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FDN-BN102-DB
FOUNDATION COURSE IN BANKING - II




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TABLE OF CONTENTS
1. US BANKING STRUCTURE..............................................................4
1. 1 History of Banking in United States............................................................................... 4
1.2Current Banking System in United States....................................................................... 8
1.2.1 Types of Banks ......................................................................................................... 11
1.2.2 Regulators of Commercial Banks .............................................................................. 12
1.3 Performance Highlights of the US Banking industry.................................................. 17
1.4 The Future of US banking.............................................................................................. 23
2. INTRODUCTION TO RETAIL BANKING IN U5 ........................ 27
2.1. Consumer Credit Products ........................................................................................... 29
2.1.1 Mortgage Lending Products....................................................................................... 29
2.1.2 Non Mortgage Products ............................................................................................. 40
2.1.2.4 Credit Scoring in US Retail Markets ...................................................................... 51
2.1.2.4.1 What Information is Included? ............................................................................ 51
2.1.2.5 Deposit products........................................................................................................ 54
3. INTRODUCTION TO WHOLESALE BANKING IN THE US ............ 60
3.1 Wholesale Banking Products ......................................................................................... 61
3.1.1 Commercial Credit Products...................................................................................... 61
3.1.2 Non-Credit Fee Based Services ................................................................................. 73
3.2 Payments and Cash Management Services .................................................................. 76
3.2.1 Cash Management Services ....................................................................................... 76
3.2.2 Payment Systems in US............................................................................................. 78
3.2.3 Small Business Banking ............................................................................................ 80
3.3 Suppliers of Credit to Small Businesses........................................................................ 85
4. INTERNET BANKING IN US ........................................................... 87
4.1 Internet Banking Vs E-Banking .................................................................................... 87
4.2 E-Banking Products........................................................................................................ 89
4.2.1 Products Related to Bank Accounts........................................................................... 89
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4.2.2 Products Not Related to Bank Accounts.................................................................... 91
4.3 Electronic Payments Systems......................................................................................... 92
4.3.1 ATM and Debit Systems............................................................................................ 92
4.3.2 Direct Deposit and Automatic Bill Payment ............................................................. 92
4.3.3 Internet Banking and Electronic Bill Payment .......................................................... 95
4.3.4 International Payments............................................................................................... 96
4.4 E-banking in US.............................................................................................................. 97
4.5 Internet Banking............................................................................................................. 98
4.5.1 Internet Banking in US .............................................................................................. 99
4.5.2 Market Share of Internet Banking Customers ......................................................... 102
4.5.3 Implications of Internet Banking for Banking and Bank regulation........................ 103
5. AN INTRODUCTION TO FOREIGN EXCHANGE AND MONEY
MARKETS ......................................................................................... 109
5.1 The Forex market ......................................................................................................... 109
5.1.1 Spot Transactions..................................................................................................... 110
5.1.2 Other transaction types ............................................................................................ 111
5.1.3 Swift Codes.............................................................................................................. 111
5.1.4 Base Currency and Variable Currencies .................................................................. 111
5.1.5 Bid & Offer Rates .................................................................................................... 112
5.1.6 Direct & Indirect Quotation..................................................................................... 112
5.1.7 Cross Rates............................................................................................................... 113
5.2 Money Market............................................................................................................... 113
5.2.1 Interbank loans/ deposits.......................................................................................... 113
5.2.2 LIBOR...................................................................................................................... 114
5.2.3 LIBID....................................................................................................................... 115
5.2.4 Certificates of Deposit ............................................................................................. 115
5.2.5 Treasury Bills........................................................................................................... 115
5.2.6 Bankers Acceptances ............................................................................................... 116
5.2.7 Commercial Paper.................................................................................................... 117
5.3 Bankss participation in the Forex and Money Markets .......................................... 118
5.3.1 Treasury Products .................................................................................................... 118
QUESTIONS - 1................................................................................. 120





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1. US Banking Structure

1. 1 History of Banking in United States

Though lheie vas no foinaI and syslenalic lanking syslen, lanks veie in exislence Iong
lefoie Aneiica decIaied ils independence fion Cieal iilain. Hovevei, lanks in Aneiica
veie in lheii nascenl slages in conpaiison lo lheii Luiopean cousins.

Iion lhe 17OO's lo 1863 lanking in Aneiica vas lasicaIIy unieguIaled and highIy
enliepieneuiiaI. These eaiIy Aneiican lanks veie statc chartcrcd lul lhe slales veie alIe
lo ieguIale lhen onIy lo a Iiniled exlenl. These lanks aIso issued piivale papei cuiiency.
This cuiiency vas supposed lo le lacked ly goId oi siIvei deposils lul oflen lhe deposils
veie nol adequaleIy nainlained. Lack of ieguIalion iesuIled in nushioon giovlh of such
lanks and lhey legan lo spiead noie and noie "bad nntcs aiound lhe counliy. These
lanks, knovn as wI!dcat banks lecane an incieasing piolIen.

In 179O, Congiess had pioposed lhal lhe ank of Noilh Aneiica shouId lake on lhe
funclions of a cenliaI lank. Hovevei, AIexandei HaniIlon, vho vas a civiI seivanl,
pioposed lhe ciealion of a nalionaIIy chaileied lank vhich vouId exeicise conlioI ovei lhe
nalion's noney suppIy and le aulhoiized lo exlend ciedil lo lhe goveinnenl.

Congiess loughl lhe HaniIlon pIan. In 1791, lhe FIrst Bank nf thc UnItcd 5tatcs vas
eslalIished. The lank's chailei vas designed lo expiie aflei 2O yeais lul couId le ieneved
ly Congiess. The Iiisl ank of lhe Uniled Slales peifoined ieasonalIy veII. In 1811, vhen
lhe line cane lo ienev ils chailei, Congiess decIined lo do so. Ovei lhe nexl five yeais, lhe
nunlei of slale-chaileied lanks aInosl liipIed, fion 88 in 1811 lo 246 in 1816. Lefl vilhoul
a cenliaI lank's iesliaining infIuence on lhe issuance of lank noles, lank nole depiecialion
and fiaud lecane ialhei connonpIace.
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This necessilaled lhe foinalion of 5ccnnd Bank nf UnItcd 5tatcs. This line, Congiess gave
lhe nalionaI lank lhe iighl lo issue ils ovn noles. These soon lecane lhe nosl videIy
accepled cuiiency in lhe nalion, piefeiied lo lhe Iess-liusled noles of lhe slale chaileied
lanks. Like lhe Iiisl ank, lhe Second ank vas a success. UnfoilunaleIy, Iike lhe Iiisl lank
of lhe Uniled Slales, il vas alandoned. y 1836 il had lecone jusl anolhei lank in
IennsyIvania.

Iion lhe line lhe Second ank ceased lo le a cenliaI lank and unliI Congiess passed lhe
NalionaI anking Acl in 1864, lhe econony's noney suppIy vas once again Iefl in lhe hands
of lhe slale lanks. Once again, unsound Ioans and ovei issuing of noles Ied lo an unheaIlhy
cIinale of unieIialIe noney.

1.1.1 Thc NatInna! BankIng Act
The NalionaI anking Acl vas passed in 1864. The oljeclive of lhis IegisIalion vas lo
deveIop a nalionaI lanking syslen. The acl ciealed a nev office, ConplioIIei of lhe
Cuiiency, housed in lhe Tieasuiy, vhich chaileied nalionaI lanks. A nalionaI lank had lo
luy Tieasuiy londs equaI lo one-lhiid of ils capilaI, and couId issue noles onIy in
piopoilion lo ils Tieasuiy lond hoIdings. AII nalionaIIy chaileied lanks had lo have lhe
voids "nalionaI" oi lhe iniliaIs "n.a." in lheii lilIe.

The Acl IegisIaled lhal lanks couId nol accepl ieaI eslale as coIIaleiaI foi Ioans, noi Iend
noie lhan 1O peicenl of lhe vaIue of lheii capilaI slock lo any singIe loiiovei. They veie
aIso iequiied lo piovide financiaI iepoils lo lhe ConplioIIei of lhe Cuiiency and veie
suljecl lo peiiodic lank audils. To encouiage slale lanks lo svilch ovei lo lhe nalionaI
syslen, lhe ConplioIIei Ievied a 1O peicenl annuaI lax on slale-chaileied lank-nole issues.
This viiluaIIy eIininaled lhe use of slale chaileied lank issued cuiiencies. Hovevei, lheie
vasn'l a iush lo conveision lo lecone nalionaIIy chaileied lanks lecause aII lhe slale-
chaileied lanks couId nol affoid lhe nininaI capilaI iequiied lo ollain a nalionaI chailei.
As a iesuIl, slale-chaileied and nalionaIIy chaileied lanks coexisled vilhin lhe lanking
indusliy. This has lecone knovn as a dua! bankIng systcm.
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US BANKING HISTORY: A SNAPSHOT

















In lhe 19
lh
cenluiy lhe duaI lanking syslen vas Iaunched in lhe US, vilh sone lanks
chaileied and ieguIaled ly lhe slales and olheis chaileied and ieguIaled ly lhe OCC

1913 - The 1913 IedeiaI Reseive Acl foined lhe IedeiaI Reseive Syslen (lhe Ied) as
a cenliaI lank. The syslen incIuded seveiaI iegionaI IedeiaI Reseive anks and a
seven-nenlei goveining loaid
1929 - The US slock naikel ciashed, Iosing 2O of ils vaIue. The cainage spiIIed inlo
lhe US lanking indusliy vheie lanks Iosl heaviIy on piopiielaiy slock inveslnenls.
Thousands of US lanks faiIed.
The CIass-SleagaII Acl of 1932 vas foined, vhich dislinguished lelveen
conneiciaI and inveslnenl lanking. The Acl aIso foined lhe IedeiaI Deposil
Insuiance Coipoialion (IDIC), lo piovide deposil insuiance foi conneiciaI lanks.
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The olhei inpoilanl Acl vas lhe Ciann-Leach-IiIey (CLM) 1999, vhich iepIaced
lhe CIass-SleagaII Acl and eioded lhe Iines of lusiness laiiieis, aIIoving lanks lo
acquiie secuiilies and insuiance fiins and vice veisa.
In lhe 9Os, conneiciaI lanks look significanl naikel iisks, liading acliveIy in
foieign exchange, financiaI fuluies, and OTC deiivalives. They enjoyed IDIC
insuiance and nenleiship in lhe IedeiaI Reseive syslen, vhich vas nol avaiIalIe
lo lhe inveslnenl lanks

The period from 1985-2002 was the M&A era for the US financial system. There were
nearly 3,300 bank mergers involving $2.7 trillion in assets in the US in this period.

The commercial banking industry changed markedly between 1990 and 2002, largely as a
result of consolidation. The number of banks declined considerably and concentration rose
on the national level. Interestingly, at the local level, average concentration has not changed
much.

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1.2Current Banking System in United States

IedeiaI Reseive (popuIaiIy knovn as lhe Ied) is lhe apex inslilulion in lhe lanking syslen
of Uniled Slales. Il is lhe cenliaI lank of lhe counliy. The IedeiaI Reseive Syslen vas
eslalIished in 1913 foIIoving a seveie financiaI ciisis in 19O7. One of lhe inpoilanl ioIes of
IRS is lo piovide an effeclive supeivision foi lhe lanking indusliy in lhe counliy.

IRS is an independenl cenliaI lank, as ils decisions do nol have lo le ialified ly lhe
Iiesidenl oi any olhei execulive. NeveilheIess, lhe syslen is undei lhe oveisighl of lhe US
Congiess.

The IRS is conposed of lhe oaid of Coveinois and lveIve iegionaI IedeiaI Reseive anks.
A najoi conponenl of lhe syslen is IedeiaI Open Maikel Connillee (IOMC) vhich
consisls of lhe nenleis of oaid of Coveinois, lhe piesidenl of lhe IedeiaI Reseive ank of
Nev Yoik and piesidenls of foui olhei IedeiaI Reseive anks, vho seive on a iolalionaI
lasis. IOMC pIays an inpoilanl ioIe in conlioIIing lhe oveiaII nonelaiy and ciedil
condilions in lhe econony.











The Principle duties of the Fed
To conduct the countrys monetary policy by influencing
monetary and credit conditions
To regulate banking institutions to ensure sound working of
the banking and financial system
To maintain stability of the financial system and contain
systemic risk
To provide financial services to depositary institutions, the US
government, and foreign official institutions, and play a critical
part in the payments system
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Bnard nf Gnvcrnnrs
oaid of Coveinois is a IedeiaI Coveinnenl Agency. The Iiesidenl of Uniled Slales
appoinls lhe nenleis of lhe oaid. The oaid pIays an inpoilanl ioIe in lhe supeivision
and ieguIalion of lhe US lanking indusliy. Il supeivises slale chaileied lanks lhal aie
nenleis of lhe IRS, lank hoIding conpanies, foieign aclivilies of nenlei lanks, US
aclivilies of foieign lanks and olhei Iiniled puipose inslilulions lhal engage in a foieign
lanking lusiness.

Fcdcra! Rcscrvc Banks
Theie is a nelvoik of lveIve IedeiaI Reseive anks and lheii lianches lo caiiy oul a vaiiely
of funclions Iike opeialing a nalionvide paynenls syslen, disliiluling nalions cuiiency,
supeivising nenlei lanks/lank hoIding conpanies and seiving as lankei foi lhe
goveinnenl. Lach Reseive lank aIso acls as a deposiloiy
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foi lhe lanks in ils ovn disliicl.





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Commercial banks are required to deposit reserve funds with Federal reserves
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Tvo olhei inslilulions, vhich pIay a key ioIe in lhe funclioning of lhe IRS, aie:

DcpnsItnry InstItutInns - These inslilulions opeialionaIize lhe nonelaiy poIicy
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AdvIsnry CnmmIttccs - They nake ieconnendalions lo lhe oaid of Coveinois and lo lhe
Reseive anks iegaiding lhe iesponsiliIilies of lhe syslen.

Role of Federal Reserve in the Payments System

The IedeiaI Reseive pIays an inpoilanl ioIe in lhe US paynenls syslen. The IedeiaI
Reseive anks piovide lanking seivices lo lhe conneiciaI lanks as veII as lo lhe fedeiaI
goveinnenl.

IedeiaI Reseive anks peifoin lhe foIIoving funclions foi conneiciaI lanks and
goveinnenls:

Mainlain lhe accounls of lhese inslilulions vilh lhe IedeiaI Reseive ank
CoIIecl Checks diavn on lhese inslilulions
LIeclionicaIIy Tiansfei Iunds
Disliilule and Receive Cuiiency/Coins

They acl as fiscaI agenls foi lhe fedeiaI goveinnenl and peifoin lhe foIIoving funclions:
Iay lieasuiy checks
Iiocess LIeclionic paynenls
Issue, liansfei and iedeen US goveinnenl secuiilies


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Help in implementing the credit policy of the Federal Reserve by increasing or decreasing the interest rates.
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1.2.1 Typcs nf Banks

Depending on lhe goveinnenlaI lody vhich chaileis lhen and vhelhei oi nol lhey aie
nenleis of lhe IedeiaI Reseive Syslen, lhe conneiciaI lanks in Uniled Slales can le
calegoiized inlo lhiee lypes:


NatInna! Banks
These aie lhe lanks, vhich aie chaileied ly lhe fedeiaI goveinnenl lhiough lhe office of
lhe ConplioIIei of lhe Cuiiency in lhe Depailnenl of lhe Tieasuiy and aie lhe nenleis of
lhe IedeiaI Reseive Syslen ly Iav.

5tatc Mcmbcr Banks
These lanks aie chaileied ly lhe slales and have eIecled lo le lhe nenleis of lhe IedeiaI
Reseive Syslen aflei neeling lhe condilions specified ly lhe oaid of Coveinois of lhe
IedeiaI Reseive.

5tatc Nnn-Mcmbcr Banks
These aie slale chaileied lanks, vhich have chosen nol lo lecone lhe nenleis of lhe
IedeiaI Reseive Syslen.

Menlei lanks nusl sulsciile lo slock in lheii iegionaI IedeiaI Reseive ank in an anounl
equaI lo 6 peicenl of lheii capilaI and suipIus, haIf of vhich nusl le paid in vhiIe lhe olhei
haIf is suljecl lo caII ly lhe oaid of Coveinois. The hoIding of lhis slock, hovevei, does
nol caiiy vilh il lhe conlioI and financiaI inleiesl conveyed lo hoIdeis of connon slock in
Typc nf Bank
NatInna! Banks 5tatc Mcmbcr Banks 5tatc Nnn-Mcmbcr
Banks
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foi-piofil oiganizalions. Il is neieIy a IegaI olIigalion of IedeiaI Reseive nenleiship, and
lhe slock nay nol le soId oi pIedged as coIIaleiaI foi Ioans. Menlei lanks ieceive a 6
peicenl dividend annuaIIy on lheii slock, as specified ly Iav.

Iion 1791 lo 1863, lhe Uniled Slales had onIy slale-chaileied conneiciaI lanks. These
lanks accepled specie on deposil and issued noles payalIe "on denand" in specie. Lach
lank issued ils ovn "denand" and "lein" noles. They nade Ioans accoiding lo lhe "ReaI
iIIs Docliine." The "ReaI iIIs Docliine" iequiied lanks lo nake onIy shoil-lein, seIf-
Iiquidaling Ioans lo lusinesses lo finance invenloiies and payioIIs. Loans veie nade ly
issuing lank noles. When lhe goods veie soId, lhe Ioans veie iepaid and lhe "lein" noles
veie ieliied.


1.2.2 Rcgu!atnrs nf CnmmcrcIa! Banks

NatInna! Banks

Fcdcra! Rcscrvc Bnard nf Gnvcrnnrs (OC), eslalIished undei lhe IedeiaI Reseive Acl of
1913, exanines, audils, and supeivises lank hoIding conpanies and slale-chaileied lanks
lhal aie nenleis of lhe IedeiaI Reseive Syslen. Sels lhe ieseive iequiienenls and seives as
Iendei of Iasl iesoil. AIso iesponsilIe foi nonelaiy poIicy: Ioosening oi lighlening lhe
avaiIalIe ciedil and ieguIaling lhe puichase of secuiilies on naigin.

Fcdcra! DcpnsIt Insurancc CnrpnratInn (IDIC), eslalIished undei lhe anking Acl of 1933,
exanines, audils, and supeivises slale-chaileied lanks, vhich aie nol nenleis of lhe Ied,
lul have IDIC insuiance. Cuaianlees funds on deposil vilh conneiciaI lanks and nuluaI
savings lanks (II) and savings and Ioan associalions (SAII). Lends noney oi luys assels
of lanks lo faciIilale neigeis oi pievenl faiIuies.

OffIcc nf thc Cnmptrn!!cr nf thc Currcncy (OCC), eslalIished undei lhe NalionaI ank
Acls of 1863/64, chaileis conneiciaI lanks. AIso, exanines, audils, and supeivises
nalionaIIy chaileied lanks.
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OffIcc nf ThrIft 5upcrvIsInn (OTS), eslalIished undei lhe IinanciaI Inslilulions Refoin,
Recoveiy, and Lnfoicenenl Acl of 1989 (IIRRLA), chaileis savings and Ioan associalions.
AIso, exanines, audils, and supeivises savings and Ioans associalion.

IedeiaI IinanciaI Inslilulions Lxaninalion CounciI (IIILC), eslalIished undei lhe IinanciaI
Inslilulions ReguIaloiy and Inleiesl Rale ConlioI Acl of 1978, lhe counciI, vhich is
conposed of lhe Chaiinan of lhe oaid of Coveinois of lhe IedeiaI Reseive Syslen, lhe
Chaiinan of lhe oaid of Diieclois of lhe IDIC, lhe Chaiinan of lhe oaid of Diieclois of
lhe Office of Thiifl Supeivision, lhe Chaiinan of lhe oaid of Diieclois of lhe NalionaI
Ciedil Union Adninislialion, and lhe ConplioIIei of lhe Cuiiency, deleinines lhe faclois
lo seive as lhe lasis foi a conposile ialing of nalionaI lank peifoinance ly lhe exanining
agencies.

State Banks

5tatc BankIng Dcpartmcnts, eslalIished ly slale IegisIaluies, exanine, audil, and supeivise
slale-chaileied lanks vhich aie nol nenleis of lhe Ied and do nol have IDIC insuiance.










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TOP TEN FEDERALLY CHARTERED AND 5TATE-CHARTERED BANK5 BY
A55ET5
As at thc cnd nf 2004


($OOO)
Rank Fcdcra!!y Chartcrcd Bank Tnta! asscts 5tatc-Chartcrcd Bank 5tatc Tnta! Asscts
1
}IMoigan Chase ank, NalionaI
Associalion 967,365,OOO SunTiusl ank CA $13O, 78O, 1 OO
2 ank of Aneiica, NalionaI Associalion 771,61 8, 758 The ank of Nev Yoik NY 92,138,427
3
Ciliank, NalionaI Associalion
694,529,OOO
Slale Slieel ank and
Tiusl Conpany MA 9O,268,259
4 Wachovia ank, NalionaI Associalion 389,963,OOO Tiusl Conpany NC 74,479,112
5 WeIIs Iaigo ank, NalionaI Associalion 366,256,OOO MeiiiII Iynch ank USA UT 66,7O9,O7O
6 Washinglon MuluaI ank 272,927,5O2 Iiflh Thiid ank AI 56,8O7,417
7
IIeel NalionaI ank
218,74O,377
Manufacluieis and
Tiadeis Tiusl Conpany OH 52,414,14O
8 U.S. ank NalionaI Associalion 194,436,638 Coneiica ank NY 52,O77,864
9 HSC ank USA, NalionaI Associalion 138,296,274 AnSoulh ank MI 49,711,241
1O WoiId Saving ank, IS 1O6,816,527 Regions ank AL 49,21O,377
Souice: IinanciaI Seivices Iaclook, 2OO6

In addilion lo lhese najoi calegoiies of conneiciaI lanks lheie aie olhei lanking
inslilulions Iike:

Thiifl Inslilulions

Ciedil Unions

IndusliiaI anks
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ThrIft InstItutInns
Savings and Ioan associalions and savings lanks aie knovn as lhiifl inslilulions. These
veie eslalIished vilh an oljeclive lo pionole peisonaI savings lhiough savings accounls
and honeovneiship lhiough noilgage Iending. Hovevei, lhey nov piovide a iange of
seivices siniIai lo nany conneiciaI lanks. Savings lanks lend lo le snaII and aie Iocaled
noslIy in lhe noilheaslein slales.

Like olhei lanking inslilulions vilh a significanl poilion of noilgages on lheii looks, lhiifls
aie associaled vilh lhe IedeiaI Hone Loan (IHL) ank Syslen. In exchange foi hoIding a
ceilain peicenlage of lheii assels in noilgage-lacked secuiilies and iesidenliaI noilgages,
lhese financiaI inslilulions nay loiiov funds fion lhe IHL ank Syslen al favoialIe iales.

IHL ank syslen vas ciealed ly lhe IedeiaI Hone Loan ank Acl of 1932 in iesponse lo
lhe depiessive econonic condilions of lhe eia vhich had inpaiied lhe U.S. lanking
syslen. The piinaiy puipose of IHL syslen vas lo inciease lhe anounl of funds avaiIalIe
foi Iending inslilulions lhal piovide noilgages and siniIai Ioan agieenenls lo individuaIs.


CrcdIt UnInns
Ciedil unions aie nol-foi-piofil financiaI coopeialives lhal offei peisonaI Ioans and olhei
consunei lanking seivices. The fiisl ciedil union in Uniled Slales vas foined in
Mancheslei, Nev Hanpshiie in 19O9. Ciedil unions nov seive noie lhan 8O niIIion peopIe
in lhe Uniled Slales.

In 1934, Iiesidenl RooseveIl signed lhe IedeiaI Ciedil Union Acl inlo Iav, aulhoiizing lhe
eslalIishnenl of fedeiaIIy chaileied ciedil unions in aII slales. In 197O, lhe NalionaI Ciedil
Union Adninislialion, vhich chaileis and supeivises ciedil unions, vas ciealed aIong vilh
lhe NalionaI Ciedil Union Shaie Insuiance Iund, vhich insuies nenleis deposils.
IndividuaI ciedil unions aie seived ly 31 fedeiaIIy insuied coipoiale ciedil unions, vhich
piovide inveslnenl, Iiquidily and paynenl seivices foi lheii nenleis.
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IndustrIa! Banks
IndusliiaI lanks, knovn oiiginaIIy as slale-chaileied Ioan conpanies, cane inlo exislence
in lhe eaiIy pail of lhe 2Olh cenluiy lo nake consunei Ioans and offei deposil accounls as
pail of a nove lo secuie ciedil foi lIue coIIai voikeis. Many of lhese inslilulions Ialei
neiged vilh conneiciaI lanks and aIlhough 12 slales sliII have indusliiaI lank-chailei
oplions on lheii looks, nosl of lhe ienaining indusliiaI lanks nov exisl in a fev slales,
nainIy in lhe vesl. Many seive niche naikels such as ieaI eslale Iending and aulonoliIe
Ioans. IndusliiaI lanks, aIso iefeiied lo as indusliiaI Ioan conpanies, aie nol ieguIaled ly
lhe IedeiaI Reseive and nay le ovned ly fiins in olhei financiaI seivices lusinesses such
as finance conpanies, ciedil caid issueis, and secuiilies fiins, oi ly non-financiaI
lusinesses such as aulonakeis and depailnenl sloies. CaIifoinia and CoIoiado have passed
Iavs in iecenl yeais lhal piohilil non-financiaI fiins fion ovning indusliiaI Ioan
conpanies.

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1.3 Performance Highlights of the US Banking industry

PrnfItabI!Ity
The piofilaliIily of savings lanks and conneiciaI lanks as neasuied in leins of ieluin on
equily (i.e. ieluin on funds piovided ly shaiehoIdeis) has leen in doulIe digils duiing 2OOO
-2OO4 peiiod. Il iegisleied a giovlh duiing 2OOO-2OO3 foi lolh lhe savings as veII as
conneiciaI lanks and lhen decIined in 2OO4. Ciedil Unions, on lhe olhei hand, iecoided a
veiy insignificanl ieluin on aveiage assels.

PrnfItabI!Ity nf 5avIngs & CnmmcrcIa! Banks and CrcdIt UnInns

Reluin on equily Reluin on aveiage assels
Yeai Savings lanks ConneiciaI lanks Ciedil unions
2OOO 11.14 13.99 1.O2
2OO1 12.33 13.O9 O.96
2OO2 12.36 14.47 1.O7
2OO3 13.66 15.31 O.99
2OO4 1O.87 13.82 O.92
Scurcc. |inancia| Scrticcs |ac| 8cc|, 2006

IinanciaI assels of lanking inslilulions incieased al lhe iale of 14.6 peicenl fion 2OO3 lo
2OO4, faslei lhan conneiciaI lanks, al 8.7 peicenl, and ciedil unions, al 6.2 peicenl.


FInancIa! Asscts nf BankIng InstItutInns ($ bI!!Inns)
Yeai
ConneiciaI
anking
Savings
Inslilulions
Ciedil
Unions
2OOO 6,469 1,218 441
2OO1 6,829 1,299 5O6
2OO2 7,329 1,357 561
2OO3 7,8O9 1,475 617
2OO4 8,487 1,691 655
Scurcc. |inancia| Scrticcs |ac| 8cc|, 2006
18
Bank branchcs
Though lheie has leen an oveiaII giovlh in voIunes, lhe nunlei of lanking inslilulions
has sulslanliaIIy cone dovn ovei a peiiod of line due lo consoIidalion in lhe indusliy.
Hovevei, lhis has nol ieduced consuneis access lo lheii deposils as lhe nunlei of
conneiciaI lank lianches and ATMs conlinues lo giov. Hovevei, lheie aie fevei savings
inslilulions lhan in 199O, lolh in leins of lanks and lianches. The nunlei of ciedil unions,
aIso diopped ly 11 peicenl duiing 199O-2OO4.

