1.

• AMERICAN COLLEGE

S K O P J E

PRINCIPLESOF BANKING

Chapter 4

Instructror : Tome Nenovski, Ph. D.

2. 4. BANKING PRODUCTS AND SERVICES

- Bank product definition:It is every product or service produced by bank no matter if it is a debtor or a creditor and no matter if that is done in its own name and account or for somebody elses name and account;

- Traditional bank task is to collect money and to invest money in different parts of the economy;

-General opinion:Bank has only mediator role in collecting money and extending credits;

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4. BANKING PRODUCTS AND SERVICES/2

- The effects of bank globalization and competition: some classical products became unprofitable and replaced with new products;

- Banks should be directed in doing the following activities:

- collecting funds (deposits, credits, capital) for financing bank credit and other activities;

- introducing and servicing new credits;

- introducing and doing contemporary noncredit transactions (money transfers, information..);

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4. BANKING PRODUCTS AND SERVICES/3

- selling consultant and management services;

-selling new products and services: brokerage, insurance, investment banking, investment funds foundation, agent activities, trust services etc.;

- bank as guarantee etc.

- Not every bank can do all the above mentioned activities.

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4.1. HISTORICAL DEVELOPMENT OF BANKING PRODUCTS AND SERVICES

- Banks have been offeringmany and different productsand services to their clients throughout the history;

- Introduction and evolution of banking products and services have been conditioned by thelevel of economic and banking development and by the public needs ;

-Most importantbanking products and services throughout the history:

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4.1. HISTORICAL DEVELOPMENT OF BANKING PRODUCTS AND SERVICES/2

a)Exchanging (trading) foreign currency;

b)Discounting commercial bills (bills of exchange);

c)Collecting funds at the market (savings, deposits);

d)Collecting deposit money (realizing checking orders);

e)Security depot services; gold and jewelry estimation.

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4.1. HISTORICAL DEVELOPMENT OF BANKING PRODUCTS AND SERVICES/3

f)Government activities support (extending credits; buying Government securities);

g)Trust services.

- Intensive banking products development during the middle centuries (a period of strong economic development, technological innovations, foreign trade the case of Lombardia, etc.).

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4.2.CLLASIC BANKING PRODUCTS

- Evolution and modification of banking products during the centuries;

- Banking products stabilization during first half of XX- th century clasical banking products and services;

- Numerial products and service;

- The oldest, largest and most voluminous banking products are collectingdeposits , extendingcreditsandoff-balanced or neutralbanking products and services.

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4.2.CLASIC BANKING PRODUCTS/2

4.2.1. DEPOSITS

- Depositium= Commited goods, commited deposit;

- Deposit= A certain amount of money that the bank is obliged to pay off or to transfer on depositor order;

- Deposit =Specific credit that depositors have extended to the bank;

- The importance of quantity, prices, liquidity and profitability;

- Deposits are basis for bank development;

- Deposits are basis for creating and developing bank mobilizing function;

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4.2.1. DEPOSITS

- Clients deposits consist 15-20% of total available funds for financing bank placement;

- The credit quantity, quality, structure and credit pricing depends on deposits quantity, quality, structure and deposits pricing;

- Crutial issues for each bank in deposit management: 1) Where and how much funds the bank can collect for the lowest price; 2) How can the bank always have enough deposits to realize planned credit and other service quantity?

- Big bank competition on deposit market.

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4.2.1.1. Types of deposits

- Different approaches in determining the types of deposits;

- Most often deposits are clasified as deposit money, savings and time deposits;

- Retail deposits and corporate deposits;

- Recently the most exploit clasification is on transaction and non transaction deposits.

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4.2.1.1. Types of deposits/2

a) Transaction deposits

-Companies and citiziens keep their transaction deposits at special bank accounts: cheques accounts, transfer accounts; current accounts etc.;

- Transaction deposits realize money payment and turnover function;

- Transaction deposits are known asdeposit money ;

-No interest bearing deposits(they are mostly represented and the cheapest funds resources for each bank);

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4.2.1.1. Types of deposits/3

a) Transaction deposits

- Interest bearing deposit money(cheques, savings..):

1)Negotiable order of withdrawal NOW;

1.2)Money market deposit account MMDAs(term deposits with limited privileges for

making payments by the depositor);

1.3)Deposits super NOW.

