2. 2.

CENTRAL BANKING The role and functions:

Central Bank of a country is the nerve centre of the monetary system and occupies a dominant position in the financial system. As apex banking institutions, central banks regulate, direct, monitor as well as foster their respective countrys financial system. While individual central banks may have uni ue and well!defined functional framework assigned to them, by and large, following are their core functions. 2.1.1 Issue and mana ement of currenc!:

"n most countries, it is the central bank that is vested with the power to issue currencies and coins. "n the past, some of the central banks used to have backup reserve in terms of gold#convertible currencies for the currencies#coins they issued. $resently very few central banks go for a %&&' asset backup for its currency issues. 2.1.2 Ban"ers to the Go#ernment (raditionally, it is the central banks that act as bankers to their respective )overnments. "n role as bankers to the )overnment, central banks effect payments and receive revenues on behalf of the )overnment. Besides, in most countries, central banks act as debt managers for the )overnment. (hus, it is the central bank that issues sovereign securities, taking care of their servicing and ultimate redemption. 2.1.$ Ban"er%s Ban"

(he central bank maintains accounts of all commercial banks. (he statutory reserves are to be kept with the central bank. (hese accounts are used for inter!bank settlements and for foreign exchange transactions by commercial banks with the central bank. (he central bank also acts as the *lender of last resort to the commercial banks. +uring critical situations banks may run out of reserves and may re uire selling assets to meet their commitments. "n such situations, Central Bank may come to the rescue of these banks, by providing funds so that they can overcome the immediate problem. ,or example, on -ctober %., %./0 1Black 2onday3, the 45 stock market suffered the worst one!day decline in its history with a wipe out of about 67' of the value of stocks. (his forced the banks, which were holding stocks as collateral securities, to sell the stocks to avoid further loss. A large number of individuals and pension funds had invested in stocks, and a huge financial collapse looked imminent. 8arly next day, the ,ederal 9eserve 1Central Banking 5ystem of 453 pledged to provide emergency loans to banks to obviate dumping of stocks in the market. (hus, a serious economic disaster was averted by the timely action of the countrys central bank.

1.

&'( I) A BANK%) C*)T(+ER,

:ormally we would describe a customer as one who uses any of the services offered by a bank. ;owever in the way banking has evolved over the years it has taken a legal flavor. (he relationship of banker and customer does not come into existence unless both parties intend to enter into it. ;ow does this happen< "f someone opens some sort of an account, ! a current, savings or deposit account, then he becomes a customer of the bank. Customer signifies the relationship, in which duration is not essential. ;e does not need to have habitual dealings with the banker in order to rank as a customer. =ust opening an account with a bank is sufficient to become a customer. 2. ACC(*NT (-ENING

A bank exercises caution before opening an account and providing full banking facilities. :ormally, a banker will not open an account on mere re uest from a stranger. Banks call for a satisfactory introduction of new customers and this is commonly obtained by asking the prospective customer to get a reference from an existing customer of the bank. But this practice, under competitive pressure is being largely done away with and other methods of verifying the bona fides are being used. An individual can produce passport, government identity card, citi>enship card, driving license, etc., as proof of his#her identity. Companies can use their certificates of incorporation#tax returns and get their account opened on ?self introduction@ basis. At times an introductory letter from existing bankers is also accepted. Banks obtain an account!opening re uest from the customer in a detailed format where a lot of details are called for along with an undertaking from the customer that he # she will abide by the regulations of the bank. (he format provides for introduction along with a specimen signature of the customer. 5pecimen signatures of other persons who may be authori>ed to operate the account are also taken at the time of opening the account. Account opening stage is considered to be an important task for the bank, where the bank is supposed to take all precautions as per the laid down guidelines. (he banks internal auditors carefully scrutini>e this activity, as any negligence at this stage is a potential risk for banks. A simple and most common account in a bank is that of resident individuals. "ntroduction to this type of account is simple and the mandate to operate the account is straightforward. 5ometimes, a customer may desire that another person operate his account by giving a mandate to the bank to that effect. (he powers that generally include are to operate the account in a normal way and not to overdraw the account. An account holder can nominate a person to whom, in the event of death, the payment of the balance in the account could be made. "n "ndia, nominations are available in all banks. "n the case of accounts with nominations, the banker is discharged if payment is made to such nominee in the event of death of the account holder.

Banking Basics

$.2

.oint accounts:

=oint accounts may be run by two or more persons#entities, although most common type is that opened by two individuals. (he choice to operate the account is given in the account opening form itself with various options like either or survivor, former or survivor or Aoint operations. (he purpose of Aoint account is that, apart from Aoint operations, upon the death of one party, the balance in the account is paid to the survivor or the survivor can continue to operate the account with least formalities. $.$ +inors: "n most countries, a minor is a person under the age of %/. (he law reserves a treatment for minors and provides them with only limited contractual powers. 2ore often than not, obligations arising out of contracts would not be binding on the minors. (his means, those entering into contracts with minors would find themselves on a weak wicket when it comes to enforcing the obligations on the minors. :onetheless, there is no legal bar as such, on any bank opening accounts in the name of minors. (he bank would face no legal problems so long as there is sufficient balance in the account. ;owever, for any banker, to allow overdraft in a minors account is not in their best interest. A minor can operate an account i.e. sign che ues, etc. but the age that is considered suitable for operating a bank account depends upon the policy of the individual bank and the individual circumstances. "t is usual for the banks to open minors account which is operated by the guardian i.e. father or mother of the minor. An important aspect of minors account is to note the date of birth of the minor and convert the same into a normal account on his#her attaining maAority. $./ -artnershi0 accounts:

Banks may or may not have separate account formats for partnership accounts and use the same formats used for individuals. But they generally examine the partnership deed to ascertain the nature of business, number of partners, their powers, etc. Bank records are suitably annotated with the names and signature of the partners who operate the account and their powers. Banks separately take a mandate signed by all the partners specifying that the partners are Aointly and severally liable for any debts incurred by them to the bank. Any change in the constitution of the firm by new partners Aoining the firm or old partners leaving the firm or death of a partner, the bank stops the account operations and gets a fresh mandate. /. ACC(*NT T1-E AN2 (-ERATI(N)

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/.1 Account T!0e +eposit taking is the earliest known operation of a bank. A deposit is defined as a sum of money paid to the bank on specific terms under which it will be repaid with or without interest. "t may be repaid on demand or after a specific period of time. Module 2
12

