Chapter 5 – Management of Banking and Financial Services, 2nd Edition

Chapter Five


1. Some authors call investment in financial markets ‘direct lending’ by investors, and deposits with banks as ‘indirect lending’.

2. Kohn, Meir (1999). Financial Institutions and Markets, Chapter 2, pp. 27–47. Tata McGraw-Hill: New Delhi.

3. A more detailed discussion on these risks is found in the chapter on ‘Risk Management’.

4. Discussed in detail in the chapter ‘Managing Credit Risk–An Overview’.

5. Discussed in detail in the chapter on ‘Risk Management’.

6. Discussed in detail in the chapter on ‘Capital—Risk, Regulation and Adequacy’.

7. Discussed in detail in the chapter on ‘Managing Credit Risk—An Overview’.

8. Discussed in Section IV of this chapter.

9. Also see chapter on ‘Banks Financial Statements’.

10. Discussed in detail in the chapters on ‘Credit’.

11. Though it is a practice to use the two terms ‘loans’ and ‘advances’ interchangeably, the difference in meanings is brought out by the following definitions: A ‘loan’ or ‘loan commitment’ is a formal agreement between a bank and its borrower, whereby the bank agrees to provide a fixed amount of credit for a specified period, subject to certain terms and conditions, with or without securities. An ‘advance’ is a payment made to a borrower under a loan agreement.

12. Banks do not lend for very long terms since the sources of their funds are essentially short term in nature. Borrowing short and lending long would lead to an asset-liability mismatch. More on this in the chapter on ‘Risk Management’.

13. Based on the approach followed by Timothy W. Koch and S. Scott MacDonald in Bank Management, Chapter 15, pp. 617-623, 4th ed. The Dryden Press, USA.

14. Deposits that need to be maintained by the borrower as a condition for getting the bank loan.

15. First used by Lloyds Bank

16. First used by TSB Bank

17. First used by Barclays Bank and Natwest Bank

18. A ‘negative lien’ prohibits the customer from disposing of or dealing with a property or asset for which full payment has not been made.

19. This is called the ‘right of set off’ and is discussed in the chapter on ‘Banks in India—Credit Delivery and Legal Aspects of Lending’.

20. A portion of the amount required will have to be brought in by the borrower as ‘margin’. Generally, such margins are maintained as ‘cash margins’ or as investments in risk free, near cash securities. In case of liquidation or non payment, the cash margins are set off against the outstanding advance amount, to reduce the bank's exposure.

21. For a detailed discussion on ‘incipient sickness,’ refer to chapter on ‘Credit Monitoring, Sickness and Rehabilitation’.

22. For a regulatory definition of ‘non-performing’ loans, see chapter ‘Managing Credit Risk—An Overview’.

23. Trade credit is not entirely without cost. For example, a firm may have negotiated the following terms with its supplier: a 2 per cent discount if the purchase is paid for within 10 days, the total credit period not to exceed 30 days. The firm will have to calculate the implied cost of this arrangement and compare it with cost of bank or other funding sources, to arrive at a cost-effective working capital financing program.

24. Refer to Section V on ‘Loan Pricing’ for more on credit scoring of borrowers.

25. For a description of ‘banker's lien’ please refer the next chapter on ‘Banks in India—Credit Delivery and Legal Aspects of Lending’.

26. For more discussion on ‘asset-liability mismatch’, please see the chapter on ‘Risk Management in Banks’. 27. See Annexure II of this chapter for a definition of the DSCR.

27. Gadanecz, Blaise (2004). ‘The Syndicated Loan Market: Structure, Development and Implications,’ BIS Quarterly Review, December, pp. 75-89.

28. Ibid., p. 80

29. Esty, Benjamin C (2004). ‘Why Study Large Projects? An

30. Introduction to Research on Project Finance’, European Financial Management, vol. 10, no. 2, pp. 213–224.

31. In this context, the word ‘profit margin’ implies the target net profit margin that the bank wants after meeting all operating and fixed costs.

32. ‘Asset management’ and ‘liability management’ concepts are explained in detail in the chapter on in the context of liquidity risk management.

33. London Inter Bank Offered Rate (LIBOR) represents the rate of interest at which banks could borrow funds from other banks, in marketable sizes, in the London inter-bank market. It is fixed daily by the British Bankers’ Association.

34. Use of the term ‘prime rate’ here is not to be confused with the ‘Prime rate’ of the US markets. In this context, prime rate is the lowest rate the bank charges its first class borrowers, and can be taken as the benchmark rate where one does not exist. Such a prime rate can vary from bank to bank, while the prime of the US is market determined similar to LIBOR.

35. Uncollected or pipeline funds appearing as part of customer's deposit balances with the bank.

36. There is some debate over what this rate should be based on. According to one view, this rate should reflect the customer's opportunity cost of funds; according to another, the rate should be the average interest yield on earning assets.

37. Credit risk is the probability that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms, and is discussed in detail in the chapters on ‘Credit Risk’.

38. Basel 2 regulations and their impact on the need for credit ratings are discussed in detail in chapters on ‘Credit risk’ and ‘Capital—Risk, Regulation and Adequacy’.

39. Source:, accessed on 16 November 2008.

40. Source:, accessed on 16 November 2008.

41. Source:, accessed on 16 November 2008

42. Source:, ‘Mapping of ICRA's long-term and short-term ratings’, ICRA rating feature, accessed at the url, on 16 November 2008.

43. See chapter on ‘Banks’ Financial Statements ‘.

44. Ibid.