Basics of Banking

Table of Contents

1. Introduction to Banking

Banking appears to have originated in Ancient Mesopotamia. Receipts in the form of clay tablets were used to record transfers between parties. It appears that these clay tablets were more in the form of a bank draft or money order issued by the private sector rather than by the state. In effect, these clay tablets were the forerunner of our more modern paper money systems. Among some of the earliest recorded laws was “Code of Hammurabi” pertaining to the regulation of the banking industry in Mesopotamia. The development of banking in Mesopotamia is quite interesting. It illustrates that all the modern practices such as “Deposits”, “Interest”, “Loans” and “Letter of Credit” existed from the time of the first great civilizations on earth.

1.1. Banking and Religious Places

Banking and money appear to have been closely centered on religious places. Often great temples, churches and mosques served as treasuries holding vast sums of wealth donated by its followers. At times, various rulers would borrow from these treasuries at a prescribed rate of interest. Thus, these religious places provided a center around which civilization grew through its interactions. Ancient homes didn't have the benefit of a steel safe, therefore, most wealthy people held accounts at their religious places. Numerous people, like priests or clerics and other workers whom one hoped were both devout and honest, always occupied these religious places, adding a sense of security.

1.2. Banking in Europe

The development of banking spread from northern Italy throughout the Holy Roman Empire, and in the 15th and 16th century to northern Europe. Though the first bank called the ‘Bank of Venice’ was established in Venice, Italy in 1157 to finance the Monarch in his wars, but modern banking began with the English goldsmiths only after 1640. This was followed by a number of important innovations that took place in Amsterdam during the Dutch Republic in the 17th century and in London in the 18th Century. In fact, Merchant banks are the original modern banks. These were invented in the Middle Ages by Italian grain merchants. In France during the 17th and 18th century, a merchant banker or marchand-banquier was not just considered a trader but also received the status of being an entrepreneur par excellence. Merchant banks in the United Kingdom came into existence in the early 19th century; the oldest was Barings Bank.

Banks have been around since the first currencies were minted, perhaps even before that, in some form or another. Currency, particularly the use of coins, grew out of taxation. In the early days of ancient empires, a tax of one healthy pig per year might be reasonable, but as empires expanded, this type of payment became less desirable. Additionally, empires began to need a way to pay for foreign goods and services, with something that could be exchanged more easily. Coins of varying sizes and metals served the purpose. In fact, Bank comes from an Italian word “Banco” whose meaning is ``bench”. Italian merchants in olden days (during Renaissance period) dealt with money between each other beside a bench. They used to place the money on that bench. Slowly the name Banco changed to Bank through the time.

The first bank to begin the permanent issue of banknotes was the Bank of England in 1695. Initially hand-written and issued on deposit or as a loan, they promised to pay the bearer the value of the note on demand. By 1745, standardized printed notes ranging from £20 to £1,000 were being printed. Fully printed notes that didn't require the name of the payee and the cashier's signature first appeared in 1855. Until the mid-nineteenth century, commercial banks were able to issue their own banknotes, and notes issued by provincial banking companies were commonly in circulation.

1.3. Banking in United States

Merchants traveled from Britain to the United States and established the Bank of Pennsylvania in 1780 to fund the American Revolutionary War (1775–1783). During this time, the Thirteen Colonies had not established currency and used informal trade to finance their daily activities. Hence, in 1781, an act of the Congress of the Confederation established the Bank of North America in Philadelphia, where it superseded the state-chartered Bank of Pennsylvania founded in 1780 to help fund the war. The Bank of North America was granted a monopoly on the issue of bills of credit as currency at the national level. In 1791, U.S. Treasury Secretary Alexander Hamilton created the Bank of the United States, a national bank meant to maintain American taxes and pay off foreign debt. President Andrew Jackson vetoed the bank in 1832 as he opposed the concentration of power in the hands of the powerful few. This decision of his was opposed by Henry Clay and Biddle (who was from a prominent Philadelphia family).

Investment banking began in the 1860s with the establishment of Jay Cooke & Company, one of the first issuers of government bonds. In 1863, the National Bank Act was passed to create a national currency, a federal banking system, and make public loans. During the period from 1890 to 1925, the investment banking industry was highly concentrated and dominated by JP Morgan & Co.; Kuhn, Loeb & Co.; Brown Brothers; and Kidder, Peabody & Co. The Federal Reserve System also known Fed is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a series of financial panics (particularly the panic of 1907) led to the desire for central control of the monetary system in order to alleviate financial crises. The Great Depression in (1929-1939) saw to the separation between investment and commercial banking known as the "Glass-Steagall Act" (a 1933 Law), but the Act was repealed in 1991 leading to the 2008 financial crisis. The Federal Deposit Insurance Corporation (FDIC) was created by the 1933 Banking Act, enacted during the Great Depression to restore trust in the American banking system. More than one-third of banks failed in the years before the FDIC's creation, and bank runs were common. On September 2, 1969, Chemical Bank installed the first ATM in the U.S. at its branch in Rockville Centre, New York. The first ATMs were designed to dispense a fixed amount of cash when a user inserted a specially coded card.

The late-2000s financial crisis is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s. It was triggered by a liquidity shortfall in the United States banking system and has resulted in the collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world.

The collapse of the U.S. housing bubble, which peaked in 2006, caused the values of securities tied to U.S. real estate pricing to drop, damaging financial institutions globally. Questions regarding bank solvency, declines in credit availability and damaged investor confidence affected global stock markets, where securities suffered large losses during 2008 and early 2009. Due to the 2008 financial crisis, and to encourage businesses and high-net-worth individuals to keep their cash in the largest banks (rather than spreading it out), Congress temporarily increased the insurance limit to $250,000. With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, this increase became permanent as of July 21, 2010.

A very long history of banking at U.S. …

1.4. Central Banks

The onset of the worldwide depression in 1929 was a disaster for the banking system. In the last quarter of 1931 alone, more than 1,000 U.S. banks failed, as borrowers defaulted and bank assets declined in value. This led to scenes of panic throughout the country, with long lines of customers queuing up before dawn in hopes of withdrawing cash before the bank had no more to pay out.

As the banks were not regulated, the needs of creation of Central Banks came into picture in the 19th Century. Many Central banks were established in European countries during the 19th century. The US Federal Reserve was created by the U.S. Congress through the passing of The Federal Reserve Act in 1913. Australia established its first central bank in 1920, Colombia in 1923, Mexico and Chile in 1925 and Canada and New Zealand in the aftermath of the Great Depression in 1934. By 1935, the only significant independent nation that did not possess a central bank was Brazil, which subsequently developed a precursor thereto in 1945 and the present central bank twenty years later. Having gained independence, African and Asian countries also established central banks or monetary unions.

2. The Ways Banks Make Money

The fundamental question: Why does a bank needs to make money?

After all banking is a business and banks too have myriad of expenses to bear such as salaries to staff, managing their varied businesses, meeting regulatory requirements, R&D (mostly for new products and investments), expansion etc., for its effective functioning. It is, therefore, very important to understand how banks make money? The marketplace is full of various types of products and services and the bank is like a shop that buys and sells money in various forms like loans, deposits, and other financial products.

Let us check on the source of funds for banks:

2.1 Source of Funds for Banks

  1. Interest Rate on Loans: With rising aspiration levels, consumers are trying to look at unique ways of realizing their dream car, house and many such materialistic ambitions. One of the easiest and non-complicated ways of receiving this dream is a bank loan. There are a wide range of loans that are on offer from home loans to car loans, personal loans, travel loans and loans for investing in securities. The bank levies varying degrees of interest rates on different types of loans depending on the duration of the loan and the amount of loan involved.

  2. Service Charges: Banks offers various services and charges nominal fees for these services rendered. When standalone these fees feel nominal to its customers but, when accumulated the service charges become a contribution to a bank's source of funds.

  3. Inter-bank Lending: Another very popular mode of earning money for a bank is through the rate of interest earned via inter-bank lending. Most of this lending is for the short-term (e.g., 3 Months), and sometimes just overnight. These loans are essentially for addressing a bank’s daily liquidity needs and day to day expenses and pay-outs that might be lined up on a daily basis. The benefit of an inter-bank lending for the borrower bank is the fact that rate of interest at which it takes the loans from another bank is always at the best possible rates compared to any loan from other sources. This helps the bank save crucial interest outgo that might otherwise have drained its balance sheet. Hence, a win-win situation for both banks.

  4. Auction of Assets: Many times, when an individual or a company defaults on a specific loan, the bank impounds on the collateral that was given in exchange of the loan amount and puts it up for sale. These can involve a wide range of products ranging from houses, cars and other personal belongings including jewellery. The bank has to otherwise bear additional cost for asset maintenance and upkeep of all these properties if not disposed. Hence, auctioning these properties is an easy way for the bank to recover the defaulted loan amount as well as profit. Also, Auction is a low expense affair to the bank.

  5. Trading in Securities: Many banks, especially the investment banks are active in equity, forex and commodity markets for their clients. The commission and fees are the main sources of funds for the banks.

  6. Charges for Financial Advices: This is another interesting and hugely beneficial services specially offered by investment banks. Many big companies which are not publicly listed and planning for initial public offerings cannot make it alone as they do not have market knowledge. Here's where investment banks help these companies for initial IPO's and make money through advisory fees. Also, investment banks help these big companies for the follow-on public offerings too. The crucial advices given by banks are in terms of "What rate the issue should be priced", "The total number of shares to be issued" etc. Banks also makes money in advices it gives while negotiating crucial acquisition and mergers of companies. The logic is when a big investment bank is involved; the chances of good deal are always higher with limited scope for foul play. Fair pricing is also another great motivation for involving an investment bank to negotiate M&A deals. Some modern banks also make money through advices given for tax planning and succession (or Estate) planning too.

  7. Charges for Vaults: Many of us are scared to keep our precious jewellery, important documents at home. The threat of theft makes them nervous, and the bank comes to the aid of all such customers. They have vaults of various sizes and dimension to suit the needs of many different types of customers who require these vault services. The bank charges annual fees for the maintenance, upkeep and also monthly rental in return for these services. While customers are happy that their precious documents and jewellery are in safe hands, the banks use this unique opportunity for enhancing its profit base. Maintaining a vault does not require a huge manpower either. In that way, it is yet another low expense formula to enhance the bank’s earnings.

  8. Underwriting Income: Investment banks help private companies go public. This means that they help sell the shares of these private companies on the open market. While doing so, they underwrite all the shares. This means that they take the risk that if these shares are not sold to the common public, then they will buy the shares themselves. Public issues generally run into millions of dollars. Investment banks charge a hefty commission on the issue size.

  9. Advisory fees: Investment banks earn advisory fee for raising capitals (even for governments), advising on investments, Fixed income trading, derivatives trading, commodities trading etc.

  10. Fee for securitization: Securitization is the process of converting assets (like loans) into saleable securities (like Bonds). During this conversion for the client, investment banks take appropriate fees and commission in every step of securitization process.

  11. Research Fees: Investment banks does a lot of research jobs for its clients for example, the profitability analysis for any Merger or Acquisition deal. This is done to ensure that they provide the most up to date reports to their clients. Also, Money managers often purchase research materials from Investment banks, to make better investment decisions.

  12. Swaps: Investment banks make money through swaps. Swaps create profit opportunities through a complicated form of arbitrage, where the investment bank brokers a deal between two parties that are trading their respective cash flows.

  13. Payments Fees: Banks charges various Payment processing fees say for wire transfers or ACH or fees charged to merchants for processing credit card payments etc.

  14. Bank Charges: Banks also earn through various charges for delays say delays in payment by the customer towards credit card, withdrawal charges for ATM (for utilizing ATM a greater number of time than the prescribed withdrawals), Overdraft interest charges, Charges for bank drafts, Charges for being an Advising bank in letter of credit, correspondent banking charges etc.

  15. Overdraft Fee: An overdraft fee is charged when a payment or withdrawal of a banking customer account exceeds the available balance and the bank covers the transaction for the customer (only up to a certain limit decided during provision of overdraft facility).

  16. Line of Credit: Bank earns interest fee through a line of credit (LOC) it offers to its customers. It is an arrangement between a bank and a customer where customer can borrow up to a certain amount from bank without applying for a loan (which is a cumbersome process) to a certain limit that can be drawn on repeatedly.

2.2 Miscellaneous Fee for Banks

Apart from above fees and commissions that bank earn, it also earn miscellaneous fees say, charges for issuing a cheque book or ATM card or access of debit card or credit card transactions internationally. While the service charges for these specific ones are very nominal, and the customer doesn’t mind paying given the convenience it entails, the bank rakes in significant sum by sheer number power. Let’s look at some more as given below:

  1. Sales: Pressure on profits from the core business has forced banks to cultivate income from non-core banking activities, including selling third-party products such as insurance policies and mutual funds, for a commission. They also sell gold coins and biscuits, retirement products, annuities for profit.

  2. Forex: Banks provide foreign exchange services to their customers. These can include buying foreign currency in cash form, making international bank-to-bank transfers or providing pure foreign exchange dealing services for large multi-nationals. A large bank might trade billions of dollars per day, buying and selling currencies and making money off the price difference meaning, Banks set a bid price (what they will pay for a currency) and an ask price (what they'll sell it for). The price difference of a bid against ask is the profit the bank makes.

  3. Treasury Services: Treasury Services are a broad collection of services that banks will offer to corporate/business clients. Banks help companies manage their accounts receivable and accounts payable, managing working capital and payroll.

  4. Credit Cards: Banks charge the merchants for each use, and they make interest money on people who carry a balance.

  5. Debit Cards: Banks earn revenue every time customer use debit card through paid interchange, or "swipe", fees.

  6. Balance Transfer: The balance transfer typically comes with a fee. If the credit card has an annual fee, that’s another opportunity for the bank to make money when customer transfer balance.

  7. Merchant Services Fee: Merchant services fees is the hardware/software, services given by the bank to its merchant customers for accepting and processing credit or debit card payments from their customers.

  8. Correspondent Banking Charges: Correspondent banks earn huge commissions and fees through its services such as payment services (international wire transfer fee) documentary services (Letter of Credit or Bank Guarantee), Treasury Services etc.

  9. Private Banking Charges: Private banking is the wealth management services provided usually by a commercial bank to it's premium customers (also called High-Networth Individuals) for a fee.

  10. Brokerage Account Fee: Banks offer online trading through their brokerage arm to its customers and earn on fees per transactions or commission or service charges as per the broker firm's norms .

3. How Banks are Formed?

Banking license or charter is a prerequisite for any firm or corporate body that wants to provide banking services. There is a relatively long and complicated procedure that goes into the application for obtaining a license or charter (This can also take a year or two). In a few countries, the formation of banks requires permission from more than one regulatory authority. Extensive information about the promoters, the business plan, senior management team, finances, capital adequacy, risk management infrastructure, and other relevant factors must be provided to the Regulators. This procedure will also depend on the type of bank license that a firm or corporate body wishes to apply for. Licensing is generally broken down into different categories, while each category has a different specialization, and a different time frame involved in the banking license or charter application process. Due to the number of different sectors in which banks may be involved, there are also bank licensing packages available in various countries. Example, at Singapore a firm or corporate body can apply for digital banking in two ways namely Digital full Bank (DFB) or Digital Wholesale Bank (DWB). Before granting a license or charter, the regulators determine that the applicant bank has a reasonable chance for success and will operate in a safe and sound manner. Next, the applicant bank must also obtain approval for deposit insurance say at United states from the Federal Deposit Insurance Corporation (FDIC).

All insured banks must comply with the capital adequacy guidelines set by their county regulators. The guidelines require a bank to demonstrate that it will have enough capital to support its risk profile, operations, and future growth even in the event of unexpected losses. Newly established banks are generally subject to additional criteria that remain in place until the bank's operations become well-established and profitable.

3.1 Types of Banks

1. Retail Banks:

Also known as consumer banks or personal banks, are financial services provided to individual customers. The primitive of Retail banking for individual customers is to save their money through deposits and have access to loan or credits mostly the home loan or mortgage. However, since the times have changed there are lot many services that are being offered by retail banks including Current/Checking, Money Market and Savings accounts, Home Loans/Mortgages, Personal Loans, Debit and Credit Cards, Fixed Deposits (FDs)/Certificates of Deposit (CDs), lines of credit etc. The broadened product offerings by retail banks are investment services such as wealth management, brokerage accounts, private banking, and retirement planning.

2. Commercial Banks: Commercial banks are known to focus on products and services offerings to businesses rather than individuals. These specifically designed products for businesses include but are not limited to deposit accounts, trade services like letter of credit or bank guarantees, lines of credit, merchant services, payment processing, commercial loans, treasury services, and other business-oriented products.

3. Merchant Banks: Merchant banking is a specialized banking services such as underwriting services, loan services, financial advising, and fundraising services designed especially for medium and large corporations and high-net-worth individuals. Merchant banks operate in several countries hence, they are experts in international trade.

4. Investment Banks: Investment banks do not service public in general. They often act as intermediaries between transacting counterparties (example, they act as custodians or administrators or transfer agents for say hedge and private equity funds) and earn fees and commission for the services rendered. Investment banks also help launch an initial public offering (IPO) and also does Mergers and Acquisitions (M&A) businesses. It also acts as arranger for big syndicated deals (such as syndicate loans or structuring and warehousing CLO’s), acts as a broker dealer for large institutional clients such as insurance companies or mutual funds or pension funds.

5. Wholesale Banks: Wholesale banking are financial services exclusively for very large clients such as Infrastructure developers, financial institutions and banks, government agencies and large companies. It is called Wholesale banking as all services that large clients expect (to do their businesses smoothly) are available within one bank such as currency conversion, working capital financing, large trade transactions, mergers and acquisitions, consultancy, underwriting etc.

6. Digital Banks: Digital banking is the new era banking where, banking services from bricks and mortar are bought to digital equipment such as mobile phone. New Services such as open account through e-KYC, manage expenses and credit cards online, automatic bill payments, Digi loans, Overseas money transfer with click of button etc are offered through a single banking application.

7. Central Banks: The central banks are called heart of all banks in a country. Central banks of the world do formulation of monetary policy, setting interest rates, acts as clearing agents, manage foreign exchange reserves, bailer for bankruptcy of banks, print currency and regulate member banks. Some of the world’s central banks are nationalized and others are not as those countries want their central banks to be politically independent.

8. Credit Unions: Credit Unions are mutual organisations that offer a range of financial services and products similar to banks. They are well known at United States. The products and services are restricted only to those who are members of these organizations. The products and services include but not restricted to home loans/mortgages, personal and car loans, credit cards and transactional accounts such as savings and checking (/current) accounts.

9. Building Societies: Building Societies is a financial institution owned by its depositors and borrowers, who are called members. They are very famous in UK. Building societies primarily make mortgage loans to their members, however they also do deposit business. Since, building societies became able to conduct banking services other than deposits and loans in the mid-1980s, most of them have demutualized and have become regular banks.

10. Industrial Banks: The industrial banks are available in Germany, Japan and in India. The function of these bank is of advancing loans to industrial undertakings for a long period (say for buying machinery and equipment and working capital management).

11. Co-operative Banks: The co-operative banks work on co-operative principle whose main business is providing loans to individuals and small businesses. They also take deposits. Cooperative banks are owned by their customers and follow the cooperative principle of one person, one vote. Co-operative banks are often regulated under both banking and cooperative legislation.

12. Payment Banks: A bank licensed as a Payments Bank can only receive restricted deposits and provide remittances. These banks cannot issue loans and credit cards.

13. Government owned Banks: Government owned banks, also called public sector banks are the banks where majority of the ownership is held by the government. Usually, more than 50% ownership by any government of a country is considered as a government owned bank.

14. Internet only banks: Internet only banks do not have any branches (simply it is not a brick-mortar bank or branch). Instead, they provide high end services through internet (computers or tabs or mobiles) such as payments, small business account maintenance etc. Some popular internet banks include Discover Bank and Synchrony Bank, which both utilize extensive online networks and are accessible by web and phone only.

15. Shadow Banks: The shadow banking system consists of financial groups that aren’t bound by the same strict rules and regulations that other banks have to comply with. The shadow banking system consists of lenders, brokers, and other credit intermediaries. Example, Hedge fund. Shadow banks are mostly in the business of lending products and do not float deposits, hence they are free from regulations as on day.

16. A Savings and Loan Association (S&L): Also called, thrift institution, specializes in deposits and mortgage & other loans. The terms "S&L" or "thrift" are mainly used in the United States and similar institutions in the Commonwealth countries (like United Kingdom) are called trustee savings banks. Similar to Credit Unions or Building societies, they are also mutually held meaning that the depositors and borrowers are members of the S&L.

17. Foreign Banks: Foreign Banks are majorly International commercial Banks that are obligated to follow the regulations of both the home and host countries.

18. Universal Banks: Universal banks can be understood as a combination of all three services that is retail banking, investment banking, and wholesale banking. These banks are not limited to traditional commercial or merchant banking but offers services like asset management, custodial services, treasury services, correspondent banking services, payments processing etc.

19. Agricultural Banks: An Agricultural Bank is established to assist agricultural development, such as Crop production, Livestock, Fishery, Poultry, Agro-machinery, Agro-processing, Transportation of agro-products and machinery, Cottage industry, Horticulture and Nursery.