Banking Basics

,or banking business, borrowing money is essential for the reason that a maAor part of their profit is earned by employment of funds deposited with them. +eposits are generally classified into three formsB Current Deposit: $ayable on demand Savings Deposit: $ayable on demand Term / Time / Fixed Deposit: $ayable at a fixed future date. /.2 Transaction Accounts 2ost common of transaction accounts in a bank are current and savings account. /.2.1 Current Account: Current Account is ideally suited for business or individuals who have large number of transactions to be put through the account. (here are no restrictions on the number of transactions, or on che ues used by the customer. (he balance standing in the customers account is repayable on demand. A customer may be even granted an overdraft i.e. he may be permitted to issue che ues up to an agreed limit, over and above the credit balance in the account. Banks provide statements to its current account customers detailing credit and debit entries in the account. :ormally interest is not paid on the credit balance in the customers account. ;owever, there are exceptions. ,or example, building societies in 4C offer interest on current accounts. "n 45 and in some other countries, current account is termed as *checking account for the reason that the account has unlimited che ue writing privilege. A study of current account features in various countries discloses variance in the product. 5ome banks in 4C and 45 offer a small interest on the credit balances in current accounts. 2ost of the banks have no limitation on issue of che ues and provide monthly statements. A sample of product variation is provided below. 5tatement of account with cancelled che ues during that period. ,acilities to sweep the daily surplus in the current account, to a mutual fund account, to maximi>e the earnings on the idle funds. ,ollow the principles of "slamic banking i.e. the relationship between the bank and the depositor is that of a custodian and the owner. (he bank uses the deposits by investing the monies in permissible activities. (he Bank is responsible is in the form of a guarantor and it is compulsory to return the funds to the customer as and when it is demanded for payment. )a#in s Account:

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/.2.2

Module 2

13

Banking Basics

5avings accounts are special type of deposit accounts that are intended primarily for small savers and individuals. "n some banks, especially in the 45, savings accounts are available for business firms also, with some conditions. :ormally, stipulations on minimum balance re uirements and issue of number of che ues are laid down. $assbooks are still in vogue in some countries. 5avings account holders update the passbooks across the counter. "n some countries like 5ingapore, che ue book facilities are not available for savings bank account holders. Customers do the withdrawals personally. (he rate of interest is little lower than that on term deposit accounts, but the rate is fairly static. "nterest is calculated on minimum balances maintained during a calendar month. Commercial banks in different countries offer savings accounts with variety of options. +ifferential interest rates on savings accounts in slabs as the balance increases. "n a D& days or E& days savings a#c, where the customer has to give D& days or E& days notice for withdrawals. 5tepped interest rates are provided for higher balances. 2ulti!currency accounts with low initial deposit. -ptions like buying # selling foreign currencies, placing standing orders, en uiry about exchange rate and interest rate, etc. are available. $rofits can be made against exchange rate spreads. "nterest rate is linked to money market interest rates. 2e0osit Accounts

/.$

When an amount is placed in a bank by a customer with instructions to hold it for a specific period, say E months, % year, 7 years, etc., at a given rate of interest, it is known as a deposit account. (he bank gives a receipt marked *not transferable and acknowledges the amount, period and interest terms. (he deposit is payable usually only on maturity and on production of the receipt duly signed by the customer. (he rate of interest may be fixed for the full term, or may be variable. "f variable, it is usually linked to a benchmark rate like F"B-9 or Fondon "nterbank -ffered 9ate. (he rates refixed a pre agreed intervals. (he customer is not entitled to draw che ues on deposit accounts. "n some countries, to withdraw a deposit account, the customer should give a notice of 0 days before withdrawal. 5ome deposit products are available with a stipulation that the customer should give a notice of D& days or E& days before withdrawal. :o doubt, the interest rates are higher for these deposits. /.$.1 )hort3term and Lon 3term de0osits:

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(he rules and regulations for short and long!term deposits more or less are similar. 5hort!term generally means, the tenor of the deposit is from 0 days to .& days. Anything

Module 2

14

Banking Basics

more than that is treated as term deposits or long!term deposits. (here is no specific demarcation of short and long!term deposits, and the differentiation is according to the market practice prevailing in each country. 5imilarly, the maximum term accepted for a deposit might be 7 years in one country and it may be 0 or %& years in another. /.$.2 Recurrin de0osits:

9ecurring deposits are more popular in "ndia than in other countries. (his scheme inculcates a regular habit of savings among wage earners, businessmen, housewives and students to deposit a fixed sum periodically for a particular term. (he installments are supposed to be remitted on an agreed date during the calendar month. Any delay in remittance will affect the calculation of interest and therefore the banks prefer to take a standing instruction for transfer from the customers current or savings account maintained with them. "nterest rates are almost e ual to the rates of fixed deposits. -n recurring deposits, interest is compounded uarterly. 9ecurring deposits if discontinued in the middle, or prematurely withdrawn, may not be eligible for interest unless the deposit completes a certain minimum period. $roduct variations are also possible. ,or example, a 2alaysian bank offers recurring deposits for 6G months at interest rates prevailing on the savings account and also provides a bonus of %7' on the interest earned at the end of %6 months and D&' at the end of 6G months. 4 T'E CLEARING )1)TE+

All crossed che ues drawn on other banks have to pass through the clearing system. "t is mandatory in most countries that che ues have to be physically presented to the paying banker. (he fundamentals of the clearing system are similar across countries. ;owever, the technologies used, the arrangements put in place and the procedures to be followed could vary from country to country. "n "ndia, clearing operation is the responsibility of 9B". (hus, wherever 9B" has an office, it takes care of clearing. "n other centres, mostly 5tate Bank of "ndia runs the clearinghouse. (here are also a few centres where the clearing operation is conducted by a bank other than 9B" or 5B". A clearinghouse, in simple words, is a meeting place for all the member banks to exchange the che ues that are drawn on each other. "n figure 6.6 below, each bank sends the instruments to the clearinghouse on a bank!wise basis. (hus, 5tandard Bank of Baroda Chartered )rindlays 15C)3 will have che ues drawn on Bank of Baroda, Canara Bank, +ena Bank, etc. 5imilarly, Bank of Baroda on the others and so on. "n the clearinghouse, 5C) will make a claim on each bank for the amount of che ues it SCG Canara ICLG time, all the other banks will has presented to them 1outward clearing3. At the same Bank make a claim on 5C) for che ues drawn on it 1inward clearing3. (he net balance ! either positive or negative ! is either due to or due from 5C).
CLEARING HOUSE

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OCLG

5i ure 2.2 3 Clearin 'ouse and +em6er Ban"s

Module 2

Syndicate Bank

15

Banking Basics

ICLG - Inward clearing (cheques drawn on bank presented by various banks) OCLG - Outward clearing (cheques drawn on various banks by the presenting bank) Wherever the volumes are heavy, the entire process illustrated above is automated. 4nder this, physical sorting, accounting and settlement are system!run. "rrespective of whether the clearing process is manual or automated, those banks with surplus clearing would get the money from the clearing, while banks with adverse clearing balances would be making payment within the stipulated time period. 5uch clearing balance adAustments arede%o!it! carried the acknowled&e! accounts maintained by Sent individual member Cu!to$er t"e out through Bank to clearin& !ection c"e#ue at t"e counter recei%t ' %ut! cro!!in& 10 a.m-2 p.m banks with the bank running the clearing house. 4.1 +a netic In" Character Reco nition 7+ICR8:

"n all!important cities in "ndia, clearing is done through 2"C9 process. (he relevant C"e#ue! are $anually C"e#ue!, !tate$ent! Sent to clearin& "ou!e at che ues in magnetic information is printed # and encoded on the bottom of the ink 12"C9 DAY encoded wit" t"e a$ount 7 p.m. flo%%y &i(en to t"e !%ecified ti$e (he code signifies the place 12umbai, +elhi, etc.3, the bank, che ue number, 1 Band3. Clearin& "ou!e type of account 1current, savings, dividend warrant, etc.3 etc. Along with these details, the presenting banker manually using magnetic encoders types the amount of che ue. )lobally 2"C9 is used and the code details may differ from country to country e.g. it may Clearin& "ou!e %roce!!e! ' include currency, account number, etc.
%ro(ide! detail! of c"e#ue! drawn on eac" ank in a flo%%y to

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!ta$% flo%%y into t"eir !y!te$ ' a !tate$ent &enerated

C"e#ue! and !tate$ent+ICR 4.2 detail! are cro!! (erified

Drawee ank download! t"e Drawee Clearin : -resentin Ban" 3 -rocedure

ank collect! t"e c"e#ue! !tate$ent! and flo%%y fro$ clearin& "ou!e

8a.m.

C"e#ue! are %o!ted to i!!uer! account! y t"e !y!te$

Module 2 DRAWEE BANK

)*ce!! re%ort &enerated to c"eck !ufficiency of fund! ' !i$ultaneou!ly c"e#ue! %"y!ically (erified for tec"nical error!

+ny c"e#ue! to e returned are included in t"e ne*t outward clearin& of t"e day

16

1 p.m.

DAY

11a.m

Banking Basics

8ffectively, a customer depositing a che ue on day!% will know the fate of the che ue on the next working day evening. )enerally, banks allow withdrawals on the third working day. ,or large value che ues amounting to more than 9s.7&&&&, there is a facility for clearance on the same day 1high!value clearing3 provided the che ues are drawn on designated#specified branches, generally nearer to the clearing house. "n high!value clearing, a che ue deposited within a specified time will be cleared on the same day before G.&& p.m. 4.$ (utstation che9ues: "n "ndia, for outstation che ues drawn on metros like Calcutta, 2umbai, +elhi, etc., 9B" has a separate clearing system known as *:ational Clearing. 4nder this, che ues are deposited with the 9B" along with a statement. 9B" sends the che ues to their counterpart in other metros by courier. (he destination branch of 9B" clears it through local clearing and remits the proceeds electronically, which in turn is credited to the collecting bankers account in the clearinghouse. (he entire process is time bound. ,or e.g. a che ue drawn on 2umbai and deposited in Chennai should get credit on the 7 th working day from the date of deposit. "n many other countries the facilities for inter!city payments are advanced, and in some cases, the che ue need not travel physically from one place to the other.

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Module 2

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Banking Basics

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Module 2

1.

Retail Banking

INTR(2*CTI(N 2ost banks of the world are involved in retail banking to a large extent. 9etail banking involves catering to the banking and other financial needs of individuals, and in some countries, small businesses like sole proprietorship and partnership companies. "t is always profitable for banks to obtain retail deposits at cheaper rates and lend them to corporates with a good margin. Although retail business has high operating costs, it is also a high margin business for the banks. (he growth of non!cash wage payment methods leading to banking habit in most developed countries has broadened the consumer base and influenced the demand for additional retail financial services. 9etail banking re uirements vary from one age group to the other. (hose who are D&!G& years old are spending and borrowing to buy houses, raise children and enAoy higher standard of living than their parents. (hose little older are saving and investing for retirement. (hose over E7 1in America for instance3 are selling their houses and investing the proceeds to generate additional income. -bviously, age is not the only feature that can influence demand. 2arital status, family structure, occupation, ethnic origin and sex all have a bearing on demand for retail services. "n retail banking, deposit taking is still the most important factor in maintaining customer relationship. 5evere competition has led many banks to diversify into product areas like insurance broking, stock broking, travel agencies, estate agencies and offering mutual fund facilities. (he result is that, there is an increasing tendency for people to receive banking services in a fashion they receive utilities such as water, piped gas or electricity. $hysical location of supplier is irrelevant to the beneficiaries, perhaps it does not matter. ;aving looked at the basic transaction and deposit accounts, in the previous module let us look at various other retail bank products. 1. RETAIL LEN2ING

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-ne of the main functions of a banker is accepting deposits and lending them Audiciously and profitably. A good banker therefore, is expected to know its borrowers well. 1.1 1.1.1 A00raisal +ethodolo !: Credit scorin :

(raditional method of appraisal is by looking into the purpose, credit worthiness and repaying capacity of the borrower. But when a bank is dealing with a large number of individuals, statistical method of appraisal is more popular and the main method used is called credit scoring. (he system followed in credit scoring is by allocating points for various aspects of applicants life. 8.g. age, occupation, how long with the present employer, nature of property occupied, etc. "t is a scientific analysis of risk factors applicable to various aspects of an individual borrower. By using computer based statistical analysis, the minimum profile of a borrower who is unlikely to default is arrived at, and the corresponding credit score is kept as the hurdle score over which, lending is approved. (his score may also be related to the amount being lent i.e. the score re uired may be higher with larger amounts. "n credit scoring, the chance to reduce lending risk, by Module 3

25

Retail Banking

removing subAectivity from the credit process, is high, as the computer has no personal biases. (he drawback is that, in certain cases the score sheet may not divulge certain factors, as it may be out of the purview of the standard data being collected. 5tatistical methods go by the principle that most borrowers of a certain basic profile and above, tend not to default. As the individual amount lent is small compared to the total lending to the individuals as a class by a bank, the methodology provides for a certain percentage of default, and builds the anticipated deficit in the interest and other charges of the product. ,or example, a typical retail bank, say, has H%&& million in retail loans. By statistical analysis, it may estimate that the bad loans may be D' of lending. 5o if its normal pricing would have been say %/' p.a., it may charge 6%' or 66' p.a. as interest to cover for the anticipated defaults. 9etail lending rates are generally high to reflect the higher risk of default on such lending. "ndividual loan si>e in retail lending is small when compared to the total si>e of lending in the retail segment. 2oreover these are spread over various income, cultural, wealth profiles, etc., which in turn spreads the risk over a variety of individual backgrounds. (he security it has taken also varies in nature from mortgage to pledge of stocks to clean loans. (his approach to lending where individual account risk is small, and the total risk is spread over large number of accounts, is called portfolio approach to lending. 1.1.2 Credit ratin 3 Indi#iduals

"n some advanced countries, credit ratings are available for individuals also. Banks appraisal process is simplified as they obtain the ratings of individuals from these agencies and use them as a basis for evaluating loan application. 8xample of such agency is (9W, ,air "saac, and 8 uifax, of 45. 2 2.1 -roducts: Clean ad#ances:

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;istorically, a large portion of overdrafts to individuals is granted without the backing of any security. (his is known as unsecured advance or clean advance. Clean advances may be made available in the form of overdraft or demand loans like educational loan, personal loan or consumer loan. Clean advances are generally given to customers who are confident about their integrity and credit worthiness. (his facility is usually made available for the depositors # existing clients of the branch. A clean facility is normally associated with higher risk, as there is no control over the end!use of the loan and is also unsecured. Where credit scoring is used, the hurdle score will be higher. (he rate of interest is therefore more for clean advances, despite lower administrative costs.