BankIng OffIccs by Typc nf Bank
1990 2000 2001 2002 2003 2004
CnmmcrcIa! banks
Nunlei of lanks
Nunlei of lianches
12,329
5O,O17
8,297
63,487
8,O62
64,965
7,87O
65,584
7,752
66,766
7,614
69,36O
5avIngs InstItutInns
Nunlei of lanks
Nunlei of lianches
2,815
18,794

1,589
12,523
1,534
12,6O2
1 ,466
12,474
1,411
12,455
1,345
12,346
CrcdIt unInns 1O,16O 1O,316 9,984 9,688 9,369 9,O14
Scurcc. |inancia| Scrticcs |ac| 8cc|, 2006
CnmmcrcIa! Banks

The US financial system includes a variety of financial institutions, the oldest of them being
commercial banks. Many of the banks established in the 19
th
century are still operating quite
successfully. In the US, commercial banks are the most significant of the financial intermediaries,
accounting for some 60 percent of the nation's deposits and loans. The US commercial banking
industry is strong, stable, vibrant, and diverse. It is also more fragmented than any of the advanced
economies today. Major US banks are international players with strong global operations.

The U.S. Banking Act of 1971 defines commercial bank as an institution that offers demand
deposits and originates loans.
The trends in growth and performance of commercial banks is discussed below:

19
CnnccntratInn
The nunlei of snaIIei conneiciaI lanks has diopped vheieas lhe nunlei of Iaigei
conneiciaI lanks conlinues lo inciease. The nunlei of snaIIei conneiciaI lanks (vilh
assels Iess lhan $1OO niIIion) in US ieduced ly 256 in 2OO4 as conpaied lo 2OO3 vheieas
Iaigei lanks vilh assel size of up lo $1 liIIion incieased ly 96 and even Iaigei lanks vilh
assel size giealei lhan $ 1O liIIion incieased ly 21. A Iaige shaie of lhe US lanking lusiness
is heId ly a ieIaliveIy snaII nunlei of lig lanks.

Assct and LIabI!ItIcs
The najoi assel foi IDIC (IedeiaI Deposil Insuiance Coipoialion)
3
insuied conneiciaI
lanks is Loans & Leases (57) foIIoved ly secuiilies (18). Secuiilies heId aie usuaIIy U.S
lieasuiy and goveinnenl agency olIigalions in addilion lo equily.

Asscts nf FDIC Insurcd CnmmcrcIa! Banks In 2004



3
FDIC provides deposit insurance to the depositors up to $100,000.
Loans & Leases
57 Secuiilies
18
IedeiaI Iunds
5
Cash
5
Olhei Assels
15
20



Tnp 25 U.5. COMMERCIAL BANK5, BY A55ET5 ($ bI!!Inns) 2005
Rank Coman Assets
1 }I Moigan Chase ank, NalionaI Associalion $983
2 ank of Aneiica, NalionaI Associalion 838
3 Cililank, NalionaI Associalion 684
4 Wachovia ank, NalionaI Associalion 454
5 WeIIs Iaigo ank, NalionaI Associalion 367
6 IIeel NalionaI ank 231
7 U.S. ank NalionaI Associalion 197
8 HSC ank USA, NalionaI Associalion 138
9 Sunliusl ank 136
1O Chase ank USA, NalionaI Associalion 88
11 Slale Slieel ank & Tiusl Co. 88
12 Keylank, NalionaI Associalion 85
13 ank of Nev Yoik 8O
14 INC ank, NalionaI Associalion 8O
15 ianch anking & liusl conpany (&T) 74
16 LasaIIe ank, NalionaI Associalion 67
17 NalionaI Cily ank 67
18 Noilh Ioik ank 6O
19 MNA Aneiica ank, NalionaI Asocialion 54
2O Iiflh Thiid ank 57
21 ank of Aneiica, NalionaI Associalion 54
22 Coneiica ank 53
23 Manufacluieis and liadeis liusl conpany 53
24 Chailei One ank, NalionaI Associalion 53
25 Tieasuiy ank, NalionaI Associalion 51
Scurcc. |inancia| Scrticcs |ac|occ|, 2006
21
ThrIft InstItutInns

Of Iale, lhe nunlei of lhiifl inslilulions has leen decIining. They veie al lheii peak duiing
196Os, vhen lheie veie noie lhan 4,8OO lhiifl inslilulions. Hovevei, due lo an inciease in
inleiesl iales in lhe Iale 197Os and lhe iecession duiing eaiIy 198Os has ieduced lheii ianks
significanlIy. y yeai end 2OO4, noslIy due lo acquisilions ly oi conveisions lo conneiciaI
lanks oi olhei savings lanks, lhe nunlei of lhiifls had faIIen lo 1,345.

TOP TEN U.5. THRIFT COMPANIE5 BY A55ET5, 2005
($ ml||lons, as of March 31)
Rank Conpany Assels
1 Washinglon MuluaI, Inc. $333,743
2 CoIden Wesl IinanciaI Coipoialion 112,588
3 Soveieign ancoip, Inc. 58,926
4 INC ank, IS 36,O24
5 L* TRADL ank 25,549
6 Nev Yoik Connunily ancoip, Inc. 24,612
7 Asloiia IinanciaI Coipoialion 23,25O
8 Hudson Cily ancoip, Inc. (MHC) 21,131
9 Lehnan iolheis ank, IS 19,457
1O IndyMac ancoip Inc. 17,966
Scurcc. |inancia| Scrticcs |ac|occ|, 2006

Tnp Fnur ThrIft InstItutInns by Rcvcnucs 2004
Rank Cnmpany Rcvcnucs(In mI!!Inn $)
1 Washinglon MuluaI $15,962
2 CoIden Wesl IinanciaI 4,473
3 Soveieign ancoip 2,7O6
4 Weslcoip 1,387
Scurcc. |inancia| Scrticcs |ac|occ|, 2006


22
CrcdIt UnInns

Duiing 198O lo 2OO4 lhe nunlei of ciedil unions has gone dovn fion appioxinaleIy 17OOO
in 198O lo 9OOO in 2OO4. lul lhe assels of fedeiaI and fedeiaIIy insuied slale ciedil unions
duiing lhe sane peiiod incieased fion $61 liIIion lo $647 liIIion.

Fcdcra! CrcdIt UnInns & Fcdcra!!y Insurcd 5tatc Chartcrcd CrcdIt UnInns
1980-2004
198O 199O 2OOO 2OO2 2OO3 2OO4
OpcratIng CrcdIt UnInns
IedeiaI 1 2,44O 8,511 6,336 5,953 5,776 5,572
Slale 4,91O 4,349 3,98O 3,735 3,593 3,442
Numbcr nf FaI!cd
InstItutInns 239 164 29 15 13 21
Mcmbcrs (000)
IedeiaI 24,519 36,241 43,883 44,611 46,155 46,858
Slale 12,338 1 9,454 33,7O5 36,336 36,273 36,71O
Asscts [$ mI!!Inns)
IedeiaI $4O,O92 $13O,O73 $242,881 $3O1,238 $336,612 $358,7O4
Slale 2O,87O 68,133 195,363 255,838 273,572 288,296
Lnans nutstandIng [$
mI!!Inns)
IedeiaI 26,35O 83,O29 163,851 181,767 2O2,898 223,878
Slale 14,852 44,1O2 137,485 16O,881 173,236 19O,377
5harcs [$ mI!!Inns)
IedeiaI 36,263 117,892 21O,188 261,819 291,485 3O8,318
Slale 18,469 62,O82 169,O53 222,377 236,856 247,8O4
Scurcc. |inancia| Scrticcs |ac|occ|, 2006

23
1.4 The Future of US banking

Factnrs Inf!ucncIng Futurc nf U5 BankIng
The fuluie of lanking viII le infIuenced ly lhe econonic, denogiaphic, ieguIaloiy,
lechnoIogicaI, paynenl-syslen and conpelilive enviionnenl.

EcnnnmIc EnvIrnnmcnt
Modeiale econonic giovlh vilhoul peiiods of Iong-Iasling oi seveie iecessions vouId le
favoialIe lo lhe giovlh and piofilaliIily of lhe lanking indusliy in Uniled Slales. Though
lank faiIuies cannol le iuIed oul, lhey viII le nainIy due lo lank specific faclois ialhei
lhan due lo nacioecononic ieasons.

DcmngraphIc EnvIrnnmcnt
The lvo inpoilanl denogiaphic faclois lhal viII affecl lhe fuluie of US lanking aie an
ageing popuIalion and lhe nunlei of innigianls. NeaiIy, 3O peicenl of lhe US popuIalion
consisls of laly looneis vho vouId ieliie oi vouId le appioaching ieliienenl duiing lhe
nexl decade. This popuIalion vouId have Iessei ciedil iequiienenls and vouId le
Iiquidaling lheii assels. They viII aIso lend lo keep a giealei piopoilion of lheii veaIlh in
Iiquid assels Iike lank deposils. Civen lhe veaIlh nanagenenl iequiienenls of lhis chunk
of popuIalion lanks couId offei a vaiiely of seivices and inciease lheii ovn piofilaliIily in
ieluin.
Innigianl popuIalion accounls foi neaiIy 11-12 peicenl of lhe US popuIalion. The nunlei
is expecled lo go up fuilhei in fuluie vilh Uniled Slales naking lhe innigialion
iequiienenls Iess sliingenl. Innigianl popuIalion viII aIso add lo lank piofils ly vay of
ienillances and olhei seivices.

Rcgu!atnry EnvIrnnmcnt
The enphasis of ieguIalion has leen lo inciease lhe lianspaiency in opeialions and lo
piovide a IeveI pIaying fieId lo aII lhe pIayeis in lhe indusliy. Civen lhis slance of lhe
IedeiaI Reseive and IDIC, il is expecled lhal lhose lanks vhich nake noie discIosuies viII
24
le alIe lo alliacl noie lusiness. Iuilhei, aseI II noins inpIenenlalion viII fuilhei veed
oul lhe 'lads and viII Iead lo noie piofilaliIily foi lhe lanking indusliy.

Tcchnn!ngIca! EnvIrnnmcnt
The lanking indusliy is nov noie dependenl on lechnoIogy lhan evei lefoie, vilh annuaI
indusliy expendiluies foi lechnoIogy lopping an eslinaled $3O liIIion. Laige lanks viII
conlinue lo deveIop nev lechnoIogies and adapl lo IegisIalive and ieguIaloiy changes, such
as aseI II. SnaIIei lanks, lhiifl inslilulions, ciedil unions, indusliiaI lanks aIso depend on
lechnoIogy lul noie as useis of pioven lechnoIogy ialhei lhan as innovalois of lechnoIogy.

TechnoIogy viII conlinue lo le a najoi expense, and secuiily viII ienain a ciuciaI issue foi
lanks of aII sizes. Il viII le ieaIIy chaIIenging foi lanking inslilulions lo iespond lo a
dynanic lechnoIogy enviionnenl. Hovevei, if piopeiIy nanaged il vouId liansIale inlo
lellei cuslonei seivice, Iovei opeialing cosls, and a noie efficienl lanking syslen.


Paymcnt 5ystcm Changcs
Duiing lhe peiiod 1995-2OOO, lhe nunlei of checks foi ielaiI liansaclions decIined fion 49.5
liIIion lo 42.5 liIIion. Duiing lhe sane peiiod lhe nunlei of eIeclionic paynenls incieased
fion 14.6 liIIion lo 28.9 liIIion. Civen lhis change, effoils aie leing nade lo change ovei lo
'e-cheques.

This aIso inpIies lhal lanks viII le iequiied lo adapl lheii pioducl offeiings, piicing as veII
as lheii lack-office opeialions. Since noie eIeclionic liansaclions aie cheapei lo piocess, as
conpaied lo lhe conveision oi liuncalion (oi lolh) of checks, lanks lhal do nol expIicilIy
chaige foi liansaclion seivices on a pei-ilen lasis viII see a ieduclion in cosls. Ioi lanks
lhal have expIicil fees foi each seivice (nainIy lanks lhal suppIy cash-nanagenenl
seivices), il viII le necessaiy lo ensuie lhal lhe piofil naigins on lhe eIeclionic liansaclion
seivices aie connensuiale vilh lhose on lhe papei liansaclion seivices.



25
CnmpctItIvc EnvIrnnmcnt
Civen lhe consoIidalion in lhe indusliy, lheie aie fev Iaige lanks doninaling lhe lanking
indusliy. This liend is expecled lo conlinue and viII inlensify lhe conpelilion. Hovevei,
given lhal il viII le a 'fighl anong equaIs, lhe lanking indusliy as veII as lhe consuneis
aie expecled lo lenefil in leins of innovalive pioducls, Iovei cosls and lellei seivices.

Prnspccts fnr VarInus Typcs nf Banks
The U.S. lanking syslen is chaiacleiized ly Iaige diffeiences in lhe size of inslilulions -
lheie aie sone of lhe voiIds Iaigesl lanking oiganizalions as veII as lhousands of
ieIaliveIy snaII lanks.

Largc BankIng nrganIzatInns
Ovei lhe pasl 2O yeais lhe sliucluie of lhe U.S. lanking syslen has changed enoinousIy in
iesponse lo changes in lhe IegaI, ieguIaloiy, and financiaI Iandscape. Al lhe end of 2OO3, lhe
25 Iaigesl insuied lanks and savings inslilulions heId 56 peicenl of lolaI indusliy assels,
vilh lhe 1O Iaigesl hoIding aInosl 44 peicenl, up fion 19 peicenl in 1984. Ioi lhe nexl 15
lanks, lhe giovlh has leen nuch Iess dianalic: lhe conlined assels of lhe lanks ianked 11
lhiough 25 have iisen onIy 2 peicenlage poinls, fion aloul 1O peicenl in 1984 lo 12 peicenl
al lhe end of 2OO3.

Il is expecled lhal foi lhe innediale fuluie, lhe Iaige lanks viII conlinue lo liy lo giov
lhiough inleinaI giovlh and acquisilions. Al lhe sane line, lhis giovlh viII give iise lo
polenliaI piolIens of nanageiiaI disecononies and coipoiale goveinance nay aiise. This
viII aIso pIace a heavy luiden on lheii financiaI and opeialionaI iisk-nanagenenl syslens.
Many of lhese piolIens aie leing addiessed.

RcgInna! and Othcr MIdsIzc Banks
anks lhal have assels of noie lhan $1 liIIion lul Iess lhan lhe assels of lhe snaIIesl of lhe
25 Iaigesl lanking oiganizalions (cuiienlIy aloul $42 liIIion) nay le cIassified as iegionaI
and olhei nidsize lanks. These lanks aie snaII enough lo avoid any disecononies of scaIe
lhal nay iesuIl fio nanaging dislanl faciIilies and heleiogeneous pioducl Iines.
26
NeveilheIess, lhey aie Iaige enough lo have skiIIed piofessionaI nanpovei, have
diveisified poilfoIios, use IT lo lheii advanlage and aIso nanage lheii iisk. LocaI lanks nay
peifoin lellei oi voise lhan iegionaI lanks depending on lhe IocaI naikel condilions.
ConsoIidalion in lhis segnenl is expecled and sone of lhese lanks nay evenluaIIy neige
anong lhenseIves oi vilh Iaigei lanks.

ThrIft InstItutInns
These inslilulions conpiising savings lanks and savings and Ioan associalions iepiesenl
aloul 94 peicenl of aII lanks in lhe Uniled Slale. The peisislenlIy Iaige nunlei of ieIaliveIy
snaII lanks is chaiacleiislic of lhe U.S. lanking syslen and iefIecls Iongslanding pulIic
poIicies lased on concein aloul lhe concenlialion of econonic povei, lhe desiie lo nainlain
IocaI ovneiship and conlioI, and effoils lo piolecl IocaI lanks fion conpelilion.

The picluie has changed giealIy as a iesuIl of lhe lanking ciisis of lhe 198Os and geogiaphic
deieguIalion. The nunlei of lhiifl inslilulions has decIined ly 47 peicenl since 1985, as a
iesuIl lolh of faiIuies (in lhe eaiIiei pail of lhis peiiod) and (noie iecenlIy and noie
significanlIy) of voIunlaiy neigeis. Moieovei, lheii shaie of lolaI lanking indusliy assels,
deposils, and offices have aIso decIined.

These inslilulions have ceilain advanlages as Iendeis lo snaII lusinesses, snaII faineis, and
olhei infoinalionaIIy opaque loiioveis. AIlhough, lheie is a liend lhal Iaigei lanks aie
enleiing inlo sone of lhe aieas eaiIiei seiviced ly lhese snaIIei lanks (Iike SML financing),
lhese inslilulions aie expecled lo ienain an inpoilanl pail of lhe US lanking indusliy.
27
2. IntrnductInn tn RctaI! BankIng In U5

ConneiciaI lanking can le calegoiized inlo lvo lioad lianches oi slieans. These aie:
RelaiI anking, and
WhoIesaIe anking

The alove Iisl is onIy an indicalive Iisl and no an exhauslive Iisl of pioducls avaiIalIe undei
ielaiI and vhoIesaIe lanking.

Commercial Banking
Retail Banking
Consumer credit products
o Mortgage lending products
Residential Mortgage
loans
Second Mortgage loans
Home Equity Loans
o Non Mortgage products
Revolving credits
Consumer loans
Credit cards
Non revolving credits
Automobile loan
Leasing
Personal Loans
Deposit Products
o Demand Deposits
o Small Time and Savings
Deposits
o LargeTime Deposits

Wholesale Banking
Commercial Credit Products
Lines of Credit
Revolving Credit
Term loans
Letters of Credit
Bank Guarantees
Bills Discounting
Export-Import Finance
Factoring
Syndicated Loans/Club Loans
Non-Credit Fee Based Products like
Project Finance, Structured Finance,
Secuiilisalion, Leasing, elc

28
RelaiI anking is lypicaI nass-lanking in vhich lhe IocaI lianches of lanks offei vaiious
seivices Iike savings and checking accounls, noilgages, peisonaI Ioans, delil caids, ciedil
caids, elc. lo individuaI cusloneis.

RelaiI lanking indusliy in Uniled Slales has undeigone a Iol of changes duiing lhe Iasl
decade. Duiing 199Os, lanks expecled lhal ielaiI cusloneis vouId evenluaIIy conducl aII
lanking onIine and foisake lhe lianch. Hovevei, lhis has yel lo happen. In facl, duiing lhe
Iasl coupIe of yeais, lanks in US have vilnessed a gieal lianching loon.

Al lhe sane line lheie has leen Iol of consoIidalion in lhe indusliy. Thioughoul lhis
consoIidalion, cuslonei piefeiences have leen Ioud and cIeai: sil dovn vilh us, Iislen lo us,
and gel lo knov us. Many lanks, Iike Washinglon MuluaI and Unpqua ank, have liied lo
iespond lo lhis need of lhe cuslonei ly naking lheii lianches noie confoilalIe and
cuslonei seivice noie accessilIe. The enviionnenl leing ciealed ly lanks loday in lheii
lianches is noie cIoseIy aIigned vilh a ielaiI shopping expeiience lhan a liadilionaI
lanking expeiience.

anks have ieaIized lhal in nany cases, lhe lesl vay lo alliacl lhe allenlion of consuneis is
ly connunicaling lo lhen lhiough noie speciaIized veisions of liadilionaI lanking
pioducls.

This noduIe discusses lhe vaiious ielaiI lanking pioducls avaiIalIe in US naikels.
29
2.1. Consumer Credit Products

Consunei ciedil pioducls aie lasicaIIy of lvo lypes:

Moilgage Lending Iioducls and
Non-Moilgage Iioducls

Moilgage Iending pioducls can fuilhei le cIassified as:
ResidenliaI Moilgage Ioans
Second Moilgage Ioans
Hone Lquily Loans

Non-Moilgage pioducls can le cIassified as

RevoIving ciedils
Consunei Ioans
Ciedil caids
Non ievoIving ciedils
AulonoliIe Ioan
Leasing


2.1.1 Mnrtgagc LcndIng Prnducts

The lein 'noilgage is used in conneclion vilh ieaI eslale Iending. A viillen docunenl
evidencing lhe Iien on a piopeily laken ly a Iendei as secuiily foi lhe iepaynenl of a Ioan.
The lein noilgage oi noilgage Ioan is used IooseIy lo iefei lolh lo lhe Iien
4
and lhe

4
The Iendeis iighl lo cIain lhe loiioveis piopeily in lhe evenl lhe loiiovei defauIls. If lheie is
noie lhan one Iien, lhe cIain of lhe Iendei hoIding lhe fiisl Iien viII le salisfied lefoie lhe cIain of
30
Ioan. In nosl cases, lhey aie defined in lvo sepaiale docunenls: a noilgage and a nole. Il
piovides lhe Iendei vilh lhe secuiily of lhe noilgaged piopeily piovided lhe noilgage is
piopeiIy iecoided in lhe counliy couilhouse. This piopeily is used as coIIaleiaI foi lhe
Ioan disluised lo lhe loiiovei. If lhe loiiovei is nol iepaying lhe dell as agieed, lhe
Iending inslilulion has lhe iighl lo seII lhe noilgaged piopeily and iecovei lheii dues.

Iion lhe IedeiaI Reseive pulIicalions (TalIe I) il can le olseived lhal faniIy noilgage
dells geneiaIIy knovn as 'Moilgage of IaniIy iesidence conslilule 76.71 of lhe lolaI
noilgage dell oulslanding.
TalIe I
Mnrtgagc Dcbt OutstandIng - Prnpcrty wIsc (In $ bI!!Inns)
As at thc cnd nf 3
rd
QUARTER -2005
Typc nf prnpcrty / assct Amnunt nutstandIng Pcrccntagc
FamI!y rcsIdcnccs -
RcsIdcntIa! Mnrtgagc !nans
8821 76.71%
Olheis 2678 23.29
TolaI 11499 1OO
Scurcc. |cdcra| Rcscrtc 8u||c|in, ]anuarq 2006 - Mcr|gagc dco| cu|s|anding
ConneiciaI lanks and olhei financiaI inslilulions oiiginale lhe noilgage Ioans. If iequiied
lhey can seII lhese noilgage Ioans lo inveslois in lhe secondaiy naikel. Majoi pailicipanls
in lhe secondaiy naikel aie lhe IedeiaI NalionaI Moilgage Coipoialion (Iannie Mae),

lhe Iendei hoIding lhe second Iien, vhich in luin viII le salisfied lefoie lhe cIain of a Iendei hoIding
a lhiid Iien, elc.

31
Coveinnenl NalionaI Moilgage Associalion (Cinnie Mae) and lhe IedeiaI Hone Loan
Moilgage Associalion (Iieddie Mac)

Lach lank foinuIales ils ovn inveslnenl decisions on lheii Ioan poilfoIio, laking inlo
accounl lhe iisks and lhe ieluins of diffeienl lypes of noilgage Ioans. Risks incIude
defauIls, decIining ieaI eslale vaIue, Iiquidily consliainls
5
and possiliIilies of piepaynenl of
Ioans. ank decides lhe size of lheii noilgage Ioan foIio lolh undei fixed and fIoaling
inleiesl iales. These decisions depend on lhe quaIily of lanks Iending lechniques,
pievaiIing ieaI eslale naikel condilions and lhe need of lhe loiioveis. Lending inslilulions
nay liy lo niligale lheii iisks eilhei ly incieasing lhe quanlun of dovn paynenl fion lhe
loiiovei oi fixing highei oiiginalion fees.

Diffeience lelveen lhe puichase piice and lhe anounl Ienl ly lhe lank is lhe dnwn
paymcnt nr bnrrnwcr's cquIty (aIso caIIed lhe Maigin Money). ReguIalois have suggesled
diffeienl Ioan-lo-piice ialio foi diffeienl calegoiies of Ioans. Ioi exanpIe, lhe !nan tn prIcc
ratIn
6
in peicenlage leins foi lhe foIIoving calegoiies aie:
Ioi iav Iands - 65
IaniIy iesidenliaI consliuclions - 85

5
These refer to non-availability of cash to meet out the payment obligations.
6
The anounl of Ioan ieIalive lo lhe piice of lhe assel (e.g. house) leing puichased. Il iefIecls lhe poilion of
equily oi dovn paynenl a loiiovei nusl liing in as his inveslnenl. Ioi exanpIe, if lhe piice of lhe assel lo le
puichased is USD1OO and if lheie is no equily fion lhe loiiovei il is knovn as '1OO peicenl ialio. If lhe assel
piice is USD 1OO and lhe Ioan anounl lo le Ienl is USD85, lhe diffeience lelveen lhese lvo is lhe loiioveis
equily. In lhis case 'Ioan lo piice ialio is 85 peicenl.

32
Ovnei occupied hones - no Iinil
Moilgage Ioans aie lacked vilh good coIIaleiaI secuiily. Il is a piefeiied coIIaleiaI
lecause due lo:
a. Il is easy lo idenlify
l. Il cannol le easiIy noved eIsevheie
c. Il is possilIe lo asceilain ils naikel vaIue
d. Il is duialIe

In spile of lhe alove advanlages, il has ceilain disadvanlage aIso. Though lhe vaIue of lhe
assel nay inciease due lo infIalionaiy condilions and denand, lheie is a possiliIily lhal lhe
vaIue nay decIine due lo
a. Lxcess suppIy and Iess denand and
l. DefIalionaiy liends.
c. VaIue gelling affecled due lo adjacenl piopeily lhal nay deveIop sulsequenlIy. Ioi
exanpIe, if lhe adjacenl vacanl sile, vhich vas used as a pIay giound sulsequenlIy
conveiled inlo a vasle dunping giound.
d. DifficuIly in disposing lhe assel al shoil nolice al lhe anlicipaled faii vaIue.

2.1.1.1RcsIdcntIa! Mnrtgagc Lnans

These aie lhe noilgage Ioans piovided lo finance lhe puichase of iesidenliaI
acconnodalion ly ielaiI cusloneis.

Iealuies of lhis pioducl:
a. UsuaIIy vilh Iongei naluiily peiiod - aiound 2O-3O yeais
l. Laigei Ioan anounls - highei Ioan lo piice ialio
33
c. WhiIe aII noilgages aie voIaliIe, iesidenliaI noilgages aie Iess voIaliIe
conpaialiveIy vilh conneiciaI.

Theie aie lvo lypes of iesidenliaI noilgage Ioans. They aie:
Iixed - iale noilgages
AdjuslalIe - iale noilgages (ARMs)

2.1.1.1.1FIxcd ratc mnrtgagcs
In lhis lype of noilgage Ioan lhe inleiesl iale is fixed al lhe line of appiovaI of lhe Ioan and
il ienains conslanl foi lhe enliie Iife of lhe noilgage Ioan. Iixed iale noilgage can have lhe
lvo lypes of iepaynenl sliucluies:
IuIIy Anoilized
IailiaIIy Anoilized

In case of fu!!y amnrtIzcd fixed iale noilgage, lhe dell is giaduaIIy exlinguished lhiough
peiiodic ieguIai equaI iepaynenls of lhe loiioved funds and lhe iepaynenls aie adjusled
lovaids poilion of inleiesl and piincipaI sinuIlaneousIy. Undei 'PartIa!!y amnrtIzcd fIxcd
ratc mnrtgagc', a poilion of lhe noilgage is exlinguished ly equaI peiiodic paynenls ovei a
shoil peiiod and lhe ienaining unanoilized poilion is paid off in one Iunp sun paynenl.

