Management of Financial Institutions (MFI)

1. Define loan sale and explain different types of loan sales.

2. Discuss the principles of sound lending.

3. Securitization

4. What is commercial bank and what are the functions of a commercial bank?

5. National Payment Switch Bangladesh (Dec-2013)

6. Point out the major guidelines of Bangladesh Bank’s management of capital of BASEL –II

(June-2013, June-2014)

7. How does Bangladesh Bank regulate the money supply through “Bank Rate Policy” and

“Open Market Operation”?

8. Explain the concept of mobile banking.

9. Stages of money laundering

10. Super NOW (Negotiable Order of Withdrawal) account

11. Short Note: BACH, Core Capital, Steps of Money Laundering, Investment Banking, Option,

NPSB, Merchant Banking, Risk Premium, RWA, SWAP, SWIFT, Marine Insurance, Portfolio

Management, Securitization, Loan Pricing, Loan Sale, Loan Classification, Agricultural Credit

Policy,

Define loan sale and explain different types of loan sales. A loan sale is a sale, often by a bank, under contract of all or part of the cash stream from a specific loan, thereby removing the loan from the bank's balance sheet. Types of Loan Sale: 1. Participation Loans 2. Assignments 3. Loan Strip 1) Participation Loans: a loan that is shared by a group of banks that join to make a loan too big for any one of them alone. 2) Assignments: A sale of loan by bank of rights against the borrower and the benefits of the loan, to the assignee bank. 3) Loan Strip: Loan Strips are short-dated pieces of a longer-term loan and often mature in a few days or weeks. The buyer of a strip is entitled to a fraction of the expected income from a loan. Discuss the principles of sound lending. a. Safety- security and repaying capacity, b. Liquidity- ability of an asset to convert in to cash without loss, c. Profitability- brings adequate return for the bank, d. Purpose- should be productive, e. Spread- Diversification of advance. Securitization Securitization means the conversion of a pool of assets into marketable debt securities. The deal starts with an originator selling a part of his assets portfolio to a body (or a trust) called the Special Purpose Vehicle (SPV) and in effect converting the assets into cash. The special purpose vehicle in turn raises money by floating a debt instrument on the strength of cash flows and the underlying assets, and using the proceeds to pay off the originator. To this extent, the SPV is only a pass through vehicle and a manager of the asset and cash flow pool. The proceeds collected by the originator on account of the outstanding loans made by him is then passed on the SPV who in turn pays off the principal and interest to the final investor, typically the wholesale investor, like the mutual funds, insurance companies and pension funds. Benefits of Securitization: 1. For the issuer, securitization provides an additional source of funds, reduces funding costs, besides resulting in economy in the use of capital, greater recycling of funds which lends to higher turnover and profitability. 2. It also improves the capital adequacy norm by removing loan assets from the balance sheet, or by substituting them with less risk weighted assets. Moreover, funds can be managed without impairing its borrowing ability. 3. Securitized assets gives the issuer, the ability to pass on or eliminate credit, interest rate and lending risks associated with balance sheet funding and hence is an effective means of diversifying credit risk. 4. For the investor, it improves the diversity of investment avenues. It also makes it possible for investing in high yielding assets like housing and consumer finance which are untouchable by banks. Moreover, the investor benefits from the purchase of securitized debt with higher quality debt with higher yields and good liquidity. Impediments to Assets Securitization in Bangladesh: 1. Lack of Awareness 2. Non Uniformity in Stamp Duty 3. Absence of Effective Foreclosure norms 4. Less demand for long term Debt Papers 5. Investments Restrictions