Module 3

26

Retail Banking

$.

ELECTR(NIC BANKING

$eople use banks because they need to, not because they really want to. 9ecent surveys show that maAority of the customers 1nearly 7&'3 visit their bank only 7 times in a given period of D months. :early 6&' of them have never visited the branch during that period. :early /&' of the customers do not know about the bank manager. (herefore age!old custom of symboli>ing the bank and bank managers to the customers is gradually disappearing. Why< 8lectronic banking is making inroads into banking services at a swift pace eliminating human intermediation as far as possible. 2oreover customers are becoming more demanding on the level of services they seek. As a response electronic banking services like A(2s, 8,($os, telephone banking, smart cards and others have emerged one after the other at uninterrupted pace. $.1 Automated Teller +achines 7AT+8:

At present, in most of the developed countries and in many developing countries, any customer of a bank re uiring cash may obtain it in one or more of the following waysB By cashing a che ue over the counter of his branch -ver the counter of another bank supported by a che ue card By using a cash card 1A(2 card3 through the teller of a branch By using cash card at a cash point in a store By using cash card in A(2 outside the branch By drawing cash on credit card

A(2 or cash dispenser, as it was called, is one of the most significant developments in banking and perhaps the most revolutionary in recent years. A(2s can be used for withdrawal and deposit of cash, deposit of che ues, re uesting a latest statement of account, re uesting a che ue book, balance en uiry, etc. $.1.2 Core functions of AT+: A(2s usually provide the following services. $.1.$ Cash withdrawal Balance en uiry 5tatement ordering facility Che ue book re uest facility +eposit 1not available in shared network3 ,unds transfer facility Bill payment 2ini statement facility $assbook updating facility 1where pass book system exists3 (ravelers che ue dispensing 1not common3

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AT+ o0eration:

Iiewed from a technical perspective, an A(2 is simply a safe electro!mechanical input and output system, which is itself controlled by a full electronic user interface. A(2

Module 3

2-

Retail Banking

manufacturers have taken considerable care to maximi>e the speed of the entire customer interaction process by making it as clear and as straightforward as feasible. A(2s are operated through a four!digit personal identification number 1$":3 1see box3. 5ome machines have an alarm that produces some kind of sound until the cash and the A(2 card is removed, as some customers tend to forget to take their cards back. PIN - Personal Identification Number Four digits PIN given to customers for ATM transactions is an effective and simple way to authori e these transactions! PIN"s are so secret that even the staffs that operate the #anks computer system do not have access to them! As soon as the customer inputs the PIN into the system$ it is encrypted and therefore never occurs in the decrypted form in the system! The most o#vious security ha ard could #e at the time of despatch of ATM cards and PIN"s #y the #ank to the customer! For this reason$ plastic cards and PIN"s are never posted together to a customer! %ither the PIN"s are posted a few days later or the customers are re&uested to collect the PIN in person at the #ank! Biometrics is the other most effective authori>ation system that uses biological attributes to establish the bona fide of the person attempting to access the A(2. (he process digiti>es a thumbprint or an entire handprint and compares it with the stored record. (he process may also make use of a voiceprint or it may scan the subAects retina in one or both eyes. Advantage of biometrics method is, it cannot be lost, stolen or recreated. Creation of $":, its maintenance and management is laborious and expensive. Biometrics system is likely to overcome these difficulties and is expected to largely replace the $": system.

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Module 3

2.

Retail Banking

$.2

Tele0hone Ban"in :

(elephone banking is a convenient and time saving method of banking. 2aAority of important banking services can be delivered through telephone banking. (he typical ranges of services available areB Balance en uiry 5tatement ordering Che ue book re uest ,unds transfer between different accounts held by the customer of the bank ,unds transfer to third parties 1utility bills3 )eneral account ueries and advice.

(he range of services is bound to increase with increased competition between banks. $.2.1 T!0es of Tele36an"in s!stem:

(elephone banking services re uire certain identification number to be keyed in to access the service, and another $": to authori>e the transaction if necessary. Where touch!tone telephone is not available or a non!routine banking transaction is to be performed, a telephone operator is made available to attend. Another method of telebanking is automated voice response technology. (his involves the customer using his tone!phone to send digiti>ed data messages to the system in order to activate a particular service. 5ometimes, the customer is re uired to say one or a number of particular words and the system software recogni>e the word and the voice. (he system works on a similar principle to those using tone commands. $.2.2 5ome telephone banking system use a $C that interfaces with the system and the data communication is by telephone. $.2.$ Ad#anta e of tele0hone 6an"in :

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(elephone banking offers substantial cost savings to the bank for automating their expensive branch based operations. Banks even provide free call system from their branches with dedicated lines to encourage use of telephone banking. Bank manager as a *delivery mechanism to offer a personal level of service is now available only for most important customers.

$.$ Internet Ban"in : (he "nternet is the best!positioned delivery mechanism since the innovation of the telephone because of its power, properties and versatility as a communication system. "t

Module 3

2/

Retail Banking

is not only about banks displaying information about their services on the web, but also about how many banks can use internet providing interactive services. As a payment system, the "nternet is in its early stage. Considering the underlying risk in payment systems, it has to be seen how "nternet is going to manage it, securely and efficiently. (he background of "nternet banking is the concept of home banking pioneered by Citibank connecting customers $C to the banks computer through a modem. (he bank provided the special software needed for online banking to the customer. 4sing this program, the customer can bank *off!line on the $C and complete the transaction through modem. (he advent of "nternet has changed everything. ,or banks, there is a single connection to the net instead of thousands of telephones and modems across the country. (he basic minimum services that a bank can provide through "nternet are account balance checking, funds transfer among accounts and electronic bill payments. 5ome of the sophisticated internet banks allow for loan applications, download account details to $C, trade in stocks and mutual funds, and examine deposit slips # cancelled che ues of the customer. "nternet banking is not the answer to all banking needs. ,or cash withdrawals and che ue deposits, the customer has to go to A(2 # branch. (he initial public response to "nternet banking cannot be termed as success. (he main re uirement for this service is that the user should have a $C and should have purchased "nternet time. ;owever, on!line banking has many advantages. "t turns a $C into a bank branch and therefore it is easy and convenient. "t is instantly accessible from anywhere by Aust using bankcard number and $":. "t is cost effective in the sense that it saves time and travel costs to and fro from a branch.

