Financial Markets Handout

What is a BANK?

Philippine Context, Section 3 of the New General Banking Law to wit:

“Banks shall refer to entities engaged in the lending of funds in the form of deposits.”

PRINCIPLES OF BANKING

Two basic principles of banking

1. Partial Reserve System- certain amount deposited will support several

times as much in credit.
2. Other principles states that a greater portion of deposit in commercial
banks arises out of the proceeds of loans.

TYPES OF BANKS

AS TO OWNERSHIP

a. Privately Owned-bank is organized and capitalized by private citizens for their

profit.
b. Publicly Owned- bank is organized by the state and sometimes has a
minimum of private ownership.

AS TO THE PLACE OF INCORPORATION

a. Domestic- bank is incorporated under the laws of the Philippines.

b. Foreign- bank is incorporated under the laws of another country, although the
bank might be doing business in the Philippines.

AS TO STRUCTURE

a. Stock Corporation- when they sell shares of stock to the general public.
b. Non-Stock Corporation- The savings and loan association either be stock or
non-stock corporation, meaning, the organization is on a membership basis.
AS TO FUNCTION AND LINE DEVELOPMENT

a. Commercial Bank- a financial institution that provides services, such as

accepting deposits, giving business loans and auto loans, mortgage lending,
and basic investment products like savings account and certs of deposit.
b. Trust Company- a legal entity that acts as a fiduciary, agent or trustee on
behalf of a person or business entity for the purpose of administration,
management and the eventual transfer of assets or beneficial party.
c. Savings Bank- established to create saving habit among the people.
d. Rural Bank- helps rational the developing regions or country to finance their
needs specially the projects regarding agricultural progress.
e. Development Bank- are dedicated on funding new and upcoming businesses
and economic development projects by providing equity capital and/or loan
capital.
f. Cooperative Bank or Banks of Cooperatives- hold deposits, makes loans and
provides other financial services to cooperatives and member-owned
organizations.
g. Investment Bank- financial intermediary that performs variety of services.
h. Central Bank- entity responsible for overseeing the monetary system for a
nation or group of nations.

AS TO MANAGEMENT

a. Unit Bank- refers to a bank that is single, usually small bank that provides
financial services to its local community.
b. Group Banking- a plan offered by banks that generally provides incentives for
groups, such as employees at a company, if the group stablishes a banking
relationship with the institution.
c. Branch Banking- refers to a bank that is connected to one or more other
banks in an area or outside of it; to its customers, the bank provides all the
usual financial services but is backed and ultimately controlled by a larger
financial institution.
d. Chain Banking- one bank has several different locations.
BANK OPERATION

Three distinct functions involved in implementing the policies of the board

through the president and other officers, the operational activities of management;
this holds true whether the bank is managed by one or two persons by a great
number of persons.

1. EXECUTIVE FUNCTION. A banker must of necessity be faced with policy

making, with establishing harmonious relations with customers in order to get
business, with gathering facts and figures about the depositors and debtors,
with recruiting personnel to do the minor operations, and with similar duties
involving the caliber of an executive. In such case the banker must be a man
of creative managerial ability, possess a charming personality, be prudent and
patient and must possess an above average intelligence, if possible.
2. TELLER FUNCTION. He accepts deposits, he changes checks to cash, big
bills with smaller denominations. He releases the checks or cash representing
loans, he receives payments for loans, such other teller functions. The teller
must be patient, understanding, accurate and careful, if not cautious. For
mistake in paying or receiving money, may make or unmake a teller.
3. BOOKKEEPING FUNCTION. To keep a faithful record of the events and
accounts, the banker must record the figures and sometimes facts. This
requires bookkeeping knowledge. He may also called upon to summarize and
interpret the facts and figures. This requires accounting ability.

MONEY MARKET INSTRUMENTS

a. Treasury Bills- are short-term securities issued by the country’s treasury. This
reduces the bank’s ability to lend to its clients leading to a contradiction of
money supply.
b. Banker’s Acceptance/Letter of Credit. Although the BA’s, as they are known,
have their origin in trade bills issued by merchants, today they are an
important money market instrument.
c. Negotiable Certificates of Deposits- are like fixed deposits except they are
bearer documents.
 d. Commercial Paper- is a debt instrument commonly issued by corporations to
fund a temporary capital requirement. This is a form of corporate borrowing
usually matures within one year.

FORMS OF BANK CREDIT

Liabilities of a bank to creditors:

1. Deposits are rights to draw on the bank for money.

Depositor gets such rights on one or more of these ways:

 By the deposit of cash or cash items

 By depositing time items for collection and credit
 By remitting securities or other property to the bank for sale and credit
 By the process of loan and discount
 By the sale o securities, real estate, personal property, or services to the
bank for credit

2. Bank Notes- are promises of the bank to pay money on demand; issued in
round denominations and transferrable without indorsement, they are
designed to circulate in lieu of metallic money. The transferee becomes in the
note holder and creditor of the bank; the bank note may come into his hands
in the ordinary transactions of his business or through any one of the five
methods by which a depositor gets deposits.

