BANK

What is a Bank and what is its role?

A bank is a financial institution that accepts deposits from the
public and creates credit.
The basic function of a bank is to borrow and lend money and
make income through arbitrage. A bank can generate revenue in a
variety of different ways including interest, transaction fees and
financial advice.
Banks are mainly classified into Retail and Corporate banking.
However, there are various other units such as Operation, Risk,
Treasury which aids and assists these two functional units to
achieve the objective of earning profit.
Retail banking caters to the need of individuals while Corporate
banking deals with companies.

Retail and Corporate banking have also classified their work based on
assets and liabilities.

Lets first understand what Assets and Liabilities mean?

Assets are resources on which Banks earn income while liabilities are
obligations which has a cost.

Can anyone explain it to me what are deposits. Is deposit asset or a

liability?

We shall apply our definition of assets and liabilities discussed earlier

and analyze if deposits are assets or liabilities.
Deposits are held with bank either by individuals or Corporate entities.
I am sure many of you have an account with a bank either a savings or
a current. Bank gives interest on deposit made by you in your savings
account, so it has a cost for the banks and as we discussed before
anything which has cost is classified as liabilities.
Thus, Deposits are liability for the Banks. Can you guys tell me how
deposit are classified by individuals and corporates in their account
books?
This is where a Corporate Investment Banker chips in. Now it will be
easier for you guys to understand what Assets’ Corporate Banking
Relationship Manager is required to do.
The basic job function of an Asset Relationship Manager is to solicit
new corporate relationship
Relationship Manager aids and assist Corporates/Companies in terms
of meeting their short term and long term financial needs.
The core job responsibility is to find out the strengths, weakness,
threats and opportunities to ensure earning avenues/fortuities
The Lending Decision Process:
• Five basic Assessments are required for any loan proposal from
inception to its disbursement:
 Credit Policy Compliance Assessment
 Financial Risk assessment
  Management Risk Assessment

 Market Risk Assessment

 Facility Risk Assessment

The reason for assessing Credit Risk is to determine if a borrower is

likely to pay loan interest and principal as scheduled with a sufficiently
high degree of probability to remain within the risk appetite of the
lender. That appetite may vary considerably from lender to lender, but
whatever its level, the credit risk assessment process must determine
whether a borrower fits within the acceptable limits.
Credit Policy Compliance Assessment:
 Every institution that extends credit has a set of loan or credit
policies that are most likely formal and thoroughly
documented. These policies generally determine the types of
credit transactions that are acceptable to the institution. The term
"acceptable" applies in broad terms to the purpose of a loan, to the
borrower defined by industry or geography, to loan portfolio
guidelines (e.g. maximum exposure to a certain borrower or sector
of an industry) and to the terms and conditions under which
money would be disbursed. Legislation may further influence
elements of an institution's general credit policies such as lending
to related entities, for example.
 For instance, a lender may specify in its set of credit policies that
loans to illegal professions or for speculative purposes are strictly
prohibited, while commercial transactions are acceptable (if they
pass all the subsequent assessments).

 Within the commercial loan category, however, a lender may

specify that loans to certain types of businesses, such as pet farms
and political campaign committees, are prohibited presumably
because of prior experiences with such operations.

 Within the commercial loan category, however, a lender may

specify that loans to certain types of businesses, such as pet
farms and political campaign committees, are prohibited
 presumably because of prior experiences with such operations.
 Credit policies may also state that every loan extended to
acceptable borrowers in acceptable business enterprises must be
fully collateralized by the assets of the borrower. In addition, credit
policies may specify that no loan can be extended for any purpose
beyond a set number of years. Some organizations also have strict
lending rules based on environmental compliance by the borrower
and may even take into account ethical considerations.

