Banking Standard XII Study Material PDF

Banking Standard XII Study Material Student Handbook Ancillary Services of Banks 1 Copyright © 2015 by BSE Institute Ltd. This book or any part thereof should not be copied, reproduced, duplicated, sold, resold or exploited for any commercial purposes. Furthermore, the book in its entirety or any part cannot be stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of BSE Institute Ltd. BSE Institute Ltd. 18th and 19th Floors, Phiroze Jeejeebhoy Towers, Dalal Street, Mumbai- 400001 2 Banking Products & Operations - I Table of Contents UNIT 1 ANCILLARY SERVICES OF BANKS 9 1.1 Safe Custody of Valuables 10 1.2 Locker Operations: 12 1.3 Remittances – RTGS / NEFT / Drafts 19 1.4 Fee based services - Issuing Bank Guarantees (BG) and Letters of credit (LC): 31 1.5 Selling Third Party Products- Insurance and Mutual fund units 44 1.6 Credit Cards & Debit Cards 46 1.7 Brokerage & Demat Services: 56 1.8 Summary: 64 1.9 Practice Questions 67 UNIT 2 INNOVATIONS IN BANKING TECHNOLOGY 74 2.1 Bank Computerization 75 2.2 Core Banking Solution (CBS) 85 2.3 Online Banking 89 2.4 Mobile Banking 92 2.5 Internet Banking 98 2.6 ATMs 101 2.7 Summary: 104 2.8 Practice Questions 106 UNIT 3 ORGANIZATION OFA BANK BRANCH 112 3.1 Bank Branch Set up, Strong Room 113 3.2 Front Office & Back Office 118 3.3 Security Arrangements in Bank 121 3.4 Clearing Houses 123 3.5 Summary 126 3.6 Practice Questions 127 UNIT 4 BASIC OF BUSINESS MATHEMATICS 133 4.1 Calculation of Simple Interest and Compound Interest 134 4.2 Fixed and Floating Interest Rates: 143 4.3 Calculation of EMIs: 146 4.4 Calculation of Interest on Savings Accounts 151 4.5 Calculations of Date of Maturity of Bills of Exchange 153 4.6 Summary: 155 4.7 Practice Questions 156 Ancillary Services of Banks 3 UNIT 5 RESERVE BANK OF INDIA REGULATION ON OUR BANKS 163 5.1 Cash Reserve Ratio 168 5.2 Statutory Liquidity Ratio (SLR) 169 5.3 Bank Rate 171 5.4 Repo Rate 171 5.5 Reverse Repo Rate: 172 5.6 Base Rate 173 5.7 Summary 174 5.8 Practice Questions 176 UNIT 6 PROFORMA OF FINAL ACCOUNTS OF BANKING COMPANIES 182 6.1 Profit & Loss Account and Balance Sheet 183 6.2 Summary 214 6.3 Practice Questions 216 4 Banking Products & Operations - I Preface The BSE Institute Ltd. is the wholly owned subsidiary of BSE Limited. BSE Institute Ltd. inherits from BSE the knowledge and insights into the capital markets industry, garnered over the past 140 years. BSE Institute Ltd. has the distinct advantage of being at the centre of action — the financial hub of India, one of the world’s most rapid emerging markets. This has helped us provide insights into the unique functions of this world. Emerging markets such as the BRIC countries — Brazil, Russia, India, and China — can entice and intimidate. However, the first-hand experience of our faculty and subject matter experts in dealing with the realities of this market enables us to appreciate how organizations, entrepreneurs, and investors identify and respond to these new challenges and opportunities. Hence, our programs are designed to help learners develop an actionable framework to delve into key aspects like:  Identifying which market institutions are working, and which institutions are missing?  Which parts of our business model can be adversely affected by these institutional voids?  How can we build competitive advantage based on our ability to navigate institutional voids?  How can we profit from the structural reality of emerging markets by identifying opportunities to fill voids, serving as market intermediaries? Our commitment to being at the forefront of the current and evolving practice of business has led to programs that reflect the realities of the marketplace. Case studies replicate actual business situations and are taught so that students must work together to make difficult decisions under typical management conditions, including a lack of complete information, complex trade off situations and time pressure. The Board takes this opportunity to thankfully acknowledge the commendable work of BSE Institute Ltd in providing support to CBSE for successfully launching and implementing courses under NSQF. Comments and suggestions are welcomed for further improvement of the book. Ancillary Services of Banks 5 Acknowledgements ADVISORS 1. Dr. Y.S.K. Sashi Kumar, Chairperson, CBSE 2 Sh. K. K. Chaudhary, Cordinator Exam of Director (VC) 3. Mr. Ambarish Datta, MD, BSE Institute Ltd. 4. Mr. Vinod Nair, Head of Academics, BSE Institute Ltd. REVIEW COMMITTEE EXPERTS 1. Prof. (Retd.) P.V. Varshney, Delhi University 2. Dr. Sunil Kumar Gupta,Associate Professor, Indira Gandhi National Open University 3. Dr. Geetika Johri,Associate Professor, Indira Gandhi National Open University 4. Ms.Archna Koul, Principal, DAV Centenary Public School CONTENT DEVELOPED BY BSE INSTITUTE LTD., MUMBAI EDITING & COORDINATION Dr. Biswajit Saha,Additional Director (VOC), CBSE Ms. Anupama Khaitan, Content Team, BSE Institute Ltd. 6 Banking Products & Operations - I Learning Objective – Unit 1 Location Duration-10 HOURS Classroom or SESSION -1 SAFE CUSTODY OFVALUABLES Banks Learning Knowledge Performance Teaching and Outcome Evaluation Evaluation Training Method After studying this 1. Requisites in a bank 1. Describe the need of Classroom teaching topic the learners for Safe Custody Safe custody of would be able to learn Services valuables about the benefits 2. Understand the 2. Explain the roles & associated with Safe difference between responsibilities of custody of valuables Safe custody and the Bank as a Bailee Locker system 3. Understand Bailor – Bailee relationship SESSION -2 LOCKERS After studying this 1. Necessity of Safe 1. Describe the need of Classroom teaching topic the learners Deposit Lockers Safe Deposit Locker would be able to state 2. Procedure followed 2. List the requirements the advantages for availing the to get this facility associated with the locker facility locker 3. Nomination facility process in case of 3. RBI guidance on lockers lockers SESSION-3 REMITTANCES- RTGS/NEFT/DRAFTS After studying this 1. Concept of 1. Discuss the need Classroom teaching topic the learners Payment of faster payment would be able to instruments system for retail / identify the distinct 2. Importance of corporate world features of RTGS / faster payments 2. Explain the NEFT / Drafts operations of  RTGS  NEFT  RTGS 3. Advantages of  NEFT RTGS / NEFT /  Drafts Drafts 3. Elucidate the risks involved in E-banking Ancillary Services of Banks 7 Location Duration-10 HOURS Classroom SESSION-4 FEE BASED SERVICES - ISSUING BANK GUARANTEES (BG) AND or LETTERS OF CREDIT (LC) Banks Learning Knowledge Performance Teaching and Outcome Evaluation Evaluation Training Method After studying this 1. Necessity for Fee 1. Enumerate the need Classroom teaching topic the learners based services & advantages of LC would be able to 2. Understanding of in International trade discuss about the BG / LC 2. Describe the LC conditions applicable types and it uses 3. Operations of BG/ for Fee based services LC 3. Explain the process of Bank Guarantee/ LC issuance. SESSION-5 SELLING THIRD PARTY PRODUCTS (TPP) - INSURANCEAND MUTUAL FUND UNITS After studying this 1. Meaning of 1. Explain the need of Classroom teaching topic the learners TPP TPP would be able to 2. Describe how TPP describe issues 2. Purpose of TPP helps Bank to be one pertaining to Selling stop shop for financial 3. Process of TPP Third Party Products products – Insurance / Mutual Funds 3. Identify the sources of income for selling Insurance / Mutual Funds SESSION-6 CREDIT CARDS, DEBIT CARDS After studying this 1. Features of Credit 1. List out differences topic the learners and Debit Card between Debit Card and Credit Card Classroom teaching would be able to 2. D i f f e r e n c e know the concepts of between Debit and 2. Study of Card life Credit cards &Debit Credit Card cycle process with Cards and identify the intermediaries the difference 3. Operation of Debit involved between them. / Credit cards SESSION-7 BROKERAGEAND DEMAT SERVICES After studying this 1. Need & purpose of 1. List out difference Classroom teaching topic the learners Brokerage / Demat between broker / dealer would be able to services 2. List the types of services identify the issues provide by broker related to Brokerage 2. Account opening houses and Demat Services process of Brokerage / Demat 3. Describe the benefits of services Depository & its impact on the Capital market 8 Banking Products & Operations - I UNIT 1 ANCILLARY SERVICES OF BANKS OBJECTIVES After reading this unit you will be able to:  Describe the features of safe custody services & Bank roles & responsibilities  List the rules of Safe Deposit locker and process of availing Bank locker facility  Elucidate the importance of Electronic payments  Summaries the advantages of RTGS / NEFT  Understand fee based services – Bank Guarantee and Letter of credit  Understand the benefits to the Banks in selling Third Party Products (TPP)  List the salient features of Credit / Debit cards  Understand the Brokerage / Demat account features and its advantages STRUCTURE 1.1 Safe Custody of Valuables 1.2 Locker Operations: 1.3 Remittances – RTGS / NEFT / Drafts 1.4 Fee based services - Issuing Bank Guarantees (BG) and Letters of credit (LC) 1.5 Selling Third Party Products- Insurance and Mutual fund units 1.6 Credit Cards & Debit Cards 1.7 Brokerage & Demat Services 1.8 Summary 1.9 Practice Questions 1.1 Safe Custody of Valuables Banks offer the facility of safe custody of valuables to the public. Though there is no obligation on them to accept the valuables for safe custody and it is not a primary function of bank, yes this facility is provided by banks to earn a fee based income. Ancillary Services of Banks 9 Wrong delivery of the articles kept with banker for safe custody to an unauthorized person is conversion (putting goods for one’s own use). Banks take charge of goods, articles, securities as Bailee not as trustee or agent. Bailor – Bailee Relationship: Bailment is a contract for delivering goods by one party to another to be held in trust for a specific purpose and returned when the purpose is over. Bailor is the party that delivers the goods to another. Bailee is the party to whom the same is delivered. So, when a customer gives a sealed box to the bank for safe keeping, the customer became the bailor, and the bank becomes the bailee. Bailment Definition: Section 148 of Indian Contract Act defines Bailment as: The delivery of goods by one to another person for some purpose, upon a contract that they shall, when the purpose is accomplished, be returned or otherwise disposed of according to the directions of the person delivering them. The person delivering the goods is called the ‘Bailor’, and the person to whom goods are delivered is called the ‘Bailee’. Essentials of Bailment: Essentials of Bailment are  Goods: Bailment can be effected only with respect to goods.  