SOURCES OF FUND

L E A R N I N G O B J E C T I V E S
After completing this chapter you should be able to:
1. understand the concept of deposit fixed and revolving
2. describe the concept of interest bearing and non interest
bearing
3. understand the concept capital and equity
4. understand the meaning reserve and surplus
5. describe the short term and long term sources of loan.

C H A P T E R O V E R V I E W

The purpose of this chapter is to give the reader the idea about the deposit, fixed and
revolving, interest bearing and non interest bearing, capital and equity, reserve and
surplus. The chapter ends with a discussion of borrowing through short term and long
term loan.
 22 TREASURY MANAGEMENT

DEPOSIT
The act of placing money with a bank is known as bank deposit. Therefore, a
deposit account is a bank account that pays interest but that imposes the
BANK DEPOSIT
requirement of notice (or a penalty in terms of interest) before withdrawal
Bank deposit is a bank
account that pays can be effected; a deposit receipt is an acknowledgement by the bank that
interest.
sums have been deposited and are being held for the account of the
depositor; a certificate of deposit is a financial instrument providing a
similar acknowledgement but where the claim of the depositor is
transferable. The acceptance of a deposit in the course of carrying on a
deposit-taking business in the UK requires authorization from the Bank of
England as competent authority.

A deposit account is a savings account, current account or any other type of

bank account that allows money to be deposited and withdrawn by the
account holder. These transactions are recorded on the bank's books, and the
resulting balance is recorded as a liability for the bank and represents the
amount owed by the bank to the customer. Some banks may charge a fee for
this service, while others may pay the customer interest on the funds
deposited.

In banking, the verbs "deposit" and "withdrawal" mean a customer paying

money into, and taking money out of, an account. From a legal and financial
accounting standpoint, the noun "deposit" is used by the banking industry in
financial statements to describe the liability owed by the bank to its
depositor, and not the funds that the bank holds as a result of the deposit,
which are shown as assets of the bank.

Subject to restrictions imposed by the terms and conditions of the account,

the account holder (customer) retains the right to have the deposited money
repaid on demand. The terms and conditions may specify the methods by
which a customer may move money into or out of the account, e.g., by
cheque, internet banking, EFTPOS or other channels.

FIXED AND REVOLVING DEPOSIT

FIXED DEPOSIT
A fixed deposit also known as time deposit. Under this deposit, customer is
FIXED DEPOSIT required to keep a fixed amount with bank for a specific period generally by
A fixed deposit the
amount of fixed amount those who do not need money for a stipulated period. The bank pays a
and fixed maturity with
higher interest rate.
 SOURCES OF FUND Chapter 3 23

higher interest on such deposits. In the emergency times, customers are

permitted to borrow 90 percent of money in lieu of extra interest. Longer the
time period of fixed deposit, higher the interest rate and vice versa. Unlike
current and savings deposits no transactions are allowed to be performed by
customer against fixed deposit. The depositor foregoes liquidity on the
deposit and the bank can freely deploy such funds for loans/advances and
earn interest.

Hence, banks pay higher interest rates on fixed deposits as compared to

savings bank deposits from which he can withdraw, requiring banks to keep
some portion of deposits always at the disposal of the depositors. Another
reason for banks paying higher interest on fixed deposits is that the
administrative cost in the maintenance of these accounts is very small as
compared to savings bank accounts where several transactions take place in
cash, transfer or clearing, thus increasing the administrative cost. Main
Features of Fixed Deposits are as follows:

– A deposit receipt is issued by the bank branch accepting the fixed

deposit- mentioning the depositor’s name, principal amount, maturity
period and interest rate, dates of the deposit and its maturity etc. The
deposit receipt is not a negotiable instrument, nor is it transferable, like
a cheque. However, a term deposit receipt evidences contract for the
deposit on the specified terms.

– Fixed deposits is generally opened by individuals, sole trading,

partnership and corporation.

- Bank must pay interest on fixed deposit and interest rate is highest
among all deposit types.

- The deposits are for fixed time. These deposits are normally withdrawn
after the maturity.

- Term deposits are not transferable.

- The interest rate and the maturity are specified on the fixed deposit
certificate.

- The bank may grant loan against the security of their fixed deposit by
charging certain additional interest rate and keeping certain margin as a
security.

- On maturity of a deposit, the principal and interest can be renewed for

another term at an interest rate prevalent at that time and a fresh deposit
 24 TREASURY MANAGEMENT

receipt is issued to the customer, evidencing a fresh contract.

Alternatively, the deposit can be paid up by obtaining the discharge of
the depositor on the reverse of the receipt.

