Bank Fund - Sources and Uses of Funds
Bank Fund - Sources and Uses of Funds
Tuesday, April 28, 2020
INTRODUCTION TO BANK FUNDS: All the money which are in the custody of a bank is called bank fund, Bank funds chiefly consists in public deposited which must be returned to the depositors later. It is shown as a liability in the balance sheet of the bank. The bank is the custodian of the public money and must use it safely and productivity.
PRINCIPLES TO UTILIZE BANK FUND Whenever banks employs or utilizes its funds follow some rules and principles. Experts of banking have given the following rules for utilizing the funds.
1. SECURITY: The basic principle which bank considers before utilizing its funds is security because bank provides loan to its customers out of the deposits of the account holders. Therefore bank first assured that loan is going in the safe hands. The bank, before giving approval of loans must consider following points
• Required loans is in proportion of the borrower`s own capital invested
• The financial position of the borrower is satisfactory.
• Character of the borrower is trustworthy and reliable.
2. LIQUIDITY: The bank does not invest its fund for a longer period otherwise its liquidity will become doubtful. Bank provides short terms loans so that its liquidity position might remain intact all the times.
3. DIVERSIFICATION: The bank does not utilize their funds in single business but employ in different businesses or industries because in case of the failure of the one business. The large amount of the bank fund will not sink.
4. PROFITABILITY: The bank employs its funds in profitable projects so that it can meet not only its operational expenses but also meets its obligation to the deposit holder. Bank employs its fund in financially sound projects and business organization.
5. LEGAL CONSTRAINTS REQUIREMENT: Banks are legally bound to follow rules laid down by the government and the central bank some of the legal requirements are as follows:
• All scheduled banks keep a part of their deposits at the central bank.
• No bank can lend a single party an amount larger than ten percent of its capital.
• No bank can lend to its director an amount above a limit specified by the rules.
• The bank can only invest in recognized portfolios.
6. FINANCIAL LIABILITY STRUCTURE: How the bank employs its funds also depends on its financial structure. One bank may have deposits mostly consisting in time deposit while the other has its most of funds in demand deposits. Both banks will have to follow different investment policies.
USES OF BANK FUNDS (PROFITABLE USES)
PRINCIPLES TO UTILIZE BANK FUND Whenever banks employs or utilizes its funds follow some rules and principles. Experts of banking have given the following rules for utilizing the funds.
1. SECURITY: The basic principle which bank considers before utilizing its funds is security because bank provides loan to its customers out of the deposits of the account holders. Therefore bank first assured that loan is going in the safe hands. The bank, before giving approval of loans must consider following points
• Required loans is in proportion of the borrower`s own capital invested
• The financial position of the borrower is satisfactory.
• Character of the borrower is trustworthy and reliable.
2. LIQUIDITY: The bank does not invest its fund for a longer period otherwise its liquidity will become doubtful. Bank provides short terms loans so that its liquidity position might remain intact all the times.
3. DIVERSIFICATION: The bank does not utilize their funds in single business but employ in different businesses or industries because in case of the failure of the one business. The large amount of the bank fund will not sink.
4. PROFITABILITY: The bank employs its funds in profitable projects so that it can meet not only its operational expenses but also meets its obligation to the deposit holder. Bank employs its fund in financially sound projects and business organization.
5. LEGAL CONSTRAINTS REQUIREMENT: Banks are legally bound to follow rules laid down by the government and the central bank some of the legal requirements are as follows:
• All scheduled banks keep a part of their deposits at the central bank.
• No bank can lend a single party an amount larger than ten percent of its capital.
• No bank can lend to its director an amount above a limit specified by the rules.
• The bank can only invest in recognized portfolios.
6. FINANCIAL LIABILITY STRUCTURE: How the bank employs its funds also depends on its financial structure. One bank may have deposits mostly consisting in time deposit while the other has its most of funds in demand deposits. Both banks will have to follow different investment policies.
USES OF BANK FUNDS (PROFITABLE USES)
A). LENDING: Bank employs their funds in advancing money and in return get interest income, the loans are provided in the following forms:
• LOANS: The payment of the loans is made in lump sum by the bank to the borrower the bank charges interest on the whole amount of the loan no matter borrower uses it or not generally, these loans are provided against the strong securities.
• OVER DRAFT: When the bank allows account holder to withdraw more than the available amount in his current account against the security it is called over draft. Bank charges interest on this amount.
