CHAPTER 3
COMMERCIAL BANK
TOPICS
Roles
and functions of
commercial bank
List of commercial banks in
Malaysia
Flows of funds: sources and uses
Commercial bank current issues:
merger and consolidation
Issues, concept and differences
between conventional bank and
Islamic bank
LEARNING OBJECTIVES
To
explain the definition of
commercial banks
To discuss the role and functions of
commercial banks
To explain the management and
services offered by commercial banks
To identify the flow of funds in the
commercial banks
To discuss the major issues related to
commercial banks in Malaysia
Commercial Banks
Commercial
banks are the largest group of financial
institutions in terms of total assets
Key financial intermediary because they serve all types of
surplus and deficit units
Major
assets - loans
Major liabilities are depositsdepository institutions
Perform services essential to financial markets
play a key role in the transmission of monetary policy
provide payment services
provide maturity intermediation
Banks
are regulated to protect against disruptions to
the services they perform
Commercial banks
Act
Excess cash
as a financial intermediary
Financial
intermediary
Financial
Institution
Need cash
Commercial Bank Assets
Cash
and balances due from other depository
institutions
Investment securities
short-term securities (e.g, Treasury bills and fed funds sold)
long-term securities (e.g., Treasury bonds, munis, MBSs)
Loans
commercial and industrial
real estate
consumer
other loans
Unearned
income and allowance for loan and lease
losses
Other assets (e.g., fixed assets, goodwill, etc.)
Commercial Bank Liabilities
Core
deposits
demand deposits
savings deposits
certificates of deposits
Other
deposits
wholesale certificates of deposits
negotiable instruments traded in secondary
markets
brokered deposits
Main Function of commercial
banks
1.
Receiving Deposits:
This is the main function of commercial banks to collect
savings of individuals and firms. They offer different types of
deposits for the facility of the customers.
Current Account or Demand Deposits:
Any amount can be withdrawn from this account any time without any
notice. No interest is allowed on this type of account.
Saving Account:
The saving account carries lower rate of interest.
Fixed Deposit (time deposit):
Amount cannot be withdrawn before the fixed future date in this type
of deposit. High interest is allowed in fixed deposit which is different
according to period, the longer the period the higher the rate of
interest offered.
Main Function of commercial banks
2.
Advancing Loans:
This is the important function of the
commercial bank. Credit is given to the
people in different ways.
a) Making Loans:
There are three types of loans given to borrowers.
i. Short Term Loans:
These loans are advanced for the period of six
months to one year. High Interest rate is charged
on this type of accounts.
ii. Medium Term Loans:
Loans from one to five years are called medium
term loans.
iii: Long Term Loans:
Loans which are advanced for the period, more
than ten years are long term loans.
Main Function of commercial
banks
b)Bank Overdraft:
Banks allows their trustful
customers to withdraw more than
the deposit they have in their
current accounts. Bank charges
interest on overdraft.
c)Cash Credit:
An arrangement whereby the bank allows
the borrower to withdraw amount up to a
specified limit. The interest is charged on
the amount withdrawn.
Secondary functions
Issuing
letters of credit, travellers cheques, circular notes
etc.
Undertaking safe custody of valuables, important
documents, and securities by providing safe deposit vaults
or lockers;
Providing customers with facilities of foreign exchange.
Transferring money from one place to another; and from
one branch to another branch of the bank.
Standing guarantee on behalf of its customers, for making
payments for purchase of goods, machinery, vehicles etc.
Collecting and supplying business information;
Issuing demand drafts and pay orders; and,
Providing reports on the credit worthiness of customers.
Retail Banking services
Automated
Automated teller
teller machines
machines (ATMs)
(ATMs)
Point-of-sale
Point-of-sale (POS)
(POS) debit
debit cards
cards
Preauthorized
Preauthorized debits
debits and
and credits
credits
Paying
Paying bills
bills via
via telephone
telephone
Online
Online banking
banking
Smart
Smart cards
cards (stored-value)
(stored-value) cards
cards
Internet
Internet banking
banking
complements
complements existing
existing business
business for
for already
already
existing
existing banks
banks
some
some new
new internet-only
internet-only banks
banks have
have no
no brick
brick
and
and mortar
mortar
Flow of funds: sources of
funds
Deposit
Accounts
Transaction deposits
Savings deposits
Time deposits
Money market deposit accounts
Borrowed
funds
Federal funds purchased (borrowed)
Borrowing from the Federal Reserve Bank
Repurchase agreements
Eurodollar borrowings
Long-term
sources of funds
Bonds issued by the bank
Bank capital
Flow of funds: sources of
funds
Transaction
Deposits
Demand deposit account or checking account
Small min balance and no interest
Negotiable order of withdrawal (NOW) account
Pays interest and provide checking services
Require larger min balance
Savings
Deposits
No check writing
No required min balance
Time
deposits
Cannot be withdrawn until specified maturity date
Certificate of deposits (CD)
No secondary market
Requires a specified min amount of funds for a specified period of time
Negotiable Certificate of Deposits (NCD)
Offer by some large banks to corporations
Secondary market exists
Flow of funds: sources of
funds
Money
Market Deposit Accounts
Do not specify maturity
More liquid than CDs and offer lower interest than
CD
Limited check writing ability, larger min balance
and higher yield compared to NOW
Federal
Funds purchased
A liability to the borrowing bank, an asset to the
lending bank
Loans are for 1-7 days
To correct short-term fund imbalances
Interest charged=federal funds rate, which
depends on demand and supply
Flow of funds: sources of
funds
Borrowing
from the Federal Reserve Banks
Short term loans
Referred to as borrowing at the discount window
Interest = primary credit lending rate
The central bank as the lender of the last resort
To resolve temporary shortage of funds
Repurchase
Agreements
Represents the sale of securities by one party to
another with an agreement to repurchase the
securities at a specified date and price
A short term source of fund
The securities serve as a collateral, less risky
Flow of funds: sources of
funds
Eurodollar
Borrowings
Borrow dollars from banks outside US that
accept dollar-denominated deposits
Bonds
issued by the bank
Used to finance fixed asset such as land,
building etc.
