gone up substantially, RBI has to change the schedule every now and then.

    Hence irrespective of whether a bank finds its name in the schedule to the RBI Act ornot, its "schedule status" can be found out from its banking licence. A bank that is not ascheduled bank is referred to as "non-scheduled" bank even in its banking licence.

    The difference lies in the type of banking activities that a bank can carry out in India. Inthe case of a scheduled bank, it is licensed by the RBI to carry on extensive bankingoperations including foreign exchange operations, whereas, a non-scheduled bank can carryout only limited operations. There are a number of factors considered by RBI to declare abank as a "scheduled bank", like the amount of share capital, type of banking activities

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    that the bank is permitted to carry out etc. An example of difference between ascheduled and non-scheduled bank is dealing in "Foreign Exchange".

    WHAT IS THE DIFFERENCE BETWEEN A COMMERCIAL BANK AND A CO-OPERATIVEBANK?

    A commercial bank is run on commercial lines, for profits of the organisation. A co-operative bank on the other hand is run for the benefit of a group of members of the co-operative body. A co-operative bank distributes only a very small portion of its profit asdividend, retaining a major portion of it in business.

    All the nationalised banks in India and almost all the private sector banks are commercialscheduled banks. There are a large number of private sector co-operative banks and mostof them are non-scheduled banks. In the public sector also, within a state, starting fromthe State Capital, there are State Co-operative Banks (example: in Karnataka, we haveKarnataka State Co-operative Bank) and District Central Co-operative Banks at thedistrict level. Under the District Central Co-operative Bank, there are Co-operativeSocieties. At present, in India, the banks can be bifurcated into following categories.

    Category 1 Public Sector banks (also referred to as "nationalised banks"), which arecommercial and scheduled. Examples: State Bank of India, Bank of India etc.

    Category 2 Private Sector banks, which are commercial and scheduled. These could beforeign banks as well as Indian Banks. Examples: Foreign Bank - CITI Bank, Standard

    Chartered Bank etc. Indian Bank - Bank of Rajasthan Limited, Vysya Bank Limited etc.

    Category 3 Private Sector banks, which are co-operative and scheduled. These are largeco-operative sector banks but which are scheduled banks. Examples: Saraswat Co-operative Bank Limited, Shamrao Vithal Co-operative Bank Limited, Cosmos Co-operativeBank Limited etc.

    Category 4 Private Sector banks, which are co-operative and non-scheduled. These aresmall co-operative banks but which are non-scheduled. Examples: Local co-operative bankswhich operate within a town or a city, like Mahesh Sahakari Bank Limited etc.

    Category 5 Public Sector banks, which are co-operative and non-scheduled. These arestate owned banks like the Maharashtra State Co-operative Bank (State level), PuneDistrict Central Co-operative Bank (District level) and Junnar Co-operative Society etc(primary level).

    Category 6 Regional Rural Banks which are state owned and have different rolesassigned to them. They are outside the purview of our discussions

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    Category 7 Gramin Banks that are also state owned and have different roles assigned tothem. They are also outside the purview of our discussions.

    Note - During the course of the workshop, we will be discussing the activities of a

    scheduled bank.

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    2.2 Banking Terms - Different Bank Accounts - Bank Facilities -Determination of interest on deposits and advances

    DIFFERENT BANK ACCOUNTS - DEPOSITS

    1. Deposit account offering withdrawal facility Savings Bank Account as well as CurrentAccount. The nomenclature of the Savings Bank Account is different in differentcountries. For example, Savings Bank Account with withdrawal facility through Chequesis referred to as "Check Accounts" in the USA. In India, while the balances in theSavings Bank Accounts get interest, the balances in the Current Accounts do not getinterest.

    2. Deposit account without withdrawal facility different categories Lump sum investment for specific periods, after which the principal amount is paid

    back together with interest for the entire deposit period. This is on a cumulative basisor reinvestment basis.

    Lump sum investment for specific periods and interest is paid on a periodic basis. Theprincipal amount is paid back on maturity/due date.

    Lump sum investment for specific periods and interest together with a part of theprincipal amount is paid periodically with last instalment payable on due date/maturitydate.

    Periodic investment, mostly on a monthly basis and repayment on a cumulative basis,both principal and interest amounts example, recurring deposit accounts

    Periodic investment, less frequent than the previous one but investment is usuallysubstantial and repayment on a cumulative basis together with interest. Periodicinvestments may not be of the same size.

    DIFFERENT BANK ACCOUNTS ADVANCES AND LOANS

    1. Overdraft An extension of current account in which the customer is allowed towithdraw more than the credit balance lying in the account. This may be a temporaryaccommodation to tide over temporary cash crunch or on a regular basis. If permittedon a regular basis, withdrawals are allowed up to a ceiling (called "a limit"), subject to

    availability of sufficient security with the bank. For "security" please refer to thefollowing section on "banking terms". It is a facility in which the customer can cancelthe previous debit balance (amount withdrawn) by subsequent credits (amountdeposited) and draw afresh as and when required, subject to a limit. In case theoverdraft is given to business enterprises, it is for day-to-day operations, which isotherwise known as working capital.

    2. Cash Credit A credit facility under which a customer draws up to a pre-set limit,subject to availability of sufficient security with the bank. The difference betweenan Overdraft and a Cash Credit account is that while the former is extended more to

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    individuals and less for business, the latter is extended only to business bodies. TheCash Credit facility is unique to India, as in most of the countries it is called"Overdraft". Further, the cash credit facility is more or less on a permanent basis solong as the business is going on. Internationally, at the end of a specific period, the

    overdraft facility is withdrawn and the customer is required to pay back the amountlent by the bank. The purpose of cash credit is for working capital. The operations aresimilar to Overdraft.

    3. Loan A lump sum amount given to the customer, either in one "tranche" or in two orthree "tranches" and repayment over a period of time in monthly or quarterly or half-yearly or annual (very rarely) instalments. Interest may be recovered separately fromthe customer who is called "borrower" or combined with the instalment. In case it iscombined with the instalment, it is known as equated instalment. If interest isrecovered separately, it is usually on a quarterly basis, while instalment can be as

    mentioned above. Loan is very common abroad and given against specific assets likeconsumer durable, white goods, house property etc. Given to individuals as well asbusiness bodies. Loans against property and for the purpose of owningflats/apartments/houses are known as "mortgage" loans.

    Repayment period: Anywhere between 2 years to 5 years for other than housing loan.For housing loan, in India, between 10-15 years and abroad, it can be even up to 30years. Withdrawal facility by cheque is not available unlike Overdraft or Cash Credit.

    BANKING TERMS OFTEN USED/ COMMON BANKING PRACTICES

    1. Bill usually mistaken for a commercial invoice. Actually bill in the banking parlancemeans a Bill of Exchange drawn by a seller on the buyer whenever he sells goods orservices on "payment later" basis. Such a transaction is referred to as a "credit"transaction. The bill is routed through the bank for collection of amount from thebuyer. Commercial invoice is a part of the documents submitted to a bank by the seller.

    A Bill of Exchange is an order made to the buyer by the seller that in exchange forthe goods or services sold by him on credit, the buyer is required to pay on a specificdate, a certain amount with or without interest to him or to any other directed

    party (mostly a bank).

    2. Discount less than face value. If the value of the bill is $100 and in case the bankgives finance against the same, the amount of finance will be less than $ 100, say $ 98.$ 98 is the discounted value of the bill for $ 100, while the difference of $ 2, isknown as discount. Discount is nothing but interest recovered up front, especially inthe case of those bills for which payment will be forthcoming after a specific orexpected period.

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    3. Remittance A facility, by which funds are made available to the bank by its customerat one place and the bank in exchange, makes the funds available to the customer orany other specified party at the required place, within the same country or abroad.

    There is more than one mode of remittance. It can be by Demand Draft (DD), MailTransfer (MT), Telegraphic Transfer (TT), Electronic Mail Transfer (EMT) throughcomputer networking (or through satellite channel), International Money Order (IMO)etc.

