MBFI Lecture Note # 02

ServiceProductsofBanks

Banksarethebackboneofanyfinancialsystem.Theyoffertokeeptheir
customersmoneyandallowthemnotonlytowithdrawmoneyfortheirown
use,butalsoallowtheircustomerstodrawChequesontheseaccounts.
Chequesareorderstothebanktomakepaymenttothepersonspecifiedin
thechequeorhisorder.And,theyareNegotiableInstruments.Thusbanks
formthebasicstructureofthepaymentssystemintheeconomy.Apartform
this,banksenjoyacertainreputationinthefinancialsystem;peoplehave
faithinthem.Theyarewillingtotrustestablishedbanksmorethanthey
wouldtheirbusinesspartnersandothers.Bankhaveevolvedoveraperiodof
timemeetingtheneedsoftheircustomersandnowprovideavarietyofnon
fundservices,ofcourseforafee,butvitaltothefunctioningofbusinessand
economy.

Mostofthenonfundproductscanbeclassifiedasunder:
Remittancerelatedinstrumentsandproducts
CollectionofChequesandBills
LettersofCredit
Guarantees
SafeCustody&Lockerfacilities
EscrowAccounts

Remittancerelatedinstrumentsandproducts
BankDraftorDemandDraft

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 MBFI Lecture Note # 02

Abankdraftisanorderbyabranchofabanktoanotherbranchofthe
samebank,instructingittopaythesumspecifiedinthedrafttothe

personnameditortotheorderofthatperson

Bankschargeacommissionforissueofdrafts

Draftscannotbedrawnpayabletobearer

Thepurchaserofadraftcanhaveitcancelledbyreturningittothebank;
beforedeliveringittothepayee.
Thepurchasercannotaskforthedrafttobecancelledafterithasbeen
deliveredtothepayee.
Duplicatedraftscanbeissuedifthebankissatisfiedthattheoriginalahs
beenmutilatedorlost.
Draftsareusefulmeansofremittancesasthereceiverwouldconsiderit
asgoodasmoney.

DraftcanbeseenasaPromissoryNote

PayOrder

ApayOrderislikeadraft,butitisissuedbythebranchonitself.
Payordersaregenerallyusedbybankswhentheyhavetomake
payments.
Thesearealsoissuedwhenacustomerrequestforone.Oftenchequesare
notacceptablebut,sincepeoplehavefaithinbanks,theircommitmentis
acceptable.
PayOrdersarenotNegotiableInstruments.

MailTransfersandTelegraphicTransfers

Remittancefromonebranchofabanktoanotherofthesamebank.

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 MBFI Lecture Note # 02

Generallyfromoneaccountofabanktoanotherinthesamebankbut
anotherbranch.
MailTransfer:thecommunicationadviseissentbymailsoslow
TelegraphicTransfer(TT):advisesentbytelegraph/telex/fax.The
chargesarehigher.
Thebeneficiaryneednotbeacustomerofthebank;butgenerallyis.

ElectronicFundsTransfer(EFT)

TransferoffundsthroughtheInfinet

Quitehighcharges,butusefultobusinesses

RTGS

RealTimeGrossSettlement

SystemofInterBankcomputerizedpaymentandsettlementsystem
Usedforallinterbankpaymentsandsettlements:Moneymarket,
GovernmentBondsMarket
Alsousedfortransferoffundsforcustomers
Quitehighcharges,butusefultobusinesses
Marketfortheseservicesisevolving

CollectionofCheques&Bills
Bankdoesnotchargeforcollectionoflocalcheques
Banksnormallychargeforcollectionofchequesdrawnonothercenters

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 MBFI Lecture Note # 02

InIndia,theNationClearingCell(NCC)clearsthechequesdrawnon
otherMetropolitancenters.
BankschargeforhandlingBillsoncollectionbasis.
Thisisalabourintensivebusinessasdocumentshavetobehandledwith
careandalotofcorrespondenceisassociatedwiththis.However,sinceno

fundsareoutlaid,itissometimescalledcleanbusiness;thereisnocredit
risk.

BillsbeingNegotiableInstrumentsarecommerciallyvaluable
documents.Lossofsuchdocumentsmayresultinalosstobanks.

LettersofCredit
AlsoknownasDocumentaryCreditsandStandbyLetter(s)ofCredit
Anyarrangementwherebyabank(theIssuingBank)actingatthe
requestandonthe
instructionsofacustomer(theApplicant)
istomakeapaymenttoortotheorderofathirdparty(the
Beneficiary),oristoacceptandpaybillsofexchange(Draft(s))
drawnbytheBeneficiary,or
authorisesanotherbanktoeffectsuchpayment,ortoaccept
andpaysuchbillsofexchange(Draft(s)),or
authorisesanotherbanktonegotiate,
againststipulateddocument(s),
providedthatthetermsandconditionsoftheCreditare
compliedwith.