 Credit policy tends to be general in nature. However, any loan

proposal being reviewed must meet credit policy standards if it is
to move along the loan decision road to the second assessment.
Finally, keep in mind that credit policies change continuously in
response to market conditions, changes in the legal and regulatory
landscape and evolving lender priorities and emphases. A loan
proposal that meets credit policy requirements today might not meet
them tomorrow.
Financial Risk Assessment:
 This area of assessment focuses on the financial risk of the
proposed transaction and the degree of probability that the lender
will receive the expected cash interest on money disbursed along
with full cash repayment of the principal.
 Financial risk assessment is ultimately a test of the borrower's
management skills and abilities demonstrated within the
competitive market environment in which the borrower
operates. It is a company's management policies, decisions and
actions that primarily determine if a lender gets repaid in cash.

 Financial risk assessment has two parts. There is an historical

analysis and an analysis of projected future results. The historical
portion focuses on past financial performance and a borrower's
track record in paying interest and amortizing debt as scheduled.
The projected portion focuses on a borrower's prospects for
generating sufficient cash in future operating periods to pay the
interest on a loan under consideration today, as well as pay back that
loan according to a mutually agreed repayment schedule.

There are five possible sources of cash to pay interest and amortize
debt:

 cash from the operations of the business

 cash from additional equity contributed to the business

 cash from the sale of non-operating assets

 cash from additional borrowing

 cash from the liquidation of the business itself.

In assessing financial risk, a conclusion must be reached concerning
the probability of obtaining cash from potentially all these
sources. However, the primary emphasis is on the first source – cash
from the operations of the business. The higher the level and the
greater the predictability and stability of cash flow, the less risky the
loan.
Management Risk Assessment:
Throughout any discussion of financial risk assessment, it is crucial to
refer to management's role in driving a company's liquidity and
solvency. Therefore, a thorough assessment of management and its
abilities is required in the lending decision process.
Four basic factors must be considered in assessing management
risk. They are:
 Integrity
 Management skills
 Management depth and succession
 Corporate governance.
Integrity, of course, is the most critical factor. In fact, some may argue
that integrity is the principal factor in the entire lending decision
process. A lender must be confident that the financial statements and
other information provided by management are trustworthy and
reliable. The lender must also believe in the intent of management to
repay the debt.
There is little point in assessing financial risk if the financial statements
cannot be trusted. In addition, there is little point in properly
structuring and documenting a loan if management's repayment
intentions are questionable.

Management's skills in developing and executing the company's

strategy, producing and selling its products or services, collecting its
receivables, managing its assets and staff, and planning for the future
are as essential to a successful lending relationship as they are to a
successful business. These skills are assessed through the information
provided by the financial statements, interviews with management,
comparing management's record of performance against plans, and
benchmarking management's actions and performance against those
of its peers.

Management depth is critical to the continuing success of any

business. A plan for management succession must be in place and
there should be provision to lessen the impact of any unexpected loss
of critical personnel.

Finally, the way in which a business is governed from the very highest
executive, advisory, and, if applicable, directorial levels, has become an
increasingly important credit risk consideration. Advisory boards and
boards of directors must take their roles and duties seriously, and
perform them with skill and integrity, if aggressive management teams
are to be kept on course, owners' investments protected, and
company activities held beyond repute.

Market Risk Assessment:

 A business, after all is said and done, does not operate in a

vacuum. In the broadest sense, the marketplace impacts a
company's sales, expenses, asset values and access to debt and
equity funding sources. Therefore an assessment must be made
concerning market risks, how they impact a borrower, and how
management anticipates and reacts to changing market conditions
and risks.
The five basic market risks are:

 Cyclicality and the economic/business environment

 Competition

 Natural Environment

 Government Regulations

 Alternative funding sources.

A business is affected by overall economic conditions as well as its

position in its own life cycle and its industry's’ life cycle. Accordingly,
the condition of the relative economies that impact the business -
global, national and regional - must be evaluated.
A borrower's relationship with the environment also requires
consideration. Factors such as hazardous waste and fixed asset
modifications to meet environmental standards may require
assessment, depending on the nature of the products manufactured or
the services rendered by the borrower.

Facility Risk Assessment:

Assessing facility risk can begin if a borrower meets credit policy
requirements and successfully passes financial, management and
market risk assessments. Facility risk assessment should be undertaken
even if concerns are detected in the other factors that can potentially
be mitigated by the terms of a credit facility.
For example, a perfected security interest in appropriate collateral may
serve to mitigate the solvency issue with a prospective borrower who
is more leveraged than its peers. As such, assessing facility risk is one
of the determinants of loss severity (or loan recovery) for the lender in
the event of borrower default.