    4. Letter of credit Seller A enters into contract with Buyer B. One of the terms ofsupply is that buyer will establish a letter of credit in favour of the seller through hisbank. The Buyer approaches his bank, which, on certain conditions, agrees to extendthis facility. Under this facility, the buyers bank gives commitment of payment to theseller through his bank. The commitment is dependent upon the seller fulfilling specific

    conditions as per the L/C. The conditions are: the seller should furnish proof of despatch of goods or services and submit all the documents required under the L/C.

    Then, the buyers bank will pay the amount of the bill drawn by the seller on the buyerunder this arrangement. International letters of credit are by and large, irrevocable(cannot be cancelled by the buyer without the consent from the seller)

    Advantage This facilitates global commerce through the banking channel which actsas the financial intermediary and based on the letter of credit established by thebuyers bank, the sellers bank will extend financial assistance to the seller till he gets

    the payment from the buyers bank.

    5. Bank guarantee Could be a finance guarantee or a performance guarantee. Underfinance guarantee, the bank guarantees the beneficiary (the person named in theguarantee to receive the guaranteed sum under stated circumstances), certain amounton behalf of its customer who has commercial relationship with the beneficiary. Underperformance guarantee, the bank guarantees performance of a contract orgoods/services supplied under a contract by its customer. However, even in the lattercase, if its customer fails to deliver, it settles the claim of the beneficiary in moneyterms only; the bank does not fulfil the contract obligation of its customer.

    Example of Finance guarantee - Two parties enter into a contract. One is the supplierand the other is the buyer. The terms of supply include 25% of advance to be given bythe buyer. The buyer wants assurance of supply as per the contract with the seller.Hence he insists on a bank guarantee by the sellers bank. The sellers bank gives thesame against some security given by the seller. In case the seller does not fulfil thecontract, the beneficiary of the guarantee lodges a claim with the guarantee-issuingbank. The bank then pays the buyer the assured sum.

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    Example of Performance guaranteeSimilarly, in the case of an export contract, the foreign buyer, who is the importermay insist upon the sellers bank issuing a performance guarantee to ensure that theseller sticks to the delivery schedule. The buyer will establish a letter of credit in

    favour of the seller through his bank only upon the buyers bank receiving the requiredperformance guarantee from the sellers bank.

    Lodging a claim under a guarantee with the guarantee-issuing bank by the beneficiaryis known as "invocation" of a guarantee.Cancellation of a guarantee is known as "revocation" of a guarantee.Letters of credit and bank guarantees play a very important role in international

    banking.

    6. Negotiation the term refers to the act of a bank extending finance to the seller

    against a letter of credit in his favour, once he furnishes proof of despatch and fulfilsall conditions of the letter of credit, as laid down by the buyer. The conditions relateonly to documents and not goods.

    7. Cash Reserve Ratio Called in short, CRR. It is in operation in India. Usually, indeveloped countries, CRR and SLR (refer to the next point) are not separately levied.They are together known as "statutory reserve". Suppose a bank has total deposits of$100 Bn. and is required to maintain a CRR of say 5%. This means that the bank shouldmaintain in current accounts with the Central Bank or any other approved bankbalances, not less than $ 5 Bn. This much amount is impounded and kept in the free

    form and the bank cannot lend this money. This acts as a buffer to the bank. InIndia, RBI decides from time to time and at present it is 8.5% of the deposits held bythe bank.

    8. Statutory Reserve Ratio Called in short, SLR. In the above example, suppose thebank is supposed to maintain SLR of 15%. This means that over and above CRR, thebank is expected to keep aside an amount of $ 15 Bn. This will be kept in easy-to-encash securities like treasury bills of the Government of USA and any other approvedsecurities. Here again, the Central Banking Authority in USA, i.e., the Federal Bank,decides the ratio. In India, at present it is 25%. This again acts as buffer to thebank and prevents the bank from lending the entire amount of deposits kept with it byvarious customers.

    Note pertaining to Reserve Ratio the investment decision is taken not at the branchlevel. It is taken at the Head Office of the bank. In India, the department handlingthis, is known as "Treasury" department at the Head Office. This is natural, as thisoutfit is in touch with the market constantly. Further, compliance with SLR is to bedone on the basis of deposits of the bank with all its branches and hence the HeadOffice is suitable for this purpose. The Head Office reports the position of deposits

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    as well as investment under CRR/SLR to the Central Banking Authority once in afortnight.

    9. Credit to a customers account Whenever any amount is received by the bank on

    behalf of its customer, it posts the amount in the credit column of its ledger accountof the customer and enhances the balance in the account if it is a deposit account andreduces the balance in the account if it is a loan account or overdraft account.

    10. Debit to a customers account Whenever any amount is paid by the bank on behalf ofits customer, it posts the amount in the debit column of its ledger account of thecustomer and reduces the balance in the account if it is a deposit account andenhances the balance in the account if it is a loan account or overdraft account.

    11. Clearing operation Suppose Customer A has his check account with Bank of New

    York, New York Branch (B.O.N.Y., N.Y.). He issues a cheque in favour of B who is acustomer of Chemical Bank, New York Branch (C.B., N.Y.). B deposits the check in hisaccount with C.B., N.Y., which presents the check to B.O.N.Y., N.Y. through a platformknown as clearing house. The Federal Bank or its authorised bank in all the majorcentres mostly conducts this across the US.

    12. B.O.N.Y., N.Y. credits C.B., N.Y. with the amount of the check after debiting the sameto its customer A and on receipt of clearing advice, C.B., N.Y. debits B.O.N.Y., N.Y.and credits the account of Customer B. Thus clearing operations enable the banks toexchange instruments such as checks, international money orders, bank drafts etc.

    drawn on one another but within the same clearing zone and not outside it. If theinstrument is drawn outside the clearing zone, the bank sends the instrument forcollection, which takes a little more time than clearing.

    13. Daily product basis This is the basis on which interest is usually determined on creditfacilities, like loan, overdraft, cash credit etc. For this, the basis is 365 days in ayear. Some banks do take 360 days in a year also. There is no hard and fast rule inthis behalf. For example Barclays Bank has given a customer an overdraft facility tothe extent of $ 10000 for 45 days at 6% p.a. On a daily product basis, the interest isdetermined as under:

    Step No. 1 10000 x 45 days = known as product = 450,000

    Step No. 2 determination of annual average as rate of interest is on annual basis, i.e.,450,000/365 = $ 1233. This means that on a 365 days per year basis, drawing $10000 for 45 days is equivalent to drawing $ 1233 through out the year, i.e., on annualbasis.

    Step No. 3 calculation of interest at 6% p.a. = 1233 x 0.06 = $ 73.98

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    This means that by adopting daily product basis we are converting the amount drawnfor a period less than a year to its annual equivalent so that the rate of interest, whichis universally on annual basis, can be applied to determine the quantum of interest.

    One may ask, why this indirect method when all the above three steps can be combinedinto one? The answer is yes. The utility of daily product basis lies in determining theannual equivalent in cases wherein the amount drawn is likely to differ every now andthen, like in the case of overdraft or cash credit. Refer to Specimen 1 for detailedcalculation of interest on daily product basis in an overdraft account, in which balancesdiffer every now and then.

    Besides credit facilities, this is the method adopted by most of the US Banks forgiving interest on current account balances also. For other deposit accounts, which are

    fixed in nature, yearly interest is straight away applied.

    14. Monthly product basis Suppose as in the case of India, in the savings account, theproduct is taken on a monthly basis. In India, the rule is interest is paid on theminimum balance in the account between the 10th and the last day of every month. Thismeans that any credit to the account after the 10th of the month is ignored for theparticular month, while debit is taken into account. Accordingly let us say for examplethe following minimum credit balances existed in a savings account earning 2% p.a.interest in the US.

    January 99 - $ 100February 99 - $ 80March 99 - $ 150April 99 - $ 250May 99 - $ 300June 99 - $ 30Total of the above = $ 910

    Suppose the interest is payable every half-year and accordingly this customer will beentitled to 1% for the half-year ending June 1999. In order to determine the correcthalf-yearly interest, the sum of the monthly products is divided by 12 to find outannual equivalent of the deposit, that the customer has kept in his savings account at2% p.a. interest. The annual equivalent amount is $ 75.83 and the interest at 2% p.a.for the half-year on this works out to $ 1.52. This is the way interest is found out ona monthly product basis.