- Many banks prepay fixed deposits, at their discretion, to accommodate

customers’ request for meeting emergent expenses. In such cases,
interest is paid for the period actually elapsed and at a rate generally 1
per cent lower than that applicable to the period elapsed. Banks also
may grant overdraft/ loan against the security of their fixed deposits to
meet emergent liquidity requirements of the customers. The interest on
such facility will be 1 per cent - 2 per cent higher than the interest rate on
the fixed deposit.

REVOLVING DEPOSIT
A revolving account is an account created by a lender to represent debts
where the outstanding balance does not have to be paid in full every month
by the borrower to the lender. The borrower may be required to make a
minimum payment, based on the balance amount. However, the borrower
normally has the discretion to pay the lender any amount between the
minimum payment and the full balance. If the balance is not paid in full by
the end of a monthly billing period, the remaining balance will roll over or
"revolve" into the next month. Interest will be charged on that amount and
added to the balance.

INTEREST BEARING AND NON INTEREST BEARING

INTEREST BEARING
Deposit accounts are attractive places to park cash for investors who want a
safe vehicle for maintaining their principle, earning a small amount of fixed
interest. The interest rate paid by financial institutions to deposit account
holders. Deposit accounts include certificates of deposit, savings accounts
and self-directed deposit retirement accounts.

SAVING DEPOSIT

This account is also called demand deposit. Saving deposit is one of the
SAVINGS DEPOSIT deposits, which is collected from small depositors or low-income investors.
Savings deposit is a type
of bank deposit that The bank usually pays small interest to the depositors against their deposit.
pays any interest.
 SOURCES OF FUND Chapter 3 25

The depositors are allowed to withdraw their money by cheques to the

amount prescribed by bank. Banks may impose certain restrictions on the
deposits regarding the number of withdrawals and the amount of deposited
in the given period. The interest rate on these deposits is low as compared to
that of fixed deposits. Savings deposits are less volatile than current deposit.

Savings accounts are normally opened in the name of individuals. Sole

trading, partnership and Joint Stock Company are restricted to open savings
accounts by unified directives. The features of the saving accounts are as
follows:

- Targeted to individuals who wish to deposits their savings.

- Saving deposit provides the stability to the overall deposit base of the bank
due to the large number of depositrs.

- Banks pay interest on savings deposits.

- Various types of savings deposits are introduced by the banks. For example,
Ketaketi bachat khata, budabudi bachat khata etc.

- Only individual persons are eligible to open this account.

- To attract the customer, banks may offer various services like ATM/debit
card, insurance, e-banking etc.

FIXED DEPOSIT

A fixed deposit also known as time deposit. Under this deposit, customer is
FIXED DEPOSIT required to keep a fixed amount with bank for a specific period generally by
A fixed deposit the
amount of fixed amount those who do not need money for a stipulated period. The bank pays a
and fixed maturity with
higher interest rate.
higher interest on such deposits. In the emergency times, customers are
permitted to borrow 90 percent of money in lieu of extra interest. Longer the
time period of fixed deposit, higher the interest rate and vice versa. Unlike
current and savings deposits no transactions are allowed to be performed by
customer against fixed deposit. The depositor foregoes liquidity on the
deposit and the bank can freely deploy such funds for loans/advances and
earn interest.

Hence, banks pay higher interest rates on fixed deposits as compared to

savings bank deposits from which he can withdraw, requiring banks to keep
some portion of deposits always at the disposal of the depositors. Another
reason for banks paying higher interest on fixed deposits is that the
administrative cost in the maintenance of these accounts is very small as
26 TREASURY MANAGEMENT

compared to savings bank accounts where several transactions take place in

cash, transfer or clearing, thus increasing the administrative cost. Main
Features of Fixed Deposits are as follows:

– A deposit receipt is issued by the bank branch accepting the fixed

deposit- mentioning the depositor’s name, principal amount, maturity
period and interest rate, dates of the deposit and its maturity etc. The
deposit receipt is not a negotiable instrument, nor is it transferable, like
a cheque. However, a term deposit receipt evidences contract for the
deposit on the specified terms.

– Fixed deposits is generally opened by individuals, sole trading,

partnership and corporation.

- Bank must pay interest on fixed deposit and interest rate is highest
among all deposit types.

- The deposits are for fixed time. These deposits are normally withdrawn
after the maturity.

- Term deposits are not transferable.

- The interest rate and the maturity are specified on the fixed deposit
certificate.

- The bank may grant loan against the security of their fixed deposit by
charging certain additional interest rate and keeping certain margin as a
security.

- On maturity of a deposit, the principal and interest can be renewed for

another term at an interest rate prevalent at that time and a fresh deposit
receipt is issued to the customer, evidencing a fresh contract.
Alternatively, the deposit can be paid up by obtaining the discharge of
the depositor on the reverse of the receipt.