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GenerallyusedinCrossBordertradeasthebuyerandsellersdonot
knoweachotherless.LCsareusedinsteadofadvanceremittanceorBill
ofExchange.
LCsgenerallyhaveaninbuiltfinancingorbillsnegotiation/discounting

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FlowChart:

o Buyer(Applicant)appliestohisbankforaletterofcreditinfavorof
theseller(Beneficiary).
o Buyer'sbank(IssuingBank)issuesandforwardsthecredittoits
correspondentbanktoadvisethebeneficiary(AdvisingBank).

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 MBFI Lecture Note # 02

o Advisingbankwillchecktheauthenticityofthecreditandadvise
thebeneficiary.Thisbankhasnofurtherresponsibility.
o Ifissuingbanksodesires,thecorrespondentconfirmsthecredit.
Theconfirmingbankobligatesitselftoinsurepayment.
o Beneficiarysubmitsthedocumentstohisbankfornegotiation.
o Hisbankersendsthedocumentstotheopeningbankforpayment.
o Generallytheopeningbankauthorisestheadvisingbanktoeither
negotiateortopayunderthecreditifthedocumentsarefoundto
beaswritteninthecredit.
o Issuingbankhastoexaminethedocumentsforcompliance.This
hastobedonewithoutreferencetotheapplicant(Seller).
o Iftheyareinorder,ieallthedocumentslistedinthecreditare
receivedandtheyintheformatthathadbeenspecified,theissuing
bankacceptsthedocumentsandmakespayment.
o Issuingbankthenforwardsthedocumentstothebuyer.
TherulesgoverninguseofLCsis:
UniformCustomsandPracticeforDocumentaryCredits
(UCPDC500)oftheInternationalChamberof
Commerce(ICC)
AkeyprincipleunderlyingLettersofCreditisthatbanksdealonlyin
documentsandnotingoods.ThedecisiontopayunderaLetterof
Creditwillbebasedentirelyonwhetherthedocumentspresentedto
thebankappearontheirfacetobeinaccordancewiththetermsand
conditionsoftheLetterofCredit.
Types:
o Revocable&IrrevocableLetterofCredit
o Sight&TermLetterofCredit
o ConfirmedLetterofCredit

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 MBFI Lecture Note # 02

Guarantees
Aguaranteeisapromisetoanswer'forthedebt,defaultormiscarriageof
another',ifthatpersonfailstomeettheobligation.
Primaryliabilityforthedebtisincurredbytheprincipaldebtor.
Theguarantorincurssecondaryliability,thatis,theguarantorbecomes
liableonlyiftheprincipaldebtorfailstopay.
Types

o FinancialGuarantees
o DeferredPaymentGuarantees
o BidBonds
o PerformanceGuarantees
Secured&UnsecuredGuarantees
NonFundBusiness,butcontingentLiabilityandthereforebank
managementsneedtokeepakeenwatchonthetotalamountsforwhich
guaranteeshavebeenissuedtoeachcustomer.Ie,guaranteesshouldbe
seenaspartofthetotalexposuretoacustomer.

SafeCustody&Lockers
Bankshavesecurevaultsforsafekeeping.Theyusethesevaultsfor
providingservicesoflockersandinsomecasessafekeepingofarticlesof
customers.Thiscouldbeagoodfeeearningserviceproduct.Alsomanybanks
utilizethelockerfacilitytoattractgoodcustomers.

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 MBFI Lecture Note # 02

EscrowAccount
Escrowisalegalarrangementinwhichanassetisdeliveredtoathird
partycalledanescrowagenttobeheldintrustpendingacontingency
orthefulfillmentofaconditionorconditionsinacontractsuchas
paymentofapurchaseprice.Uponthateventoccurring,theescrow
agentwilldelivertheassettotheproperrecipient.
Banksleverageonthefaiththatbusinesshaveinthem.
Largelyusedinsalepurchaseofshipsandairplanes.
ThesedaysbanksprovidesuchservicestocompaniesissuingIPOs.
AnotherpopularusageisinthePowerIndustry.Increasingly,power
plantsarebeingputupthroughthePPProute.Inthisthedebt
providersderivecomfortfromtheirfirstchargeonthecashflowsofthe
project.Toensuretheirfirstrighttocashflows,anescrowaccountis
openedwithabanker,whopromisesnottoreleasetheamounttilldebt
servicingisdone.