Properly structured, documented and priced credit facilities are critical

to a mutually beneficial lending relationship. Therefore, the three
factors considered in assessing facility risk are:
 Loan structure
 Loan documentation
 Loan pricing.
 Assessing loan structure determines whether the repayment terms
and conditions sufficiently match the repayment capabilities of
the borrower. Repayment capabilities may include not only the
cash flow from the business, but also cash available from
guarantees and pledged collateral.
 Even though a loan proposal may successfully pass the previous
assessments, it is still critical to determine whether the repayment
schedule, in terms of amounts and timing, matches the cash
available for repayment If a lender has enough doubts about
the cash available for repayment from normal business
operations within the time frame being considered, a claim on
other cash repayment sources is generally required. This may
include the company’s assets in the form of receivables, inventory
or fixed assets.
 Keep in mind that an institution's credit policies may place limits
on loan structure possibilities. The credit policies themselves
frequently specify maximum repayment periods for various types
of loans, or the types of assets that can be taken as collateral.

 Loan documentation is also very important. A lender may feel

comfortable about a proposed loan in terms of policy, credit risk,
structure and pricing, but all elements of the lending transaction
must still be fully documented to protect the lender’s legal
position in the transaction and assure compliance with the loan’s
terms.
 Assessing loan documentation may or may not be straightforward
depending on an institution’s practices. Some lending
organizations make substantial use of pre-formatted notes and
other forms, while others consult legal counsel for transaction-
specific documents the majority of the time. Regardless of the
process, such documentation properly prepared and executed
encompasses all the agreed terms and conditions of the lending
arrangement, including:

 The amount of the loan

 fees, interest rates and repayment schedules

 the type and form of collateral

  Legal filings where appropriate
 Loan covenants and conditions about the borrower’s
operation and financial status
 Reporting requirements

 Loan documentation may not be a glamorous part of the

lending process, but it is an important part of any credit decision.

 Pricing focuses on the value of the transaction to the lender. A

loan proposal may pass all other areas of assessment only to
fail miserably if insufficient profit is earned on the transaction
itself. Therefore, the degree of risk must be assessed in considering
an appropriate return on funds advanced. The greater the risk, the
greater the reward should be.
 Lenders normally establish minimum acceptable yields on loan
transactions, frequently as part of their credit policies. Yield
requirements should consider the cost of the transaction in terms
of administrative expenses, account management expenses, the
cost of funds advanced and the cost of risk. Revenues earned on
the transaction from interest income, fees and possibly
compensating account balances should offset these costs.

 Pricing is an important factor that is receiving much more attention

as lenders find themselves in a very aggressive and competitive
environment to be sufficiently profitable, every lender must
effectively estimate the cost of risk and, equally important
make the business decision based on fully incorporating that cost into
the transaction structure.
Loan Management:
Frequently, action taken after the loan is committed or disbursed is as
essential to a successful credit extension as the initial assessment and
decision process. Risk mitigation through loan management therefore
focuses on the manner in which a loan is managed. In some respects,
the elements of loan management are contained in the
documentation. That is, the borrower is required:

 to make interest and debt amortization payments on

specified dates

 to submit financial data on further specified dates

  to operate the business within financial constraints and
limitations contained as part of the loan covenants

 to submit to receivables and inventory audits for asset-

based loans

 However, someone needs to monitor and manage all these

elements to see that they actually take place as scheduled.

 Proper loan management requires having a system in place that

allows a lender to monitor all elements of the loan per the letter of
offer and loan covenants. It also requires using that system to
assure that the terms and conditions of the loan are honored
 If the loan is not properly managed, the efforts invested in the
initial decision process may be wasted. Conditions change
continuously. It can never be assumed that the responsibility of a
lender ends with the commitment and disbursement of the loan. In
fact, it could be said that the responsibilities are just beginning,
especially if the lender desires a long-term relationship with the
business borrower.