Bank Management

Two

For

PGDM

Indian Institute of Management Calcutta

By

Praloy Majumder

(For Classroom discussion only)

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 Class Two

Sources of Bank Fund

Banks are financial intermediary which help the movement of fund from the savings
unit to the investment unit. So the major sources of bank fund would be in from the
savings unit i.e. individual . Accordingly , the major source of bank fund is deposits.
There are two types of deposits which banks issue to raise money. One is called
demand deposit and the other is called term deposit.

Demand Deposit : This is the deposit which does not have any maturity at the time
of raising the fund by the bank. Besides these deposit would not provide any interest
to the depositor. If any deposit scheme issued by bank is providing this
characteristics such deposit is called as demand deposit. Examples of demand
deposit is Current Account and part of Savings Account balance . Current Account
and Savings Account deposits are popularly known as CASA.

Current Account : These are accounts opened by the business entity to carry out
their day to day transaction . For a bank the benefit of current account is that banks
need not to pay interest on current account. So the cost of fund is very low in the
case of current account. Here one thing has to be kept in mind that in the case of
cost of fund , interest is not the only factors involved. Apart from interest part the
issue of cost of servicing the account should also be kept in mind while calculating
the cost of deposit.

Savings Account : In the case of savings bank account, individual would maintain
account with bank. The uniqueness of saving bank account is that individual keep a
portion of their liquidity requirement in the savings account. Since banks have to pay
interest at a rate of 3.5% on the daily balance , the interest cost of deposit is quite
low. Each savings bank account would be provided Cheque books and also other
facilities like internet banking , ATM services, Debit and Credit Cards and other
freebies.

A Bank which is having higher portion of CASA would be considered a good bank.

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A Bank of higher CASA is prone to lower degree of shock in the increased interest
rate scenario. The aim of a bank is to increase the CASA to a great extent. For this
banks can draw different strategies. Some of such strategies are given below :

 Opening of salary account : Banks can approach its advance clients and
accordingly it would ask employees of advance clients to open savings
account with the banks. Bank must use data mining techniques to achieve
this in a scientific manner.
 Opening of accounts of students: Banks can approach schools to open
students’ accounts. Here bank must design some product which would
provide attractive benefits to students. Students savings account with
insurance benefits for income earning parents would be an excellent product
for increasing the number of students accounts.
 Opening of accounts with multiple banking channel : It has been found out
that in India , internet use habits are increasing at an exponential pace within
younger generations. These people would be having surplus which they would
put in Savings accounts. So proper advertisement strategy by making them
aware about such facilities would help banks to collect more savings deposits.
 Opening of current accounts of governments : Banks can approach
governments for opening of current accounts . This can be clubbed with cash
remittances facilities of government disbursement.
 Opening of accounts with traders: Banks can target trading communities to
open current accounts with them. This is important as floats available in such
account would be of great advantage to the banks.
However, increasing of CASA in a competitive market would not be easy. The
increase of CASA may take place if concerned banks use the following :
 Use of technology to increase the transaction mode with the clients . This
includes use of ATM, Internet Banking , Phone Banking and Mobile Banking;
 Use of branch net works to improve the flow of fund : Banks must use the
branch net work to collect the fund within shortest period of time.
 Better customer service : A proper mix of branch banking and remote banking
is must to improve the CASA .

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Term Deposits :

Term deposit is a deposit which promises to pay interest at the time of opening the
deposit and also has a fixed maturity period for opening the deposit. The tenure of
term deposits can be from 7 days to 10 years for a bank. However banks take lot of
precaution before raising deposit for longer tenure.

There are different versions of term deposit possible depending on the following
factors namely :

 Periodicity of payment of interest;

 Periodicity of compounding of interest;
 Periodicity of deposits of amount in the deposit account;

Reinvestment Scheme : Under this scheme the interest amount is reinvested at a

periodic interval at the contractual rate and on maturity the total amount is paid. If
the principal amount of deposit is Rs 10,000/- , the interest rate is 10% p.a. , the
periodicity of compounding is half yearly and the tenure of deposit is 2 years , the
maturity value is given as below :

Rs 10,000/- [ 1+ (10%/2)]4 = Rs 12,155/- .