Delivery: Delivery of goods by one person to another is essential.  ‘Delivery’ includes: Physical delivery, Constructive delivery or Symbolic delivery. Goods are to be returned to the bailor without demand unless agreed otherwise. The same goods along with any accretion, are to be returned e.g., bonus shares, calf born to a cow. Duties of Bailor:  To disclose faults in goods:  Only known faults where bailment is gratuitous.  All faults including not known but existing at the time of bailment in case of non- gratuitous bailment.  To bear expenses:  Gratuitous Bailment: All expenses – ordinary or extra-ordinary.  Non-Gratuitous Bailment: Only extra-ordinary expenses.  To indemnify for loss caused to the bailee because of defective title. Duties of Bailee: Bailee’s duty is not to mix bailor’s goods with his own or other bailor’s goods. If he does so, then, where goods can be separated, Bailee shall bear the cost of separation. Where goods cannot be separated, Bailor has to be compensated for loss to return the goods in specie 10 Banking Products & Operations - I Bailee duties are to take as much care of the goods bailed as a man of ordinary prudence will take in respect of his own goods of the same nature and value. and, Not to make unauthorized use of the goods Liabilities of Bailee: Liabilities of the Bailee are:  As per Section 148 of Indian Contract Act, the Bank becomes custodian and as a Bailee is liable for any loss caused to the Bailor due to his negligence  He should return any increase in goods to the true owner i.e. the bailor.  Sec 164 – Indian Contract Act, the bailee has to take as much care of such goods as an ordinary prudent man will take. 1.2 Locker Operations: Safe deposit vaults or bank lockers have long been considered the safest place to store valueable viz. jewellery, stock certificates, deeds and other valuables. While most banks offer such a facility, the locker size, annual rent, deposit required, time period and provision for refund differs from bank to bank. A box, usually located inside a bank, is used to store valuables. A safe deposit box is rented by the bank and can be accessed with keys, pin number or some other security pass. Valuables such as documents and jewellery are placed inside the box and customers rely on the security of the building to protect those valuables. Need of Bank Lockers: Storing too much jewellery and valuables in the house at times becomes a security issue and an impediment in case of natural calamities. A bank locker offers a safe, trustworthy space to store valuables, jewellery, documents and other things dear to you. Persons who can avail Bank locker facilities: A bank locker can be leased to any adult, firm or association. Most banks insist on some kind of collateral. So, they give a locker only to their existing account holders, or to those who agree to open an account (savings or current) or make a fixed deposit that covers rentals for three years and charges for breaking open the locker in case of an eventuality. Customer / Bank relationship: The relationship between a p3erson hiring the locker and the bank is that of a lessor and a lessee. The banks do not know what is kept in the lockers, so they do not want to compensate if the contents of the locker go missing. Bank Locker Charges The rent of the locker may vary for different branches of the same bank depending on the branch location. The locker rent is higher if the branch is located in a prime commercial area of the city. Ancillary Services of Banks 11 Moreover, private and foreign banks charge a much higher rent compared to public sector banks. If you decide to close your locker in midyear, in most cases, you forego the annual rent which you paid at the beginning of the year. As regards the safety aspect, most banks claim that confidentiality of the locker’s contents is maintained, unless the income tax authorities or the police require otherwise. Process for hiring Bank Locker: In order to rent a safe deposit vault, you must first have a savings account with the particular bank. Some banks may also ask you to deposit a fixed amount as cautionary deposit for a specific time period. You have to pay the locker rent in advance, either for one year or more, depending on the rules of the bank. Apart from the usual documents required for opening a bank account (identity and address proof), banks require signature to be verification process to be completed before renting out a locker. All you need to do is fill out a simple locker application form and sign a locker agreement, agreeing to abide by the terms and conditions, and pay the deposit and the rent. You can operate the locker either singly or jointly, but only one key is allotted per customer, while the other key remains with the bank. 12 Banking Products & Operations - I SAMPLE AGREEMENT FOR HIRING LOCKER The Federal Bank Limited, having its registered office at Alwaye and one of its branches at....................................................................................... (hereinafter called ‘the Bank’) agrees to let on hire and................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................... (hereinafter called the Hirer(s) agree(s) to take on hire, subject to the terms and conditions endorsed herein below, the Bank’s Locker No.......................................................... (Key No...................................) Class......................for a period of................................................ months from this day at a rental of Rs............................................... for the said period. Unless and until determined in accordance with the terms and conditions noted herein, the hiring will continue to like periods upon the terms and conditions given hereunder at periodical rentals which shall be payable in advance on the last day of the preceding period for the next ensuing period. FOR THE FEDERAL BANK LIMITED (MANAGER) ………………………………… } ………………………………… } Hirer(s) ………………………………… } Ancillary Services of Banks 13 TERMS AND CONDITIONS 1. The safe deposit vault will remain open on bank working days during ordinary banking hours. 2. The hirers shall have no right of property in the locker but only exclusive right of use thereof and access thereto during the period of the agreement and in accordance therewith. The hirer(s) shall neither assign or sub-let the locker or any part of it nor permit it to be used for any purpose other than for the deposit of documents, Jewellery or other valuables nor shall the hirer use the locker for the deposit of any property of an explosive nature or goods or any articles, the keeping of which is illegal. 3. The rent is payable strictly in advance for a minimum period of twelve months. If the rent due is not paid in due course, the bank reserves the right to refuse access to the locker. 4. In case of default of payment of rent, the Bank may after issuing a registered notice giving one month’s time at the registered address of the hirer, break open the locker and make a list of the contents and may remove the contents to another safe and/or the bank is at liberty to auction all or any part of the goods and appropriate the proceeds towards the arrears of the rent and also towards the cost of breaking the safe and repairs thereto. The hirer will have no right to complain against the said procedure or to question the list of contents made by the Bank. 5. All repairs required to be done to the locker; lock or keys shall be done exclusively by workmen appointed by the bank. 6. In case of loss of keys, the Bank should be notified without delay. All charges for opening and replacing the locker or keys shall be payable by the hirer(s). 7. The Bank will not be responsible for any damage or loss to articles in safe custody as a result of any act of war or civil disorder. The Bank will exercise all such normal precautions as it may in its absolute discretion deem fit. It will not accept liability for any loss or damage whatever sustained to items deposited with it. Accordingly hirers are advised in their own interest to insure any item of value deposited in a safe deposit locker with the Bank. 8. Either party may terminate the agreement on giving the other party 7 days notice in writing prior to the date on which the agreed period of hiring terminates. The keys of the locker shall in such case delivered by the hirer to the Bank during working hours on the day of termination of the hiring. 9. If no such notice has been given, the hiring of the locker shall be considered renewed but this condition is without prejudice to rights of the bank accrued to the bank in the meantime. 10. Hirer(s) is / are requested to keep the keys of her / his / their lockers in a place of safety not to divulge number of their locker, pass words (if any given) and not to deliver their keys to any person other than their duly authorised agent. 14 Banking Products & Operations - I 11. For reasons of grave or urgent necessity the Bank reserves the right of closing the safe deposit department for such periods as it may consider necessary. The Bank also reserves the right of making changes in the opening and closing hours of the department without previous intimation. 12. Any change in the address of the hirer(s) should be intimated to the Bank immediately and any notice or communication sent by post to the address of the hirer(s) as given to the Bank shall be considered to have been duly served. 13. It is hereby agreed that the relation of Bank and the hirer in this connection is that of a Lessor and Lessee and not that of banker and a customer or a bailor and bailee. 14. The hirer(s) agree(s) to abide by such rules and regulations as the Bank may from time to time adopt. 15. In cases where the locker is rented to more than one person any one of them will have access to the locker unless instruction to the contrary is given in writing. Duly appointed agent(s) will have access to the locker, provided such authority is registered with the bank. 16. Access to the said locker shall during the joint lives of the Hirers or the survivors of them be had by the Hirers of the survivors of them jointly / any one or more of the Hirers. On the death of all the Hirers save one all of the rights the Hirers hereunder shall vest in such survivor and upon his / her death shall vest in his / her legal representative(s). 