EMPLOYMENT OF FUNDS

CHAPTER=7

EMPLOYMENT OF FUNDS

Short Answer Type Question (1/2 Marks)

Q.1. What do you mean by Employment of funds?  2001

Ans:- Use of fund of banking institution in various types of assets such as loans and advances to customer investment in securities etc with a view to earn profit to run the business is called employment of funds.

Q.2. What do you mean by liquidity and Liquid assets?

Ans:- Liquidity:- The term liquidity means the capacity of the bank to give cash on demand to the depositors.

           Liquid assets:-Liquid assets are those assets which can be readily converted into cash without loss.

Q.3. Define Mortgage?  2012

Ans:- Mortgage is the transfer of an interest in an immovable property like land and building to the creditor for the purpose of securing a debt.

Q.4. What is Cash Reserve Ratio?

Ans:- Commercial banks have to maintain statutory cash reserve in the Reserve bank of India against their time and demand liabilities which is called cash reserve ratio.

Q.5. What is Statutory Liquidity Ratio?       2006, 08, 11, 14

Ans:- The commercial banks beside maintaining the cash reserve with the central bank are also statutorily required to maintain certain liquid assets to meet its liabilities. This is termed as statutory liquidity ratio.

Q.6. What do you mean by Hypothecation?    2009, 2011

Ans:- Hypothecation is a mode of creating a charge against a movable property for payment of a debt. It is a legal transaction whereby a specific movable property is made available by the borrower as security for a debt. The possession of the property is not transferred to the creditor (banker), it continues to be in the possession of the borrower and is used by the borrower.

                                          Hypothecation is the most convenient mode of creating a charge over the movable property in those cases where transfer of possession of the property is either impossible or inconvenient.

Q.7. What is the meaning of Lien?

Ans:- Lien is the right of the lender or creditor to retain the possession of the property given as security by the borrower or debtor until the debt is satisfied.

Q.7. What is the meaning of Pledge?

Ans:- Pledge is the delivery of goods by the borrower or debtor known as pledger to the lender or creditor known as pledgee as security for payment of a debt.

Q.8. What is cash credit?

Ans:- Cash credit is an arrangement by which a customer can borrow money from the bank through his current account upto a certain limit. The bankers sanction cash credit against some tangible securities which are charged with bank.

Q.9. Explain briefly about the cash balance of a commercial bank?

Ans:- Cash balances are the most liquid assets of a bank cash balances refers to the following:-

a)      Cash held by the bank itself.

b)      Cash with the central bank and

c)      Cash with other banks in current account.

                              These cash balances are called the ‘first line of defence’ of the bank as they defends the solvency, reputation and goodwill of the bank. In technical language it is known as ‘vault cash’. With the help of these cash balances the bank can meet the demand of its customers immediately to customer’s satisfaction.

Q.10. What is loan?

Ans:- A loan is a receive money from bank or financial institution in exchange for future repayment of the principal, plus interest. The principal is the amount borrowed and the interest is the amount charged for receiving the loan.

Q.11.What is overdraft?

Ans:- Overdraft means an arrangement with a bank by which a current account holder is allowed to withdrawn more than the balance standing to his credit upto a certain limit.

Q.12. What do you mean by money at call and short notice?

Ans:- Money at call and short notice represent the very short period loans of a bank. It is the second most liquid assets of a bank and is called the “second line of defence” of the bank.

                                  Call loans are given for a maximum period of 7 days and are repayable at any time the banker recalls them. Short notice advances are given for a maximum period of 14 days and are repayable within a short notice.

Q.13. What is the most liquid assets of a banks?

Ans:- Cash balances are the most liquid assets of a bank. Cash balances refer to the followings:-

        i.            Cash held by the bank itself.

       ii.            Cash with the central bank.

     iii.            Cash with other banks in current account.

Long Answer Type Question   (3/4/5/8 Marks)

Q.1. What do you mean by liquidity? What are its Composition? Explain it’s significant?

Ans:- The term liquidity means the capacity of the bank to give cash on demand. In other words, it is the ability of the banker to satisfy the demand of customers for cash in exchange for deposits. Liquidity depends on the availability of liquid assets. Liquid assets are those assets which can be readily converted into cash without loss.

   Composition of liquid assets:-

   The liquid assets of a bank are composed of the following:-

        i.            Cash in hand,

      ii.            Cash balance with the Central Bank.

    iii.            Cash balance with other banks.

    iv.            Money at call and short notice.

      v.            Advances.

Significance of liquidity:-

The term liquidity has special significance in banking business. The deposits accepted by a bank are largely payable on demand. In other words, the depositor has the right to withdraw money as and when they needs. The banker should attach great significance to his obligation to pay his depositors on demand. In case a bank fails to pay cash on demand to the depositors on account of shortages of liquid cash, it may lose the trust and confidence of the public. The banking business is based on public confidence and hence such failures on the part of the banker may ultimately result in the closure of the bank.

     Thus, the banker must safeguard his position by maintaining sufficient liquid assets with him to meet the demand of the depositors for cash.

Q.2. What are the factors affecting quantum of cash balance of banks?