Under this scheme the investor would get more money but would not get any
intermittent cash flow . So any investor who wants to have some periodic cash flow
would not prefer such scheme. However if some one is interested in end of period
money, the investor would prefer this scheme. In Indian banking scenario, this
scheme is mostly preferred by banks for canvassing retail deposits .

Periodic Interest Scheme: Under this scheme, banks pay interest in periodic interval
to investors on annually, half yearly , quarterly and monthly basis. However if the
interest is paid on monthly basis , interest amount is paid after discounting. This
type of investment is preferred by those investors who want periodic return like the
retired person , pensioners etc.

Flexible deposit scheme : Under this scheme , an investor can invest one single
amount and can withdraw in multiples of the invested amount at different period of
time. For example , an investor can invest Rs 10,000/- for 2 years at an interest rate

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of 10% p.a. with interest paid at quarterly intervals. However the investor can
withdraw amount at a unit of Rs 1000/- at any time and the interest rate to be paid
on this withdrawal would be applicable rate for the tenure of the investment . If the
investor withdraws Rs 1,000/- after one month and the applicable rate for one month
is 6%, the investor would be paid interest rate of 6% on this Rs 1,000/- . However
the remaining Rs 9,000/- would continue to attract at an interest rate of 10% p.a.
This type of deposit is beneficial for investor who does not want to make rigid
investment horizon.

Borrowing in the money market : The bank can also raise resources
from money market . By definition ,a money market instrument is that instrument
where the remaining maturity of the instrument is less than 1 year. Please keep in
mind that an instrument which was originally a capital market instrument will
become a money market instrument when it enters the last year of its maturity. For
example , a GOI security which was issued on 1991 for 15 years would become a
money market instrument in the year 2006.
In the money market, we have the following instrument:
 Call Money Instrument
 Notice Money Instrument
 Term Money Instrument
Call Money : If the tenure of instrument is overnight, it is called a call money
instrument. When money is borrowed under call money then the borrower would
issue a receipt and this receipt is called call money receipt. The receipt says that the
money would be paid on the next date. This is an example of call money
instrument.
Notice Money : If the tenure of the instrument is more than overnight but less
than seven days , it is called notice money. For example, when a bank borrows
money under Liquidity Arrangement Facility ( LAF) for 3 days, then the instrument
issued by the bank is an example of the notice money instrument.
Term Money : If the tenure of the instrument is equal and more than 7 days , it is
called a term money instrument. When a bank raises fixed deposits for 15 days ,
the deposit receipt it issues is a term money instrument.
Call Money Market : To under stand the concept of call money market one needs
to understand the bank balance sheet carefully. A sample analysis of consolidated

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bank balance sheet of schedule commercial banks in India would reveal the
following :

In % of total
Liability Asset
Capital 0.50% Cash and Bank Balance 4.49%
with RBI
Reserves & Surplus 5.37% Balance with Bank and 3.54%
call
Deposits 83.50% Investments 26.59%
Borrowings 7.49% Loans and Advances 58.31%
Other Liabilities 3.13% Fixed Assets 1.06%
Other Assets 6.01%
Total 100.0% Total 100.0%

Fig 2.1: % composition of liability and assets of PSU Bank.

If we analyse the above, we find that majority of the source of fund for the
scheduled commercial banks is deposit which constitutes about 83% of the source of
the fund. The onus of the banks is to pay to the deposit holder the interest and
principle in time so that the faith reposed on the banking system by these deposit
holders are kept intact. So banks would basically try to invest in assets where the
repayment is more or less assured and the time of repayment is also known with
certainty.
Since the major source of fund is of debt in nature, the assets would also be debt in
nature. That is exactly is seen in the balance sheet of the banks where more than
83% investments is in the nature of the debt. This ensures that the principal of the
deposit holders are intended to be protected as the debt instrument carries a
commitment of protection of principal and interest.
The next step should address the issues on timing of payment of interest rate. The
maturity profile of liability and assets need to be analyzed. The maturity profile of
deposits of the banking system would reveal the following:

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 % of Total deposit
Type of Public Sector Private Foreign All SCB
Banks Banks Sector Banks Banks
Maturity
Up to 1 year 43.6% 42.9% 64.2% 44.4%
More than 1 22.4% 26.8% 28.6% 24.0%
year to 3
years
More than 3 10.7% 9.50% 7.20% 10.2%
years to 5
years
More than 5 23.3% 20.9% 0.00% 21.5%
years

Fig 2.2 The Maturity profile of deposits in the banking system

% of Total loans and advances

Type of Public Sector Private Foreign All SCB
Banks Banks Sector Banks Banks
Maturity
Up to 1 year 26.0% 31.3% 57.8% 29.2%
More than 1 41.2% 34.1% 21.0% 37.9%
year to 3
years
More than 3 12.4% 12.9% 7.9% 12.4%
years to 5
years
More than 5 20.3% 19.2% 13.4% 20.4%
years

Fig 2.3 The Maturity profile of loans and advances in the banking system

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It is obvious from the above that majority of the deposits are maturing within 3
years. So the bank needs to invest in assets ( mainly debt assets ) of this maturity.
However this is a very difficult task considering the SLR requirement of 25% of the
net demand and time liabilities of the banking system. This shows that about 20% of
the banking liability should be in the eligible SLR securities which is predominantly in
the long term in nature. So the system should be such that these securities can be
sold of before maturity and here lies the importance of secondary market for SLR
securities. Besides, the banks may not be able to find other investments for
matching the deposit profile and in this case banks should be provided with some
access to meet the requirement of the depositors in case depositors ask for money.
Previously banks were resorting to inter bank call money market to meet sudden
requirement of funds. Accordingly there was high volatility in the call money market.
Over the years, the central bank i.e. RBI introduced lot of avenues through which
banks can raise funds to meet the sudden requirement of funds from depositors.
The aim was to reduce the dependence on the call money market so that the interest
rate volatility in the call money market is reduced to a great extent. Besides, in the
other market, RBI decides the interest rate through auction mechanism and
accordingly RBI can control the call money market indirectly. This mechanism
worked out very well in the Indian context. Besides deciding the factors of the call
money market, let us first discuss the other sources for meeting the sudden
requirement of fund by the banking system.

Bill Rediscounting Facility : When bank gives loans and advances under bill
discounting scheme to its clients, it locks the fund up to the tenure of the bills. For
example, if a bank has lent Rs 100 crores under Bill Discounting scheme and as on
November 1, 2010 , the average maturity of such fund is 50 days then the bank
would get this Rs 100 crores after 50 days only. In the mean time if the bank
suddenly requires Rs 50 crores, it can get refinance against this facility which it can
repay either from realization of bills discounted or from fresh deposits mobilized. This
gives an option to bank for raising resources.
Export Refinance Facility : Banks can avail refinance against the export finance
lent to its customers. This would also help the bank to meet the sudden requirement
of funds.

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SIDBI Refinance Facility : Banks can get refinance from SIDBI for the assistance
provided to small scale industry . This also helps the bank to fund the sudden
requirement .
Liquidity Adjustment Facility : Under this scheme, banks can get fund from RBI
for a period ranging from one day to 7 days. They get fund under repo scheme
where the approved securities are SLR securities. This refinancing window is made
available by RBI on a regular basis and the RBI decided the rate and quantum
through auction process.
Repo Facility : Under this scheme, the fund is available to be banks by RBI and
other banks for more than 7 days against repurchase of approved securities which
are mostly SLR securities.
Please keep in mind that all the above facilities are borrowing windows for banks to
meet sudden demand from the depositors and carries interest rate determined by
the market.
Because of these several sources, the dependence on inter bank call money market
is reduced to a great extent over the years. This is also the reason for reducing the
number of participants in the call money markets as entities can park their short
term funds in several other short term avenues as mentioned above.