17. The Bank shall have a general lien on all property of the hirer(s) in the Safe Deposit for all moneys due from the hirer(s) with power to realise such property or party thereof in satisfaction of moneys due but not paid. 18. A deposit of Rs…… per locker is to be made at the time of lease. This amount will be refunded when the locker is surrendered and key thereof is returned to the Bank in good condition and provided the hirer(s) does / do not owe to the Bank any amount by way of arrears of rent or other charges. 19. The Bank will have the option to enhance the rent of the locker after giving notice to the hirer(s) and the hirer(s) will be bound to pay the enhanced rent as decided by the Bank. 20. The Hirer(s) agree(s) that the bank may at any time, at its discretion and without assigning any reason call upon them to withdraw the articles from the said locker failing which the Bank will be absolved from all the responsibilities in respect of the articles. 21. The Hirer(s) shall have no right to claim refund of the proportionate amount of rent for the unexpired portion of the agreed period of one year if the Hirer(s) terminates the agreement before the agreed period. 22. Notwithstanding the time specified herein before, the Hirer(s) agree(s) that this agreement shall be deemed to be in force, unless it is specifically terminated by either of the parties. 23. The Bank will have the right to appropriate the key deposit, if any occasion arises to break open the cubicle on account of non-payment of rent / loss of key. Name and Address: Signature of hirer(s) Ancillary Services of Banks 15 F. RBI Guidelines on Lockers: Allotment of Lockers:  Linking the lockers facility with placement of fixed or any other deposit beyond what is specifically permitted is a restrictive practice and should be prohibited forthwith.  Fixed Deposit as security for lockers: Banks may face situations where the locker-hirer neither operates the locker nor pays rent. To ensure prompt payment of locker rent, banks may at the time of allotment, obtain a Fixed Deposit which would cover 3 years rent and the charges for breaking open the locker in case of an eventuality. However, banks should not insist on such Fixed Deposit from the existing locker-hirers.  Wait List of Lockers: Branches should maintain a wait list for the purpose of allotment of lockers and ensure transparency in allotment of lockers. All applications received for allotment of locker should be acknowledged and given a wait list number. Banks are also advised to give a copy of the agreement regarding operation of the locker to the locker-hirer at the time of allotment of the locker. Due Diligence: In a recent incident, explosives and weapons were found in a locker in a bank branch. This emphasises that banks should be aware of the risks involved in renting safe deposit lockers. In this connection, banks should take following measures:  Banks should carry out customer due diligence for both new and existing customers at least to the levels prescribed for customers classified as medium risk. If the customer is classified in a higher risk category, customer due diligence as per KYC norms applicable to such higher risk category should be carried out.  Where the lockers have remained un-operated for more than three years for medium risk category or one year for a higher risk category, banks should immediately contact the locker- hirer and advise him to either operate the locker or surrender it. This exercise should be carried out even if the locker hirer is paying the rent regularly. Further, banks should ask the locker hirer to give in writing, the reasons why he / she did not operate the locker.  Banks should have clear procedure drawn up in consultation with their legal advisers for breakings open the lockers and taking stock of inventory. Loss of Locker Contents: The bank will, in no way, be responsible / liable for the contents kept in the locker by the hirer. In case of theft, burglary or similar unforeseen events, action will be initiated as per law.” The RBI has also said that even if the banks do not know about the contents of the locker, they should take necessary steps to protect the contents in the locker. There have been a few cases in the past where customers have received compensation for loss or damage to locker contents. 16 Banking Products & Operations - I Nomination Facility: It is always beneficial to avail the benefits of nomination facility/ survivorship clause provided to locker-hirers. The major advantage of availing these facilities is that in the event of unfortunate death of one of the joint locker-hirer, the right of access to the contents of the locker does not automatically devolve on the surviving joint locker-hirer/ nominee (s), unless there is a survivorship clause/ nomination. Operations of Bank Locker: The locker has two keys for opening the locker. One key is with the lessee (customer) and one master key is with the bank. The lessee needs to visit the branch during the specified time mentioned for the locker operations.  Lessee will sign the register filling in the locker number and signs.  Responsible Bank officer will verify the signature with the Bank records.  If the signature tallies, the officer will take the customer to the locker room.  Bank officer will open the locker with his key and then lesser will open the locker with his key to open the locker.  Once the locker is opened, the Bank officer will leave the locker room and the lesser will deposit / withdraw valuables he wants  Once he completes his transaction, he closes the locker door and locks the locker with his key only. The locker operation may vary from the Bank to Bank based on the type of locker, standard procedure followed by the Bank 1.3 Remittances – RTGS/NEFT/Drafts Ways to transfer money: To transfer funds (money) from one person to another person, the banks have various channels which are:  Paper Based:  Cheques  Demand Draft  Electronic Funds Transfer  NEFT  RTGS  Cards  Credit Cards  Debit Cards Ancillary Services of Banks 17 There are a few large value payment systems functioning in the country. These are:  Inter-Bank Cheques Clearing Systems (the Inter-bank Clearing),  High Value Cheques Clearing System (the High Value Clearing),  Government Securities Clearing System (the G-Sec Clearing),  Foreign Exchange Clearing System (the Forex Clearing) and  Real Time Gross Settlement (RTGS) System. All these systems (except the High Value Clearings) are electronic based systems. These mostly relate to interbank / inter-financial institutional transactions except the High Value Clearing where high value customer cheques are cleared. The Inter-bank Clearing functions in 7 places and the High Value Clearing in 15 places – both are managed by the Reserve Bank of India. The G-Sec Clearing and the Forex Clearing are managed by the Clearing Corporation of India Limited (CCIL). The RTGS System is operated by the Reserve Bank of India. All these are deemed to be Systemically Important Payment Systems (SIPS) and therefore the Reserve Bank has, in line with the international best practices in this regard, moved them (except High Value Clearings) to either secure and guaranteed systems or the RTGS System. A. Real Time Gross Settlements Payments System (RTGS) : The acronym ‘RTGS’ stands for Real Time Gross Settlement, which can be defined as the continuous (real-time) settlement of funds transfers individually on an order by order basis (without netting). ‘Real Time’ means the processing of instructions at the time they are received rather than at some later time; ‘Gross Settlement’ means the settlement of funds transfer instructions occurs individually 18 Banking Products & Operations - I (on an instruction by instruction basis). Considering that the funds settlement takes place in the books of the Reserve Bank of India, the payments are final and irrevocable. Under normal circumstances the beneficiary branches are expected to receive the funds in real time as soon as funds are transferred by the remitting bank. The beneficiary bank has to credit the beneficiary’s account within two hours of receiving the funds transfer message. RTGS Operation: i. Limit: Type Minimum Maximum RTGS Rs. 2 Lakhs No Limit ii. Time of Operations: RTGS transactions will be sent to RBI based on the following schedule: RBI settlement Timings for R-41 transactions (other than Inter Bank transactions) Day Start Time End Time Monday to Friday 09:00 hrs 16:30 hrs Saturday 09:00 hrs 13:30 hrs RTGS Tariff: With a view to rationalize the service charges levied by banks for offering funds transfer through RTGS system, a broad framework has been mandated as under:  Inward transactions – Free, no charge to be levied.  Outward transactions:  Between Rs 2 lakhs to 5 lakhs - not exceeding Rs 30.00 per transaction;  Above Rs 5 lakhs – not exceeding Rs 55.00 per transaction. The remitting bank receives a message from the Reserve Bank that money has been credited to the receiving bank. Based on this the remitting bank can advise the remitting customer through SMS that money has been credited to the receiving bank. The remitting customer has to furnish the following information to a bank for initiating a RTGS remittance:  Amount to be remitted  Remitting customer’s account number which is to be debited Ancillary Services of Banks 19  Name of the beneficiary bank and branch  The IFSC Number of the receiving branch  Name of the beneficiary customer  Account number of the beneficiary customer  Sender to receiver information, if any National Electronic Funds Transfer NEFT has gained popularity due to its saving time and the ease with which the transactions can be concluded. National Electronic Funds Transfer (NEFT) is a nation-wide payment system facilitating one-to-one funds transfer. Under this Scheme, individuals, firms and corporate can electronically transfer funds 20 Banking Products & Operations - I from any bank branch to any individual, firm or corporate having an account with any other bank branch in the country participating in the Scheme. For being part of the NEFT funds transfer network, a bank branch has to be NEFT- enabled. The list of bank-wise branches which are participating in NEFT is provided in the website of Reserve Bank of India at http://www.rbi.org.in/scripts/neft.aspx Individuals, firms or corporate maintaining accounts with a bank branch can transfer funds using NEFT. Even such individuals who do not have a bank account (walk-in customers) can also deposit cash at the NEFT-enabled branches with instructions to transfer funds using NEFT. However, such cash remittances will be restricted