20. Mutual Savings Banks: Mutual savings banks are generally organized under what's called the "trustee system." It is this particular feature that separates them from cooperative banks. With co-operative banks, the customers are the owners. But with mutual savings banks, its relationship with depositors is that of debtor and creditor, requiring the need of a "trustee" to govern the bank's operations without profiting themselves.

4. Banking Products and Services

Bank has Array of Products and Services being catered to its customers as given below:

1) Checking (/Current Account):

A Checking (/Current) Account is a demand deposit account. Demand Deposit means, bank has the responsibility to provide money to the customer when demanded through checks, ATM’s or Debit Cards (hence, this account is considered to be a very liquid account). The checking account can be opened singly or jointly by any legal person(s), but usually is utilized by businesses or people wanting account for commercial purpose for daily and frequent or very frequent transactions. Mostly, banks allow unlimited transactions meaning, several frequent withdrawals and unlimited deposits for this account. Also, usually, nil or very nominal interest is paid by banks on these accounts.

2) Savings Account:

Savings account as name implies is generally preferred by individual customers for the purpose of saving. Hence, banks pay good interest for deposit balances in this account. However, the interest rate payable is usually not fixed but, variable in nature. Withdrawals have restrictions for this account unlike the checking account, but this account comes with unlimited deposits. Savings account also comes under the category of demand deposit. The transactions in this account can be done online or through ATM’s or through checks or in certain countries through withdrawal slips.

3) Certificate of Deposit (/Fixed Deposit):

Certificate of Deposit (CD) also known as Fixed Deposit (FD) are onetime deposits which are offered for specific time range (e.g., 7 days deposit, 14 days deposit, 1 month deposit, 3 months deposit, 6 months deposit, 1 year deposit…5 years deposit). Depositors have the choice of the length of time. The interest amount and the tenure of the deposit are fixed at the time of depositing money. Customer has option of withdrawing the certificate of deposit at maturity (at the end of time period decided at the start of the deposit) or can put certificate of deposit in auto renewal mode too. However, if required, the CD/FD can be broken before maturity (prematurely). In such cases, banks will pay lesser interest rate than that was decided at the time of deposit. For those who cannot afford to deposit lump sum amount, banks provide a special product called a Recurring Deposit (RD), a kind of term deposit where customers with regular incomes can deposit a fixed amount every month into their recurring deposit account and earn interest at the rate equivalent to a fixed deposit. CD’s/FD’s and RD’s are also called as Time Deposits as the banking customer availing this facility choose to withdraw from these accounts only after the maturity or total time period agreed by the customer with the bank.

4) Bank Lockers:

Bank Lockers have been the first choice to safeguard valuables such as gold, silver, precious ornaments or documents and certificates. Some banks may insist opening a savings account with them to avail locker facility. The lockers provided are of different sizes and customer can choose the size of the locker based on the requirement. The deposit amount and the charges for hiring the locker vary as per the size and also from bank to bank. Most of the banks ensure that the locker minimum has a nominee of the customer or is operated with joint ownership. The customer will receive a ‘memorandum of letting’ or similar termed letters, which essentially is a document that states locker details while hiring the locker. Each locker has two keys: the customer keeps one key, while the other stays with the bank. The locker can be opened only when both keys are used.

5) Bancassurance: It is a tie up between Insurance companies and banks where banks sell insurance products along with their products to their banking customers for a fee or commission. Like this, insurance companies benefit getting new customer base.

6) Gold Loan:

Gold Loan as the name, is the loan given to customers of bank for pledging equivalent gold. Banks offer this loan at attractive rates. Banking customers opt for this loan for short period to meet their requirements such as children’s education, marriage etc. Some banking customers pledge gold and take loan thinking that instead of keeping the gold idle at home or locker, loan against gold is the best option.

7) ATM

The simplest way for withdrawing money is through ATM (/Automated Teller Machines). Banking customers can withdraw money from their Bank ATM and also from another Bank’s ATM. However, there are certain restrictions for transactions in ATM like, beyond certain number of transactions, customer is liable to pay additional charges for using the ATM services. ATM’s can be used for several purposes like, withdrawal of money, knowing balances in the customer account, deposit money, transfer money etc.

8) Credit Card:

A credit card is offered by a bank as a line of credit to the cardholder. Credit cards are accepted in larger establishments in almost all countries, and are available with a variety of credit limits. The cardholder can borrow money for payment to a merchant or even use cash advance by withdrawing from any Bank ATM within the credit limits set by the bank during issuance of the card. However, cash advances are not recommended as they come with hefty fees. The first six digits for any Master or Visa card credit card is the bank identification number. The next nine digits are the individual account number, and the final digit is a validity check code. Credit Cards comes with either a magnetic strip or smart card technology computer chip. A credit card's grace period is the time the cardholder has to pay the balance before interest is assessed on the outstanding balance. Grace periods may vary depending on the type of credit card and the issuing bank. Usually, if a cardholder is late paying the balance, finance charges will be calculated.

9) Debit Card:

A Debit card is not a line of credit but, payment card linked to customers savings or checking account that can be used instead of cash when making purchases with any merchant who accepts bank cards. Debit cards are also used for instant withdrawal of cash from ATM. There are usually daily limits on the amount of cash that can be withdrawn.

10) Gift Cards:

Gift Cards also called cash cards are pre-loaded stored value cards, that allows the cardholder to use it for the purchases with merchants or online. The cards become obsolete after customer has consumed the equivalent amount that was preloaded in the card. It can also be given by a retailer as a part customer ecstasy.

11) Banker’s Draft:

A banker's draft also called a teller's check is simply a check issued by a bank provided to a customer of a bank on request drawn on another bank or payable through or at a bank. The bank customer actually purchases the banker's draft by authorizing the bank to deduct self-account (plus any applicable charges) and credit bank's account. The banker’s check is considered more secure than a customer check as the funds have already been transferred hence, are proven to be available.

12) Bank Overdraft:

An overdraft is a credit line given to banking customers when their account balance becomes zero. In overdraft facility the interest is charged on the credit actually utilized, i.e., to the extent amount is overdrawn.

13) Cash-Credit:

Under cash-credit a bank advances short term cash loans to the customer on the basis of certain security or hypothecation of customer’s current assets, receivables or fixed assets in favor of the banker. Cash credit is relatively a long-term facility.

14) Treasury Services:

Treasury Services is a specialized service by investment banks managing any firm's collections, disbursements, investment and funding activities. Example, Accounts Receivable services where bank manages money receivables for its client’s business deals or sales and services; Accounts Payable services such as bank helping its client with solutions for making payments to its business partners; Liquidity Management services where a bank takes care of its clients working capital requirements; Trade Finance Services where a bank helps client trade across borders.

15) Custody Services:

Custody services provided by a bank typically include the account administration, transaction settlements, safekeeping, collection of dividends and interest payments, tax support, and reporting of customers' marketable securities and cash to its clients.

16) Documentary Services: Documentary Services include services such as letter of credit and bank guarantees example, opening of import letters of credit; advising and confirmation of export letters of credit; Issuing and advising of all kinds of bank guarantees; opening and advising of standby letters of credit.

17) Credit Services: Credit Services include but not limited to:

  1. Commercial Lending: Business loans given by banks to corporate to operate or expand or to purchase real estate.

  2. Mortgage: Loan given by banks to finance house.

  3. Auto Finance: Loans provided by banks to consumers wanting to buy any type of motorized vehicle for own or commercial purposes.

  4. Commercial Real Estate: Banks providing capital for commercial real estate.

  5. Advances: Generally provided for a shorter duration of time, for instance, a year example, short-term loan, an overdraft, cash credit or a bill purchase.

  6. Credit Cards: An unsecured loan provided by banks to retail customer based on capacity of repayments.

18) Asset Management: Asset Management include but not limited to:

  1. Banks acting as administrators or custodians or transfer agents or combination for funds.

  2. Personal financial advisory to High-Net-Worth-Individuals.

  3. Escrow services for real assets.

  4. Advisory services for equity, fixed income, real estate, commodities, alternative investments and mutual funds.

19) Foreign Exchange: Foreign exchange services include, remittances, clearing travelers checks, getting best rates of foreign exchange trades.

20) Derivatives: Derivative services include executions of trades, documenting contracts for futures and options, Swap settlements, Cost benefit analysis, set algorithm parameters to suite trading objectives etc.

21) Traveler's Checks: A traveler’s check is a prepaid fixed amount which operates like cash. The purchaser instead of carrying cash can easily carry travelers check in the wallet especially while travelling overseas. Banks also exchange travelers check for cash.

22) Retiral Accounts: Retirement accounts are tax-advantaged accounts that individuals use to save and invest for retirement. The customers can choose wise range of investments which encompass a range of financial products, including stocks, bonds, and mutual funds.

23) Sweep Accounts: A sweep account is a bank account that automatically sweeps amounts from one account to the other based on shortfall from certain level in an account or into a higher interest-earning account at the close of each business day.

24) Remittance or Payment Services: The most famous among the banking services is the electronic funds transfer, ACH Services or execution of standing instructions.

25) Money Market Account: A money market account (MMA) or money market deposit account (MMDA) is a deposit account. The interest paid is based on current interest rates in the money markets. These interest rates are generally higher than those of other transaction accounts.

4.1. Cheques

1. Introduction:

A Check (/Cheque) is a negotiable instrument an order to a bank to pay a specific amount of money to the payee. In any country a cheque has more or less the below fields:

  1. Drawer: Drawer is the legal person on whose name underlying account exist (Savings or Checking) and whose transactional account gets debited when a cheque gets cleared. In the individual cheques, the drawer's name and account number is preprinted on the cheque, and the drawer is usually the signatory (the other signatory can be the joint holder). In the entity cheques, the drawers name (the name of the entity on whose name the cheques have been issued) and account is preprinted and signatory is generally an individual with authority to sign as per signature mandate of that entity.

  2. Payee: The name of the legal person to whom the payment is be made.

  3. Drawee: The bank which is ultimately responsible for clearing the cheque and making payment as per drawers’ instructions on the cheque. This is usually preprinted on the cheque.

  4. Amount and Currency: The amount and currency usually must be written in words and in figures.

  5. Issue Date: The date on which the drawer has written the cheque. This field is very important as this date decide when the cheque will become stale (as per the validity of the cheque rules in different countries). Typically, in major countries a cheque is valid for six months after the date of issue. Further, a cheque that has an issue date in the future is called a post-dated cheque.

* In short, drawer is the legal person who writes the cheque, payee is the party to whom the check is written and drawee is the financial institution where the drawer has an account.

  1. Cheque Number: A cheque number is associated with each of the leaf of a cheque in sequential order (This number has an importance as this is the tool for basic fraud detection by banks and making sure that a cheque is not presented twice).

  2. Memo Line: Cheques may contain a memo line (in countries such as United States) where the purpose of the cheque can be written. In cheques where a memo line is not available still a purpose may be written on the reverse side of the cheque (a practice common in countries like United Kingdom).

  3. MICR (Magnetic Ink Character Recognition): Machine readable routing and account information is usually available at the bottom of cheques.

  4. A Cross on the cheque: Drawer can manually cross a cheque (The format and wording varies from country to country, but generally two parallel lines may be placed in the top left hand corner) indicating that the funds must be paid into a bank account only.

  5. Bearer Cheque: A bearer cheque comes with the words “or bearer” or does not have the word “bearer” cancelled out in the cheque. This means the cheque can be made payable to the bearer (payable to the person who presents it to the bank for encashment).

2. Features of Cheques:

a) When a cheque is not crossed, it is known as an "Open Cheque" or an "Uncrossed Cheque". These cheques may be cashed at any bank and the payment of these cheques can be obtained at the counter of the bank or transferred to the bank account of the bearer.

b) Cheque in which the drawer mentions the date earlier than the date on which it is presented to the bank, it is called as "anti-dated cheque". Such a cheque usually is valid up to six months from the date of the cheque.

c) Cheque on which drawer mentions a future date to the date on which it is presented, is called post-dated cheque. Banks do not accept Postdated cheques.

d) If a cheque is presented for payment after six months from the date of the cheque it is called stale cheque. After expiry of that period, no payment will be made by banks against that cheque.

e) When a cheque is torn into two or more pieces and presented for payment, such a cheque is called a mutilated cheque. The bank will not make payment against such a cheque without getting confirmation of the drawer.

f) In the bottom of the cheque, you will have numbers written. The first set of numbers relate to the Cheque number (usually 6 digits). The second set of number represents MICR code (9 digits). The third set of number represents account code (6 digits) and the final set of numbers (2 digits) represent transaction code.

g) MICR code written on the cheque has following relevance. The first three number represents City code, the next three numbers are Bank code (i.e., which bank has issued the cheque to the account holder) and the last three number represent Bank Branch code (i.e., location of branch of that bank). MICR code is used by clearing bank during clearing process.

3. Different Types of Cheques:

a) Cashiers Cheque:

A cashier's cheque or cashier's order is a cheque purchased by an account holder. Cashier's checks are treated as guaranteed funds because the bank, rather than the purchaser, is responsible for paying the amount. They are commonly required for real estate and brokerage transactions.

b) Traveller's Cheque:

A traveller's cheque is purchased for the convenience it brings i.e., carrying it in a wallet instead of carrying cash. Hence, mostly travellers purchase such cheques from banks or other financial institutions. The purchaser of such cheques can also exchange it for cash. The safety feature of traveller's cheque is that the customer signs them when they purchase it and then they sign them again while cashing it.

c) Gift Cheque:

Gift cheque is like a bank draft which is preloaded and can be gifted instead of cash. The gift cheque can be purchased with a teller at a bank. These days gift cheques are replaced with gift cards. The gift cards are preloaded cards.

4. The Cheque Clearing Process:

The clearing process of a cheque means that the drawers account should get debited and the payees account should get credited. If the drawers account and payees account is the same bank, the bank does internal transfers settling the payments. This would take one business day or may be less depending on the time when the cheque is received and two conditions one, availability of sufficient funds in the drawers account and secondly, the cheque drawn is in order (meaning the date is valid, the signature is matching etc.).

When the drawers bank is different from payees bank, the settlement is done through exchange of checks in a clearing house or digitally under a cheque truncation system.

5. Inward Clearing or In-clearing of a cheque (/check): Inward clearing cheques are those cheques that are received by a drawee bank through clearing house from other banks for debiting drawer’s account (Our customer holding account with us).

6. Outward Clearing: Outward Clearing is when cheques drawn by other bank customers are presented for clearing in favor of (our) customer with the drawee bank through clearing house.

4.2. Wire Transfers


SWIFT (Society for Worldwide Interbank Financial Telecommunication) is the global provider of secure and cost-effective financial messaging services. The messages are transmitted through Swift Codes. A Swift code may be of eight to eleven digits and has the following components:

  • The first four characters are used as the bank codes (only letters).

  • The next two characters are to describe or give the country code (only letters).

  • The next two characters are used for location-based codes (mix of both numbers and letters).

The last three characters of the code are used to give details about the branch code (optional and mix of numbers and letters).

Example, CHASUS33ARP where:

1. Chas is JP Morgan Chase Bank NA.

2. US is United States.

3. 33 is the location Code and,

4. ARP is Account Reconciliation Processing.

Swift transmits transactions related messages through Message Texts. For Example, MT 103 is Message Text representing Single customer credit transfer meaning instruction of a fund transfer from one customer account to another account. MT 202, requests the movement of funds between financial institutions.

Let us learn how Instruction flow taking an example.

Scenario 1. ICICI Bank has a Nostro Account with Citi Bank US.

John has an account with ICICI Bank in India and wants to transfer $1000 to his daughter Mary studying at United States who has an account with Citi Bank. John visits the ICICI Branch fills in the swift form and submit it with the teller. Teller sends the swift instruction form to back office for execution. At Back office, a swift 103 is created in the swift interface and the transaction goes as below.

1. John’s Account Debit (If John has INR account, the currency conversion to USD is done by ICICI Bank).

2. ICICI Bank’s Nostro Account Credit (credited by ICICI Bank).

3. ICICI Bank’s Nostro Account Debit (Debited by Citi).

4. CITI Bank Customer account (Mary's account) Credit.

Scenario 2. ICICI Bank has a Nostro Account with JP Morgan Chase Bank and no relation with Citi Bank US.

1. John’s Account Debit (If John has INR account, the currency conversion to USD is done by ICICI Bank).

2. ICICI Bank’s Nostro Account Credit (JP Morgan account of ICICI Bank).

3. ICICI Bank’s Account Debit (Debited by JPMorgan).

4. JP Morgan Chase and CITI Bank US will settle amounts as per normal clearing process or Interbank exchange.

5. CITI Bank Account Credit (Mary's Account).


The Federal Reserve Banks provide the Fedwire Funds Service, a real-time gross settlement system that enables participants to initiate funds transfer that are immediate, final, and irrevocable once processed. Depository institutions and certain other financial institutions that hold an account with a Federal Reserve Bank are eligible to participate in the Fedwire Funds Services. The Fedwire Funds Service is generally used to make large-value, time-critical payments.

The Fedwire Funds Service is a credit transfer service. Participants originate funds transfers by instructing a Federal Reserve Bank to debit funds from its own account and credit funds to the account of another participant. Participants may originate funds transfers online, by initiating a secure electronic message, or off line, via telephone procedures.


CHIPS is the largest private sector USD clearing system in the world, clearing and settling $1.8 trillion in domestic and international payments per day. CHIPS provides fast and final payments and the most efficient liquidity savings mechanism. Its patented algorithm matches and nets payments resulting in an extremely efficient clearing process.


CHAPS is a sterling same-day system that is used to settle high-value wholesale payments as well as time-critical, lower-value payments like buying or paying a deposit on a property. Direct participants in CHAPS include the traditional high-street banks and a number of international and custody banks. Many more financial institutions access the system indirectly and make their payments via direct participants. This is known as agency or correspondent banking. CHAPS payments have several main uses:

  • Financial institutions and some of the largest businesses use CHAPS to settle money market and foreign exchange transactions

  • Corporates use CHAPS for high value and time-sensitive payments such as to suppliers or for payment of taxes

  • CHAPS is commonly used by solicitors and conveyancers to complete housing and other property transactions

  • Individuals may use CHAPS to buy high-value items such as a car or pay a deposit for a house

Payment obligations between direct participants are settled individually on a gross basis in RTGS on the same day that they are submitted. The transfer of funds is irrevocable between the direct participants.

Operating hours: The CHAPS system opens at 6am each working day. Participants must be open to receive by 8am and must send by 10am. CHAPS closes at 6pm for bank-to-bank payments. Customer payments must be submitted by 5.40pm.

4.3. Electronic Fund Transfer (EFT)

Transfer of Funds through online networks or electronically is an EFT. An Electronic Fund transfer is instruction based fund transfer where a customer instructs a bank to transfer fund to another account of same bank or other banks. A credit card or debit card swipe at a POS (Point of Sale) is also an electronic fund transfer. All electronic fund transfer has two steps:

  1. Initiation of a Transaction: The primary initiator of the transaction is always a customer whose instructions is received by the bank. In electronic fund transfer of card based transaction, the card associations are the intermediaries.

  2. Settlement of a Transaction: The settlements are always done between the banks (even if the intermediaries like card associations are part of transactions, ultimately the settlement is done between banks). Settlement means, funds originated ultimately reaching the destined accounts.

Let us check some of the Electronic Fund Transfers:

1. Automated Clearing House (ACH):

An ACH payment is a type of electronic bank-to-bank payment in the US. It’s made via the ACH network, rather than going through the card networks such as Visa or Mastercard. There are two main categories of ACH payments namely, Direct Deposits and Direct Payments. Direct Deposit covers all kinds of deposit payments from businesses or government to a consumer. This includes payroll, employee expense reimbursement, government benefits, tax and other refunds, and annuities and interest payments. Direct Payment covers the use of funds for making payments, either by individuals or organizations. This type of ACH transaction is the primary focus of this guide - any reference to ACH payment, ACH transfer, or ACH transaction in this guide refers to Direct Payments, unless stated otherwise. Further, there are two main types of ACH transfers - ACH credits and ACH debits. They largely differ by how the funds are transferred between accounts - with ACH credits the funds are pushed into an account, while with ACH debits the funds are pulled out of an account. ACH debit is not an instant payment method. Payments may take more than 3 working days to appear in a bank account.

2. Real Time Gross Settlement (RTGS):

As the name suggests it is a fund transfer or securities transfer one bank to any other bank on a "real-time" and on a "gross" basis. Real time here means funds or securities settlements happening without any waiting period and gross here means the total funds being instructed by the customer are transferred. The RTGS transfers neither happen for small transactions nor for group or batch transactions it is always one-one transaction. RTGS are intermediated by the central banks of those countries. As a real-time gross settlement (RTGS) system for the United States and the U.S. dollar, the Federal Reserve Banks’ Fedwire® Funds Service plays a critical role in the implementation of United States monetary policy through the settlement of domestic money market transactions. The Fedwire Funds Service is also used for time-critical payments such as the settlement of commercial payments and financial market transactions, and for the funding of other systemically important financial market infrastructures. Similarly, at UK the CHAPS work on RTGS basis.

3. Netting:

Netting is also one of the ways of clearing transactions as RTGS and here too central banks take responsibility of clearing the payments. The RTGS is real time and one -one clearing system whereas in netting, the transactions often are queued in bundle or group at the central banks and only a net amount is settled by the central banks with originator banks and receiving banks. Meaning say if Bank A is eligible to receive $ 500 from Bank B and Bank B is eligible to receive $2000 from Bank A, the central bank will debit the net amount of $1500 ($2000-$500) from Bank A's Nostro account and Credit Nostro Account of Bank B. The NEFT (or National Electronic Fund Transfer) in India and United Kingdom's Bacs Payment Schemes Limited, which was previously known as the Bankers' Automated Clearing Services (BACS).