2.1.1.1.2 Adjustab!c ratc mnrtgagcs
In lhis lype of noilgage Ioans, Iendeis have lhe fieedon lo ievise lhe inleiesl iale vhen lhe
naikel iale changes. This heIps lhe Iending inslilulions lo adjusl lheii ieluins accoiding lo
34
lhe incieasing cosl of funds and aIso piovide lhe lenefil of Iov inleiesl iales lo lhe
cuslonei in case of ieducing inleiesl iale scenaiio. Revision of Inleiesl iale viII have an
inpacl on lhe nonlhIy iepaynenls and lhe peiiod of noilgage.

Lendeis piefei lo have a confoilalIe spiead lelveen lhe cosl of funds and lhe ieluins on
lhe noilgage Ioans. This can le achieved ly Iinking lhe inleiesl iales on noilgage Ioans lo
a slandaid lenchnaik iale Iike one-yeai lieasuiy yieId
7
.
Whenevei lhe index changes, Iendei nay accoidingIy ievise,
The nonlhIy iepaynenl scheduIe.
The naluiily of lhe Ioan
The piincipaI payalIe keeping lhe nonlhIy iepaynenl conslanl vilh lhe exlended
naluiily oi enhanced nonlhIy iepaynenl.

To iIIusliale:
Maluiily of lhe Ioan - 15 yeais
MonlhIy iepaynenl - USD 2OOO
Inleiesl iale - 7.5
If lheie is an upvaid novenenl in lhe index and lhe inleiesl iale is ievised lo 8foIIoving
ievisions aie possilIe:
Oplion I: MonlhIy iepaynenl scheduIe can le ievised as USD 21OO lo acconnodale
lhe incieased inleiesl expenses vilhoul ievising lhe naluiily peiiod.

7
The return on one-year treasury bills. T-bills are issued by the central bank to finance the funds requirement
of the government. The yield on T-bills is often used as a proxy for risk-free rate of return.
35
Oplion II: Maluiily of lhe Ioan can le ievised lo 16 yeais inslead of 15 yeais vilhoul
changing lhe nonlhIy iepaynenl. MonlhIy iepaynenl scheduIe conlinues lo le al USD
2OOO and incieased inleiesl expenses have lo le nel ly enhancing lhe naluiily fion 15
yeais lo 16 yeais.
Oplion III: IiincipaI Ioan anounl can le ievised lo acconnodale lhe addilionaI inleiesl
expenses. AccoidingIy eilhei lhe iepaynenl oi lhe naluiily of lhe Ioan has lo le ievised.

Lendeis keep a naigin lhal is added lo lhe index. The naigin ienains conslanl liII lhe
noilgage is Iiquidaled. Lendeis liy lo nake ARMs alliaclive lo lhe loiioveis ly offeiing
Iovei inleiesl iales foi lhe fiisl yeai of lhe noilgage. SulsequenlIy lhe ARM viII le
adjusled lo iefIecl lhe cuiienl index. The Iovei iale offeied lo lhe loiioveis aie knovn as
'leasei iale.

Using ARMs Iendeis shifl lheii inleiesl iale iisk of hoIding noilgage Ioans fion lhenseIves
lo loiioveis. Lendeis aie exposed lo a highei anounl of iisk in ARMs.
Conpaiing vilh fixed iale noilgages, ARMs yieId Iessei inleiesl incone duiing
peiiod of decIining inleiesl iales.
ARMs have highei iale of defauIl iisk due lo:
Loan- lo-vaIue ialios aie highei foi ARMs lhan fixed iale noilgages
ARMs aie noie fiequenlIy used ly fiisl line luyeis.

The deIinquency iales nay gel voise if lhe iepaynenl scheduIe is ievised upvaid due lo
inciease in lhe inleiesl iales. Since lheie nay nol le any inciease in lhe loiioveis
36
disposalIe incone lo neel lhe incieased inleiesl paynenls in lhe noilgage Ioans lheie viII
le a possiliIily of defauIl iisk.

In a conpelilive naikel, loiioveis have lhe fieedon lo decide lhe lype of noilgage lhey
piefei. Theii piefeience depends on lhe anlicipaled novenenls of inleiesl iales. When lhe
inleiesl iales lend lo nove upvaid, loiiovei piefeis fixed iale noilgage. If lhe naikel
expeclalions aie olheivise, i.e., inleiesl iales aie expecled lo faII, lhe loiiovei piefeis lo opl
foi ARM. Lendeis on lhe olhei hand nay piefei ARMs vhen lhe inleiesl iales aie expecled
lo nove up so lhal lhey can Ieveiage lheii cosl of funds in a lellei nannei.
2.1.1.25ccnnd Mnrtgagc !nans

oiioveis, vho have aIieady avaiIed lhe fiisl noilgage Ioan againsl lhe piopeily, nay iaise
addilionaI Ioan againsl lhe sane piopeily. In lhe evenl of foiecIosuie
8
, lhe Iendei has lhe
suloidinaled cIain
9
lo lhis piopeily.

2.1.1.3Hnmc EquIty !nans / 5ccnnd mnrtgagc !nans
Undei lhis schene, loiiovei aIieady ovning a piopeily noilgages il foi avaiIing
ciedil faciIily. Lendei sanclions a ievoIving Iine of ciedil oi fixed Iunp sun ciedil on lhe
coIIaleiaI of lhe piopeily. This Iine of ciedil can have a fIexilIe iepaynenl scheduIe and if il
is vilh a fixed ciedil Iine loiiovei can viile cheques up lo lhe equily Ioan anounl
appioved. If il is a fixed Iunp sun disluisenenl, il can le iepaid in agieed nunlei of
inslaIInenls.


8
Repayment happening before the scheduled maturity date.
9
The right to claim against property is junior in hierarchy to the first claim holders right.
37
Since loiiovei has offeied lhe hone as coIIaleiaI, lhe Iendei is piepaied lo aIIov such Ioans
al cheapei inleiesl iale. Inleiesl chaiged on such Hone Lquily Loans nay le lax deduclilIe
unIike olhei consunei Ioans.

To iIIusliale, cuslonei has an assel vaIued al USD 5OO,OOO. This assel is noilgaged and lhe
Iendei sanclions a Iine of ciedil of USD 4OO,OOO (8O of lhe naikel vaIue of lhe assel).
Ciedil can le sanclioned eilhei
AIIoving a fixed Iunp sun disluisenenl lo lhe loiiovei
o Wilh a fIexilIe iepaynenl oi
o Wilh a fixed iepaynenl oi
AIIoving lhe loiiovei lo viile cheques vhenevei iequiied suljecl lo lhe naxinun
Iine of ciedil sanclioned.
2.1.1.3a Rcpaymcnts

MonlhIy iepaynenls of noilgages depend on lhe size of lhe Ioan, lhe inleiesl iale and lhe
naluiily. WhiIe fixing lhe nonlhIy noilgage paynenls lvo faclois aie lo le Iooked inlo:
Inleiesl Rale
Yeais lo naluiily
MonlhIy noilgage paynenl incieases as lhe inleiesl iales aie incieasing. InveiseIy as lhe
yeais lo naluiily incieases, foi exanpIe fion 1O lo 2O yeais, nonlhIy noilgage paynenl
decieases.

Moieovei, if lhe nonlhIy noilgage paynenl is exanined in delaiI, ve nay olseive lhal lhe
anounl appiopiialed lovaids inleiesl poilion is noie lhan lhe anounl appiopiialed
38
lovaids piincipaI duiing lhe eaiIy yeais of a noilgage Ioan. The Iendeis eain noie inleiesl
incone duiing lhe eaiIy yeais of lhe noilgage Ioans. This is iIIuslialed undei TalIe No.II
given leIov:
Tab!c II
MORTGAGE LOAN REPAYMENT 5CHEDULE
LOAN AMOUNT: USD 1OO,OOO
INTLRLST: 7.5
RLIAYMLNT ILRIOD 3O YLARS
MONTHLY IAYMLNT: USD 7OO
IROM 1
ST
TO 12
TH
MONTH
Monlh Inleiesl IiincipaI aIance
1 625 75 99,3OO
2 621 79 98,6OO
3 616 84 97,9OO
4 612 88 97,2OO
5 6O7 93 96,5OO
6 6O3 97 95,8OO
7 599 1O1 95,1OO
8 594 1O6 94,4OO
9 59O 11O 93,7OO
1O 586 114 93,OOO
11 581 119 92,3OO
12 577 123 91,6OO

Iion lhe alove lalIe il can le olseived lhal lhe poilion appiopiialed lovaids inleiesl is
noie duiing lhe eaiIy yeais of lhe noilgage Ioan.

2.1.1.3bMaturIty

If lhe nonlhIy noilgaged paynenls aie Iov, lhe lolaI cosl of funds is highei vilh Iongei
naluiilies as conpaied lo shoilei naluiilies vilh highei nonlhIy paynenls.
This can le iIIuslialed as foIIovs :


39

Table III
Inleiesl Rale Maluiily Anoilized nonlhIy
paynenls
TolaI Inleiesl IayalIe
7.5 1O yeais 1,187.O2 42,442
7.5 3O yeais 699.21 151,715
1O 1O yeais 1,321.51 58,581
1O 3O yeais 877.57 215,925

Theiefoie foi a noilgage of USD 1OO,OOO vilh lhe naluiily of 3O yeais al 1O, loiiovei
pays an inleiesl of USD215,925. Ioi lhe sane anounl lul vilh shoilei naluiily of 1O yeais,
loiiovei pays USD 58,581 as Inleiesl.

2.1.1.4 Mnrtgagc Insurancc
Lendeis nay ieduce lheii iisk ly advising lheii loiioveis lo covei lheii Ioans vilh piivale
mnrtgagc Insurcrs.
Mnrtgagc Insurcrs issues financiaI guaianlee lhal insuies lhe Iendeis againsl Ioss in
lhe evenl a loiiovei defauIls on a noilgage. The insuiei consideis cIain fion
Iendei onIy aflei Iendei has cIosed oul aII avenues incIuding foiecIosuie. If lhe
loiiovei defauIls and lhe Iendei lake lilIe lo lhe piopeily, lhe noilgage insuiei
(MCIC, foi exanpIe) ieduces oi eIininales lhe Ioss lo lhe Iendei. In effecl, lhe
noilgage insuiei shaies lhe iisk of Iending lhe noney lo lhe loiiovei. (Moilgage
insuiance shouId nol le confused vilh noilgage Iife insuiance, vhich piovides
coveiage in lhe evenl of a loiiovei's dealh, oi honeovnei's insuiance, vhich
piolecls lhe honeovnei fion Ioss due lo danage fion fiie, fIood oi olhei disaslei.)
Moilgage Ioans lhal aie insuied ly IedeiaI Housing Adninislialion (IHA) oi guaianleed
ly Veleians Adninislialion (VA) aie knovn as goveinnenl-lacked oi goveinnenl insuied
noilgages.
40
A noilgage insuied ly lhe Fcdcra! HnusIng AdmInIstratInn:
TypicaIIy, IHA noilgages iequiie sonevhal Iovei dovn paynenl and Iess
sliingenl quaIificalion iequiienenls. The loiiovei pays a ieIaliveIy high noilgage
insuiance pieniun, vhich can le paid nonlhIy oi added lo lhe lolaI Ioan anounl.
VA mnrtgagc
Il is a iesidenliaI noilgage nade lo an eIigilIe niIilaiy veleian. The Ioan is
guaianleed ly lhe Depailnenl of Veleians Affaiis lo piolecl lhe Iendei againsl Ioss
in lhe evenl of defauIl.

Those noilgages, vhich aie nol insuied, aie knovn as 'cnnvcntInna! mnrtgagc !nans'.

2.1.2 Nnn Mnrtgagc Prnducts
Consunei ciedil is ieceiving good iesponse vilh lhe lanking secloi and lhe lolaI anounl of
ciedil undei lhis segnenl is iepoiled as USD 2.162 TiiIIion (}anuaiy 2OO6). ConneiciaI
anks aie hoIding lhe najoi shaie of 33 of lolaI ciedil undei consunei ciedil. IinanciaI
conpanies, Savings inslilulions and olhei ciedil unions aie hoIding lhe ienaining shaie.
Consunei ciedil ieIales lo Ioans lo individuaIs foi peisonaI househoId expenses oi foi
faniIy expenses. Consunei ciedils aie foining lhe najoi chunk undei RelaiI anking.

Consunei ciedil naikel is highIy conpelilive vilh iegaid lo inleiesl iales, fIexilIe
iepaynenl scheduIe and quanlun of Ioan anounl. Sone of lhe Iendeis aie aIso offeiing
non-ciedil seivices Iike insuiance covei foi aulonoliIes, accidenl covei foi liaveIeis,
discounl on consunei duialIe puichases and cash discounl on ceilain puichases.
41

Consunei ciedils aie noie piofilalIe foi lhe Iending inslilulions lhan coipoiale oi lusiness
Ioans lecause of inleiesl iale diffeienliaIs. In lusiness Ioans vheie coipoiale viII laigain
foi a lellei Iending iale, in consunei ciedils lheie is no such piessuie on lhe Iending
inslilulions on inleiesl spieads.

Consunei ciedils can le eilhei ievoIving oi non-ievoIving depending on lhe puipose of lhe
Ioan.

2.1.2.1Revolving credits: These are open-end credit where borrower has a line of credit up
to certain amount. Repayment schedules are flexible not having a definite maturity.
Borrower can draw up to the line of credit approved at the required time and pays interest
only for the amount he has drawn. The borrower need not pay the entire amount to continue
availing the facility. He can pay the minimum amount required to be paid or just pay the
interest on the amount previously withdrawn and continue with the facility. Most of the
consumer credits are opened ended in which the borrower may avail the credit for purchase
of travel tickets, meeting medical expenses, buying durable goods and services. Borrower
may not be in a position to offer any collateral for these products. 37.2 of consunei ciedils
aie undei ievoIving calegoiy. Ciedil caid faciIilies aie exanpIes of ievoIving ciedils.

2.1.2.2CrcdIt cards
Caid is one of lhe lasic consunei Iending pioducl lanks aie pioviding lo lheii cusloneis.
In 2OOO, lheie veie aloul 9OOO niIIion ciedil caids in lhe US. Lach aduIl vas hoIding an
42
aveiage of 4 caids. anks concenliale noie on nass naikeling of lhis pioducl ly nass
naiIings of appIicalion foins lo gioup of cilizens on lhe lasis of dala avaiIalIe vilh ceilain
agencies. On ieceipl of lhe appIicalion foin, ank evaIuales each appIicanl on lhe lasis of
lhe 'ialing noduIe deveIoped ly lhe individuaI lank. Once lhe cuslonei is ialed
accoiding lo lheii ialing syslen, lank issues lhe ciedil caid fixing lhe ciedil Iinil lo lhe
caidhoIdeis.

Ciedil caids aie used ly cusloneis foi puichasing goods and seivices on ciedil and lo diav
noney up lo lhe peinissilIe diaving Iinil (knovn as lhe cash Iinil). These caids aie aIso
knovn as IIaslic noney. This is one of Iucialive seivices exlended ly nosl of lhe lanks as
an addilionaI faciIily lo lheii cusloneis.

2.1.2.2.1 P!aycrs Invn!vcd In CrcdIt Card busIncss:
IssuIng Bank
Issuing lank is a lank oi any financiaI inslilulion lhal issues ciedil caids. They aie
nenleis of sone ciedil caid paynenl nelvoiks IikeVisa, Mas|crCard , Anex, elc.

Cardhn!dcr
The caidhoIdei is lhe cuslonei - soneone vho an issuing lank deens ciedilvoilhy
enough lo exlend ciedil up lo a piesciiled Iinil.

Mcrchant
A lusiness oiganizalion lhal has a neichanl accounl foi accepling ciedil caids. Lven
lhough leing idenlified as "lhe neichanl" in lhe ciedil caid indusliy, lhis lein
43
ieaIIy iefeis lo lhe lusiness, nol lhe ovnei lhough lhey nay le lhe sane in lhe case
of a soIe piopiieloiship concein.

AcquIrIng Bank
The lank, vhich appioves a neichanl foi accepling ciedil caids, and lhen coIIecls
lhe neichanl's onIine paynenls. Acquiiing anks aie usuaIIy nenleis of lhe Visa
and Mas|crCard Associalions.

Indcpcndcnt 5a!cs OrganIzatInn (I5O)
A lhiid-paily conpany lhal piovides seivices lo neichanls on lehaIf of lhe
acquiiing lank. These seivices incIude neichanl accounls, funds piocessing, and
accounl aclivily iepoiling.

AssncIatInn
Visa and MasleiCaid aie acluaIIy associalions of nenlei lanks and financiaI
inslilulions. The associalions specify nenleiship iuIes, lul do nol issue ciedil
caids, lhe nenleis issue lhe caids. Ancrican |xprcss, Discctcr, and Dincr's C|uo aie
singIe coipoialions and nol associalions, and lhey issue lheii ovn caids.

Paymcnt Gatcway
A paynenl galevay aulhenlicales lhe pailies invoIved and acls as a channeI foi
handIing ciedil caid liansaclions fion lhe neichanl lo a paynenl piocessoi

Paymcnt Prnccssnr
An oiganizalion / conpany lhal nanages lhe piocess of liansfeiiing aulhoiized and
capluied ciedil caid funds lelveen diffeienl financiaI accounls.

2.1.2.2.2 Issuancc nf CrcdIt Cards
44
On the basis of credit information report submitted by the Credit Bureau, issuing bank issues
card to the customer on the basis of the credit history.

anks have lhiee lypes of aiiangenenls foi issuing caids, vhich aie as foIIovs:
1. ank issues lheii ovn caids, nainlaining lhe caidhoIdeis accounl, liIIing and
coIIecling lhe paynenls. ank independenlIy nanaging lhe enliie opeialions ieIaling
lo lhe caid lusiness. LxanpIe, Cili ank issuing ils ovn ciedil caid and
independenlIy nanaging lhe enliie opeialions. ank of Aneiica IIalinun caid
enliieIy nanaged ly lhe lank independenlIy.
2. Undei second lype of aiiangenenl, one lank acls as a Iiniled agenl foi lhe piincipaI
lank. IiincipaI lank issues lhe caid, caiiies lhe luIk of lhe ciedil and peifoins olhei
funclions Iike liIIing and coIIecling lhe paynenl. Agenl lanks aie lo eslalIish lhe
accounls of lhe neichanl accounls (ielaiI oulIel /eslalIishnenls) and accepl lhe
neichanl saIes diafls. Agenl lank is eIigilIe foi a shaie in lhe connission eainings
vilhoul any najoi inveslnenl in infiasliucluie. AII piocessing viII le done al lhe
piincipaI lank. LxanpIe, ank of Texas Visa Check caid. In lhis case, ank of Texas
in associalion vilh Visa USA issues ciedil caids. Visa USA nanages lhe enliie syslen
and ank of Texas acls as a Iiniled agenl. In Oichaid ank Maslei Caid, Oichaid
ank has a lie up aiiangenenl vilh Maslei Caid Associalion. Maslei Caid nanages
lhe enliie lusiness foi Oichaid ank.
3. Undei lhiid lype of aiiangenenl, ank issues lheii ovn caids in associalion vilh
olhei eslalIishnenls Iike liaveI and enleilainnenl agencies, shopping cenleis elc.
CaidhoIdei can use lhe caid up lo lhe slipuIaled anounl and lhe lank viII iecovei
45
paynenl eilhei innedialeIy oi as pei lhe aiiangenenl. y lhis aiiangenenl lolh lhe
eslalIishnenl and lhe lank aie alIe lo inciease lheii voIune of lusiness.
Ioi exanpIe, Chase in associalion vilh ConlinenlaI AiiIines is offeiing ciedil
caid vilh aulonalic liaveI accidenl insuiance up lo USD 5OO,OOO.

2.1.2.2.3 Purchase Authorization Flow
These aie lhe delaiIed sleps foi lhe aulhoiizalion of a puichase ly a caidhoIdei.

1. A cuslonei iniliales a liansaclion ly pIacing an oidei in a shop using a ciedil
caid.
2. The shop sends lhe liansaclion infoinalion lo lhe neichanl's paynenl
galevay. The info incIudes lhe sloie's idenlificalion info, lhe cuslonei's nane and
addiess info, and lhe anounl of lhe puichase.
3. The paynenl galevay checks ils dalalase lo see vhich acquiiing lank/ISO lhe
sloie.
4. The galevay sends lhe liansaclion infoinalion lo lhe acquiiing lank's
paynenl piocessoi.
5. The paynenl piocessoi exanines lhe cuslonei's ciedil caid nunlei lo
deleinine lhe issuing lank.
6. The paynenl piocessoi sends lhe cuslonei infoinalion and liansaclion
anounl lo lhe issuing lank.
7. The issuing lank checks lo see if lhe cuslonei infoinalion is vaIid and if lheie
is enough ciedil in lhe accounl lo covei lhe liansaclion. Al lhe sane line, il
veiifies lhal lhe liIIing addiess on lhe oidei nalches lhe liIIing addiess on fiIe foi
lhe ciedil caid (lhis is caIIed Addiess Veiificalion Seivice).
46
8. If lhe accounl is vaIid and lheie is enough ciedil and lhe addiess is veiified, lhe
issuing lank sends an aulhoiizalion code lack lo lhe paynenl piocessoi and puls
a hoId on lhe funds in lhe cuslonei's accounl.
9. If lhe accounl is nol vaIid oi lheie isn'l enough ciedil lo covei lhe liansaclion oi
lheie is a piolIen vilh lhe liIIing addiess, lhe issuing lank sends a "liansaclion
decIined" nessage lack lo lhe paynenl piocessoi.
1O. The paynenl piocessoi sends lhe aulhoiizalion code (oi decIined nessage)
lack lo lhe paynenl galevay.
11. The paynenl galevay sends lhe aulhoiizalion code (oi decIined nessage) lack
lo lhe shop.
12. The shop dispIays a ieceipl lo lhe cuslonei if lhe liansaclion vas aulhoiized,
oi a "piolIen" nessage if decIined.
13. The shop iecoids lhe oidei as "aulhoiized" in lhe sloie's oideis dalalase.

2.1.2.2.4 Capture and Settlement Flow

Iiocess foi a liansaclion lo le capluied and sellIed:

1. When lhe neichanl cIicks lhe iII Oideis lullon in lhe sloie lo "capluie" lhe
funds, lhe sloie sends lhe capluie infoinalion lo lhe neichanl's paynenl
galevay. The infoinalion incIudes lhe sloie's idenlificalion, lhe liansaclion
nunleis and aulhoiizalion codes lhal veie ieceived lack fion lhe issuing lank,
and lhe anounl of lhe liansaclions.
2. The paynenl galevay checks ils dalalase lo see vhich acquiiing lank lhe sloie
uses, vhich leIIs il vhich paynenl piocessoi lo send lhe capluie iequesl and
infoinalion lo.
3. The paynenl galevay sends lhe infoinalion lo lhe paynenl piocessoi.
4. The paynenl piocessoi exanines each lhe infoinalion foi each liansaclion lo
deleinine vhich issuing lank lo send il lo. Renenlei lhal aII of lhe oideis veie
47
pIaced in lhe sane sloie, lul lhey veie piolalIy aII chaiged lo diffeienl ciedil
caids.
5. The paynenl piocessoi foivaids lhe infoinalion lo lhe issuing lanks.
6. The issuing lank liansfeis funds lo lhe acquiiing lank. This is caIIed sellIing.
7. The acquiiing lank/ISO deposils lhe noney in lhe neichanl's IocaI accounl,
ninus lhe discounl iale and liansaclion fee. This piocess couId lake fion lvo
days lo lvo veeks, depending on lhe poIicies of lhe acquiiing lank/ISO.

CaidhoIdei can use lhis caid foi lhe puipose of diaving cash aIso in addilion lo puichase of
goods and seivices. Cash diavings aie aIIoved up lo a piesciiled Iinil. Caid issuing
lanks foin a gioup and offei lhe caidhoIdei lo use lhe ATM faciIilies of lhe olhei nenleis
of lhe gioup. Ioi exanpIe, Union ank of CaIifoinia can have an aiiangenenl vilh Cili
ank lheiely Union ank of CaIifoinia caidhoIdeis aie aIIoved lo use lhe Cili ank ATM
unils foi diaving funds fion lheii accounl. In lhis case, Cili ank nay chaige a fee fion
lhe caidhoIdei foi using lheii infiasliucluie.

Sone of lhe lanks aie issuing ciedil caids vilh lhe phologiaph of lhe caidhoIdeis.

anks aie Iooking foivaid lo inciease lheii ciedil caid lusiness since il enhances lhe
visiliIily of lhe lanks seivices and lanks aie aIso alIe lo inpiove lheii incone lhiough:

1. CoIIeclion of annuaI fees- (sone of lhe lanks aie nol chaiging annuaI fees
piesenlIy).
48
2. Inleiesl incone foi lhe deIayed paynenls ly lhe caidhoIdei. Since lhe
caidhoIdei is halilualed vilh lhe usage of ciedil caid he oi she uses lhe caid as a
convenienl nelhod of nanaging lheii Iiquidily posilion.

2.1.2.3 Nnn-rcvn!vIng crcdIts: These Ioans aIvays have a pie defined iepaynenl scheduIe
and fixed naluiily. Such Ioans lhal aie having a fixed naluiily aie knovn as 'cIosed end
Ioans oi lein Ioans. Lending inslilulion fixes lhe naxinun Iinil foi lhe ciedil, iepaynenl
peiiod, inslaIInenls and lhe inleiesl iale. Once lhe loiiovei pays lack lhe ciedil, lhis
accounl is exlinguished. AulonoliIe Ioans, educalion Ioans aie sone of lhe exanpIes of
non-ievoIving ciedils.

2.1.2.3.1AutnmnbI!c !nan
|ca|urcs.
Ciedil can le sanclioned foi puichase of oId oi nev cais. Loan anounl can le up lo 9O of
lhe vaIue of cai and il can le noie lhan 9O in ceilain eIigilIe cases. Repaynenl peiiod of
lhe Ioan is fixed as sevenly-lvo nonlhs oi noie. In case of such Iong-lein Ioans, lhe
naikel vaIue of cai nay go dovn duiing lhe Ialei pail of lhe Ioan peiiod (due lo veai and
leai). If a loiiovei piefeis lo seII lhe cai duiing lhe Ioan peiiod, he is iequiied lo fiisl
payoff lhe Ioan and lhen seII lhe cai. He is nol peinilled lo seII lhe cai vilh lhe Ioan
oulslanding.

49
Ceilain lanks enlei inlo rcpurchasc agrccmcnt vilh lhe loiiovei ly vhich lhe lank
iepuichases lhe cai fion lhe loiiovei. Repuichase agieenenl nay slipuIale specific
condilions on lhe nainlenance of lhe vehicIe Iike niIeage and veai and leai.