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4.2.1.1. Types of deposits/4

b) Non transaction deposits (savings and term deposits)

- Interest bearing deposits with no allowance for making payments by their owners;

1) Savings

- They are sight deposits;

- Bear higher interest than transaction

deposits and have lower service costs;

- Banks must pay attention to growing citizen

interest awearness;

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4.2.1.1. Types of deposits/5

b) Non transaction deposits (savings and term deposits)

2) Term deposits

- These deposits bear higher interest than

savings;

- Deposits with volatile interst rates;

- Cerificate of deposits CDs(transferable and

non transferable CDs; revocable and non

revocable CDs);

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4.2.2. CREDITS/LOANS

- Credits are second most important banking products;

- Credits represent over of bank assets and almost 2/3 of bank total revenues

- Extending credit is theheart of the bank industry ;

- Big concentration ofrisk ;

- Need for carefulcredit analysis ;

- For maximizing the profit, the bank has to insist on the highest possible invested money return, parallel to decreasing the ever present credit risk;

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4.2.2. CREDITS/2

- Credit principles:

1)Financing credit worthy clients;

2)Financing most profitable projects with lowest risk;

3)Diversifing assets (credits) for lowering risk;

4)Part of the assets (credits) must be very high liquid (to be transformed in primary liquidity in very short period of time).

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4.2.2.1. TYPES OF CREDITS

- Different types of credits for different clients ;

- Credits for different purposes;

-Factorsthat determine structure of bank credit portfolio:

1)Market area characteristics;

2)How big the bank is (how big bank capital is);

3)Bank general credit policy, bank management expeirence and personnel proffesional skills;

4)The expected income from each credit (gross income versus net income);

5)Number of bank clients;

6)Costs for extending a certain credit -The importance of Functional Cost Analysis.

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4.2.2.1. TYPES OF CREDITS/2

- Commercial and retail credits;

- Insured and uninsured credits;

- Fixed interest credit rates and flexible interest credit rates;

- Credits that are payed off at once and credits that are paid on instalements;

- Most often credit division: Short - term and long - term credits (loans).

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a) SHORT-TERM CREDITS

- Up to one year term to maturity;

- Credits that are used for financing temporarily and seasonal companies and citizen needs;

1) Self liquidating credits

- Credits used for buying raw materials;

- Credits paid off by selling stock of goods;

- Credit term of maturity: 2-3 months;

- These credits represent more than of bank credits to

corporations.

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2) Credits for working capital

- Very similar to self liquidating credits;

- Term to maturity: couple of days to 1 year;

- Used for covering companies seasonal needs;

- The importance of credit lines;

- Collateral: Stoks or client money receivables;

- Commitment fee on unused credit;

- Compensatory deposit.

3) Temporarily credit for construction

- Credit must be collateralized by long-term mortgage;

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4) Assets based credits

- Credits based on client stock of goods (up to 30% of total credit) and money receivables (up to 60% of total credit);

- The cases of factoring /commission trade (higher risk higher interest rate).

5) Open credit line

- Up to one year term to maturity;

- Flexible interest rate;

- Without collateral (Alternative: Compensatory deposit);

- Extended to the most credible clients;

- Informal and formal (agreed) credit lines.

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6) Retail trade (business) credit

- Collateralized by businessman goods;

7) Credits to security dealers

- Collateralized by first class government securities;

- Term to maturity: Several days.

8) Syndicated credits

- Several banks extend credit in a big amount to some big corporation.

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b) LONG TERM CREDITS (LOANS)

- Term to maturity over one year;

- These credits are used for financing long trying company needs, particularly for buying fixed assets, refinancing other credits, mergers and acquisitions etc.

-Most often classificationis: Term credits, Revolving credits, Project credits, Credits for supporting companies merger or acquisition and Credit line stand by.