What is commercial bank and what are the functions of a commercial bank? As per Negotiable Instrument Act 1881 and Bank Company Act 1991, “Banker means the accepting, for the purpose of lending or investment, of deposit of money from the public, repayable on demand or otherwise and withdrawable by cheque, draft, and order or otherwise”. A commercial bank is a type of financial institution and intermediary. It is a bank that lends money and provides transactional, savings and money market accounts and that accepts time deposits. Prof. Rozer “the bank which deals with money and money’s worth with a view to earning profit is known as commercial bank” Prof. Nath, “commercial bank is an intermediary profit making institution”. The traditional functions of a Commercial bank are to receive deposit from the surplus unit with a condition to repay on demand or otherwise and allowing loans/advances/investment to the deficit unit. But now-a-days the functions of a commercial bank diversified and acting as a superstore. So, the functions may be divided into five categories, such as (1) General functions, (2) Functions related to foreign trade and foreign exchange, (3) Agency functions, (4) Welfare functions and (5) Other functions General functions are: a) Maintain account of the clients, b) To receive deposits of various types, c) To make advance/investment against with or without securities, d) To create deposits, e) To create medium of exchange through cheque, Draft, Pay – order etc. f) To issue guarantees (local) g) To discount Bills. Functions related to Foreign trade & Foreign exchange: a) To make correspondent banking with overseas banks, b) To place foreign currency funds with correspondents abroad, c) To issue Letter of Credit (LC), d) To issue Back to Back Letter of Credit (BTB L/C), e) To amend L/Cs, f) To extend investment/credit facilities to the importers through creating PAD/MIB, MTR/LTR, LIM/LAM/MP etc, g) To extend credit/investment facilities to the exporters through the modes of Musharaka Pre-shipment/PC/ECC, LDBP, FDBP etc, h) Acceptance of Bill of Exchange and make payment, i) Make forward booking of foreign exchange on behalf of importer for preventing them from exchange loss, j) Sale and purchase of Foreign currency, TC, Credit Cards, k) Maintaining Foreign Currency accounts, l) Outward foreign remittance for import, foreign tour, travel, education, treatment, pilgrims, training etc., m) Inward foreign remittance – export proceeds, wage earners remittance etc., n) Issuing guarantees (foreign). Agency functions: a) To transfer money, b) To collect funds and makes payment for the clients, c) To maintain confidentiality of customers, d) To sale and purchase of shares and securities, e) To make payments for utility charges and insurance premium on behalf of the client, f) To receive rent, dividend, premium etc.

g) To work as trustee, h) To work as representative of Central Bank. Welfare functions: a) Social welfare functions/Corporate Social Responsibility, b) Functions related to the welfare of the employees/retired employees such as • Establishment of institution, • Establishment of Trust, • Pensions and allowance. Other functions: a) Underwriting, b) Work as safe custody through Locker service, c) Advices the clients on business matters, d) Repo, e) Customer financing, f) Leasing, g) Income sharing, h) Syndication, arrangement of funds, i) Issuance of SanchayPatra, ICB Unit Certificate, Bond, j) Sale of Prize Bond, k) Any other functions approved by the Gov’t/Bangladesh Bank. l) Merchant banking. National Payment Switch Bangladesh (Dec-2013) The Bangladesh Bank has taken initiative to establish National Payment Switch (NPS) in order to facilitate interbank electronic payments originating from different delivery channels e.g. Automated Teller Machines (ATM), Point of Sales (POS), Internet, Mobile Applications, etc. The main objective of NPS is to create a common platform among the existing shared switches already built-up by different private sector operators. NPS will facilitate the expansion of the card based payment networks substantially and promote e-commerce throughout the country. Online payment of Government dues, using cards and account number information through Internet will greatly be enhanced using NPS. Payment Systems Division (PSD), Department of Currency Management and Payment Systems (DCMPS), BB has started the implementation of NPS which is funded by the International Finance Corporation-Bangladesh Investment Climate Fund (IFC-BICF). Point out the major guidelines of Bangladesh Bank’s management of capital of BASEL –II (June-2013, June-2014) A committee of central banks and bank supervisor and regulators from he major industrialized countries (Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Sweden, Switzerland, U.K and USA) that meets every three months at BIS in Basel. Objectives of Basel II: The objectives of Basel II are given below: 1. Should constitute a more comprehensive approach to address banking risks. 2. Appropriately sensitive to degree of risk. 3. Should continue to enhance competitive equality and promote safety and soundness of the financial system.