Like noilgage Ioans, aulonoliIe Ioans aIso can le 'oo|ed and securltlted. Securltltatlon
is lhe issuance of a dell insliunenl in vhich lhe pionised paynenls aie deiived fion
ievenue geneialed ly a defined pooI of Ioans. The 'oo| of |oans incIude noilgage Ioans,
ciedil caid Ioans, aulonoliIe Ioans and Ioans lo lusiness. ank decides vhich of lhe Ioans,
eilhei noilgage oi ciedil caid oi aulonoliIe oi lusiness aie lo le pooIed. Ioi exanpIe,
pooIing can le done eilhei laking oul Ioans having conpIeled a fixed peiiod oi on lhe lasis
of lhe iesiduaI naluiily oi on lhe lasis of oveidue oulslanding. The Iendei seIIs lhese
pooIed Ioans lo a luyei vho issues a dell insliunenl coveiing lhe discounled vaIue
1O
of
such Ioans. y lhis piocess, lhe Iendei is alIe lo inciease lheii Iiquidily posilion and focus
on nev pioducls.

2.1.2.3.2 LcasIng
Leasing is an aIleinale pioducl foi financing langilIe assels such as aulonoliIes, aiiIineis
and ships. A Iease is a conliacl lhal enalIes lhe usei (Iessee) lo secuie lhe use of a langilIe
assel ovei a specified peiiod of line ly naking paynenl lo lhe ovnei (Iessoi). ank is
knovn as 'Lessor, vho hoIds lhe lilIe of lhe assel. This assel is Ieased lo lhe cuslonei
knovn as '|essee, vho has physicaI conlioI of lhe Ieased assel. Since lhe Icsscc is using lhe
assel, he is iesponsilIe foi nainlenance of lhe assel.

10
The value of payments expressed in terms of currency of the current purchasing power i.e. what is the value
of such loans as on today.
50

ank (|csscr) al lhe line of piocessing lhe appIicalion liies lo find oul vhelhei lheii
cuslonei (|csscc) is in a posilion lo nainlain lhe Ieased assel in piopei condilion. Al lhe end
of lhe Iease lein oi in lhe evenl of defauIl lhe Iessoi nusl le alIe lo iecovei lheii dues ly
disposing of lhe assel. If lhe Iessee is nol nainlaining lhe assel piopeiIy, lhe iesaIe vaIue of
lhe Ieased assel nay nol le equivaIenl lo lhe Ioan anounl. Hence piopei caie lo le laken ly
lhe lanks in seIecling lheii cuslonei undei Ieasing finance.

Leasing finance can le of lvo lypes:
a) Open ended
l) CIosed ended

a) Open ended Iease:
Al lhe end of lhe Iease peiiod, lhe lank has lhe iesponsiliIily of seIIing lhe vehicIe. If lhe
saIe piice of lhe 'Ieased vehicIe is Iessei lhan lhe Ieased anounl, cuslonei has lo pay lhe
diffeience. If lhe eslinaled vaIue of lhe 'Ieased vehicIe is aiound USD 25,OOO and lhe
condilion of vehicIe al lhe line of ieluin is USD2O,OOO, lhe Iessee is IialIe lo pay USD 5,OOO
lo lhe Iessoi VaIualion of lhe 'Ieased vehicIe is deleinined ly an independenl appiovei.
The fees incuiied foi vaIualion lo le paid ly lhe Iessee. If lhe appioveis vaIualion of lhe
'Ieased vehicIe is noie lhan lhe iesiduaI vaIue, Iessee ieceives lhe diffeience fion lhe
Iessoi.

l) CIose-ended Iease:
51
Undei lhis schene, lhe lank assunes lhe iisk of lhe naikel vaIue leing Iess lhan lhe
iesiduaI vaIue of lhe assel. MonlhIy paynenls foi cIosed ended Ieases aie highei lhan lhe
open-ended Ieases lecause of lhe iisk of naikel vaIue leconing Iess lhan lhe iesiduaI vaIue
of lhe assel al lhe end of lhe Iease peiiod. Hovevei lheie is one advanlage foi lhe lanks.
Since lhey ovn lhe vehicIe lhey aie eIigilIe foi lax lenefil in lhe foin of depiecialion.
NalionaI lanks nusl have insuiance on lhe iesiduaI vaIue
11
of cIosed-end Ieases.

2.1.2.4 Credit Scoring in US Retail Markets

Sone of lhe Ieading ciedil ialing agencies Iike Lxpeiian, Lquifax and Tiansunion in US
piovide infoinalion lo anyone vilh vhal is consideied a peinissilIe puipose.

2.1.2.4.1 What InfnrmatInn Is Inc!udcd?
Pcrsnna! InfnrmatInn: ConpiIed fion ciedil appIicalions you've fiIIed oul, lhis
infoinalion noinaIIy incIudes youi nane, cuiienl and iecenl addiesses, SociaI Secuiily
Nunlei, dale of liilh, and cuiienl and pievious enpIoyeis.

CrcdIt hIstnry: The luIk of youi ciedil iepoil consisls of delaiIs aloul ciedil accounls lhal
veie opened in youi nane oi lhal Iisl you as an aulhoiized usei (such as a spouse's ciedil
caid). Accounl delaiIs, vhich aie suppIied ly ciedilois vilh vhich you have an accounl,
incIude lhe dale lhe accounl vas opened, lhe ciedil Iinil oi anounl of lhe Ioan, lhe paynenl
leins, lhe laIance, and a hisloiy lhal shovs vhelhei oi nol you've paid lhe accounl on line.
CIosed oi inaclive accounls, depending on lhe nannei in vhich lhey veie paid, slay on
youi iepoil foi 7 lo 11 yeais fion lhe dale of lheii Iasl aclivily.

InquIrIcs: Ciedil iepoiling agencies iecoid an inquiiy vhenevei youi ciedil iepoil is
shovn lo anolhei paily, such as a Iendei, seivice piovidei, IandIoid, oi insuiei. Inquiiies
ienain on youi ciedil iepoil foi up lo lvo yeais.

11
The value of the leased asset as at the end of the lease period
52

Pub!Ic rccnrds: Malleis of pulIic iecoid ollained fion goveinnenl souices such as couils
of Iav -- incIuding Iiens, lankiuplcies, and oveidue chiId suppoil -- nay appeai on youi
ciedil iepoil. Mosl pulIic iecoid infoinalion slays on youi ciedil iepoil foi 7 yeais.


What Is Nnt Inc!udcd?
A ciedil iepoil does nol incIude infoinalion aloul youi checking oi savings accounls,
lankiuplcies lhal aie noie lhan 1O yeais oId, chaiged-off oi dells pIaced foi coIIeclion lhal
aie noie lhan seven yeais oId, gendei, elhnicily, ieIigion, poIilicaI affiIialion, nedicaI
hisloiy, oi ciininaI iecoids. Youi ciedil scoie is geneialed ly infoinalion on youi ciedil
iepoil, lul is nol pail of lhe iepoil ilseIf.

Whn Can Lnnk at Ynur CrcdIt Rcpnrt?
Anyone vilh vhal is consideied a peinissilIe puipose can Iook al youi iepoil. These
conpanies, gioups, and individuaIs incIude:
IolenliaI Iendeis
LandIoids
Insuiance conpanies
LnpIoyeis and polenliaI enpIoyeis (usuaIIy onIy vilh youi viillen consenl)
Conpanies you aIIov lo noniloi youi accounl foi signs of idenlily lhefl
Sone gioups consideiing youi appIicalion foi a goveinnenl Iicense oi lenefil
A slale oi IocaI chiId suppoil enfoicenenl agency
Any goveinnenl agency (aIlhough lhey nay le aIIoved lo viev onIy ceilain
poilions)
Soneone vho uses youi ciedil iepoil lo piovide a pioducl oi seivice you have
iequesled
Soneone lhal has youi viillen aulhoiizalion lo ollain youi ciedil iepoil


53
2.1.2.4.2CrcdIt ratIng agcncIcs In U5

ExpcrIan is one of lhe gIolaI infoinalion soIulions conpany. Il heIps oiganizalions use
infoinalion lo ieach nev cusloneis and lo luiId, nuiluie and naxinize Iasling cuslonei
ieIalionships.
They heIp lhe oiganizalions lo undeisland lheii cusloneis cIoseIy so lhal oiganizalions can
iespond noie piofessionaIIy lo lhe individuaI needs and ciicunslances.
They nainlain infoinalion aloul consuneis, hov lhey lehave, aloul lusinesses and hov
lhey peifoin, and aloul naikels and hov lhey aie changing

EquIfax is one of lhe Ieading ciedils iepoiling agencies in lhe Uniled Slales. Il nainlains
infoinalion aloul lhe individuaIs and lheii ciedil hisloiy. This infoinalion is galheied on
an ongoing lasis fion nany souices lhal have exlended ciedil.
Lendeis, enpIoyeis, IandIoids, and olhei seivice piovideis luy lhal infoinalion in lhe foin
of a ciedil iepoil lo heIp lhen in deciding vhelhei lo appiove lhe appIicalion foi a Ioan,
ciedil caid, jol, oi housing, oi lo offei you a pioducl oi seivice al a pailicuIai iale.

TransUnInn offeis pioducls and seivices, as veII as faciIilaling oplions and oppoilunilies,
vhich pionole giealei financiaI heaIlh.

They piovide Coman Otertleu vilh fasl facls. They aIso piovide infoinalion aloul lhe
indusliies caabl|ltles and markets and iepoiling lhe ciuciaI ioIe pIayed ly indusliies in
econonic deveIopnenl undei lndustr Otertleu.





54
2.1.2.5 Deposit products

Deposils aie lhe piine souice of funds foi a lanks enliie Ioan and inveslnenl opeialions.
Lfficiency vilh vhich a lank can noliIize Iov cosl funds and lhe avaiIaliIily of funds al lhe
desiied line foi lhe lanks Iending aclivilies aie lhe lvo najoi faclois lhal viII have diiecl
inpacl on lheii piofilaliIily.

In lhe piesenl conpelilive, deieguIaled fiee enviionnenl a lank has lo offei lhe lesl
inleiesl iale, conpaialiveIy highei, lo alliacl and ielain lhe exisling deposilois and
inveslois. SinuIlaneousIy lhe sane lank has lo offei conpaialiveIy cheapei inleiesl iales
foi lheii loiioveis. Ieifoinance of a lank depends on lheii efficiency in nanaging lolh
lheii deposilois and loiioveis.

anks have a videi iange of deposil pioducls and nosl of lhe pioducls aie designed lo
alliacl a specific segnenl of cusloneis.

ank deposils can le calegoiized inlo coie deposils and puichased deposils. Coie deposils
aie fion lhe ieguIai cusloneis, incIuding lusiness fiins, goveinnenl unils and
househoIds. These Coie deposils piovide a slalIe, Iong-lein souice of funds. Coie deposils
aie coveied undei IedeiaI Deposil Insuiance Coipoialion (IDIC) up lo USD 1OO,OOO pei
deposil. In addilion lo inleiesl eainings coie deposils have lhe addilionaI lenefils Iike fiee
checking, convenienl lianch office elc. lhal aie knovn as inpIicil seivice ieluins.
Iuichased deposils aie acquiied fion lhe financiaI naikel ly lhe lanks ly offeiing
conpelilive inleiesl iales. These deposils seive as a Iiquidily ieseive lhal nay le lapped
vhen needed. Iuichased deposils aie of Iaige voIune and nay nol le coveied undei
IedeiaI Deposil Insuiance Coipoialion, vhich coveis deposils onIy up lo USD 1OO,OOO.
Due lo lhe alove ieasons puichased deposils aie noie sensilive lo inleiesl iale iisk and
lank iisk conpaialiveIy lhan lhe coie deposils. If lhe naikel peiceives lhal inveslnenl in a
pailicuIai lank is iisky lecause of lhe decIining piofils, deposilois nay nol invesl vilh lhal
lank lheiely Ieading lo Iiquidily ciunch. To cone oul of lhe Iiquidily ciunch, lhe lank nay
55
le piepaied lo pay a highei iale of inleiesl foi acquiiing fiesh deposils oi piepaied lo ioII
ovei lhe exisling puichased deposils al a highei cosl.

Theiefoie coie deposils and puichased deposils aie having diffeienl iisk and ieluin faclois.

Deposil accounls nay fuilhei le cIassified as denand deposils, snaII line and savings
deposils and Iaige line deposils. Denand deposils hisloiicaIIy doninaled lhe IialiIily side
of conneiciaI lanks. Duiing nid 196Os line and savings deposils exceeded lhe denand
deposils. In 197Os non-deposil loiiovings expanded iapidIy. Nnn-dcpnsIt bnrrnwIngs aie
souices of funds incIude fedeiaI funds, IedeiaI Hone Loan ank loiiovings, lankeis
acceplances, conneiciaI papei and noles and delenluies.

In 198Os inleiesl iales on deposils veie deieguIaled vhich paved lhe vay foi inlioduclion
of innovalive nev pioducls. Due lo lhe Iov IeveI of inleiesls lelveen 199Os and eaiIy 2OOOs
lanks veie conpeIIed lo offei diffeienl noney naikel and inveslnenl insliunenls as an
aIleinale avenue foi inveslois.

2.1.2.5.1DIffcrcnt catcgnrIcs nf dcpnsIts
2.1.2.5.1a Dcmand dcpnsIts
These deposils aie lhose vhich can le vilhdiavn al lhe shoilesl nolice ly lhe cuslonei
eilhei in peison oi ly a lhiid paily designaled ly lhe cuslonei lo le lhe iecipienl of lhe
funds. Denand deposils can fuilhei le cIassified inlo lvo calegoiies:

a) Inleiesl leaiing denand deposils
l) Non-inleiesl loiioving denand deposils

56
2.1.2.5.1a1 Intcrcst bcarIng dcmand dcpnsIts:
a.I) 5avIngs DcpnsIts

Savings deposils aie inleiesl-leaiing deposils lhal do nol have fixed naluiilies. These
deposils can le sel up peiiodicaIIy lo covei ovei-vilhdiavaIs of liansaclions accounls
,knovn as aulonalic liansfei seivice (ATS) oi lo piovide liansaclions funds ly neans of
Iiniled check viiling piiviIeges.

a.II) NcgntIab!c Ordcr nf WIthdrawa! (NOW):

Inleiesl leaiing hyliid checking-savings deposils veie inlioduced duiing 197Os in Nev
LngIand in lhe foin of NcgntIab!c Ordcr nf WIthdrawa! (NOW) accounls. Undei lhis
schene lank has a iighl lo insisl piioi nolice of vilhdiavaI fion lhe cuslonei. Since lhe
nolice iequiienenl is iaieIy exeicised, NOW can le opeialed jusl Iike a checking accounl lo
pay foi lhe puichase of goods and seivices. Due lo lhe passage of Deposiloiy Inslilulions
DeieguIalion Acl of 198O in 1981, NOWs veie peinilled lhioughoul lhe counliy. Hovevei
NOWs aie avaiIalIe lo individuaI consuneis, goveinnenl agencies, non-piofil
oiganizalions and singIe piopiieloiships in vhich lheie is no diffeience lelveen lhe peison
and lhe fiin.

a.III) Mnncy Markct DcpnsIt Accnunts (MMDA)

Wilh lhe passage of Cain-Sl.Ceinain Deposiloiy Inslilulions Acl in 1982, lvo olhei
inpoilanl inleiesl leaiing liansaclion accounls veie inlioduced in US naikel in 1983.
They aie, Mnncy Markct DcpnsIt Accnunts (MMDA) and 5upcr NOWs (5NOW).
MMDAs have no inleiesl iale iesliiclions and aIIov lhe consuneis lo nake up lo six
liansfeis in a nonlh. These accounls veie designed lo conpele vilh Money Maikel MuluaI
Iunds (MMMIs).

a.iv) 5upcr NOWs (5NOW).

57
These deposils offei fIexilIe noney naikel inleiesl iales lul accessilIe via check oi
pieaulhoiized diafl lo pay foi lhe goods and seivices.
In 1986 inleiesl iale iesliiclions on NOWs veie ieIaxed so lhal lheie is no Iongei any
dislinclion lelveen NOWs and SNOWs. SNOWs veie eIigilIe foi fedeiaI deposil insuiance
and suljecl lo ieseive iequiienenls.

To sun up Savings deposils:
Nol having fixed naluiily.
Deposils can le sel up peiiodicaIIy lo covei ovei-vilhdiavaIs (diaving in excess of lhe
laIance avaiIalIe)
Iiovide liansaclions funds ly neans of Iiniled check-viiling piiviIeges.

2.1.2.5.1a2 Nnn-Intcrcst bcarIng dcmand dcpnsIts:
Duiing 1933 lhiough CIass-SleagaII Acl of 1933 inleiesl paynenls veie piohililed on
ieguIai checking accounls. Congiess feaied al lhe line lhal paying inleiesl on innedialeIy
vilhdiavalIe deposils endangeied lank safeIy vhich vas sulsequenlIy found lo have IillIe
suppoil fion ieseaicheis.

Mosl non-inleiesl leaiing denand deposils aie heId ly lusiness fiins, hovevei nany
consuneis loday have noved lheii funds inlo olhei lypes of checkalIe deposils lhal leai
inleiesl.

In 1998 pioposaIs veie ieinlioduced in US Congiess lo aIIov US lanks lo pay inleiesl on aII
denand deposils incIuding lusiness denand accounls. y lhis anendnenl, consunei is
eIigilIe foi inleiesl ieluin foi lheii shoil-lein Iiquidily suipIus.

58
2.1.2.5.1b 5ma!! tImc and savIngs dcpnsIts

2.1.2.5.1b1 CcrtIfIcatc nf DcpnsIts (RctaI!) nr 5avIngs CcrtIfIcatcs

RelaiI CDs, an inleiesl leaiing ieceipl foi deposil of funds in a lank oi non-lank inslilulion,
Iov iisk inveslnenls caiiy a fixed lein and lheie is fedeiaIIy inposed penaIly foi eaiIy
vilhdiavaIs. CDs aie najoi souice of funds foi snaII lanks. RelaiI CDs can le a najoi
souice of funds foi Iaige lanks aIso in case of Iiquidily ciunch.

Inleiesl iale offeied foi CDs veie nol alliaclive. anks have nov innovaled nev pioducls
Iike 'markct-Indcxcd CD'. Undei lhis schene, ieluins aie lased on a naikel index such as
Slandaid & Ioois 5OO oi Chicago oaid of Lxchange Inleinel index. If lhe slock naikel
faIIs in vaIue, deposilois ieceive nininun ieluin on lheii piincipaI upon naluiily.
Advanlages of lhis schene aie:
Inveslois can pailicipale in lhe naikel upsvings
Inveslois aie aIso piolecled fion Iosing lheii oiiginaI inveslnenl capilaI undei
deposil insuiance up lo USD 1OO,OOO.

2.1.2.5.1c Largc tImc dcpnsIts

2.1.2.5.1c1 NcgntIab!c CcrtIfIcatc nf DcpnsIts (NCDs).
Tine deposils vilh denoninalions of USD 1OO,OOO oi noie aie knovn as NegolialIe
Ceilificale of Deposils (NCDs). Laige CDs (}unlo) aie naikelalIe secuiilies vilh a
naluiily peiiod of fouileen days lo eighleen nonlhs. Iiisl NalionaI Cily ank of Nev Yoik
issued lhe fiisl CD in Ieliuaiy 1961, vhich vas sulsequenlIy foIIoved ly olhei deaIeis in
olhei cenleis. VoIune of CD venl up lo lhe IeveI, second lo Tieasuiy liIIs anong lhe
oulslanding noney naikel insliunenls.

When coipoiale denand deposils veie nol ieceiving any inleiesl fion lhe lanks, such
funds veie diveiled lo ConneiciaI Iapei, Tieasuiy iIIs and iepuichase agieenenls vilh
lhe deaIeis. y 1973 inleiesl iale ceiIings veie ienoved on Iaige CDs. IiesenlIy Iaige CDs
59
lecone piinaiy souice of funds foi IialiIily nanagenenl. MoslIy CD inveslois aie non-
financiaI coipoialions.

CeneiaIIy CDs aie issued in denoninalions exceeding USD 1OO,OOO il is nol coveied undei
IDIC. Hence defauIl iisk of lhe issuing lank nay affecl lheii iale of inleiesl on lhese CDs.
60

3. Introduction to Wholesale Banking in the US

WhoIesaIe lanking is aIso knovn as lusiness-lo-lusiness lanking. Il iefeis lo lhe
liansaclions lelveen lanks and Iaige cuslonei Iike coipoiales and goveinnenl invoIving
Iaige suns of noney. Il aIso incIudes lhe liansaclions lelveen lanks. HisloiicaIIy,
conneiciaI lanks focused piinaiiIy on Iaige and nediun-sized lusinesses lecause lhe
aveiage doIIai vaIue of liansaclions (incIuding Ioans) in lhese segnenls vas high. Hovevei,
conpelilive piessuies in lhe US, pailicuIaiIy in lhe conneiciaI ciedil naikel, have
dianalicaIIy aIleied lhe vhoIesaIe lanking enviionnenl. Ioilune 1OOO cusloneis aie going
diieclIy lo lhe capilaI naikels foi funding.


HIgh!Ights nf Whn!csa!c BankIng In U5

Thiily yeais ago, Ioan poilfoIios veie lhe donain of conneiciaI lanks and veie
lheii piinaiy piofil geneialois. Today, lhe conneiciaI lank is onIy one of nany
vhoIesaIe Iendeis in lhe US, and conneiciaI lanks aie shifling lheii focus fion
Iending lo fee-lased liansaclion lusinesses.

In lhe pasl, conneiciaI lanks couId focus lheii effoils on lhe noie piofilalIe Iaige
and nediun-sized lusinesses. Today, nev financing aIleinalives such as non-lank
Iendeis and especiaIIy lhe capilaI naikels aie cannilaIizing conneiciaI financing
oppoilunilies.

Despile lhe conpelilive piessuies, US vhoIesaIe lanks conlinue lo finance an
incieasing anounl of conneiciaI dell. InleieslingIy, conneiciaI Iending conlinues
lo exhilil significanlIy sliongei giovlh lhan ielaiI Iending.

61
As a iesuIl of lhe deveIoped secondaiy capilaI naikels, insuiance conpanies,
goveinnenl agencies, and even coipoialions lhenseIves have essenliaIIy lecone
vhoIesaIe Iendeis. SliiclIy defined, a vhoIesaIe Iendei offeis a slandaid aiiay of
Ioans foi lusinesses in need of financing. Lven ly lhis definilion, lhe vhoIesaIe lank
is sliII onIy one of nany pIayeis in lhe conneiciaI ciedil space.

Changes in lhe sliucluie of lhe financiaI seivices indusliy have nade a nunlei of
capaliIilies such as snaII lusiness Ioan acquisilion and secuiilized assel seivicing
ciilicaI sleppingslones foi lhe vhoIesaIe lanking in lhe nexl niIIenniun.

3.1 Wholesale Banking Products

The ain of WhoIesaIe anking is lo neel iequiienenls of coipoiale cIienls ly offeiing a fuII
iange of lanking pioducls and seivices. WhoIesaIe lanking pioducls and seivices can le
divided inlo lvo calegoiies:

ConneiciaI Ciedil Iioducls
Non-Ciedil Iee ased Seivices

3.1.1 CnmmcrcIa! CrcdIt Prnducts

Mosl of lhe conneiciaI ciedil pioducls aie in lhe foin of Ioans. Loan is a conpiehensive
lein used lo iefei lo lhe vaiious lypes of shoil, nediun and Iong lein ciedil faciIilies nade
avaiIalIe ly lanks. Loan is a conliacluaI agieenenl lelveen lhe loiiovei and lhe Iendei of
lhe funds vhich slales lhe undeiIying leins and condilions such as Ioan anounl,
iepaynenl peiiod, iale of inleiesl, penaI piovisions foi lieach of lhe conliacl, elc.

Theie aie diffeienl lypes of ciedil pioducls offeied ly lanks lo lusinesses foi diffeienl
puiposes. Sone of lhe connon conneiciaI ciedil pioducls aie as foIIovs:
Lines of Ciedil
RevoIving Ciedil
Tein Ioans
62
Lelleis of Ciedil
ank Cuaianlees
iIIs Discounling
Lxpoil-Inpoil Iinance
Iacloiing

We have Ieained aloul lhese lasic ciedil pioducls in lhe geneiic vhoIesaIe lanking
noduIe. These pioducls aie avaiIalIe in US loo vilh noie oi Iess lhe sane geneiic
sliucluie. Hovevei, given lhal lhe capilaI naikels aie veII deveIoped and aie easy lo
access, nosl conpanies (excepl snaII and nediun sized lusinesses) use dell and equily
naikels as a souice of finance. As a iesuIl, lanks focus noie on sliucluied Ioan liansaclions
ialhei lhan on lasic conneiciaI ciedil pioducls.

The lein 'sliucluied finance' neans cuslonized finance vheie lank 'designs oi 'sliucluies
lhe Ioan using vaiious ciedil sliucluies and pioducls.

A lank lakes an exisling piece of dell (lhe 'undeiIying dell') lhal doesn'l quile fil lhe
iequiienenls of lhe lank's invesloi cusloneis - peihaps il's lhe viong cuiiency, oi lhe
ciedil ialing isn'l iighl oi nayle inveslois aie nol peinilled lo hoId il foi ieguIaloiy
ieasons. The lank seIIs lhe undeiIying dell lo anolhei conpany and enleis inlo a svap vilh
lhe conpany lo change lhe cuiiency oi piovide sone foin of ciedil enhancenenl. Nol
suipiisingIy, lhe lank gels a fee foi ils seivices. The conpany issues londs lo lhe invesloi,
secuied on lhe undeiIying dell and lhe svap/ciedil enhancenenl, lhus funding ils
puichase of lhe undeiIying dell fion lhe lank.

Sliucluied Iinance incIudes:
Iiojecl Iinance
Assel ased Iinance
Secuiilisalion
Syndicaled Ioans / CIul Ioans
63
Leasing
Senioi Slielch Iinancing
Second Lien
High YieId Dell
}unioi Secuied Loans
Mezzanine Iinance
Meigei & Acquisilion Iinance

3.1.1.1 Iiojecl Iinance
This is a speciaIized financing pioducl foi Iong-lein piojecls such as consliuclion of a
povei slalion oi a connunicalions nelvoik. UsuaIIy diffeienl lanks speciaIize in diffeienl
lypes of piojecls depending upon lhe piojecl speciaIisls lhey have. Ciedil Suisse Iiisl oslon
(CSI) is lhe Ieading lank in piojecl finance in Noilh Aneiica. Il vas nandaled aiiangei of
$2.2 liIIion of piojecl finance Ioans in Noilh Aneiica duiing 2OO3-O4 giving il a Ieading
shaie of noie lhan 26 of lhe naikel. SiniIaiIy, Ciligioup is lhe Ieading lank pioviding
piojecl finance in Lalin Aneiica.

3.1.1.2 Assel ased Iinance
An asset-based loan is secured by a company's accounts receivable, inventory, equipment,
and/or real estate, whereby the lender takes a first priority security interest in those assets
financed.

When providing asset based finance banks underwrite cash flow as their primary repayment
source. Consequently, they require less security in the form of collateral from the borrower.
However, in order to ensure that the cash flows on which they depend for their repayment are
not endangered they may specify some restrictive covenants on the borrower.

For "asset rich" companies, an asset-based loan may make more funds available because it is
not based strictly on the anticipated levels of cash flow. Additionally, the structure often
requires fewer covenants, providing more flexibility for many borrowers.
64

Asset based financing may be used for working capital requirements, capital expenditures,
turnaround financing, etc.