5. Know Your Customer

Banking Business is essentially relationship building. And, any relationship requires to know who is the person with whom the relationship is being built. It cannot be a short term or bye-bye relationship. Banks wants to retain its customers as long as possible. To do so, it has to know the details of its customer in full. This process is called “Know Your Customer” or KYC. KYC is a standard built in Banking systems to record and scrutiny its ongoing relationship with its customers.

Banks need to perform KYC when:

1. While establishing business relations also called New Business (/customer onboarding):

New Business onboarding is the first introduction of bank with its customers. Hence, banks want to collect as much as information possible from its customers so that it can assess a risk to its customer. Risk that the customer may use the banking resources to do fraud or money laundering or terrorist financing. The more the bank think the risk a customer profile carry’s the more the rating of the risk needs to be for the incoming customer. Risk of a customer profile is divided into low, medium and high risk. Initially, it has to rigorously work on collecting and evidencing the below elements while onboarding:

1. Identifying the customer followed by verifying that customer’s identity using reliable, independent source documents, data or information.

2. Identifying the beneficial owner, and taking reasonable measures to verify the identity of the beneficial owner through documentary evidences.

3. Identifying the controllers, and taking reasonable measures to verify the identity of the controllers through documentary evidences. The controllers usually are the entity controllers (such as directors) and account controllers the authorized signatories who can execute transactions on behalf of the customer.

4. Understanding the nature of business (or occupation for individuals).

5. Knowing the domicile of the customer (or country of citizenship for individuals) to understand the country risk.

6. Understanding the products and services offered to the customer and obtaining information on the purpose and intention to use such products.

7. Understanding the expected transactions in transactional accounts of the customer to anticipate value and volumes of transactions (helping to assess any deviation in future).

8. Know source of funds and/source of wealth of the customer anticipating the genuineness of sources.

9. Collect financials to understand customer business revenues and assets.

10. Collecting Associated party information who do business with the customer.

11. Understanding the Money Laundering Risks in the customer profile and recording them.

12. Check any aspects of the customer riskiness after the individuals and entities related to the customer have been screened against appropriate black lists loaded in the screening platforms (such as world check).

2. Change in Customer Profile:

While there is a change in customer profile such as change in constitution of the customer or customer opting for a new product (also called Trigger Event/Event Driven Review):

a. Partial due diligence: Conducting ongoing but limited due diligence on the certain request received. For example, if the request is for product addition, the contracting location, servicing location and booking location is required to be checked if there are any additional countries that have been added and accordingly additional requirements of such countries needs to be performed.

b. Full Due Diligence: Conducting ongoing full due diligence is required for example, if there is a change in constitution of the customer (say from LLC to a corporation), a full due diligence is required.

3. Periodic Refresh or Review:

a. Full Due Diligence: Conducting ongoing due diligence with full review of the customer profile is required when a customer profile is nearing its due date (e.g., a high-risk profile every year, a medium risk profile every three years and a low risk profile every five years). Usually, banks initiate Periodic reviews at least three months prior to the due date and try to close the requirements within this three-month window period. Any profile going beyond three months is required to be reported to AML Officer (AMLO) with reasons. If AMLO thinks, there are appropriate reasons for not conducting the Periodic Review, he/she can give extension (Example, in the pandemic season the personal documents of directors have not been obtained) or approve exception (Certification is not there on the personal document etc.). Where ever there is a change in the risk, additional due diligence needs to be performed (Example, a profile moved to High Risk from Medium or Low an enhanced due diligence will be required.)

b. Partial Due Diligence: Partial due diligence is required when Termination Letter is received but products are active. In such case, the due diligence is done as per the available documents, meaning a refresh of documents is not required. However, screening has to be re-performed for such profiles and elevation of risks needs to be checked.

c. Closure: A closure of profile is done when all the products in a customer profile are inactive and there are no balances or frugal balances (which can be ignores like $0.09) in the transaction products.

5.1. Building KYC Profile-CIP

The step of any KYC profile building process starts with knowing the minimum elements of Customer Identification Program which are:

I. Individuals:

  1. Name.

  2. Date of Birth

  3. Government Identification Number or Tax Identification Number (e.g., for United States W9).

  4. Address of the individual.

II. Entity:

  1. Name

  2. Date of Incorporation

  3. Government Identification Number or Employer Identification Number for United States (EIN number in W9).

  4. Address of the entity.

5.2. Building KYC Profile-Customer Type

A KYC officer must identify, the correct type of customer type, so that correct KYC checklist or Questionnaires are generated in the KYC Platform used by the banks.

The customer types are as given below:

1. Banks: The categories of banks that needs to be identified are Central Banks, Foreign Correspondent Banks, Commercial Banks, Mutuals such as Credit Unions and Building Societies, Savings Banks, Payment Banks, Internet only Banks and Offshore Banking Unit.

2. Organizations: The categories of Organizations are Trusts, Societies, Associations, Foundations, Non Government Organizations, Non Profit (/Not for Profit) Organizations, Charitable organizations, Cooperative Organizations, Professional Organizations and Clubs.

3. Partnerships: The categories of Partnership firms are General Partnerships, Limited Partnerships, Limited Liability Partnerships and Limited Liability Limited Partnerships.

4. Corporates: The categories of Corporates are, Private Corporates, government owned Corporates and Public Corporates.

5. Funds: The categories of Funds are, Hedge Funds, Private Equity Funds, Mutual Funds or SICAV’s, Business Development Companies, Blockers, REIT’s, OEIC and ICAV’s.

6. Government or Quasi Government Organizations: This category includes, Government organizations which are wholly owned and run by government and Quasi Government Organizations such as Museums.

7. Non-Operating Companies or Asset Holding Companies: The category includes, Holding companies, Private Investment Corporations, Personal Holding Companies, CDO’s and CLO’s, RMBS, CMBS and Private Investment Vehicles.

8. Individuals.

9. Sole Proprietorship.

10. Family offices (E.g., Hindu Undivided Family).

5.3. Building KYC Profile-NAIC's Code of SIC Code

The next important field is the identification of proper NAIC’s Code or SIC Codes. Let us understand what a NAIC or SIC codes are. The North American Industry Classification System (NAICS) is used by the United States, Canada, and Mexico to classify businesses by industry. Each business is classified into a six-digit NAICS code number based on the majority of activity at the business. The North American Industry Classification System or (NAICS) is the standard used by Federal statistical agencies in classifying business establishments for the purpose of collecting, analyzing, and publishing statistical data related to the U.S. business economy. The Banks maintaining KYC records, are also required to put in their contributions for collection of data by putting appropriate NAICS code for each of the new onboarding happening in the bank. The first two digits designate the economic sector, the third digit designates the subsector, the fourth digit designates the industry group, the fifth digit designates the NAICS industry, and the sixth digit designates the national industry. For Example, the NAICS code for a Commercial Bank is 522110.

The Standard Industrial Classification (SIC) is a system for classifying industries by a four-digit code. The SIC system is used by agencies in other countries, e.g., by the United Kingdom's Companies House.

5.4. Building KYC Profile-High Risk Industry Category or Designation

Not all banks may have this but, it is very important to identify High Risk Industry categorization. Banks based on this categorization decide whether or not to do any specialized due diligence (The answers to the questions which a general checklist or questionnaire does not cover). Examples of high-risk industry types are, Non-Profit organizations, Banks, Arms and Ammunition Industry, Charitable Organizations, Vehicle Sellers, Casinos, Travel agencies, Money Services Business etc. It is not mandatory that each entity profile has to be designated in terms of High-risk industry types. The High-risk types are default listed in the KYC Platforms in the banks. The High-risk industry type does not by default make a profile high risk. The High-risk industry categorization is also one of the components while calculating the risk profile of an entity.

5.5. Building KYC Profile-Customer Details

The general details of the customer type such as:

  1. Legal Name (if individual, as per the government ID and for entity as per the Certificate of Incorporation.)

  2. Physical address (Where the individual resides or entity is operational).

  3. Communication Address {Where the individual or entity wishes to obtain all couriers (such as physical bank statement) from bank}

  4. Government ID (such as say social security number for individuals; incorporation number).

  5. Tax identification number (such as at US W9 for individuals or entities).

  6. Domicile (Country of residence for individuals and domicile of the Entity meaning the country where it has been incorporated).

  7. Business Description (applicable to entities; a short essay of what is the business all about?). There should always be a consistency between Business description and the NAICS code selection.

  8. NAICs or SIC Code (for entities).

  9. Financials (Source of Wealth and Source of Funds for individuals and for entities details such as Assets and Revenue or Assets under Management for Funds.)

  10. FATCA and CRS details, (including GIIN number where applicable), available in the FATCA and CRS Declaration form of account opening form (for entities).

  11. MIFID Classification, applicable only for European entity onboarding (for entities).

  12. Regulation status or Listing status (for entities). This field determines whether the entity is eligible for CIP exempt or not though there are other indicators too.

* Note, no single document can fulfill two requirements.

5.6. Building KYC Profile-Products and Services

For individuals, the banking products and services offered includes but not limited to savings and checking accounts, mortgages, personal loans, debit or credit cards, and certificates of deposit.

At entity level, there are several products and services that customer requires. Each of the product carry a risk component. The risk of each of the product should be auto calculated by the KYC systems as this is a known detail in a bank. Each of the product should and must have broad category. This is helpful while reporting to regulators. Example, Issuing and confirming of letter of credit, Bank Guarantees should fall under broad category of Trade Finance or, The FATCA and CRS services should fall under Regulatory or Compliance Category. Credit Cards, Loan Syndicates etcetera should fall under broad category of Credit.

Some banks even have sub categories designed in Products especially the Global Banks for better reporting. Further, there are certain products which are transactional products such as Custody or ACH. Banks should perform Expected Versus Actual Analysis based on such products. This Expected Versus Actual Analysis is not required for non-transactional products.

Some of the products in banks for entities are:

  1. Treasury Services,

  2. Documentary Services (Letter of Credit or Bank Guarantees)

  3. Credit Services (Loans).

  4. Trade Finance.

  5. Project Finance and etc.

5.7. Building KYC Profile-Account Information

The KYC system of a bank should have account information as given below.

1. Types of Account: The type of account is what customer intends to open such as Savings account, Checking or Current account, Money Market Account, Fixed Deposit, Demat accounts or trading accounts.

2. Purpose of Account: the KYC systems should have mention of the purpose or details of usage of such accounts. The KYC officer should refer back such KYC forms, where the purpose of account is not mentioned.

3. Jurisdiction Details: The country details where transactions happen are collected for Cash, Check and Wire Transfers. During initial onboarding, these details are collected by the KYC officer through relationship manager which are likely countries or jurisdictions. However, during Periodic reviews of accounts, such details should be collected from the actual transactions that has happened in the customer account. Wherever required jurisdictions are added or deleted from the listings during periodic reviews.

4. Value and Volumes of Transactions: The details of expected transactions in each of cash, check and wire transfers are required to be collected during the new business onboarding. While periodic review the same should be compared to the actual transactions and wherever there is re-baselining (meaning changes occurred) are required to be noted in records. The re-baselining activities can contribute to change of risk profile of the customer.

5.8. Building KYC Profile-Enhanced Due Diligence

The KYC Officer is required to collect and record, the details of Enhanced due diligence questions, built in the questionnaires of Enhanced Due Diligence section in a KYC system of the bank.

Let us take the ‘bank’ as a customer type and check what can be the Enhanced Due Diligence questions.

Category 1. Business areas and ownership:

  1. What are the business areas applicable to your Bank? (Like, say Retail banking, Private banking, Wealth management, Commercial banking, Transaction banking, Investment banking, financial markets trading, Securities services or custody, Broker or Dealer, Multilateral development bank etc.)

  2. Does the bank have a significant (greater than 10 percent) offshore customer? If yes, provide the countries.

  3. What is the number of Employees at the bank?

  4. What is the Size of the bank?

  5. What are the Total Assets of the Bank?

Category 2. Products and services.

  1. Does your Bank offer domestic banks correspondent banking services?

  2. Does your Bank allow domestic bank clients to provide downstream relationships?

  3. Does your Bank have processes and procedures in place to identify downstream relationships for domestic banks?

  4. Does your Bank offer Foreign Banks correspondent banking services?

  5. Does your Bank allow downstream relationships with Foreign Banks?

  6. Does your Bank have processes and procedures in place to identify downstream relationships with Foreign Banks?

  7. Does your Bank offer regulated MSBs or MVTS correspondent banking services? Does your Bank allow downstream relationships with MSBs or MVTS?

  8. Does your Bank deal in Private banking business?

Category 3. AML or CFT questions.

  1. Does your Bank have a program that sets minimum AML, CFT and sanctions standards?

Category 4: Anti-Bribery and Corruption.

  1. Has your Bank documented policies and procedures consistent with applicable Anti-bribery and corruption regulations and requirements to (reasonably) prevent, detect and report bribery and corruption?

Category 5: List of Nostros.

  1. List all the Nostros that your bank is maintaining with other correspondent banks. Category 6: Downstream correspondent banking.

  2. Does your bank have downstream correspondent banking relations or nested accounts? Does your bank offer Payable through accounts?

The complexity of the enhanced due diligence increases with the complexity of the customer type.

5.9. Building KYC Profile-Identification and Verification

There is a difference between identification and verification. Identification means collecting the requisite information from documents for example, collection of ‘list of directors’ of an entity from say annual report. Verification means collection of personal documents of each of the directors with documentary proofs such as passport or driving license etc. Similarly, identification and verification is also required for individual accounts.

*Note: Identification and verification is not used separately in banks but, used as a combination called "ID & Va".

a. Identification and verification details that are required to be collected by a KYC officer of the bank for individuals are:

  1. Identity Proof (such as any Government issued cards).

  2. Address Proof (such as utility bills).

  3. DOB Proof

  4. Citizenship proof.

*Each of the ID&VA collected should be latest (say, utility bill within three months) or not expired.

b. Identification and verification details that are required to be collected by a KYC officer of the bank for entities are:

1. Constitutional Documents: There are various constitutional documents collected for different entity types. Example, constitutional documents for a corporate are Memorandum of association and Articles of Association, for trust it is the trust deed and say for a partnership, it is the partnership deed.

2. Certificate of Incorporation: The certificate of incorporation is a birth certificate of an entity having the details of the legal name and seal and signature of the registrars.

3. Controlling Party Information: The controlling parties are those entities or individuals, who control the onboarding entity such as directors or trustees or partners etc. The controlling parties if are entities, then complete drill down of ownership of such entities are required. The controlling parties if are individuals, their personal documents such as passports and address proofs are required to be collected. The personal identification should have minimum details like Name of the person, Nationality of the person, and unique identification number of the document presented such as say passport number.

There are two categories of controlling parties:

  1. Entity Controllers: Such as directors and Senior managers (also called C suit, who are, chairman, CEO, CFO and COO) for a corporate structure or trustees for trusts and general partners for limited partnerships.

  2. Account Controllers: The other set of people are those who are controllers of the accounts for transactional purposes. They are the authorized signatories. The KYC officer is required to collect the authorized signatories list (or ASL) from the entity which is getting on-boarded.

*Note that the details of account controllers are required only and only if there is at least one transactional product being used by the onboarding customer. Else, this is not a requirement.

5.10. Building KYC Profile- Beneficial Owners and Associated Third Parties

The beneficial owners are the owners of the onboarding entity. The beneficial owners can be entities as well as individuals. The beneficial owners who are individuals are called ‘Ultimate Beneficial Owners’ or UBO’s.

The KYC Officer should as per the risk categorization must drill down the entity structure till all ultimate beneficial owners are identified. If there are no UBO’s for any structure, the same should be noted in KYC profile of such customer with proper justifications and documentary evidences.

Commonly, the drill down requirements in banks are 25 percent or more for Low and Medium risk customers and 10% or more for high-risk customers, complex ownership structured entities, Private investment companies and Offshore Banking Units.

Note: Some countries like The Cayman Island domiciled or contracted (product contracted) entities are required to be drilled downed till 10% mandatorily.

Banks can exempt identification and verification for certain entities (called CIP exempt entities) such as banks which are regulated, publicly traded companies, regulated pension funds and government organizations.

Further, the KYC officer is also required to collect other associated parties for example, details of auditors, details of Prime brokers, details of custodian etc., based on the customer type as prescribed by the banks policies.

5.11. Building KYC Profile- Screening

When, all individuals and entities (including the on boarding entity) who have been recorded in the KYC system such as UBO’s or controlling parties or associated third parties are screened by banking software's such as World Check, Norkom, or RDC and PCR. Such screening software's will give matching results of individuals and entities of the onboarding entity against the list of blacklisted individuals or entities, or individuals who are PEP’s or, individuals or entities who have negative news.

The screening will usually result in identification of three major risks namely, sanctions risk, risk of Politically exposed person and individuals and entities with negative news. The job of the KYC officer is to carefully screen all the matching results and confirm whether the match is either True positive or false positive. False positive means, mismatch of information put up by the software and the individuals who have been screened. The mismatch can be of several types such as “Name Mismatch” or “Location Mismatch”.

The true positives are analyzed separately by the screening officers with the help of Banking AML officers, if required. The true positive hit of Politically exposed persons will trigger filling of PEP form by the KYC officer. Based on the PEP form AML officers give approvals and sometimes, they also suggest to change (or override) the risk of the customer.

The true positive hits of Negative news should be analyzed and be approved by AML officers. AML officers based on the severity of the news, may increase the risk profile attached to the customer or set it to default high risk.

The true positive hit of Sanctions requires a detailed sanctions relation analysis. Based on the analysis, the AML officers (specialized in sanctions) suggest two actions.

  1. Terminate the relation.

  2. Enhance the risk of the customer to default high risk.

5.12. Building KYC Profile- Risk Rating

Risk Rating are mostly built-in features available in the KYC systems in a bank. Some banks prefer calculating the same through XLS. Whatever the method used by the banks to calculate risks, the KYC officer should be aware of risk elements contributing the rating.

The elements which contribute to the risk rating are:

  1. Entity Type.

  2. High Risk Industry Designation.

  3. Risk of Products and services.

  4. Risks associated to Transactions.

  5. Jurisdictions where the on-boarding entity has relations and or, is domiciled.

  6. Negative News, PEP and Sanctions.

* Some Banks also take into account the number of years of business relations particular customer has with the bank (in banking Jargon since long).

Each of the element will be scored separately.

The bank also set the scores for example say, score between 1 to 3 to be low, score between 4 to 6 to be medium and score between 7 to 10 is high.

Let us calculate by taking an example of a corporate, as given below.

Entity Type is corporate and score is 5;

High risk industry designation is not applicable. Hence, the score is 0;

Risk associated with the product and services say, is 4;

Risks associated to Transactions say, is 0;

Jurisdictional scores say, is 3;

Negative News, PEP and Sanctions scores say, is 4.

The total score of this entity is (5+0 +4+0+3 +4) equals to 16. Average score is 16/6 = 2.6.

Hence, the risk of this corporate structure is low.

In the above example, if we increase the score of High-risk industry to say 8, the average score than becomes 4, which is a medium risk.

*Note: During Periodic Reviews, most of the banks also take into consideration the length of relationship as one of the factors to calculate risk score.

5.13. Building KYC Profile- AML Risk Summary

The AML risk summary will contain the details of all the AML risks identified during the onboarding process.

  1. Write about Entity type and its activities which may have a feel of risk. If there is no risk, write no risk.

  2. Mention about availability of high-risk products if any.

  3. Write about country risk of the entities domicile.

  4. Write if you have noticed any high-risk industry designation.

  5. Write about categories of FATCA and CRS.

  6. Write if any negative news or sanctions relation or PEPs are found during onboarding.

  7. Mention about the risk rating of the customer profile and why do you think it is justified.

  8. Write about any high-risk jurisdictions in the Transaction monitoring tab of KYC.

6. Blockades of Customer Identification Program

Banks should be more vigilant while dealing with below which can be blockades for effective Customer identification program. The front office and middle or back office must ask sufficient questions and be vigilant or alert always. Let us see each of the scenarios.

1. Walk-in Customers: In case of transactions carried out by a non-account-based customer, that is a walk-in customer, where the amount of transaction is equal to or exceeds threshold limits, whether conducted as a single transaction or several transactions that appear to be connected, the customer's identity and address should be verified.

If a bank has reason to believe that a customer is intentionally structuring a transaction into a series of transactions below the threshold levels, the bank should verify identity and address of the customer and also consider filing a suspicious transaction report.

2. Trust, Nominee or Fiduciary Accounts: There exists the possibility that trust, nominee or fiduciary accounts can be used to circumvent the customer identification procedures. Banks should determine whether the customer is acting on behalf of another person as trustee or nominee or any other intermediary. If so, banks should insist on receipt of satisfactory evidence of the identity of the intermediaries and of the persons on whose behalf they are acting, as also obtain details of the nature of the trust or other arrangements in place. While opening an account for a trust, banks should take reasonable precautions to verify the identity of the trustees and the settlors of trust (including any person settling assets into the trust), grantors, protectors, beneficiaries and signatories. Beneficiaries should be identified when they are defined. In the case of a 'foundation', steps should be taken to verify the founder managers or directors and the beneficiaries, if defined.

