Reference no: EM132604182
ALI'S CONCERNS
Ali said that First Commercial had 20 branches spread over Pakistan. Fifty percent of the branches were in Karachi and Lahore, while over 75% of the deposits were mobilized in Karachi and Lahore and 90% of the loans originated from there (see Exhibit 3). However, due to regulatory constraints, the FCB had to abide by the State Bank of Pakistan's formula on new branch openings. For every branch opened in one of three larger urban areas, a branch also had to be opened in a smaller regional site. Hence, FCB could not open all the new branches could be opened in Karachi and Lahore.
Ali pointed out that the bank had launched a variety of new products for the customers, although not all of them were available throughout the country. A summary of the main liability products is provided in Exhibit 4. Ali elaborated further on these products:
1. Current Accounts : These were checking accounts offering no profit. Such accounts were not marketed independently, except in cities such as Turbat and Quetta in Balochistan, and parts of Peshawar in the North West Frontier, where there was a clientele which demanded non-interest products. All other current accounts were by- products of facilities given to customers, such as receipts from exports or sales proceeds. The market for current accounts was small, and in the annual deposit mobilization plan, there was no expectation that these accounts would increase. They were treated as complements of the marketing of advances.
2. Savings Accounts : These were accounts based on the profit-and loss-sharing (PLS) formula introduced by the banking system in 1985. As such, banks did not 'sell' such accounts, since the average rate of return of 6% was generally low for many customers. However, savings accounts were preferred to current accounts, and retained their liquidity and flexibility of withdrawal. Under PLS system, interest rates could be cha nged every six months.
3. Classic Accounts: These were the key liability products of the bank, and FCB's sales teams had estimated that at least 60% of fresh deposit mobilization would be in this form. They were checking accounts on which interest was computed on a daily basis. This rate of return varied with the balance that the clients maintained in the Classic Accounts, although the average cost was about 10%.
4. Anchor Accounts: These were cash management deposits targeted at business customers, so that surplus cash could earn higher returns. Interest was paid on the minimum balance in the account, which was based on the amount of the deposit balances. The average cost of Anchor to FCB was 11.00%, while it was predicted that at least 20% of fresh deposits would come from this source.
5. Term Accounts : These were fixed deposits varying in maturity from less than one year to tenors exceeding a year. Typically the former maturities had an average cost of 10% for FCB, and the latter about 12%.
6. Foreign Currency Accounts (FCAs): FCB had mobilized some five billion rupees in FCAs when they had been frozen by the Government of Pakistan in May, 1998. Two years later, only 10% of this balance remained. Another Rs 200 million was expected to be withdrawn by the end of the current year, especially since FCB was making no attempt to retain these accounts, as there were a large number of regulations governing them, and it was very costly to maintain them. Although no interest was paid on these accounts, FCB paid an 8% percent fee to the State Bank of Pakistan to obtain foreign exchange cover (hedging).
7. New Foreign Currency Accounts (FX): These had been introduced under Circular (FE 25) issued by the State Bank of Pakistan, to satisfy a demand from customers for the new foreign exchange accounts. FCB did not encourage FX accounts and paid only 2% rate of return on them. Although FCB earned 4% by placing these funds in Nostro5 accounts outside Pakistan, the Bank generated no liquidity from them and was unable to use them for lending purposes.
Ali argued that deposit mobilization was the critical area of any bank. However, the notion that a bank having more long-term deposits also had more stable deposits was not true. While long-term deposits allowed a bank to lock in interest rates, the capacity to do conventional business was dependent on the ability to raise stable and low cost deposits and retain them. This was a function of relationship building and efficient service.
LENDING
- Sameer Chaudhry, FCB's Head of Credit was invited by Ali to discuss the loan portfolio (see Exhibit 5). Sameer said that the most critical variable for FCB was the loans to deposits ratio, commonly referred to as the Credit Deposit Ratio (CDR). Bankers traditionally looked at it very carefully, and prudent bankers preferred a ratio as low as 60%. Sameer felt that "as a rule of thumb, a rush on the bank would result in a 40% withdrawal. If the Bank could meet this demand, the panic of hasty withdrawals would subside."
- FCB had set its CDR at 70%, which included both loans and refinance6 facilities, although refinance was not funded from the banks' deposits. The State Bank of Pakistan encouraged commercial banks to provide loans with tenors up to 180 days at below- market rates of 8%. In turn, the State Bank provided refinance to banks at 6% giving them a 200 basis point cushion. However, experience indicated that up to 10% of refinance from the State Bank of Pakistan was actually financed by FCB from its own funds. This was because borrowers were unable to adjust the loans from their own cash flows after 180 days. Hence, the risk of providing refinance was borne by the bank and not by the State Bank of Pakistan.
- Jahangir, the CFO, interjected at this point to remind the group of the importance of operating leverage and net assets, which included the mark-up7 receivable from clients, as well as fixed assets and deferred taxes. The lower this amount was, the more funds would be available to the bank to invest in earning assets. The aim was to keep net assets below 5% of deposits, although the slow recovery of mark-up as well as deferred tax had made it very challenging to meet this target ratio.
QUESTION:
Problem 1. How do we treat a customer who takes a loan but also places deposits with the bank?