3.1.1.3 Syndicaled Loans/CIul Loans
Assel-lased financing can le used foi snaII vaIue Ioans. Hovevei foi Iaigei Ioans ($5O
niIIion+) - 'syndicaling oi disliiluling lhe dell anong a gioup of financiaI inslilulions
heIps lo lellei nanage iisk. A syndicaled Ioan is lypicaIIy sliucluied and piiced ly a Iead
aiiangei, oi agenl, vho lhen seIIs poilions of lhe ciedil lo olhei Iendeis oi invesloi gioups
undei leins negolialed ly lhe agenl.

Syndicaling assel-lased deaIs iequiies a pailicuIai sel of skiIIs--coIIaleiaI exans as veII as
nachineiy, equipnenl, and ieaI eslale appiaisaIs. CiilicaI lo syndicalion is lhe iepulalion of
lhe Iead aiiangei and adninislialive agenl.

3.1.1.4 Secuiilisalion
'Secuiilisalion is a financing lechnique lhal invoIves lhe conveision of usuaIIy iIIiquid
assels vilh piediclalIe cashfIovs inlo naikelalIe secuiilies. LssenliaIIy, il is lhe piocess of
ciealing secuiilies lacked ly pooIs of assels vilh lhe secuiilies lhen leing soId lo
inslilulionaI inveslois. Secuiilisalion vas fiisl deveIoped in lhe U.S. in lhe eaiIy 198O's.

A lypicaI Secuiilisalion liansaclion vouId invoIve an enlily (lhe "SeIIei") seIIing a pooI of
assels lo a speciaI puipose vehicIe ("SIV"- leing a liusl oi a conpany). As lhe liansaclion is
geneiaIIy sliucluied as an assel saIe, lhe assels aie ienoved fion lhe SeIIei's laIance sheel.
The SIV, in oidei lo fund lhe puichase, vouId issue noilgage oi assel-lacked secuiilies
("MS/AS") vhich aie soId lo inslilulionaI inveslois in lhe doneslic oi inleinalionaI
capilaI naikels. Inveslois lheiefoie ieIy on lhe cashfIovs fion lhe pooI of assels (and nol
lhe SeIIei) foi iepaynenl of lheii inveslnenl.

Secuiilisalion sepaiales lhe iisks inheienl in any coipoiale finance liansaclion and liansfeis
lhese iisks fion lhe SeIIei lo lhe puichasei of assels.
65

Secuiilisalion aIIovs aInosl any assel, oi pooI of assels, lhal has a ieIialIe, conliacluaI oi
piediclalIe cash fIov lo le iepackaged and soId as dell secuiilies lo inslilulionaI inveslois.
The foIIoving is a Iisl of lhe lypes of assels oi cashfIov slieans lhal have leen secuiilised:

Hone Loans
Aulo Loans
Leases
usiness Loans
ConneiciaI Loans
ConneiciaI ReaI Lslale Loans
RenlaI Slieans
Consunei Loans
RoyaIly Slieans
Coipoiale Loans
Ciedil Caids
Tiade ReceivalIes
Iinance Loans

The SeIIei piovides goods and/oi seivices lo ils cusloneis (lhe "OlIigois") vilh paynenl lo
le ieceived al a Ialei dale and in doing so, cieales an assel. A pooI of assels is lhen soId lo
lhe speciaI puipose secuiilisalion vehicIe ("SIV") vhich funds lhe puichase of lhe ieIevanl
assels ly issuing dell insliunenls lo Inveslois.

To neel invesloi iequiienenls, lhe dell insliunenls aie lypicaIIy sliucluied lo neel lhe
highesl possilIe ciedil ialing IeveIs as piovided foi ly lhe inleinalionaIIy iecognised ialings
agencies. This appioach aIso lenefils lhe SeIIei in lhal lhese highIy-ialed dell insliunenls
alliacl lhe finesl piicing.

66
In geneiaI, lhe ciedil ialing of lhe dell insliunenls is dependenl upon lhe ciedil quaIily of
lhe pooI of assels lo le secuiilised and aIso on lhe ciedil and Iiquidily suppoil piovided lo
lhe SIV.

Ciedil enhancenenl piovides pioleclion foi inveslois againsl Iosses aiising fion lhe non-
peifoinance of lhe assels secuiilised. Liquidily suppoil ensuies lhal lhe SIV viII aIvays le
alIe lo neel lhe lineIy paynenl of ils olIigalions.

The cashfIovs ieceived fion olIigois in iespecl of lhe undeiIying assels aie lhen passed
lhiough lo lhe Inveslois in lhe foin of inleiesl paynenls and lo iepay lhe piincipaI
anounls oulslanding on lhe dell insliunenls issued.
5ccurItIzatInn Prnccss (Up tn Issuc nf Dcbt
Instrumcnts)
Secuiilizalion can le done on a iecouise oi non-couise lasis. In case of secuiilizalion vilh
iecouise lasis, an invesloi/ puichasei can seek paynenl againsl an inveslnenl lo lhe
oiiginaloi of lhe inveslnenl. Hovevei, usuaIIy secuiilizalion is done on a non-iecouise
lasis in vhich case lhe invesloi cannol cIain paynenl on lhe inveslnenl insliunenls fion
lhe oiiginaloi. The invesloi can onIy cIain paynenl fion lhe SIV.

67
3.1.1.5 Leasing
Leasing nay le defined as a conliacluaI agieenenl in vhich lhe ovnei of an assel (aIso
knovn as lhe 'Lessoi) liansfeis lhe iighl lo use lhe assel lo a counleipaily caIIed lhe Lessee
in ieluin foi a peiiodicaI paynenl (caIIed lhe Iease ienlaI). The ovneiship of lhe assel
ienains vilh lhe Iessoi and is nol liansfeiied lo lhe Iessee.

Theie aie foui lypes of Iessois:
anks and lheii affiIiales
"Caplives" (lypicaIIy nanufacluieis' sulsidiaiies)
Independenls (non-affiIialed Iessois foi vhon Ieasing is lhe najoi souice of
ievenue), and
Diveisified financiaI-seivices oiganizalions (such as insuiance conpanies, pension
liusls, oi olhei enlilies foi vhich Ieasing is an addilionaI ievenue souice)

The lvo lasic lypes of Iease pioducls aie finance Ieases, and opeialing Ieases. A finance
Iease is a fuII-payoul, non-canceIalIe agieenenl in vhich lhe Iessee is iesponsilIe foi
nainlenance, laxes, and insuiance. On lhe olhei hand, an opeialing Iease is a shoil-lein
canceIalIe Iease.

In an opeialing Iease, lhe Iessoi (oi ovnei) liansfeis onIy lhe iighl lo use lhe piopeily lo lhe
Iessee. Al lhe end of lhe Iease peiiod, lhe Iessee ieluins lhe piopeily lo lhe Iessoi. Since lhe
Iessee does nol assune lhe iisk of ovneiship, lhe Iease expense is liealed as an opeialing
expense in lhe incone slalenenl and lhe Iease does nol affecl lhe laIance sheel. This lype of
Iease is usuaIIy used foi financing assels Iike conpules, office equipnenls, vehicIes, elc.

In a finance Iease, lhe Iessee assunes sone of lhe iisks of ovneiship and enjoys sone of lhe
lenefils. ConsequenlIy, lhe Iease, vhen signed, is iecognized lolh as an assel and as a
IialiIily (foi lhe Iease paynenls) on lhe laIance sheel. This lype of Iease is used foi financing
capilaI assels vhich aie iequiied foi a Iong -lein.

68
A Iease shouId le liealed as a capilaI Iease if il neels any one of lhe foIIoving foui
condilions:
(a) if lhe Iease Iife exceeds 75 of lhe Iife of lhe assel

(l) if lheie is a liansfei of ovneiship lo lhe Iessee al lhe end of lhe Iease lein

(c) if lheie is an oplion lo puichase lhe assel al a "laigain piice" al lhe end of lhe Iease lein.

(d) if lhe piesenl vaIue of lhe Iease paynenls, discounled al an appiopiiale discounl iale,
exceeds 9O of lhe faii naikel vaIue of lhe assel.

anks usuaIIy piovide foIIoving lypes of Ieases:
Lquipnenl Lease
ReaI Lslale Lease

3.1.1.5 a |quipncn|s |casc
Lquipnenl Ieasing is a nelhod of assel acquisilion and is a ciilicaI eIenenl of capilaI
foinalion in lhe US. The lypicaI equipnenl Ieased incIude heavy nachineiy, nanufacluiing
equipnenls, consliuclion equipnenls, nining equipnenls, elc. Lquipnenl Ieasing offeis a
nunlei of advanlages. Sone of lhese aie:
1OO financing
Iixed inleiesl iales
IossilIe lax lenefils
Iixed paynenls
IIexilIe paynenl leins, usuaIIy 2 lo 7 yeais

Lquipnenl Ieasing is a $2OO liIIion doIIai indusliy in lhe US and 8O of US lusinesses use
equipnenl Ieasing. Acioss lhe U.S., gioving conpanies achieve lheii lusiness goaIs
lhiough equipnenl Ieasing.

3.1.1.5 o Rca| |s|a|c |casc

69
ReaI eslale Ieasing nay invoIve Ieasing lhe Iand, oi luiIding oi lolh Iand and luiIding. ReaI
eslale Iease can le of diffeienl lypes. Il can le gioss oi nel Iease. In case of a gioss Iease lhe
lenanl pays lhe ienlaI and lhe ovnei of lhe Iand/luiIding pays lhe nainlenance, insuiance
and olhei cosls associaled vilh ovning lhe assel. On lhe olhei hand, in case of a nel Iease,
lhe lenanl pays a poilion of lhe ovneiship cosls aIso in addilion lo lhe ienlaI.


3.1.1.6 Senioi
12
Slielch Iinancing

Senioi Slielch is a hyliid financing soIulion lhal faIIs lelveen an assel-lased Ioan and a
cash fIov Ioan. AIso knovn as an "ovei-advance Ioan", il is sliucluied vilh lolh assel-
lased and cash fIov conponenls, pioviding a highei IeveI of Ieveiage and deIiveiing noie
capilaI up fionl lhan cash fIov onIy Ioans. This hybrid loan benefits business owners
because it enables them to raise capital quickly without adding to equity participation in the
company through stock or mezzanine financing.

3.1.1.7 Second Lien

A senioi secuied second Iien voiks in landen vilh an assel-lased Ioan and piovides a
conpany vilh sone Iiquidily vhen olhei capilaI souices nay le Iess accessilIe. Il hoIds lhe
sane iighls and covenanls as a liadilionaI lank Ioan excepl lhal il is second in Iine in leins
of iepaynenl piioiily.

3.1.1.8 High YieId Dell

High yieId dell offeis a highIy fIexilIe and Iess iesliiclive financing aIleinalive foi nany
conpanies. High yieId dell is lypicaIIy used lo neel Iongei-lein fixed iale financing needs

12
The creditor has the highest priority in terms of repayment.
70
ieIaled lo voiking capilaI, iefinancing, iecapilaIizalions
13
, acquisilions, oi capilaI
expendiluies
14
.

High yieId secuiilies aie non-inveslnenl giade dell insliunenls vilh an S&I ialing of +
and leIov oi a Moodys iale of a1 and leIov. High yieId secuiilies aie iegisleied vilh lhe
SLC and connonIy soId lo inslilulionaI inveslois such as pension funds, nuluaI funds, and
insuiance conpanies--vheie a highei IeveI of ciedil iisk and Ieveiage is acceplalIe.

CrcdIt RatIngs
Mnndy's 5&P/FItch Gradc RIsk
Aaa AAA Inveslnenl Highesl
QuaIily
Aa AA Inveslnenl High QuaIily
A A Inveslnenl Sliong
aa Inveslnenl Mediun
a, , Non-
Inveslnenl
SpecuIalive
Caa/Ca/C CCC/CC/C Non-
Inveslnenl
HighIy
SpecuIalive

3.1.1. 9 }unioi Secuied Loans

A junioi secuied Ioan, aIso knovn as lianche Ioan, piovides incienenlaI Iiquidily and
Ieveiage lo loiioveis vho aie lapped oul vilh lheii exisling senioi Iendeis. As a foin of
junioi dell, lianche Ioans aie iiskiei lhan liadilionaI senioi dell and lheiefoie iequiie
highei ieluins.

3.1.1.1O Mezzanine Iinance

13
Change in companys capital structure. RecapilaIizalion is oflen undeilaken vilh lhe ain of naking lhe
conpany's capilaI sliucluie noie slalIe
14
Inveslnenl in fixed assels Iike pIanl and nachineiy, Iand and luiIding, elc.
71
Mezzanine financing is a hyliid of dell and equily financing. Il is geneiaIIy used lo finance
lhe expansion of exisling conpanies. asicaIIy, il is dell capilaI, vilh cuiienl iepaynenl
iequiienenls, lul vilh iighls lo conveil lo an ovneiship oi equily inleiesl in a conpany. Il
is geneiaIIy suloidinaled lo dell piovided ly senioi Iendeis (such as a lank) and is iefeiied
lo as suloidinaled dell. Mezzanine financing is advanlageous in lhal, on lhe laIance sheel
of a conpany, il is liealed Iike equily and nay nake il easiei lo ollain slandaid lank
financing.

Mezzanine financing, leing a hyliid of dell and equily financing, is geneiaIIy nol
coIIaleiaIized. Oflen, lheie is a iepaynenl olIigalion vilh nezzanine financing. Mosl
inslilulions pioviding nezzanine financing aie Iooking foi ieluins of 2O oi highei.

3.1.1.11 Meigei & Acquisilion Iinance

Meigei is defined as lhe coning logelhei of lvo oi noie conpanies and foining a singIe
IegaI enlily. The shaiehoIdeis of lhe neiging conpanies gel conpensaled lhiough
shaiehoIding in lhe neiged enlily on piopoilionale lasis and depending upon lhe
ieIalionship lelveen lhe vaIues of lhe neiging conpany and lhe conpany vilh vhich il is
neiging.

A neigei is oflen financed ly an aII slock deaI (a slock svap). An aII slock deaI occuis vhen
aII of lhe ovneis of lhe oulslanding slock of eilhei conpany gel lhe sane anounl (in vaIue)
of slock in lhe nev conlined conpany.

Acquisilion nay le defined as a fiiendIy lakeovei of one conpany ly lhe olhei. The
acquiiing conpany nay le inleiesled in lhe acquisilion lecause of seveiaI ieasons Iike
slialegic, size, quick giovlh, elc. The acquiiing conpany gels lhe olhei conpany vaIued ly
a lankei and lhen lhe piice is negolialed. Aflei acquisilion, lhe acquiied conpany Ioses ils
idenlily lhough lhe acquiiing conpany nay sliII conlinue vilh lhe liands of lhe acquiied
conpany.

72
An acquisilion can invoIve a cash and dell conlinalion, oi jusl cash, oi a conlinalion of
cash and slock of lhe puichasing enlily, oi jusl slock.
ConneiciaI lanks aie veII posilioned lo acl as Iendeis as veII as advisois in neigeis and
acquisilion aclivilies. anks nay heIp in deleinining lhe appiopiiale piice foi lhe neigei oi
acquisilion, syneigislic gains lhal aie expecled and lhe iisks undeiIying lhe liansaclion.
73

3.1.2 Nnn-CrcdIt Fcc Bascd 5crvIccs

anks aIso offei fee-lased seivices undei lhe unlieIIa of coipoiale lanking lo lheii cIienls.
Sone of lhe connon seivices offeied aie as foIIovs:

Dell CapilaI Maikels Seivices
Lquily Maikel Seivices
Iaynenls and Cash Managenenl

3.1.2.1 Dell CapilaI Maikels Seivices
Undei lhe dell capilaI naikel seivices, lanks offei lhe foIIoving pioducls/seivices lo lheii
coipoiale cIienls:

ConneiciaI Iapei Iiogians
Mediun Tein Noles
Iiivale IIacenenls

3.1.2.1.1 ConneiciaI Iapei (CI) Iiogians
ConneiciaI papei (CI) is a shoil-lein unsecuied pionissoiy nole issued piinaiiIy ly
conpanies lo neel lheii shoil-lein financing iequiienenls. Depending on vhelhei lhe
issuing conpany is a financiaI oi a non-financiaI conpany, conneiciaI papeis aie cIassified
as IinanciaI CIs and Non-IinanciaI CIs. Theie is anolhei calegoiy of CIs aIso knovs as
Assel lacked ConneiciaI Iapei. Assel lacked conneiciaI papei is diffeienl fion a
convenlionaI CI in lhe sense lhal il is secuied.

The naluiily peiiod of conneiciaI papeis nay iange fion 1 nonlh lo 12 nonlhs. These aie
issued al a discounl lo lheii face vaIues and iedeened al lhe face vaIue, lhe diffeience
iepiesenling lhe yieId oi ieluin lo lhe luyei of lhe insliunenl. Ioi exanpIe, if lhe face vaIue
is $ 1OO and lhe issue piice is say $94.6O, lhe diffeience (1OO - 94.6O = 5.4O) iepiesenls lhe
ieluin lo lhe hoIdei. In peicenlage leins, il liansIales inlo 5.7O peicenl (5.4O/94.6O).

74
UsuaIIy CIs aie puichased ly lanks. Hovevei, lanks nol onIy aie lhe luyeis of
conneiciaI papeis lhey aIso acl as Iead aiiangeis and lank agenls foi CI piogians of lheii
coipoiale oi inslilulionaI cIienls.

The lolaI conneiciaI papei oulslanding al lhe end of 2OO5 in US vas $1646 liIIion in
convenlionaI CIs. Oul of lhis, $132 liIIion veie non-financiaI CIs and $1514 liIIion veie
financiaI CIs. In addilion, $926 liIIion assel lacked CIs veie aIso oulslanding.

3.1.2.1.2 Mediun Tein Noles (MTN) Iiogians
Mediun lein noles (MTNs) aie dell insliunenls issued ly conpanies lo iaise finances foi
a nediun lein (2 lo 5 yeais). Il enalIes conpanies lo ieceive dell funding on a conlinuous
lasis. MTNs liidge lhe gap lelveen shoil-lein convenlionaI CIs (naluiily up lo 1 yeai)
and Iong-lein coipoiale dell (naluiilies ianging lelveen 15-3O yeais).

MTN piogians aie deveIoped and soId ly lanks on lehaIf of lhe coipoiale cIienl. These
nay le soId ly lanks on a 'fiin connilnenl lasis oi 'lesl effoil lasis. If il is on 'fiin
connilnenl lasis, il inpIies lhal in case lhe lank is nol alIe lo seII lhe MTNs, il has lo lake
up lhe unsulsciiled poilion. If il is on lesl effoil lasis, lheie is no such olIigalion. anks
chaige a fee foi pioviding lhis seivice.

3.1.2.1.3 Iiivale IIacenenls
Iiivale pIacenenl unIike a pulIic offei foi sulsciiplion lo secuiilies issued ly a conpany,
invoIves issuing of secuiilies piivaleIy lo a seIecled gioup of inveslois vhich nay incIude
high nel voilh individuaIs oi coipoiales.

Il nay le dell piivale pIacenenl oi an equily piivale pIacenenl depending on lhe naluie of
secuiilies vhich aie pIaced.

In lhe Uniled Slales, piivale pIacenenl oflen does nol need lo le iegisleied vilh lhe
Secuiilies Lxchange Connission. A SLC ieguIalion caIIed ReguIalion D goveins piivale
pIacenenl exenplions. Undei lhe Secuiilies Acl of 1933, any offei lo seII secuiilies nusl
75
eilhei le iegisleied vilh lhe SLC oi neel an exenplion. ReguIalion D piovides exenplions
fion lhe iegislialion iequiienenls, aIIoving sone snaIIei conpanies lo offei and seII lheii
secuiilies vilhoul having lo iegislei lhe secuiilies vilh lhe SLC.

WhiIe conpanies using a Reg D exenplion do nol have lo iegislei lheii secuiilies and
usuaIIy do nol have lo fiIe iepoils vilh lhe SLC, lhey nusl fiIe vhals knovn as a "Ioin D"
aflei lhey fiisl seII lheii secuiilies. Ioin D is a liief nolice lhal incIudes lhe nanes and
addiesses of lhe conpanys ovneis and slock pionoleis, lul conlains IillIe olhei
infoinalion aloul lhe conpany.

The vaIue of piivale pIacenenl in US in 2OO4 vas $545 liIIion. Oul of vhich $515 liIIion vas
dell and $3O liIIion vas equily.

3.1.2.2 Lquily Maikel Seivices
The connonIy offeied equily naikel seivices ly vhoIesaIe lanks aie as foIIovs:
Lquily Reseaich
IIOs

3.1.2.2.1 Lquily Reseaich
This is a speciaIized seivice offeied ly lanks. Lquily ieseaich invoIves anaIysis of lhe equily
shaies of a conpany vilh a viev lo nake inveslnenl in lhe sane. Il invoIves idenlifying lhe
slocks vhich aie undeivaIued on lhe lasis of econonic, indusliy and conpany anaIysis.
Thiough equily ieseaich, financiaI and slialegic advice necessaiy foi successfuI assel
nanagenenl is piovided lo lhe cIienls.

A lank offeiing equily ieseaich enpIoys piofessionaIIy quaIified ieseaich anaIysls vho
liack vaiious indusliiaI seclois and vaiious conpanies in each secloi.

3.1.2.2.2 IIOs
IIO oi iniliaI pulIic offeiing invoIves issue of equily shaies ly a conpany lo lhe geneiaI
pulIic. Coipoiales use lhis ioule lo iaise finance vhen lhey have expansion pIans and lhe
76
inveslnenl iequiied is huge. When a conpany goes foi an IIO il has lo fuIfiII ceilain
condilions Iaid dovn ly lhe ieguIaloi iegaiding piicing and discIosuie of infoinalion.
The vhoIesaIe lanking division piovides IIO nanagenenl seivices vheie lhe lank
nanages lhe enliie shov. Il piovides piicing advice, ieguIaloiy conpIiance advice and
naikeling seivices lo lhe conpanys IIO. Wilhoul lhis kind of suppoil, il nay le difficuIl
foi a conpany lo access lhe pulIic equily naikels.
3.2 Payments and Cash Management Services

3.2.1 Cash Managcmcnt 5crvIccs
In Uniled Slales, lanks offei sone speciaIized cash nanagenenl seivices lo Iaige lusiness
cIienls. Sone of lhe connonIy offeied seivices aie as foIIovs:

3.2.1.1 Ainoied Cai Seivices: This seivice is offeied lo Iaige ielaiIeis vilh huge anounl of
daiIy cash coIIeclions. In lhis seivice, lhe lank gels lhe cash coIIecled fion lhe pienises of
lhe ielaiIei in a secuied ainoied cai. The lank nay chaige a noninaI fee foi lhis seivice.

3.2.1.2 aIance Repoiling Seivices: In lhis seivice, lhe lank piovides sophislicaled
conpiIalions of lanking aclivily in lhe cIienls accounl and geneiaIIy incIudes laIances in
foieign cuiiencies as veII as lhose al olhei lanks. They vouId incIude infoinalion on cash
posilions as veII as 'fIoal' (eg. checks in lhe piocess of coIIeclion). Iuilheinoie, lhey offei
liansaclion-specific delaiIs on aII foins of paynenl aclivily, incIuding deposils, checks, viie
liansfeis, elc.

3.2.1.3 Cash Concenlialion Seivices: Laige oi nalionaI chain ielaiIeis oflen aie in aieas
vheie lheii piinaiy lank does nol have lianches. Theiefoie lhey open lank accounls al
vaiious IocaI lanks in lhe aiea. To pievenl funds in lhese accounls fion leing idIe and nol
eaining sufficienl inleiesl, nany of lhese conpanies have an agieenenl sel vilh lheii
piinaiy lank, vheiely lheii piinaiy lank uses lhe Aulonaled CIeaiing House (ACH) lo
eIeclionicaIIy "puII" lhe noney fion lhese lanks inlo a singIe, inleiesl leaiing lank accounl.

77
3.2.1.3 Aulonaled CIeaiing House: These seivices aie usuaIIy offeied ly lhe cash
nanagenenl division of a lank. The Aulonaled CIeaiing House is an eIeclionic syslen
used lo liansfei funds lelveen lanks. Conpanies use lhis lo pay olheis. Ceilain conpanies
aIso use il lo coIIecl funds fion cusloneis.

3.2.1.4 Locklox seivices: Oflen conpanies vhich ieceive a Iaige anounl of paynenls via
checks in lhe naiI (such as uliIilies), have lhe lank sel up a IO ox foi lhen, open lheii naiI
and deposil lhose checks. This is caIIed "Iocklox syslen.

3.2.1.5 Zeio aIance Accounling: Conpanies vilh Iaige nunlei of Iocalions couId veiy
oflen le confused if aII lhose lianches deposiled inlo a singIe lank accounl. TiadilionaIIy, il
vouId le inpossilIe lo knov vhich deposils veie fion vhich lianches, vilhoul seeking lo
viev inages of lhose deposils. To heIp lhis piolIen, lanks deveIoped a syslen vheie each
lianch vas given lheii ovn lank accounl, lul aII lhe noney deposiled inlo lhe lianch
accounl vas aulonalicaIIy noved inlo lhe conpanys nain lank accounl. This aIIoved lhe
conpany lo Iook al individuaI slalenenls foi each lianch. US anks al lhe piesenl line
hovevei aie aInosl aII conveiling lheii syslens so lhal conpanies can leII vhich sloie nade
a pailicuIai deposil, even if lhese deposils veie aII leing done inlo one accounl. Theiefoie
zeio laIance accounling is leing used Iess fiequenlIy.

3.2.1.6 Iosilive Iay: Iosilive pay is a seivice vheiely lhe conpany eIeclionicaIIy shaies ils
check iegislei of aII viillen checks vilh lhe lank. The lank lheiefoie viII onIy pay checks
Iisled in lhal iegislei, vilh exaclIy lhe sane specificalions as Iisled in lhe iegislei (anounl,
payee, seiiaI nunlei, elc.). This syslen dianalicaIIy ieduces check fiaud.

3.2.1.7 Sveep Accounls: These aie lypicaIIy offeied ly lhe cash nanagenenl division of a
lank. Undei lhis syslen, excess funds fion conpanys lank accounls aie aulonalicaIIy
noved inlo a noney naikel nuluaI fund oveinighl, and iepIaced lhe nexl noining. This
aIIovs lhen lo eain inleiesl ovei nighl.
78

3.2.2 Paymcnt 5ystcms In U5

3.2.2.1 IedWiie
The vhoIesaIe paynenl syslen in Uniled Slales is knovn as Laige-DoIIai Iaynenl Syslen.
Laige doIIai paynenls in lhe US conpiise of eIeclionic paynenls lelveen conneiciaI
lanks lhal use FcdwIrc (a vhoIesaIe viie liansfei syslen opeialed ly lhe IedeiaI Reseive
Syslen). The Iedviie is in opeialion since 1956 and is lhe nain funds liansfei syslen in
US. Aloul 8OO lanks aie Iinked logelhei undei Iedviie foi liansnission of funds and
slalenenls. IiinaiiIy il is used foi liansfeiiing ieseive accounl laIance of deposiloiy
inslilulions, high vaIue doneslic paynenls, inlei-lank liansfeis, lhiid paily liansfeis and
high vaIue inlei-coipoiale paynenls.