Three Pillars of Basel II: 1. Minimum Capital Requirement 2. Supervisory Review 3. Market Discipline Guidelines for Minimum Capital Requirement: 1. Minimum Capital Requirement 2. Assessing Overall Capital Adequacy 3. Disclosure of Information on Bank’s Risk Profile, Capital Adequacy and Risk Management. Capital Base: Regulatory capital is composed of: • Tier -1 or Core Capital • Tier-2 or Supplementary Capital • Tier-3 or Additional Supplementary Capital What is Tier – 1 Capital: Tier-1 capital or Core Capital comprises of highest quality capital elements: • Paid up capital/capital deposited with Bangladesh Bank • Non-repayable share premium account • Statutory Reserve • General Reserve • Retained Earnings • Minority interest in subsidiaries • Non-cumulative irredeemable Preference Share • Dividend Equalization Account What is Tier-2 Capital? Tier-2 capital or Supplementary Capital represents other elements which fall short of some of the characteristics of the Core Capital but contribute to the overall strength of a bank. Tier-2 capital is for long term. • General Provision • Asset Revaluation Reserves • All other Preference Share • Perpetual Subordinated Debt • Exchange Equalization Account • Revaluation Reserves for Securities What is Tier-3 Capital? Tier-3 capital of Additional Supplementary Capital consists of short-term subordinated debt (original/residual maturity less than or equal to five years but greater than or equal to two years) would be solely for the purpose of meeting capital requirement for market risk. Conditions for Maintaining Regulatory Capital: 1. T-2 + T-3 cannot exceed T-1. 2. At least 20% market risk to be supported by T-1. 3. General provisions is limited to maximum 1.25% of Total Risk Weighted Asset (TRWA) 4. Subordinated debt (T-2) shall be limited to maximum 30% of T-1. 5. 50% of asset and security revaluation reserve shall be eligible for T-2. 6. For downside revaluation full amount will be deducted but for upside revaluation only 50% will be added. 7. T-3 is limited to 250% of T-1 after meeting credit risk. Eligible Regulatory Capital: 1. Following Deductions are to be made from T-1:

a) Book value of Goodwill

b) Provisioning shortfall c) Deficit on account of revaluation in investment.

2. Eligible T-2 and T-3 will be derived after deducting components, if any, qualified for deduction. 3. Total Eligible Regulatory Capital = (Eligible Tier-1 Capital + Eligible Tier-2 Capital + Eligible Tier-3 Capital). Minimum Capital Requirement: • No schedule bank in Bangladesh shall commence and carry on business unless it has minimum paid up capital/capital deposited with Bangladesh Bank as fixed by Bangladesh Bank. • Capital Requirement = ≥ 10% with Tier-1 at least 5%. • TRWA = RWA for Credit Risk + 10 (capital charge for market risk and operational risk). Methodology for Calculating RWA 1. Convert OBSA to BSA by multiplying with the credit conversion factors. 2. Apply Risk Mitigation Technique 3. Multiply each asset and converted OBSA by appropriate R. W. in order to get RWA. 4. Then, sum these RWA and get TRWA. How does Bangladesh Bank regulate the money supply through “Bank rate policy” and

“Open Market Operation”?

Bank rate policy: The bank rate is the rate of interest at which BB re-discounts the first class bills of exchange from commercial banks. Whenever BB wants to reduce credit, the bank rate is raised and whenever the volume of bank credit is to be expanded the bank rate is lowered. This is because by change in the bank rate. BB seeks to influence the cost of bank credit. The efficacy of bank rate policy depends, to a greater extent, on its power to influence the market rates. There is no organized money market in our country and thereby the market rates seldom respond to bank rate changes. The absence of any kind of conventional relationship between the central bank and other components of the money market further adds to the ineffectiveness of the bank rate policy Open Market Operations: The Central Bank buys or sells ((on behalf of the Fiscal Authorities (the Treasury)) securities to the banking and non-banking public (that is in the open market). One such security is Treasury Bills. When the Central Bank sells securities, it reduces the supply of reserves and when it buys (back) securities-by redeeming them-it increases the supply of reserves to the Deposit Money Banks, thus affecting the supply of money. Explain the concept of mobile banking. Mobile banking (also known as M-Banking, m-banking) is a term used for performing balance checks, account transactions, payments, credit applications and other banking transactions through a mobile device such as a mobile phone or Personal Digital Assistant (PDA). Mobile banking and Mobile payments are often, incorrectly, used interchangeably. The two terms are differentiated by their service provider-to-consumer relationship; financial institution-to-consumer versus commercial institution-to-consumer for mobile banking and payments, respectively. Mobile Banking involves using mobile devices gain to access financial services. Mobile payments on the other hand may be defined as the use of mobile devices to pay for goods or services either at the point of purchase or remotely. Bill payment is not considered a form of mobile payment because it does not occur in real time. The following services are provided by a bank to its customers through mobile banking:

A. Pull services I. Account balance inquiry II. Last three transactions III. Cheque leaf status IV. Profit/interest rate on deposit V. Foreign currency exchange rate VI. Branch location/ phone number VII. ATM booths location I. SMS registration information II. Help list for key words to send SMS III. Help message format to send SMS A. Request services I. Fund transfer II. Mobile bill payment III. Cheque book request IV. Account statement print request V. Account statement request by courier/e-mail B. Execution services: I. Stop payment II. Stopped cheque leaf reactivation III. PIN change C. Alert services I. Debit alert II. Clearing cheque return alert III. Loan expiry IV. Scheme deposit maturity alert Stages of money laundering Money Laundering Prevention Act, 2002 defines money laundering as properties acquired or earned directly or indirectly through illegal means; illegal transfer, conversion and concealment of location of the properties earned through legal or illegal means or assistance in the said acts. There are three main stages of money laundering. These are: 1. Placement: The physical disposal of the initial proceeds derived from illegal activity e.g. depositing the money earned by theft, robbery, bribery or hijacking to a bank account. 2. Layering: Separating illicit proceeds from their sources by creating complicated layers of financial transactions designed to disguise the audit trail and provide anonymity e.g. electronic transfer of the fund to a fake firm, issuing overseas bank draft, purchasing travelers cheques, transfer of fund from one bank account to various names of different bank branches. 3. Integration: It means the provision of apparent legitimacy to property gained in an unlawful way. If the layering process is complete, integration process place the laundered proceeds back into the economy in such a way that they re-enter the financial system appearing as normal business fund e.g. sale of flat/house/land purchased by illegal income. Super NOW (Negotiable Order of Withdrawal) account Super NOW (Negotiable Order of Withdrawal) account is one type of bank account in which interest rate is tagged with money market dealing interest rate and the rate is lower than the existing money market rate. A minimum deposit amount is required and there is no interest rate ceiling. If money market rate goes up, interest rate also goes up. If money market rate falls, interest rate also falls but never goes below a certain minimum rate of interest.

MFI Math (Dec-2013) The following information is for New Bank Ltd. (in million Tk.): - Total Income= 1875 Interest Expense = 1210 Total Asset = 15765 Securities gain (loss) = 21 Earning Asset = 12621 Total liabilities = 15440 Taxes = 16

Shares = 145000 Non-Interest Income = 501 Non-Interest Expense = 685 Provision for Loan Loss = 381. Calculate: ROE, ROA, NIM, EPS, NNIM, Net Operating Margin.

Solution: Net Income = Interest Income + Non Interest Income + Securities Gains - Interest Expense - Non Interest Expense – Taxes – Provision for Loan Loss = 1875 + 501 + 21 – 1210 – 685 – 16 – 381 = 105 Total Equity = Total Assets – Total Liabilities = 15765 – 15440 = 325 ROE = Net Income / Total Equity = 105 / 325 = 32.30% ROA = Net Income / Total Assets = 105 / 15765 = 0.66% NIM = (Interest Income – Interest Expenses) / Earning Assets = (1875 - 1210) / 12621 = 665 / 12621 = ?% EPS = Net Income / No of Shares = 105,000,000 / 145,000 = Tk. 724.14 per share Net Non-interest Margin = (Non-interest Income - Non-interest Expenses) / Earning Assets = (501 – 685) / 12621 = (184) / 12621 = ?% Here, Total Operating Income = Int. Income + Non Interest Income = 1875 + 501 = 2376 Total Operating Expenses = Int. Expenses + Non Int. Expense + Provision for Loan Loss = 1210 + 685 + 381 = 2276 Net Operating Margin = (Total Op. Income – Total Op. Expenses) / Total Assets = (2376 – 2276) / 15765 = 0.63%