    15. Premature withdrawal of fixed deposit Even though fixed deposit is a contractbetween two parties, banks usually allow premature withdrawal, i.e., withdrawal beforematurity date. However, there will be penalty for premature withdrawal in the form

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    of reduced interest. Suppose rate of interest is 6% p.a. for a three-year deposit andthe depositor wants withdrawal after a year. The rate of interest relevant for thisdeposit is the one-year rate as the deposit has been kept only for one year. Supposethe rate of interest for one year is 5% p.a. The penalty may range between 1% to 2%

    and everything is bank dependent.

    Some of the banks may not levy any penalty. Hence instead of paying interest atcontract rate, interest will be paid at a rate as applicable to the period for which thedeposit has been kept with the bank. This is okay so long as the deposit is oncumulative basis. On the other hand, in case the deposit is on a periodic paymentbasis, interest would already have been paid at the contract rate and the excess

    interest, if any, needs adjustment at the time of withdrawal. An example

    Amount of deposit - $ 10000

    Contract period 2 yearsRate of interest 6% p.a.Compounded annually in case interest is paid on maturityRequest for payment after 1 yearRelevant rate of interest for 1 year period 5%p.a.

    Alternative 1No penalty and relevant rate of interest is 5% p.a.Interest payable on maturity and no interest has been paidAmount payable on maturity on annual compounding of interest

    $ 10000 x 1.05 = $ 10,500

    Alternative 2No penalty and rate of interest is 5% p.a.Interest payable half-yearly and hence no compoundingHalf-yearly interest paid at contract rate of 6% p.a. for the first half-year = $ 300Total interest payable for the period of deposit at 5% p.a. = $ 500Total amount payable including interest for the entire period = $ 10500Less interest already paid = $ 300Amount now payable = $ 10200

    Alternative 3Penalty of 1% and rate of interest for one year deposit = 5% p.a.Interest payable on maturity and no interest has been paidAmount payable on maturity = $ 10000 x 1.04 = $ 10400

    Alternative 4Penalty of 1% and rate of interest is 5% p.a.Interest payable half-yearly and hence no compounding

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    Half-yearly interest paid at contract rate of 6% p.a. for the first half-year = $ 300Total interest payable for the period of deposit at 4% p.a. = $ 400Total amount payable including interest for the entire period = $ 10400Less interest already paid = $ 300

    Amount now payable = $ 10100

    Note In case the contract for deposit is for 5 years and the request for prematurewithdrawal is after 2 years and if the deposit is on regular payment of interest basis,it may so happen that excess interest paid as per contract rate, upon adjustment, mayeven reduce the principal amount. The amount to be adjusted depends upon thefollowing factors:

    Whether there is any penalty involved for premature withdrawal? What is the term for payment of interest, i.e., on a cumulative basis or on periodic

    payment basis? What is the periodicity of compounding, i.e., monthly, quarterly, semi-annually or

    annually?

    16. Repayment holiday Whenever a loan is taken especially for acquiring fixed assets, therepayment does not start immediately. It starts after the fixed asset starts giving areturn especially in the case of business enterprises. This is not so in the case ofpersonal loans. The period during which there is no repayment is known as repaymentholiday period. This is also known as Moratorium period. This period is longer in thecase of industrial loans and minimum or absent in the case of personal loans. It should

    be noted that during this period, interest is charged and there is no period for non-levy of interest, although there may be a period of non-recovery of interest, i.e.,interest, although levied not recovered for a specific period. Again if this is the case,interest on interest is recovered.

    17. Credit instruments Any instrument that is drawn on a bank, against surrender ofwhich the concerned bank will pay us the amount mentioned in the instrument.Examples checks, drafts, mail transfers, travellers checks, international moneyorders etc.

    18. Negotiable instruments All the credit instruments that are transferable from oneperson to another by a process known as endorsement are called negotiableinstruments. Suppose A is receiving payment by means of check from C. A owesmoney to B. The check is a negotiable instrument as it enables A to settle his duesto B by endorsing the same in favour of B. This renders the check a negotiableinstrument. There may be some restriction on some of the above instruments, notallowing free transferability either by the banks or by the issuers of the instrumentsthemselves.

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    19. NOSTRO Account A current account which a bank has with another bank abroad,which is usually its correspondent bank and the currency in which the balance ismaintained is foreign and not local. For example, CITI Bank, Baltimore has an accountwith Barclays Bank, London, expressed in British Pounds. It is said to have a NOSTRO

    Account with Barclays Bank in British Pounds. Thus, whenever we mention NOSTROAccount, it is necessary for us to know with whom it is maintained and in whichcurrency. All the banks in India dealing in foreign exchange are required to maintainNOSTRO Accounts abroad with different correspondent banks in different currenciesin different countries. In India at present, the RBI should know the names ofcorrespondent banks with which such accounts are being maintained.

    Further, payment for imports cannot be made in Indian Currency, as it is not fullyconvertible means that other than Indians and travellers coming to India, others donot have any value for the Indian Rupee at this juncture. (The low exchange value of

    Indian Rupee vis--vis US $ or any other foreign currency is quite different from this.Even a currency whose unit value is less than that of Indian Rupee, say, Italian Lira is auniversal currency. These two are different phenomena.)

    Suppose Deutsche Software has account with Deutsche Bank, Bangalore. DeutscheBank, Bangalore has NOSTRO Account with Bank of America, Seattle. When theexport bill of Deutsche Software is routed through Deutsche Bank gets paid, Bank ofAmerica, Seattle, credits Deutsche Bank's NOSTRO Account with it. Once this adviceis received, Deutsche Bank, Bangalore advises Deutsche Software and at the prevailingexchange rate between US $ and the Indian Rupees, converts the amount of credit

    (less their charges, if any) and credits the account of Deutsche Software with it.

    Similarly let us see an example for import payment. Suppose Deutsche Softwareimports a testing kit from UK. The bill is raised in British Pounds. The bill will berouted through Deutsche Bank, Bangalore. Deutsche Bank, in order to settle this bill inBritish Pounds has to have a British Pound NOSTRO Account with a British Bank. Letus assume that it has with Standard Chartered Bank, London. Upon receiving debitinstructions from Deutsche Bank, Bangalore, Standard Chartered Bank, London, debitsits NOSTRO British Pound Account and credits the bank of the exporter with thesame amount.

    Thus we see whenever export payment is received NOSTRO Account is credited

    and whenever import payment is made NOSTRO Account is debited.

    Note Standard Chartered Bank, London is referred to as "Correspondent Bank" forDeutsche Bank, Bangalore. The current account that is maintained by Deutsche Bankwith it in British Pounds is called a NOSTRO Account. Correspondent banks work onmutual arrangement basis. This is to say that while Standard Chartered, London, UK is

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    the correspondent bank for Deutsche Bank, Bangalore, it will in turn be theCorrespondent Bank for Standard Chartered, London, UK.

    20. VOSTRO Account The NOSTRO Account of Deutsche Bank, Bangalore with Standard

    Chartered, London, UK is a VOSTRO Account for Standard Chartered Bank, London, ofDeutsche Bank, Bangalore. In short for a correspondent bank, whichever account it isholding on behalf of a foreign bank is its VOSTRO Account.

    21. Foreign Exchange Reserves These are primarily balances in the NOSTRO Accounts invarious currencies (converted into equivalent Dollars) of all the banks in India. Thereare other constituents of the Foreign Exchange Reserves also, but the NOSTROAccounts balances constitute the major portion of the reserves.

    22.Acceptance We have seen what a Bill of Exchange is. The buyer who has already

    received goods or services from the seller is required to acknowledge his debt to theseller by signing on the Bill of Exchange. This act of acknowledgement is calledacceptance. At times in this, banks are also involved just to enhance the credibilityof a bill of exchange. This is called banker's acceptance for which the bank chargescommission. It is similar to giving bank guarantee.

