Chapter 2 - Banking Business

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Banking Business
A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM

Banking Business
The primary function of a bank is to collect funds (deposits) at a lower interest rate and lend them out at a higher interest rate. A bank makes money via ‘Net Interest Income’ Net Interest Income (NII) = Interest Earned on Loans – Interest Paid on Deposits However, a sizeable portion of income comes from fee charged on various services such as • • • • Demand drafts Advisory services to corporate, Trading income, Commission via selling other (non-bank) financial products like insurance and mutual funds.

Cost of Funds for a Bank
It is critical for a bank to keep close track of the cost of the money it is borrowing. It has thousands of deposits, each of different tenors (tenures/maturity) and with different interest rates. Only if it knows the cost of this money it is borrowing, can it figure out its lending rate. WACC We can find the cost of funds using the concept of Weighted Average Cost of Capital. It can be calculated as shown below. Rate Savings A/cs Fixed deposits Current A/cs 3% 7% 0% Weight 0.45 0.25 0.3 Weighted cost 1.35 1.75 0 WACC = 3.1 %

Spread The difference between the average deposit rate and the average lending rate is called the ‘spread’ In India, banks typically work on spreads of 3-5%. So, if SBI says its spread is 3%, it means that the difference between its average deposit rates and lending rates is 3%. Difference between Spread and NII

©Finitiatives Learning India Pvt. Ltd. (FLIP), 2010. Proprietary content. Please do not misuse!

Banking Business
A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM NII is the income earned (difference of the actual interest earned and paid) by the bank in absolute terms. Spread is the difference between the interest rates.

Business Offerings of a Bank
Banks are structured based on what specific businesses they focus on. For example, if its two-wheeler loans business is large, it may have a separate business unit (department) just for this product. If not, there maybe a unit catering jointly to two wheeler loans, loans against securities, etc. Described below is a generic overview of what a large bank would look like.

Broadly, a bank’s divisions can be categorized for easier understanding, into: 1. Line Functions - Business units which are a key part of banking operations, are called ‘Line Functions’ – and are customer facing or part of the ‘Front Office’. this means they are interacting with the customer. These include the sales functions, the channels and each specific group of offerings like retail banking, corporate banking, etc. as shown. 2. Back Office or Operations - The second category also comprises key line functions, but these are ‘back office’ or operations. They support the front office. These include all operations such as account opening, loan documentation processing; also risk management, payments, new product development and Asset & Liability Management or ALM.

©Finitiatives Learning India Pvt. Ltd. (FLIP), 2010. Proprietary content. Please do not misuse!

Banking Business
A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM 3. Staff Functions - The third set is the ‘staff’ functions – they are not key banking or line functions, and would be there in any large organization. These are functions like Human Resources, IT, Legal, Finance & Control, etc. Let us know about each section in brief Channels: Systems/Infrastructure which enables a customer to access the bank’s services. Sales & Marketing: Division managing sales of all the products of the bank Retail Banking: Division which handles banking requirements of domestic individuals and small businesses –proprietorships and partnerships. NRI Banking: Specific to India – handles banking requirements of NRIs. This can be clubbed in the Retail Banking Division. Rural/Agricultural Banking: Division seen mainly in Public Sector Banks (PSBs) in India, as they must, by mandate, cater to the needs of this sector. SME Banking: Small and Medium Enterprises division. Sometimes also included under Corporate Banking – depends on the bank Corporate/Wholesale Banking: Division which handles the banking needs of corporates only. Pvt. Banking & WM: Managing the investment needs of wealthy individuals, called High Networth Individuals (HNIs) Investment Banking: A specialized division that caters to the niche requirements of corporates. For example, Mergers and Acquisitions advisory (M&A). Financial Markets & Treasury: Trading division of the bank. This could be proprietary (for their own books) or on the behalf of clients. Product Development: Designs new product offerings based on market requirements Operations: Entire set of processes to enable banking services. Can be divided into Operations for each division or merged for economies of scale. Risk Management: Handles credit, market, operational, liquidity risks for the bank – can be segregated for each division. Payments/Remittances: Handles all the payments processing. Large operational area, hence separate division ALM: Manages a bank's balance sheet to minimize interest rate and liquidity risk. HR: Manages Human Resources function such as recruitment, training etc. Legal & Compliance: Ensures compliance to regulatory requirements IT: Managing the technology required for the various processes.

©Finitiatives Learning India Pvt. Ltd. (FLIP), 2010. Proprietary content. Please do not misuse!

Banking Business
A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM Audit: Internal function, ensuring processes are within guidelines Finance & Control: Preparing the financial statements, budgeting, forecasting & internal reporting of the bank. Let’s look at the channels in detail

Channels
Banking channels refer to the means by which customers access a bank’s products and services. Typical channels offered by banks include: 1. Branch Banking Branch banking refers to a physical location where a bank offers a wide array of services to its customers. It involves large investment in infrastructure and employees. Branch banking is the most popular channel and also the most expensive channel for a bank. Functions of a branch - The functions of a branch are illustrated below. They can be divided into: Front-office or customer interfacing functions - The front office or customers facing functions are those of the teller, customer service and sales staff. Often, as shown, one person can have dual responsibilities: A teller can also answer customer queries or a customer service staff can use his interaction time to sell a bank product. Back office or operations - The typical back office operations are payments, check book processing, loan processing etc. These operations are usually centralized in a region. Hence for large banks, operations within each branch are minimal.
2. ATMs

An Automated Teller Machine (ATM) is a computerized device that provides the customers of a bank easy access to transactions, without the need for a branch. ATMs can be just cash dispensers or evolved facilities offering facilities such as: • • • • • • • • • • • • • • Balance Enquiry Statement of Accounts Cash Withdrawal Cash deposit Check deposit Check cashing Funds transfer Bill Payment Currency Exchange Loan Application Investment Advice MF, Insurance sales Electronic Purse loading Ticketing

©Finitiatives Learning India Pvt. Ltd. (FLIP), 2010. Proprietary content. Please do not misuse!

Banking Business
A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM 3. Internet Banking
Internet Banking refers to the ability to access banking services/products via the internet. It is one of the cheapest channels for a bank Typical Internet Banking offerings include: • • • • • • Static information about the bank’s offerings, application forms Specific account information: Statements, Alerts, Ability to change/edit account information Stop payments, cheque book requests/other instructions Payment transactions to other accounts within and external to the bank Bill Payments

4. Phone Banking Call centers enable customers to access services as described below: Enquiries about Loans and Deposits - Check your account balance, enquire the last five transaction details, make general foreign exchange rates enquiry etc. Transactions - Request for a cheque book or account statement, transfer funds between accounts (same currency), make bill payments etc. 5. Mobile Banking Banking using a mobile phone network can use either SMS or WAP technology. Interactions can be classified as either transactions or enquiries; as also if they are bank initiated (‘Push’) or Customer initiated (‘Pull’), as shown in the table below.

©Finitiatives Learning India Pvt. Ltd. (FLIP), 2010. Proprietary content. Please do not misuse!

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