to a maximum of Rs.50,000/- per transaction. Such customers have to furnish full details including complete address, telephone number, etc. NEFT, thus, facilitates originators or remitters to initiate funds transfer transactions even without having a bank account. Individuals, firms or corporate maintaining accounts with a bank branch can receive funds through the NEFT system. It is, therefore, necessary for the beneficiary to have an account with the NEFT enabled destination bank branch in the country. a. NEFT Operations: Ancillary Services of Banks 21 NEFT is an electronic fund transfer system that operates on a Deferred Net Settlement (DNS) basis which settles transactions in batches. In DNS, the settlement takes place with all transactions received till the particular cut-off time. These transactions are netted (payable and receivables) in NEFT For example, currently, NEFT operates in hourly batches. [There are twelve settlements from 8 am to 7 pm on week days and six settlements from 8 am to 1 pm on Saturdays.] Any transaction initiated after a designated settlement time would have to wait till the next designated settlement time. Step-1: An individual / firm / corporate intending to originate transfer of funds through NEFT has to fill an application form providing details of the beneficiary (like name of the beneficiary, name of the bank branch where the beneficiary has an account, IFSC of the beneficiary bank branch, account type and account number) and the amount to be remitted. The application form will be available at the originating bank branch. The remitter authorizes his/her bank branch to debit his account and remit the specified amount to the beneficiary. Customers enjoying net banking facility offered by their bankers can also initiate the funds transfer request online. Some banks offer the NEFT facility even through the ATMs. Walk-in customers will, however, have to give their contact details (complete address and telephone number, etc.) to the branch. This will help the branch to refund the money to the customer in case credit could not be afforded to the beneficiary’s bank account or the transaction is rejected / returned for any reason. Step-2: The originating bank branch prepares a message and sends the message to its pooling centre (also called the NEFT Service Centre). Step-3: The pooling centre forwards the message to the NEFT Clearing Centre (operated by National Clearing Cell, Reserve Bank of India, Mumbai) to be included for the next available batch. Step-4: The Clearing Centre sorts the funds transfer transactions destination bank-wise and prepares accounting entries to receive funds from the originating banks (debit) and give the funds to the destination banks (credit). Thereafter, bank-wise remittance messages are forwarded to the destination banks through their pooling centre (NEFT Service Centre). Step-5: The destination banks receive the inward remittance messages from the Clearing Centre and pass on the credit to the beneficiary customers’ accounts. b. IFSC: IFSC or Indian Financial System Code is an alpha-numeric code that uniquely identifies a bank- branch participating in the NEFT system. This is an 11 digit code with the first 4 alpha characters representing the bank, and the last 6 characters representing the branch. The 5th character is 0 (zero). IFSC is used by the NEFT / RTGS system to identify the originating / destination banks / branches and also to route the messages appropriately to the concerned banks / branches. c. NEFT Charges: The charges that can be levied on the customer for NEFT are given below: 22 Banking Products & Operations - I  Inward transactions at destination bank branches (for credit to beneficiary accounts)  Free, no charges to be levied on beneficiaries  Outward transactions at originating bank branches – charges applicable for the remitter  For transactions up to Rs 10,000 : not exceeding Rs 2.50 (+ Service Tax)  For transactions above Rs 10,000 up to Rs 1 lakhs not exceeding Rs 5 (+ Service Tax)  For transactions above Rs 1 lakhs and up to Rs 2 lakhs: not exceeding Rs 15 (+ Service Tax)  For transactions above Rs 2 lakhs: not exceeding Rs 25 (+ Service Tax) With effect from 1st July 2011, originating banks are required to pay a nominal charge of 25 paisa each per transaction to the clearing house as well as destination bank as service charge. However, these charges cannot be passed on to the customers by the banks. The beneficiary can expect to get credit for the NEFT transactions within two business hours (currently NEFT business hours is from morning 8 AM to evening 7 PM on all week days and from morning 8 AM to afternoon 1 PM on Saturdays) from the batch in which the transaction was settled. In case of non-credit or delay in credit to the beneficiary account, the NEFT Customer Facilitation Centre (CFC) of the respective bank can be contacted (the remitter can contact his bank’s CFC; the beneficiary may contact the CFC of his bank) and can be escalated to NEFT Help Desk (or Customer Facilitation Centre of Reserve Bank of India) at National Clearing Cell, Reserve Bank of India, Mumbai or the General Manager, Reserve Bank of India, National Clearing Centre, First Floor, Mumbai Regional Office, Fort Mumbai 400001. If it is not possible to afford credit to the account of the beneficiary for whatever reason, destination banks are required to return the transaction (to the originating branch) within two hours of completion of the batch in which the transaction was processed. NEFT can be used to transfer funds from or to NRE and NRO accounts in the country. This, however, is subject to the adherence of the provisions of the Foreign Exchange Management Act, 2000 (FEMA) and Wire Transfer Guidelines. Besides personal funds transfer, the NEFT system can also be used for a variety of transaction including payment of credit card dues to the card issuing banks, payment of loan EMI etc. It is necessary to quote the IFSC of the beneficiary card issuing bank to initiate the bill payment transactions using NEFT. In case of successful credit to the beneficiary’s account, the bank which had originated the transaction is expected to send a confirmation to the originating customer (through SMS or e-mail) advising of the credit as also mentioning the date and time of credit which remitter provided to the branch at the time of originating the transaction. The remitter can track the NEFT transaction through the originating bank branch or its CFC using the unique transaction reference number provided at the time of initiating the funds transfer. It is Ancillary Services of Banks 23 possible for the originating bank branch to keep track and be aware of the status of the NEFT transaction at all times. Following are the pre-requisites for putting through a funds transfer transaction using NEFT:  Originating and destination bank branches should be part of the NEFT network  Beneficiary details such as beneficiary name, account number and account type, name and IFSC of the beneficiary bank branch should be available with the remitter  Customers should exercise due care in providing the account number of the beneficiary, as, in the course of processing NEFT transactions, the credit will be given to the customer’s account solely based on account number provided in the NEFT remittance instruction / message. d. Benefits of NEFT: NEFT offers many advantages over the other modes of funds transfer:  The remitter need not send the physical cheque or Demand Draft to the beneficiary.  The beneficiary need not visit his / her bank for depositing the paper instruments.  The beneficiary need not be apprehensive of loss / theft of physical instruments or the likelihood of fraudulent encashment thereof.  Credit confirmation of the remittances sent by SMS (Short Message Service) or email.  Remitter can initiate the remittances from his home / place of work using the internet banking also.  Near real time transfer of the funds to the beneficiary account in a secure manner. Demand Draft: 24 Banking Products & Operations - I Demand Draft is a cheque that contains an order by one branch of a bank (Drawer branch) directing another branch of the same bank (Drawee branch) to pay on demand a certain sum of money to a specified beneficiary (Payee). a. Features of Demand Draft: Demand draft is discussed in section 85(A) of the NI Act. The features are:  A Demand Draft is payable on demand  A Demand Draft can NOT be paid to its bearer  A DD is negotiable and its features are similar to that of a bill of exchange and not a Cheque.  If a Bank fails to honour the Draft, the Bank is liable and not the person who got it issued.  If there are wrong signatures on the Bank Draft, the Bank is liable. b. Advantages of Demand drafts are:  Demand draft may be crossed also. Hence it cannot be-encashed at the counter  No counterparty risk as the risk shifts to the Bank  No risk of its being dishonoured due to insufficiency of funds  It is a secured instrument for the payee c. Key Differences between Banker’s Cheque and Demand Draft Banker’s Cheque is issued for transfer of money within the local limits of the drawer branch, whereas Demand Draft is issued for transferring money to a person residing at a different place. The area of banker’s cheque is limited while the area of demand draft is very vast. The banker’s cheque is pre-printed with the word “Not Negotiable” however, this is not so in the case of demand draft. A demand draft of value Rs. 20,000 or more can be issued only with A/c payee crossing, however in case of banker’s cheque there is no such condition. Banker’s cheque can only be cleared in the branch of bank from where it is issued, but Demand Draft can be cleared at any branch of the same bank. Ancillary Services of Banks 25 1.4 Fee Based Services - Issuing Bank Guarantees (BG) and Letters of credit (LC): In the face of declining net interest margin banks have entered into new product areas over the past two decades, moving from traditional lending to areas that generate non-interest revenues. The change is of importance for financial stability. The more unstable is a bank’s earnings stream, the more risky the institution is. The conventional wisdom in the banking industry is that earnings from fee-based products are more stable than loans Fee-based activities reduce bank risk via diversification. Types of Bank Income: There are two broad sources of a bank’s income or revenues. One is Interest Income or Fund Based Income and second is, Non-Interest Income or Non-fund Based Income. Non-Interest Income / Non-Fund Based Income ‘Non funded’ facilities are those where in immediate payment of