Commercial and

Investment Banking

By
Asiya Sohail

The Financial Markets and Financial System

Financial Markets:
Markets in which funds are transferred from people who have an excess of
available funds to people who have a shortage.

Financial System:

It is a complex system comprising many different types of financial institutions

including banks, insurance companies, mutual funds, finance companies,
investment banks.

It is heavily regulated by the government.

Financial Intermediaries:
Institutions that borrow funds form people who have saved and in turn make
loans to others.

The Banking System

Banks:

Banks are financial institutions that accept deposits and make loans.

The term bank includes commercial banks, savings and loan associations,
mutual saving banks and credit unions.

Types of Banks:

Commercial Banks

Merchant Banks

Savings Banks

Mortgage Banks

Consumer Banks

Investment Banks

Development Banks

Cooperative Banks

Eximp Banks

Small and Medium Enterprise (SME) Banks

Central Banks

Commercial Banking
Commercial Banks:
The banks in the business of providing banking services to
individuals, small businesses and large corporations.
They are engaged in the business of accepting deposits and giving
loans.
In Pakistan , the commercial banks can be broadly classified as;
Public Sector Banks,
Private Sector Banks
Foreign Banks

Functions of Commercial Banks

Primary Functions:
Accepting deposits
Surplus income and savings are mobilized on the basis of short term and

long term deposits at a specified interest rate.

Providing loans and Advances

Loans are usually long term lendings i.e. for more than a year.
Advances are usually for short terms like cash credit, overdraft,

discounting of bills.

Secondary Functions:
Safe custody of valuables
Providing Foreign Exchange
Transfer of money
Issuing Guarantees and Letters of Credit
Providing business support services like credit reports etc.

Functions of Commercial Banks

The Business of Banking

Main
Income
Component

Main Cost
Component

Interest paid on deposits

paid on bonds issued by the

bank and borrowings

Employee Cost

Interest earned on lending

business

Provising costs for Non

Performing Loans (NPL)

Fee income, Brokerages and

Commissions

Income from Treasury

Operations Sale of
Investment

Business Segmentation - Commercial Banking

1. Retail Banking:

High street branches dealing with the general public, shops and very small
businesses.

It covers currents accounts, saving accounts, cheque facilities and loan

facilities like overdraft, personal loans like auto loans and mortgages.

2. Wholesale Banking:

It covers lending to medium and large corporate entities and government.

It includes activities such as working capital loans, project finance, term

loans, money markets, foreign exchange and finance for trade.

3. Treasury Operations:

It involves investment in bonds, equity, mutual funds,

commodities,

derivatives, trading and forex operations.

4. Other Banking Activities:

It involves hire purchase activities , leasing business, merchant banking,

syndication services, etc.

Important rates in the Banking Industry

1. Bank Rate:

The interest rate at which the central bank advances short term loans to
commercial banks.

Changes in the bank rate are reflected in the prime lending rates offered
by the commercial banks to the customers.

Managing the bank rate is a preferred method by which central banks can
regulate the level of economic activity. Lower bank rates can help to
expand the economy, when unemployment is high, by lowering the cost
of funds for borrowers. Conversely, higher bank rates help to reign in the
economy, when inflation is higher than desired

Other term used is discount rate.

2. Base Rate:

It is the minimum rate of interest that a bank is allowed to charge from its
customers.

No bank can offer a rate lower than base rate to any of its customers.

Important rates in the Banking Industry

3. Repo Rate or Reverse Repo Rate:
Repo rate is the rate at which the central bank lends short-term money
to the banks against securities. A reduction in the repo rate will help
banks to get money at a cheaper rate. When the repo rate increases
borrowing from the central bank becomes more expensive. It is more
applicable when there is a liquidity crunch in the market.
Reverse repo rate is the rate at which the banks can park surplus funds

with reserve bank, while the repo rate is the rate at which the banks
borrow from the central bank. It is mostly done when there is surplus
liquidity in the market.

Regulatory Requirements
A bank has to set aside a certain percentage of total funds to meet regulatory
requirements. It is used to regulate money supply in the economy. For this
two ratios are used namely;

1. Cash Reserve Ratio (CRR):

It is the percentage of net total of deposits that a bank is required to
maintain in the form of cash with the central bank.
It is used to control liquidity in the economy.
Higher the CRR, the lower is the amount banks will be able to use for
lending activities and vice versa.

2. Statutory Liquidity Ratio (SLR):

It is the percentage of net total of deposits that a bank is required to

maintain in the form of gold, cash and/ or other approved securities.

It is used to regulate the credit growth in the economy.

Higher the SLR, the lower is the amount that banks will be able to inject in

Investment Banks

Provide financial advisory services and investment services.

Assist financial markets and provide capital intermediation

services.

Provide consultancy, market research and broking services to

assist high net worth individuals and other entities in their
investment goals

Develop ventures through project finance to support funds

needed and export

Finance to meet international trade ventures.

Functions of Investment Banks

Personalized services to high net worth individuals with

customized solutions.

Provide lease and mortgages.

Pension Management

Investment Management

Private Banking

Valuation services

Mergers and amalgamations services

Providing

information

based

Research

Asset Management Services

Corporate Advisory services

on

Industry

analysis

and

Risk Management Structure of Banks

Financial Risk of Banks

Market Risk

Operational Risk

Credit Risk

Equity Risk

Loan Transaction

Interest Rate

Risk

Risk

Counter Party Risk

Currency Risk

Loan Composition

Commodity

Risk

Risk