    23. Credit Report It is called by different names. At times, it is referred to as CreditInformation Report. At other times, it is also called Customers confidential report.Bankers report also means the same. With the growth of commerce within a countryand abroad, most of the times, trade is done with organisations, about which you are in

    the dark. The banker provides good platform for knowing something about thebusiness enterprise with which you are likely to deal. There are acceptedabbreviations internationally for denoting the soundness or the lack of it of a businessenterprise. These abbreviations are commonly used in such reports. You can seekconfidential information about your prospective customers about whom you do not havesufficient knowledge. The banker provides this information for a fee, which includesthe fees that they have to remit to International Credit Agencies.

    24.Syndication Making arrangement for loans for borrowers. Should not be confusedwith granting of loans. The bank may or may not participate in the loan process, butwould assume responsibility for getting in principle sanction from all the participatingbanks and financial institutions. It is more common internationally and syndicationfees are quite substantial abroad. Syndication fees are part of non-interest income asno funds are involved in the activity. For example an Indian company wants a ForeignCurrency Loan of 100 M. $. Making arrangement for this is called syndication. Even ifthe arranging bank participates in the loan by granting a portion of it, syndication isdifferent from it. It gets paid separately for this activity.

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    25.Depository Depository for securities, i.e., shares/bonds etc. For this fees arecharged, which is a non-interest income.

    26.Custodial services - As per instructions of the customers, accepting dividend and

    interest warrants on shares and bonds/debentures respectively and credit theproceeds of the same to the customers account. For this also separately fees arecharged, which is a non-interest income.

    27. Charges in a letter of credit Letter of credit opening charges which depend upon the period for whichthe L/C will be valid

    L/C advising charges to be paid to the advising bank, which will mostly bethe correspondent bank

    L/C confirmation charges to be paid to the confirming foreign bank

    L/C negotiation charges to be paid to the bank which is negotiating, whichwill mostly be the correspondent bank

    L/C amendment charges payable to the L/C opening bank whenever any termof the L/C is changed.

    28.Charges in a bill Commission for collection and recovery of postage/courier charges. Both ofthese together are known as handling charges.

    Interest or discount in case bank finance is given to the customer againstthe bill.

    29. Charges in a loan account Processing fees for processing the application of the borrower which is ad-valorem, i.e., depending upon the amount of loan

    Documentation and legal fees for preparation of documents and fees paid tofirm of solicitors, if any.

    Credit Management fee

    Annual fees recovered at the time of renewal of the limits every year

    30. Security - Fixed assets like land, building, plant and machinery etc. as well as workingcapital assets like inventory or bills receivable are offered as security to a lender by aborrower for assurance of repayment of the loan taken by him. Suppose it is a housingloan. The value of the apartment is $30000. This is the value of security for themortgage loan. The bank would give loan to the extent of certain prescribed % of thevalue of the security. Security can be paper security like shares, debentures, fixeddeposit receipts, life insurance policies etc.

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    31. Margin This is expressed in % of the value of security. In the above example,suppose the margin is 25%, it means that the housing loan would be to the extent of $22500. At times the margin is also expressed as the amount of loan in % terms to thevalue of security. Accordingly the margin would work out to be 75% in this case. This

    should be borne in mind while preparing the programme for a bank.

    32. Foreign exchange It is one of the most important aspects of international banking, asa result of the different currency systems in the two countries involved. For examplean American company imports from France and the bill is in French Francs. It isobvious that the exporter wants French Francs in France. Where does the Americanimporter get the French Francs from? He gets it from the banking system. Heexchanges US $ for French Francs. In fact the importer need not possess FrenchFrancs at all. It is enough he surrenders US $ to his bank in the US and in exchangefor the same, the US bank will give equivalent French Francs to the French exporter in

    France. This transaction will be through its NOSTRO Account as seen earlier,maintained with a correspondent bank in France.

    Then the question comes as to who decides at what rate the exchange should takeplace. In a country like the USA, it is an open market system and hence the foreignexchange market decides the exchange rate between the French Franc (F.F.) and theUS Dollar. The Foreign Exchange Market is a perfect market influenced by demandand supply. The market as soon as it opens in the morning starts giving quotations forall the major currencies in the world. The quotation will be a two-way quote one pricefor purchase and the other purchase for sale. The purchase price has to be less than

    sale price. Foreign Exchange is like any other commodity. "Buy low" (at a lower price)and "sell high" (at a higher price) is the motto of this market.

    For example, in the above case, 1 US $ = F.F. 7.818

    This does not give a true picture, as it is not a two-way quote. The correct way toquote will be 1 US $ = F.F. 7.818/7.808. This quotation is known as bid/offer quote,thereby meaning that the former is the rate at which the bank will purchase F.F. fromthe market ("buy more" in quantity) and the latter is the rate at which the bank willsell F.F. to a buyer ("sell less" in quantity). In our case, as import is involved, therelevant rate is 1 US $ = F.F. 7.808. The difference between bid/offer rates is calledas "the margin" or "spread" for the bank, representing his profit in the transaction.In this case, since the bank is purchasing F.F. the motto should be buy higher quantityof foreign currency for one unit of home currency (i.e., US $) and sell less quantity offoreign currency for one unit of home currency.

    Bid means the bank wants to purchase. Offer means the bank wants to sell.

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    Thus in the case of any international trade, foreign exchange is involved and onecurrency gets converted into another currency at the market determined rates, inmost of the developed countries. This may not be so in the case of developingmarkets like India. Developing markets in general and some of the developed markets

    too adopt a policy, which enables the Government or the Central Banking Authority ofthe country to monitor this market and intervene, if necessary. The internationalforeign exchange market every day transacts in trillions of dollars. Out of this volumemore than 90% is for speculation and not backed by trade of services or goods. InIndia, speculation in foreign exchange market is not permitted. Even banks dealing inforeign exchange have some limits (periodically set by the RBI), up to which only, theycan hold balances in permitted foreign currency/currencies, without the backing ofcommercial transactions with its customers.

    Different types of quotations in the foreign exchange market depending upon the

    period of transaction:

    A rate quoted today is for transaction to be put through at the end of 48 Hours.Hence this is called spot rate.

    A rate quoted for transaction within 24 hours is known as TOM, acronym forTomorrow

    A rate quoted for transaction to be done immediately is known as Cash transaction A rate quoted for transaction beyond 2 days is known as forward rate and a contract

    is entered into with the buyer of the foreign exchange/the seller of the foreignexchange. In the case of import, we happen to buy the foreign exchange and in the

    case of export, we happen to sell foreign exchange. This contract is known as "forwardcontract".

    We will see some examples to familiarise ourselves with these terms and appreciatethe effect of different trends in the forward rates on importer and exporter.

    Example Spot rate for US$ in terms of French Franc, 1 US $ = FF 7.818/7.808Forward rate for transaction 1 month hence, 1 US $ = F.F. 7.808/7.796

    This means that with the passage of time you are getting less F.F. for US $. Thisindicates that foreign currency is becoming dearer (costlier) vis--vis US $.

    What is the impact on an importer in the USA?This is not favourable for an importer in F.F., as he will be required to fork out moreUS $ for the same quantum of F.F. than in the past.

    Then, what happens to an exporter from the USA in case the invoice is in US Dollars?

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    This will not affect him as he is getting the quantum of US Dollars as per his invoice.However, the importer in France will be benefited, as he will require less amount of FFto pay for the import bill, as FF has increased in value vis--vis US Dollar.

    What will be the scenario if the forward rate is 1 US $ = F.F. 7.828/7.818?This means that F.F. is becoming cheaper vis--vis US $. So, in the case of import inFF, the effect will be the opposite. The US importer will be benefited. The case ofthe US exporter will be the same as in the previous case. The US exporter will beaffected only if the export done by him is in FF. Raising invoice for export from theUS in a currency other than US Dollar is permitted by the US Federal Bank.

    Thus it is seen that whenever you are exporting in a foreign currency you are

    benefited in case the foreign currency is becoming stronger and similarly whenever

    you are importing in a foreign currency you are benefited in case the home

    currency is becoming stronger.

    The quotations in the foreign exchange market depend upon the type of transaction.This aspect is examined in the following paragraphs.