money / funds is not involved but the bank gives a sort of support in the form of a guarantee or promise or undertaking (Letter of Credit) on behalf of the customer (Applicant) in favour of third parties (Beneficiaries). If the customer fails to fulfill his agreed Financial obligations or Performance obligations, the Bank pays the beneficiaries, in terms of the guarantee / undertaking. At the time when the bank makes such payments, the ‘Non-funded’ credit facility becomes a ‘funded’ facility i.e. a loan to the customer. Letters of Credit & Bank Guarantee comes under non fund, fee based activities. A. Bank Guarantee: A Bank Guarantee is non-fund credit facility. This is an unconditional commitment on the part of the bank on behalf of its customer (applicant) to pay another person (the beneficiary) a certain sum of money IF the applicant fails to pay. a. Definition of Guarantee: Bank guarantee (BG) is an agreement between 3 parties viz. the bank, the beneficiary (party to whom the guarantee is given) and the applicant (party who seeks the bank guarantee from the bank). BGs are an important banking arrangement and play a vital role in promoting international and domestic trade. A contract of Guarantee is a “Contract to perform the promise or discharge the liability of a third person in case of his default”. Bank guarantee is an additional tool to fulfil the obligations under the contract. The creditor who is not sure about the solvency of the borrower protects himself against default by the debtor to pay the debt. In this case, the borrower pays a fixed amount to the bank for giving guarantee. Guarantee fee is thus a non interest income to the bank. 26 Banking Products & Operations - I Specimen of Guarantee Letter: Parties to the Guarantee: Guarantor: A person or institutation who issues a letter of guarantee which contains his commitment to pay a sum of money, of the principal debtor defants. Principal Debtor: is the debtor who has the obligation to pay the monthly. Beneficiary: is the creditor of the principal debtor, in whose favour the guarantee is given. a. BG Process: BG is issued by a bank on the receipt of request from the “applicant”. He promise to pay “guarantee amount” towards some purpose/underlying transaction to the “beneficiary”. If the applicant defaults. Ancillary Services of Banks 27 While granting the Guarantee facilities on behalf of a borrower, the bank would assess the financial position (credit worthiness) of the borrower as well as the technical ability, experience in the line, reputation etc. of the borrower to complete the contract satisfactorily. While issuing Guarantees the banks charges their non-refundable Guarantee fees from the borrower. This constitutes Bank’s Non Interest based income If the bank i.e. “the guarantor” receives the “claim” from the beneficiary, it results in “BG invocation”. In case of foreign BG, apart from these 3 parties, there is also a “correspondent bank”. If a bank does not have branch in some foreign country, it issues BG in that country through its “correspondent bank”. The bank does all the required due diligence, financial and business analysis before issuing the guarantee. For example: An exporter called “ABC LTD.” in Dubai seeks a bank guarantee from an importer called “XYZ Pvt. Ltd” in India. In this case, “XYZ Pvt. Ltd” approaches Corporation Bank to give a bank guarantee on his behalf to the exporter. Now, if Corporation bank does not have a branch in Dubai, Corporation bank would issue the guarantee through State Bank of India (SBI). Here, “XYZ Pvt. Ltd” is the applicant; “ABC LTD” is the beneficiary; “Corporation Bank” is the issuing bank and “SBI” is the correspondent bank. This BG agreement acts as an undertaking assuring the beneficiary that the bank would pay the specified amount, in case of its applicant’s default in meeting his obligation as mentioned in the guarantee. In effect, the BG acts as a promise that in case the liability of the debtor/applicant is not met, the contractual liability will be met by the bank. BG contract is independent from the underlying transaction/contract that exist between the beneficiary and the applicant. Features of a Valid Guarantee:  Guarantee is always issued for a specific amount  The purpose of the guarantee is clearly stated  Guarantee is valid for a specific defined period  The grace period allowed to enforce guarantee rights is also stated in the guarantee It is important that guarantee can be enforced based on terms of the contract (i.e. guarantee agreement) existing between the bank and the beneficiary. Generally, beneficiaries do state a clause to be included for charging penal interest in case of delayed payment. Hence, it is essential for the bank to be cautious while finalizing the format and text of the contract (the guarantee agreement). While signing the same, the provision of penal interest and clauses attached to delays and default are to be carefully noted. Types of Bank Guarantees Financial Guarantee: The bank guarantees that the principal debtor will meet the financial obligation and in case he fails, the bank as a guarantor is bound to pay. Performance Guarantee : Guarantee issued is for completing a particular task in the prescribed/ agreed upon manner as stated in the guarantee document. 28 Banking Products & Operations - I Advance Payment Guarantee: This guarantee assures that the advance amount would be returned, in case the agreement for which the advance is given does not get fulfilled. Payment Guarantee / Loan Guarantee: The guarantee is for assuring the payment / loan repayment. In case, the party fails to do so, guarantor is bound to pay on behalf of the defaulting borrower. Bid Bond Guarantee: As a part of the bidding process, this guarantee assures that the bidder would undertake the contract he has bid for, on the terms the bidding is done. Deferred Payment Guarantee: When the bank guarantees some deferred payment, the guarantee is termed as Deferred Payment Guarantee. For example: A company purchases a machine on credit basis with terms of payment being 6 equal instalments. In this case, since the payment is deferred to a later period, creditor seeks deferred payment guarantee with an assurance that the payment would reach him in the given time period. Importance of Bank Guarantees: Importance of bank guarantee is as follows: Adds to Creditworthiness: BGs reflect the confidence of the bank in the business of the applicants. Assessment of Business: In case of foreign transactions or transactions with Government organisations, the foreign party or a Government Undertaking is constrained and cannot assess soundness of each and every applicant to a project. In such cases, BGs act as a trusted instrument to assess stability and creditworthiness of companies applying for projects. Confidence of Performance: When new parties associate in business and are sceptic about performance of the company undertaking the project, performance guarantees help in reducing the risk of the beneficiary. Risk Reduction: Advance payment guarantees act as a protection cover wherein the buyer can recover the advance amount paid to the seller, if seller fails to deliver the goods or services. This protects against any probable loss that a party can suffer from a new seller. Difference between a Bank Guarantee and a Letter of Credit: A letter of credit is an obligation taken upon is by a bank to make a payment once certain criteria are met. Once these terms are completed and confirmed, the bank will transfer the funds. This ensures the payment will be made as long as the services are performed. A bank guarantee, like a line of credit, guarantees a sum of money to a beneficiary. Unlike a line of credit, the sum is only paid if the opposing party does not fulfill the stipulated obligations under the contract. For example a letter of credit could be used in the delivery of goods or the completion of a service. The seller may request that the buyer obtains a letter of credit before the transaction occurs. The buyer would get this letter of credit issued by a bank and forward it to the seller. This letter would substitute the bank’s credit for that of its client, ensuring timely payment. A bank guarantee might be used when a buyer obtains goods from a seller and then runs into cash flow difficulties and can’t pay the seller. The bank would pay an agreed-upon sum to the seller. Ancillary Services of Banks 29 These financial instruments are used in trade financing when suppliers, or vendors, are selling goods to overseas customers with whom they don’t have established business relationships. The instruments are designed to reduce the risk of non-payment by the buyer. B. Letter of Credit (LC): An LC is a bank’s (Issuing Bank-IB) written irrevocable commitment, made on behalf of its client (applicant of the LC-buyer of goods / services) to pay the beneficiary (seller of the goods/services), a specified amount of money on the due date provided the beneficiary submits ‘complying’ documents (i.e. submits the documents as stipulated in the LC) to the IB within the stipulated time at the stipulated place. A Non-funded credit facility means that the bank does not release any funds to the borrower at the time of sanctioning the facility. It is a commitment to pay on behalf of the borrower contingent upon the beneficiary fulfilling the conditions and the borrower not paying the dues before the due date. SAMPLE - IRREVOCABLE STANDBY LETTER OR CREDIT 30 Banking Products & Operations - I a. Letter of Credit Definition: A document issued by a bank / financial institution on behalf of a buyer stating the amount of credit the buyer is availing, and that the institution will honor drafts up to that amount drawn by the seller on the buyer. It gives the buyer the prestige and financial backing of the issuing institution and satisfies the requirements of the seller in completing the transaction. A commitment, usually by a bank on behalf of a buyer, to pay the beneficiary a stated amount of money under specified conditions gives an assurance to the seller to recover his dues from the buyer on the due date. b. Parties involved in LC transaction:  The Applicant is the party that applies for the letter of credit to be issued (i.e. the buyer).  