Iedviie pailicipanls aie any enlilies lhal nainlain a secuiilies accounl vilh a Reseive ank
in lhe enlilies' nane. Suljecl lo lhe Reseive anks' and lhe oaid of Coveinois' iisk
ieduclion poIicies, vheie appIicalIe, enlilies aulhoiized ly Iav, ieguIalion, poIicy, oi
agieenenl lo le pailicipanls incIude:

Deposiloiy inslilulions,
Agencies and lianches of foieign lanks,
Menlei lanks of lhe IedeiaI Reseive Syslen,
The Tieasuiy and any enlily specificaIIy aulhoiized ly fedeiaI slalule lo use lhe
Reseive anks as fiscaI agenls oi deposiloiies,
Lnlilies designaled ly lhe Secielaiy of lhe Tieasuiy,
Ioieign cenliaI lanks, foieign nonelaiy aulhoiilies, foieign goveinnenls, and
ceilain inleinalionaI oiganizalions, and
Any olhei enlilies aulhoiized ly a Reseive ank lo use Iedviie Secuiilies Seivice

79
The Iedviie funds liansfei syslen is a ieaI-line gioss sellIenenl syslen (RTCS)
15
in vhich
aloul 9,5OO deposiloiy inslilulions iniliale liansfeis of funds lhal aie innediale, finaI, and
iiievocalIe vhen piocessed. Deposiloiy inslilulions lhal nainlain a ieseive oi cIeaiing
accounl vilh a IedeiaI Reseive ank nay use Iedviie lo send paynenls lo, oi ieceive
paynenls fion, olhei accounl hoIdeis diieclIy.

Deposiloiy inslilulions use Iedviie lo handIe Iaige-vaIue, line-ciilicaI paynenls, such as
paynenls foi lhe sellIenenl of inleilank puichases and saIes of fedeiaI funds, lhe puichase,
saIe, and financing of secuiilies liansaclions, lhe disluisenenl oi iepaynenl of Ioans, and
lhe sellIenenl of ieaI eslale liansaclions

3.2.2.2 CHIIS
CHIP5 (CIeaiing House Inlei-lank Iaynenl Syslen) is a piivale eIeclionic funds liansfei
syslen vhich is opeialed ly Iaige piivale lanks in Nev Yoik foi inleinalionaI novenenls
of funds. CHIIS lecane opeialionaI in 197O. Mosl of lhe inleinalionaI funds liansfei goes
lhiough CHIIS. IinanciaI liansaclions Iike foieign/doneslic liade seivices, inleinalionaI
Ioans, syndicaled Ioans, foieign exchange saIes/puichases, elc. aie done lhiough CHIIS.
Doneslic LIT (LIeclionic Iunds Tiansfei) paynenls aie aIso done lhiough CHIIS.

CHIIS is a ieaI-line, finaI paynenls syslen foi U.S. doIIais lhal uses li-IaleiaI and nuIli-
IaleiaI nelling foi naxinun Iiquidily efficiency. CHIIS is lhe onIy Iaige vaIue syslen in lhe
voiId lhal has lhe capaliIily of caiiying exlensive ienillance infoinalion foi conneiciaI
paynenls. CHIIS piocesses ovei 285,OOO paynenls a day vilh a gioss vaIue of $1.4 liiIIion.
Il is a pieniei paynenls pIalfoin seiving lhe Iaigesl lanks fion aiound lhe voiId,
iepiesenling 19 counliies voiId vide.

3.2.2.3 SWIIT
5WIFT (Sociely foi WoiIdvide Inlei-lank IinanciaI TeIeconnunicalion) is opeialed ly
lanks lhioughoul lhe voiId lo faciIilale inleinalionaI paynenls. SWIIT is lasicaIIy a

15
An electronic funds transfer system in which both the legs of the transaction are executed independently on a
real time basis.
80
nessage liansnission syslen. This vas founded in 1973 ly 239 lanks spiead ovei 15
counliies vilh an oljeclive of ciealing a unified inleinalionaI liansaclion piocessing and
liansnission syslen. The sociely is a nol-foi-piofil oiganizalion eslalIished undei lhe
eIgian Iav vilh ils headquaileis in iusseIs.

The nain fealuies of SWIIT aie as foIIovs:
OpeialionaI 247 aII lhiough oul lhe yeai
Tiansnission of nessage lo any pail of lhe voiId is on ieaI line lasis
Message foinals foi inlei-lank liansaclions aie slandaidized. Aloul 4OO diffeienl
slandaidized foinals aie used.
AII nessages aie acknovIedged (accepled oi iejecled)
ConfidenliaIily of infoinalion is nainlained
Accuiacy and lineIy deIiveiy of vaIidaled nessages is ensuied

Slandaid nessage foinals have deveIoped ly SWIIT lo lake caie of lhe foIIoving lusiness
aieas:
Cuslonei Tiansfeis and Cheques
IinanciaI Inslilulions Tiansfeis
IinanciaI Tiading
Docunenlaiy Ciedils and Cuaianlees
Secuiilies
Iiecious MelaIs and Syndicalions
TiaveIei Cheques
Suppoiling Syslen Messages

3.2.3 5ma!! BusIncss BankIng

Accoiding lo a lioad guideIine used ly lhe SnaII usiness Adninislialion (SA), a snaII
lusiness is a fiin oi enleipiise vilh fevei lhan 5OO enpIoyees. This definilion enconpasses
noie lhan 99 peicenl of aII lusinesses in lhe Uniled Slales.

81
SnaII lusinesses conliilule significanlIy lo lhe slienglh and vigoi of lhe U.S. econony.
Accoiding lo lhe U.S. SnaII usiness Adninislialion, fiins vilh fevei lhan 5OO enpIoyees
enpIoy noie lhan one-haIf of piivale-secloi voikeis and pioduce noie lhan one-haIf of lhe
piivale-secloi oulpul. Laige and successfuI conpanies oflen legin as snaIIei fiins lhal
piospei and giov.

Hovevei, gelling slailed ilseIf can le piolIen foi a snaII lusiness. The ieason leing lhal
unliI a lusiness has deveIoped a good ciedil iecoid, conneiciaI lanks viII nol le viIIing lo
Iend lo such lusinesses.

Depending on lhe slage of deveIopnenl, lhey can gel ciedil fion diffeienl financiaI
inslilulions. DeveIoping lusinesses can le in cIassified inlo foui calegoiies:

usinesses aie Slail Ups
usinesses have lusiness pIans and pioducl sanpIes lul no ievenues
usinesses have conpIele lusiness pIans and piIol piogians in pIace
usinesses have leen opeialion foi sone line and have docunenled ievenues and
expenses.

Iionoleis of calegoiy one and lvo alove shouId ideaIIy seek financing fion infoinaI
souices such as fiiends oi ieIalives, pailneis, IocaI deveIopnenl coipoialions, slale and IocaI
goveinnenls offeiing Iov-inleiesl nicio Ioans, piivale foundalions offeiing piogian-
ieIaled inveslnenls, ciedil unions fealuiing snaII lusiness Iending, and univeisilies vilh
laigeled ieseaich and deveIopnenl funds. usinesses in calegoiy lhiee and foui alove aie
sufficienlIy deveIoped lo appioach a conneiciaI lank foi financiaI assislance.

3.2.3.1 Typcs nf TradItInna! CrcdIt Uscd by 5ma!! BusIncsscs
Mosl snaII lusinesses use liadilionaI lypes of ciedil. These incIude:

Ciedil Lines
Moloi VehicIe Loans
82
usiness Moilgages
CapilaI Leases
Lquipnenl Loans
Olhei lypes of Ciedil

3.2.3.1.1` CrcdIt LIncs -A Iine of ciedil aIIovs a conpany lo loiiov up lo a pie-fixed
anounl caIIed lhe ciedil Iinil foi shoil-lein lusiness iequiienenls. The lank usuaIIy
chaiges sone anounl of fee as veII as inleiesl on such loiiovings. This is lhe nosl
connon liadilionaI foin of ciedil used ly snaII lusinesses.

3.2.3.1.2 Mntnr VchIc!c Lnans - These aie lhe Ioans laken ly snaII lusiness fiins foi
financing lhe noloi vehicIes used in lusiness.

Moloi vehicIe Ioans is lhe second nosl connonIy used lype of liadilionaI ciedil. These aie
nosl fiequenlIy used in lhe lianspoilalion indusliy.

3.2.3.1.3 Mnrtgagc Lnans - These aie Ioans lacked ly noilgages i.e. lhe lusinesses offei ieaI
eslale as a coIIaleiaI foi lhe Ioan. This is lhe lhiid connonIy used lype of ciedil ly snaII
lusinesses in US.

Moilgage Ioans aie lhe nosl inpoilanl foin of finance in lhe insuiance and ieaI eslale
indusliy.

3.2.3.1.4 CapIta! Lcascs - Lease is a conliacluaI agieenenl vheie lhe ovnei of lhe assel
(aIso knovn as Lessoi) liansfei lhe 'iighl lo use lhe assel lo a counleipaily (caIIed lhe
Lessee) in ieluin foi a peiiodicaI paynenl caIIed lhe Lease ienlaI. The ovneiship of lhe
assel ienains vilh lhe Iessoi. Al lhe end of lhe Iease peiiod, lhe assel is ieluined lo lhe
Iessoi.

CapilaI Ieases aie Ieases on equipnenl and aie oflen piovided ly lhe nanufacluiei of lhe
equipnenl and is oflen used ly snaII lusinesses vho do nol vish lo Iock lheii funds in
luying lhe equipnenl. This ioule nay aIso le used ly lhe lusiness ovneis if lhe iale of
83
olsoIescence is veiy high and lhey do nol vanl lo le Iefl vilh an olsoIele assel aflei a fev
yeais of puichase.

CapilaI Ieases aie nosl heaviIy used in nanufacluiing indusliies. CapilaI Ieases, vhich
incIude aulonoliIe Ieases, aie aIso an inpoilanl neans of finance in lhe lianspoilalion
indusliy

3.2.3.1.5 EquIpmcnt Lnans - These aie lhe Ioans laken foi financing lhe puichase of
equipnenls Iike pIanl and nachineiy, elc. ly lhe snaII lusinesses.

Lquipnenl Ioans aie nosl significanl in indusliies lhal ieIy heaviIy on equipnenl Iike
consliuclion and nining, piinaiy nanufacluiing, olhei nanufacluiing, and lianspoilalion.

3.2.3.1.6 Othcr typcs nf CrcdIt - These incIude ievoIving ciedils, lein Ioans, Ioans fion
faniIy and fiiends, elc. vhich have aIieady leen discussed alove.

84
3.2.3.2 Typcs nf A!tcrnatIvc CrcdIt Uscd by 5ma!! BusIncsscs
SnaII lusiness ovneis nay luin lo aIleinalive foins of ciedil if lhey find lhenseIves unalIe
lo ollain liadilionaI foins oi if lhey find lhe leins of lhese olhei pioducls noie favoialIe.
These aIleinalive lypes incIude:

Ciedil Caids
Tiade Ciedil
Loans fion Ovneis

3.2.3.2.1 CrcdIt Cards - Ciedil Caids have leen discussed eaiIiei in lhe RelaiI anking
noduIe. To iecaII, a ciedil caid aIIovs lhe usei lo nake paynenl foi goods oi seivices in lhe
piesenl and iepay il lo lhe caid issuei Ialei. The caid issuing lank Ievies sone chaiges
incIuding inleiesl foi pioviding lhis faciIily lo lhe usei.

Ciedil caids can seive as a convenienl aIleinalive lo paying expenses in cash if a lusiness
pays laIances on line and in fuII each nonlh, oi lhey can sulslilule foi liadilionaI foins of
ciedil vhen laIances aie caiiied nonlh lo nonlh. Ciedil caids used foi lusiness puiposes
can le issued lo lhe fiin ilseIf oi lo lhe ovneis of lhe fiin, vho nay aIso use lheii peisonaI
ciedil caids foi lusiness expenses. SnaII lusinesses use eilhei a lusiness oi a peisonaI
ciedil caid lo pay foi lusiness expenses. IeisonaI ciedil caids ienain a noie videIy used
neans of finance lhan lusiness ciedil caids.

3.2.3.2.2 Tradc CrcdIt - Tiade ciedil aiises vhen a lusiness puichases goods oi seivices foi
vhich paynenl is deIayed. Tiade ciedil is geneiaIIy exlended foi an inleinediale peiiod
(3O-6O days), al vhich poinl paynenl is due. When paynenl is nol nade ly lhe due dale,
lhen financing chaiges aie appIied, and liade ciedil lecones an aIleinalive nelhod of
financing lusiness expenses. Tiade ciedil is a veiy coslIy foin of ciedil foi fiins lhal do nol
nake lineIy paynenl. IiequenlIy, suppIieis viII offei cash discounls (lypicaIIy 1 peicenl lo
2 peicenl of lhe puichase piice) foi eaiIy paynenl, noinaIIy five, len, oi fifleen days aflei
deIiveiy.

85
Tiade ciedil is sIighlIy Iess connon lhan ciedil caid use lul noie connon lhan ciedil
Iines, Ioans, oi capilaI Ieases

3.2.3.2.3 Lnans frnm Owncrs - Menleis of pailneiships and ovneis of coipoialions nay
ieIy on lhenseIves as an aIleinalive souice of ciedil ly naking peisonaI Ioans lo lheii
lusinesses. Il nay nol le feasilIe foi aII snaII lusinesses, as sone lusiness ovneis nay
have insufficienl veaIlh. Hovevei, lhis foin of finance iepiesenls anolhei aIleinalive lo lhe
liadilionaI foins of ciedil. Loans fion ovneis aie diffeienl fion lhe olhei lypes of ciedil in
lhal ovnei Ioans have eIenenls of lolh ciedil and equily.

3.3 Suppliers of Credit to Small Businesses

The piovideis of ciedil lo snaII lusinesses incIude conneiciaI lanks, savings inslilulions,
non-financiaI fiins, finance conpanies and individuaIs incIuding faniIy nenleis and
fiiends. Of aII lhese, conneiciaI lanks aie lhe Ieading piovideis of ciedil lo snaII fiins.
Indivi-
duaIs
Iinance Conpanies
Non-IinanciaI Iiins
Savings Inslilulions
ConneiciaI anks
86
Aveiage lanking oiganizalion vilh $1 liIIion oi Iess in lolaI assels heId aInosl 2O peicenl of
ils poilfoIio as snaII lusiness Ioans in }une 2OO1. In conliasl, oiganizalions vilh assels
lelveen $1 liIIion and $1O liIIion heId 13.6 peicenl of lheii assels as snaII lusiness Ioans,
and lhe Iaigesl oiganizalions~lhose vilh assels giealei lhan $1O liIIion~heId Iess lhan 8
peicenl of lheii assels as such Ioans.

SnaIIei lanking oiganizalions lend lo le ieIaliveIy noie vigoious snaII lusiness Ioan
oiiginalois lhan lheii Iaigei iivaIs. AIlhough Iaige lanking oiganizalions aie
piopoilionaleIy Iess aclive in snaII lusiness Iending lhan snaIIei lanks, lhe Ieading snaII
lusiness Iendeis nonelheIess lypicaIIy incIude lhe Iaigesl lanking oiganizalions. Ioi
inslance, nine of lhe len lanks vilh lhe Iaigesl hoIdings of snaII lusiness Ioans aie anong
lhe lvenly-five Iaigesl lanking oiganizalions in lhe indusliy.
87
4. Internet Banking in US
4.1 Internet Banking Vs E-Banking

LIeclionic anking oi L-anking as il is connonIy knovn as is a noie conpiehensive lein
lhan Inleinel lanking. LIeclionic lanking enliaces a lioad iange of pioducls and seivices.
ioadIy, il conpiises of LIeclionic noney pioducls, eIeclionic deIiveiy channeIs and
eIeclionic paynenl syslens. Inleinel lanking is one of lhe deIiveiy channeIs of L-lanking.















E-BankIng
E!cctrnnIc Mnncy
Prnducts
E!cctrnnIc Dc!Ivcry
Channc!s
ATMs
Phnnc
BankIng
Intcrnct
BankIng
DcbIt Card
CrcdIt Card
5mart Card
88
L-lanking pioducls and seivices can le lioadIy cIassified inlo lvo calegoiies:
Iionl Lnd, and
ack Lnd

'Iionl end pioducls and seivices aie piovided diieclIy lo lhe consuneis. Ioi exanpIe,
ATM caids and conpulei lanking seivices. On lhe olhei hand, ''lack end
pioducls/seivices aie used ly financiaI inslilulions, neichanl eslalIishnenls, and olhei
seivice piovideis lo piocess eIeclionic liansaclions. Ioi exanpIe, eIeclionic cheque
conveision vhich invoIves infoinalion fion a check (iouling nunlei, accounl nunlei, and
anounl of lhe liansaclion) gelling conveiled inlo eIeclionic foinal in oidei lo nake a one-
line eIeclionic fund liansfei fion an accounl.



The e-lanking pioducls/seivices can aIso le cIassified on lhe lasis of lheii Iinkage oi
olheivise vilh lhe lank accounl of lhe consunei. Iioducls ieIaled lo lank accounl incIude,
ATM caids, Delil caids, conpulei lanking, elc. Iioducls nol ieIaled lo lank accounls
incIude payioII caids, snail caids, elc.


E-BankIng
Prnducts/5crvIccs
Back-End (E.g.
E!cctrnnIc
transactInn
prnccssIng)
Frnnt End (E.g.
ATM Cards,
DcbIt Cards,
Cnmputcr
E-BankIng Prnducts/5crvIccs
Prnducts rc!atcd tn
Bank Accnunt nf Custnmcr
Prnducts nnt rc!atcd tn
Bank Accnunt nf Custnmcr

89
4.2 E-Banking Products

4.2.1 Prnducts Rc!atcd tn Bank Accnunts

4.2.1.1 Dlrect deoslt: This is a foin of paynenl in vhich an oiganizalion (such as an
enpIoyei oi a goveinnenl agency) pays funds (such as pay oi lenefils) via an eIeclionic
liansfei. The funds aie diieclIy ciediled inlo a consuneis lank accounl. Diiecl Deposil can
le used foi payioII, dividends, disliilulions, ielales, ieinluisenenls, iefunds, goveinnenl
lenefils and olhei paynenls nade lo lhe consunei.

4.2.1.2 ATM cards: ATM slands foi Aulonaled TeIIei Machine. This is an eIeclionic leininaI
piovided ly lanks/financiaI inslilulions lhal peinil consuneis lo vilhdiav cash fion
lheii lank accounl, nake deposils, check laIances, and liansfei funds using an ATM caid.

ATM caids veie inlioduced in lhe Iale 196Os lo heIp consuneis nake cash vilhdiavaIs
fion lheii deposil accounls.

4.2.1.3 Deblt cards: A caid used al an ATM oi a poinl-of-saIe (IOS) leininaI lhal enalIes a
consunei lo have funds diieclIy deliled fion his oi hei lank accounl (usuaIIy a checking
accounl). This is same as regular ATM card if used at a banks ATM. If used at a POS
terminal, the customer a/c is debited and the amount is credited directly to the a/c of the
vendor.

4.2.1.4 Preauthorlted deblts: This is a foin of paynenl lhal aIIovs a consunei lo aulhoiize
aulonalic paynenl of ieguIai, iecuiiing liIIs fion his oi hei accounl on a specific dale, and
usuaIIy foi a specific anounl (foi exanpIe, aulo Ioan paynenls, paynenls of housing Ioan
LMIs, elc.). The funds aie eIeclionicaIIy liansfeiied fion lhe consuneis accounl lo lhe
ciedilois accounl.

Use of ATM caids and delil caids iequiie an ''aclive cuslonei-inleiaclion vilh lhe
lechnoIogy, vheieas pieaulhoiized delils is noie of a ''passive lechnoIogy, once lhe
90
piocess has leen eslalIished, lhe consunei does nol need lo do anylhing noie unliI a
change is desiied (foi exanpIe, a change in lhe paynenl dale). This is siniIai lo a slanding
insliuclion lo lhe lank lo delil lhe accounl on a ceilain dale eveiy nonlh.

This is diffeienl fion a diiecl paynenl lhal aIso aIIovs a consunei lo pay liIIs lhiough
eIeclionic fund liansfeis. Hovevei, in case of a diiecl paynenl, each liansaclion has lo le
inilialed ly lhe consunei as il is a one line paynenl and is nol a slanding insliuclion lo le
given lo lhe lank.

4.2.1.5 Comuter banklng or lnternet Banklng: anking seivices lhal consuneis can access,
ly using an Inleinel conneclion lo a lanks conpulei cenlei, in oidei lo peifoin lanking
lasks, ieceive and pay liIIs, and so foilh. Many olhei financiaI seivices can le accessed via
lhe Inleinel (foi exanpIe, paying ciedil caid liIIs on a ciedil caid issueis vel sile), lul
lhose seivices nay nol le cIassified as conpulei lanking.

Il faciIilales access lo lank accounls foi funds liansfei, liIIs paynenl, accounl laIances
checking, ieviev of accounl slalenenls, and aIso lo conducl olhei lanking aclivilies Iike
oideiing cheque look and issuing slop paynenl oideis foi sone cheques. Consuneis aIso
use lhe Inleinel lo conducl olhei peisonaI financiaI lusiness, such as noniloiing inveslnenl
accounls, ievieving ciedil caid slalenenls, and shopping foi ciedil, inveslnenl, and
insuiance pioducls. Consuneis nay le alIe lo nake eIeclionic fund liansfeis fion eilhei
lheii lanks conpulei lanking piogian oi lheii financiaI seivices vel sile, foi exanpIe,
lhey nay le alIe lo pay lheii ciedil caid liIIs lhiough eilhei lheii lanks conpulei lanking
seivice oi lheii ciedil caid conpanys vel sile.

AIso incIudes seivices Iike LIeclionic liII piesenlnenl and paynenl (LII) ly vhich liIIs
aie piesenled lo a cuslonei onIine, via eilhei e-naiI oi a nolice in an e-lanking accounl.
Aflei piesenlnenl, lhe cuslonei nay pay lhe liII onIine vhen convenienl. The paynenl is
eIeclionicaIIy deducled fion lhe cusloneis accounl.

91
4.2.2 Prnducts Nnt Rc!atcd tn Bank Accnunts
These pioducls lhal aie nol lied lo a consuneis lank accounl lul inslead sloie nonelaiy
vaIue in a ieIaled dalalase oi on a caid. Ioi exanpIe, piepaid caids(such as phone and gifl
caids), payioII caids, coIIege and niIilaiy caids, caids used lo deIivei insuiance lenefils lo
disaslei viclins, and caids used ly slales lo deIivei chiId suppoil paynenls. These caids
nay le siniIai in appeaiance lo lhe liadilionaI delil caids (foi exanpIe lhey nay caiiy a
MasleiCaid oi Visa Iogo) and nay even le caIIed delil caids ly neichanls and vendois.

4.2.2.1 Preald card: A sloied-vaIue caid on vhich nonelaiy vaIue is sloied and foi vhich
lhe consunei has paid lhe issuei in advance. Il can eilhei le a singIe-puipose oi a nuIli-
puipose caid. In case of a singIe-puipose sloied vaIue caid, lhe caid issuei and acceploi aie
geneiaIIy lhe sane enlily, and lhe funds on lhe caid iepiesenl piepaynenl foi specific
goods and seivices (foi exanpIe, a phone caid). A singIe-puipose caid is geneiaIIy iesliicled
lo veII defined poinls of saIe vilhin a given Iocalion. A nuIli-puipose caid, on lhe olhei
hand, can le used al seveiaI seivice piovideis foi a vide iange of puiposes, il nay caiiy a
MasleiCaid oi Visa Iogo oi lhe Iogo of anolhei inlei lank nelvoik.

Sloied-vaIue caids have leen aiound since lhe197Os. They veie oiiginaIIy issued as singIe-
puipose caids foi Iov-vaIue liansaclions lul aie nov popuIai as highei vaIue, lioadIy
usalIe caids. Mosl sloied vaIue caids have a nagnelic sliip lhal Iinks lhe caid lo a nonelaiy
vaIue sloied in a dalalase.

4.2.2.2 Paro|| cards: IayioII caids aie a papeiIess nechanisn ly vhich an enpIoyees pay
is Ioaded on sloied-vaIue caid.

4.2.2.3 Smart cards: A lype of sloied-vaIue caid in vhich one oi noie chips oi
niciopiocessois aie enledded, naking lhe caid capalIe of sloiing dala, peifoining
caIcuIalions, oi peifoining speciaI-puipose piocessing (lo vaIidale peisonaI idenlificalion
nunleis, aulhoiize puichases, veiify accounl laIances, and sloie peisonaI iecoids). The
nenoiy in sone snail caids is updaled vhen lhe caid is used. The chip oi niciopiocessoi
physicaIIy sloies iecoids, such as lhe vaIue of funds ienaining on lhe caid. These caids can
92
le used in ''cIosed syslens (foi exanpIe, a liansil syslen) oi ''open syslens (foi exanpIe,
MasleiCaid oi Visa nelvoiks).

Snail caids have leen used since lhe eaiIy 199Os, foi exanpIe, ly pailicipanls in fedeiaI
veIfaie piogians~Tenpoiaiy Assislance foi Needy IaniIies (foineiIy Aid lo IaniIies
vilh Dependenl ChiIdien) and lhe food slanp piogian~lo access lheii lenefils al ATMs
and al poinl-of-saIe leininaIs in gioceiy sloies. The Iaigesl issuei of snail caids in lhe
Uniled Slales is nov lhe Depailnenl of lhe Tieasuiy, vhich uses lhen lo nake paynenls
and ieinluisenenls lo niIilaiy peisonneI voiIdvide.

4.3 Electronic Payments Systems

4.3.1 ATM and DcbIt 5ystcms
The nosl connon foin of eIeclionic noney liansfei is lhe ATM, oi aulonaled leIIei
nachine, vhich enalIes consuneis lo access exisling accounls and nake deposils, ollain
cash, and liansfei funds lelveen accounls. To access an accounl fion an ATM, a consunei
nusl fiisl gel an ATM caid fion his oi hei lank oi financiaI inslilulion. Sone olhei lypes of
caids, such as ciedil caids and sone sloied vaIue caids, can aIso le used al ATMs lo gel
cash. The consunei inseils oi svipes lhe caid inlo lhe nachine, enleis a IIN (peisonaI
idenlificalion nunlei) on lhe keypad, and lhen can peifoin lhe liansaclion. When lhe
liansaclion is conpIeled, lhe consunei ieceives a ieceipl shoving lhe dale, lhe doIIai
anounl and lhe lype of liansaclion.

4.3.2 DIrcct DcpnsIt and AutnmatIc BI!! Paymcnt
Tvo foins of eIeclionic paynenl aie diiecl deposil and aulonalic liII paynenl. olh aie
usuaIIy cIeaied lhiough Aulonaled CIeaiing Houses (ACH) opeialed ly lhe IedeiaI
Reseive Syslen oi a piivale piovidei. Diiecl deposils aie aulonaled ciedils oi incieases lo
lhe consunei's accounl. Aulonalic liII paynenls aie aulonaled delils oi ieduclions.
UnIike ATM and delil caid liansaclions, no access caid is needed.

93
Diiecl deposils aie ieguIaiIy used ly enpIoyeis, goveinnenl agencies and olhei
oiganizalions lhal nake ieguIai paynenls, such as vages and dividends, lo individuaIs.