MFI Math (Dec-2013)

6(a) Net Income = Interest Income + Non Interest Income + Securities Gains - Interest Expense - Non Interest Expense – Taxes – Provision for Loan Loss = 1875 + 501 + 21 – 1210 – 685 – 16 – 381 = TK. 105 M Total Equity = Total Assets – Total Liabilities = 15765 – 15440 = TK. 325 M Debt= Deposit Account+ Bills Payable+ Borrowings (from Other or any Bank) ******* Contra will not count (Ignore) Equity= Share Capital + Profit and Loss + Reserve Fund and other Reserves+ Surplus Debt Equity Ratio or Burden%= Debt/Equity Net Interest Income NII= Interest Income-Interest Expense = (Interest on Advances+ Interest on Investment)-0) Non Interest Income = Commission, Exchange and Brokerage+ Others Revenue+ Profit on sale on Investment Non Interest Expenses = Salary+ Allowance+ MD’s Fee + Legal Fees + Sales Expenses + Printing& Stationary + Postage & Telegram + Repair & Maintenance Net Non Interest Income =Non Interest Income- Non Interest Expense (Operating Income (Interest Income-Interest Expenses+ Other Income) - Operating Expenses (All Expenditure excluding Interest Paid and Provision)) ROE= Return on Equity = Net Income / Total Equity = 105 / 325 = 32.30% ROA = Return on Asset= Net Income / Total Assets = 105 / 15765 = 0.66% NIM = Net Interest Margin= (Interest Income – Interest Expenses) / Total Assets = (1875 - 1210) / 15765 = 665 / 15765= 4.21% EPS = Earnings Per Share = 105,000,000 / 145,000 = Tk. 724.14 per share Net Non Interest Margin = (Non Interest Income – Non Interest Expenses) / Total Assets = (501 – 685) / 15765 = (184) / 15765 = - 1.16% Here, Total Operating Income = Int. Income + Non Interest Income = 1875 + 501 = TK. 2376 M Total Operating Expenses = Int. Expenses + Non Int. Expense + Provision for Loan Loss = 1210 + 685 + 381 = TK. 2276 M Net Operating Margin = (Total Op. Income – Total Op. Expenses) / Total Assets = (2376 – 2276) / 15765 = 0.63% (Post by Ayesha Parvin Ruby)

MFI Math (June-2014) The following information is for XYZ Bank Ltd. (in million Tk.): - Total Income= 2250 Interest Expense = 1452 Total Asset = 18918 Securities gain (loss) = 25 Earning Asset = 15145 Total liabilities = 18528 Taxes = 20

Shares = 145000 Non Interest Income = 600 Non Interest Expense = 820 Provision for Loan Loss = 455. Calculate: ROE, ROA, NIM, EPS, NNIM, Net operating margin.

Solution: Net Income = Interest Income + Non Interest Income + Securities Gains - Interest Expense - Non Interest Expense – Taxes – Provision for Loan Loss = 2250 + 600 + 25 – 1452 – 820 – 20 – 455 = 128 million Total Equity = Total Assets – Total Liabilities = 18918 – 18528 = 390 million ROE = Net Income / Total Equity = 128 / 390 = 32.82 % ROA = Net Income / Total Assets = 128 / 18918 = 0.68 % NIM = (Interest Income – Interest Expenses) / Earning Assets = (2250 - 1452) / 15145 = 798 / 15145 = 5.27 % EPS = Net Income / No of Shares = 128,000,000 / 145,000 = Tk. 724.14 per share Net Non-interest Margin = (Non-interest Income - Non-interest Expenses) / Earning Assets = (600 – 820) / 15145 = (220) / 15145 = ? % Here, Total Operating Income = Int. Income + Non Interest Income = 2250 + 600 = 2850 Total Operating Expenses = Int. Expenses + Non Int. Expense + Provision for Loan Loss = 1452 + 820 + 455 = ? Net Operating Margin = (Total Op. Income – Total Op. Expenses) / Total Assets = (2850 – ?) / 18918 = ? %