The Beneficiary is the party named in the letter of credit in whose favour the letter of credit is issued (i.e. seller)  The Issuing or Opening Bank is the applicant’s bank that issues or opens the letter of credit in favour of the beneficiary and substitutes its creditworthiness for that of the applicant. c. Beneficiary: The beneficiary is normally the seller of goods who receives payment if he has complied with the terms and conditions mentioned in the LC. A Letter of credit is issued in favor of the beneficiary to enable him or his agent to obtain payment once he performed his part of the contract and submitted stipulated documents showing compliance with the terms and conditions of the letter of credit. In case of a transferable letter of credit, the credit is transferred to another party, the original beneficiary is known as first beneficiary the person to whom the credit is transferred is known as the second beneficiary. The beneficiary decides the terms of payment when sales contracts are negotiated. He assesses the risk of nonpayment even when compliant documents are presented in the case of unconfirmed LCs. Scrutinizes LC on receipt from the advising bank to check whether it is in accordance with the sales contract and whether it is otherwise acceptable to him. e. Advising Bank: An Advising Bank may be named in the letter of credit to advise the beneficiary that the letter of credit has been issued. The role of the Advising Bank is limited to establish authenticity of the credit, which it advised to the beneficiary. f. Paying Bank: The Paying Bank is the bank nominated in the letter of credit that makes payment to the beneficiary, after determining that documents conform, and upon receipt of funds from the issuing bank or another intermediary bank nominated by the issuing bank. Ancillary Services of Banks 31 g. Confirming Bank The Confirming Bank is the bank, which, under instruction from the issuing bank, substitutes its creditworthiness for that of the issuing bank. It ultimately assumes the issuing bank’s commitment to pay. If the LC facility is in respect of import of goods from abroad, then the country’s ‘EXIM Policy’ will have to be taken into account by the opening banker. It has to follow the rules of the government regarding the goods which can be imported. RBI’s ‘Exchange Control Policy’ will also be considered by it to ascertain whether payment in a particular currency is permissible. h. Letter of Credit Process flow: L e tte r o f C r e d it P ro c e s s ©2 01 2 BSE In stitu te L imite d 62 CBSE Std XII - Int ro du ctio n to Ban king a nd I nsu ra nc e- II  Applicant approaches Issuing/ Opening Bank with LC application form duly filled and requests Issuing Bank to issue a Letter of Credit in favour of Beneficiary.  Issuing Bank issues a Letter of Credit as per the application submitted by an Applicant and send it to the Advising Bank, which is located in Beneficiary’s country, to formally advise the LC to the beneficiary.  Advising Bank advises the LC to the Beneficiary.  Once Beneficiary receives the LC and if it suits his/ her requirements, he/ she prepares the goods and hands over them to the carrier to dispatch to the Applicant.  He/ She then hands over the documents along with the Transport Document as per LC to the Negotiating Bank to be forwarded to the Issuing Bank. 32 Banking Products & Operations - I  Issuing Bank reimburses the Negotiating Bank with the amount of the LC post Negotiating Bank’s confirmation that they have negotiated the documents in strict conformity of the LC terms. Negotiating Bank makes the payment to the Beneficiary.  Simultaneously, the Negotiating Bank forwards the documents to the Issuing Bank to be released to the Applicant to claim the goods from the carrier.  Applicant reimburses the Issuing Bank for the amount, which it had paid to the Negotiating Bank.  Issuing Bank releases all documents along with the titled Transport Documents to the Applicant. i. Settlements of LC: All commercial letters of credit must clearly indicate whether they are payable by sight payment, by deferred payment, by acceptance, or by negotiation. These are noted as formal demands under the terms of the commercial letter of credit.  In a sight payment, the commercial letter of credit is payable when the beneficiary presents the complying documents and if the presentation takes place on or before the expiration of the period of commercial letter of credit.  In a deferred payment, the commercial letter of credit is payable on a specified future date. The beneficiary may present the complying documents at an earlier date, but the commercial letter of credit is payable only on the specified future date.  An acceptance is a time draft drawn on, and accepted by, a banking institution, which promises to honor the draft at a specified future date. The act of acceptance is without recourse as it is a commitment to pay the face amount of the accepted draft.  Under negotiation, the negotiating bank, a third party negotiator, expedites payment to the beneficiary upon the beneficiary’s presentation of the complying documents to the negotiating bank. The bank pays the beneficiary, normally at a discount of the face amount of the value of the documents, and then presents the complying documents, including a sight or time draft, to the issuing bank to receive full payment at sight or at a specified future date. j. Advantages of using an LC are:  The beneficiary (seller) is assured of payment as long as it complies with the terms and conditions of the letter of credit.  The credit risk is transferred from the applicant (buyer) to the issuing bank.  The beneficiary minimizes collection time as the letter of credit accelerates payment of the receivables.  The beneficiary’s foreign exchange risk is eliminated with a letter of credit issued in the currency of the beneficiary’s country. Ancillary Services of Banks 33 k. Risks involved in LC: Since all the parties involved in Letter of Credit deal with the documents and not with the goods, the risk of Beneficiary not shipping goods as mentioned in the LC is still persists. The Letter of Credit as a payment method is costlier than other methods of payment such as Open Account or Collection. The Beneficiary’s documents must comply with the terms and conditions of the Letter of Credit for Issuing Bank to make the payment. The Beneficiary is exposed to the Commercial risk on Issuing Bank, Political risk on the Issuing Bank’s country and Foreign Exchange Risk in case of Usance Letter of Credits. l. Different payment structures for LC:  Sight Credit: In this the payment is release to Beneficiary on presentation of documents  Acceptance Credit: In this beneficiary draws the bill of exchange on issuing bank and allows some time for acceptance  Deferred Credit :Is same as Acceptance Credit except there is no bill of exchange  Back to Back Credits: Exporter receives a credit from his buyer (Selling credit). He has to procure goods from other suppliers. He opens a credit for purchase of the goods (buying credit). Second credit is said to be back to back to the first one. Bill proceeds of the export LC (Selling LC) will be used to meet liabilities under the second (Buying LC). Amount of back to back credit will be lower. Usance period of the back to back credit should be equal to or more than that of the export credit. Bank still at risk if the customer fails to export. No concession in margin and security norms.  Revolving Credits: Credit is opened to cover a series of regular transactions over a longer period. Beneficiary will submit a series of documents. Maximum value of each document will be fixed and is the revolving limit. LC amount is the maximum value of documents that can be handled under the credit. The credit may be reinstated automatically or after payment of earlier bill. It can be opened as cumulative or non cumulative.  Standby Letters of Credit: Credit is issued for a particular amount and for a particular period. Trade takes place on running account basis. Beneficiary does not submit documents to bank. m. Recourse in case of default: If there is a default, he can claim funds from opening bank giving a certificate of default. No quibbling over discrepancies and documents. Opening bank will pay on demand. Works like a bank guarantee. UCPDC is applicable if so declared in the credit n. General documents required to be submitted under documentary credits:  Commercial Invoice  Packing List  Bill of lading and other transport documents 34 Banking Products & Operations - I  Certificate of Origin  Inspection Certificate  Bill of Exchange  Insurance Documents o. Regulations applicable to LC are:  Foreign Trade Policy requirements.  FEMA requirements.  Credit norms of Central Bank.  UCPDC 600 Provisions.  Bank’s Internal Credit Policies/ procedures.  Public notices issued by DGFT  Uniform Rules for bank-to-bank reimbursements 525  Incoterms 2010 p. Bank’s Obligation & Responsibilities: Issuing Bank (opening bank) (UCP Article 7) Issuing Bank being the prime obligator needs to ensure credit-worthiness and trust-worthiness of the applicant. Once credit is opened, the bank is placing itself as a substitute for the buyer. Advising Bank has the obligation to authenticate the credit once it is received and passing it promptly on to the beneficiary (Art.9). Confirming Bank takes over the responsibilities of the issuing bank as far as the beneficiary is concerned though it has got recourse to the Issuing Bank (Art 8). Negotiating Bank to examine documents within 5 banking days after receipt of the documents at their counters (Art 14b). To ensure compliance of credit terms on the basis of documents alone and consistency of documents with each other 1.5 Selling Third Party Products- Insurance and Mutual fund units Commission earned on selling other companies’ products (or third party’s product distribution business) is emerging as a new source of revenue for many banks. Although the fee amounts are small, they make a valuable contribution to diversify revenue streams, increasing the mix of non- interest income in the overall profits. Ancillary Services of Banks 35 A. Mutual Funds: A Mutual Fund means an investment vehicle that pools the money of a large group of investors and invests in a variety of securities to achieve a specific investment objective. In other words Mutual Fund means a diversified portfolio of securities invested on behalf of a group of investors and professionally managed. Individual investors own a part of the fund represented by the number of units they purchased and thus share in any gains or losses of the fund. Life Insurance Products: Here bank earned revenue through the selling of life insurance policies on behalf of insurance company. The contract of insurance is between the insurer and the insured and not between the bank and the insured. Bank just earns commission by selling the insurance policies. Non-Life Insurance Products: Non-life insurance means general insurance. Which includes automobile and homeowners’ policies, fire insurance, medical insurance etc. General insurance typically comprises any insurance that is not life insurance; it may safeguard any property from any casualty. The contract of insurance is between the insurer and the insured and not between the bank and the insured. Advantages of Selling Third Party Products by the Banks: Bank profitability is increased by diversification of source of income by selling third party products. Fee Based products are less risky, hence do not require additional capital E. Disadvantages of Selling Third Party Products by the Banks:  Banks offering wealth management services are exposed to reputational risks on account of miss-selling of products & conflict of interest.  