Il is easy lo ieceive funds ly diiecl deposil. A consunei fiisl nusl aulhoiize lhe deposil.
The paily naking lhe paynenls, usuaIIy an enpIoyei, lhen cieales an eIeclionic nessage.
This nessage specifies lhe anounl of lhe paynenl and idenlifies lhe financiaI inslilulion
and accounl lo le ciediled. This dala is liansnilled ly lhe enpIoyei's financiaI inslilulion lo
lhe ACH, vhich coIIecls and soils lhe infoinalion. The ACH lhen liansnils lhe accounl and
paynenl infoinalion lo lhe consunei's financiaI inslilulion. In luin, lhal inslilulion ciedils
lhe consunei's accounl.

Aulonalic liII paynenl uses lhe sane syslen, lul in ieveise. In an aulonalic liII paynenl
aiiangenenl, a consunei aulhoiizes a liIIei, such as a uliIily conpany, lo deducl funds
aulonalicaIIy fion lhe consunei's accounl foi lhe ieguIai paynenl of liIIs. Aulonalic liII
paynenl nay aIso le iefeiied lo as diiecl paynenl oi diiecl delil.


A consunei fiisl enioIIs in lhe liIIei's aulonalic liII paynenl piogian, usuaIIy ly fiIIing
oul a foin on lhe liII oi on lhe liIIei's Wel sile. This foin indicales vhen paynenls aie lo
le nade, a specific doIIai anounl oi lhe laIance due, and lhe accounl fion vhich lhe funds
94
viII le paid. This foin is lhen senl lo lhe liIIei, vho nakes aiiangenenls vilh lhe
consunei's financiaI inslilulion.

efoie a paynenl is deducled fion lhe consunei's accounl, lhe liIIei viII send a
nolificalion of paynenl lo lhe consunei, usuaIIy a veek oi lvo in advance. This nolificalion
is ilenized jusl Iike a ieguIai liII. The consunei can check lhe chaiges and conlacl lhe liIIei
if lheie is an eiioi. If lhe consunei vishes, he oi she can slop lhe eIeclionic paynenl ly
nolifying lhe ciediloi and lhe financiaI inslilulion.

Aulonalic paynenl is nosl connonIy used foi iecuiiing paynenls such as a noilgage oi
ienl, uliIily liIIs, Ioans, and insuiance pieniuns.

The advanlage of lhis nelhod foi lusinesses is ils incieased efficiency. LIeclionic
liansaclions cosl Iess lo piocess lecause lheie aie no papei checks lo le lianspoiled,
handIed, oi ieconciIed. The efficiency of eIeclionic paynenls can ieduce cosls foi lolh
lusinesses and lhe financiaI inslilulions lhal piocess lhe liansaclion. Ioi lhe consunei, il
neans faslei piocessing Ieading lo quick and ceilain paynenls and ieceipls. Anolhei
advanlage foi lhe consunei is nol having lo voiiy aloul paying a liII "loo eaiIy" oi sending
lhe paynenl "loo Iale."


95
4.3.3 Intcrnct BankIng and E!cctrnnIc BI!! Paymcnt
Consuneis can aIso nake eIeclionic liII paynenls ovei lhe Inleinel. This lype of eIeclionic
liII paynenl can le nade eilhei al lheii liIIei's Wel sile oi al lhe Wel sile of a liII
consoIidaloi such as a financiaI inslilulion. Consuneis can oflen choose lo ieceive lheii liIIs
eIeclionicaIIy, loo, eilhei via e-naiI oi onIine. In oidei lo pay a liII eIeclionicaIIy al lhe Wel
sile of a liIIei vho offeis lhis oplion, a consunei nusl fiisl visil lhe liIIei's Wel sile. Theie
lhe consunei can enioII in lhe syslen, vhich viII lypicaIIy nean pioviding sone
idenlifying infoinalion and choosing a useinane and passvoid. Once lheii idenlily has
leen veiified, consuneis can Iog on lo lhe sile, ieviev lheii liII and pay il eIeclionicaIIy.

Sone liIIeis offei consuneis seveiaI diffeienl vays lo pay lheii liII eIeclionicaIIy. A
connon nelhod is a one-line liansaclion lhal lakes pIace ovei lhe sane syslen lhal
piocesses aulonalic paynenls and diiecl deposil. The consunei fiIIs oul an onIine foin lhal
incIudes infoinalion such as lhe anounl lhey vanl lo pay and lhe nunlei of lhe accounl
fion vhich lhey vanl lhe liII lo le paid, usuaIIy lhe nunlei viillen al lhe lollon of lheii
papei checks. The consunei lhen aulhoiizes lhe liIIei lo deducl lhe paynenl fion lhe
consunei's accounl.

Anolhei vay lhal consuneis can pay lheii liIIs onIine is vilh a ciedil oi signaluie delil
caid lhal does nol iequiie a IIN, lhough nol aII liIIeis offei lhis oplion. Consuneis nusl
fiisl visil lhe liIIei's Wel sile lo enioII and veiify lheii idenlily. When lhey seIecl lhe
paynenl nelhod, lhey indicale vhich lype of caid lhey vanl lo pay vilh, lheii accounl
nunlei and lhe expiialion dale. Sone liIIeis aIso iequiie lhe consunei lo enlei lhe lhiee-
oi foui-digil secuiily code usuaIIy viillen on lhe signaluie sliipe on lhe lack of lhe caid.

Mosl Iaige financiaI inslilulions and nany snaIIei ones offei onIine lanking and leIephone
lanking, vhich aIIov lheii cusloneis vho enioII lo do lhings such as viev accounl
infoinalion Iike cuiienl laIance and iecenl liansaclions, liansfei laIances fion one accounl
lo anolhei, pay liIIs, and even appIy foi a Ioan. Many financiaI inslilulions and olhei
conpanies aIso offei a seivice lhal aIIovs consuneis lo pay seveiaI oi aII of lheii liIIs al one
Wel sile. To enioII in onIine lanking, consuneis usuaIIy go lo lheii financiaI inslilulion's
96
Wel sile and enlei lheii nane and accounl infoinalion. Sone financiaI inslilulions offei lhis
seivice foi fiee lo lheii cusloneis, lul olheis chaige a snaII fee. IinanciaI inslilulions use a
vaiiely of nelhods lo nake suie lheii cusloneis' lanking infoinalion is kepl piivale, and
onIine lanking is consideied lo le veiy secuie. CuiienlIy, noie lhan 6O niIIion Aneiicans
pay liIIs onIine, and nany expeils lhink lhis nunlei viII inciease significanlIy in lhe nexl
fev yeais.

4.3.4 IntcrnatInna! Paymcnts
Many peopIe in lhe U.S. ieguIaiIy send noney lo faniIy and fiiends Iiving in olhei
counliies. UnliI iecenlIy, aInosl aII of lhese paynenls veie senl eIeclionicaIIy lhiough
conpanies vilh agenls Iocaled neai lolh lhe sendei and ieceivei. Moie and noie, olhei
conpanies aie offeiing siniIai seivices. Sone financiaI inslilulions have inlioduced
piogians lhal aIIov soneone in lhe U.S. lo pul noney inlo an accounl lhal can le accessed
al an ATM in anolhei counliy ly lhe iecipienl. These seivices aie oflen avaiIalIe lo
eveiyone, even peopIe vho don'l have an accounl al lhe financiaI inslilulion. In lhe Iasl
seveiaI yeais, lhe nunlei of conpanies conpeling foi lhis lusiness has giovn, and lhe cosl
of sending noney inleinalionaIIy has legun lo faII.

Theie aie nany 'eIeclionic paynenl seivices avaiIalIe on lhe inleinel loday vhich heIp in
liansfei of noney eIeclionicaIIy lo anyvheie in lhe voiId. Sone of lhe connon seivices aie
IayIaI, Yahoo Diiecl, idIay, C2IT, elc. IaypaI is lhe nosl popuIai anong lhese. idpay is
lhe seivice piovided ly Weslein Union vheieas C2IT is lhe seivice piovided ly Cililank.
AII lhese seivices piovide fund ienillance faciIily onIine. They chaige a fee foi lusiness
puipose ienillances. Hovevei, funds liansfei foi individuaIs is usuaIIy piovided foi as a
fiee seivice.

Stored-Value Cards

One eIeclionic paynenl nelhod lhal is leconing incieasingIy popuIai is lhe sloied-vaIue
caid. Sloied-vaIue caids piovide a convenienl sulslilule foi cash and checks. The caids
conlain a nagnelic sliip lhal iecoids a doIIai laIance. A vaiialion on lhis syslen is lhe snail
97
caid, vhich conlains a conpulei chip lhal iecoids infoinalion aloul lhe caid's laIance,
usage and olhei dala. The caid's laIance is eilhei piedeleinined oi eslalIished ly lhe
consunei vhen lhe caid is puichased. The doIIai vaIue of each liansaclion is deducled unliI
lhe laIance ieaches zeio. Sone sloied vaIue caids can le ieIoaded vilh noney al speciaI
leininaIs and aie ieusalIe.

Mosl of lhese caids aie iefeiied lo as "cIosed-syslen" caids. Thal neans lhe caids can le
used onIy foi ceilain liansaclions in specific Iocalions. IulIic liansil syslens in nany Iaige
cilies use lhese caids, as do sone univeisilies and ielaiIeis. Consuneis can puichase sloied-
vaIue caids in nany Iocalions foi use al pulIic leIephones. Sloied vaIue lechnoIogy is even
used on nany loII ioads and highvays lo aIIov cais lo quickIy pass lhiough loII slalions.

Nol aII sloied-vaIue caids voik on cIosed syslens. Sone, such as payioII caids and gifl
caids, voik jusl Iike delil caids, and can le used anyvheie delil caids aie accepled. Lach
line lhe consunei nakes a puichase using lhe caid, oi vilhdiavs noney fion an ATM,
noney is deducled fion an accounl hoIding lhe caid's vaIue foi lhe consunei.

4.4 E-banking in US
The use of eIeclionic lanking is videspiead anong U.S. househoIds and lhe piopoilions of
househoIds using liadilionaI (non-eIeclionic) lanking nelhods has decIined in iecenl lines.
NeveilheIess, a Iaige piopoilion of consuneis sliII conducl al Ieasl sone lanking lusiness
''in peison.









98
Grnwth nf E-BankIng In U5
Prnduct 1999 2003
Diiecl Deposil 65.OO 7O.OO
ATM Caid 59.OO 65.OO
Delil Caid NA 54.OO
IieAulhoiized Delils 31.OO 46.OO
Aulhonaled Ihone syslen 4O.OO 44.OO
Conpulei anking 1O.OO 32.OO
Snail Caid NA 6.OO
Iiepaid Caid NA 73.OO

4.5 Internet Banking

Inleinel lanking nay le defined as lhe use of lhe Inleinel as a ienole deIiveiy channeI foi
lanking seivices foi liadilionaI (e.g. liansfeiiing funds anong deposil accounls) as veII as
nev lanking seivices (e.g. eIeclionic liII piesenlnenl and paynenl, vhich aIIov cusloneis
lo ieceive and pay liIIs ovei a lanks Wel sile).

Inleinel lanking is offeied ly lanks in lvo vays. IiislIy, an exisling lank vilh physicaI
offices can eslalIish a Wel sile and offei Inleinel lanking lo ils cusloneis in addilion lo ils
liadilionaI deIiveiy channeIs. SecondIy, a lank nay le eslalIished as a viiluaI,
lianchIess, oi Inleinel onIy lank, vilh onIy a conpulei seivei lhal is housed in an
office lhal seives as lhe lanks IegaI addiess oi al sone olhei Iocalion. ViiluaI lanks nay
offei cusloneis lhe aliIily lo nake deposils and vilhdiav funds al aulonaled leIIei
nachines (ATMs) oi olhei ienole deIiveiy channeIs ovned ly olhei inslilulions.

AccoidingIy, a lank can peifoin Inleinel aclivilies in one oi noie of lhe foIIoving vays:

InfnrmatInna!~This is lhe lasic IeveI of Inleinel lanking. In lhis node, lhe lank
piovides naikeling infoinalion aloul lhe lanks pioducls and seivices lo lhe useis.
99
Hovevei, no inleiaclion vilh lhe lank is possilIe ovei inleinel and no liansaclions can
le caiiied oul.
CnmmunIcatIvc~This lype of Inleinel lanking syslen aIIovs sone inleiaclion
lelveen lhe lanks syslens and lhe cuslonei. The inleiaclion nay le Iiniled lo
eIeclionic naiI, accounl inquiiy, Ioan appIicalions oi slalic fiIe updales (nane and
addiess changes).
TransactInna!~This IeveI of Inleinel lanking aIIovs cusloneis lo diieclIy execule
liansaclions vilh financiaI inpIicalions. The lasic liansaclionaI sile onIy aIIovs a
liansfei of funds lelveen lhe accounls of one cuslonei and lhe lank. The advanced
liansaclionaI sile piovides a neans foi geneialing paynenls diieclIy lo lhiid pailies
oulside of lhe lank. This can lake lhe foin of liII paynenls via a lank officiaI check oi
eIeclionic funds liansfei/aulonaled cIeaiing house enliies. Many lanks aie aIso
offeiing paynenls fion consunei lo consunei using eilhei paynenl nelhod.

Adtan|agcs cf |n|crnc| 8an|ing
1. Convenience
2. Disciepancies in accounl, if any, can le caughl quickIy and can le soiled oul
sviflIy
3. Reduced cosl of lanking

Disadtan|agcs cf |n|crnc| 8an|ing
1. Secuiily of liansaclions done lhiough inleinel has lo le ensuied olheivise
hackeis nay lake advanlage of lhe IoophoIes
2. VuIneialIe lo fiaud
3. IeisonaI louch vhich is so conspicuous in liadilionaI lanking is nissing

4.5.1 Intcrnct BankIng In U5
In lhe US, viiluaI lanks can le foined in lhiee vays:
1. y ollaining a chailei fion a slale oi fedeiaI supeivisoiy aulhoiily lo
eslalIish a nev independenl viiluaI lank,
100
2. y ciealing a sepaialeIy capilaIized sulsidiaiy of lhe lank hoIding conpany,
and
3. y acquiiing lhe chailei of an exisling lank and iecasling lhe lank as a
viiluaI lank undei lhe chailei.

An aIleinalive lo a viiluaI lank is a liade nane inleinel lank vhich is sel up as a sepaiale
division of an exisling lank. A liade nane inleinel lank opeiales independenlIy fion lhe
iesl of lhe lank. In 2OOO, lheie veie appioxinaleIy 2O liade nane inleinel lanks in US.

4.5.1.1 Kcy Intcrnct BankIng 5crvIccs

The key inleinel lanking seivices offeied ly lanks in US aie as foIIovs:

aIance inquiiy and funds liansfei
iII Iaynenl
Ciedil AppIicalion
Nev accounl sel-up
iokeiage
Cash Managenenl
Iiduciaiy
iII Iiesenlnenl
Insuiance

These seivices can le giouped inlo ASIC and IRLMIUM seivices. ASIC seivices incIude
on-Iine laIance inquiiy faciIily, funds liansfei and liII paynenl seivices foi vaiious uliIilies.
IRLMIUM seivices incIude lhese ASIC seivices pIus olhei speciaIized seivices Iike
liokeiage, ciedil appIicalion, cash nanagenenl, elc.




101

Pcrccntagc nf TransactInna! Intcrnct Banks OffcrIng 5c!cctcd 5crvIccs (2003)

Typc nf 5crvIcc A!! Banks Lcss than $
100 mI!!Inn
$100
mI!!Inn tn
!css than
$1 bI!!Inn
$1 bI!!Inn
tn !css
than $10
bI!!Inn
$10 bI!!Inn
and nvcr
aIance inquiiy and
funds liansfei
88.8 74.1 9O.2 94.5 1OO.O
iII Iaynenl 78.2 6O.O 77.4 9O.4 1OO.O
Ciedil AppIicalion 6O.O 51.8 51.7 75.3 8O.5
Nev accounl sel-up 36.6 29.8 43.9 45.2 43.9
iokeiage 21.6 1O.6 14.7 41.1 53.7
Cash Managenenl 15.7 14.1 16.2 15.1 17.1
Iiduciaiy 11.9 3.5 9.8 12.3 41.5
iII Iiesenlnenl 1O.6 7.1 7.9 16.4 24.4
Insuiance 5.4 2.4 2.3 6.8 .3
ASIC 77.6 56.5 77.4 9O.4 1OO.O
IRLMIUM 23.9 14.1 17.O 41.1 58.5
Source: Office of the Comptroller of Currency
*Figures in Billions depict the size of the bank in terms of assets


Ioi sone of lhe inleinel lanking seivices, lhe size of lhe lank is an inpoilanl paianelei.
Hovevei, foi olhei seivices lheie is nol nuch of a diffeience lelveen Iaige lanks and
snaIIei lanks. Ioi exanpIe, fion lhe lalIe alove il is olvious lhal Iaigei lanks aie noie
IikeIy lo accepl ciedil appIicalions on-Iine. On lhe olhei hand, lanks of aII sizes veie
ioughIy equaIIy IikeIy lo offei on-Iine cash nanagenenl seivices. Ioi speciaIized seivices
Iike liokeiage, fiduciaiy, and insuiance seivices leing offeied on-Iine, il is cIeai lhal Iaigei
lanks aie nuch noie IikeIy lo offei lhese seivices lhan snaIIei lanks.

4.5.1.2 Rcgu!atInn nf Intcrnct BankIng
The Office of lhe ConplioIIei of Cuiiency (OCC) is lhe nalionaI ieguIaloiy aulhoiily foi
ieguIaling e-lanking aclivilies of nalionaI lanks in US.
102

The OCCs iuIes cuiienlIy piovide |na| a na|icna| oan| naq pcrfcrn, prctidc, cr dc|itcr |nrcugn
c|cc|rcnic ncans and faci|i|ics anq func|icn, prcduc|, cr scrticc |na| i| is c|ncruisc au|ncrizcd |c
pcrfcrn, prctidc cr dc|itcr. Tnis sc-ca||cd |ransparcncq dcc|rinc is a |cq prctisicn fcr na|icna|
oan|s cngaging in c|cc|rcnic ac|iti|ics occausc i| ca||s fcr |nc OCC |c |cc| |nrcugn |nc ncans oq
unicn |nc prcduc| is dc|itcrcd and fccus ins|cad cn |nc au|ncri|q cf |nc na|icna| oan| |c cffcr |nc
undcr|qing prcduc| cr scrticc.

Ccnsis|cn| ui|n |nc princip|c |na| i| is |nc suos|ancc cf an ac|iti|qand nc| i|s c|cc|rcnic fcrn|na|
is |cq |c |nc dc|crnina|icn cf unc|ncr i| is pcrnissio|c, |nc fina| ru|c prctidcs |na| uncn a na|icna|
oan| cngagcs in an c|cc|rcnic ac|iti|q oascd cn |nc |ransparcncq dcc|rinc, |nc c|cc|rcnic ac|iti|q ui||
nc| oc cxcnp| frcn |nc rcgu|a|crq rcquircncn|s and supcrtiscrq guidancc, inc|uding |ncsc prcscriocd
oq OCC rcgu|a|icns cr ccn|aincd in c|ncr OCC issuanccs, |na| ucu|d app|q if |nc ac|iti|q ucrc
ccnduc|cd oq ncn-c|cc|rcnic ncans cr faci|i|ics. Tnis ncu prctisicn c|arifics |na| na|icna| oan|
ac|iti|ics ui|| ccn|inuc |c oc gctcrncd oq OCC rcgu|a|crq rcquircncn|s and supcrtiscrq guidancc
rcgard|css cf unc|ncr |na| ac|iti|q is ccnduc|cd c|cc|rcnica||q cr oq |radi|icna| ncans.

Tnc OCCs ru|cscurrcn||q and as ancndcd oq |nis fina| ru|c prctidc |na| a na|icna| oan| naq
ccnduc| oq c|cc|rcnic ncans anq func|icn cr ac|iti|q |na| i| is c|ncruisc au|ncrizcd |c ccnduc|. Tnc
rcsc|u|icn cf anq issuc aocu| |nc app|icaoi|i|q cf S|a|c |au |c an ac|iti|q |na| a na|icna| oan|
ccnduc|s c|cc|rcnica||q is, acccrding|q, gctcrncd oq |nc prccnp|icn princip|cs |na| ucu|d app|q |c
ac|iti|ics ccnduc|cd oq |radi|icna| ncans

Ioi exanpIe, lhe eIeclionic liII piesenlnenl has leen consideied as a Iegilinale inleinel
lanking aclivily lecause liIIing and coIIecling seivices aie olheivise peinissilIe foi a
nalionaI lank in US.

4.5.2 Markct 5harc nf Intcrnct BankIng Custnmcrs

The lop five Inleinel lanks accounl foi aInosl 36 peicenl of aII U.S. cusloneis using
Inleinel lanking. Oul of vhich, lhe lop lvo Inleinel lanks logelhei accounl foi aInosl 25
peicenl of aII Inleinel lanking cusloneis in lhe Uniled Slales. Hovevei, even lhese lop five
103
Inleinel lanks have nol leen equaIIy successfuI in alliacling cusloneis lo use Inleinel
lanking. The peicenlage of lanks aclive on-Iine cusloneis~lhal is, cusloneis using
Inleinel lanking al Ieasl once a nonlh~vaiies anong lhese lanks. OnIy lvo of lhese lop
five Inleinel lanks have noie lhan 5O peicenl of onIine cusloneis vho can le consideied
aclive useis of Inleinel lanking.

Tnp FIvc Intcrnct Banks In U5
Bank
ActIvc On-!Inc Custnmcrs
as a pcrccntagc nf Its tnta!
On-!Inc Custnmcrs (%)
Bank's sharc nf a!!
U5 nn-!Inc
custnmcrs (%)
WeIIs Iaigo 55.7 13.1
ank of Aneiica 46.5 1O.6
ank One Coip 47.3 4.4
Cililank 63.1 3.9
Iiisl Union Coip 9.9 3.8
Scurcc. Officc cf |nc Ccnp|rc||cr cf Currcncq

4.5.3 Imp!IcatInns nf Intcrnct BankIng fnr BankIng and Bank rcgu!atInn

4.5.3.1 Imp!IcatInns fnr bankIng Industry structurc and pcrfnrmancc
1. Inleinel lanking viII Iead lo inleinalionaIizalion of lhe naikels ly ieducing laiiieis
associaled vilh geogiaphy and nalionaI loundaiies.
2. Il viII aIso Iead lo inciease in conpelilion due lhe ieduclion of geogiaphicaI laiiieis
and aIso inciease lhe aliIily of lank cusloneis lo seaich foi and Iocale nev suppIieis
eIeclionicaIIy.
3. Inleinel lanking viII aIso acceIeiale lhe ongoing piocess of financiaI deepening".
TiadilionaIIy, snaII, slail-up fiins, vhich suffeied fion opacily of infoinalion
found il difficuIl lo secuie exleinaI funding in foinaI ciedil naikels, incIuding
lanking. TechnoIogicaI advancenenls in dala coIIeclion, dala nanagenenl, and
financiaI engineeiing have inpioved lhe aliIily of polenliaI ciedilois lo assess lhe
104
ciedilvoilhiness of polenliaI loiioveis and lo piice lhe iisk associaled vilh lhose
loiioveis lhiough slandaidized nechanisns such as ciedil scoiing. As a iesuIl, lhe
iange of lusinesses and individuaIs lhal can ollain Ioans lhiough financiaI
inslilulions is expanding iapidIy.
4. The inpacl of Inleinel lanking on lhe consoIidalion of lhe lanking indusliy is Iess
cIeai-cul. On lhe one hand, lhe Inleinel aIIovs financiaI fiins of diffeienl sizes lo
enlei naikels and ieach cusloneis pieviousIy oul of ieach lo lhen. On lhe olhei
hand, lheie aie sulslanliaI econonies of scaIe and scope in dala sloiage and dala
piocessing, and Iaigei lanks aie lellei pIaced lo expIoil lhese econonies lhan
snaIIei lanks. Iuilheinoie, lhe inciease in lhe nunlei of Inleinel Wel siles neans
lheie nay le a sulslanliaI advanlage foi lanks alIe lo diffeienliale lheii
pioducls/seivices fion lhose of olhei lanks (i.e., lo engage in lianding).

4.5.3.2 Imp!IcatInns fnr rcgu!atnry pn!Icy

The deveIopnenl of Inleinel lanking has aIso Ied lo lhe foIIoving polenliaI chaIIenges foi
ieguIaloiy poIicy:
1. Inleinel lanking, and deveIoping lechnoIogy noie geneiaIIy, is changing lhe
sliucluie and funclion of financiaI inslilulions. The exisling ieguIaloiy sliucluie has
leen deveIoped lased on liadilionaI Iines of denaicalion anong diffeienl lypes of
financiaI inslilulions, lul lhese Iines of denaicalion aie leconing Iess ieIevanl ovei
line.
2. Inleinel lanking nay aIso iaise eilhei nev conceins oi inciease/ieduce lhe conceins
aloul exisling pulIic poIicy issues. Ioi exanpIe, a pulIic poIicy concein enphasized
ly Inleinel lanking has leen lhe issue of piivacy.
3. Inleinel lanking aIso chaIIenges liadilionaI nelhods of safely and soundness
supeivision ly changing lhe naluie and scope of exisling iisks, and ly Ieading lo
nev iisks.
4. The naluie and scope of lechnoIogicaI change viII iequiie a ielaIancing ly lhe
aulhoiilies of lheii enphases on ieguIaloiy iuIes and indusliy discielion.

105
1. Thc Impact nf fInancIa! IntcgratInn nn rcgu!atInn and supcrvIsInn
i. TechnoIogicaI advances nake il incieasingIy desiialIe and easy lo offei a videi
iange of seivices foi sone inslilulions. Inpiovenenls in lhe aliIily lo inlegiale
financiaI pioducls and noie efficienlIy naikel and cioss-seII aie najoi advanlages
of lhe onIine enviionnenl. Hovevei, lhis viII nake lhe lasks of idenlifying vhich
Iines of lusiness lanks aie engaged in noie inliicale and il aIso lecones difficuIl lo
cooidinale supeivision anong funclionaI supeivisois.

ii. TechnoIogicaI advances aie aIso iesuIling in a giealei penelialion of liadilionaI
lanking Iines of lusiness ly non-lanks, incIuding unieguIaled/Iess ieguIaled
enlilies. Iuilheinoie, poIicy nakeis aie aIso sliuggIing lo adapl exisling ieguIalions
and inlegialing nev Iavs lo lhe voiId of Inleinel lanking. They nusl sliike an
appiopiiale laIance lelveen neeling ieguIaloiy oljeclives, and avoiding
unnecessaiy cosls and disloilion lhal viII hain lhe deveIopnenl of Inleinel lanking
and eIeclionic conneice.

2. PrIvacy
The safeguaiding of cuslonei infoinalion and peisonaI piivacy has Iong leen a najoi issue
foi lhe financiaI seivices indusliy. ConsoIidalion of lhe lanking indusliy and lhe expanding
scope of pioducls offeied ly financiaI seivices fiins neans lhal lhe indusliy viII le
iesponsilIe foi nainlaining and safeguaiding huge dalalases conlaining exlensive
infoinalion on individuaIs. A lank lhal does nol piolecl lhis infoinalion couId suffei
danage lo ils iepulalion as veII as polenliaI financiaI IialiIily.