MFI Math (Nov-2011)

4(c) i) Net Interest Income = Interest Income - Interest Expense = (80,000+15,000) - 19,500 = Taka 75,500 thousands. ii) Net Non-interest Income = Non-interest Income - Non-interest Expenses =(20000+2000+8000) - (7500+3500+2000+2500+25000) = 30000 - 40500 = (10500) iii) Net Interest Margin = (Interest Income – Interest Expenses) / Total Assets = (95000 - 19500) / 682500 = 11.06% iv) Operating Efficiency Ratio = Total Operating Expenses / Total Operating Income = (19500+7500+3500+2000+2500+25000) / 125000 = 48% v) PLL% = Provision for Loan Losses / Loans = 7500 / 295000 = 0.0254 or 2.54% vi) Burden% = (Non Interest Op Expenditure - Non Interest Income)/ Average Assets = [(7500+3500+2000+2500+25000) - (20000+2000+8000)] / 682500 = 1.53% vii) ROA = Net Income / Total Assets = 65000 / 682500 =9.52% viii) ROE = Net Income / Total Equity = 65000 / (200000+115000+130000) = 14.60% ix) Equity Multiplier (EM) = Total Assets / Total Equity = 682500 / 445000 = 1.53 times x) Equity to Asset Ratio = Total Equity / Total Assets = 445000 / 682500 = 65.20%

MFI Math (June-2013, Nov-2014) MFI Math (June-2014) – 4(a)

MFI Math (June-2014) – 4(b)

MFI Math (Dec-13-3(b)] MFI Math (June-14-4(a)]

MFI Math (June-14-4(b)] MFI Math (Dec-13-3(a)]

MFI Math (Nov-2014)

Given the following information for ABC Bank Ltd. (in million Tk.): - Total Income= 2345 Interest Expense = 1510 Total Asset = 19700 Securities gain (loss ) = 30 Earning Asset = 15780 Total liabilities = 19300 Taxes = 20

Shares = 181250 Non-Interest Income = 630 Non-Interest Expense = 850 Provision for Loan Loss = 480. Calculate: ROE, ROA, NIM, EPS, NNIM, Net operating margin.

Solution: Net Income = Interest Income + Non Interest Income + Securities Gains - Interest Expense - Non Interest Expense – Taxes – Provision for Loan Loss = 2345 + 630 + 30 – 1510 – 850 – 20 – 480 = 145 million Total Equity = Total Assets – Total Liabilities = 19700 – 19300 = 400 million ROE = Net Income / Total Equity = 145 / 400 = 36.25% ROA = Net Income / Total Assets = 145 / 19700 = 0.74% NIM = (Interest Income – Interest Expenses) / Earning Assets = (2345 - 1510) / 15780 = 2.34% EPS = Net Income / No of Shares = 145,000,000 / 181,250 = Tk. 800.00 per share Net Non-interest Margin = (Non-interest Income - Non-interest Expenses) / Earning Assets = (630 – 850) / 15780 = (220) / 15780 = - 1.39% Here, Total Operating Income = Int. Income + Non Interest Income = 2345 + 630 = 2975 Total Operating Expenses = Int. Expenses + Non Int. Expense + Provision for Loan Loss = 1510 + 850 + 480 = 2840 Net Operating Margin = (Total Op. Income – Total Op. Expenses) / Total Assets = (2975 – 2840) / 19700 = 0.69%

MFI Math (Dec-2013)

Solution to 4(b)

Given,

Return on Assets, ROA = 0.80%

Equity Multiplier, EM = 12 times

So, Return on Equity, ROE = ROA * EM = 0.80 * 12 = 9.6%