Bank
capital
Through the issuance of stocks or
retained earnings which represents equity
No obligation to pay out funds
Flow of funds: uses of
funds
Cash
Bank
loans
Investment in securities
Federal funds sold (loaned out)
Repurchase agreement
Eurodollar loans
Fixed assets
Flow of funds: uses of
funds
Cash
As reserve for the purpose of SRR
controlling the money supply
To maintain liquidity hold necessary amount
Bank
loans
Main use
Type of business loans
Working capital loan to support ongoing business
operations
Term loans to finance the purchase of fixed assets
such as machinery
Speciffed period of time and specified purpose
The asset purchased may serve as collateral
Can be 2, 5 or 10 years
May impose protective covenants to protect the banks from
Flow of funds: uses of
funds
Type
of Business Loans
Direct lease loan
The bank purchase the assets and lease them to the
firm
Avoid having more debt on firms balance sheet
Informal line of credit
To borrow up to a specified amount within a
specified period of time
Do not know precisely when they need the fund
Revolving credit loan
Obligates the bank to offer up to some specified
max amount of funds over a specified period of time
Charges a commitment fee on any unused funds
Flow of funds: uses of
funds
Prime
Rate
What Does Prime Rate Mean?
The interest rate that commercial banks charge their most
credit-worthy customers. Generallya bank's best
customersconsist of large corporations. The prime interest
rate, or prime lending rate, is largely determined by the
federal funds rate, which is the overnight rate which banks
lend to one another. The prime rate is also important for retail
customers, as the prime rate directly affects the lending rates
which are available for mortgage, small business and personal
loans.
Investopedia explains Prime Rate
Default risk is themain determinerof the interest rate abank
will charge a borrower. Because a bank's best customers have
little chance of defaulting, the bank can charge them a rate
that is lower thanthe rate that would be charged to a
customer who has a higher likelihood of defaulting ona loan.
Flow of funds: uses of
funds
Loan
Participation
Pooling of funds by several banks to
cater the need of a large corporation
who wish to borrow a larger amount
One bank will be the lead bank who
prepares the documents etc.
Loan syndication
Loans
supporting leveraged buyouts
Loans to support the purchase of equity
of another business
Flow of funds: uses of
funds
Types of Consumer Loans
Installment loans eg. purchase car, involve periodic
payments
Credit card
Real estate loans
Mortgage loans of typical 15-30 years
Investment
in securities
More liquid compared to loans
Federal
Funds sold
Interbank lending and borrowing
Repurchase
agreements
Eurodollar loans
Fixed assets
Risks associated with
commercial banks
Commercial
Commercial banks
banks face
face unique
unique risks
risks
because
because of
of their
their asset
asset structure
structure
credit
credit (default)
(default) risk
risk is
is the
the risk
risk that
that loans
loans
are
are not
not repaid
repaid
liquidity
liquidity risk
risk is
is the
the risk
risk that
that depositors
depositors will
will
demand
demand more
more cash
cash than
than banks
banks can
can
immediately
immediately provide
provide
interest
interest rate
rate risk
risk is
is the
the risk
risk that
that interest
interest
rate
rate changes
changes erode
erode net
net worth
worth
credit,
credit, liquidity,
liquidity, and
and interest
interest rate
rate risk
risk all
all
contribute
contribute to
to aa commercial
commercial banks
banks level
level of
of
insolvency
insolvency risk
risk
Commercial banks in
malaysia
Currently, there are 23 commercial banks in
Malaysia, 9 L, 14 F ([Link])
Affin Bank Bhd
Alliance Bank Malaysia Bhd
AmBank (M) Bhd
Bangkok Bank Bhd
Malayan Banking Bhd
Bank of China (Malaysia) Bhd
Bank of Tokyo-Mitsubishi UFJ (Malaysia) Bhd
CIMB Bank Bhd
Citibank Bhd
RHB Bank Bhd
EON Bank Bhd
Hong Leong Bank Bhd..