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Module 3

30

'orporate Banking

1.

&'AT C(N)TIT*TE) C(R-(RATE BANKING,

Corporate banking is a collection of services by banks to "ndustrial and Commercial 8ntities 1"C8s3 or corporates, encompassing wide range of products and services, including facilities like cash and portfolio management. (his way, all banking services rendered to "C8s and corporates should be regarded as Corporate Banking. ;owever, there are many products # services that investment banks or investment banking arms of commercial banks offer to corporates ! new issue of stocks, bonds and debentures, raising foreign currency loans, etc. "t then may be thought that all investment banking activity should also be considered a part of corporate banking. (he definition of corporate banking is further complicated by the rapid financial integration due to the growth of international or multinational banks that offer domestic and international services to corporates. "t is difficult to standardi>e the pattern of corporate funding even within a country. )reater usage is being made of new techni ues like securiti>ation, factoring and leasing. 9ise of international bonds and credit markets has opened up new channels in corporate financing. A profile of corporate borrowing in developed countries shows that =apan and West )ermany are inclined to use bank borrowed funds for business unlike 4C and 45, where market based funding is more prevalent. A particularly high degree of bank closeness with corporate customers is practiced in West )ermany and =apan. )iven the heterogeneity of the markets which these banks serve it is difficult to analy>e and define corporate banking practiced in various markets. A flavor of some services offered under the banner of Corporate Banking by some banks is provided in the box below. 8ven entities other than banks have also entered certain part of the corporate business. Corporate bank services rendered by banks and others Societe Generale (France) (! So ecash! )pen foreign currency accounts$ handle purchase and sale of foreign currencies and international transfers! Allows companies to get detailed statement of accounts all over the world!
Cu!to$er State$ent Societe Generale State$ent 1orei&n Bank

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*! Pro estel "resorerei! Monitor overall cash position in all +ociete ,enerale group accounts!

-! So ecash International Nettin ! )ffset invoices in any currency paya#le to$ and receiva#le from su#sidiaries of corporate clients!

'orporate Banking

.! So ecash International Poolin ! 'entrali e cash #alances held #y su#sidiaries of corporate clients in various countries and currencies in accordance with local legislation! /! So estel! Bank 0 to 0 #usiness electronic communication service! Transmits instructions of transfers$ standing orders$ etc! P' to P' on line! 1! #$uipment and %ehicle Finance! Provides hire purchase and leasing for vehicles! Also provides long0term rental and management!

/.1 Cash credit : (#erdraft: An overdraft is structured in a current account the bank agrees to allow a customer to draw over the credit balance i.e. the customer is permitted to issue che ues beyond the available credit balance up to a certain limit. -verdraft is granted only for short!term re uirements of the borrower like working capital or temporary needs of funds shortfall in the business. /.1.1 -rocess:

(he bank assesses the working capital re uirements of the customer and also the probable future cash flow pattern. A limit is fixed for the customer, say, 9s.67 lakhs, for a particular period. (he customer can issue che ues, once the documentation is complete to the satisfaction of the bank. ,or example, the current account of a company ABC Ftd. is given below in table G.D. Table 4.3 2ate -articulars 2r. Cr. Balance 6.%... By cash %&,&&& %&,&&& Cr. D.%... (o che ue E7,&&& 77,&&& +r. -verdraft is created %&.%... (o che ue D,D7,&&& D,.&,&&& +r. 6&.%... By che ue 6,&&,&&& %,.&,&&& +r. 67.%... (o che ue 6%,&&,&&& 66,.&,&&& +r. D&.%... By cash G&,&&& 66,7&,&&& +r. D.6... (o che ue G,%&,&&& 6E,E&,&&& +r. Fimit exceeded -n the en uiry screen, it will appear asB Current BalanceB FimitB ,loatB Available BalanceB 1Drd ,eb..3

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9s.6E, E&,&&& 9s.67, &&,&&& !! 9s. %,E&,&&& +r.

Jou may notice that the account is a running account i.e. the customer can deposit and withdraw according to his convenience. (he interest is calculated on the actual amount overdrawn. (he account has to be operated within the agreed limit. "f it exceeds, the

'orporate Banking

bank may dishonor the che ue 1Drd ,eb..3 or honor it by allowing excess. $enal interest will be charged for such excesses. /.1.2 5eatures:

-verdraft may be granted clean i.e. without backing of any security or secured i.e. covered by securities like stocks, book debts, etc. -verdrafts are payable on demand and therefore the bank may re uest the borrower to repay the outstanding amount at any time. /.$ Bills discountin : When a company buys raw material for production, there are two ways of settling the payment. By cash or che ue or postpone the payment for a future date 1credit3. (his credit sale may be done by documenting a Bill of 8xchange as follows.

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5ormat of Bill of E;chan e: 7<$/=>??8 -lace: Bristol 2ate: +a! 2= 1>>@ D& days after date, pay to order or ourselves a sum of KDG,.&& for value received. (o )eneral 2otors Ftd. 12idland, buyer3 5tar 5teel "ndustries Ftd. 15eller3 ,or claiming payment, the seller forwards invoice, delivery receipt and a bill of exchange 1B#83 to the buyer. Bill of 8xchange may be drawn at sight, if payment is to be made immediately or may be drawn for a certain period 1tenor3 say, D& days, E& days, etc. and is called *usance bill. 4sance bill therefore has a definite maturity date. Figure 4.2 - Bill Dis ounting
2. Draw! B7) ' forward! it 3. +cce%t! B7) 1. Sell! &ood! 4. Di!count!
S)LL)4 + B+56

B23)4 B

. 8ay! on t"e due date

5. 4ecei(e! credit

'orporate Banking

5eller A sells goods to buyer B. A would like to have the money immediately, but B would like a credit period of D& days. "n such a situation, A draws a bill of exchange on B and sends it to B who acknowledges his responsibility 1acceptance3. When B accepts the bill, he has closed the transaction for A. A can now take the accepted bill to his bank and in exchange get money. (his process is called discounting the bill of exchange. -n the due date or maturity date, B pays the bank directly. "n real life situation, the transactions may not be as simple as above. (he bill may pass many hands before its maturity. "n working capital framework, the debtors of a company can be reali>ed by having them accept bill of exchange and then discount it with its bankers. A part of the working capital facility may therefore be structured this way. 4.1 Letter of Credit:

"n an international trade transaction, a seller wants to receive his payment promptly at his own bank after despatch of goods. A buyer wants an assurance that he pays only after the seller fulfills his obligations correctly. Also the buyer may need bank finance and assistance in dealing with complex transactions. 4.1.1 Letter of Credit 7LC8 comes into picture to satisfy the re uirements of both the buyer and the seller. FC is an arrangement by banks for settling international commercial transactions. FC provides a form of security for the parties involved and ensures that the terms and conditions of the transaction are fulfilled. 4.1.2 LC and 0arties to an LC: An FC is a commitment by the buyers bank to the seller that it guarantees the payment as per the contract of sale, if the conditions stipulated in the document # letter issued by the bank 1based on buyers re uirements3 is met by the seller. (his document is called an FC or letter of credit. (he buyer#importer who applies for FC is called the applicant. "ssuing bank is the bank that opens FC for the importer. Advising bank is the bank to which FC is sent by the issuing ban with a re uest to inform seller#exporter. (he bank to which the exporter presents the documents for settlement is known as settlement bank. (his normally is routed through the exporters bank, if the bank settling the FC is not the exporters bank itself.

