National College of Business Administration & Economics

Subject: Money & Banking

Topic: Business of Banking

Submitted BY: Name: Class: Sobia Ali MPhil ( 2 nd

Semester )

Submitted to: Dr. Muhammad Usman

The Business of Banking An Overview of Banking Industry:

The banking industry is an enormous sector of business and finance that has existed in human civilization in some form for thousands of years. In the modern world, the banking industryplays a large part in financial dealings, as it is a major and popular means for investing, borrowing, and storing money. Banks exist all over the world, and are usually heavily regulated by world governments in order to prevent corruption and protect the money of the general public. Though there is some evidence of a banking industry in ancient Greece and throughout other early civilizations, the Middle East and Asia are believed to have played an important part of the development of a banking industry. The word check derives from an old Arabic word for a promise of payment on delivery, and historical records show some evidence of an internationalbanking trade between Islamic nations and China as early as the 9th century. Many historians trace the foundations of modern banking to 14th century Italy, where wealthy Italian families established banks for the lending and investing of money on trade and commerce. Banks sprang up throughout Europe during the following centuries, concentrating in the great ports of the old world where commerce was a part of daily life. With the shift from precious metal currency to fiat money systems, the banking industry was less limited by finite resources and could expand ever further. The development of computer technology also playing a critical part in creating a global industry, since users were no longer limited by the need to physically visit a bank to manage transactions. The banking industry provides clients with a variety of services and options. The most basic function of a bank is to provide customers with a safe, guaranteed record of their accumulated money, usually done through a checking account that can be easily accessed for withdrawals and deposits. Banks also provide savings accounts, which are also easily accessed but provide a slightly higher interest rate for funds. For many people, involvement with the bankingindustry is limited to these two basic accounts, but this is only a bare minimum of what theindustry offers. Banks play a major part in the investing and loaning of money. Most banks can use the funds deposited in accounts to loan out money or make investments; this practice allows a constant flow of lending and borrowing that keeps money circulating throughout the economy. Loans that many banks offer include commercial loans, property loans, vehicle loans, and lines of credit. Investment services offered by many banks include retirement, certificate of deposit (CD), and money market accounts.

How the banking industry has changed.

The banking industry has broadened its scope. In addition to traditional banking products and services, banks in many countries have begun to sell insurance products and securities. Indeed the breaking down of the regulatory wall between investment banking and commercial banking in many parts of the world has helped transform commercial banks into universal banks. Indeed deregulation has erased the traditional distinction between banks, insurance companies, and securities firms.

The old classification of banks still remains as banks have ventured into new territories even while protecting their traditional domains. Consequently, banks continue to be identified by their traditional strengths. Most global banks in the banking industry now fall in the commercial banks category. Commercial banks offer traditional banking services to individuals, businesses, and governments. The commercial bank universe is populated by large global banks, community banks and regional banks. The leading commercial banks operate across the globe. These banks are active in cross-border lending and foreign-currency trading besides offering traditional banking services.

Sources Of Bank Funds:

A bank is a business firm. Its main aim is to earn profit. In order to achieve this objective it provides services to the customers. It offers a variety of interest bearing obligations to the public. These obligations are the sources of funds for the bank and are shown on the liability side of the balance sheet of a commercial bank. The main sources which supply funds to a bank are as follows: 1: Banks Own Funds. 2: Borrowed Funds. 1. Banks own funds. Banks own funds are mainly of three types; (a) Paid up capital, (b) Reserve fund and (C) Portion of undistributed profit. Banks Own Funds. Banks own paid up capital. The amount with which a banking company is registered is called nominal or authorized capital. It is the maximum amount of capital which is mentioned in the capital clause of the memorandum of association of the company. Capital is further divided into (i) paid up capital and (ii) subscribed capital. The banks in Pakistan raise authorized capital by issuing ordinary shares of Rs. 10 each which are fully paid up. 2. Reserve fund. Reserve is another source of fund which is maintained by all commercial banks. At the time of declaring dividend, a certain portion of the profit is transferred to the reserve fund. This reserve belongs to the .shareholders and at the time of liquidation, the Shareholders are entitled to these reserves along with the capital. The main purpose of setting aside part of profit is to meet unforeseen expenses of the bank. The Banking Companies Ordinance has made it obligatory (binding) for every banking company incorporated in Pakistan to create a reserve fund. 3. Profit. Profit is another source to a bank for the purpose of business. Profits signify the credit balance of the profit and loss account which has not been distributed. The accumulated profits over the years increase the working capital of the bank and strengthens its financial position.