3. Accounts of Companies and Firms: Banks need to be vigilant against business entities being used by individuals as a ‘front’ for maintaining accounts with banks. Banks should examine the control structure of the entity, determine the source of funds and identify the natural persons who have a controlling interest and who comprise the management. These requirements may be moderated according to the risk perception example, in the case of a public company it will not be necessary to identify all the shareholders.

4. Client Accounts Opened by Professional Intermediaries: We will two scenarios of professional intermediaries.

  1. When the bank has knowledge or reason to believe that the client account opened by a professional intermediary is on behalf of a single client, that client must be identified. Banks may have additional due diligence for 'pooled' accounts managed by professional intermediaries on behalf of entities like mutual funds, pension funds or other types of funds. Banks should have sufficient controls in place where it maintains 'pooled' accounts managed by lawyers or chartered accountants or stockbrokers for funds held 'on deposit' or 'in escrow' for a range of clients. Where the banks rely on the 'customer due diligence' (CDD) done by an intermediary, they should satisfy themselves that the intermediary is regulated and supervised and has adequate systems in place to comply with the KYC requirements. It should be understood that the ultimate responsibility for knowing the customer lies with the bank.

  2. Banks should not allow opening and or holding of an account on behalf of a clients by professional intermediaries, like Lawyers and Chartered Accountants, etc., who are unable to disclose true identity of the owner of the account or funds due to any professional obligation of customer confidentiality.

5. Accounts of Politically Exposed Persons resident outside banks jurisdictions:

  1. Banks should verify the identity of the person and seek information about the sources of funds before accepting the PEP as a customer.

  2. The decision to open an account for a PEP should be taken at a senior level which should be clearly spelt out in Customer Acceptance Policy.

  3. Banks should also subject such PEP accounts to enhanced monitoring on an ongoing basis. The above norms may also be applied to the accounts of the family members or close relatives of PEPs.

  4. In the event of an existing customer or the beneficial owner of an existing account, subsequently becoming a PEP, banks should obtain senior management approval to continue the business relationship and subject the account to the CDD measures as applicable to the customers of PEP category including enhanced monitoring on an ongoing basis. These instructions are also applicable to accounts where a PEP is the ultimate beneficial owner.

  5. Further, banks should have appropriate ongoing risk management procedures for identifying and applying enhanced CDD to PEPs, customers who are close relatives of PEPs, and accounts of which PEP is the ultimate beneficial owner.

6. Accounts of Non-Face-to-Face Customers:

With the introduction of telephone and electronic banking, increasingly accounts are being opened by banks for customers without the need for the customer to visit the bank branch. In the case of non-face to-face customers, apart from applying the usual customer identification procedures, there must be specific and adequate procedures to mitigate the higher risk involved.

Certification of all the documents presented should be insisted upon and, if necessary, additional documents may be called for. In such cases, banks may also require the first payment to be affected through the customer's account with another bank which, in turn, adheres to similar KYC standards.

In the case of cross-border customers, there is the additional difficulty of matching the customer with the documentation and the bank may have to rely on third party certification or introduction. In such cases, it must be ensured that the third-party is a regulated and supervised entity and has adequate KYC systems in place.

7. Know Your Compliance

The purpose of the compliance function in a bank is to assist the bank in managing its compliance risk. The compliance risk is also called integrity risk. Hence, the compliance is not a function or a department or a group of people, but cumulative responsibility of all the staff who are working in a bank. However, the watch dog is still the compliance department.

Compliance is Second Line of Defense in a Bank as they are responsible for providing guidance and oversight to the first line of defense (the operations). A compliance function is always independent of any department as they are responsible to mitigate risks related to insiders trading, data breaches, misconduct, fraud, money laundering and other forms of non-compliance. The heart of the compliance function is reporting. All the malfunctions and failure of internal controls whether or not leading to loss is required to be reported to the chief compliance officer in the bank (who is the head of compliance function). The chief compliance officer in turn reports to senior managers in the bank. The reporting should have the details of malfunctions and internal control failures with the details of their mitigants too. The compliance function is also so important since this department should be vigilant of all the regulatory changes in the world and implement changes to the banks’ internal policies and procedures.

An enterprise-wide compliance program is what runs the banks compliance function. Through this program, the bank can look, at across business lines and its activities as a whole. Also, how activities are aligned and functioning to avoid the regulatory risks. The compliance function guided by this program, is responsible for identifying and managing the compliance risk through all levels of the organization. Whenever breaches are identified compliance function will jump into the picture and will take appropriate remedial or disciplinary action.

7.1. Common Compliance Risks

  1. False Claims, such as medical claims and travel reimbursements.

  2. Bribery, such as granting a banking contract (like vendor selection for food or technology or other services).

  3. Fraud, such as debiting banking accounts (such as suspense accounts) and crediting self-account use dead people accounts or dormant accounts for illegal purposes (say Smurfing).

  4. Theft, such as lending money to corporates without proper collateral, granting lower interest rates (even though there are no such provisions in the rule books), using trading money for overnight self-investments etc.

  5. Privacy breaches, such as sending bank statement of one customer to other.

  6. Cyber-crime attacks, such as banks servers have been hacked.

  7. No proper Business Continuity Plan in place, such as Work from home available but not split operations (meaning back-up of operations available in another city or location not nearby to the main city of operations).

  8. Leak of sensitive information, such as say a bank is arranging an IPO for a client and the information is leaked to brokers.

  9. Data compromise or breaches, such as crucial banking data leaked and sold to a private web publisher.

  10. Process risks, such as deviation from the standard process.

  11. Workplace health and safety breaches say specific health and safety protocols not followed like in pandemic situation the desks are not sanitized in the intervals between hot desking.

  12. Direct Losses and notional losses, direct losses say a customer’s payment wrongly sent to another customer who has withdrawn the funds and notional losses, say a wire transfer sent with wrong instructions but has been recovered from the correspondent bank.

  13. Insider trading, say a syndication of loan information is leaked to outside investor.

  14. Behavior breaches, say a senior employee is using abusive language to a group of people during meetings and general conversations.

  15. Customer review breaches, say all the KYC information not collected as per the KYC norms.

  16. Exception breaches, say exception has been given for an account opening who is a potential sanctions match.

  17. Payments and communication breaches, say payments have been made to wrong beneficiary or banking confidential information has been sent to different customers than that of the customers who are eligible to receive it.

7.2. Compliance Risk Mitigations

  1. The Compliance Manual: The Compliance Manual itself is the biggest risk mitigant as it consists of guidelines that needs to be strictly implemented across bank.

  2. Risk Assessment: Compliance team should regularly review the internal controls, the key risk indicators and audit & self-test recommendations to prepare course corrections. The compliance risk team also require from time to time assess the business process maps, procedures and standard operating procedures.

  3. Vendor Assessment: Check for proper bid documentation prior to the deal, contract documentations and actual work being done by Vendor, Purchase orders are available etc.

  4. Compliance Manual Training: Compliance head should ensure that proper staff training is done by the compliance officers explaining key areas of the compliance training.

  5. Regulations (Up-to-date knowledge): The compliance team should be observant for all the regulatory changes happening in the world and wherever, required updates are cascaded to the relevant departments of the changes.

  6. Culture of Ethics: The compliance team is responsible to ensure that all staff work with ethical integrity and follow the organizational culture.

  7. Whistleblower or Speak Up: The compliance team should ensure that proper platforms are available for staff to whistle-blow or speak up for any breaches that are happening. Also, these conversations are required to be kept anonymous.

  8. Data Backups: The compliance team is responsible to see that sufficient data backup, (a copy of computer data taken and stored elsewhere (other servers or on cloud or disks) so that it may be used to restore the original after a data loss event) is available at bank.

  9. Robust transaction monitoring systems: The compliance team is responsible for the right functioning of transaction monitoring function as it is the only way a bank can detect money laundering or fraud or financing of terrorism. The compliance team should do a test from time to time that all the possible combinations of suspicions are being filtered by the surveillance systems of the bank.

  10. KYC and ongoing due diligence: The compliance should at least every quarter refresh the policy guidelines as they are the frontline who are aware of change of regulations and its their duty to ensure all regulatory changes are incorporated in the KYC and ongoing due diligence of the bank.

8. Online Banking

When you think of online banking, you probably think about a computer (either a desktop or laptop or a tablet), a three or four step security process and then an interface that lets you view the balance of your various bank accounts and credit cards, whilst permitting you to transfer money and pay bills. But the broader definition of online banking should really be any platform that lets you move or otherwise manage your financial affairs digitally.

In today's fast changing world of technological progress, more and more people are turning to any option that makes their life run more smoothly and affords them more convenience in handling day to day activities. One such activity, managing their bank account, is made easier through the use of their computer and the internet. Known as internet or online banking, this has become a widespread and very popular way of handling banking duties. The concept of internet banking was formed back in the early 80's. Its actual use didn't come into play on a very widespread basis until the mid-90's. Nowadays it is the exception to find a bank that does not offer online banking options to its customers. There are many banks, in fact, existing only on the internet. Use of internet banking can allow the customer to handle almost all their banking transactions online. They are able to access their account balances, past and present transactions, transfer funds from one account to another, pay bills, look up checks, reorder checks, stop payments, complete loan applications, and make contact through messaging with bank staff members. One of the most appealing parts of it all is being able to do these things 24 hours a day, seven days a week, and without leaving their homes. Customers will also realize a savings in time, effort, petrol and fees for parking when they do their banking through the internet. They won't have to worry about making a frenzied dash to try to get to the bank before closing time. All Banks have firewalls and security features on their sites that will guarantee complete privacy and that account information is visible only to the customer. Basically, the process of using internet banking is pretty much the same with most banks. The customer sets up access to their online account by either choosing or being assigned a username and password. Once the customer has logged in using their username and password, they will have access to their account information and will be able to see any transactions that have taken place as well as deposits, charges, and transactions that are in progress. This information can be printed off so that a written copy is available for records or in case proof is needed to verify something later on. When the customer is finished, he or she needs to be sure to log off properly so that their information is safe and can't be accessed by anyone else. Let us see some of the services offered online detailed below which have changes lives of several people who once only believed in brick-and-mortar Banking.

8.1. Online Banking-Certain List of Services

  • View Account Details/Balance

  • Funds transfer

  • Download Account Statement

  • Request for Stop Cheque Payment

  • Request for Cheque book

  • Apply for Gift Card

  • Create Fixed Deposit

  • View Credit Card Details

  • Pay Credit Card Bills

  • Reward Points

  • Buy Gold/Silver

  • View Broker Account Details

  • View Portfolio Summary/Snapshot

  • Apply for IPO Online

  • Loan A/C Details

  • Service requests

  • Mail Box

  • Personal Profile Details

  • Register for e-statement

  • Register for SMS Banking

  • Recharge Mobile

  • Request for Demand Draft

  • Pay utility Bills

  • Pay Credit Card Bills

  • Pay Income Tax

8.2. Digital Banking

Digital Banking is the automation of traditional banking services. Digital banking enables a bank’s customers to access banking products and services via an electronic/online platform. Digital banking means to digitize all of the banking operations and substitute the bank’s physical presence with an everlasting online presence, eliminating a consumer’s need to visit a branch. Some of the Digital Banking Services are:

1. Personal Finance Planning:

Personal finance in its simplicity is managing money. Banks have utilized this new buzz word and most of them have successfully bought banking, budgeting, insurance, mortgage, investments, retirement planning, tax and estate planning online.

2. Advance Options:

Adding to personal finance planning, customers have now the ability to advance features online due to digitization such as clearance of cheques through RDC (Remote Deposit Capture), paying bills, managing credit cards, payments through virtual wallets, option for sweep accounts, provision of emergency fund based on customer profile, Overdraft or other kinds of credit lines under one single app or website which is accessible through any of customer’s electronic devises including a mobile. Some banks have gone a little further to include loan calculators, premium calculators, financial planning tools like mutual fund investments to their apps and websites. If the customer is HNI, they can do even more such as say investments overseas through mobile apps.

9. Transaction Monitoring

1. Introduction:

a. Purpose of transaction monitoring:

The purpose of transaction monitoring is to alert Banks that certain transactional activities appear to be unusual or suspicious for further examination and investigation.

b. Scope of coverage:

For a transaction monitoring system to be effective, the scope and complexity of the monitoring process should be determined on a risk-sensitive basis. This means that a Bank may need to undertake different levels of monitoring within its different business units depending on factors such as the activities of the business unit, its customer base and the country in which the unit operates. The basic purpose of having a strong AML transaction monitoring system is to identify and protect the institution from any transactions that may lead to money laundering and terrorist financing and result in the Banks filing relevant Suspicious Activity Reports (SARs).

2. Suspicious Activity Report:

A suspicious activity report or (SAR) is not an accusation, but a report, by which financial institutions alert Financial Intelligence Unit of that country that an irregular activity or activities have been found and may be lined to possible money laundering, Terrorist Financing or related crimes. The financial intelligence units collect various such SAR reports from Financial Institutions, do further analysis and disseminate the information to Law enforcement agencies to investigate further and take appropriate action as per land laws of that country. In US, a SAR is required to be filed within 30 days of detection of such transactions leading to suspicion. If more time is required for investigation, the financial institutions get an additional 30 days.

3. Currency Transaction Report (CTR):

Currency Transaction Report forms a part of Transaction reporting process. CTR is a report that documents a physical currency transaction exceeding a certain monetary threshold. For example, in United States, a CTR form should be filed by a financial institution for a day transaction such as deposit or withdrawal equivalent to $10000 and above. A CTR also take into consideration multiple currency transactions that occur in one day and exceed the required reporting threshold.

4. KYC and Transaction monitoring relation:

Understanding the Bank’s customers and updating their risk profiles on a risk-sensitive basis are important elements of an effective transaction monitoring system. The better the Bank knows its customers the greater will be its ability to identify discrepancies between a given transaction and the customer’s risk profile. This in turn will provide the Bank with critical information to assess whether unusual or suspicious activities exist. In addition, a good understanding of the Banks customers is a prerequisite for applying differentiated monitoring for customers with different levels of AML/CFT risks.

9.1. Transaction Monitoring-KYC Components

An effective monitoring system comprises the following two components: -

(i) Monitoring performed by staff who deal directly with customers (e.g., relationship managers) or process customer transactions (e.g., frontline staff).

(ii) Regular reviews of past transactions to detect unusual activities.

Monitoring of past transactions: Effective monitoring requires the production of periodic MIS reports and/or alerts and the establishment of proper review procedures to ensure that customer transactions are captured in the Bank monitoring efforts on a risk-sensitive basis. Periodic transaction monitoring reports and/or alerts should at the minimum cover the following transactions: cash transactions, wire transfers, cheque transactions, loan payments and prepayments and reactivation of dormant accounts followed by unusually large or frequent transactions.

Identification of suspicious transactions: To determine whether a transaction or activity is unusual or suspicious, an effective transaction monitoring system will include procedures to evaluate not only the current transaction of the customer but also the pattern of transactions and the transaction flow. The current transaction will be compared with the past transaction patterns and risk profile of the customer. In addition, reference to known money laundering methods identified in typology studies undertaken by local or international AML/CFT bodies should be made as far as practicable.

9.2. Management of Suspicious Transaction

A monitoring system is effective only if suspicious transactions identified by the system are carefully examined and investigated; follow-up action taken is tracked and proper audit trails are maintained for inspection by auditors. It is therefore important that proper policies and procedures on transaction monitoring are developed and maintained. Specifically, the procedures should clearly set out the responsibilities of individual departments (e.g., Business Departments and Compliance department) involved in transaction monitoring. Effective monitoring may necessitate the automation of certain parts of the monitoring process. The appropriate degree of automation will vary from institution to institution and is dependent on the scale, nature, and complexity of the Bank business. Rules-based automated monitoring systems are capable of identifying unusual activities based on a set of parameters determined by the Bank. These rules can be customized over time with regard to changes in the Bank business and the latest money laundering and terrorist financing methods.

10. Credit Cards

A credit card is a plastic card with a magnetic stripe that holds a machine readable code. The card gives the convenience to purchase our needs (such as goods in supermarkets, Petrol in Petrol Stations etc., where Credit Card machine has been installed). Bank based on card holders account history and credit worthiness sets a limit on the card. The user can use amount up to the limit set on the card. One can use the credit card for purchases as well withdraw cash from ATM’s in case of emergencies.

a. Advantage of Credit Card:

When you use your credit card on merchant outlet or online for buying something you get a grace period which is called an interest free credit period. You have to pay back to the bank within the grace period. You are enjoying interest free credit within this grace period. Usually, the grace period is given for 45 days.

b. Shortcoming of Credit Card:

You will be levied with say an interest of 2.5% or more per month as per the issuer bank norms in case if you are not repaying the credit used within the grace period. A late fee charge will also attract if you are unable to pay within the billing date. Presently in India, banks can charge late fees only in the next billing cycle following a missed payment.

c. Payment options for Credit Card:

Bank usually gives two options for making payment a) Minimum balance amount or b) full amount. If you are paying minimum balance amount or any higher amount which is less than the full payment within the billing cycle, interest is still levied on the remaining outstanding amount.

d. Cash Withdrawal from Credit Card:

When you withdraw cash from credit card, right from the day one you have to pay interest which ranges between 24 to 48 percent per annum on that advance amount that you have withdrawn.

e. Shortcoming of Cash Withdrawals:

You have two choices to pay this amount, either minimum balance amount or full amount. If you are unable to pay minimum amount due, you have to pay late payment charges which maybe 30 percent of the outstanding balance. Apart from that if you are not paying the full amount, you are paying that interest, which is 24-28 percent per annum. Also, the grace period which is applicable for your other transactions, if the full amount is not repaid before due date, then you do not get any grace period and you have to pay interest on the new purchase from the day one.

f. Conversion into installments:

For the convenience of customers, bank also gives option of converting the loaned money to pay back in installment. You just need to pick your mobile and inform your banks call center that you need to convert the purchases made into installments.

10.1. Players of Credit Cards

1. Cardholder:

A cardholder is someone who obtains the credit card from a card issuing bank. They then present that card to merchants as payment for goods or services.

2. Merchant:

A merchant is any business that maintains a merchant account that enables them to accept credit cards as payment from customers (cardholders) for goods or services provided.

3. Acquiring Bank (Merchant Bank):

An acquiring bank is a registered member of the card associations (Visa and MasterCard). An acquiring bank is often referred to as a merchant bank because they contract with merchants to create and maintain accounts that allow the business to accept credit and debit cards, (i.e. merchant accounts). Acquiring banks provide merchants with equipment and software to accept cards, promotional materials, customer service and other necessary aspects involved in card acceptance. The acquiring bank also deposits funds from credit card sales into a merchant’s account.

4. Issuing Bank (Cardholder Bank):

An issuing bank issues credit cards to consumers. The issuing bank is also a member of the card associations (Visa and MasterCard).

5. Card Associations (Visa and MasterCard):

Visa and MasterCard aren’t banks and they don’t issue credit cards or merchant accounts. Instead, they act as a custodian and clearing house for their respective card brand.

The primary responsibilities of the Card Association are to govern the members of their associations, including interchange fees and qualification guidelines, act as the arbiter between issuing and acquiring banks, maintain and improve the card network and their brand, and, of course, make a profit. That last one has become even more important now that Visa and MasterCard are public companies. Visa uses their VisaNet network to transmit data between association members, and MasterCard uses their Banknet network.

6. Payment Processors: Payment processors company communicates and relays information from customer’s credit card to both merchants bank and banking customer’s bank.

10.2. Credit Card Transaction Processing

a. Credit Card Authorization:

A cardholder begins a credit card transaction by presenting his or her card to a merchant as payment for goods or services. The merchant uses their credit card machine, software or gateway to transmit the cardholder’s information and the details of the transaction to their acquiring bank, or the bank’s processor. The acquiring bank (or its processor) captures the transaction information and routes it through the appropriate card network to the cardholder’s issuing bank to be approved or declined. MasterCard transaction information is routed between issuing and acquiring banks through MasterCard’s Banknet network. Visa transactions are routed through Visa’s VisaNet network. The credit card issuer receives the transaction information from the acquiring bank (or its processor) through Banknet or VisaNet and responds by approving or declining the transaction after checking to ensure, among other things, that the transaction information is valid, the cardholder has sufficient balance to make the purchase and that the account is in good standing. The card issuer sends a response code back through the appropriate network to the acquiring bank (or its processor). The response code reaches the merchant’s terminal, software or gateway and is stored in a batch file awaiting settlement.

b. Credit Card Clearing and Settlement:

A merchant begins the settlement process by sending their batch of approved authorizations to their acquiring bank (or the bank’s processor). Authorization batches are typically sent at the close of each business day. The acquiring bank (or its processor) reconciles and transmits the batch of authorizations through interchange via the appropriate card association’s network (VisaNet or Banknet).The acquiring bank also deposits funds from sales into the merchant’s account via the automated clearinghouse (ACH) and debits its merchant’s account for processing fees either monthly, daily or both depending on the merchant’s processing agreement. The card association debits the issuing bank’s account and credits the acquiring bank’s account for the net amount of the authorizations which is gross receipts less interchange and network fees. The card issuing bank essentially pays the acquiring bank for its cardholder’s purchases. The cardholder is responsible for repaying his or her issuing bank for the purchase and any accrued interest and fees associate with the card agreement.

10.3. Credit Card Balance Transfer

A credit card balance transfer is the transfer of the balance (the money owed) in a credit card account to an account held at another credit card company.

