Banking Law and Practice Hand out No 6 PRINTED 14 .10.

2021 Pages 1/8

BS (Hons.) BAF Year IV, Sem.VII (Sep21 – Feb22), Session 2021-2022

Class on 20 October 2021

You are never fully dressed until you wear a smile.

Bankers’ Core Business — Deposits
Money is the raw material for a bank. The bigger the stock of money, the more the business that a bank can conduct
and the higher the profits it can make. Deposits are rightly said to be the life blood for a bank.

The Bank as Depository

We have discussed earlier the definitions of ‘bank’ / ‘banking’. One of the basic services rendered by the
bank to the public is that of depository, both an essence and an important component of ‘banking’ business.
(CORE: The most important or central part of something)

Importance of Deposits –
The key to all growth and development of the banking system lies in the mobilization of resources and their
judicious utilization. In banking the phrase ‘mobilization of resources’ means all the efforts that a bank
makes for attracting, obtaining and retaining the DEPOSITS from its customers.
The Section 5(b) of the Banking Companies Ordinance, 1962 defines banking particularly highlighting these
aspects:
“Banking means the accepting, for the purpose of lending or investment, of deposits of
money from the public, repayable on demand or otherwise, and withdrawable by cheque,
draft, order or otherwise”.
As such the first pre-requisite of banking is the ‘acceptance of deposits’ from the public and then its
utilization by way of lending or investment in such a manner that the depositors may also withdraw their
funds on demand or otherwise. Impliedly, it further envisages that the investment of funds should be
judiciously made so as to be able to generate earnings for paying a reasonable return to depositors of
money, besides meeting operational expenses of the bank and providing for reserves and paying dividend
to shareholders. It implies that deposits are effectively the ‘working capital’ of the banking business. Unless
there are resources, neither these can be invested in profit making avenues and ventures nor would it be
possible to pay reasonable return to the depositors.
Mobilization of Deposits —
Some banks / DFIs were in the past publicizing their deposit mobilization schemes without disclosing the
correct & complete terms and conditions with regard to the rate of return on such deposits. The use of
ambiguous terms, like “conditions apply” etc., in advertisements were the cause of complaints to SBP from
aggrieved depositors. All the banks/DFls, have been directed to ensure that all advertisements in media
(print, electronic or in any other form) soliciting deposits from the general public should explicitly indicate
the annualized rate of expected return. The words “conditions apply” or other similar wordings should not
be used. The schemes on which profit is paid on monthly/quarterly/half yearly or any other regular interval,
the expected rate of profit to be paid on such intervals should be clearly indicated in the account opening
form or advertising material in bold letters. (DFI means Development Finance Institution for example Industrial
Development Bank of Pakistan).

Core Earning of a bank is the “Spread” of Interest or Profit

Resource mobilization of deposits needs to be done carefully so as to ensure that in the ultimate end, it
does not become counter-productive for the bank. In mobilizing deposits, therefore, two basic points viz.,
average cost of deposits and average earning to the bank on the lending of the deposits, should be kept in view.

A prudent banker would always try to maintain an efficient deposit mix which would keep its average cost of
deposits within safe limits so as to maintain the spread and profitability for the bank.
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BS (Hons.) BAF Year IV, Sem.VII (Sep21 – Feb22), Session 2021-2022