3. Acceptance and Letter of Credit.

Acceptances are bills of exchange drawn in a bank, which, for the a
commission, it obligates itself to pay, but to provide funds for which payment
the person for where the letter of credit is procured is obligated to the bank.
Letters of Credits are agreements by the bank to accept, and to pay at
maturity and on demand, bills of exchange drawn under certain specified
conditions.

4. Bills Payable are promissory notes, secured or unsecured, interest-bearing,

and running or a period of time, by which a bank borrows in large, irregular
 sums at various times. Sometimes the borrowing is done by selling some of
the bills receivable, acceptances, or other commercial paper which the bank
has in its portfolio, a process which incurs the contingent liability of
indorsement or agreement to repurchase.

Bank credit extensions more commonly take the forms of deposits and bank
notes, and therefore the theory of these two will be fully developed.

SOURCES OF BANK FUNDS

Banks basically make money by lending money at higher rates than the cost
of the money they lend. More specifically, banks collect interest on the loans and
interest payments from the debt securities they own and pay interest in deposits,
CD’s and short-term borrowings.

The difference known as the spread or net interest income, and when that net
interest income is divided by the bank’s earning assets, it is known as the net
interest margin.

I. Deposits- are the largest source by far of funds for banks; primary
source of loanable funds for almost every bank; money that accounts
holders entrusts to the bank for safekeeping and use in future
transactions, as well as modest amounts of interest.

Core deposits are typically the checking and savings accounts that so
many people currently have.

II. Share Equity- important part of bank’s capital. Several important

regulatory ratios are based on upon the amount of shareholder capital
a bank has and shareholder capital is, in many cases, the only capital
that a bank knows will not disappear.
III. Debt- raises capital through debt issuance; bank often uses this to
smooth out the ups and downs in their needs.

IV. Use of Funds Loans- loans are the primary use of their funds and the
principal way in which they earn income. Loans are typically fixed-
terms, at fixed rates and are typically secured with real property; often
 the property that the loan is going to be used to purchase. While banks
will make loans with variable or adjustable interest rates and penalty,
banks generally shy h them with appropriate borrowers can often repay
loans early, with little or no penalty, banks generally shy away from
these kinds of loans, as it can be difficult to match them with
appropriate funding sources.

Part and parcel of a bank's lending practices is its evaluation of

the credit worthiness of a potential borrower and the ability to charge
different rates of interest based upon that evaluation. When
considering a loan, banks will often evaluate the income, assets and
debt of the prospective borrower, as well as the credit history of the
borrower. The purpose of the loan is also a factor in the loan
underwriting decision, loans taken out to purchase real property, such
as homes, cars, inventory, etc., are generally considered less risky, as
there is an underlying asset of some value that the bank can reclaim in
the event of nonpayment.

V. Automobile lending is another significant category of secured lending

for many banks. Compared to mortgage lending, auto loans are
typically for shorter terms and higher rates
Banks face extensive competition in auto lending from other
financial institutions, like captive auto financing operations run by
automobile manufacturers and dealers
VI. Credit cards are another significant lending type and an interesting
case; are, in essence, personal lines of credit that can be drawn down
at any time. While Visa and MasterCard are well-known names in
credit cards, they do not actually underwrite any of the lending. Visa
and MasterCard simply run the proprietary networks through which
money (debits and credits) is moved around between the shopper’s
bank and the merchant’s bank after transaction.
Not all banks engage in credit card lending and the rates of
default are traditionally much higher than in mortgage lending or other
types of secured lending. That said, credit card lending delivers
lucrative fees for banks: Interchange fees charged to merchants for
 accepting the card and entering into a transaction, late-payment fees,
currency exchange, over-the-limit and other fees for the card user, as
well as elevated rates on the balances that credit card users carry,
from one month to the next.

WHY THE STATE SUPERVICES BANKS

The State does not only supervise banks, but with the advent of central
banking, it also controls the bank's operations. Banks exert an important influence in
the economic setup, not to mention the maintenance of the trust and confidence
upon which the practice of banking is ingrained.

The following are some of the reasons why the state supervises and controls
banks:
1) The banks are entrusted with other people's money.
2) The state wants to assure that the banks will perform their function in the best
interest of their clients through the honest and efficient conduct of their
functions.
3) The banks may ether abuse their power or use them prudently
4) The banks, furthermore, are quasi-public corporations and as in all other
corporations of this calling, the state must exert its restraining influence to
safeguard the welfare of its constituents. In the granting of charter to a
corporate entity, the state is one of the parties whose duty is to protect the
interest of the citizens.