Inleinel useis aie incieasingIy suljecled lo scans lased on nisIeading oi faIse
connunicalions lhal liick lhe usei inlo sending noney, oi liick lhe usei inlo ieveaIing
enough infoinalion lo enalIe vaiious foins of idenlify lhefl lhal iesuIl in financiaI Ioss. One
cIass of such scans, caIIed `phishing', uses faIse e-naiI ieluin addiesses, sloIen giaphics,
slyIislic inilalion, nisIeading oi disguised hypeiIinks, so-caIIed `sociaI engineeiing', and
olhei ailifices lo liick useis inlo ieveaIing peisonaIIy idenlifialIe infoinalion. Aflei
ollaining lhis infoinalion, lhe `phishei' lhen uses lhe infoinalion lo cieale unIavfuI
106
idenlificalion docunenls and/oi lo unIavfuIIy ollain noney oi piopeily. In oidei lo ensuie
piivacy of peisonaI infoinalion, lhe Anli-Ihishing Acl, 2OO5 vas enacled lo ciininaIize lhe
Inleinel scans invoIving phishing.

Il vas sponsoied in lhe Senale ly Ialiick Leahy and in lhe House of Repiesenlalives ly
DaiIene HooIey.

The Anli-Ihishing Acl of 2OO5 piohilils lvo nev ciines. The fiisl leing lhe ciealion oi
piocuienenl of a velsile lhal iepiesenls ilseIf lo le lhal of a Iegilinale lusiness, and lhal
allenpls lo induce lhe viclin lo divuIge peisonaI infoinalion, vilh lhe inlenl lo connil a
ciine of fiaud oi idenlily lhefl. The second leing lhe ciealion oi piocuienenl of an enaiI
lhal iepiesenls ilseIf lo le lhal of a Iegilinale lusiness, and lhal allenpls lo induce lhe
viclin lo divuIge peisonaI infoinalion, vilh lhe inlenl lo connil a ciine of fiaud oi
idenlily lhefl.'

The liII pioposed a five-yeai piison senlence and/oi fine up lo $25O,OOO foi individuaIs
vho connil idenlily lhefl using faIsified coipoiale velsiles oi e-naiIs.

3. 5afcty and snundncss supcrvIsInn
Theie aie lvo lioad safely and soundness lhenes lhal viII giov in inpoilance as lhe
suppIy of and denand foi Inleinel lanking inciease. These aie:
syslen secuiily and
vendoi nanagenenl

Sqs|cn Sccuri|q: As eIeclionic lanking lecones noie videspiead and conpIex, lhe necessily
foi lanks lo assess and nanage opeialionaI iisks viII lecone noie ciuciaI. Secuiily faiIuie
al a pailicuIai inslilulion couId nol onIy cause Iaige Iosses foi lhal inslilulion, lul couId
spavn a geneiaI Iack of confidence in eIeclionic lanking innovalions, lheiely ielaiding
deveIopnenl. Iooi secuiily nay aIso cieale iepulalionaI oi IegaI iisks foi lanks lhal aie
seen as pioviding inadequale pioleclion foi cusloneis' peisonaI dala. As financiaI
inslilulions seaich foi nev and noie convenienl vays of using lechnoIogy lo open Inleinel
107
lanking accounls onIine (inslead of having lo fiII oul a papei appIicalion, sign il, and naiI
il), lhey aIso nusl addiess hov lo Iinil fiaud and secuiily vuIneialiIilies.

The OCC expecls nalionaI lanks lo piovide a IeveI of IogicaI and physicaI secuiily
connensuiale vilh lhe sensilivily of lhe infoinalion and lhe individuaI lanks iisk
loIeiance. Sone nalionaI lanks aIIov foi diiecl diaI-in access lo lheii syslens ovei a piivale
nelvoik vhiIe olheis piovide nelvoik access lhiough lhe Inleinel. AIlhough lhe pulIicIy
accessilIe Inleinel geneiaIIy nay le Iess secuie, lolh lypes of conneclions aie vuIneialIe lo
inleiceplion and aIleialion. Ioi exanpIe, haidvaie oi soflvaie sniffeis can ollain
passvoids, accounl nunleis, ciedil caid nunleis, elc. vilhoul iegaid lo lhe neans of
access. NalionaI lanks lheiefoie nusl have a sound syslen of inleinaI conlioIs lo piolecl
againsl secuiily lieaches foi aII foins of eIeclionic access. A sound syslen of pievenlive,
deleclive, and coiieclive conlioIs viII heIp assuie lhe inlegiily of lhe nelvoik and lhe
infoinalion il handIes.

IiievaIIs aie fiequenlIy used on Inleinel lanking syslens as a secuiily neasuie lo piolecl
inleinaI syslens and shouId le consideied foi any syslen connecled lo an oulside nelvoik.
IiievaIIs aie a conlinalion of haidvaie and soflvaie pIaced lelveen lvo nelvoiks
lhiough vhich aII liaffic nusl pass, iegaidIess of lhe diieclion of fIov. They piovide a
galevay lo guaid againsl unaulhoiized individuaIs gaining access lo lhe lanks nelvoik.

The neie piesence of a fiievaII does nol assuie IogicaI secuiily and fiievaIIs aie nol
inpenelialIe: fiievaIIs nusl le configuied lo neel a specific opeialing enviionnenl and
lhey nusl le evaIualed and nainlained on a ieguIai lasis lo assuie lheii effecliveness and
efficiency. IndividuaIs vho aie lechnicaIIy conpelenl nusl peifoin lhe inslaIIalion,
configuialion, evaIualion, and nainlenance of fiievaIIs. The specific iisks invoIved nay
iequiie a lioad iange of secuiily conlioIs.

Vcndcr Managcncn|. The deveIopnenl of Inleinel lanking has nade lanks incieasingIy
ieIianl on lhiid paily seivice piovideis. Ioi exanpIe, Iaigei lanks nay ieIy on lhiid pailies
lo piovide pioducls and seivices oulside of lheii coie conpelencies, vheieas snaIIei lanks
108
nay oulsouice lecause lhey Iack lhe necessaiy lechnicaI expeilise and iesouices lo luiId
and nainlain an Inleinel lanking deIiveiy pIalfoin on lheii ovn. Hovevei, lhe giealei
lanks ieIiance on oulsouicing, lhe noie dependenl lhe safely and soundness of individuaI
lanks, and lhe lanking syslen, lecone on lhiid paily seivice piovideis, nany of vhich aie
nol pail of a ieguIaled indusliy. This piesenls poIicy nakeis vilh lhe chaIIenge of laIancing
access lo, and oveisighl of, non-lank lechnoIogy conpanies on lhe one hand, and avoiding
excessive expansion of lank ieguIalion and supeivision lo such fiins on lhe olhei hand.

4. Ru!cs vcrsus DIscrctInn
An addilionaI lioad poIicy consideialion is laIancing vhen lo eslalIish iuIes veisus
aIIoving financiaI inslilulions lo deveIop lheii ovn non-ieguIaloiy appioaches lo nanage
nev iisks ("iuIes veisus discielion"). Rapid changes in lechnoIogy nake il difficuIl lo design
haid and fasl ieguIaloiy iuIes and supeivisoiy poIicies, such an effoil couId iesuIl in
olsoIele, oi al Ieasl olsoIescenl poIicies. Al lhe sane line, vhiIe nainlaining consideialIe
fIexiliIily nay le desiialIe, ieIying on indusliy discielion iequiies supeivisoiy aulhoiilies
lo nainlain expeilise lo evaIuale indusliy decisions on a case-ly-case lasis. Too nuch
ieIiance on indusliy discielion nay oveilax ieguIalois iesouices.
109

5. An Introduction to Foreign Exchange and Money
Markets

Iiins lhal liade inleinalionaIIy undeilake lusiness liansaclions acioss vaiious cuiiencies -
Ioi exanpIe, a fiin nighl luy iav naleiiaIs invoiced in USD and seII lhe finished goods in
Luiope, invoiced in LUR. Theiefoie, lhis fiin viII ieceive ils ievenue on lhe liansaclion in
LUR, lul viII le incuiiing lhe cosl in USD. This fiin has an exposuie lo lhe exchange iale
of LUR vs lhe USD.

Ioieign exchange is lhe liading of one cuiiency foi anolhei. InleinalionaI liade cieales a
iequiienenl foi foieign exchange. In lhe alove exanpIe, lhe fiin viII seek lo seII ils LUR
and luy USD againsl il lo covei ils exposuie lo lhe exchange iale.

WhiIe inleinalionaI liade has leen lhe genesis foi lhe foieign exchange liading, in lhe
cuiienl age, foieign exchange liading is doninaled ly fIovs on accounl of gIolaI
inveslnenls. Ioi exanpIe, a US conpany, vanling lo invesl in lhe Indian slock naikels,
vouId need lo seII lhe USD and luy Indian Rupees (INR) in exchange. Wilh lhis INR, lhe
US Conpany viII le alIe lo luy shaies on lhe Indian slock naikels.

5.1 The Forex market
A foieign exchange liansaclion is a conliacl lo luy oi seII a quanlily of one cuiiency in
exchange foi anolhei al
An agieed iale of exchange
Ioi deIiveiy on a specified dale
The piice al vhich one cuiiency is liaded in exchange foi anolhei is caIIed lhe exchange iale
lelveen lhe lvo cuiiencies.

The IX naikel faciIilales lhe idenlificalion of lhe appiopiiale exchange iales. Hovevei, lhe
IX naikel is nol an oiganized naikel Iike a slock exchange. A IX naikel is nade up of
110
deaIing ioons of vaiious lanks, Iinked lo each olhei and lheii cusloneis, via leIecon and
Ieased Iines.

y viilue of lhe inleinalionaI naluie of lhe naikel, lhe IX naikels span aInosl 24 houis of
lhe day. The lig cenlies foi IX liading aie London, Nev Yoik & Tokyo. Lxchange iales
vaiy conlinuousIy ovei lhe day, diiven ly lhe denand and suppIy foi lhe cuiiencies leing
liaded.

5.1.1 5pnt TransactInns
In a spot transaction, the delivery date for the currencies is two business days after the
transaction date. Nole lhal ly lhe lvo-lusiness days ahead iuIe, deaIs done on Iiiday viII
have Tuesday of lhe foIIoving veek as lhe vaIue dale if Saluiday and Sunday aie lank
hoIidays as lhey aie in nosl financiaI cenleis.

LxanpIe:
Cuiieny Iaii: USD/ INR
Conliacl Anounl : USD 1,OOO,OOO
Lxchange Rale: 45.8O
Tiansaclion Dale: 2 }une 2OO6
DeIiveiy Dale: 6 }une 2OO6

This is a spol liansaclion as lhe deIiveiy is lvo lusiness days aflei lhe liansaclion dale. A
lusiness day is defined as a day lhal is a voiking day in hone counliies of lhe cuiiency
paii. On 6
lh
}une, in lhe alove exanpIe, lhe lank luying USD viII ieceive USD 1 niIIion in
ils noslio
16
accounl and and pay oul INR 45.8O niIIion in exchange.




16
A 'Noslio accounl is a lanks ovn foieign cuiiency accounl usuaIIy heId in a lank in lhe counliy of
lhal cuiiency. Ioi exanpIe, a US lank nighl hoId CI sleiIing noslio vilh lank in London. Noslio
accounl can le used foi ieceiving lhe paynenls nade in lhal foieign cuiiency ly lhe counleipaily.

111
5.1.2 Othcr transactInn typcs
Cash Tom Spot Forward
Delivery Date Same day as
transaction date
One business
day after
transaction date
Two business
days after
transaction date
> 2 business
days after
transaction date
Example
Currency Pair USD/INR USD/INR USD/INR USD/INR
Contract
Amount
USD 1,000,000 USD 1,000,000 USD 1,000,000 USD 500,000
Exchange Rate 45.7800 45.7950 45.80 45.8500
Transaction
Date
1-June-2006 2-June-2006 2-June-2006 2-June-2006
Delivery Date 1-June-2006 5-June-2006 6-June-2006 12 June-2006
Bank Buying
USD receives
USD 1 million USD 1 million USD 1 million USD 0.5 million
Bank Buying
USD pays
INR 45.78
million
INR 45.7950
million
INR 45.80
million
INR 22.925
million

5.1.3 5wIft Cndcs
Lach cuiiency in lhe financiaI naikels is idenlified ly a lhiee Iellei code. The fiisl lvo
Ielleis USUALLY iepiesenl lhe nane of lhe counliy and lhe lhiid Iellei lhe nane of lhe
cuiiency. Ioi exanpIe, as seen alove, lhe Indian Rupee is iepiesenled as INR, 'IN slanding
foi India andR foi Rupee. SiniIiaiy foi USD. Hovevei, a significalion devialion fion lhis
iuIe is lhe LUR, vheie LUR couId sland foi Luiope oi Luio (lhe nane of lhe connon
euiozone cuiiency).

5.1.4 Basc Currcncy and VarIab!c CurrcncIcs
Spol Rales aie quoled as one uinl of lase cuiiency againsl a nunlei of unils of a vaiialIe
cuiiency. In lhe exanpIe alove, lhe lase cuiiency is USD, and lhe vaiialIe cuiiency is INR.
WhiIe naning an exchange iale, lhe lase cuiiency is naned fiisl and lhe vaiialIe cuiiency
112
aflei lhal. Theiefoie, USD/ INR (ase Cuiiency/ VaiialIe Cuiiency) has an exchange iale
of 45.8O in lhe alove exanpIe.

To faciIilale a connon undeislanding and quolalion nechanisn in lhe foieign exchange
naikels, lhe naikelpIace foIIovs sone convenlions vhiIe idenlifying lhe lase cuiiency foi
quoling iales. Ioi nosl of lhe quoles invoIving USD, lhe USD is lhe lase cuiiency.

5.1.5 BId & Offcr Ratcs
Lxchange iales aie noinaIIy expiessed as a piice, oi a lid and a ask iale. Ioi exanpIe, on a
given day and line, foi lhe USD/ INR cuiiency paii, lhe spol exchange iale couId le
USD/ INR = 45.8O/ 45.81
The lid piice is lhe iale al vhich lhe lank quoling lhe piice, oi lhe 'naikel nakei viII
luy lhe lase cuiiency fion ils cuslonei. In lhe exanpIe alove, lhe lid iale is 45.8O
The ask oi offei piice is lhe iale al vhich lhe lank quoling lhe piice, viII seII lhe lase
cuiiency lo ils cuslonei. In lhe exanpIe alove, lhe offei iale is 45.81

5.1.6 DIrcct & IndIrcct QuntatInn

WhiIe quoling lhe exchange iale foi a cuiiency if lhe unil of foieign cuiiency is kepl
conslanl and ils vaIue is expiessed in leins of vaiialIe hone cuiiency, lhe nelhod of
quoling exchange iale is diiecl quolalion. In lhis case, lhe unil of hone cuiiency viII le
vaiying foi eveiy unil of foieign cuiiency.
e.g., USD 1 = Rs 43.8O
CI 1 = Rs 81.8O

When lhe unil of hone cuiiency is kepl conslanl and lhe unil of hone cuiiency is expiessed
in leins of vaiialIe unils foieign cuiiency, lhen lhis nelhod of quoling exchange iale is
caIIed Indiiecl quolalion.

L.g., Rs 1OO = USD 2.28
Rs 1OO = CI 1.22
113

5.1.7 Crnss Ratcs
When lhe exchange iale quole lelveen lvo cuiiencies is nol diieclIy avaiIalIe, il is lo le
deiived fion lhe exchange iale quole foi lvo diffeienl cuiiencies. When lhe exchange iale
is deleinined in such a nannei, il is caIIed cioss exchange iale. Ioi exanpIe, if lhe exchange
iale lelveen USD (US doIIai) and INR (Indian Rupees) is Rs.44.7O and lhe exchange iale
lelveen USD and }IY (}apanese Yen) is 116.8O, lhe exchange iale lelveen INR and }IY can
le deleinined as 116.8O/44.7O oi 2.61 }IY = 1 INR. This viII le caIIed lhe cioss iale lelveen
INR and }IY

5.2 Money Market
Money naikels aie naikels foi liading shoil lein financiaI insliunenls. Money Maikel is
lhal pail of lhe financiaI naikels in vhich lhe secuiilies oi financiaI insliunenls issued have
a naluiily of Iess lhan oi equaI lo one yeai.

The nain noney naikel pioducls aie:
Inleilank Ioans/ deposils
Ceilificale of Deposils
Tieasuiy iIIs
ankeis Acceplances
ConneiciaI Iapei
Repuichase Agieenenls

Sone of lhe connonIy used leins in ieIalion lo noney naikel aie as foIIovs:

5.2.1 Intcrbank !nans/ dcpnsIts
Majoi lanks Iend and loiiov deposils anongsl one anolhei. The ieason foi lhis Iending/
loiioving is a funclion of lheii funds posilion. Ioi exanpIe, if a lanks Iending lo ils
cusloneis is in excess of ils deposils, lhe lank vouId vanl lo loiiov in lhe inleilank
naikel, lo covei lhe deficil lelveen ils Iending and deposils. The iales al vhich lanks Iend
114
and loiiov in lhe naikels depend on lhe naikel condilions, as siniIai lo foieign exchange
naikels, lhe iales of loiioving vaiy lhiough lhe day.

Al any poinl of line, diffeienl lanks viII le quoling diffeienl iales foi loiioving/ Iending,
depending upon lheii Iiquidily posilion. Hovevei, ly viilue of vaiious lanks liy lo loiiov
and Iend noney, lheie viII le a naikel ciealed vilh lhe lesl avaiIalIe iale ly a loiioving
lank, leing jusl leIov lhe lesl avaiIalIe iale ly a Iending lank.

Ioi exanpIe, lhe naikel foi a lhiee nonlh loiioving/ Iending in USD couId le
3.48OO / 3.48125

The iale alove says lhal lhe lesl iale al vhich a lank is viIIing lo loiiov is al 3.48 and
lhe lesl iale al vhich funds aie offeied is al 3.48125. The naigin lelveen lid and offei is
noinaIIy 1/8
lh
of a peicenl oi 12.5 lasis poinls. AcluaI deaIs couId le al conpionise iale,
lelveen 3.48 and 3.48125.

No coIIaleiaI secuiily is iequiied lo covei lhese liansaclions.

If lhe loiioving/ Ioan is foi one day oi oveinighl, lhe naikel is caIIed a nolice noney oi
caII noney naikel. The caII naikel enalIes lhe lanks and inslilulions lo even oul lheii day
lo day deficils and suipIuses of noney.

5.2.2 LIBOR
WhiIe diffeienl lanks couId quole diffeienl iales foi loiioving/ Iending noney duiing a
day, lhe London naikel has eslalIished a lenchnaik oi iefeience iale foi lhe inleilank
naikel in London. This is caIIed lhe London Inleilank Offeied Rale oi LIOR. Liloi iales
aie pulIished on each lusiness day in London ianging fion iales foi oveinighl loiioving
lo iales foi peiiods of one veek, one nonlh, lvo nonlhs and so on uplo 12 nonlhs. The
Liloi iale iepiesenls lhe aveiage iale of Iending oi offeiing funds ly lanks in lhe London
naikels al 11:OO an on lhe given day. LIOR is lheiefoie lhe inleiesl iale al vhich lanks
can loiiov funds, in naikelalIe size, fion olhei lanks in lhe London inleilank naikel.
115
LIOR is lhe nosl videIy used lenchnaik foi shoil-lein inleiesl iales. The iales foi Iess
piefeiied loiioveis aie Iinked lo lhis lenchnaik.

5.2.3 LIBID
This is lhe inleinalionaI iale al vhich lanks Iend lo olhei lanks. This is a 'lid iale diffeienl
fion LIOR vhich is 'offei iale. Il is noinaIIy one eighlh of a peicenlage poinl Iess lhan
LIOR.

5.2.4 CcrtIfIcatcs nf DcpnsIt
Ceilificale of Deposils oiiginaled in lhe US naikels, vheie vheie aie diiecled piinaiiIy al
lhe ielaiI naikel. In Luiope hovevei, CDs aie IaigeIy deaIl in lhe inleilank naikel. A CD is
a iecoid evidencing lhe pIacenenl of a deposil vilh lhe CD issuei (loiiovei) foi a slaled
peiiod of lien al a given iale of inleiesl. A CD is a ceilificale foi a line deposil, and is a
leaiei secuiily. Theiefoie, a CD hoIdei can seII lhe enlilIenenl lo lhe undeiIying deposil
lefoie naluiily lo soneone eIse. The gieal advanlage of a CD ovei a line deposil, lo lhe CD
hoIdei, is lhal il is liadealIe in lhe secondaiy naikel. Hence CDs piovide a neans foi lhe
hoIdei lo deposil funds shoil-lein vhiIsl ielaining lhe fIexiliIily lo conveil lhen inlo cash
shouId lhe iequiienenl aiise. In ieluin foi lhis Iiquidily, lhe CD hoIdei vouId accepl a
Iovei yieId lhan on an inleilank deposil. CDs lheiefoie noinaIIy yieId aIleasl 1O lasis
poinls leIov lhe equivaIenl iale foi an inleilank deposil.

5.2.5 Trcasury BI!!s
Like a lank oi a copoiale iequiiing lo loiiov funds foi lheii aclivilies, goveinnenls loo
need lo loiiov noney lo covei lheii expenses. Coveining loiioving foi duialions Iess lhan
one yeai occuis lhiough an insliunenl caIIed a Tieasuiy iII. Tieasuiy liIIs do nol caiiy an
inleiesl oi coupon iale. In olhei voids, lhey caiiy a zeio inleiesl iale.

A lieasuiy liII lheiefoie is sulsciiled al a discounl lo lhe face vaIue. This is expIained in
lhe exanpIe leIov

Iace VaIue = USD 1OO
116
Maluiily = 3 nonlhs
Inleiesl Rale = O.

Hov nuch shouId an invesloi pay lo gel an inleiesl of 5 ovei lhe 3 nonlh peiiod of lhe
lieasuiy liII`
Anounl lo le paid oul ly invesloi =
Return) Desired (1
Value Face
+

Desiied Reluin of 5 annuaIIy vouId le equaI lo 5/4 oi 1.25O ovei a lhiee nonlh
peiiod.
Theiefoie Anounl lo le paid oul ly invesloi =
1.25%) (1
100
+
=98.76543
A lieasuiy liII is soId al a discounl (in lhis exanpIe, soId al 98.76543, a discounl of 1.23456
lo lhe face vaIue. This discounl ensuies lhal lhe invesloi eains an inleiesl on a zeio inleiesl
insliunenl.
The inleiesl eained ly an invesloi ovei lhe lhiee nonlh peiiod can le caIcuIaled as alove:

Inleiesl Rale Lained =
Outlay Initial
Gain
=
98.76453
1.23456
= 1.25 foi lhiee nonlh oi 5 foi a yeai.

5.2.6 Bankcrs Acccptanccs
A ankeis acceplance is a liII of exchange diavn lo finance a liade liansaclion (inpoil/
expoil) and accepled ly a lank as good foi paynenl. The lank pIaces ils slanp and
aulhoiized signaloiies on lhe liII and fion lhen on , lhe insliunenl (lhe liII of exchange) is
equivaIenl lo caiiying lhe iisk of lhe accepling lanks ciedil.

Ioi exanpIe, a iII of Lxchange has leen diavn foi USD 1 niIIion payalIe on 5
lh
Seplenlei
2OO6. On 12
lh
}une (85 days lefoie naluiily), lhe liII is piesenled lo ank A foi discounling.
ank A discounls lhe liII al 1O and pays lhe expoilei
)
365
% 10 * 85
(1
1,000,000
+
= USD 977,242.3O lo
lhe expoilei. ank A couId nov eilhei hoId lhe liII of exchange liII naluiily and ieceive
117
USD 1 niIIion on lhe 5
lh
Seplenlei 2OO6 oi ank A couId seII lhe iII of exchange in lhe
naikel vilh his ovn acceplance,

5.2.7 CnmmcrcIa! Papcr
As a lieasuiy liII is funds iaised ly lhe goveinnenl, a ConneiciaI papei denoles a siniIai
insliunenl, excepl lhal lhe issuei of lhe secuiily is nov a coipoiale ialhei lhan lhe
goveinnenl. ConneiciaI Iapeis can have a lenoi oi duialion of loiioving of uplo one
yeai. Mininun lenois aie lypicaIIy nol Iovei lhan 14 days.


118
5.3 Bankss participation in the Forex and Money Markets
anks pailicipale in lhe Ioiex and noney naikels via lheii Tieasuiy funclion.




The frnnt nffIcc of lieasuiy consisls of deaIeis oi liadeis vho liade (i.e. luy and seII)
vaiious lieasuiy (foiex , noney naikel and olhei) pioducls.

The mId nffIcc of a lieasuiy Iooks aflei lhe iecoid keeping and accounling, MIS, iisk
nanagenenl, elc.

The back nffIcc Iooks inlo sellIenenl issues i.e. in case of naluiing deaIs vhelhei lhe
paynenl has leen ieceived oi nade as pei lhe agieenenl and in case of canceIIed deaIs
vhelhei lhe liansaclion has leen ieveised oi nol.

5.3.1 Trcasury Prnducts
The lieasuiy depailnenl deaIs in vaiious pioducls and usuaIIy lhe fionl office is oiganized
inlo vaiious 'desks vheie each desk consisls of deaIeis vho liade in a specific lype of
pioducl. Sone of lhe connonIy found desks in lhe fionl office of a lieasuiy aie:

Trcasury
Frnnt nffIcc MId- OffIcc Back-OffIcc
119
Ioieign Lxchange Desk
Money Maikel Desk
Iixed Incone Desk
Deiivalives Desk

Ioieign Lxchange and noney naikel insliunenls have leen coveied in lhis seclion. Iixed
Incone & Deiivalives shaII le coveied in olhei noduIes.































120

Questions - 1

1. The Federal Reserve Act did not provide for
a. Establishment of Federal Reserve banks
b. Eurnish an elastic currency
c. Establish a more effective supervision of banking in the United States
d. Deposit Insurance

2. Which of the following statements is correct?
a. Federal Open Market Committee (FOMC) consists of the members of Board of Governors,
the president of the Federal Reserve Bank of New York and presidents of four other Federal
Reserve Banks
b. FRS is composed of the Board of Governors and twelve regional Federal Reserve Banks
c. Board of Governors is a Federal Government Agency
d. All of the above

3. Which of the following is/are a function performed by the Federal Reserve Banks for
depository institutions?
a. Collect Checks
b. Electronically Transfer Funds
c. Distribute and Receive Currency/Coins
d. All of the above

4. Which of the following is not a type of commercial bank in US?
a. National banks
b. National non-member banks
c. State member banks
d. State non-member banks

121


5. Which of the following statements is incorrect?
a. In case of fully amortized fixed rate mortgage, the debt is gradually extinguished through
periodic regular equal repayments of the borrowed funds
b. Under partially amortized fixed rate mortgage, a portion of the mortgage is extinguished
by equal periodic payments over a short period and the remaining unamortized portion is
paid off in one lump sum payment
c. In adjustable rate mortgages lenders have the freedom to revise the interest rate when the
market rate changes
d. None of the above

6. Those mortgages that are not insured are known as
a. VA mortgages
b. FHA mortgages
c. Conventional mortgages
d. None of the above

7. Which of the following statements is incorrect?
a. Securitization is the issuance of a debt instrument in which the promised payments are
derived from revenue generated by a defined pool of loans
b. Mortgage loans can be securitized
c. Automobile loans cannot be securitized
d. None of the above

8. Which of the following information is not included in a credit report?
a. Credit hstory
b. Public records
c. Personal information
d. Information about checking and savings account
122


9. Experian, Equifax, and Transunion are
a. US Banks
b. Thrift Institutions
c. Credit Unions
d. Credit Rating Agencies in US

10. Structured finance products does not include
a. Project Finance
b. Asset Based Finance
c. Securitisation
d. Bill Discounting