Borrowed Funds. The borrowed capital is a major and an important source of fund for any banking business. It mainly comes from deposits which are accepted on varying terms in different accounts. Banks borrowing is mostly in the form of deposits. Bank collects three kinds of deposits from its customers (1) current or demand deposits (2) saving deposits and (3) fixed or time deposits. The larger the deposits of bank, the larger will be its (use) fund for employment and so higher are its profit. 1. Borrowing from central bank. The commercial banks in times of emergency borrow loans from the central bank of the country. The central bank extends help as and when financial help is required by the commercial banks. 2. Other sources. Bank also raise funds by issuing bonds, debentures, cash certificates etc. etc. Though it is not common but is a dependable source of borrowing. 3. Deposits. Public deposits are a powerful source of funds to a bank. There are three types of bank deposits (i) current deposits (ii) saving deposits and (iii) time deposits. Due to the spread of literacy, banking habits and growth in the volume of business operations, there is a marked increase in deposit money with banks.

Bank Loans:
In finance, a loan is a debt evidenced by a note which specifies, among other things, the principal amount, interest rate, and date of repayment. A loan entails the reallocation of the subject asset(s) for a period of time, between the lender and the borrower. In a loan, the borrower initially receives or borrows an amount of money, called the principal, from the lender, and is obligated to pay back an equal amount of money to the lender at a later time. Typically, the money is paid back in regular installments, or partial repayments; in an annuity, each installment is the same amount. The loan is generally provided at a cost, referred to as interest on the debt, which provides an incentive for the lender to engage in the loan. In a legal loan, each of these obligations and restrictions is enforced by contract, which can also place the borrower under additional restrictions known as loan covenants. Although this article focuses on monetary loans, in practice any material object might be lent.

Types of loan:
Secured A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral.

A mortgage loan is a very common type of debt instrument, used by many individuals to purchase housing. In this arrangement, the money is used to purchase the property. The financial institution, however, is given security a lien on the title to the house until the mortgage is paid off in full. If the borrower defaults on the loan, the bank would have the legal right to repossess the house and sell it, to recover sums owing to it. In some instances, a loan taken out to purchase a new or used car may be secured by the car, in much the same way as a mortgage is secured by housing. The duration of the loan period is considerably shorter often corresponding to the useful life of the car. There are two types of auto loans, direct and indirect. A direct auto loan is where a bank gives the loan directly to a consumer. An indirect auto loan is where a car dealership acts as an intermediary between the bank or financial institution and the consumer. Unsecured Unsecured loans are monetary loans that are not secured against the borrower's assets. These may be available from financial institutions under many different guises or marketing packages:

credit card debt personal loans bank overdrafts credit facilities or lines of credit corporate bonds (may be secured or unsecured)

Interest rates on unsecured loans are nearly always higher than for secured loans, because an unsecured lender's options for recourse against the borrower in the event of default are severely limited. An unsecured lender must sue the borrower, obtain a money judgment for breach of contract, and then pursue execution of the judgment against the borrower's unencumbered assets (that is, the ones not already pledged to secured lenders). In insolvency proceedings, secured lenders traditionally have priority over unsecured lenders when a court divides up the borrower's assets. Thus, a higher interest rate reflects the additional risk that in the event of insolvency, the debt may be uncollectible.

Cash Asset:
An asset that can be converted into cash immediately, such as bank account balances and marketable securities. An asset that provides liquidity to a portfolio. In Russell Performance

Attribution (RPA), cash assets are used to ensure that all day-weighted entries are correctly balanced. Cash assets include anything you own that can readily convert into cash such as savings, shares, stocks, loans to others, or the net equity of property you own but don't live in.