Class on 20 October 2021

What is the meaning of an “efficient deposit mix”? There are basically three types of deposit accounts
that a bank has. To learn this concept, it is better to look at the actual deposit mix of MCB based on Annual
Accounts at 31 Dec 2014.
Total Balance Approx. percent cost of funds
1) Current Accounts 369 Billion nil % pa
2) Savings Accounts 552 Billion 5% pa
3) Term Deposit a/cs 94 Billion 8 % pa
Aggregate Customers Deposits 1,015 Billion
1) Current Accounts on which the bank does not pay any interest or profit. Such accounts are
generally used by businesses for receiving and making payments for trading purposes. The
transactions are usually large and at the end of the day there are substantial balances in the
accounts even though there are no restrictions of minimum balance. A bank has millions of such
accounts and at each day-end the bank has a substantial total balance. These funds are available
to the bank, free of cost.
2) Savings Accounts where individuals and philanthropic organizations like charities and provident
funds are allowed to keep chequing accounts. Profit rate on these accounts is around 5% at
present.
3) Term Deposits which are also called fixed deposits where individuals and businesses are allowed to
keep deposits cashable at maturities of 1month or more generally up to 5 years and sometimes
even more with profit payable either at maturity or on agreed intervals like every month, every
quarter, six monthly, yearly or at maturity of fixed deposit. Generally, the rate of profit rises with the
tenure. The average cost of fixed deposits would these days be around 8%.
The weighted average cost of the aggregate funds totalling Rs 1,051 Billion at the costs shown above
comes to 3.51 % per annum. This weighted average interest rate turns out to be lower than the rates of 5%
and 8% because the profit rate is zero on a large deposit in current accounts. This matter will be elaborated
further in this hand out.
(Kindly remember that this cost only represents the profit paid to the depositors, it does not include the salaries
of officers, cost and rents of buildings computers, furniture, cars communication costs and the dividend expected
by the shareholders. When lending the funds, the bank has to charge a rate which covers all these other factors
plus the interest/profit paid to depositors.)

Due to the differing rates of profit on each type of deposit, this weighted average cost of funds depends
upon the deposit mix of the bank. Deposit mix means relative ratios of the three types of deposits in the
aggregate deposits. If the bank starts accepting more and more Fixed Deposits on which the profit rate is
high (8%) the weighted average cost of funds will increase and in order to retain their profitability the bank
may have to raise the lending rates too high which the market may not be able to take.
Please remember that to keep the overall costs of funds low, the commercial banks make maximum efforts
to increasing Current Accounts and Savings Accounts.
We briefly discuss the important SBP instructions on the use of the customer deposits.
1) State Bank statutory requirements lay down that 5 % of total demand liabilities and time liabilities of
maturities less than one year of the bank (i.e. customer deposits) are compulsorily to be held in a
current account with the State Bank of Pakistan free of any return (SBP pays 0% profit on this amount)
This is called Statutory Cash Reserve (SCR). It gives financial strength & liquidity to the banks.
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BS (Hons.) BAF Year IV, Sem.VII (Sep21 – Feb22), Session 2021-2022

Class on 20 October 2021

2) An amount equal to 19% of customer deposits can only be invested in unencumbered approved
securities. This is called Statutory Liquidity Reserve (SLR). State Bank defines the avenues in
which this amount can be invested. Banks can invest in Treasury Bills, Government of Pakistan
Loans from 1-10 year maturity, NIT Units, Sukuk Bonds issued under Govt guarantees etc. The profit
rate on such investments is generally less than what can be earned on advances and loans to the
private sector but these investments are much more secure and the bank can easily get cash against
disposing these off. The liquidity of such investments is high. These safe investments boost the safety
and solidity of the bank.
The SCR and SLR requirement give financial stability and liquidity to the banking system.

The advances-deposits ratio is currently set at 70%. It means that if the customer deposits in a bank total
100, the bank can give loans and advances upto Rs 70 only. With SCR at 5% and SLR at 19% the bank is
left with 6% of customer deposits which are used for investment on Bank Premises, Furniture fixtures
Computers, etc. (Kindly note that funds raised by bank by issuing share capital or retained earnings are not
subject to cash and liquidity ratios and banks can utilize capital wherever they like).