- Many banks prepay fixed deposits, at their discretion, to accommodate

customers’ request for meeting emergent expenses. In such cases,
interest is paid for the period actually elapsed and at a rate generally 1
per cent lower than that applicable to the period elapsed. Banks also
may grant overdraft/ loan against the security of their fixed deposits to
meet emergent liquidity requirements of the customers. The interest on
such facility will be 1 per cent - 2 per cent higher than the interest rate on
the fixed deposit.
 SOURCES OF FUND Chapter 3 27

CALL DEPOSIT

Call deposit is also known as hybrid deposit. It is the combination of current

CALL DEPOSIT and fixed deposit to meet the customer’s requirement in flexible manner.
Call deposit is the hybrid
account between savings Due to increasing competition, this deposit is introduced. Call deposit
and current. mainly serves the need of appropriate assets liability management of the
banks and financial institutions. Normally the practice of inter bank
borrowing and lending activities are conducted through this product. The
features of call deposits are as follows:

- Generally opened by firms, corporation and bank and financial

institutions.

- Bank pays certain rate of interest to the depositors.

- The deposit is not maturity specific. The depositor generally is entitled

to withdraw any amount upon request.

- The interest rates are generally dependent on the negotiation between

the client and the bank.

NON-INTEREST BEARING
A deposit account which does not earn interest on the money in the account.
A non-interest-bearing account is often used as a basic or starter checking
account, frequently for children or teens who are only storing a small
amount of money. Another advantage of these accounts is that in some
cases, a non-interest-bearing account will have limited or no fees.

CURRENT DEPOSIT

It is also known as demand deposits. Under this deposit, any amount may
CURRENT DEPOSIT
be deposited. There are no restrictions regarding the number of withdrawals
Current deposit is a type
of bank deposit that or the amount of the withdrawals. The bank does not pay any interest on
does not pay any
interest. such deposits but sometimes bank may charges a small amount on the
customers having current account. Traders and businessman keep their
money with the bank under current accounts. The features of current
deposits are as follows:

- Normally opened by business firms.

- Banks do not pay any interest on these accounts.

 28
MARGIN DEPOSIT
Margin deposit is the
deposit of money for
various facilities from the
bank.
CAPITAL OR EQUITY
TREASURY MANAGEMENT
- Cheques / Bills collection and purchase facilities may also be granted to the
current account holders as per agreement.
- No restriction on the number and amount of withdrawals or deposits.
- Volume of deposits is highly volatile.
MARGIN DEPOSIT
This deposit is made for holding margin money of the customers as deposits
to avail various facilities from the bank. It is non interest bearing deposit.
Customers are not allowed to withdraw any amount from such accounts till
the expiry of the availed facilities. Margins are required for letter of credit
(LC), guarantee, remittance and some other facilities.
Equity is residual account in the sense that it is the difference between total
assets on the left hand side of the balance sheet and total liabilities on the
right hand side of the balance sheet. Bank capital also includes reserves that
are set aside to meet anticipated bank operating losses from loans, leases,
and securities. Moreover, bank capital is subject to detailed regulatory
requirements that attempt to ensure adequate capital to absorb normal level
of operating losses. Equity consists of common stock, preferred stock,
surplus, and undivided profits.
The accounting value of common (and preferred) equity is equal to the
number of shares outstanding multiplied by their par value per share.
Surplus is the amount of paid in capital in excess of par value realized by the
bank upon the initial sale of stock. Finally, undivided profits equal retained
earnings, which are the cumulative net profits of the bank not paid out in the
form of dividends to shareholders. The sum of these components is the book
value of equity.
Another way to measure common stock and preferred stock is in terms of
the market value of equity. Market values reflect not only the past, such as
the historical book value of equity, but also the expected future value of the
bank. Indeed, stockholders are most concerned about future earnings
available to them and the associated risk of those earnings. Therefore, the
book value and market value of equity differ from one another.
 SOURCES OF FUND Chapter 3 29

Banks set aside earnings for loan (and lease) loss reserves. When a loan
defaults, the loss does not necessarily reduce current earnings because it can
be deducted from the reserve account. To establish reserves to meet
anticipated loan losses, bank expense an account known as the provision for
loan losses (PLL) on their income statement. By expensing PLL, banks
reduce their tax burden.

Another reserve account is the reserve for loan losses. This account is
reported on the liability side of the balance sheet and is also known as the
allowance for loan losses. The reserve for loan losses is calculated as the
cumulative PLL minus net loan charge offs. Since this reserve is deducted
from total loans to get net loans, it is a contra-asset account. Part of the
reserve for loan losses is counted as capital on the right hand side of the
balance sheet. These capital reserves are employed by regulators in
measures of capital adequacy. Capital reserves are used to pay dividends or
retire stocks and bonds outstanding, as well as funds held for unexpected
losses.