Lack of knowledge and clarity on products  Frauds  Front line staff at banks may be more interested in pushing insurance and para-banking products instead of promoting core banking products.  Staffs may be untrained to the job and do not take responsibility of the outcome in any manner. Bank Income in selling Mutual Funds: Banks earns in the following way:  Upfront commission: is the commission paid by AMC (Mutual Funds Company) to agent in the first year which varies from scheme to scheme (0.40 % to 1.00%)  Trail commission: is the commission paid to agents by AMC in subsequent years which is percentage of total AUM (aspects under management) which varies from 0.05% to 0.40% G. Bank Income for selling insurance products: As per Insurance Act, 1938, the life insurance companies are allowed to pay: 36 Banking Products & Operations - I  A maximum commission of 40 per cent of the first year’s premium  7.5 per cent of the second year’s premium and  5 per cent thereafter.  The commission paid is limited to 2 per cent in case of single premium policies.  Pension plans: Commission is limited to 7.5 per cent of the first year’s premium and 2 per cent thereafter. 1.6 Credit Cards & Debit Cards A card issued by a finance company giving the holder an option to purchase goods and services, usually at point of sale. Banks charge interest on the amount whom by the card holder Thus chards are primarily used for short-term financing. Interest usually begins one month after a purchase is made and borrowing limits are pre-set according to the individual’s credit rating. Credit cards have higher interest rates (around 34-36 % per year) than most consumer loans or lines of credit. Almost every store accepts payment for goods and services through credit cards. Because of their wide spread acceptance, credit cards are one of the most popular forms of payment for consumer goods and services. A credit card is a payment card issued to users as a system of payment. It allows the cardholder to pay for goods and services based on the holder’s promise to pay for them. The issuer of the card creates a revolving account and grants a line of credit to the consumer (or the user) from which the user can borrow money for payment to a merchant or as a cash advance to the user. A. Credit card a. Credit card numbering: The numbers found on credit cards have a certain amount of internal structure, and share a common numbering scheme. The card number’s prefix, called the Bank Identification Number, is the sequence of digits at the beginning of the number that determine the bank to which a credit card number belongs. Ancillary Services of Banks 37  First six digits for MasterCard and Visa cards  Next nine digits are the individual account number, and  Final digit is a validity check code. In addition to the main credit card number, credit cards also carry issue and expiration dates (given to the nearest month), as well as extra codes such as issue numbers and security codes. Not all credit cards have the same sets of extra codes nor do they use the same number of digits. b. Parties to Credit card:  Cardholder: The holder of the card used to make a purchase; the consumer.  Card-issuing bank: The financial institution or other organization that issued the credit card to the cardholder. This bank bills the consumer for payment and bears the risk that the card is used fraudulently. American Express and Discover were previously the only card-issuing banks for their respective brands, but as of 2007, this is no longer the case. Cards issued by banks to cardholders in a different country are known as offshore credit cards.  Merchant: The individual or business accepting credit card payments for products or services sold to the cardholder.  Acquiring bank: The financial institution accepting payment for the products or services on behalf of the merchant.  Independent sales organization: Resellers (to merchants) of the services of the acquiring bank.  Merchant account: This could refer to the acquiring bank or the independent sales organization, but in general is the organization that the merchant deals with.  Credit Card association: An association of card-issuing banks such as Discover, Visa, MasterCard, American express, etc. that set transaction terms for merchants, card-issuing banks, and acquiring banks.  Transaction network: The system that implements the mechanics of the electronic transactions. May be operated by an independent company, and one company may operate multiple networks.  Insurance providers: Insurers underwriting various insurance protections offered as credit card perks, for example, Car Rental Insurance, Purchase Security, Hotel Burglary Insurance, Travel Medical Protection etc. The flow of information and money between these parties — always through the card associations — is known as the interchange, and it consists of a few steps. c. Credit card Operations: 38 Banking Products & Operations - I  The Cardholder makes a purchase using a credit card. The merchant must obtain authorization for the purchase from the bank who issued the card  The merchant swipes the credit card through a POS unit  The POS machine sends authorization request along with card data to Acquiring Processor, e.g. First Data  The Acquiring Processor, First Data, routes the authorization request to Visa  Visa then forwards the authorization request to the Issuing Bank  The Issuing Bank verifies the authorization information then checks the account for available funds or credit and sends an approval or decline to Visa.  Visa routes the approval / decline to the Acquiring Processor (F.D.).  The Acquiring Processor (F.D.) sends the approval or decline to the merchant’s terminal.  The merchant completes the sale with the customer.  If approved, the customer is billed for the transaction on his next monthly statement. Batching: Authorized transactions are stored in “batches”, which are sent to the acquirer. Batches are typically submitted once per day at the end of the business day. If a transaction is not submitted in the batch, the authorization will stay valid for a period determined by the issuer, after which the held amount will be returned to the cardholder’s available credit (see authorization hold). Some transactions may be submitted in the batch without prior authorizations; these are either transactions falling under the merchant’s floor limit or ones where the authorization was unsuccessful but the merchant still attempts to force the transaction through. (Such may be the case when the cardholder is not present but owes the merchant additional money, such as extending a hotel stay or car rental.) Clearing and Settlement:  First Data submits request to Visa.  Visa in turn submits request to Issuing Bank. Ancillary Services of Banks 39  Issuing Bank funds Visa.  Visa in turn funds First Data.  First Data settles funds with Merchant. The acquirer sends the batch transactions through the credit card association, which debits the issuers for payment and credits the acquirer. Essentially, the issuer pays the acquirer for the transaction. Funding: Once the acquirer has been paid, the acquirer pays the merchant. The merchant receives the amount totalling the funds in the batch minus the “discount rate”, “mid-qualified rate”, or “non- qualified rate” which are tiers of fees the merchant pays the acquirer for processing the transactions. Chargeback’s: A chargeback is an event in which money in a merchant account is held due to a dispute relating to the transaction. Charge backs are typically initiated by the cardholder. In the event of a chargeback, the issuer returns the transaction to the acquirer for resolution. The acquirer then forwards the chargeback to the merchant, who must either accept the chargeback or contest it. d. How is the Interest charges calculated by the credit card companies? Credit card issuers usually waive interest charges if the balance is paid in full each month, but will charge full interest on the entire outstanding balance from the date of each purchase if the total balance is not paid. For example, if a user had Rs 1,000 transaction and paid it in full within the grace period, there would be no interest charge. If, however, even Rs1.00 of the total amount remained unpaid, interest would be charged on the Rs 1,000 from the date of purchase until the payment is received. The precise manner in which interest is charged is usually detailed in a cardholder agreement which may be summarized on the back of the monthly statement. The general calculation formula which most financial institutions use to determine the amount of interest to be charged is Interest: APR/100 x ADB/365 x number of days revolved. Take the annual percentage rate (APR) and divide by 100 then multiply by the amount of the average daily balance (ADB) divided by 365 and then take this total and multiply by the total number of days the amount revolved before payment was made on the account. Financial institutions refer to interest charged back to the original time of the transaction and up to the time a payment was made, if not in full, as residual retail finance charge (RRFC). Thus after an amount has revolved and a payment has been made, the user of the card will still receive interest charges on their statement after paying the next statement in full (in fact the statement may only have a charge for interest that collected up until the date the full balance was paid, i.e. when the balance stopped revolving). e. Benefits to the credit card holders: The main benefit of credit card to the card holder is convenience. Compared to debit cards and cheques, a credit card allows small short-term loans to be quickly made to a customer who need not calculate the balance which remains before every transaction, provided the total amounts does do not exceed the maximum credit line for the card. 40 Banking Products & Operations - I Many credit cards offer rewards