The average cost of deposits up to which deposit mobilization could be feasible would have, therefore, to
be considered with reference to the average return on the lending or investment of these deposits after
meeting statutory (legal) cash and liquidity obligations.
Another important aspect in deposit mobilization is the quantum of efforts that are put in, on this behalf. The
cost of mobilizing deposits like advertising, hiring special teams of officers, their salaries and commissions,
free services promised to customers, all costs must be accounted for. To this end the following guidelines
could be of assistance.
i. Identify target market for deposit mobilization. As first priority potential sources/areas of deposits
and the persons, if any, to be contacted in this behalf should be identified. The next step would be
to develop contacts and support, as may be considered necessary, for mobilizing these deposits.
ii. In the case of the bank extending letter of credit or guarantee facilities, which either as per SBP’s
guidelines or the bank’s own policies, require an amount of margin to be deposited with the bank.
The margin taken against issuing letters of credit and guarantees also helps to increase bank’s
deposits though in a lesser volume.
iii. Branches falling in home remittance areas could do well to contact persons receiving foreign
inward remittances for opening accounts with their bank and arranging remittances through direct
deposit in accounts which would provide quicker credits to their accounts by avoiding delays
involved in receipt of funds through instruments of remittance like cheques or drafts. The remitters
abroad could also be likewise approached for arranging remittances through their bank for credit to
the beneficiary’s account on the same lines with assurances of efficiency of service.
iv. Issuing drafts, pay orders and other forms of remittances are also sources of funds as the “float”
lying with the bank can be large in case of increased volumes of such businesses. What is a float?
(time delay between payment and receiving due to mailing, processing, and clearing)

v. Branch deposits should be periodically compared with those of other banks operating in the same
areas and the available deposit potential. This would enable the branch officials to make a
comparative assessment of their performances and plan their future strategies and line of action in
respect of advertising and hiring/training of deposit promotion officers.
Customer’s Bank Accounts –

The most basic account is the savings account which cannot be overdrawn. Then there are current
accounts which are payable on demand either by withdrawal or by the customer instructing the bank to
make payment to a third party. Current Accounts can be overdrawn by way of overdraft. Then there are
foreign currency accounts and a number of other deposit accounts with different features and services.
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BS (Hons.) BAF Year IV, Sem.VII (Sep21 – Feb22), Session 2021-2022

Class on 20 October 2021

Account holders vary as well, from individuals through multinational enterprises and government agencies.
There are special rules relating to account-holding by unincorporated associations, partnerships, executors,
minors, mentally ill and so on. Banks themselves hold accounts with other banks as a result of
correspondent banking relationships.
Demand deposits/liabilities are accounts, withdrawals from which can be made immediately on demand at
any time; whereas in the case of Time/Term deposits/liabilities, funds are available for withdrawal only after
a fixed term or determinable period. All deposit products are Liability products and all lending/investment
products are ‘Assets products’ and reported in the balance sheet accordingly.
A bank’s profitability depends on its ability to mobilize deposits effectively. Generating expensive deposits
and lending or investing at cheaper/lower interest rates can cause profit erosion. ‘Cost of deposit’ or cost
of funds is a term used for the weighted average rate that the bank pays to its depositors. This rate
must be high enough to attract desirable levels of deposits but low enough to ensure profit sustainability.
Banks lend at a particular interest rate which is determined by keeping in view the cost of the bank’s deposits
and other factors. It is the treasurer’s job to maintain the pool of the bank’s money in a profitable and feasible
manner.
Section 26-A of Banking Companies Ordinance 1962 pertains to Deposits. The salient features of this section
are:
❖ Banks may accept deposits on participation in profit and loss (PLS).
❖ Free of interest or return in any other form.
❖ Banks shall make a complete record of the investments made and funds allocated for liquid assets.
❖ Deposits which are received on Profit or Loss Sharing (PLS) basis shall be invested by the banks at
their absolute discretion in businesses where return is not fixed. Depositors who have invested money
on a PLS basis are entitled to receive periodical profits from a share of profits of banks as may be
determined by them and in case of loss shall be liable to bear the proportionate loss.