BORROWING: SHORT TERM VERSUS LONG TERM

Short term borrowing

Long term borrowing

Long term debt includes subordinated notes and debentures. Because this debt
is second priority to depositor claims in the event of bank failure, it is said to be
subordinated. Banks use far less long term debt than do nonfinancial firms
because most of their debt is in the form of short and intermediate term deposit
and non-deposit funds, which essentially are money market sources of funds. A
major advantage of using debt capital is that interest payments are tax
deductible, whereas equity earnings are fully exposed to income taxes. Debt is
also less expensive after tax source of external capital than equity in general.

Reserves

The amount of paid up share capital of the banking institutions is the long
term sources of financing. Amount credited in share capital by issuing bonus
30 TREASURY MANAGEMENT

shares utilizing the accumulated profit and reserves. This head includes
authorized capital, issued capital, paid up capital, proposed bonus shares
and calls in advance.

2. Reserve and Funds

Licensed institution shall include the amounts received from allocation of

profits in connection with maintaining reserves or created from any other
process and the amount reserved without allocation in profit/loss account in
this heading. Normally, amount shall be deposited to this heading having
debited the profit/loss account and while using these reserves, the
concerned reserve and fund account shall have to be debited.

(a) General/Statutory Reserve Fund:

General reserve fund is the statutory reserve. In this reserve, the amount
transformed from appropriation of net profit according to the Banks and
Financial

Institutions Act, 2006 shall be included. No type of dividend (cash or bonus

share) shall be distributed from the amount in general/statutory reserve
fund. Approval of this Bank shall be required in order to use the amount in
this fund.

(b) Capital Reserve Fund

Following heads are shown under capital reserve head:

(i) Share Premium

This represents the amount of money collected on issue of shares in excess of

its face value. The outstanding amount in this account shall not be
considered eligible for distribution of dividend.

(ii) Capital Reserve

Following amounts shall be included under this head:-

- Amount from share forfeiture due to non-payment of remaining amount

for the unpaid shares.

- Capital grants received in cash or kind.

(iii) Assets Revaluation Reserve.

Reserve created from revaluation of assets shall be shown under this head.

(iv) Other capital reserve:

 SOURCES OF FUND Chapter 3 31

(c) Dividend Equalization Fund

For the purpose of maintaining uniformity in dividend payment, certain

amount of profit during the year of profit making may be transferred into
this account. Dividend may be distributed by debiting this account with the
approval of the Board of Directors and endorsed by the General meeting.

(d) Accumulated Profit/Loss

Under this, the balance of accumulated profit or loss according to the Profit
and Loss Appropriation Account shall be shown. Accumulated loss shall be
presented having marked negative (-) or in brackets.

(e) Capital Equalization Fund

The amount deposited having created Capital Equalization Fund or

deposited as calls in advance to make up minimum paid up capital have to
be deposited under this head.

(f) Other Reserve Fund

Any reserve created with specific or non-specific purpose (except stated in

above) shall be shown under this by disclosing accounting heads.

Capital or equity, Reserve and surplus, Borrowing- Short term vs. long term.
32 TREASURY MANAGEMENT

SUMMARY
This chapter discussed a treasury function of the banks. The key concepts covered are listed
below.

1. Treasury Management includes a firm's collections, disbursements, concentration,

investment and funding activities.

2. Front office is the dealing room of the treasury department and responsible to take the
decisions regarding the trading and investment.

3. Mid office is responsible for analyze and control the risk of treasury dealings. Mid office
take care of market and credit risks.

4. This office is responsible for settlement and delivery. Back office also prepares the various
Treasury related reports.

5. Assets/liability management is the process of making such decisions about the composition
of assets and liability and the risk assessment.

6. An asset-liability committee (ALCO), also known as surplus management, is a supervisory

group a company employs for coordinating the management of assets and liabilities with a
goal of earning adequate returns.

TRUE FALSE QUESTIONS

Indicate whether the following statements are ‘True’ or ‘False’. Support your answer with reasons.

1. The principal purpose of asset/liability management has been to increase the size of the
firm as measured by total assets.
2. The principal purpose of asset/liability management has been to control the size of net
interest income.

Ans: 1. F; 2. T; 3. F; 4. T; 5. T; 6. F; 7. T; 8. F; 9. T; 10. T; 11. F; 12. T; 13. T; 14. F; 15. F

THEORETICAL QUESTIONS
1. What do you mean by Treasury Management? Explain the scope of Treasury Management.

2. Explain the functions of front office, middle office and back office.

3. What do you mean by Asset liability management? Explain the role and responsibilities of
ALCO.

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