Commercial Bank Products - Essay Example

?Commercial Bank Products Commercial banks provide a variety of products to the consumers at present. The various products that are offered by a commercial bank can be classified mainly into two categories, namely Asset Products and Liability Products. The term asset and liability is used on the perspective of Banks and not on the perspective of customers. Therefore, by nature, Asset products are assets for banks and liability products are liabilities for the banks. A brief description of asset and liability products is given below. Liability products: Liability products are the most common products that are offered by a commercial bank. Liability products consist of checking and savings account, fixed deposits, certificate of deposits, etc. These products are by nature liabilities for banks as a result of which banks are obliged to pay interest to the customers for all these products. Except for checking accounts all other liability products provide interest to the customers. In short liability products are intended to raise fund for providing asset products. Asset products: Asset products are the revenue earning products for the banks because such products are by nature, assets for the banks. The most common asset products offered by banks are loans (personal and business), credit cards and mortgages. Among these, loans are the most revenue generating asset products of the banks. Banks use the funds raised through their liability products for providing liability products. Therefore, both asset and liability products are equally important for commercial banks. Two liability and asset products that will be discussed further in this essay are Savings account, Certificate of deposits, Mortgage loans and Credit cards. Savings account and Certificate of deposits: Savings account and Certificate of Deposits (CD) are the two main liability products of commercial banks. Savings account provides modest interest rates to the account holders of the bank. It is a very liquid form of asset to the customers as they provide withdrawal of amount at any point of time. Savings account is the primary source for commercial banks to raise money for lending. For the customers it provides a liquid asset with modest interest. A certificate of deposit provides higher interest rates than that of a savings account. CD is a promissory note issued by a bank that entitles the bearer to receive interest. Unlike savings account there is restriction on the withdrawal of funds from CD until the end of the term. For the customers, CD’s provide a safe and high interest bearing investment though it is less liquid. For the banks it provides a source of fund for longer period as early withdrawals by the customers are not entertained. Mortgage loans and credit cards: Mortgage loan is a secured loan provided by the banks to the customers. Such loans are secured by real assets of the customers. Therefore, for the banks the risk of loss is limited compared to usual unsecured loans. Mortgage loans usually bear less interest rate than unsecured loans. Such loans are mostly used by customer for acquiring properties, (residential and commercial). Credit card is growing to be one of the most revenue generating products for commercial banks. Credit card provides the customers with a line of credit which can be used by them to purchase goods or services. There is a credit limit attached to the card beyond which the customers are restricted to use. It provides the banks with revenue from annual card fee and interest on the purchases of not repaid within the billing period. Change in market interest rates and impact on Asset products Change in the market interest rates will have a direct impact on the products of commercial banks. “A bank’s interest rate risk reflects the extend to which its financial condition is affected by changes in market interest rates.” (English, 2002) An increase in the market interest rates will have an adverse impact on the asset products of banks. Some of the main asset products of the banks are personal and business loans, mortgages, auto loans and credit cards. The impact of interest changes on banks can be demonstrated with the example of loans. Take for instance Standard Chartered granted an auto loan of ?20000 for 4 years at the rate of 6.9%. Now when the market interest rate increases by 2%, the yield on the loan is less than the prevailing market rate thus resulting in a loss of 2%. It will also affect the spread of the bank. At an increasing interest rate scenario banks have to borrow funds at a higher rate and finance the liabilities at the same old rate. Another major impact on the liability products on banks is due to the presence of option products in the portfolio in the asset products. Presently commercial banks use a lot of embedded options in its liability products. “Instruments with embedded options include various types of bonds and notes with call or put provisions, loans such as residential mortgages that give borrowers the right to prepay balances without penalty, and various types of deposit products that give depositors the right to withdraw funds at any time without penalty” (English, 2002) In most cases at an increasing interest rate scenario, the options will be exercised by the banks customers. This will lead to a potential loss for the commercial banks as they don’t have the right on the products. Therefore interest rate risk management is one of the most crucial challenges faced by commercial banks. Central bank and its functions Central bank or national bank is a term that has evolved over years. Central bank is different from that of a commercial bank in the sense that the main function of central bank is to regulate the commercial banks and economy of a country. “In other words, the central bank