Types of Deposit Accounts

An account is a relationship with the customer, operated on a day-to-day basis, into which deposits are
received and out of which cheques are paid. A deposit account is usually in credit, but an overdraft facility
may be taken on current accounts by pre-arrangement with the bank. Some deposit accounts are opened for
a limited time such as:

1. Notice Account — repayable after a notice period of seven days, or 29 days, etc. Such account is
repayable in the future. The condition is that the customer has to give a written notice to the bank seven
days or 29 days before the date the customer needs the money depending upon whether the deposit is
on 7 days’ notice or 29 days’ notice.

2. Term Deposit Account — repayable after a fixed time ranging from one month to 10 years or even
longer. Profit on such deposits is payable either at maturity or yearly, half yearly, quarterly or monthly
as per contract.

3. Current Account — A current account is an account from which any part of the balance may be
withdrawn on demand. Withdrawal from the account can be made via cheques, direct debit, standing
instructions, on-line banking or ATM. Funds in the account can be debited or credited in the form of
cash, cheques and financial instruments. No interest / profit is paid on the current account.
These accounts are generally for business purposes and can be overdrawn on arrangement with the
bank. Zakat is not deducted on current accounts. The initial deposit can be as per each bank’s own
policy.
Before account opening, ‘due diligence’ should be exercised and all Know Your Customer (KYC)
requirements are to be fulfilled (KYC is explained in detail in other hand outs).
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BS (Hons.) BAF Year IV, Sem.VII (Sep21 – Feb22), Session 2021-2022

Class on 20 October 2021

4. PLS Savings Account (PLS means Profit and Loss Sharing Basis)— Savings accounts
are meant solely for saving purposes. Saving means to set aside money for future use or to retain money
to meet future spending needs. Saving accounts have all the features of a current account, except that
profit is paid on the balance maintained as per the PLS rules of the bank. Saving accounts are generally
opened in the name of individuals but can also be opened in the name of charitable institutions, for
provident funds, benevolent funds and pension funds. Zakat is deducted on the balance maintained on
the valuation date (first day of Ramadan). (Exemption from Zakat can be claimed by submitting Zakat
declaration 30 days prior to the Zakat valuation date).
Different banks have introduced different products of saving accounts for individuals and eligible
institutions where profit is paid bi-annually or monthly. Zakat rules for these accounts are similar to that
of the normal saving accounts.
In the past SBP used to fix the rate of profit on Savings Bank Accounts.
Now SBP fixes ONLY the Policy rate and Savings and other DEPOSIT Rates are in the discretion of the
bank management.
The savings rates these days range between 2% and 7% depending upon the size of the deposit.

5. Basic Banking Accounts (BBA)— Government of Pakistan has been keen on the documentation of
the economy so that the economic data available from the financial institutions helps the state in
formulating policies and increasing the tax base of the country. This can be achieved if all the people
have bank accounts and instead of cash transactions, everybody uses the banks for their buying and
selling and other monetary transactions.
BBAs were introduced by SBP, with special features; vide BPD circular No. 30 dated 29th November
2005, to facilitate banking for low income people in Pakistan. Prior to the introduction of BBAs banks
used to collect service charges from all the customers who failed to maintain a minimum balance in
their accounts as per each bank's policy. In order to resolve this issue and to facilitate banking for
small depositors, SBP has formulated the BBA scheme with the following features:-
❖ Initial deposit to open a BBA is Rs.1000/-
❖ No profit is paid on the balance in this account.
❖ No minimum balance is required and no service charges are to be paid by the customer.
❖ If an account remains at Nil for a continuous period of six months, the bank has the right to close it.
❖ Maximum two deposits and two cheque withdrawals are allowed free of charges in a month.
❖ Unlimited free of charge ATM withdrawals are allowed from bank’s own ATMs.
❖ In case of withdrawal from ATMs of any other bank, charges will be recovered from the other bank.
❖ A regular banking account can be converted to a BBA on the customer's request / consent.
❖ There is NO bar on opening a joint BBA account.
6. PLS Term Deposits— Term deposits are the deposits repayable after a predetermined future date.
Such deposit transactions may be for a period ranging from one month to ten years or even longer.
❖ Profit is paid on the simple interest basis.
❖ Roll-over option can be made available.
❖ Zakat is applicable on the face value, if TDR (term deposit receipt) was outstanding on Zakat
valuation date or payment of profit whichever is earlier.
❖ Tax / withholding tax shall be recovered as per law of the land on profit disbursed. (Withholding tax
is applicable on all types of accounts where the bank pays profit including savings accounts. Tax
rate is 10% to 15% on profit.)
Different banks have issued different liability products for RTA (Rupees Transactional Accounts) and
Term Deposit Accounts. The applicable rules are within the parameters explained above.
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BS (Hons.) BAF Year IV, Sem.VII (Sep21 – Feb22), Session 2021-2022