    For example a simple remittance in F.F. will get a better quote than a quote for animport bill, as the bank is required to handle the documents in the case of an importbill. Similarly in the case of an export bill, a simple remittance will get better rate incomparison with an export bill. Let us see the following examples.

    Spot rate 1 US = F.F. 7.818/7.808Let us assume that this rate is for simple remittance. Then for a bill transaction, thequote will be somewhat on the following lines.

    1 US $ = F.F. 7.821/7.805. The analysis for this quote is as under:

    For a simple remittance in F.F. into the US, the bank is prepared to give you US $ atthe rate of 1 US $ = F.F. 7.818. This is called T.T. Buying quote.

    For remittance of an export bill in F.F. into the US, the bank is prepared to give youUS $ at the rate of 1 US $ = F.F.7.821, which means that you will get less US $. Thisis called Bill Buying quote or BC buying quote.

    Similarly for a simple remittance in F.F. (outward) from the US, the bank is preparedto sell F.F. at the rate of 1 US $ = F.F. 7.808. This is called T.T. Selling quote.

    For an import bill in F.F. the bank is prepared to sell F.F. at the rate of 1 US $ = F.F.7.805 less F.F. than for a simple remittance. This means that for a given amount of

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    F.F. you will be required to shell out more US $. This is called Bill Selling quote or BCselling quote.

    Note We will appreciate the above examples provided we keep the following in mind:

    The US importer has US $ which he exchanges with the bank for acquiring F.F. to payfor import from France. Similarly in case the US exporter has raised invoice in FF, heacquires F.F. from the importer, at least abroad and does not have any use for thesame in the US. Hence he wants to exchange it for the US $ which is the homecurrency. The examples can be better understood with a fictitious F.F. amount of10000. (Please do this exercise for absorbing the fundamental difference between aforeign exchange quotation for ordinary remittance and that for a bill transaction)

    In India, there is restriction on holding foreign currency assets. Companies and

    individuals are not permitted to hold foreign currency assets. The banks arepermitted, as this is necessary for international trade. Selected Indian companies(depending upon their requirement and nature of business - for example, a softwarecompany operating in India and doing software export will be required to hold foreigncurrency deposit.) Hence RBI gives permission to such companies to have their ownNOSTRO accounts abroad. Individuals are not permitted at present. (Do not confusewith non-resident Indians deposits, as they are not resident Indians).

    As against this, in the US, even the individuals are permitted to hold foreign currency

    deposits with the permission of the Federal Bank through their individual banks. Hencein the instant case, the exporter earning F.F. may not feel the need to convert his F.F.earning into Indian Rupees, especially if he knows that F.F. is going to appreciate in thenear future, thereby enabling him to earn more US $ for the same amount of F.F.

    33.SecuritisationThis is the process whereby traditional bank assets, namely, mortgages are sold by thebank to a trust or a corporation, which in turn sells the assets as securities. This isvery reliable way of raising resources for the banks and this concept is catching upwell internationally.

    INTERNATIONAL TRADE GLOSSARY EXCLUDING TERMS ALREADY EXPLAINEDABOVE

    Acceptance

    A bill of exchange on the face of which the drawee has written the word Accepted overhis signature. The date and place payable are usually indicated (Specimen 1)

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    Acceptor

    The person to whom the Bill is addressed and who shows his assent by signing his nameacross the Bill indicating that he will pay the bill on maturity. (Specimen 2)

    Advance against collectionProvide funds to an exporter by purchasing his collection documents with recourse to himshould the collection not get paid

    Advising Bank

    The bank, which advises the beneficiary that another bank, has opened a letter of credit.Has no obligation or responsibility, but will probably authenticate and ensure compliancewith local regulations before passing on to the beneficiary.

    Air Way Bill (AWB)

    A receipt for goods sent by air. Also a contract of carriage of goods. It is a part ofinternational trade and the documents submitted to the sellers bank, after despatch ofgoods. The goods will be handed to the consignee who is named in the AWB againstidentification only.

    Amendment

    The terms of a letter of credit can be changed by amendment provided all parties agree.

    Back to Back

    A letter of credit (L/C) has been opened by a bank in favour of a trader (frequently a

    middleman) covering certain goods. On the strength and security of this L/C, anotherbank opens a separate L/C on behalf of the trader in favour of the supplier of goods.Such an arrangement may be described as a Back to Back Credit.

    Bank Acceptance

    A Bill of Exchange drawn on and accepted by a bank.

    Beneficiary

    The party in whose favour a Letter of Credit is opened normally the seller.

    Bid Bond

    Supports a tender for a contract, guaranteeing compensation should the bidder win thecontract but fail to sign it.

    Bill of Lading

    A receipt issued by an ocean carrier for merchandise to be delivered to a person at somedistant point. It is also evidence of a contract of carriage. Unlike in the case of AWB thebill of lading can be endorsed in some one elses favour, unless this is restricted.

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    Carrier

    The transport company (shipping company, airline etc.) carrying the goods from one

    destination to another destination.

    Certificate of origin

    A certificate issued by the proper authorities, e.g., a Chamber of Commerce, whichaccompanies the documents covering the shipment of goods. The certificate usuallyspecifies the origin of material or labour used in the production of such merchandise.

    Clean Bill of Lading

    A term defining a bill of lading when the transportation company has not noted anyirregularities in packing, general condition etc. of all or any part of the shipment.

    Clean Credit

    A letter of credit, which is available to the beneficiary against presentation of only a billof exchange duly, accepted by the buyer and/or receipt for goods issued by the buyer.This is rare. It means that the buyer has received the goods and hence no transportdocument like AWB or Bill of Lading is present.

    Collecting Bank

    In the collection process, the bank in the vicinity of the drawee responsible for makingpresentation and collection proceeds.

    Commercial Invoice

    An invoice of the seller of the goods or services, addressed to the buyer giving adescription of the goods, quantity, rate, charges, if any etc.

    Confirming Bank

    The bank, which adds its confirmation to the Irrevocable Letter of Credit of anotherbank, thereby adding its own guarantee that payment will be made by the L/C issuing bank.Protects against failure of L/C establishing bank to meet payment obligations.

    C.I.F.

    Part of INCO terms. INCO is an acronym for International Commercial. This is oneof the terms of supply in international trade. Means Cost, Insurance and Freight chargesare included in the commercial invoice.

    C. & F.

    Cost and Freight. Insurance is not included in the value of the invoice. It is theresponsibility of the buyer.

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    C.F.S.

    Containerised Freight Service Another INCO Term. This means that till the

    consignment reaches the specified Containerised Services Depot, all the charges areincluded in the cost and from the Containerised Services Depot, the charges will accrueand the consignment is the responsibility of the drawees from that point.

    Deferred Payment Credit

    A credit giving the buyer a specified time in which to pay after presentation ofdocuments, but without a bill of exchange. The seller should not be at a disadvantage fordiscounting his bills. Hence, wherever this is extended, it is backed by a bank guarantee.On the basis of the bank guarantee, bank finance is obtained.

    Documentary creditA letter of credit, which is available to the beneficiary against presentation of a draftand certain specified documents.

    Documents against Acceptance

    An indication on the bill of exchange that the documents attached are to be released tothe drawees upon acceptance of the bill of exchange.

    Documents against payment

    An indication on the bill of exchange that the documents attached are to be released to

    the drawees upon payment only.

    Drawee

    The person on whom the bill of exchange is drawn, usually the buyer of goods or services.When he signs on the bill of exchange in acceptance of his liability to the seller of goodsor services, he is called an acceptor.

    Drawer

    The person who draws the bill of exchange, usually the supplier of goods or services,thereby giving an order to the drawee to pay the amount of the bill to himself (drawer) orto the directed person on the specified date.

    Endorsement

    A signature on the reverse of a negotiable instrument made primarily for the purpose oftransferring the rights of the holder to another. It is a contract between the holder andall parties to the instrument. Each endorser orders the prior parties to fulfil thecontract to his endorsee. He also agrees with the endorsee that if they do not, he will.