prevents the country's banking system from failing.” (Haekal, 2011) The effective operation of a central bank is essential for the smooth functioning of a nation’s economy and its financial system. The main functions of a central bank are as follows: 1. Issue currency 2. Control national currency 3. Banker to the commercial banks 4. Formulate monetary policy 5. Banker for government The above functions can be explained with reference to Qatar Central Bank (QCB). Qatar Central Bank is the national bank of Qatar and is the primary regulator of the Qatar financial system. With reference to QCB, the functions of a central bank can be explained as follows: (Qatar Central Bank, 2011) Issue Currency: One of the main functions of a central bank is to issue the currency notes and coins. Qatar’s national currency Qatari Riyal is issued by QCB. QCB controls the issue of Qatari Riyal based on the demand and supply situation of the market. This function involves an effective forecasting for the demand for currencies. QCB also takes necessary steps against counterfeiting of Qatari Riyal. Control National Currency: Another main function of QCB is to control the value of Qatari Riyal as against other currency. Excessive appreciation and excessive depreciation of the currency is not healthy for the economy and currency in itself. Excessive appreciation of the currency is unfavourable for the exporting sector of the country and excessive depreciation is dangerous for the importing sector. There should always be a stable position for the currency. It should always be regulated and helped to move as per the economic condition. QCB controls Qatar Riyal’s stability and its convertibility to other currencies. Banker to commercial banks: The third function of a central bank is to act as a banker to other commercial banks operating in the country. Every bank that operates in a particular country should abide by the rules formulated by the central bank. For instance, Citi Bank, when operating in Qatar is under the legal framework of QCB. All commercial banks will have to maintain reserves with QCB for just a nominal interest rate. This is done in order to ensure the financial stability of the banks operating in Qatar, thereby protecting the customers and the nation’s economy. Formulate monetary policy: The monetary policy of a country is governed by its central bank. QCB advises the Qatar government in taking the necessary monetary and financial policies. This mainly involves controlling the interest rates and the money supply. QCB’s monetary policy mainly focuses on maintaining the exchange rate of Qatari Riyal. Qatari Riyal is maintained at 1 Qatari Riyal = 3.64 USD. The primary goal of QCB’s monetary policy is to maintain a fixed exchange rate with USD. They give intense focus on the stability of the interest rates in order to maintain the fixed exchange rate. It is the Monetary Policy Committee at QCB that formulates timely monetary policies for the stability of the economy. Thus monetary policy formulation and implementation is one of the crucial functions of a central bank. Banker for government: Central bank acts as a banker for the government of a country. It receives the money on behalf of the government and also pays money for the government needs. It is the central bank that maintains the foreign exchange reserves on behalf of the government. QCB’s investment policy manages its investment in other currencies and investment tools. QCB invests mainly in government bonds of major countries, Gold, other international banks, etc. The main objective is to reap better capital appreciation and protection against risks. Safety, liquidity and Profitability are the three main principles of QCB. Central Bank and its operations have become very much important in the last twenty four months in many countries. The reason being the much discussed and though about recession and slow down that hit the economies world over. Central banks across the globe have been at a high pressure with the slowdown hitting the economy badly. Federal Reserve, the central bank of United States is the primary bank among them. Federal Reserve has adopted several series of rate cuts in order to bring the economy back in action. RBI, the central bank of India had formulated effective policies to insulate the economy from the recession that has hit the markets worldwide. Many governments and central banks had to go through conventional as well as unconventional methods to come out of recession. RBI infused adequate liquidity in the market, reduced interest rates and provided better support for the exports sector. Similarly, central banks of all countries were taking effective measures to either tide away the recession that has hit them or to insulate itself from the rippling effect of the recession. Therefore, the successful recovery of a nation from such a situation depends on the quality of decisions of its central bank. Works Cited William, B, English. Interest rate risk and bank net interest margins. [Online] Available at: http://www.bis.org/publ/qtrpdf/r_qt0212g.pdf [Accessed 10 March 2011] Reem, Haekal. 2011. What are central banks. [Online] Available at: http://www.investopedia.com/articles/03/050703.asp [Accessed 11 March 2011] Qatar Central Bank. 2011. Core Purposes. [Online] Available at: http://www.qcb.gov.qa/English/AboutQCB/CorePurposes/Pages/CorePurposes.aspx [Accessed 11 March 2011] Nomura Research Institute. 2006. Impact of rising interest rates on bank spreads. [Online] Availabe at: http://www.nri.co.jp/english/opinion/lakyara/2006/pdf/lkr200607.pdf [Accessed 11 March 2011] David, M, Wright., James, V, Houpt. 1996. An analysis of commercial bank exposure to interest rate risk. [Online] Available at: http://www.federalreserve.gov/pubs/Bulletin/1996/296lead.pdf [Accessed 11 March 2011] Read More