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1) Term (investment) credits

- Most frequent long term credit;

-Usage:Financing middle and long term business investment (equipment, machines, object construction);

- Paying back by installments (monthly, three months,6 months);

- Depreciation plan;

-Collateral:Long trying capital (equipment, building, land);

-Higher interest ratethan interest rate on short-term credits;

-High level of credit risk;

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2) Revolving credits

- One of most flexible type of credits;

- It could cover 3,4, or 5 years;

- Collateral: Some client real assets;

- They are used for buying long trying turnover resources;

- Formal bank financial obligation;

- Confirmed credit line (less obligatory credit agreement);

- Business credit cards.

3) Project credits

- Credits for mines, refineries, electric power systems etc.;

- Most risky credits;

- Long-term syndicated credits;

- Shelter based credits (collateralized by credited company assets);

- Non shelter base credits (presence ofbig risk).

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4) Credit for companies merger and acquisition

- Leveraged by out (LBO) credits;

- Bank Consortium;

- Collateral: Client real property or its turnover assets;

- Very risky type of credit.

5) Stand by credit line

- Credits for note issuing facilities NIF (commercial securities);

- Term to maturity:3-7 years;

- Bank agrees to buy commercial securities if the company could not sell securities at the profitable interest rate.

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4.2.3. OFF - BALANCE SHEET (NEUTRAL) BANK PRODUCTS AND SERVICES

- Bank plays neither the role of debtor nor the role of creditor;

- The oldest bank products and services;

- For such services bank pays off provision fee, not interest;

- Two types of neutral bank services: Interference and Commission services.

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4.2.3. OFF - BALANCE SHEET (NEUTRAL) BANK PRODUCTS AND SERVICES/2

a)Service that bank is doing on behalf of client name and account is calledinterference service:

- Payment turnover (making payments home or in abroad);

- Collection activities(collecting funds from client money receivables and investing money on behalf of the client; paying client obligations for rents, electric power, etc.);

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4.2.3. OFF - BALANCE SHEET (NEUTRAL) BANK PRODUCTS AND SERVICES/3

b) Bankservice that is done on behalf of its own name and client account is calledcommission service:

- Client securities emission;

- Issuing commercial letters of credit;

- Issuing guarantees and guarantee letters;

- Depot services;

- Buying and selling securities (brokerage activities);

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4.2.3. OFF - BALANCE SHEET (NEUTRAL) BANK PRODUCTS AND SERVICES

-Commission credit activities (credits for supporting issuing or buying out company commercial papers..) ;

- Trust services: Bank acts as a client agent withfull responsibilityin managing client property or asan agentfor doing some specific activities. Three types of trust services:

a)Corporative trust service (realization of securities emission);

b)Corporative agency service (transfer client securities, paying dividends, paying company obligations, registration of company securities etc.);

c)Company employers benefits trust (pensions, profit distribution, accounting, reporting etc).

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4.3. CONTEMPORARY BANKING PRODUCTS

- Bank domination on money market till the end of 70s of XX century;

- Appearance and development of investment and pension funds;

- Issuing own company securities for collecting the needed money;

- Money market competition increase;

- Banks are forced to broaden their activities and to create new products and services, particularly in dealing with securities;

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4.3.1. Most important contemporary banking products

a)Annuities (saving-deposit instrument)

- Fix Annuities;

- Variable annuities;

b)Joint venture loans (founding company with joint capital);

c)Leasing;

d)Pension plans;

e)Project financing;

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4.3.1. Most important contemporary banking products/2

f)Insurance activities (issuing insurance policies) Bank and Insurance company as parts of some Bank Holding company Convergence;

-Advantages for banks :1)Stabilizing bank cash flow and efficiency Stabilizing bank profitability;2)Economies of scale;3)Economies of scope;

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4.3.1. Most important contemporary banking products/3

g)ATS (Automatic Transfer Savings) accounts;

h)Overnight repurchase (margin account);

j)Financial and information advice for the clients (solving the problem of information irregularity information asymmetry);

k)Electronic change of data and making payments.

Bank revolution:Offering new products and services for increasing clients appropriates;

Banks asmultifunctional super storesof modern time;

Universal Banking.