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'orporate Banking

(hus, the importer by opening an FC through its bank is providing the backing of its banker to the seller to meet the payment commitment, if the documentary proofs stipulated therein are provided. )enerally these documents are invoice, proof of despatch of goods 1airway bill, bill of lading3, insurance documents, uality inspection certificate, etc. @.1 Cash +ana ement )er#ices:

A corporate customer, who maintains a current account with LJM Bank has branches, has manufacturing or sales or administrative units in the four cities. 5ome centres are surplus with funds, as the sales activities are high. -thers are short of funds principally, as their manufacturing and administrative units are situated there 1,igure G./3. Figure 4.! - Closing balan e as on 3"st #ul$ "%%% 9s.6/ lacs Cr. 9s.0 lacs
Del"i

+r. Mu$ ai

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Ban&alore

9s.%7 lacs +r. Calcutta

9s.D. lacs Cr.

"t may be noticed that at +elhi and Bangalore the company has surplus funds, whereas at Calcutta and 2umbai the accounts are overdrawn and the company may be re uired to pay interest on debit balances. (he process of cash management service is to move all the funds to one centre ! generally the place where the head office or corporate office is situated, and net the balances available in all centres. "n the above example, the net balance at the head office, say 2umbai, would be 9s.G7 lacs and the balance at the other three centres would be nil. A situation may also arise when payments may have to be made from one of the centres, say 9s.7 lacs in Calcutta. "n such a situation, if the netting is not done, then Calcutta may show a debit balance of 9s.6& lacs. Cash management facilitates pooling all the balances into single account, thereby payments at all centres can be effected in time and overdrawn balances may be reduced or eliminated. (he customer need not verify the balance and initiate the transfers from one centre to another. (he basic range of services under cash management could be balance reporting, sending transfers or payment orders, netting of balances for intra!group settlements and pooling the group cash balances. (he other feature of cash management service could

'orporate Banking

be collection services, where the bank pools all the collection items at one place and employs accelerated collection process. "nstead of making a whole series of payments in different currencies, the customer can make a single payment to the netting centre. Cash 2anagement service is technologically intensive. "n an international basis, this may call for currency wise pooling and netting, dealing with various payment and clearing systems across the globe, co!ordinating with a network of own branches and those of correspondent banks, etc. ,rom a customer point of view, it may call for efficient on!line retrieval of paid items, che ue images and on!line account reconciliation. "nformation reporting on all the above services may have to be made available through a link to the customers computer or through the "nternet. Figure 4."" - Cas& 'anagement
269GB8 Ger$any9D)M

1rance91r1

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NE!!ING CEN!ER

2S9:

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7#i8

RE-() and Re#erses:

+ealers in government securities use repurchase agreements also called *repos or *9$s as a form of short!term funding, many a times on an overnight basis, with an agreement to sell and buy back securities the next day at a slightly higher price. (he increase in the price is the overnight interest. (he dealer thus takes a one!day loan from the investor and the securities serve as collateral. Fonger!term repos, generally over D& days are called term repos. (he mechanism is the same. 9epos are considered safe in terms of credit risk because loans are backed by government securities. A *reverse repo is the mirror image of repo. ;ere the dealer finds an investor holding government securities and buys them, agreeing to sell them back at a specified higher price at a future date. (o provide or absorb short!term li uidity in the market, many central banks also provide two way repo uotes for various periods. (his way the excess securities with a dealer or bank can be made to earn, and on the other hand, the lenders surplus can be invested in a useful and secured manner. 45 has a very large repo market, while in 4C it is limited. "n Australia these are called *buy!backs and *reverse buy!backs and, are mainly used between the central bank and securities dealers. "n )ermany *pensionsgeschaft is a repo popular with insurance companies. "n =apan these are called *gensaki agreements and are a maAor source of call money. (he market is well established from overnight to six months. %. ,orward sale contract 6. 5ale to inter!bank # international markets. All foreign exchange transactions will have an effect on exchange position and cash position. 8xchange position is affected at the time of booking the contract and cash position is affected at the time of delivery of funds i.e. o o for every purchase transaction *bought in exchange position, credit balance in nostro account increases ! the point to note is that the timing may not coincide and for every sale transaction *sold in exchange position is increased and balance in nostro account decreases. ;ere too the timing of the too may not coincide.

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When doing a spot buy 45+ for example, the 45+ exchange position is N on the contract or transaction date but, the 45+ nostro will get credit only on the value date i.e. two working days from the contract date. ;ence while the exchange position has been affected on contract date there is nothing happening to the cash position. -n the value date the cash position will get affected and will move to N. While the exchange position enables the bank to remain s uare and avoid exchange risk, the cash position enables the bank to keep Aust ade uate funds in the nostro account to meet its commitments without incurring interest cost 1towards borrowing to meet commitment3. Module 5
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Treasury )perations

"t may be noted that steps taken to correct an imbalance in exchange position may or may not affect cash position immediately. ,or example, if the bank has overbought position and corrects it by selling forward, it would not affect cash position on the same day. Whereas, steps taken to correct balance in cash position would affect the exchange position. ,or example, to rectify overdrawn position of nostro account, the bank has to buy spot cash that would affect exchange position. /.4.1 Co#er deals:

As a conse uence of the banks dealings with its customers, the bank has to purchase or sell foreign exchange in the market to cover the exchange position. (his is known as *cover deal and the purpose is to insure the bank against any fluctuation in the exchange rates. (he bank is not only particular in covering the position but to cover it immediately i.e. to sell immediately whatever it purchases and purchase immediately whatever it sells. "n other words, the bank would like to keep its exchange position s uared. "n the case of spot deals, the transaction is simple. "f the bank has purchased 45+ 6&,&&& spot, it would endeavor to find another customer to whom it can sell spot for a similar amount. /.4.2 Tradin :

(rading refers to purchase and sale of foreign exchange in the market other than to cover banks transactions with the customers. (he purpose may be to gain on the expected changes in exchange rates. "n "ndia, the scope for trading, although still subAect to controls, is getting wider due to relaxation being made in the exchange control. ;owever, the bank fixes a daylight limit and overnight limit for each currency. +aylight limit, for example, means, a bank fixes a limit of 45+ 7 million, then a dealer can purchase and sell 45+ so long as the balance outstanding at anytime during the day is not exceeding 45+ 7 million. -vernight limit means the extent to which the currency position can be kept open at the end of the day. :ormally, the overnight limit would be much less than the daylight limit. /.4.$ E;chan e and Cash -osition 3 Illustration:

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(ransactions reported say on %st -ctober are as followsB %. 6. D. G. 7. 8xport Bill on :ew Jork for 45+ 7&,&&& purchased ! payment due on D%st +ec. (( sent to Fondon for )B$ 6&,&&& +raft issued for )B$ %,7&& (( remitted to Canada for 45+ 67,&&& Che ue for )B$ 7,&&& drawn on 2anchester purchased

(hese transactions will result inB

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8xchange positionB 45+ Bou ht 7&,&&& )old 67,&&& 8xchange positionB )B$ Bou ht 7,&&& )old 6&,&&& %,7&& Net !%E,7&& Net N67,&&&

Cash positionB 45+ 2r. 67,&&& Cr. Balance 72r.8 67,&&&

Cash positionB )B$

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6&,&&& %,7&& 7,&&& %E,7&& /.4./ )Aa0 Transactions:

2r.