Class on 20 October 2021

7. Cash Management Accounts— There are three types of above accounts.

❖ Simple Cash Management Account.— Cash Management Account is a banking service

provided to high profile business customers through which they can speedily obtain funds from
their collection accounts maintained at almost all cities in the country and transfer funds to their
main account which is usually in overdraft. The remittances are affected through a computer
module. The module collects and consolidates data from the customer's bank accounts in
many locations in the country. Through cash management, customers can speed up collection
of their accounts receivable and utilize their funds to the optimum level. Example Pakistan
State Oils (PSO) cash management account for Petrol pumps proceeds. PSO has an overdraft
facility in Karachi. The PSO petrol pumps all over the country get proceeds of petrol from
vehicle users. Petrol pumps deposit proceeds in branches located geographically close to
them all over the country. The computer module remits all the amounts to the overdraft facility
account at Karachi with advices to all concerned. In this way PSO saves on interest costs as
the proceeds of collections are efficiently pooled to reduce the overdraft.

❖ Non-Discretionary Wealth/Cash Management Account—The customer opens account and

enters into an agreement with the bank where the customer deposits funds in the account.
Customer makes decision and instructs the bank to invest designated sums in bank deposit
schemes or in equity shares or in mutual funds or in bonds issued by private institutions,
and/or in securities issued by the government like Treasury Bills, Pakistan Investment Bonds.
In return for a fee the bank does all the paper work, invests the funds as desired by/on behalf
of the customer, collects profit, sells the investments when requested. The bank does all the
operational work in the process on customer instructions. The bank handles all the periodical
profit and capital gains the customer earns for his/her investments. The client makes all the
buy/sell decisions and gains or losses from his decisions. Bank recovers all transaction costs
at an agreed fee from the client.

❖ Discretionary Wealth/Cash Management Account— The bank and customer enter into an
agreement whereby the customer deposits his amount and gives ‘discretionary authority’ to the
bank to invest the amount in securities / avenues as chosen by the investment experts of the
bank. The bank hires capable security analysts who invest the amounts in shares, bonds or
other avenues of investments in their best judgement. The bank performs all the sales,
purchases, collections for the customer. All profits and capital gains/losses are passed to the
customer. The decisions to buy/sell are made by the bank experts. The customer pays a fee
and other costs to the bank. The gain/loss is borne by the client.

8. Donation Collection accounts—Collection accounts are opened for collection of funds at the request
of charitable institutions and on the instructions of the government in the case of any disaster.
For the scenario listed above, a Master account is opened in any one branch of the bank. In addition
to this Master account, “collection accounts” are opened in other branches from where funds are
transferred to the Master account as per instruction / arrangement. For example, in order to assist the
public to donate for the rehabilitation of people displaced by the powerful earthquake in Baluchistan,
Prime Ministers Relief Fund has been instituted and collection accounts have been opened in all the
commercial bank branches in Pakistan. Amounts credited to these collection accounts are remitted to
the Central Relief Fund Account at the disposal of the Central Government.
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BS (Hons.) BAF Year IV, Sem.VII (Sep21 – Feb22), Session 2021-2022