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    Expiry Date

    The final date upon which drafts and documents under a letter of credit may be

    presented for negotiation or payment. A latest shipment date may also be specified and atime limit within which to present after shipment (21 days if not specified).

    F.A.S.

    Free Alongside Ship another INCO Term. The supply price includes all costs till itboards the ship. Even the cost of putting them on board is not included and the buyer isresponsible for it.

    F.O.B.

    Free on Board another INCO Term. The supply price includes all costs including the

    boarding charges to put the consignment on board. Once the consignment is on board, thecharges are to the buyers account and it is his responsibility.

    Freight paid/collect

    A bill of lading will state whether freight has been paid or is to be collected. The shippingline has a lien on the goods until freight has been paid.

    Holder

    The holder who is in possession of a bill, who may either be the payee, an endorser, or thebearer.

    Holder for value

    A person who holds a bill for which value has at some time been given though notnecessarily by the holder himself.

    Hypothecation

    Making over or assigning to lenders, as security, goods or documents of title thereto, bywritten agreement, creating a lien on the goods in favour of the lender.

    Maturity Date

    The date on which an accepted bill of exchange becomes due for payment.

    Open Account

    An arrangement whereby a seller ships goods trusting his buyer to pay in due course,without the protection of a bank.

    Performance Bond

    A bond supplied by one party to another, protecting the party against loss in the event ofimproper performance or completion of the terms of an existing contract.

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    Tenor

    The period of time, as stated or indicated on the bill, for which a bill is drawn to run

    before it matures. For example "At sight; or At 90 days after sight; or Three monthsafter date; or on 30th June, fixed.

    Time Draft

    A Bill of Exchange, drawn to mature at a certain fixed time after presentation oracceptance. A Bill of Exchange drawn to mature on a fixed date, irrespective of the timeof acceptance, for example 90 days after date is often referred to as a date draft.

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    International Banking

    As mentioned in the introduction, international banking revolves around the following: international trade

    tourism,

    remittance of funds from one place to another place,

    syndication of loans globally for large business houses and multinationals,

    accessing international markets for equity/borrowing in the form of bonds etc. forcorporate houses/multinationals

    Foreign exchange management etc.

    The above give rise to the following transactions:

    INTERNATIONAL TRADE

    Letters of Credit,

    International Guarantees like performance guarantee, advance

    Money guarantee etc.

    Deferred Payment Credit backed by bank guarantee

    Bills for collection

    Foreign exchange involved in remittance of proceeds from the

    importing country to the exporting country

    TOURISM -

    International Travellers checks

    International Money Orders

    Foreign exchange involved in encashment of travellers checks

    and International Money Orders/Demand Drafts/Telegraphic Transfer/SWIFT

    remittance etc.

    Credit card business and international bills settlement under credit cards

    REMITTANCE OF FUNDS FROM ONE PLACE TO ANOTHER PLACE BESIDESTOURISM/INTERNATIONAL TRADE

    Routine transfer from persons employed abroad

    Donations/charity remittances

    Remittances for disbursement of loans (inward for the borrowing country)

    Remittances for repayment of loans (outward for the borrowing country)

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    Remittance for payment of interest (outward for the borrowing country)

    Remittance of royalty, dividend (outward for remitting country)

    SYNDICATION OF LOANS GLOBALLY FOR CORPORATE HOUSES

    This does not involve any funds and it is a non-fund based activity earning non-interestincome

    ACCESSING INTERNATIONAL MARKET FOR EQUITY/BORROWING IN THE FORM OFADR/GDR AND EURO BONDS ETC.

    This again does not involve any funds and it is a non-fund based activity earning non-interest income

    FOREIGN EXCHANGE MANAGEMENT

    This is common to all the activities listed above, which involve funds. Such activitiesare called fund-based activities of the bank, unlike syndication and/or accessinginternational markets for GDR/ADR, Euro bonds etc., which are non-fund-basedactivities.

    Note: A discussion about international banking is not complete without mention ofelectronic cash on the Internet or E-cash. This could easily become global currency,issued by Governments and private firms alike. The explosive growth of this phenomenonwill tremendously influence globally the banking industry and hence everybody in the

    banking industry is watching this development with interest, awe and fear, all at the sametime.

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    Profile of a bank

    DIFFERENT LAYERS OF BANKING OPERATIONS IN INDIA IN GENERAL

    Branch banking This is the operating unit of a bank - a place wherein all the operations

    of a branch take place, both retail and wholesale. This is the place for operations and notfor bank administration, although branch administration is a part of branch operations. Abranch is responsible to itself and does not control another branch.

    Bank administrative units which control branches within its territory/jurisdiction Theseare at different levels, the first level being a Regional Office or a Divisional Office or anArea Office, the second level being a Zonal Office and the third and apex level being theHead Office. These administrative units do not carry on any banking operations likebranches but monitor and control all the branches within its jurisdiction to ensure thatthe functioning is smooth and as per the guidelines of the Bank as a whole and the ReserveBank of India (the countrys Central Banking Authority). Further in respect of decisionmaking, starting from the branch to Head Office, there are different levels with eachsuccessive higher level having higher delegated powers than the previous level.

    At the same time, we can easily visualise that among the operating units, i.e., branches, allthe branches may not be at the same level in terms of delegated powers. The extent ofpowers enjoyed by a branch will depend upon its size, i.e., mix of deposits and advances atits command etc. Small branches will enjoy less authority; medium sized branches enjoymore authority, while large branches will enjoy maximum authority. The authority relates

    to the extent of finance that they can give at their level without any reference to thenext higher level of authority (Regional Office or Zonal Office) or the highest level ofauthority (Head Office).

    The designation of the controlling offices differs from bank to bank and no uniformpractice is seen in India. The level of authority or extent of authority to be wielded by aparticular layer is decided by the Board of Directors who meet in the respective HeadOffices. The Board of Directors is headed by a Chairman and is assisted, most of thetimes by an Executive Director. In turn, the Executive Director is assisted by GeneralManagers (some banks have additional posts called Chief General Manager, Deputy Chief

    General Manager etc.), Deputy General Managers, Assistant General Managers, ZonalManagers, Regional Managers, Branch Managers (at the branch level) etc. This is just togive an overall view of the possible hierarchical structure within a bank in India and notmeant for giving the reader the organisation chart of a bank.

    Most of the large size banks have an international banking department.

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    WHAT ARE THE DUTIES OF AN INTERNATIONAL BANKING DEPARTMENT?

    1. Exchange operations

    2. Opening of documentary credits of importation as well as providing notices and

    confirmation of export documentary credits.

    3. Remittance to correspondents of documents for collection and handling of collectionreceived from them.

    4. Issuing bond guarantees on foreign countries or issuing bonds or guaranties for theaccount of foreign banks or firms in favour of local firms.

    5. Handling foreign currency assets of the bank.

    6. Granting lines of credit to banks or firms abroad and securing and handling lines ofcredit granted to the bank by its correspondents.

    7. Maintaining public relation to assure permanent contact, directly or indirectly, withcustomers within the country or abroad.

    8. Maintaining close supervision of relations with correspondent banks world-wide, which,aside from credit and service aspects, also means permanent control over reciprocityreceived or given.

    9. Compiling statistical data to evaluate the evolution of bank operations in theinternational sector.

    TYPICAL DUTIES OF THE CHIEF DEALER OF FOREIGN EXCHANGE IN ANINTERNATIONAL BANKING DEPARTMENT

    1. Execute and supervise the banks purchases and sales of foreign currencies.

    2. Provide all agencies and branches with duly buying and selling rates of differentcurrencies with which the bank normally deals.

    3. Provide current quotes for those same currencies for all operations about which thedealer or desk has been consulted.

    4. Modify rates previously transmitted as well as suspend any authorisation given tobranches and agencies to operate freely up to certain limited amounts.

    5. Maintain contact with principal bank customers about foreign exchange matters.

    6. Review operations daily.

    7. Watch for irregularities.

    8. Monitor the foreign exchange position.

    9. Supervise the foreign currency cash assets that the bank holds in its correspondentbanks abroad.

    10. Carry out transfers or coverage transactions so that accounts abroad have the leastnumber of overdrafts thereby avoiding unnecessary interest charges.