Cr.

Balance 72r.8

"t may be noticed in the above example that any imbalance in exchange position or cash position has to be rectified immediately by cover operations. A swap transaction is used as a mechanism for rectifying mismatch in the cash flows between two value dates. "n the above exchange position example for 45 dollars, if the net position of H 67,&&& is covered, it may result in cash flow mismatch i.e. export bill proceeds H 7&,&&& will be received only after D months, whereas (( to Canada H 67,&&& has to be effected immediately. 5wap is an exchange transaction in which there is a simultaneous sale and purchase of specified foreign currency for different value dates. "n a swap deal, exchange position of the bank does not get altered. ,or example, an exporter books a forward contract for 45+ 7&,&&& for a bill drawn on :ew Jork for E& days and his bank purchases the bill on submission of documents by the exporter. (he forward contract is booked for /& days 1E& N 6& days transit3. ;owever the bill gets paid in E7 days from the date of booking the forward contract and 45+ 7&,&&& is credited to nostro account of the bank. (he bank will hold this 45+ 7&,&&& idle for %7 days till the relative cover deal is taken up. "nstead the bank can opt for a swap by

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Treasury )perations

effecting a ready#cash sale and buy forward for %7 days and earn a small income for the bank.
+d;u!t$ent! of 1und! 7 1und! Mana&e$ent 8ur%o!e! of !wa%! +d;u!t$ent! of &a%!

swap is therefore a transaction between two counter parties to buy and sell a specified foreign currency si!ultaneously for different !aturities" (he basic obAective of a currency swap is to rectify the mismatch of cash flows. (his may be either shortage of currency balances to meet immediate re uirements or utili>ation of unproductive surplus balances. A swap deal should fulfill the following conditionsB (here should be simultaneous buying and selling of same foreign currencies of same value. (he maturity periods of buying and selling should be different. Both buying and selling transactions should be between the same counter parties. (he deal should be concluded with a distinct understanding between the counter parties that it is a swap deal.

,or example, if Bank of (okyo and Floyds Bank enter into a swap deal, then Bank of (okyo sells spot 45+07, &&& and buys four months forward and Floyds Bank buys spot and sells four months forward 45+07, &&&. /.4.4 1. Need for )Aa0 deals: AdBustment of a0s:

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5wap deals are undertaken to correct the mismatched position in cash flows. (he mismatched position may arise due to various factors such as early or late deliveries under forward contract, cancellation of forward contracts, mismatch on account of cover operations, etc. 8.g. a bank has the following mismatched position in )B$. 1)B$ "n millions3 5pot N% % month N %.7 6 months !% D months N6 G months !6 7 months ! %.7 (he overall exchange position for )B$ is s uare but there is a mismatch in cash flows. (his can be corrected by the following swap deals.

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a3 sell spot and buy 6 months )B$ % mio b3 sell % month and buy 7 months )B$ %.7 mio c3 sell D months and buy G months )B$ 6 mio 2. 5unds +ana ement:

Banks are interested to manage the funds in nostro account more profitably by utili>ing the surplus balances Audiciously and avoiding a overdrawn balance. Balances held in nostro accounts of a bank have to be commensurate with its day!to!day re uirements. 5urplus balances may not earn any return. (he bank has to decide as to whether surplus funds should be kept as overnight deposit with the correspondent bank or undertake a swap and raise rupee resources based on the interest rates at both the centers. ;owever, the management of banks has sufficient controls to prevent risk arising out of swaps employed for speculation. Case stud$: Bank A enters into a forward purchase deal for C;, 6.7 million for 6 months with its customer. "t may not always be possible to cover in the inter!bank market for this large amount for the same period. At the same time, the bank cannot wait till it finds one because the rate may change adversely. (o cover the exchange risk, the bank will sell spot immediately. ;owever, for the spot sale the bank has to arrange funds in their nostro for payment. #robably$ the ne%t day$ the bank will carry out a swap by buying spot and selling two !onths forward C&' (") !illion to cover the cash position" Fet us assume that the rates dealt by the bank on *ay +, 6 months forward purchaseB 9s.6/.GD 5pot saleB 9s.6/.&/ +ay 6B 5pot purchaseB 6 months forward saleB +ay %B OOOO +ay 6B PP.
8urc"a!e

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9s.60./D 9s.6/.6&

2 $ont"!

Sale

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Treasury )perations

(he profit or loss for the bank in the swap deal may be worked out as underB ,orward 5pot -urchases 7Rs.8 6/.GD 5pot 60./D ,orward 4C.2C )ales 7Rs.8 6/.&/ 6/.6& 4C.2@

-he net gain is ( paise per C&' for the bank" /.C 5ore; Ris"s:

(he +ealing 9oom is identified as a main profit center for a bank. "t is also true that any scope for profits is associated with the risks of losing. (he following are the maAor risks in foreign exchange dealings. (i) *pen position ris+ refers to the risk of change in exchange rates affecting the overbought or oversold position in foreign currency held by the bank. (ii) Cas& balan e ris+ refers to actual balances maintained in nostro accounts at the end of each day. Any surplus balance does not earn interest, while any overdraft will incur interest payment. (iii) 'aturit$ mismat & ris+ also known as li uidity risk or gap risk. (his risk arises on account of the maturity period of purchase and sale contracts in a foreign currency not coinciding. As a result of this, cash flows from purchases and sales will mismatch. (iv) Credit ris+ arises when the failure of the counterparty to honor the contract. Fimits are fixed on the aggregate outstanding commitments and separately for the amount of funds to be settled on a single day. (v) Countr$ ris+ known as sovereign risk and is related to the ability and willingness of a country to service its external liabilities. (vi) *vertrading ris+ refers to the huge volume of transactions undertaken by a bank beyond its administrative and financial capacity. (vii) Fraud ris+: ,rauds may be manipulated by the dealers or operational staff in order to conceal a mistake or for personal gains. 8.g. dealing for own benefit without putting them through bank accounts, undertaking unnecessary deals to pass on brokerage for a kickback, sharing benefits by uoting unduly better rates to customers, etc. (viii) *perational ris+ includes inadvertent mistakes in the rates, amounts, and misdirection of funds due to human errors, telecommunication mistakes.