• CASH CREDIT: According to which the bank permits the customer to draw the amount from the bank to the extent of a particular limit against the securities of bonds. In this method borrower does not pay the interest on the total amount of the sanctioned loan but only on the amount, which he factually withdraws.
• CALL LOANS: They are made for a very short period of time, which ranges from a few hours to a few weeks, or they may be called back any time. The rate of interest on them is low.
• DISCOUNTING BILLS: Discounting by the bank refers to purchasing the bill at a discount. Generally, the bill period runs from thirty to ninety days. The interest is charged for the period the bill is cashed or discounted. The discount is the amount deducted by the bank from the bill as an interest for the period for which the bill is still to run.
B). INVESTMENT: Investments refer to buying shares, bonds, debentures, treasury bills in the open market. Banks earns money in the form of dividends, interests and capital gains. Shares and bonds can be bought and sold at the stock exchange. The bank employs its fund in the following types of investments:
• PURCHASE OF STOCK MARKET SECURITIES: The commercial bank also utilizes its available funds for the purchase of corporate shares (market securities). The commercial bank purchase securities include bonds & share issued by the corporations.
• PURCHASE OF GOVERNMENT SECURITIES: The commercial bank also utilizes its available funds for the purchase of government securities. The commercial bank purchase government securities include Federal Government Treasury bills, Federal Government Treasury notes, Federal Government Treasury bonds, Local Government bonds, and foreign Government bonds
USES OF BANK FUNDS (NON PROFITABLE USES)
• LOANS: The payment of the loans is made in lump sum by the bank to the borrower the bank charges interest on the whole amount of the loan no matter borrower uses it or not generally, these loans are provided against the strong securities.
• OVER DRAFT: When the bank allows account holder to withdraw more than the available amount in his current account against the security it is called over draft. Bank charges interest on this amount.
• CASH CREDIT: According to which the bank permits the customer to draw the amount from the bank to the extent of a particular limit against the securities of bonds. In this method borrower does not pay the interest on the total amount of the sanctioned loan but only on the amount, which he factually withdraws.
• CALL LOANS: They are made for a very short period of time, which ranges from a few hours to a few weeks, or they may be called back any time. The rate of interest on them is low.
• DISCOUNTING BILLS: Discounting by the bank refers to purchasing the bill at a discount. Generally, the bill period runs from thirty to ninety days. The interest is charged for the period the bill is cashed or discounted. The discount is the amount deducted by the bank from the bill as an interest for the period for which the bill is still to run.
B). INVESTMENT: Investments refer to buying shares, bonds, debentures, treasury bills in the open market. Banks earns money in the form of dividends, interests and capital gains. Shares and bonds can be bought and sold at the stock exchange. The bank employs its fund in the following types of investments:
• PURCHASE OF STOCK MARKET SECURITIES: The commercial bank also utilizes its available funds for the purchase of corporate shares (market securities). The commercial bank purchase securities include bonds & share issued by the corporations.
• PURCHASE OF GOVERNMENT SECURITIES: The commercial bank also utilizes its available funds for the purchase of government securities. The commercial bank purchase government securities include Federal Government Treasury bills, Federal Government Treasury notes, Federal Government Treasury bonds, Local Government bonds, and foreign Government bonds
USES OF BANK FUNDS (NON PROFITABLE USES)
BANK RESERVE: All schedule banks are bound to keep a certain part of their deposits at the central bank. Central bank uses that amount in clearing house service & providing loans to the commercial banks to enable them to discharge their liabilities. CASH RESERVE: Schedule bank also uses their funds to keep a sufficient amount as reserve to meet unforeseen obligations.
PURCHASED OF FIXED ASSETS: Schedule bank also uses their funds in purchased of fixed assets to carry to its business activities
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SOURCES OF BANK FUNDS Banks obtained funds through various sources, which are capital, deposit, loan & Federal Funds Purchased.
1. CAPITAL: Capital is the bank’s equity. Banks come into being under company ordinance issued shares in the capital market to raise capital. The capital of the bank has two components.
• Paid-up-capital
• Retained earnings (Accumulated profits over the previous years)
Ordinarily seven percent of the bank’s total assets (except bonds and promissory notes) constitute capital. Remaining 93 percent are the deposits. That is, the bank is able to attract 93 rupees as deposits with an investment of seven rupees as capital.