Loan Pricing:
Risk-based pricing is a methodology adopted by many lenders in the mortgage and financial services industries. It has been in use for many years as lenders try to measure loan risk in terms of interest rates and other fees. The interest rate on a loan is determined not only by the time value of money, but also by the lender's estimate of the probability that the borrower will default on the loan. A borrower who the lender thinks is less likely to default will be offered a better (lower) interest rate. This means that different borrowers will pay different rates. In theory, borrowers who are safer--or who are engaged in safer activities--should be more likely to borrow and resources should therefore be allocated more efficiently. The lender may consider a variety of factors in assessing the probability of default. These factors might be characteristics of the individual borrower, like the borrower's credit scoreor employment status. These factors might also be characteristics of the loan; for example, a mortgage lender might offer different rates to the same borrower, depending on whether that borrower wished to buy a single-family house or a condominium. Concerns have been raised about the extent to which risk-based pricing increases borrowing costs for the poor, who are generally more likely to default, and thereby further increases their likelihood of default. Some supporters of risk-based pricing have argued that, at least in certain contexts, default prediction should be limited by ethical considerations and focus on factors that are under borrowers' control. Factors affecting Loan Pricing: Credit score and history, property use, property type, loan amount, loan purpose, income, and asset amounts, as well as documentation levels, property location, and others, are common risk based factors currently used. Lenders 'price' loans according to these individual factors and their multiple derivatives. Each derivative either positively or negatively affects the cost of an interest rate. For example, lower credit scores equal higher interest rates and vice-versa; typically, those who provide less verifiable income documentation due to self-employment benefits will qualify for a higher interest rate than someone who fully documents all reported income. Mortgage and other financial service industries value credit score and history most when pricing mortgage interest rates.

What is Risk-Based Pricing? Risk-based pricing is a system that evaluates the risk factors of your mortgage application and credit profile and adjusts the interest rate and discount points up or down based on this risk evaluation. What Factors Can Affect My Loan Pricing? Various factors interact to adjust your loan pricing. The major factors include: Credit Profile: We will obtain a credit report that shows the amount of debt you have outstanding and how you have historically paid on your debt and obligations. The credit report will also contain a "credit score" that ranks your credit history. Credit scores look at five main kinds of credit information, namely: payment history; amount owed; length of credit history; new credit; and types of credit in use. Generally, if you have had any history of nonpayment or late payments on any loans or debt, this may lower your credit score and increase your interest rate and costs. People with high credit scores consistently: pay their debts on time, keep balances low on credit cards and other revolving loans; and apply for and open new credit accounts only as needed. Property: The type of property you are mortgaging also impacts your loan pricing. For example, investment property, condominiums or multifamily housing are usually considered to have a higher risk to lenders than single-family detached homes. The value of the property (usually determined by an appraisal) as compared to the amount you wish to borrow (the "loan-to-value ratio" or "LTV") also impacts your loan price. The higher the LTV, the higher the interest rate and costs. LTVs over 80% also usually require mortgage insurance. The price of mortgage insurance may vary based on your credit profile. Income/Debt: The amount of your mortgage payments and total debt payments as compared to your income, ("debt-to-income ratios") may also impact your loan cost. The higher your debt-toincome ratio, the higher our risk, and so the higher the interest rate and fees. Other Factors: Other factors may also affect our risk, and your interest rate and origination charge. These factors include, but are not limited to: previous bankruptcies, foreclosures or unpaid judgments; and the type of loan product applied for, such as adjustable rate versus fixed rate, or cash out refinance versus rate and term refinance.

Bank Deposit Pricing:

Money placed into a banking institution for safekeeping. Bank deposits are made to deposit accounts at a banking institution, such as savings accounts, checking accounts and money market accounts. The account holder has the right to withdraw any deposited funds, as set forth in the terms and conditions of the account. The "deposit" itself is a liability owed by the bank to the depositor (the person or entity that made the deposit), and refers to this liability rather than to the actual funds that are deposited. When someone opens a bank account and makes a deposit of $500 cash, the account holder surrenders legal title to the $500 cash. This cash becomes an asset of the bank; the account becomes a liability. In the United States, the Federal Deposit Insurance Corporation (FDIC) provides deposit insurance that guarantees the deposits of member banks up to $250,000 per depositor, per bank. Member banks are required to place signs visible to the public stating that "deposits are backed by the full faith and credit of the United States Government."