1. Overview:

This process is actively encouraged by almost all credit card issuers as a means to attract new customers. Such an arrangement is attractive to the consumer because the new bank or credit card issuer will offer incentives such as a low interest or interest-free period, loyalty points or some such other device or combination of incentives. It is also attractive to the credit card company which uses this process to gain that new customer and of course detrimental to the prior credit card company.

An order of payments for every credit card specifies which balance(s) will be paid first. In nearly all cases payments apply to lowest-rate balances first - highest-rate last. Any balance under a teaser rate or fixed rate will be paid off sooner than any purchases or cash advances, which usually have the highest Annual percentage, rate (APR). By avoiding making purchases or taking cash advances altogether, the borrower can ensure they maintain the full benefits of the original balance transfer.

The process is extremely fast and can be concluded within a matter of hours in some cases. Automated services exist to help facilitate such balance transfers. Other similar services do exist, but they may not be free to use. Decisions on whether or not a card holder decides to transfer one’s credit card balance depend on a combination of three things:

a. Normal rate (Prime):

This is the normal interest rate on a credit card. The lower this rate, the better for the consumer (less cost of capital) and the worse for the credit card company (less profit). The transferred balance will be subject to same rate as the card's purchase (merchandise) rate. Occasionally the same terms will apply as to purchases that may be interest free until the payment date for the statement on which the transfer appears. More often such transferred balances move immediately to the full purchase rate. Credit card balance transfers involving transfer of funds from a high APR credit card or a store card (which often has high APR) to a low- or zero-APR credit card will result in a reduction in monthly outflows for the card holder.

b. Teaser rate:

A teaser rate is an especially low rate that a credit card company offers to new customers to entice them to transfer their balance. It is a lure for catching new customers. With an extra low initial rate, transferring customers have lower than normal interest which ultimately means lower initial monthly outflows of money to the credit card company. The 0% rate is the most common when a new credit card account is opened.

This teaser rate is temporary. The duration of teaser rates vary from (typically) 6 to 15 months, after which the remaining transferred balance is subject to purchase rate.

c. Fixed Life of Loan rate offer:

A low rate that is fixed until the transferred balance is paid in full. This type of offer is usually guaranteed only as long as the account is current (see Teaser rate). Whilst this allows the borrower to save interest on their existing debts without the need to initiate further balance transfers once a teaser rate offer expires, the fixed offer rate is higher than the limited duration teaser rate offer. (Typically, it may be between one-half and two-thirds of a fixed rate, fixed term personal loan)

2. Transaction fee

A transaction fee is a commission earned by the credit card company earning one's business and is a direct transfer of money from the user to the credit card company. This varies from (typically) 1-5% of transferred debt - sometimes with a maximum capped amount, but otherwise an uncapped percentage.

3. Balance transfer arbitrage:

Because transferring to new credit cards often results in lowered rates, one can repeatedly make use of this process to save quite a lot of money over the years. The idea is to switch to a new credit card the moment the previous one's teaser rate has expired. There is a caveat: the credit card contract may include a clause preventing the credit card holder from transferring the balance a second time within a certain period of time. There may also be ways of extending the teaser rate or at least preventing it from disappearing prematurely. This method is often advocated by personal finance self-help sources.

To deter this type of behavior, many credit card issuers have stopped offering no fee balance transfers.

10.4. Debit Card

A Debit card is similar in size to a credit card. The difference between debit card and credit card is that in debit card, you are not asking for a loan from the bank instead you are using your own money in your Savings Account for making purchases at merchant outlets or online. You can withdraw money from ATM’s through Debit Card. Your savings account gets directly debited when you do a transaction at ATM. Debit cards, which are linked to customers’ Savings accounts at banks, come in two forms: signature-based and PIN-based. Both capabilities typically reside on the same card. Signature-based debit transactions (also known as “offline debit”) tend to be routed through either MasterCard or Visa, much like a credit card transaction. These transactions are debited from a customer’s account about two days after the purchase – similar to credit transactions. The process uses two separate messages for authorization, clearing and settlement. Consumers typically do not pay a fee for signature-based transactions, and the logo for the association is on the front of the card.

Signature debit transactions (which occur on the Visa and MasterCard networks) and credit transactions follow essentially the same processing route. As mentioned previously, the process uses two separate messages for

1. Authorization.

2. Clearing and Settlement.

  1. The consumer selects a card for payment. The cardholder data is entered into the merchant’s payment system, which could be the point-of-sale (POS) terminal/software or an e-commerce website.

  2. The card data is sent to an acquirer/payment processor, whose job it is to route the data through the payments system for processing. With e-commerce transactions, a “gateway” provider may provide the link from the merchant’s website to the acquirer.

  3. The acquirer/processor sends the data to the payment brand (e.g. Visa, MasterCard, American Express, etc.) who forward it to the issuing bank/issuing bank processor

  4. The issuing bank/processor verifies that the card is legitimate, not reported lost or stolen, and that the account has the appropriate amount of credit/funds available to pay for the transaction.

  5. If so, the issuer generates an authorization number and routes this number back to the card brand. With the authorization, the issuing bank agrees to fund the purchase on the consumer’s behalf.

  6. The card brand forwards the authorization code back to the acquirer/processor.

  7. The acquirer/processor sends the authorization code back to the merchant.

  8. The merchant concludes the sale with the customer.

Further, PIN-based debit (also known as “online debit”) requires the consumer to enter a personal identification number at the point of sale (POS); the transaction is then routed through electronic-funds-transfer (EFT) networks such as STAR®, Pulse®, NYCE®, MAC®, and SHAZAM® (Check for logo’s at the back of your Cards). These all require users to enter a PIN for both ATM and POS transactions. PIN transactions also can be run through EFT networks at MasterCard (Maestro®) and Visa (Interlink®). The PIN-based format uses a single message for authorization, clearing and settlement. Unlike signature debit, the customer’s savings account is debited immediately, much like an ATM withdrawal. PIN-based transactions have an additional step if the merchant and issuing banks belong to different EFT networks. If so, the transaction passes through the acquiring processor, then on to a gateway processor that acts on behalf of a national EFT network, such as Visa’s Interlink or MasterCard’s Maestro. These national networks act as a bridge between the regional ones. With the gateway processor, the transaction is then routed the same way to the issuing bank’s processor, then on to the issuing bank for authorization.

10.6. Debit Card Vs. Credit Card

Credit Card

Credit cards are lines of credit. When you use a credit card, the issuer puts money toward the transaction. This is a loan you are expected to pay back in full.

Not required to be connected to a Savings/Current account.

Monthly Bills are generated for transactions.

Application process is difficult, depending on one's credit score and other details.

The credit limit is set by the credit issuer. Limits increase or stay the same over time as a borrower's creditworthiness changes.

If a credit card bill is not paid in full, interest is charged on outstanding balance.

Credit cards are not very secured if stolen can be used to transact online.

Some credit card companies allow overdrawing amount over the maximum credit line with a fee. However, Overdraft fee is low.

PIN may or may not be required for Credit Cards.

Debit Card

Any time you use a debit card to buy something, money is deducted from your account. With a debit card, you can really only spend the money you have.

Required to be connected to Current or Savings Account.

No Bills are generated for transactions.

Application process is easy, with no barrier to receiving a

debit card.

Debit card limit is the amount available in the bank account connected to the card.

No interest is charged as no money is borrowed.

A PIN makes them secure so long as no one steals the card number and PIN, and as long as you don't lose the card itself.

Banks allow overdrawing amount over the account limit. However, Overdraft fees are high.

Debit Card transactions cannot be done without a PIN.

11. Specialized Services-Underwriting

Underwriters are found in banking, insurance, and stock markets. Underwriters in the banking sector perform the role of finding credit worthiness of a potential customer and whether or not to offer a loan. This is done by analyzing, the credit history of the customer through their past financial records. The loans world-wide are gauged on the following parameters by the banks:

  1. Condition – how resilient the borrower’s business (/occupation) is to changes in economic conjuncture, volatility, sharp price swings and other similar cases;

  2. Cash flow – borrower’s liquidity indicators;

  3. Collateral – credit securitization and its type;

  4. Capital – borrower’s own capital, as well as assets and types of assets;

  5. Character – borrower’s individual qualities.

Factors affecting loan underwriting:

1. Credit Score:

In an international practice many companies develop credit scores based upon various contents that range differently. The table below illustrates companies and their score ranges:

  1. Equifax: Equifax Credit Score ranges from 280 to 850.

  2. Experian: Experian Plus Score ranges from 330 to 830.

  3. TransUnion: Trans Risk New Account Score ranges from 300 to 850.

  4. Fair Isaac Corporation (FICO): FICO score ranges from 300 to 850.

  5. CRIF: CRIF Score ranging from 400 to 600.

  6. Shufa: Schufa-Vollauskunft ranging from 100 to 600.

  7. CreditInfo: Credit Info Predictor 250 to 900.

The US produced VantageScore is also widely used in addition to the above. The VantageScore LLC is considered to be the partner of the Equifax, Experian and TransUnion. The Company develops a final unique score using specific models and advanced databases to gather aggregate credit data from three credit reporting organizations (Equifax, Experian, TransUnion). VantageScore ranges between 501- 990.

Although parameters of credit data stipulate the formation of credit scores are basically similar, their weight varies in terms of impact on the score. The scoring depends on the following:

  1. Payment history.

  2. Debt amount.

  3. Length of credit history.

  4. New loans.

  5. Types of loans.

Each of the above parameters are given as % and total score is arrived. For example say, Payment history covers 35%, Debt amount covers 30%, Length of credit history covers 15%, New loans cover 10% and Types of loans cover 10%.

1. Payment history: Payment history includes the borrower’s payment manner on all credits, the number of delinquencies on all overdue credit liabilities, and overdue amount, as well as other acts of public responsibility (seizure of salary, litigations, other outstanding debt etc.) and their amounts.

2. Debt amount: Debt amount analyzes aggregate outstanding amount of active loan debts, the number of active loan accounts, the ratio to used credit lines and the credit line limit.

3. Length of credit history considers the following 2 factors:

i. age of the oldest credit account;

ii. average age of all accounts.

It is possible to get a good score with a short credit history. However, in practice the ‘antiquity’ of the credit history has an upward effect on the score.

4. New loans cover: This indicator is affected both by the number of newly obtained loans and the number of credit enquiries credit institutions maintained on him to evaluate borrower’s financial standing. This parameter allows for the following indicators:

  • number of loan requests made to credit institutions in the recent date;

  • number of loans obtained in the recent date;

  • time passed since the last loan request made to credit institutions;

  • time passed since the time of the last loan.

5. Types of loans cover: A credit file with different loan products has a positive effect on the score. It is rational to balance between revolving debts (credit cards, credit lines) and the types of debt with equal installments (car loans, mortgage loans etc.) to get a high score.

2. Income:

Whether the customer owns a corporation, run a sole proprietorship, or draw income from full-time or part-time employment, underwriters want to make sure that the customer can make consistent, on-time monthly payments. Hence, the second factor income comes into picture. Let’s check on each of the scenarios:

  1. Salaried Employees: If customer draw a salary an underwriter will calculate the income by taking customers current yearly salary and breaking it down to a per-month basis.

  2. Hourly Employees: To calculate the income of an employee paid on an hourly basis, underwriters use the average number of hours worked per pay period and multiply it by the hourly rate. Based on that number, they will arrive at a monthly income amount.

  3. Overtime and Bonuses: Generally, underwriters will take the income earned from bonuses or overtime in the past two years and average it out. If the amount earned from overtime or bonuses is declining, the underwriter will use the most conservative calculation to determine customers monthly income.

  4. Sole Proprietor: To determine income of sole proprietor’s underwriter requires one- or two-year’s worth of tax returns. A sole proprietor’s income is based on his or her past one or two years of adjusted gross income.

  5. Corporations & LLC’s: If customer own an LLC or S corporation, usually such customer will have a combination income and corporate distributions which Underwriters considers and calculate these two types of income differently.

3. Current Debts and Liabilities:

The monthly EMI's (Monthly installments) shouldn’t be more than 30-35% of the monthly income.

4. Collaterals:

In case of secured loans such as home loans, underwriters check the collaterals value to ensure that it can be used to recover the loan amount in case of a default.

11.1. Specialized Services- Private Banking

Private banking is personalized financial and banking and advisory services offered to a bank's high net worth individuals. The main advantage of private banking is that a dedicated relationship manager is assigned to the customer who takes care of customer’s banking and financial needs. Be it a simple thing like wanting cash delivered at customer’s doorstep, or complex financial planning for customer’s kids, or customers retirement, or drafting a will, or investing short-term surplus money, or buying a complex structured product - all of it is taken care of by the private banker. The services are not provided to all the customers of the bank but chosen one based on customers financial wealth.

Different banks have different norms for customers eligible for such services. Example, in United states, customers having at least $250,000 in investable assets are eligible to receive private banking services. The private banker helps customer in all banking and wealth management needs.

Private banking relationship start with the banker having regular scheduled meetings with the customer to understand their risk appetite, cash flows, needs and wants. Based on the details obtained from such meetings, the banker develops an asset-allocation ratio for the customer. Using this model, banker allocates the client's wealth into various assets such as equities, debt or real estate. Within each category, banker offers various products. Once a portfolio is structured and built, it is monitored on a monthly or quarterly basis. The private banker comes up with appropriate strategies to enhance returns from the portfolio. A private banker's role is to anticipate and understand client needs and to help achieve customers immediate and long-term wealth goals.

Private bankers at different banks don’t necessarily offer the same services. But the following products and services may be there in a banks private banking menu:

1. Preferential rates and pricing on deposit accounts:

Private banking clients may be eligible for higher interests on savings accounts, CDs/FD’s, interest-bearing checking accounts and money market accounts. They also may enjoy lower fees or waived fees on their accounts, and they may receive preferential pricing on loans and mortgages too.

2. Financial Planning:

A private banker can walk customer through major financial decisions, such as deciding how much house can be afforded or how and when to start saving for child’s future college expenses etc.

3. Investment advice and wealth management:

Private bankers will often give their clients advice on investing, including preventing tax-loss etc.

4. Estate planning:

Private bankers advise on how to set up customer’s estate plan, although some aspects of planning will require a visit to another professional, such as an estate attorney. Private bankers will often refer their clients to trusted professionals for that purpose.

5. Lending:

Customer looking to purchase a home, or a real asset or interested in investment property are assured loan from the bank but, with a condition of any collateral which can be the asset itself sometimes. The private banker sometimes provides leverage support meaning say, customer wants to invest 100 Million dollars on debt or equity, the banks can offer more 100 million dollars from there side as leveraged loan.

6. Tax planning:

The private banker will show investment opportunities to their client whish also save on their taxes.

11.2. Specialized Services- Bank Guarantee

A bank guarantee is a promise from a bank that if a particular borrower defaults on a loan, the bank will cover the loss. There are two types of guarantees a financial guarantee and a performance guarantee.

a. Financial Guarantee – This type of guarantee is given by the bank to the creditor on behalf of debtor that debtor will pay his or her debt to the creditor on time and in the event of default made by the debtor, bank will compensate to the credit for the loss due to failure of repayment by the debtor.

b. Performance Bank Guarantees– As the name suggests, Performance Bank Guarantees are the ones by which the issuing bank, also known as the Guarantor, guarantees the ability of the applicant to perform a contract, to the satisfaction of the beneficiary and on agreed time.

11.3. Specialized Services- Letter of Credit

The importer or buyer arranges for the issuing bank to open a Letter of Credit in favor of the exporter or seller. The issuing bank transmits the Letter of Credit (LC) to the advising bank (exporters banker who advises the exporter) which forwards it to the exporter. The exporter forwards the goods and documents to a freight forwarder. The freight forwarder dispatches the goods and submits documents to the advising bank. The advising bank checks documents for compliance with the Letter of Credit and pays the exporter. The importer’s account at the issuing bank is debited as per the arrangement between issuing bank and advising bank. The issuing bank releases documents to the importer to claim the goods from the carrier. In Letter of Credit transactions, banks deal in documents only, and not goods.

Letter of Credits can be issued as revocable or irrevocable. Most LC’s are irrevocable, which means they may not be changed or cancelled unless both the buyer and seller agree. If the LC does not mention whether it is revocable or irrevocable, it automatically defaults to irrevocable. Revocable LC’s are occasionally used between parent companies and their subsidiaries conducting business across borders.

11.4. Specialized Services- Correspondent Banking

Correspondent banking is the services provided by one bank to another bank especially in foreign currency as the local bank (also called Respondent Bank) do not have any branches or physical presence in the other country where the other bank (Correspondent Bank) in that country is active. The primary services are payment services and documentary services related to trade. The other services that a local bank can avail with the correspondent bank are treasury management services, cash management services, custodial services, credit or financing services, wire transfers of funds, Cheque clearing, foreign exchange services, managing international investments, fixed deposits.

The Respondent bank to do payments and receive remittances in foreign currency opens an account (usually checking or current account) with the correspondent bank. In respondent bank's book such an account is called Nostro account and the same account in the books of correspondent bank is called Vostro account.

11.5. Specialized Services- Wealth Management

Wealth management services are provided to affluent customers who have wide businesses and cannot take out time for investments or time to manage their wealth. In short, wealth management is a branch of financial services dealing with the investment needs of affluent customers. Adding, Wealth management is more of a consultative process. It involves consultations with affluent customers, discussions on their financial needs and goals. The services include, planning wealth meaning ’grow while protecting the wealth earned’, tax planning meaning efficient investments in such products where tax payments may be avoided, estate planning, succession planning and other such services related to wealth. Certain salient features include:

1. Advisory Services: Banks often advise the client of investments which usually is certain Bips higher than what general banking products provide. They also provide leveraged loan (meaning banks provide its own money to the client giving greater returns for such investments to the customer).

2. Customised Products: Wealth management division usually comes up with individual plans which are tailored to client-specific needs.

3. Confidentiality: Wealth adivsers in the banks handle client sensitive information with full confidentiality.

4. Tax Planning: Specialized professionals in banks also provide tax planning for their customers as per the earnings and already accumulated wealth; helping the client to avoid paying more taxes.

5. Estate Planning: Estate planning allows an individual to decide exactly who will benefit from their estate, and to what extent. The Estate planners in the banks help its customers to plan the estate and avoid probate.

12. Sanctions

Sanctions are decisions taken by a country (Say United States or Russia) or international organizations (Say European Union or United Nations) that are part of efforts to protect national security interests, or to protect international law, or to defend against threats to international peace and security. These decisions include restrictions to trade, or travel, or ports or organizations or individuals or sectors.

Certain types of sanctions are:

a. Economic Sanctions: Economic sanctions is imposed on specific country or group of countries, organizations, or individuals(targets). Economic sanctions is used for achieving international compliance and abiding by international laws. These sanctions can be partial or complete prohibition of commerce and trade with the target.

b. Trade Sanctions: Trade sanctions are partial or complete prohibition of trade with a particular country or group of countries or a territory.

c. Military Sanctions: Military sanctions may include arms embargoes or the termination of military assistance or training.

d. Travel Bans: Prohibition of travelling to or travelling from a country, countries or territories.

e. Sectoral Sanctions: These sanctions apply to specific territory also called a sector or a region. Example, crimea region of Ukraine.

f. Sports Sanctions: Sport sanctions are intended to crush the morale of the general population of the target country. Sports sanctions were imposed as part of the international sanctions against Federal Republic of Yugoslavia, 1992–1995, enacted by UN Security Council by resolution 757.

12.1. Sanctions Program at a Bank

In order to avoid breaching sanctions, banks should have in place a compliance program based around a robust policy on sanctions and comprehensive systems to implement the policy effectively.

Such a program should include:

  1. Customer and transaction due diligence and screening against applicable financial sanctions target lists, including HM Treasury’s Consolidated List, the Iran List and OFAC’s SDN List.

  2. Have checks in place while dealing in trade finance that if imported goods are in any way restricted

  3. Maintaining a list of countries which are subject to wider embargoes and ensuring that equipment, good and services are not supplied to persons and entities in those countries, including via a third-party distributor or otherwise indirectly, unless an exemption applies.

  4. Training in policies and procedures; and

  5. Regular monitoring of transactions and periodic audits of sanctions compliance.

12.1. Iran Sanctions

Since Iran's nuclear programme became public in 2002, the UN, EU and several individual countries have imposed sanctions in an attempt to prevent it from developing military nuclear capability. Iran insists its nuclear activities are exclusively peaceful, but the world's nuclear watchdog has been unable to verify this.

Iran and world powers agreed an interim deal in 2013 which saw it gain around $7bn in sanctions relief in return for curbing uranium enrichment and giving UN inspectors better access to its facilities. World powers also committed to facilitate Iran's access to $4.2bn in restricted funds.

Several rounds of sanctions in recent years have targeted Iran's key energy and financial sectors, crippling its economy.

The UN sanctions include:

  • A ban on the supply of heavy weaponry and nuclear-related technology to Iran

  • A block on arms exports

  • An asset freeze on key individuals and companies.

The EU also imposed its own sanctions, among them:

  • Restrictions on trade in equipment which could be used for uranium enrichment

  • An asset freeze on a list of individuals and organisations that the EU believed were helping advance the nuclear programme, and a ban on them entering the EU

  • A ban on any transactions with Iranian banks and financial institutions

  • Ban on the import, purchase and transport of Iranian crude oil and natural gas - the EU had previously accounted for 20% of Iran's oil exports. European companies were also stopped from insuring Iranian oil shipments.