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4.

2ealin functions and control of dealin :

"ncreasing volatility in both the exchange rate movements and interest rate levels have on several occasions precipitated substantial loss for several banks. (his has resulted in increased attention being placed on asset # liability management and the organi>ations strategy to contain these exposures. "t is now uite common for banks with extensive branch network to centrali>e the management and control of treasury divisions and dealing centers. (he necessity for heightened controls, particularly to cover foreign exchange dealing operations of banks falls under the supervisory authority of the Central Bank in most countries. 4.1 2ealin room:

Bank trading rooms share common physical characteristics. All are e uipped with the modern communications e uipment, to keep in touch with other dealing banks, forex brokers, and corporate customers. Banks and brokers communicate their rates either through 9euters, (elerate or other similar automated media, or through telephone # telex. Although automated media is an important source of data, a dealers primary form of communication for keeping in touch with markets are direct telephone lines to brokers, banks, internal group dealing centers and other maAor users and suppliers of money. 2ost maAor dealing rooms have loudspeaker systems, which are fed from brokers office and facilitate an instant awareness of prices as communicated internally within those offices. (raders also subscribe to the maAor news services to keep current on financial and political developments that might influence exchange trading. 4.2 Bac" office:

Banks also maintain extensive ?back office@ support staffs to handle routine operations such as confirming exchange contracts, paying and receiving foreign currencies and general ledger accounting. (hese operations are generally kept separate from the trading room to assure proper management and control. 4.$ Tradin 0olicies:

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(he senior management sets the basic obAectives of a banks trading policy. (he policy depends up on factors such as the si>e of the bank, the scope of its international banking commitments and, the nature of its trading activities at its foreign branches. ,urther the management must also decide to what extent the trading function should be aimed at providing a service for the banks customers and to what extent it should be looked up on as a profit center. (his purely depends on the banks attitudes toward risk and capacity to absorb risk. 4./ 2e0artment structure:

8very bank has its own decision!making structures. :evertheless some generali>ations can be made. A chief dealer supervises the activities of the traders and in turn reports to the senior officer in charge of the banks international asset liability management area, which normally includes foreign currency trading and 8urocurrency activities. 5enior traders typically handle the most actively traded currencies, sometimes assisted by the Aunior traders, who might be responsible for less actively traded currency. Module 5

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Treasury )perations

Whatever the rank, actions of any trader commit the bank to potentially large sums of money. (raders give uotations to customers and other banks, approach the brokers market, arrange swaps needed to balance daily payments and receipts resulting from maturing contracts, and alert corporate clients to significant market developments. 5enior traders may be authori>ed to ?take a view@ on potential short!term exchange rate movements and thus to establish long or short positions. 5imilarly they may be authori>ed to take a view on the potential interest rate movements and thus seek a particular maturity pattern. (he chief dealer is responsible for the profit or loss of the whole operations as well as, for ensuring that deals are within the trading limits to control risks. 4.4 Tradin Limits:

(he establishment of limits is highly relevant to dealing staff, as thereafter they are held responsible and accountable for positions maintained. (he following are considered while establishing trading limitsB 8ach dealers maximum outright position limit is clearly defined, differentiating between intra!day 1or daylight3 exposure and end of day positions. 8ach dealers authority to operate within mis!matched limits for each dealing book, e.g., currency deposits, foreign exchange, or other portfolios, is also defined. 5top!loss or the necessity to report adverse dealing positions at a particular level of loss is clearly defined and established. $redefined bank and other counter party limits are established. +ealers undertake transaction with other market participants within approved counterparty limits and # or credit limits. Where transactions are undertaken in respect of a customer, the concerned dealer is responsible to ensure that appropriate limits are available to accommodate such business. -ther forms of control over trading exposure are communicated as and when imposed. (0erational -olic!:

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4.C

8ach bank may structure its own operational poli ies with regard to dealing and would broadly encompass the followingB Within the authority delegated to him each dealer is solely responsible and accountable for position maintained by him. "t is the responsibility of the dealer to check with the broker, Aobber, bank telex backing sheets or 9euters printout, all trades undertaken during the day. 8ach dealer should also ensure that all

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Treasury )perations

transactions are properly recorded on dealing slips or other initial record of trade and are submitted to the operations area for further processing. (he accuracy of all information recorded in the dealing slips and the legibility thereof are important factors to ensure misunderstandings do not occur in the accounting and processing areas. +ealers annotate on dealing slips, the correct rates at which the deals were concluded. ,ictitious rates must not be recorded on dealing slips for any reason. Confirmations:

4.D

"n the course of each business day, confirmations are produced and despatched by each principal to the other with whom trades were undertaken. "f the trade involves a broker he confirms the deal with both the principals. 4pon receipt, all parties verify the details with their own accounting records. "t is pertinent to mention here that there is an increasing tendency within the markets for unsigned computer produced confirmations to be utili>ed. Although unsigned confirmations are binding, it is customary to obtain suitable indemnity from the issuing bank for errors, omissions, etc. At the end of each day each dealer verifies that all transactions have been processed correctly. (his is achieved by telephone confirmation, telex backing sheets or hard copies taken from computeri>ed dealing system. With in the context of telephone markets, the importance of confirmations and verification thereof, cannot be over!stressed. (his is particularly so where forward value dates are concerned. 5ame day, one day and spot value transactions will fre uently be settled prior to a confirmation being received. "t is however necessary that confirmations to all deals are despatched immediately after the deal is concluded. 5imilarly immediate attention should be given to confirmations received which cannot be identified with recorded transactions. All confirmation procedures and controls are undertaken by staffs who are not connected with nor have access to the dealers or dealing room. 4nder no circumstances should dealers be involved in procedures relating to incoming and outgoing confirmations. 4.@ Nostro : Corres0ondent 6an" reconciliation:

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"t is essential that correspondent statement of accounts in both currency and commodities are efficiently reconciled on a regular basis. 4p on receipt of the statement it is first essential that items are immediately *marked off against the in!house nostro record, thereby identifying large outstanding which can then be immediately investigated. 4.> Re#aluation : +ar" to mar"et:

$rocedures for revaluation and # or mark to market exercises must be established with attention being focussed on where precisely the rates used for this purpose originate. (he rates used for revaluation must be checked or provided independently of the dealing

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room. "f undertaken properly revaluation will highlight any substantial underlying losses that have not been reported or identified. +ealers usually maintain a running position of the profits as they estimate them to be, these should be compared with the result as reflected from a revaluation of the accounting records and any significant discrepancies investigated and monitored. All accounting record must be properly and accurately maintained to ensure the accurate and timely reporting of all profit and loss figures at desired fre uencies and in accordance with each banks accepted accounting policies.

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