Class on 20 October 2021

9. Share Subscription account— When a public limited company floats its shares for subscription, it
has to open subscription accounts in banks which are nominated as "bankers to the issue". These
banks authorize their branches to collect share subscription applications from the public against
deposits of subscription money in collection accounts in the branches; this is ultimately transferred to
a main Subscription account of the share issuing limited company on the closing date of the
subscription. If the number of share applications is more than the shares offered, balloting takes place
and refunds to unsuccessful applicants are made through the branches where the applications were
received. The subscription amount relating to the successful share applications remains available at
the disposal of the share issuing Company. Once the funds are transferred to the main company
account the subscription accounts are closed.
LOOSE CHEQUES—
In case of an EMERGENCY a customer, who does not have a cheque book, can request the issuance of a
loose cheque. A record of loose cheques issued should be maintained in the cheque Book Issued Register
by allocating last few pages of the register for the purpose separately for Current and Savings Deposit
Accounts.
Loose cheque should be issued after completion of the following formalities:
❖ The party requiring a loose cheque should sign the loose cheque requisition slip which is attested
by an officer, who preferably knows him personally and the signature of the account holder is
verified by the Officer In-charge, Deposits Department or the Manager after very carefully examining
specimen signature of the account holder available on the bank’s record.
❖ A stamp bearing the words “Loose Cheque” is affixed on the face of the cheque at the top. Close to
the “Loose Cheque” stamp, words “Not more than Rs so and so may be written as a precautionary
measure.

What is a Weighted Average.

This is a very easy concept but is highly important for bankers and business people who create portfolios of
lending or investment. The rate of return received on a given portfolio is not the same on all the
investments. Some investments yield a high return and some investments yield a low return.
The investor wishes to know what is the average rate of return so that he can check that the average return
is sufficiently higher than the average cost of funds.
Suppose a person has taken a total loan of 11 million at average cost of funds of x % per annum. He
places Rs 1 million in Behbood certificates at 16 % profit and the remaining 10 million in regular income
certificates at 12 % per annum profit. If we think like a layman we would consider only the arithmetic
average of the two figures 16% and 12% which comes to 14%. We would reach the result that the average
return to the investor is 14% per year.
Is this CORRECT ?
Let us do some calculations.
1 million placed at 16% will in one year give the return Rs 160,000.00
10 million placed at 12% will in one year give the return Rs 1.2 m
Total return Rs 1.36m
Principal amount 11 million , profit in one-year Rs1.36 million
Weighted average profit rate will come to 12.36% (1.36/11 million)
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BS (Hons.) BAF Year IV, Sem.VII (Sep21 – Feb22), Session 2021-2022

Class on 20 October 2021

The layman's idea that it is 14% is incorrect. Pl note that in this example if most of the total amount was
invested in the behbood certificates the weighted average would move towards 16%. If most of the amount
is placed in regular income certificates the weighted average will move towards 12%.
Weighted average concept is very important in banking and finance.
In this example the investment portfolio will break even if the cost of funds was 12.36%. The investor would
make a profit if the weighted average cost of funds was less than 12.36%.
The above concept is of tremendous practical importance in finance. I would recommend that you research
this concept further on google. It will be useful in your life.
When deciding what rate of profit to be charged from a borrower the bank should know the bank’s weighted
average cost of funds.
The bank raises funds from various sources at varying rates of profit.
If we accept the arithmetic average of the various deposits in the bank as the average cost of funds. We
would arrive at an incorrect cost of funds and actions based on it can be disastrous for the bank.
Another example
We calculate average salary in an organization.

The arithmetic average comes to dollars 303,000. This high average is influenced by the top management
salary. However, the no of employees in top management is only five. If we take the weighted average it
comes to dollars 76,031 which is more representative as 4000 employees are earning dollars 75000.
When a banker talks about average cost of funds or average rate of earning, he/she is mostly talking of the
weighted average.