Japan and South Korea have also imposed sanctions similar to those of the EU.

As well as more recent sanctions aimed at Iran's financial, oil and petrochemical sectors, the US has imposed successive rounds of sanctions since the 1979 Tehran hostage crisis, citing what it says is Iran's support for international terrorism, human rights violations and refusal to co-operate with the IAEA. The US sanctions prohibit almost all trade with Iran, making some exceptions only for activity "intended to benefit the Iranian people", including the export of medical and agricultural equipment, humanitarian assistance and trade in "informational" materials such as films. However, US has announced lifting economic sanctions against Iran if Iran adhere to certain rules around its nuclear programme.

12.2. Cuba Sanctions

At the height of the Cold War, and following the Cuban government's nationalization of U.S. properties and its move toward adoption of a one-party system of government, the United States imposed an embargo on Cuba in 1960 and broke diplomatic relations in 1961. The details are as given below:

  1. Exporting To Cuba - Except for publications, other informational materials (such as CDs and works of art), certain donated food, and certain goods licensed for export or re-export by the U.S. Department of Commerce (such as medicine and medical supplies, food, and agricultural commodities), no products, technology, or services may be exported from the United States to Cuba, either directly or through third countries, such as Canada or Mexico.

  2. Importing Cuban-Origin Goods or Services - Goods or services of Cuban origin may not be imported into the United States either directly or through third countries, such as Canada or Mexico.

  1. Transactions Involving Property in which Cuba or a Cuban National Has An Interest - In addition to the prohibitions on exports to and imports from Cuba, the Regulations prohibit any person subject to U.S. jurisdiction from dealing in any property in which Cuba or a Cuban national has an interest.

  2. Specially Designated Nationals - The Regulations prohibit buying from or selling to Cuban nationals whether they are physically located on the island of Cuba or doing business elsewhere on behalf of Cuba. Individuals or organizations who act on behalf of Cuba anywhere in the world are considered by the U.S. Treasury Department to be “Specially Designated Nationals” of Cuba. A non-exhaustive list of their names is published in the Federal Register, an official publication of the U.S. Government.

  3. Accounts And Assets - There is a total freeze on Cuban assets, both governmental and private, and on financial dealings with Cuba; all property of Cuba, of Cuban nationals, and of Specially Designated Nationals of Cuba in the possession or control of persons subject to U.S. jurisdiction is “blocked.” Any property in which Cuba has an interest which comes into the United States or into the possession or control of persons subject to U.S. jurisdiction is automatically blocked by operation of law.

  4. Sending Gifts - Gift parcels may be sent or carried by an authorized traveler to an individual or to a religious, charitable, or educational organization in Cuba for the use of the recipient or of the recipient's immediate family (and not for resale), subject to the following limitations: the combined total domestic retail value of all items in the parcel must not exceed $200 (with the exception of donations of food, which are not so restricted); not more than one parcel may be sent or given by the same person in the U.S. to the same recipient in Cuba in any one calendar month; and the content must be limited to food, vitamins, seeds, medicines, medical supplies and devices, hospital supplies and equipment, equipment for the handicapped, clothing, personal hygiene items, veterinary medicines and supplies, fishing equipment and supplies, soap-making equipment, or certain radio equipment and batteries for such equipment.

  5. Cuba-Related Travel Transactions - Only persons whose travel falls into the categories discussed below may be authorized to spend money related to travel to, from, or within Cuba.

  • General license: The following categories of travellers are permitted to spend money for Cuban travel and to engage in other transactions directly incident to the purpose of their travel under a general license without the need to obtain special permission from the U.S. Treasury Department: Official Government Travellers, Persons regularly employed as journalists, Persons who are travelling to visit close relatives in Cuba in circumstances of humanitarian need, Full-time professionals whose travel transactions are directly related to professional research in their professional areas, Full-time professionals whose travel transactions are directly related to attendance at professional meetings or conferences in Cuba organized by an international professional organization, Amateur or semi-professional athletes or teams travelling to participate in Cuba in an athletic competition.

  • Specific licenses for educational institutions: Specific licenses authorizing travel transactions related to certain educational activities by any students or employees affiliated with a licensed academic institution may be issued by the Office of Foreign Assets Control.

  • Specific licenses for religious organizations: Specific licenses authorizing travel transactions related to religious activities by any individuals or groups affiliated with a religious organization may be issued by the Office of Foreign Assets Control.

  1. Sending or Carrying Money to Cuba - U.S. persons aged 18 or older may send to the household of any individual in Cuba “individual-to-household” cash remittances of up to $300 per household in any consecutive three-month period, provided that no member of the household is a senior-level Cuban government or senior-level Cuban communist party official.

  2. Estates and Safe Deposit Boxes - An estate becomes blocked whenever a Cuban national is an heir or is the deceased; money from a life insurance policy is blocked whenever the deceased is a Cuban resident.

  3. Payments for Overflights - Private and commercial aviators must obtain a specific license authorizing payments for overflight charges to Cuba.

On December 17, 2014, President Obama announced the beginning of a normalization process between the United States and Cuba, starting a new chapter in U.S.-Cuba relations. A major step in this process was reached on July 1, 2015, when President Obama announced the decision to re-establish diplomatic relations between the United States and Cuba, effective July 20, 2015 with the re-opening of embassies in both countries.

Absent a democratically-elected or transition government in Cuba, legislative action will be required to lift the embargo. The U.S. government is reaching out to the Cuban people by fostering increased travel access and people-to-people exchanges, encouraging the development of telecommunications and the internet, and creating opportunities for U.S. businesses to support the growth of Cuba’s nascent private sector. Through the opening of embassies, the United States is now able to engage more broadly across all sectors of Cuban society, including the government, civil society, and the general public.

The revised regulations are designed to empower the Cuban people and support the emerging Cuban private sector. These actions build upon previous Commerce regulatory revisions, and will ease restrictions on authorized travel, enhance the safety of Americans travelling to the country, and allow more business opportunities for the nascent Cuban private sector. These additional adjustments have the potential to stimulate long overdue economic reform across the country and improve the living standards of the Cuban people.

These measures will further facilitate travel to Cuba for authorized purposes; expand the telecommunications and internet-based services general licenses, including by authorizing certain persons subject to U.S. jurisdiction (which includes individuals and entities) to establish a business presence in Cuba, such as through subsidiaries or joint ventures; allow certain persons to establish a physical presence, such as an office or other facility, in Cuba to facilitate authorized transactions; allow certain persons to open and maintain bank accounts in Cuba to use for authorized purposes; authorize additional financial transactions, including those related to remittances; authorize all persons subject to U.S. jurisdiction to provide goods and services to Cuban nationals located outside of Cuba; and allow a number of other activities, including those related to legal services, imports of gifts, and educational activities. These amendments also implement certain technical and conforming changes. Cuba was also removed from the list of state sponsors of terrorism. However, the comprehensive restrictions still apply to Cuba.

In the first United Nations vote on a resolution condemning the U.S. embargo against Cuba since the two countries renewed diplomatic ties in July 2015, Cuba scored its biggest victory yet as the General Assembly voted 191-2 to adopt the resolution.

The European Union believes that the United States trade policy towards Cuba is fundamentally a bilateral issue. Notwithstanding, the European Union and its member States have been clearly expressing their opposition to the extraterritorial extension of the United States embargo, such as that contained in the Cuban Democracy Act of 1992 and the Helms-Burton Act of 1996.

12.3. North Korea Sanctions

The US and EU comply by the UN Resolution 2094 (2013) and earlier resolutions regarding restrictions (and bans) against North Korea on the following:

  • Travel and asset freezes on certain individuals involved in arms dealing and exports of goods and equipment related to ballistic missiles and other weapons.

  • Asset freezes of certain organizations involved in supporting activities towards arms and weapon dealings, as well as illegal trading activities.

  • Items, Materials, Equipment, Goods, and Technology (nuclear items, missile items, and chemical weapons list).

  • Luxury goods (jewellery, pearls, gems, precious, and semi-precious stones and precious metal, as well as transportation items like yachts, racing cars, and luxury automobiles).

The first EU sanction was imposed in 2006 in reaction to North Korea’s first test of a nuclear device. Currently, the European Union has autonomously banned provision of new DPRK bank notes and coins, any financial support which could be used for nuclear-related or weapons of mass destruction (WMD) program, and any new commitment towards DPRK in the form of concessional loans and financial assistance. There is a restriction on the issue and trade in certain bonds, use of EU airports, and establishment of subsidiaries or branches of DPRK banks. Moreover, there will be enhanced monitoring of banks in DPRK that work with EU financial institutions, as well as increased scrutiny of DPRK diplomats.

In addition to supporting the UN resolutions, the US has time and again imposed sanctions on North. The US, which has backed South Korea since the start of the Korean War, first imposed an economic embargo on the North in 1950. From 1988 to 2008, the US designated the DPRK government as state sponsor of terrorism. Though there are many sanctions in place against North Korea, the US has not levied any travel ban for US citizens, nor is there a ban on trade of basic goods (the trade volume is negligible though).

The Office of Foreign Assets Control’s (OFAC’s) current North Korea sanctions program began in 2008, when the President issued Executive Order (E.O.) 13466. In E.O. 13466, the President declared a national emergency to deal with the threat to the national security and foreign policy of the United States constituted by the current existence and risk of the proliferation of weapons-usable fissile material on the Korean Peninsula, and continued certain restrictions with respect to North Korea that previously had been imposed under the authority of the Trading With the Enemy Act (TWEA). Also in 2008, the President signed Proclamation 8271, terminating the application of TWEA authorities with respect to North Korea. Since 2008, the President has issued subsequent Executive orders expanding the 2008 national emergency and taking additional steps with respect to that emergency, including blocking the property of certain persons and prohibiting certain types of transactions.

12.4. Syria Sanctions

The EU has widened the criteria for including people in its sanctions regime against Syria in Council Regulation (EU) 2015/1828.

Previously, the regime targeted those responsible for violent repression of civilians or benefiting from / supporting the Syrian regime. In addition, it now also specifically targets:

1. Leading business people operating in Syria;

2. Members of the Assad or Makhlouf families;

3. Syrian Government Ministers in power after May 2011;

4. Members of the Syrian Armed Forces of the rank of “colonel” or higher in post after May 2011;

5. Members of the Syrian security and intelligence services in post after May 2011;

6. Members of regime-affiliated militias; and

7. People operating in the chemical weapons proliferation sector, and their associates.

United States Sanctions on Syria:

Syria has been subject to U.S. sanctions for several decades. The U.S. restrictive measures respond to a series of activities by the Syrian government that concern U.S. national security interests. The most notable of these concerns is Syria’s apparent support for terrorists groups, such as Hezbollah and Hamas. Other activities, including the Syrian government’s occupation of Lebanon, its intent to pursue weapons of mass destruction (WMDs) and missile programs, allegations of their involvement in the assassination of Lebanese Prime Minister Rafiq Hariri, and undermining of U.S. and international efforts with respect to the stabilization and reconstruction of Iraq, have resulted in additional sanctions.

Aim of these Sanctions:

The U.S. restrictive measures aim primarily to stop the Syrian government’s weapons proliferation, involvement in terrorist activities, and its ongoing widespread and systematic attacks on Syrian civilians. Among other things, the sanctions deprive the Syrian regime of financial revenues and materials that it uses to self-sustain and to prolong its violent campaigns against civilians.

The U.S. sanctions regime against Syria prohibits all foreign assistance to the country, as well as exports and re-exports of items on the U.S. Munitions List, all items on the Commerce Control List, and all other U.S. products except food and medicine. U.S. sanctions prohibit any financial transaction with the Syrian government and block all property of the Syrian government, its senior leaders, U.S. persons that support the Syrian government, and individuals and entities involved in the planning, sponsoring, organizing, or perpetrating of terrorist attacks.

12.4. Sudan Sanctions

Sanctions imposed on Sudan since late 90s have been partially relaxed since the establishment of the independent South Sudan. Some sanctions remain in force.

a. UN Sanctions:

The Security Council first imposed an arms embargo on all non-governmental entities and individuals, operating in Darfur on 30 July 2004 with the adoption of resolution 1556. The sanctions regime was modified and strengthened with the adoption of resolution 1591 (2005), which expanded the scope of arms embargo and imposed additional measures including a travel ban and assets freeze on individuals designated by the Committee. The enforcement of the arms embargo was further strengthened by resolution 1945 (2010) and updated by the resolution 2035 (2012). The sanctions measure currently in effect can be summarized as follows:

  • Arms embargo for parties acting in the Darfur region (otherwise allowed subject to confirmation that end user is not prohibited/sanctioned)

  • Travel ban - designated individuals are not allowed to visit or transit UN states

  • Assets freeze - of individuals and entities controlled by designated individuals

b. US Sanctions:

US first introduced sanctions against Sudan in November 1997 with the Executive Order 13067. They were further expanded in the Executive Order 13400 (blocking property of persons connected to conflict in the Darfur region).

A further Executive Order 13412 of 13 October 2006 introduced a country wide blocking of Government of Sudan (the regional government of South Sudan was later excluded).

All transactions by U.S. persons relating to Sudan's petroleum or petrochemical industries, including, but not limited to, oilfield services and oil or gas pipelines are prohibited. However, trade and humanitarian assistance are not prohibited in the exempt areas, provided that these activities do not involve Sudan's petroleum or petrochemical industries or any property or interests in property of the Government of Sudan.

Specific areas of Sudan are exempt from the prohibition: Southern Sudan, Southern Kordofan/Nuba Mountains State, Blue Nile State, Abyei, Darfur, and marginalized areas in and around Khartoum.

Financial transactions involving third country banks or non-SDN Sudanese banks located in the Specified Areas of Sudan are not prohibited and do not require authorization from OFAC, provided that: the transaction does not involve activities in the non-Specified Areas of Sudan, the Government of Sudan does not have an interest in the transaction, and the transaction is not related to Sudan's petroleum or petrochemical industries.

In addition OFAC has issued several general licenses with respect to Sudan:

  • Activities and transactions related to petroleum and petrochemical industries and related financial transactions & transhipment of goods, technology and services through Sudan to/from South Sudan and related financial transactions are allowed.

  • Since April 2013 certain academic and professional exchange activities between US and Sudan are allowed.

On 3 April 2014 the President signed a new Executive Order related to the situation in South Sudan. The Executive Order does not target the country of South Sudan, but rather targets those responsible for the conflict there, which has been marked by widespread violence and the obstruction of humanitarian operations. This Executive Order allows the United States to impose sanctions against any individual or entity that threatens the peace, stability, or security of South Sudan, commits human rights abuses against persons in South Sudan, expands or extends the conflict in South Sudan, or undermines democratic processes or institutions in South Sudan.

c. EU Sanctions:

In March 1994 the European Union imposed an arms embargo on Sudan in response to the civil in war in the southern part of the country (Council Decision 94/165/CFSP). In January and June 2004 the embargo was modified to also cover technical and financial assistance related to arms supplies.

In May 2005 the EU implemented the UN sanctions on Sudan related to the conflict in Darfur by merging them with the existing EU arms embargo on Sudan (including providing technical assistance, brokering services or other services related to military initiatives or manufacturing, maintenance and use of prohibited items). The arms embargo was also amended to allow assistance and supplies provided in support of implementation of the Comprehensive Peace Agreement between the Sudanese Government and the South Sudanese rebels, the Sudan People's Liberation Movement.

After South Sudan became independent, the EU in July 2011 amended the arms embargo to cover both Sudan and South Sudan by Council Decision 2011/423/CFSP. The supply of non-lethal military equipment and related assistance to support Security Sector Reform in South Sudan was exempted from the arms embargo.

On 7 May 2015 EU issued a new Council Regulation 2015/735 combining sanctions previously divided among several documents. It also opens for imposing further sanctions on persons obstructing political process in South Sudan or committing serious violations of human rights.

12.5. Russia Related Sanctions (Crimea Region of Ukraine)

a. EU Sanctions:

In response to the illegal annexation of Crimea and deliberate destabilisation of a neighbouring sovereign country, the EU has imposed restrictive measures against the Russian Federation.


The European Union is focusing its efforts on de-escalating the crisis in Ukraine. The EU calls on all sides to continue engaging in a meaningful and inclusive dialogue leading to a lasting solution; to protect the unity and territorial integrity of the country and to strive to ensure a stable, prosperous and democratic future for all Ukraine's citizens. The EU has also proposed to step-up its support for Ukraine's economic and political reforms.

An extraordinary meeting of the Council of the European Union on 3 March 2014 condemned the clear violation of Ukrainian sovereignty and territorial integrity by acts of aggression by the Russian armed forces as well as the authorisation given by the Federation Council of Russia on 1 March for the use of the armed forces on the territory of Ukraine. The EU called on Russia to immediately withdraw its armed forces to the areas of their permanent stationing, in accordance with the Agreement on the Status and Conditions of the Black Sea Fleet stationing on the territory of Ukraine of 1997.

In a statement of the Heads of State or Government following an extraordinary meeting on 6 March, the EU underlined that a solution to the crisis must be found through negotiations between the Governments of Ukraine and the Russian Federation, including through potential multilateral mechanisms.

Having first suspended bilateral talks with the Russian Federation on visa matters and discussions on the New (EU-Russia) Agreement as well as preparations for participation in the G8 Summit in Sochi, the EU also set out a second stage of further measures in the absence of de-escalatory steps and additional far-reaching consequences for EU-Russia relations in case of further destabilisation of the situation in Ukraine.

In the absence of de-escalatory steps by the Russian Federation, on 17 March 2014 the EU imposed the first travel bans and asset freezes against Russian and Ukrainian officials following Russia’s illegal annexation of Crimea. The EU strongly condemned Russia’s unprovoked violation of Ukrainian sovereignty and territorial integrity.

The EU believes a peaceful solution to the crisis should be found through negotiations between the Governments of Ukraine and the Russian Federation, including through potential multilateral mechanisms.

The EU also remains ready to reverse its decisions and reengage with Russia when it starts contributing actively and without ambiguities to finding a solution to the Ukrainian crisis.

Restrictions for Crimea and Sevastopol

As the EU does not recognise the annexation of Crimea and Sevastopol, the following restrictions have been imposed:

  1. The EU has adopted a prohibition on imports originating from Crimea and Sevastopol unless accompanied by a certificate of origin from the Ukrainian authorities.

  2. Investment in Crimea or Sevastopol is outlawed. Europeans and EU-based companies may no longer buy real estate or entities in Crimea, finance Crimean companies or supply related services.

  3. In addition, EU operators will no more be permitted to offer tourism services in Crimea or Sevastopol. In particular, European cruise ships may no more call at ports in the Crimean Peninsula, except in case of emergency. This applies to all ships owned or controlled by a European or flying the flag of a member state.

  4. It has also been prohibited to export certain goods and technology to Crimean companies or for use in Crimea. These concern the transport, telecommunications and energy sectors or the prospection, exploration and production of oil, gas and mineral resources.

  5. Technical assistance, brokering, construction or engineering services related to infrastructure in the same sectors must not be provided.

  6. Measures targeting sectoral cooperation and exchanges with Russia ("Economic" sanctions):

  7. EU nationals and companies may no longer buy or sell new bonds, equity or similar financial instruments with a maturity exceeding 30 days, issued by:

(1) Five major state-owned Russian banks, their subsidiaries outside the EU and those acting on their behalf or under their control.

(2) Three major Russia energy companies and Three major Russian defence companies.

  • Services related to the issuing of such financial instruments, e.g. brokering, are also prohibited.

  • EU nationals and companies may not provide loans to five major Russian state-owned banks.

  • Embargo on the import and export of arms and related material from/to Russia, covering all items on the EU common military list.

  • Prohibition on exports of dual use goods and technology for military use in Russia or to Russian military end-users, including all items in the EU list of dual use goods.

  • Export of dual use goods to nine mixed defence companies is also banned.

  • Exports of certain energy-related equipment and technology to Russia are subject to prior authorisation by competent authorities of Member States.

  • Export licenses will be denied if products are destined for deep water oil exploration and production, arctic oil exploration or production and shale oil projects in Russia.

  • Services necessary for deep water oil exploration and production, arctic oil exploration or production and shale oil projects in Russia may not be supplied, for instance drilling, well testing or logging services.

b. US Sanctions:

In response to the protracted crisis in Ukraine, the Obama administration authorized traditional and innovative economic sanctions against Russian and Ukrainian persons through Executive Orders 13660, 13661, 13662 and 13685.

In keeping with other traditional sanctions programs, the U.S. government has added dozens of Russian and Ukrainian entities and individuals to the Specially Designated Nationals and Blocked Persons List (SDN List) since March 2014. The SDN List details the specific targets of U.S. sanctions, and these traditional U.S. sanctions prohibit any transactions involving designated persons and U.S. persons or the territory of the United States.

In December 2014, the president also prohibited U.S. investment in or trade with the Crimean region. The recent sanctions against Crimea are comparable to other comprehensive sanctions programs the U.S. maintains against Sudan, Iran, Syria and Cuba. In July 2014, however, the U.S. government created an entirely new type of sanctions regime, the "sectoral sanctions," that aims to limit certain sectors of the Russian economy from gaining access to U.S. capital and debt markets, as well as U.S. technology and expertise in the energy sector.

On July 16, 2014, OFAC created a new Sectoral Sanctions Identifications (SSI) List pursuant to Executive Order 13662, which had authorized sanctions against certain sectors of the Russian economy, including the financial services, energy, mining, and defence and related materiel sectors.