and benefits packages, such as enhanced product warranties at no cost, free loss/damage coverage on new purchases, various insurance protections, for example, rental car insurance, common carrier accident protection, and travel medical insurance. Credit cards can also offer reward points which may be redeemed for cash, products, or airline tickets. f. Benefits to Merchants for accepting credit cards: For merchants, a credit card transaction is often more secure than other forms of payment, such as cheques, because the issuing bank commits to pay the merchant the moment the transaction is authorized, regardless of whether the consumer defaults on the credit card payment (except for legitimate disputes). In most cases, cards are even more secure than cash, because they discourage theft by the merchant’s employees and reduce the amount of cash on the premises. Finally, credit cards reduce the back office expense of processing checks/cash and transporting them to the bank. For each purchase, the bank charges the merchant a commission (discount fee) for this service and there may be a certain delay before the agreed payment is received by the merchant. The commission is often a percentage of the transaction amount, plus a fixed fee (interchange rate). g. Costs to the merchants for accepting credit cards: Merchants are charged several fees for accepting credit cards. The merchant is usually charged a commission of around 1 to 4 percent of the value of each transaction paid by credit card holder. The merchant may also pay a variable charge, called an interchange rate, for each transaction. Merchants are also required to lease processing terminals, for some terminals, merchants may also need to subscribe to a separate telephone line. Merchants must also satisfy data security compliance standards which are highly technical and complicated. In many cases, there is a delay of several days before funds are deposited into a merchant’s bank account. Because credit card fee structures are very complicated, smaller merchants are at a disadvantage to analyze and predict fees. Finally, merchants assume the risk of chargeback’s by consumers. B. Debit Cards: A debit card (also known as a bank card) is a plastic payment card that provides the cardholder electronic access to his or her bank account(s) at a financial institution. Some cards have a stored value with which a payment is made, while most relay a message to the cardholder’s bank to withdraw funds from a payer’s designated bank account. The card, where accepted, can be used instead of cash when making purchases. Unlike credit cards, payments by using a debit card are immediately made from the cardholder’s designated bank account. Debit cards usually also allow for instant withdrawal of cash, acting as the ATM card for withdrawing cash. Merchants may also offer cash back facilities to customers, where a customer can withdraw cash along with their purchase. Ancillary Services of Banks 41 Details on the front of a typical debit card are:  Issuing bank logo  EMV chip  Hologram 42 Banking Products & Operations - I  Card number  Card brand logo  Expiration date  Cardholder’s name Details on the reverse side of a typical debit card:  Magnetic stripe  Signature strip  Card Security Code a. Debit Card system works: Online debit cards require electronic authorization of every transaction and the debits are reflected in the user’s account immediately. The transaction may be additionally secured with the personal identification number (PIN) authentication system; some online cards require such authentication for every transaction, essentially becoming enhanced automatic teller machine (ATM) cards. Ancillary Services of Banks 43 One difficulty with using online debit cards is the necessity of an electronic authorization device at the point of sale (POS) and sometimes also a separate PIN pad to enter the PIN, although this is becoming commonplace for all card transactions in many countries. Overall, the online debit card is generally viewed as superior to the offline debit card because of its more secure authentication system and live status, which alleviates problems with processing lag on transactions that may only issue online debit cards. Some on-line debit systems are using the normal authentication processes of Internet banking to provide real-time on-line debit transactions. b. Advantages of a Debit Card  Easy to obtain: Once you open an account most institutions will issue you a debit card upon request.  Convenience: Purchases can be made by swiping the card rather than paying in cash.  Safety: You don’t have to carry cash or a cheque book.  Readily accepted: When out of town, debit cards are usually widely accepted c. Disadvantages of a Debit Card  No grace period: Unlike a credit card, a debit card debits funds directly from your bank account. A credit card allows you credit, thus leaving disposable cash in your account.  Check book balancing: Balancing your account may be difficult unless you record every debit card transaction. d. Difference between Credit and Debit Card:  Credit Card  Borrowing money from a bank or financial institution. (Spending “other’s” money)  Need not be connected to any bank account  Pay additional interest drawn on the amount borrowed  Limit: Credit line  Debit Card  Funds taken from the money that you have in your Bank account. (Spending your “own” money)  Needs Checking Account / Savings Account  No interest to be paid  Limit: Equals your account balance / limit 44 Banking Products & Operations - I 1.7 Brokerage & Demat Services: A. Brokerage Services: Investment Bank Dealers know their customers’ needs and can help meet the two customers. Bank Dealers buy / sell financial products on behalf of their customers. This service of buying / selling financial products is known as Brokerage services. Bank Dealers provide brokerage services in case of:  Equity shares  Debt Instruments  Currencies  Derivatives instruments Bank earns brokerage income and profit from buying / selling of securities. Dealers do underwriting of shares and they have an inventory of shares with them. Dealers are market makers for securities. Security Dealers: They maintain an inventory and buy and sell from that inventory. A dealer offers to buy at the bid price and offers to sell at the asked price. The size of the bid-asked spread depends upon two major factors.  Volume of trading.  Inherent price risk. Security Brokers: Brokers are agents who carry out transactions for buyers or sellers. Brokers charge commissions for their services. Different types of brokerage services available in the market: There are different types of brokers.  Full-service brokers provided execution and advice and charge the highest fees.  Discount brokers provided execution only.  Securities Brokerage Full Service Brokers: offer clients research and investment advice, but usually charge a higher commission on trades. Discount Broker: provides facilities to buy/sell securities but offers no advice. Many on-line discount brokerage firms do have significant research available Types of orders for buying / selling:  Securities Orders: when you call a brokerage house to buy or sell a security, you essentially have three options: Ancillary Services of Banks 45  Market Order: buy or sell security at current price  Limit Order: you specify the most you are willing to pay (buy) or the least you are willing to accept (sell) for a security  Short Sales: sell a security you don’t own with the intent of buying it back at a later date (hopefully at a lower price) B. Demat Services: An effective and fully developed depository system is essential for maintaining and enhancing the efficiency of a mature capital market Depository: Depository is an organization where the securities are held in electronic form and which carries out the securities transaction by book entries. A depository is an organization, which assists in the allotment and transfer of securities and securities lending. The shares here are held in the form of electronic accounts i.e. dematerialized form and the depository system revolves around the concept of paper-less or scrip-less trading. It holds the securities of the investors in the form of electronic book entries avoiding risks associated with paper securities. It is not mandatory and is left to the investor to decide. Depositories carry out its operations through various functionaries called Depository Participants. Need of Depository: Before the introduction of Depository system, the problems faced by investors and corporate in handling large volume of securini were as follows:  Bad deliveries  Fake certificates  Loss of certificates in transit  Mutilation of certificates  Delays in transfers  Long settlement cycles 46 Banking Products & Operations - I  Mismatch of signatures  Delay in refund and remission of dividends etc Depository mitigates the above risks by removing the paper certificates in the market Depository System: In India, the depository system was introduced in 1996 with the enactment of Depositories Act 1996. Their operations are carried out in accordance with rules, bye-laws of Depositories Act and SEBI (Depositories and Participants) Regulations Act 1996. Presently there are two Depositories working in India: i. National Securities Depository Limited (NSDL): It was registered by the SEBI on June 7 1996 as India’s first Depository to facilitate trading and settlement of securities in the Demat form. It was promoted by IDBI, UTI, and NSE ii. Central Depository Services (India) Limited (CDSL): It commenced its operations during Feb 1999 and was promoted by Bombay Stock Exchange in association with Bank of Baroda, Bank of India, SBI and HDFC Bank. Constituents of a Depository System:  Depository  Depository Participants (DP)  Securities Issuers and Registrars and Share Transfer Agents  Stock Exchanges and Stock Brokers  Clearing Corporations, Clearing House and Clearing Members  Banking system  Investors i. Depository Participants (DP): A DP is an agent of the depository and functions as the interacting medium between the depository and the investor. He is registered with the SEBI. DP must possess requisite qualifications prescribed by the concerned depository of which he is the participant. He is responsible for maintaining the investors’ securities accounts with the depository and handles them as per the investors written instructions. He is linked to a broker who trades on behalf of investors. To avail their services an account similar to a bank account has to be opened by investors with the DP. As per SEBI Regulati

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