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    Banking Transactions/Flow chart of activity in a bank

    Having examined the various aspects of banking organisation, let us now examine theoperations at the unit level, i.e., at the branch level.

    DAILY ACTIVITIES IN A BRANCH

    At start of Day

    Prepare office for routine work

    Close Previous days books of accounts

    Working cash to be retrieved from Vault andDistributed to tellers

    Process remittances from other banks

    Get the applicable rates for the day Exchange rates, interest rates, changes in fees, serviceCharges etc.

    Initiate the computer system

    During the Day

    Handle mail from customers and process them

    Process customer transactions at the teller counter

    Execute standing instructions for customers

    Prepare statements of accounts for customers

    Perform tasks relating to Term Deposits/Loans

    Process cheques for inward and outward clearing(Inward cheques issued by various customers of the bankon the branch and outward- cheques deposited by variousCustomers of the bank drawn on other banks within thesame banking centre)

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    DAILY ACTIVITIES IN A BRANCH (Contd.)

    End of Day

    Balance cash, instruments

    Process vouchers to be sent for remittance

    Prepare Day Books, Journals, Trial Balance

    Prepare General Ledger for the Day

    ROUTINE ACTIVITIES ( NOT ON DAILY BASIS)

    PERIODICAL ACTIVITIES

    Accrue Interest

    Prepare Statutory Reports Friday Reports forControllingAuthorities, i.e., the Central Banking Authority

    Send pieces of advice to customers

    Prepare statistical reports for Internal MIS

    OPENING OF ACCOUNTS

    Accept Detailed Information about the customer

    - Demographic profile

    - Income, Age, Family size

    - Employment Details

    - Credit Cards, Insurance Details

    Perform analysis required for the account typee.g., credit rating score of the customer to be eligible for a loan

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    Accept and scrutinise details mandatorily required for theAccount type e.g., loan accounting requiring collateral security.

    Open the account assign account no. Customer identity etc.

    Issue certificates / agreements e.g., term loan agreement, term deposit certificates etc.

    ACCOUNT / ACCOUNT FACILITIES MAINTENANCE

    Standing Instructions Details

    Stop Cheque Details

    Linking Accounts

    Change Account Status

    Change in Account Address

    Group Interest Details

    CUSTOMER DEPOSITS

    Cash Deposits Accept cash and credit the account

    Cheque deposits Accept cheques and forward themfor clearing

    FX Purchased from the customer Accept Foreign

    CurrencyCash and credit the account

    Travellers cheques purchased from the customers Accept unutilised TCs and credit the account

    Draft Purchases Accept unencashed drafts and credit the account

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    TYPICAL DEPOSIT TRANSACTIONS AT THE TELLER MACHINES

    CHEQUE DEPOSIT

    Accept cheques and note down the details

    Calculate the date of realisation of the cheques andinformThe customer suitably

    Increase uncleared balance in the customers account

    If transfer from some other account within the sameBranch initiate transfer processing like getting theCheque debited to the issuers account with you,Recording the transaction in the books as a transferTransaction and then crediting the beneficiarys accountWith you.

    If clearing operation, initiate outward clearing bywritingThe details of the cheques in the clearing register(outward)

    CUSTOMER WITHDRAWALS

    Cash withdrawals (withdrawal slips / cheques)Check account balance and handover cash

    Cheque encashingValidate cheque and hand over cash

    Travellers cheque saleIssue travellers cheques (own and other banks)

    Draft sale Issue Drafts (Own)

    FX Sale Hand over Foreign Currency to Customer

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    TYPICAL WITHDRAWAL TRANSACTIONS AT COUNTER

    Cash Withdrawals

    Verify account status

    Verify sufficiency of Account Balances

    Apply overdraft limits, Credit line limits etc.

    Cheque Withdrawals

    Verify signature, date, cheque no. etc.

    Verify stop on cheques

    Verify account status and operating instructions

    FOREIGN EXCHANGE OPERATIONS

    Exchange rates given by the Treasury at the beginningof the day

    Rates may be different as TT/Bill etc.

    Rates need fine tuning for a transaction/customer

    Variance limits assigned for fine tuning depending uponUtility of the customer

    Inform Treasury at Head Office level about High ValueTransactions to facilitate Exposure Management

    Commission and charges usually charged in localCurrency

    FOREIGN EXCHANGE TRANSACTION (F.X. = Acronym for Foreign Exchange)

    FX Sale amount = $ 1000

    Commission = 1%

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    Charges = Rs.100/-

    Exchange rate for conversion for customer to purchase 1 US $ = Rs.43/-

    Indian Rupee equivalent of $ 1000 = Rs.43, 000/-

    Commission at 1% = Rs.430/-

    Charges = Rs.100/-

    Total amount to be debited to the customers account = Rs.Rs.43530/-

    BILL PAYMENTS

    Facilitates convenient payment to the account holder

    Reduces processing volume and time for the beneficiary

    Pre-authorised debits to the account

    Examples of bill payments Telephone bills, Electricity billsInsurance PremiumSchool Fees, Charity Payments,Club Subscriptions etc.

    Account holder gives account details to the beneficiary

    Account holder gives authorisation details to the bank

    Beneficiary or his bank collates the amount due from thebuyerAnd informs the buyers bank

    Buyers bank debits all the charges to its customers accountand credits the beneficiarys account, provided he has accountwith the same bank or his bank through clearing operation etc.

    FEATURES OF DIFFERENT INSTRUMENTS

    CHEQUES

    Processed through Transfer/Clearing

    Instant credit not given usually for clearing cheques

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    DRAFTS

    Prepaid at the time of issue

    Place of encashing the draft is known at the time of issue

    Issued at one place and drawn on another place mostlyanotherBranch of the same bank exception drafts drawn oncorrespondentArrangements

    Instant credit is released by the drawee branch, provided the

    beneficiaryIs having account with it or otherwise, through clearing operation.

    PAY ORDERS OR BANKERS CHEQUES

    For local use as opposed to draft which is for outstation use

    Issued by the Bank (example Interest Payment by Cheque)

    Issued at the request of a customer

    Pay order should be presented to the same branch which isissuingthe instrument. Means this can be used only locally by a customerwhoDoes not have account with that branch or bank.

    TRAVELLERS CHEQUES

    Issued by a branch for domestic use or international useprovidedThe branch is authorised to deal in foreign exchange

    Issued at the request of a customer

    Place of encashing the instrument is not known

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    Can be encashed at Branch / Departmental stores etc.

    Comes back to the Branch that issued it.

    CHEQUES AND CLEARING OPERATIONS

    PROCESSING OF CHEQUES

    Clearing - Outward

    Inward

    Collection - Outstation

    Foreign

    PARTIES TO A CHEQUE

    Drawer Person drawing or issuing the cheque

    Drawee The bank which is liable to pay the cheque

    Payee The beneficiary of the cheque, either whose name isWritten on the cheque or who is the endorsee of the

    Cheque

    Collecting bank The bank which receives payment on behalfof its customer

    Clearing Section Designated Section which deals with

    Clearing operations

    Clearing House Physical Location where Cheques and otherCredit Instruments are exchanged among the

    Banks. Usually it is the Central BankingOrganisation which is responsible for runningThe Clearing House. Some times, its dulyAuthorised Representative also runs theClearing House

    WHEN A BANK IS OBLIGED TO PAY THE CHEQUE DRAWN ON IT?

    The cheque is complete in all regards, i.e., with respect to details.

    The customer has sufficient funds in his account on which the cheque is drawn.