2. DEPOSIT: Deposits refer to money received from the account holder by the bank for safe keeping. There are three basic kinds
• DEMAND DEPOSITS (CURRENT ACCOUNTS): In these kinds of deposits, account holder can withdraw the amount by cheques from the bank any times. Bank receives them through current accounts. According to a survey, demand deposits constitute 38 percent of total deposits.
• TIME DEPOSIT (SAVINGS ACCOUNT & FIXED DEPOSIT): Time deposits are of two kinds Savings accounts & fixed deposit. Both the accounts base on interest. The greater the period the higher is the rate of interest. In fixed accounts amount cannot be withdrawn before maturity period. On the other hand, in savings accounts required amount can be drawn not more than twice a week, not above the limit fixed by the bank.
• EURODOLLARS: Local banks possess branches in foreign countries where they have large deposit in foreign exchanged on foreign branches are called Eurodollars. Such deposits are easily convertible into dollars
3. OBTAINING LOANS: Loans are one of the leading sources for commercial banks funds these loans are not-depository in nature and are obtained for a fixed period of time
• STATE BANK OF PAKISTAN BANKS LOANS: The commercial bank borrows from the central bank by getting its bill of exchange rediscounted and hence it can meet its immediate cash requirement.
• ISSUE OF BONDS: The bank issued its bonds on the open market and invites public to invest their surplus money by purchasing its bonds. They are secured, long-term and carry a fixed interest rate. The interest is payable annually. The creditor is known as bondholder.
4. FEDERAL FUNDS PURCHASED: Sometimes the balance at the central bank falls below the required ratio. In such a circumstance, the commercial bank with the short balance borrows from the other one with surplus balance at a certain interest rate. The central bank raises no objection to such a transaction which is known as federal funds purchased. The transaction benefits both the banks. The bank with surplus balance earns profit, and the one with shortage is able to raise the balance
PURCHASED OF FIXED ASSETS: Schedule bank also uses their funds in purchased of fixed assets to carry to its business activities
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SOURCES OF BANK FUNDS Banks obtained funds through various sources, which are capital, deposit, loan & Federal Funds Purchased.
1. CAPITAL: Capital is the bank’s equity. Banks come into being under company ordinance issued shares in the capital market to raise capital. The capital of the bank has two components.
• Paid-up-capital
• Retained earnings (Accumulated profits over the previous years)
Ordinarily seven percent of the bank’s total assets (except bonds and promissory notes) constitute capital. Remaining 93 percent are the deposits. That is, the bank is able to attract 93 rupees as deposits with an investment of seven rupees as capital.
2. DEPOSIT: Deposits refer to money received from the account holder by the bank for safe keeping. There are three basic kinds
• DEMAND DEPOSITS (CURRENT ACCOUNTS): In these kinds of deposits, account holder can withdraw the amount by cheques from the bank any times. Bank receives them through current accounts. According to a survey, demand deposits constitute 38 percent of total deposits.
• TIME DEPOSIT (SAVINGS ACCOUNT & FIXED DEPOSIT): Time deposits are of two kinds Savings accounts & fixed deposit. Both the accounts base on interest. The greater the period the higher is the rate of interest. In fixed accounts amount cannot be withdrawn before maturity period. On the other hand, in savings accounts required amount can be drawn not more than twice a week, not above the limit fixed by the bank.
• EURODOLLARS: Local banks possess branches in foreign countries where they have large deposit in foreign exchanged on foreign branches are called Eurodollars. Such deposits are easily convertible into dollars
3. OBTAINING LOANS: Loans are one of the leading sources for commercial banks funds these loans are not-depository in nature and are obtained for a fixed period of time
• STATE BANK OF PAKISTAN BANKS LOANS: The commercial bank borrows from the central bank by getting its bill of exchange rediscounted and hence it can meet its immediate cash requirement.
• ISSUE OF BONDS: The bank issued its bonds on the open market and invites public to invest their surplus money by purchasing its bonds. They are secured, long-term and carry a fixed interest rate. The interest is payable annually. The creditor is known as bondholder.
4. FEDERAL FUNDS PURCHASED: Sometimes the balance at the central bank falls below the required ratio. In such a circumstance, the commercial bank with the short balance borrows from the other one with surplus balance at a certain interest rate. The central bank raises no objection to such a transaction which is known as federal funds purchased. The transaction benefits both the banks. The bank with surplus balance earns profit, and the one with shortage is able to raise the balance