Due Diligence of the Ownership Structure of Targeted Entities:

As with all U.S. sanctions, the Ukraine-related sanctions apply to any entity owned 50 percent or more by a sanctioned person. Based on recent guidance from OFAC, this rule now applies to aggregate ownership by sanctioned persons.

The individuals and companies designated under the Ukraine-related sanctions often have vast and sometimes non-transparent holdings throughout the world, meaning that businesses cannot simply screen counterparties' names against the OFAC lists.

They also must determine whether sanctioned persons directly or indirectly own — in the aggregate — 50 percent or more of their counterparties. As a result, due diligence of counterparties should go beyond only screening counterparty names against watch lists to include analyzing ownership structures.

13. Why banks fail?

Let us check on some of the major reasons why some banks miserably fail as given below:

  1. When it can't meet its financial obligations to creditors and depositors.

  2. When bank’s assets falls to below the market value of the bank’s liabilities

  3. When NPA (Non Performing Assets) are too high for a bank to handle.

  4. When, a banking company stake in a market (stock/bond/derivative/forex/commodity) is misfired.

  5. People have lost trust due to an event and depositors are in a rush to take back there funds from the bank.

  6. When there have been heavy fines levied by various regulators to the bank.

  7. Lack of Internal controls or non-availability of standards across bank and every branch is working in silo's.

13.1. Washington Mutual

Washington Mutual had more than 40,000 employees, 2,000 plus branch offices in 15 states. Its biggest customers were individuals and small businesses. Nearly 60 percent of its business came from retail banking and 21 percent came from credit cards. Only 14 percent were from home loans. A very good situation for the banks to survive.

Washington Mutual wanted to expand. During expansion, it did not think of location where it was acquiring branches and made its expansion rapidly in every location it could. Most of these locations were low-income individuals. This resulted in too many subprime mortgages to buyers who could afford it.

Housing prices hadn't fallen in decades in United States. But in 2006, home values across the United States started falling. By the end of 2007, many loans were more than 100 percent of the home's value. Even though Washington Mutual had tried to be conservative. But when housing prices fell…’

By August 2007 the secondary market for mortgage-backed securities collapsed. Like many other banks, Washington Mutual could not resell these mortgages. Falling home prices meant they were more than the houses were worth. The bank couldn't raise cash.

By September 2008, Lehman Brothers went bankrupt leading to panicked depositors who started withdrawing funds and most of Mutual Washington’s savings and checking accounts balances diminished It diminished to such a low level that the Federal Deposit Insurance Corporation (FDIC) said the bank had insufficient funds to conduct day-to-day business. The U.S. government started looking for buyers who could purchase Washington Mutual as government knew that Washington Mutual was a moderate bank to bail out.

The reasons for failure:

1. Rapid expansion.

2. Subprime Mortgages.

3. Situation of the economy.

13.2. Barings Bank

Barings Bank was a British merchant bank based in London, and one of England's oldest merchant banks after Berenberg Bank. It was founded in 1762 by Francis Baring, a British-born member of the German-British Baring family of merchants and bankers.

Nick Leeson was, the bank’s then 28-year-old head of derivatives in Singapore. He had made vast sums for the bank in previous years, at one stage accounting for 10% of its entire profits. This gave Nick Leeson a freedom on trading desk, there have been no trade surveillance systems with a whole bunch of triggers continuously looking at what kind of activity he is engaged in, and red flagging anything that seems potentially violative of internal policies or regulatory requirements. Also, Leeson was so much deep into the bank that he could manipulate internal accounting systems and misrepresent his losses and falsify trading records. At that point of time in 90’s, typically banks did not have robust governance, risk management and compliance programs with independent committees and senior executives responsible for their oversight.

Leeson’s assignment in Singapore was to execute “arbitrage” trade, generating small profits from buying and selling futures contracts on the Japanese Nikkei 225 in both the Osaka Securities Exchange and the Singapore International Monetary Exchange. However, rather than initiating concurrent trades to capitalize on small differences in pricing between the two markets, he retained the contracts in the hope of creating much larger profits by betting on the rise of the underlying Nikkei index. The downturn in the Japanese market following the Kobe earthquake on January 17, 1995 rapidly unraveled his unhedged positions. Leeson's losses accounted for £827 million, twice Barings's available trading capital, and after a failed bailout attempt the bank declared bankruptcy in February 1995.

The reasons for failure:

1. Allowing unrestricted trade to a single trader.

2. Lack of governance and oversight can bring a stable bank to exit.

3. Lack of Internal record and reporting governance.

13.3. State Bank of Victoria

The State Bank of Victoria was an Australian bank that existed from 1842 until 1990. It was year 1984, the chief executive of the State Bank of Victoria was Bill Moyle. He made the best decision of his life, to sell the State Bank's 26% interest in Tricontinental-a merchant bank.

Mitsui and Credit Lyonnais were both seeking Australian banking licences in Australia and were potential bidders for Tricontinental. Mitsui called upon Touche Ross to survey the acquisition.

The Touche Ross report revealed that:

  1. Tricontinental had several major client groups whose loans constitute a major portion of the company's portfolio.

  2. A significant amount of total loans is provided to the Jewish community, and in loans for property development.

  3. There are a number of loans which have been in arrears for some time and which have not been closed because of concern that action may endanger the underlying security.

  4. Information on loans, particularly those loans in arrears, is not always completely documented on the files and significant reliance must be placed on senior staff.

Mitsui withdrew and Tricontinental could have suffered severe consequences, so Bill Moyle switched from being a seller to a buyer.

On March 20, 1985, Moyle went to the then Victorian Treasurer, Rob Jolly, and explained that the bank was prepared to buy all of Tricontinental. Jolly expressed surprise at Mitsui's decision but agreed that the State Bank stepping in was the "proper course in the circumstances".

Moyle wanted the Tricontinental board to include State Bank and Tricontinental executives, who would report to the full State Bank board. He believed the State Bank divisional heads would then be able to exercise direct control over functional areas of Tricontinental. In other words, Moyle would control it.

The Commonwealth Government's decision to increase interest rates in 1989 brought about the deep recession that put pressure on those financial institutions that were heavily exposed to the property market. Ironically, it was the venerable government-owned State Bank of Victoria that failed. The massive losses resulting from the grossly irresponsible lending of its merchant bank subsidiary, Tricontinental, were too great for the parent to absorb without government support. The besieged State Government agreed to sell the SBV to the Commonwealth Bank of Australia at a loss in 1990.

Reasons for Failure:

1. Concentration risk meaning the majority lending was done to a group of borrowers.

2. Poor Recording practices.

3. Bad debts should be identified early and such loans should get closed.

13.4. Bank of Credit and Commerce International

The Bank of Credit and Commerce International (BCCI) was an international bank founded in 1972 by Agha Hasan Abedi, a Pakistani financier. The bank was registered in Luxembourg with head offices in Karachi and London. A decade after opening, BCCI had over 400 branches in 78 countries and assets in excess of US$20 billion, making it the seventh largest private bank in the world. Abedi, a prolific banker, had previously set up the United Bank Limited in Pakistan in 1959 sponsored by Saigols. Preceding the nationalization of the United Bank in 1974, he sought to create a new supranational banking entity which is BCCI.

BCCI expanded rapidly in the 1970s, pursuing long-term asset growth over profits, seeking high-net-worth individuals and regular large deposits. The company itself divided into BCCI Holdings with the bank under that splitting into BCCI SA (Luxembourg) and BCCI Overseas (Grand Cayman). BCCI also acquired parallel banks through acquisitions: buying the Banque de Commerce et Placements (BCP) of Geneva in 1976, and creating KIFCO (Kuwait International Finance Company), Credit & Finance Corporation Ltd, and a series of Cayman-based companies held together as ICIC (International Credit and Investment Company Overseas, International Credit and Commerce [Overseas], etc.). Overall, BCCI expanded from 19 branches in five countries in 1973 to 27 branches in 1974 and 108 branches by 1976, with assets growing from $200 million to $1.6 billion.

Unlike any ordinary bank, BCCI was from its earliest days was made up of multiplying layers of entities, related to one another through an impenetrable series of holding companies, affiliates, subsidiaries, banks-within-banks, insider dealings and nominee relationships. By fracturing corporate structure, record keeping, regulatory review, and audits, the complex BCCI family of entities created by Abedi was able to evade ordinary legal restrictions on the movement of capital and goods as a matter of daily practice and routine. In creating BCCI as a vehicle fundamentally free of government control, Abedi developed in BCCI an ideal mechanism for facilitating illicit activity by others, including such activity by officials of many of the governments whose laws BCCI was breaking.

BCCI's criminality included fraud by BCCI and BCCI customers involving billions of dollars; money laundering in Europe, Africa, Asia, and the Americas; BCCI's bribery of officials in most of those locations; support of terrorism, arms trafficking, and the sale of nuclear technologies; the commission and facilitation of income tax evasion, smuggling, and illegal immigration; illicit purchases of banks and real estate; and a panoply of financial crimes limited only by the imagination of its officers and customers. Among BCCI's principal mechanisms for committing crimes were its use of shell corporations and bank confidentiality and secrecy havens; layering of its corporate structure; its use of frontmen and nominees, guarantees and buy-back arrangements; back-to-back financial documentation among BCCI controlled entities, kick-backs and bribes, the intimidation of witnesses, and the retention of well-placed insiders to discourage governmental action.

In 1977, BCCI developed a plan to infiltrate the U.S. market through secretly purchasing U.S. banks while opening branch offices of BCCI throughout the U.S., and eventually merging the institutions. BCCI had significant difficulties implementing this strategy due to regulatory barriers in the United States designed to insure accountability. Despite these barriers, which delayed BCCI's entry, BCCI was ultimately successful in acquiring four banks, operating in seven states and the District of Colombia, with no jurisdiction successfully preventing BCCI from infiltrating it.

The techniques used by BCCI in the United States had been previously perfected by BCCI, and were used in BCCI's acquisitions of banks in a number of Third World countries and in Europe. These included purchasing banks through nominees, and arranging to have its activities shielded by prestigious lawyers, accountants, and public relations firms on the one hand, and politically well-connected agents on the other. These techniques were essential to BCCI's success in the United States, because without them, BCCI would have been stopped by regulators from gaining an interest in any U.S. bank. As it was, regulatory suspicion towards BCCI required the bank to deceive regulators in collusion with nominees including the heads of state of several foreign emirates, key political and intelligence figures from the Middle East, and entities controlled by the most important bank and banker in the Middle East.

BCCI's decision to divide its operations between two auditors, neither of whom had the right to audit all BCCI operations, was a significant mechanism by which BCCI was able to hide its frauds during its early years. For more than a decade, neither of BCCI's auditors objected to this practice. BCCI provided loans and financial benefits to some of its auditors, whose acceptance of these benefits creates an appearance of impropriety, based on the possibility that such benefits could in theory affect the independent judgment of the auditors involved. These benefits included loans to two Price Waterhouse partnerships in the Caribbean. In addition, there are serious questions concerning the acceptance of payments and possibly housing from BCCI or its affiliates by Price Waterhouse partners in the Grand Caymans, and possible acceptance of favors provided by BCCI officials to certain persons affiliated with the firm.

BCCI became the focus of a massive regulatory battle in 1991, and, on 5 July of that year, customs and bank regulators in seven countries raided and locked down records of its branch offices.

Reasons for Failure:

1. Encouraging money laundering.

2. Support to criminals.

3. Helping Fraudsters.

13.5. Herstatt Bank

Herstatt Bank was a privately owned bank in the German city of Cologne. Herstatt Bank was founded in 1955 by Ivan David Herstatt, with financial assistance from Herbert Quandt (a German industrialist), Emil Bührle (an arms manufacturer, art collector) and Hans Gerling (Head of the Europe’s Largest Insurance Gerling Konzern).

Herstatt got into trouble because of its large and risky foreign exchange business. In September 1973, Herstatt became over-indebted as the bank suffered losses four times, its own capital. The losses resulted from an unanticipated appreciation of the dollar.

For some time, Herstatt had speculated on a depreciation of the dollar. Only late in 1973, did the foreign exchange department change its strategy. The strategy of the bank to speculate on the appreciation of the dollar worked until mid-January 1974, but then the direction of the dollar movement changed again.

The mistrust of other banks aggravated Herstatt’s problems. In March 1974, a special audit authorised by the Federal Banking Supervisory Office (BAKred) discovered that Herstatt’s open exchange positions amounted to DM 2 billion, eighty times the bank’s limit of DM 25 million. The foreign exchange risk was thus three times as large as the amount of its capital.

The special audit prompted the management of the bank to close its open foreign exchange positions. When the severity of the situation became obvious, the failure of the bank could not be avoided. In June 1974, Herstatt’s losses on its foreign exchange operations amounted to DM 470 million. On 26 June 1974, BAKred withdrew Herstatt's licence to conduct banking activities. It became obvious that the bank's assets, amounting to DM 1 billion, were more than offset by its DM 2.2 billion liabilities.

Herstatt got into trouble because of its large and risky foreign exchange business. In September 1973, Herstatt became over-indebted as the bank suffered losses four times, its own capital. The losses resulted from an unanticipated appreciation of the dollar. For some time, Herstatt had speculated on a depreciation of the dollar. Only late in1973, did the foreign exchange department change its strategy. The strategy of the bank to speculate on the appreciation of the dollar worked until mid-January 1974, but then the direction of the dollar movement changed again. The mistrust of other banks aggravated Herstatt’s problems. In March 1974, a special audit authorised by the Federal Banking Supervisory Office (BAKred) discovered that Herstatt’s open exchange positions amounted to DM 2 billion, eighty times the banks limit of DM 25 million. The foreign exchange risk was thus three times as large as the amount of its capital. The special audit prompted the management of the bank to close its open foreign exchange positions. When the severity of the situation became obvious, the failure of the bank could not be avoided. In June 1974, Herstatt’s losses on its foreign exchange operations amounted to DM 470 million. On 26 June 1974, BAKred withdrew Herstatt's licence to conduct banking activities. It became obvious that the bank's assets, amounting to DM 1 billion, were more than offset by its DM 2.2 billion liabilities.

The cause of Herstatt crisis took place shortly after the collapse of the Bretton Woods System in1973. The bank had a high concentration of activities in the area of foreign trade payments. Under the Bretton Woods System, where exchange rates were fixed, this area of business tended to carry little risk. In an environment of floating exchange rates, this area of business was fraught with much higher risks.

The Herstatt crisis is well known in international finance because of ‘Herstatt risk’. Herstatt risk refers to risk arising from the time delivery lag between two currencies. Since Herstatt was declared bankrupt at the end of the business day, many banks still had foreign exchange contracts with Herstatt for settlement on that date. Many of those banks were experiencing significant losses. Hence, Herstatt risk represented operational risk for those banks which were exposed to the default of Herstatt. But, Herstatt risk was not a reason for the Herstatt crisis. In the end, its forecasts concerning the dollar proved to be wrong. Additionally, open positions exceeded considerably the limit of DM 25 million. The management of the bank significantly underestimated the risks that free-floating currencies carried.

Reasons for Failure:

1. The business model did not change as per the changing circumstances.

2. The Forex is a sensitive market, measures were not taken accordingly.

3. Forecasts was not managed properly.

13.5. Continental Illinois National Bank & Trust Co.

Continental Illinois can be traced back to two Chicago banks, the Commercial National Bank, founded during the American Civil War, and the Continental National Bank, founded in 1883. In 1910, the two banks merged to form the Continental & Commercial National Bank of Chicago with $175 million in deposits – a large bank at the time. In 1932 the name was changed to the Continental Illinois National Bank & Trust Co.

The bank, created by merger in 1910, had conservative roots, but its management implemented a rapid-growth strategy in the late 1970s. By 1981, it had become the largest commercial and industrial lender in the United States (FDIC 1997, 236). In 1982, it became clear that the bank had made some risky investments. Regulations at the time prohibited banks and bank holding companies from branching and owning banks across state lines, which led many of them to purchase loans from banks in other states. Continental Illinois had purchased $1 billion in speculative energy-related loans from Oklahoma-based Penn Square Bank, loans that originated from the 1970s oil and gas exploration boom (FDIC 1997, 241). Penn Square Bank failed in July 1982, highlighting Continental Illinois’s exposure to losses. Continental Illinois had also invested in developing countries, which experienced a debt crisis brought on by Mexico’s default in August 1982. These events caused investors to re-examine the bank’s risk-pricing and lending practices during its high-growth period. The bank took actions to stabilize its balance sheet in 1982 and 1983. But in the first quarter of 1984 the bank posted that its nonperforming loans had suddenly increased by $400 million to a total of $2.3 billion (FDIC 1997, 243).

Reasons for Failure:

1. Before acquisition, the economic conditions were not considered.

2. Too much of concentration on speculative products.

3. Risky investments.

13.6. Almena State Bank

On October 23, 2020, the Kansas Office of the State Bank Commissioner (OSBC) closed Almena State Bank (ASB) and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. ASB was a state-chartered, non-member bank that the FDIC insured in 1936. The bank operated two offices in Almena and Norton, Kansas. ASB was wholly owned by Almena Investments, LLC, a one-bank holding company. Former Chairman of the Board of Directors (Board), Shad Chandler, and his wife, Director Amy Chandler, jointly controlled 59 percent of the outstanding shares of the bank. According to the FDIC’s Division of Finance, the estimated loss to the Deposit Insurance Fund (DIF) was $18 million or 27 percent of the bank’s $69 million in total assets.

Based on our review of FDIC documents, ASB’s failure occurred because of a Board that did not provide adequate corporate governance or management oversight. The Board’s performance and management were considered to be critically deficient. Chairman Chandler was considered by examiners to be a “dominant official” and substantially influenced the bank’s policies and practices. According to FDIC examiners, in 2014 and thereafter, Chairman Chandler led an aggressive growth strategy that focused on originating large government guaranteed loans, largely funded through liquid assets and higher cost, wholesale funds. Examiners also found the Board and bank management, however, lacked the requisite skills and experience to ensure appropriate loan underwriting and credit administration, and sufficient levels of liquidity and capital. As a result, beginning in 2018, ASB experienced significant asset quality problems, eroding the bank’s capital and threatening its continued viability.

Reasons for Failure:

1. Lack of Corporate Governance.

2. Lack of Skill and experience for loan administration.

14. Systemically Important Banks (SIBs)

A systemically important bank (SIB) is a bank, whose failure might trigger a financial crisis not only in the home country but, other countries too where it is operating or has exposure. They are colloquially referred to as "too big to fail".

At present, there is no such thing as a global regulator. Likewise, there is no such thing as global insolvency, global bankruptcy, or the legal requirement for a global bail out. Each legal entity is treated separately. Each country is responsible for containing a financial crisis that starts in their country from spreading across borders. It was observed during every global financial crisis that problems faced by certain large and highly interconnected bank hampered the orderly functioning of the financial system of the world, which in turn, negatively impacted the real economy of several countries.

Government intervention is a must to ensure financial stability in all jurisdictions reducing the probability of failure of SIBs and the impact of the failure of these banks. Also, the continued functioning of Systemically Important Banks (SIBs) is critical for the uninterrupted availability of essential banking services to the real economy.

14.1. Assessment Methodology

In October 2010, the Financial Stability Board (FSB) recommended that all member countries needed to have in place a framework to reduce risks attributable to Systemically Important Financial Institutions (SIFIs) in their jurisdictions. The FSB asked the Basel Committee on Banking Supervision (BCBS) to develop an assessment methodology comprising both quantitative and qualitative indicators to assess the systemic importance of Global SIFIs (G-SIFIs). The BCBS has developed a methodology for assessing the systemic importance of G-SIBs.

The methodology is based on an indicator-based measurement approach. The indicators capture different aspects that generate negative externalities, and make a bank systemically important and its survival critical for the stability of the financial system. The selected indicators are:


Global (cross-jurisdictional) activity,


Lack of substitutability (financial institution’s infrastructure), and

Complexity of the G-SIBs.

The methodology gives an equal weight of 20% to each of the five categories of systemic importance indicators. Except the size category, the BCBS has identified multiple indicators in each of the other four categories, with each indicator equally weighted within its category. That is, where there are two indicators in a category, each indicator is given a weight of 10%; where there are three, the indicators are each weighted 6.67% (i.e. 20/3). For each bank, the score for a particular indicator is calculated by dividing the individual bank amount (expressed in EUR) by the aggregate amount for the indicator summed across all banks in the sample.

The banks with score (produced by the indicator-based measurement approach) that exceeds a cut-off level set by the BCBS are classified as G-SIBs. Supervisory judgement may also be used to add banks with scores below the cut-off to the list of G-SIBs. This judgement will be exercised according to the principles set out by BCBS. The banks identified as G-SIBs would be plotted in four different buckets depending upon their systemic importance scores in ascending order and they would be required to maintain additional capital in the range of 1% to 2.5% of their risk weighted assets depending upon the order of the buckets. The additional capital (higher loss absorbency requirement) is to be met with Common Equity Tier 1 (CET1) capital.

An empty bucket at the top (fifth bucket) with a CET1 capital requirement of 3.5% has been provided to take care of banks, in case their systemic importance scores increase in future beyond the boundary of the fourth bucket.

If this bucket gets populated in the future, a new bucket will be added. The bucketing system provides disincentive for adding to the systemic importance scores and incentives for banks to avoid becoming systemically more important. The higher loss absorbency (HLA) capital requirement would be phased-in parallel with the capital conservation buffer and countercyclical capital buffer.