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    CASH TRANSACTION Refer to Specimen No. 2

    OUTWARD CLEARING Refer to Specimen No. 3

    INWARD CLEARING Refer to Specimen No. 4

    TRANSFER TRANSACTION Refer to Specimen No. 5

    OUTSTATION CHEQUES - Refer to Specimen No. 6

    FLOW CHART OF ACTIVITIES IN A BANK Refer to Specimen No. 7

    FRONT OFFICE OPERATIONS IN A BRANCH Refer to Specimen No. 8

    BACK OFFICE OPERATIONS IN A BRANCH Refer to Specimen No. 9

    NOTE ON CALCULATION OF INTEREST ON LOANS AND DEPOSITS Refer toSpecimen No. 10

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    ACCOUNTING EFFECTS OF TRANSACTIONS

    Examples

    S. No. Transaction Voucher Accounting Entry

    1 Cash Deposit Cash Pay in slip Dr. CashCr. Customers Account

    2 Cheque Deposit Cheque Pay in slip Dr. Clearing BranchCr. Customers AccountUpon realisation

    3 Cash Withdrawal Withdrawal slip/ Dr. Customers Account

    cheque Cr. Cash

    4 DD/TT/MT Sale DD/TT/MT slip Dr. Cashby cash Cr. DD/MT/TT paying

    branch of the same bankCr. CommissionCr. Postage (if any)

    5 DD/TT/MT sale DD/TT/MT slip Dr. Customers Accountby Cheque & cheque Cr. DD/MT/TT paying

    branch of the same bankCr. Commission

    Cr. Postage (if any)

    6 TC sale by cash TC slip Dr. CashCr. TC AccountCr. Commission

    7 TC sale by cheque TC slip Dr. Customers Account& Cheque Cr. TC Account

    Cr. Commission

    8 Interest on DepositsVouchers Dr. Interest Expense(Dr./Cr. slips) Cr. Customer Account

    OR Cr. Interest Payable

    9 Interest on Advances Vouchers Dr. Customers Account(Dr./Cr. slips) OR Dr. Interest Receivable

    Cr. Interest Income

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    10 General Expense Voucher Dr. Expense(Dr. slip) Cr. Cash

    BOOKS OF ACCOUNTS AND TRANSACTIONS FLOW IN DAILY OPERATIONS

    Customer Ledger

    Cash Receipt Scroll

    Cash Payment Scroll

    Outward Clearing Register

    Inward Clearing Register

    Subsidiary Ledgers for General Ledger

    Day Book

    General Ledger

    Other Memorandum Books and Registerse.g. Drafts Issue Register, Transfer scroll,TC Issue Register etc.

    GENERAL LEDGER

    Contains all the account heads of Income,Expenditure, Assets, Liabilities, Head Office AccountFor inter-branch transactions, Correspondent bankAccounts etc.

    Posting from the Day Book

    An extract of all the general ledger accounts givesTrial Balance at the end of the day

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    MAJOR ACCOUNT HEADS IN GENERAL LEDGER

    Cash Account

    Accounts with other banks

    Accounts with other branches Head Office/Inter-branch transactions

    Various types of deposit accounts of customers Various types of loans and advances of customers

    Share capital Account

    All types of income accounts

    All types of expense accounts

    All types of Fixed Assets of the branch

    END OF THE PERIOD ACCOUNTING ACTIVITIES

    Interest Accrual and Capitalisation

    Depreciation of Assets

    Provision for Unpaid Expenses

    Creation of Reserves

    Revaluation of FCY Accounts

    Provisional Closing and Transfer of Profit/Loss to HO

    Reopening of Books and Back Dated Entries uponFinalisation of accounts for the branch

    Ascertainment of Contingent Liabilities

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    PERIODIC RECONCILIATION ACTIVITIES

    Suspense Accounts

    Inter-Branch and HO Accounts

    Inter Bank Accounts

    SUSPENSE ACCOUNT

    Why Suspense Account?

    Need for Control of Suspense Accounts and the RisksAssociated with Suspense Account

    Reconciliation Process

    - Matching Debits and Credits- Based on Doc. No. Value Date & Amount- Unreconciled entries to Account for balance

    In the Account

    INTER BRANCH ACCOUNT

    For Remittances

    For Clearing (Local Branches to Main BranchAnd Main Branch to Local Branches)

    Originating and Responding Entries

    Bills Transactions (outward and inward)

    Instruments deposited by customers sent toUpcountry branches for collection (outward)And received from outstation branches (inward)

    FCY Transactions Etc.

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    INTER BANK ACCOUNTS

    Correspondent Banks With Whom NOSTRO AccountsAre Maintained

    Correspondent Banking ArrangementsWithin A Country on A Reciprocal Basis

    Other Banks With Whom Current Accounts AreMaintained For Clearing Operations Etc.

    Accounts With Federal OR Central Banking AuthorityOR Its Duly Authorised Representative Bank/s

    NOSTRO Statements and Image Accounts

    Reconciliation Based On- Doc. No. Value Date and Amount- DRS. Matched with Corresponding CRS.- Inter Bank Dues to be Reconciled periodically

    PRECAUTION WHILE REMITTING FUNDS FROM ONE PLACE TO ANOTHER PLACE

    This depends upon the mode of remittance:

    1. Demand Draft - a branch of a bank usually draws it on another branch of the samebank. This is true of operations within the same country. However, it is quite commonthat internationally, drafts are drawn on correspondent bank in case the drawing bankdoes not have its own branch in that place. This mode of remittance has to ensurethat the branch on which the draft is drawn is aware of the transaction by sending asuitable advice to the drawee branch immediately after issuing the draft. Neither theremitter nor the beneficiary needs to have a bank account with the bank issuing the

    draft. Authorised officials of the bank whose signatures are available with the payingbranch alone should sign the demand drafts.

    2. Mail Transfer The customer has to have an account with the remitting branch and

    the beneficiary has to have an account with another branch of the same bank, unlike inthe case of demand drafts. The transfer is authorised by authorised officials of thebank whose signatures are on record with the paying branch.

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    3. Transfer by Wire or Telegraphic Transfer Since this is an open mode of transfer,there is a need for coding and decoding. The coding involves various parameters asunder:

    The code of the remitting branch

    The code of the responding branch The date of the transaction The day of the transaction The month of the transaction The amount involved etc.

    Upon receipt of the telegraphic transfer communication, the responding branch willdecode the entire message and will keep it in abeyance in case there is any discrepancyin the message. It will seek clarification from the remitting branch and only uponbeing thoroughly satisfied the message is responded to.

    4. Electronic Mail Transfer In case online connection is available within a bank amongthe branches through networking, as is the case with most of the foreign banks andrecent private sector banks in India, remittance is done through this networking andthe beneficiary's account gets credited on the same day anywhere in the country.This is the latest mode of remittance and has revolutionised remittances and customerservice across the globe. Most of the US Banks have networking through satellite linkand use exhaustively this mode for remittance from one place to another place notonly within the country but also globally, at least in selected centres.

    5. SWIFT Transfer Society for World Wide Inter-Bank Financial Tele-communications.

    This was the most common mode of transfer before EMT came into existence. Thisused to ensure that communication for remittance is received within 48 hours of issuefrom one place. The message is as per pre-set format and is the most economicalmode of communication. The receiving branch verifies the authenticity of the messagebefore responding to it or acting on it.

    SWIFT MESSAGE Refer to Specimen No. 12

    ADMINISTRATIVE FUNCTIONS IN A BANK

    Different administrative units in a Bank

    There is distinction between banking operations at a branch level and at administrativelevels. The names of the administrative offices differ from one banking institution toanother. Please refer to Section 2.4 page no. 37 also in this behalf. To illustrate thesame, let us study the following structure.

    Tier No. 1 Branches of various business mix and sizes of business, small, medium, largeand very large.

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    Tier No. 2 Regional Offices or Area Offices

    Tier No. 3 Zonal Offices or Divisional Offices

    Tier No. 4 Head Office

    Tier No. 1 functions already seen.

    Tier Nos. 2, 3 and 4 constitute the administrative units of the bank. It does not meanthat at the branch level there is no administration. What the branch does is calledbranch administration as opposed to the function of these 3 tiers, known as bankadministration.

    Typical functions of different administrative units of a bank:

    1. To ensure conformity with the rules and regulations of Head Office by the branchesand other smaller administrative units under its control.

    2. To ensure conformity with the Central Banking Rules and Regulations as applicablefrom time to time by all the branches and other smaller administrative units undercontrol. (In India, the central banking agency is the Reserve Bank of India.

    3. To grant loans and other credit facilities to branch borrowers whose requirements falloutside the delegated authority

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