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4.4. DEALING WITH SECURITIES

- Emission and selling client securities (underwriting) and buying and selling securities on behalf of the clients (brokerage services);

- In some countries investment banks are only authorized to deal with securities. Reasons for that are:

- dealing with securities is very risky;

- possible conflict of interests between bank and clients;

- financial market efficiency is increasing by competition between bank credits and issuing client own securities;

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4.4. DEALING WITH SECURITIES/2

- In other countries it is completely allowed banks to deal with securities (it decreases risk of bankruptcy and increases competition);

- Three ways of dealing with securities on behalf of the client:

a)Service for securities emission on primary market;

b)Service for buying and selling securities on secondary market (brokerage service);

c)Consultant service.

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4.4. DEALING WITH SECURITIES/3

4.4.1.Service for securities emission on primary market

- Three bank functions:

a)Consultant function;

b)Overtaking securities emission (Overtaking risk by the bank for selling the client securities Extending commission credit for buying out securities);

c)Selling the client securities;

- Price for covering bank costs (provision as a percent of sold securities): Different costs for Public offering and Private placement.

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4.4. DEALING WITH SECURITIES/4

4.4.2. Brokerage services (secondary market)

- Bank trust services for realizing client orders for buying or selling securities;

- Bankinvestment plans : voluntarily and automatic;

- Dividend reinvesting plans;

- Security swaps;

- Paying off provision fee.

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4.4. DEALING WITH SECURITIES

4.4.3. Financial-consultancy services

- Client financial performance analyses;

- Possible fund resources;

- Client ownership and client financial

reconstruction advice (merger, acquisition) etc.

- Paying off provision fee.

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KEY WORDS/TERMS:

Banking product

Exchanging foreign currency

Discounting commercial bills

Depot service

Trust service

Off-balanced (neutral) bank products and services

Deposit

Deposit money

Retail deposits

Corporate deposits

Transaction deposits

Non transaction deposits

Savings

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KEY WORDS/TERMS:

Term deposits

Certificate of deposits CDs

Credit/Loan

Credit principles

Commercial credits

Short-term and long-term credits

Self-liquidating credits

Credits for working capital

Assets based credits

Open credit line

Retailtrade (business) credit

Credits to security dealers

Syndicated credits

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KEY WORDS/TERMS:

Investment credits

Revolving credits

Project credits

Credits for companies merger and acquisition

Stand by credit line

Interference service

Making payments

Collection activities

Commission service

Commercial letter of credit

Guarantees

Annuities

Join venture loans

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KEY WORDS/TERMS:

Leasing

Pension plans

Project financing

Insurance activities

ATS Automatic Transfer Savings

Overnight repurchase

Securities

Brokerage services

45.

CHECKING QUESTIONS:

What is bank product?

Enumerate at least five of the most important banking products and services throughout the history?

Define bank deposit in contemporary sense.

What is the main function of transaction deposits?

Make difference between no interest and interest bearing transaction deposits.

What is non transaction deposits consisted of?

What bank has to insist on for maximizing profit when extends credits/loans?

What are the main credit principles (4)?

What are the main factors that determine structure of bank credit portfolio (6)?

Explain shortly the meaning of self-liquidating credits.

Explain shortly the meaning of credits for working capital.

46.

CHECKING QUESTIONS:

Explain shortly the meaning ofassets based credits.

Explain shortly the meaning of open credit line

Explain shortly the meaning of retailtrade (business) credit;

Explain shortly the meaning of credits to security dealers;

Explain shortly the meaning of syndicated credits;

Explain shortly the meaning of term (investment) credits;

Explain shortly the meaning ofrevolving credits;

Explain shortly the meaning of project credits;

Explain shortly the meaning of credit for companies merger and acquisition;

Explain shortly the meaning of stand by credit line;

What does it mean interference bank service?

What does it mean commission bank service/

47.

CHECKING QUESTIONS:

Enumerate at least five types of bank commission services.

What are annuities?

What is bank leasing?

What are the advantages of insurance activities for a bank?

Define overnight repurchase bank activity.

What are the ways (3) of bank dealing with securities on behalf of the client?

What are the bank service functions (3) on primary securities market?