14.2. Role of FSB and BCBS

In November 2010, the Basel Committee on Banking Supervision (BCBS) introduced new guidance (known as Basel III). To improve the resiliency of banks and banking systems Basel III introduced the following:

  • Increase in the quality and quantity of regulatory capital of the banks,

  • Improving risk coverage,

  • Introduction of a leverage ratio to serve as a backstop to the risk-based capital regime,

  • Capital conservation buffer and countercyclical capital buffer as well as a global standard for liquidity risk management.

These policy measures will cover all banks but specifically targeted to SIBs.

In November 2011, the Financial Stability Board (FSB) published a first list of global systemically important financial institutions (G-SIFIs).

It is important to note that both the FSB and the BCBS are only policy research and development entities. They do not establish laws, regulations or rules for any banks directly. They merely act in an advisory or guidance capacity.

Further, it is up to each country's specific lawmakers and regulators to enact whatever portions of the recommendations they deem appropriate for their own Domestic Systemically Important Banks (D-SIBs).

15. Banking Stress Test

A bank stress test is an analysis conducted under a simulation, designed to determine whether a bank has enough capital to withstand a negative economic shock. These scenarios include un-favourable situations, such as a deep recession or a financial market crash. While stress tests have gradually become mainstream, it is important to keep in mind their limitations. Stress test results are vulnerable to many factors, including limitations in data quality and granularity, severity or scope of the scenarios, and model risk; especially in relation to complex methodologies and related assumptions. They do not “forecast” future banks’ performance under stress; rather, they aim to identify the impact on banks of a specific stress scenario, based on a number of given assumptions.

The first use of stress tests can be dated back to the early 1990s, when they were mainly run by individual banks for internal risk management purposes. Stress tests’ design and functions have significantly evolved over time. Most of the exercises were small-scale and were used to complement other statistical tools available to bank management to evaluate a bank’s trading activities. The practice of using stress tests to evaluate trading portfolios was formalised in the 1996 market risk amendment to the Basel Capital Accord (BCBS (1996)). In addition, in 2004, with the Basel II framework, banks were asked to apply rigorous internal stress testing exercises in both Pillar 1 and Pillar 2. However, Basel II was not universally implemented, and most internal stress testing models were found to be still at the developmental stage. Moreover, stress tests were typically conducted only for individual institutions. Nevertheless, already in the early 2000s authorities started to consider the possibility of system-wide exercises, and to analyse the complexities of aggregating bank-level results based on different methodologies and scenarios.

In general, there are two types of tests:

  1. Systemwide stress tests conducted by central banks and/or supervisory agencies; and

  2. Stress tests that focus on individual banks and that can be carried out by banks themselves or supervisors.

System-wide stress tests have emerged as a key risk management tool to guide bank recapitalisation, especially since the Great Financial Crisis (GFC). The emphasis on stress tests to assess and replenish bank solvency was justified by the fact that capital is at the core of a bank’s ability to absorb losses and continue to lend. Solvency stress tests help to assess banks’ capital planning as well as their capital adequacy, thereby reducing the likelihood of failure. Stress tests are more than just numerical calculations of the impact of a scenario. They can help policymakers to set micro prudential measures to ensure that individual banks are adequately resilient.

15.1. Types of Stress Test

In terms of policy objectives, a stress test can be classified as “macroprudential” or “microprudential”:

a) Macroprudential Stress Test:

a stress test designed to assess the system-wide resilience to financial and economic shocks, which may include effects emerging from linkages with the broader financial system or the real economy. Interactions between individual banks can also be taken into account.

b) Microprudential Stress Test:

a stress test designed to assess the resilience of an individual bank to macroeconomic and financial vulnerabilities and respective shocks. Instruments, mechanisms and measures available to the supervisor are usually applied at bank level. In microprudential exercises, authorities use stress test results as part of the supervisory review to assess the strategies, processes and risk resilience of individual institutions. Here, the supervisory authorities use the results as an important input into the supervisory review process. They complete the qualitative part of the supervisory assessment of the banks by providing a wealth of granular information on each individual bank. In this context, some authorities use stress tests for reviewing and validating the Internal Capital Adequacy Assessment Process of banks, for determining the Pillar 2 capital requirements or for checking the soundness of individual banks’ capital planning. In terms of who performs the exercise, a stress test can be either “top-down” or “bottom-up”:

a) Top-down Stress Test:

A stress test performed by a public authority using its own stress test framework (data, scenarios, assumptions and models). Either bank-level or aggregated data may be used, but always in models with consistent methodology and assumptions, generally developed by the authority.

b) Bottom-up Stress Test:

A stress test performed by a bank using its own stress test framework as part of a system-wide exercise, or as part of a stress test where authorities provide banks with common scenario(s) and assumptions.

Finally, in terms of balance sheet projections, they can be described as “dynamic” or “static”:

a) Dynamic Balance Sheet (DBS):

An assumption that the size, composition or risk profile of a bank’s balance sheet is allowed to vary over the stress test horizon.

b) Static Balance Sheet (SBS):

An assumption that the size, composition and risk profile of a bank’s balance sheet are invariant throughout the stress testing time horizon. The starting point of a stress testing exercise is the stress scenario(s). The scenario is a combination of macro-financial variables that are expected to affect the resilience of individual banks and of the financial sector. Stress scenarios simulate a severe, broad-based downturn affecting the real economy as well as financial markets and asset prices. The stress scenario, which can be one or more, is a defining feature of a stress test exercise. It can correspond to a historical or hypothetical crisis configuration, depending on the underlying narrative.

Based on the risk factors under consideration, it determines the intensity of the shocks, the transmission channels and time horizon over which the stress factors can affect the banks. In all cases, it is a fundamental driver of the quantitative results of the exercise.

15.2. Different Test Scenarios in Different Locations

1. Europe:

EU law requires the ECB (European Central Bank) to carry out stress tests on supervised banks at least once per year. The ECB conducts several types of stress test:

a. Annual Stress Tests:

EU-wide stress tests led by the European Banking Authority (EBA), complemented by the ECB’s stress test under the Supervisory Review and Evaluation Process (SREP)

b. Thematic stress tests:

Stress tests as part of comprehensive assessments (a large-scale financial health check of banks, consisting of a stress test and an asset quality review, that helps to ensure banks have enough capital to withstand losses)

c. Stress Tests for Macroprudential Purposes:

Focusing on financial stability and system-wide effects rather than individual banks.

d. Specific Stress Tests:

In addition to these, specific stress tests can also be conducted on individual banks or groups of banks if necessary.

2. United States:

a. The Dodd-Frank Supervisory Stress test (DFAST):

Dodd-Frank Act stress testing is a forward-looking exercise that assesses the impact on capital levels that would result from immediate financial shocks and nine quarters of adverse economic conditions. And,

b. The Comprehensive Capital Analysis and Review (CCAR):

The Comprehensive Capital Analysis and Review is a stress-test regime for large US banks. It aims to establish whether lenders have enough capital to cope with a severe economic shock, and assesses their risk modelling practices. CCAR is an integral part of the US Federal Reserve’s oversight of risk management and internal controls at these firms. Bank holding companies with consolidated assets of at least $50 billion are required to submit annual capital plans to the Fed describing their internal processes for determining capital adequacy, as well as planned capital distributions and the policies governing them.

3. Japan:

At Japan the stress test is done by The Bank of Japan stress test and the Financial Services Agency, Japan. For instance, the BOJ and FSA have examined the results of the financial institutions' own stress tests and have held a series of dialogues with financial institutions to encourage them to improve their stress testing models and incorporate the results in their managerial decisions. In addition, the BOJ conducts macro stress testing using its own model.

4. Switzerland:

In Switzerland, the stress tests are conducted in collaboration with the Swiss Financial Market Supervisory Authority (FINMA) and the Swiss National Bank (SNB). These banking sector stress tests complement other approaches, such as the analysis of financial systemic risk and spill over analysis and the assessment of the quality of banking sector supervision.

16. Introduction Foreign Exchange

The foreign exchange market is the generic term for the worldwide institutions that exist to exchange or trade the currencies of different countries. It is organized in two tiers namely, the retail tier and the wholesale tier. The retail tier is where the small agents buy and sell foreign exchange. The wholesale tier is an informal, geographically dispersed, network of about 2,000 banks and currency brokerage firms that deal with each other and with large corporations. The foreign exchange market is open 24 hours a day, split over three time zones (the Asian, European, and North American sessions, which are also referred to as the Tokyo, London, and New York sessions). A 24-hour forex market offers a considerable advantage for many institutional and individual traders because it guarantees liquidity and the opportunity to trade at any conceivable time. Also, since most traders can't watch the market 24/7, there will be times of missed opportunities, or worse when a jump in volatility leads to a movement against an established position when the trader isn't around. For this reason, a trader needs to be aware of times of market volatility and decide when it is best to minimize this risk based on their trading style. Foreign exchange trading begins each day in Sydney, and moves around the world as the business day begins in each financial centre, first to Tokyo, London and New York.

The foreign exchange or forex market is the largest financial market in the world (larger even than the stock market), with a daily volume of above $6.5 trillion. Forex trading is buying and selling currencies. Market participants include large banks, forex brokers, hedge funds, retail investors, corporations, central banks, governments, and institutional investors such as pension funds.

Foreign Exchange Market loosely organized in two tiers namely the retail tier and the wholesale tier. The retail tier is where the small agents buy and sell foreign exchange. The wholesale tier is an informal, geographically dispersed, network of banks and currency brokerage firms that deal with each other and with large corporations. The major forex markets is London taking a lead (around 40% daily volume), followed by New York (15% or more) followed by Singapore, Hong Kong, and Tokyo.

The foreign exchange market is the market where exchange rates are determined. Exchange rates are the mechanisms by which world currencies are tied together in the global marketplace, providing the price of one currency in terms of another. An exchange rate is a price, specifically the relative price of two currencies. For example, the U.S. dollar/GBP exchange rate is the price of a Pound expressed in U.S. dollars. Example, let us say today 1 GBP is 1.3922 USD, in market notation it means, 1.3922 GBP/USD.

Like in any other market, demand and supply determine the price of a currency. At any point in time, in a given country, the exchange rate is determined by the interaction of the demand for foreign currency and the corresponding supply of foreign currency.

The exchange rate is not just a price for conversion, but it plays a very important role in the economy since it directly influences imports, exports, & cross-border investments. It has an indirect effect on other economic variables, such as the domestic price level, and real wages.

For example: in the above quote (1.3922 GBP/USD) when exchange rate increases, imports become more expensive in USD. Then, the domestic price level increases and, thus, real wages decrease (through a reduction in purchasing power).

In order to deal with foreign exchange, a bank needs to be an Authorized forex dealer meaning it has received authorization from a relevant regulatory body to act as a dealer involved with the trading of foreign currencies. Authorization ensures that Forex transactions are being executed safely. Example, the National Futures Association (NFA) and Commodity Futures Trading Commission (CFTC) authorize forex dealers in the United States, FCA in UK, ASIC in Australia, MAS in Singapore, HKMA at Hong Kong and RBI in India.

Given the international nature of the forex market, the majority (circa 60%) of all foreign exchange transactions involves cross-border counterparties. This highlights one of the main concerns in the foreign exchange market the counterparty risk. Hence, a good settlement and clearing system is clearly needed.

16.1. Foreign Exchange and Banks

Coming to banks, there are typically two roles that bank involve in forex trading:

1. Banks for their customers act as brokers buying and selling currencies and moving funds between accounts denominated in various currencies.

2. Banks for their own Treasury, deal in foreign currencies to either make profit or manage its own exposure to various currencies.

The proprietary trading of currency is done in banks majorly by the treasury (forex) team. But for customers, they have a separate Forex Department. The forex department takes orders from the customers, obtain a quote from the currency trader and quote to the customer to see if they want to deal on it. Although online forex trading is preferred avenue by the customers in a bank but corporate customers and private banking customers still prefer to deal directly with forex department personnel on a trading desk of a bank as they get preferential rates and advise on mitigants for adverse movements in currency exchange rates.

For interbank trading, bank dealers decide on their prices based upon current market rate and the volumes traded. An interbank trader also considers the bank's forecast or view on where the currency pair might be headed. All of the banks can see the best market rates currently available. But the forex interbank market is a credit approved system meaning, banks trade based solely on the credit relationships they have with other banks. The more credit relationships they can have, and the better pricing they will be able to access.

The speciality of the foreign exchange market is that it happens between banks (called interbank transactions) primarily over-the-counter (OTC). It either occurs via electronic platforms or on the phone between banks. Only (approximate) 3% of trades, mostly futures and options, is done on exchanges. In the forex market, trades are made in the specific time zones of that particular region. For example, European trading opens in the early morning hours for U.S. traders, while Asia trading opens after the close of the U.S. trading session. As a result of the currency market's 24-hour cycle, spanning multiple trading sessions, it's difficult for one large trade to manipulate a currency's price in all three trading sessions. Currency markets as such are not regulated but, most of the parties who are involved in the trading of currencies such as brokers and banks are. Currencies are quoted in pairs using two different prices, call the bid and ask price. The bid price is the price you would receive if you were selling the currency and the ask price is the price you would receive if you were buying the currency. The difference between the bid and ask prices of a currency is known as the bid-ask spread, which represents the cost of trading currencies minus broker fees and commissions.

Central Bank is responsible for fixing the price of its native currency on foreign exchange. Any action taken by a central bank in the forex market is done to stabilize or increase the competitiveness of that nation's economy. Central banks can engage in currency interventions to make their currencies appreciate or depreciate. For example, a central bank may weaken its own currency by creating additional supply during periods of long deflationary trends, which is then used to purchase foreign currency. This effectively weakens the domestic currency, making exports more competitive in the global market.

Further, banks face Credit risk (arise when a counterparty defaults foreign exchange contract, or a loan), Exchange rate risk (risk of adverse exchange rate movements) and interest rate risk (arises from the maturity mismatching of foreign currency positions).

16.2. Ways Banks Are Engaged in Forex Market

1. Spot Contracts: A foreign exchange spot transaction, also known as FX spot, is an agreement between two banks to buy one currency against selling another currency at an agreed price for settlement on the spot date. A spot FX contract stipulates that the delivery of the underlying currencies occur promptly (usually 2 days) following the settlement date.

2. Swaps: A foreign exchange currency swap, is an agreement to exchange currency between two foreign banks. The agreement consists of swapping principal and interest payments on a loan made in one currency for principal and interest payments of a loan of equal value in another currency.

3. Forward Trades: A forward contract is a foreign exchange agreement between two banks to buy one currency by selling another on a specified date in future at a specified rate called the forward rate. forward rate is the exchange rate agreed today to transfer the currency later.

4. Options: A foreign exchange option, is a derivative where one of the transacting parties (can be another bank) pays the premium to purchase a right (but not the obligation) to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date with a bank. The forex market is a decentralized market meaning none of the exchange or trade happening in this market is recorded. Also, there is no clearinghouse for forex transactions. Each bank records and maintains their own trades.

17. Financial Statement

Banking is a highly leveraged business requiring regulators to dictate minimal capital levels to help ensure the solvency of each bank and the banking system. As financial intermediaries, banks assume two primary types of risk as they manage the flow of money through their business. Interest rate risk is the management of the spread between interest paid on deposits and received on loans over time. Credit risk is the likelihood that a borrower will default on its loan or lease, causing the bank to lose any potential interest earned as well as the principal that was loaned to the borrower. These are the primary elements that need to be understood when analyzing a bank's financial statement.

The major banking financial statements are designed to provide a complete picture of the overall financial position and performance of the bank. The Financial Statements have the following:

  1. Income Statement or Profit and Loss Account.

  2. The Balance Sheet.

  3. The Cash Flow Statement.

17.1. Financial Statement-Income Statement

The income statement of the bank includes the following:

1. Interest Income: The interest income usually covers Loans (Real estate/commercial or Industrial), Credit Cards, Lease Financing receivables, interest and dividend income from securities.

2. Interest Expense: The interest expense consists of interest on deposits like interest bearing deposit accounts like savings deposits, time deposits and MMDA accounts.

*Note: Interest Income-Interest Expense=Net Income.

3. Non-Interest Income: The non interest income usually covers Income from fiduciary activities, Service charges on deposit accounts, Trading Revenue, Fees and commissions from security brokerage, investment banking advisory and underwriting fees and commission, fees and commission from annuity sales, underwriting income from insurance and re-insurance activities, venture capital revenue.

4. Non-Interest Expense: The non-interest expenses include Salaries and employee benefits, expenses of premises and fixed assets, amortization expense, impairment losses for other intangible assets.

The Income Statement or P&L account for a period, simply shows the total revenue generated during a particular period and deducts from this the total expenses incurred in generating that revenue. The difference between the total revenue and the total expenses will represent either profit or loss.

17.2. Financial Statement-Balance Sheet

The balance sheet sets out the financial position of a business at a particular moment in time. The balance sheet reveals the assets of the business, on the one hand, and the claims against the business on the other. Before we get into details, let us understand what an asset and a liability for a bank is.

1. Assets of the bank:

1. Cash and balances due from depository institutions (Noninterest-bearing balances and currency & coin; and Interest-bearing balances)

2. Securities (Held to Maturity Securities, Available for sale debt securities, Equity securities not held for trading)

3. Loans and lease financing receivables.

4. Trading assets.

5. Premises and fixed assets.

6. Other real estate owned.

7. Investments in unconsolidated subsidiaries and associated companies.

8. Direct and indirect investments in real estate ventures.

9. Intangible assets.

10. Other assets.

2. Liabilities of the bank:

1. Deposits (Non interest and interest bearing).

2. Securities sold under agreements to repurchase.

3. Trading Liabilities.

4. Other borrowed money (includes mortgage indebtedness and obligations under capitalized leases).

5. Subordinated notes and debentures.

6. Other Liabilities.

* Note: Bank Capital is the difference between bank’s assets and its liabilities. It represents the net-worth of the bank.

17.3. Financial Statement-Cash Flow

Cash flow statements are an essential part of financial analysis for three reasons:

1. Liquidity: The Cash Flow Statement show how much liquid is the bank. Meaning banks is aware as to how much operating cash flow they have.

2. Changes in Assets and Liabilities: The Cash Flow Statement show the changes in assets, liabilities, and equity in the forms of cash outflows, cash inflows, and cash being held.

3. Future Cash Flow: The Cash Flow Statement help to create cash flow projections, so the bank plan for how much liquidity its business will have in the future. That’s important for making long-term business plans.

The main components of the cash flow statement are:

1. Operating Activities:

The statement provides information about the cash generated from a bank’s daily operating activities. Operating activities are those which produce either revenue (Customer using products and services of the bank) or are the direct cost say, cost of producing new banking products or services.

Operating activities which generate cash inflows include fees and commission, receipts of interest and dividends, and other operating cash receipts.

Operating activities which create cash outflows include payments to vendors, payments to employees, interest payments, payment of income taxes and other operating cash payments.

2. Investing Activities:

Investing activities include purchase or sale of stock and securities, loan money & receive loan payments and sales of noncurrent assets such as property.

3. Financing Activities:

Financing activities include borrowing and repaying money, like interbank borrowing or lending.

17.4. Financial Statement-Reading

Reading a financial statement of bank means understanding of how banks earn revenue and how to analyse which type of incomes are driving revenue. Bank financial statements are relatively easy to understand as they only have a balance sheet, an income statement and cashflows to observe. The net interest income derived is interest income earned minus the interest expenses. Basically, this gives an idea of the spread between the interest earned from loans and the interest paid out to depositors. Non-Interest income shows how banks diversify their revenue stream.

Net Income shows the profit earned by the bank that can be compared to previous financials to calculate the percent a bank must have grown.

In the balance sheet of a bank, capital (the difference between a bank's assets and its liabilities) represents the net worth of the bank or its equity value to investors.

In Cash flow statement, positive cash flow indicates that a bank's liquid assets are increasing, enabling it to cover obligations, reinvest in its business, return money to shareholders, pay expenses, and provide a buffer against future financial challenges.

18. Regulations of Banks

Banks are required to be compliant with the guidelines provided by the banking regulators. Banking regulators usually ensure that banks are transparent, treat customer fairly, maintain proper balances with central banks to keep themselves liquid, follow guidelines etc. Banking regulators also monitor that all banks follow standardized practices such as:

a. Avoid too much concentration or exposure on a single customer or same group customers.

b. Avoid adverse trading or put lenience to traders.

c. Detect, Deter and Protect Money Laundering, Terrorist Financing and Frauds.

d. Protect customer confidentiality.

e. Provide credit to the most needy.

f. Have and participate in corporate social responsibility.

g. Have sufficient internal controls to manage risks.

h. Have sufficient liquid assets for meeting customer needs.

e. Strictly follow all banking guidelines put forth by international self regulatory organizations and regulators.

18.1. United States-Banking Regulators

a. The Office of the Comptroller of the Currency (OCC):

The OCC supervises more than 1,600 national banks and federal savings associations and about 50 federal branches and agencies of foreign banks in the United States. These institutions comprise nearly two-thirds of the assets of the commercial banking system. The OCC is an independent bureau of the U.S. Department of the Treasury.

In regulating national banks and federal thrifts, the OCC has the power to:

  • Examine the national banks and federal thrifts.

  • Approve or deny applications for new charters, branches, capital, or other changes in corporate or banking structure.