Ans:- The following factors help the banks to decide the quantum of cash balances to be maintained:-

        i.            Banking habit:- banking habits play a significant role in determining the cash balances of a bank. Banking habits refers to the utilization of banking services buy the public. If the people have developed banking habits, i.e. they usually make or receive payments through cheques then of cash in transaction is reduced and the banks need to keep lesser amount of liquid cash.

      ii.            Structure of banking:- The banking structure of the country also influence the liquidity requirements of the bank. In a branch banking system, the banks can function with less cash reserve because in case of emergency cash can be transferred from one branch to another.

    iii.            Nature of bank accounts:- The nature of deposits accounts viz. Saving, current or fixed accounts affect the amount of cash balance to be kept by the banks. In case of fixed deposit account holders, the bank can manage with less cash balance as against current account where it must keep a larger cash balance.

    iv.            Type of depositors:- The type of depositors is another determinant of cash balance of the banks. If the majority of the depositors of the bank are business firms, corporations, schools, college etc. the bank will have to maintain high liquidity because of unpredictable demand behavior of these institutions.

      v.            Seasonal requirements:- The banks have to take into consideration the seasonal requirement of credit from the customers. It is an established fact that during busy season e.g. festivals, sowing, harvesting etc. season, there is increased demand for credit. Hence, the banks should keep large amount of cash to meet these increase demand of the customers.

    vi.            Nature of advances:- The nature of advances of bank i.e. loans, cash credit, overdraft and purchasing and discounting of bills also affect the size of the cash balance of the bank.

Q.3. Discuss the principles of Sound lending?  2001, 2003, 2010

Ans:- The principles of Sound lending by commercial banks are:-

        i.            Safety:- Safety of the funds is the primary concern of a bank while lending money. As the banker deals with borrowed funds he must ensure that it is safe to lend to a particular borrower before advancing money. Safety means that the borrower shall repay the principal amount along with interest.

      ii.            Liquidity:- Liquidity of loans is another principle of sound lending. The term liquidity of loan indicates the state of quick realization of loans from the borrowers. Banks are essentially dealers in short term fund and therefore, they lend money mainly for short term period. The banker should see that the borrower is able to repay the loan on demand or within a short notice. In such a situation the banker shall be able to satisfy his liquidity requirement.

    iii.            Profitability:- Commercial banks are profit seeking institutions and hence they must also ensure that their funds earn profit for them. While granting advances, the banker has to see that there will be sufficient earning to pay interest to the depositors, to meet establishment expenses and distribute dividend to the shareholders.

    iv.            Purpose of the loan:- At the time of granting loans, the banker must enquire about the purpose of the loan. The banker should grant loans for productive purpose only and not for unproductive and illegal activities. In case loan is given for unproductive purpose it may prove to be a burden on cash generation and subsequent repayment capacity of the borrower.

      v.            Diversification of risk:- The element of risk in relation to loans cannot be totally eliminated, It can only be reduced. Risks of lending can be reduced by diversifying the loans. While granting loans, the banker should not grant a major part of the loan to one single particular person or particular firm or an industry. If the banker grants loans and advances to a number of firms, persons or industries, the banker will not suffer a heavy loss even if a particular firm or industry does not repay the loan.

    vi.            National policies:- Banks have certain social responsibilities towards society also. The banks have to take into account the economic and social priorities of the country beside safety, liquidity and profitability. While formulating the lending policy, the banks are guided by the government policies in relation to disbursal of credit. Thus, national interest and policies also influence the lending decisions of banks.

Q.4. What do you mean by Investments? What are the principles of sound Investment?   2003, 2005, 2008

Ans:- The Term investment means employment of fund to buy an asset. Here investment means employment of funds by the bans to buy securities from the market. The securities which are purchased by the banker from the market includes:

        i.            Government securities:- These are the securities which are issued by the governments to raise fund such as stock, bearer bonds and promissory notes.

      ii.            Semi- government securities:- These are the securities which are issued by semi-government organization like municipal corporations, port trust, state financial institutions etc and these securities include debentures or bonds.

    iii.            Industrial securities:- These are the securities which are issued by industrial or business concern such as shares and debentures.

The following principles of Sound investment:-

        i.            Safety of principal:- A banker deals in borrowed funds and therefore his main consideration is sfety of principal invested in securities. The banker has to ensure that the principal amount invested by him remain safe. The safety of investment depends on the solvency and ability of the issuing authorities to honour their commitment made to the investors. The government and semi government securities are the safest securities because they are guaranteed by the government.

      ii.            Price stability:- The price of security selected by the banker should remain stable. The safety of investments depends on the stability in the prices of securities. Banker should prefer those securities whose prices remain fairly stable over a period of time. The prices of government securities remain stable and do not fluctuate.

    iii.            Marketability or liquidity:- The primary objective of buying securities by the banker is to earn income and at the same time maintain his liquidity position. Thus, the banker should see that the securities in which he invests his funds possesses a ready market i.e. they can be sold in the market without loss of time and money. Marketability of securities ensue liquidity of investments government sand semi government securities are highly liquid as they have a ready market.

    iv.            Profitability or yield:- After ensuring the safety of the principal money invested in securities, the banker should consider the returns from the investments. In other words, the banker should not give undue importance to higher yield at the cost of safety. Te banker should not expect windgall profit, because high profit may beat the germ of loss.

      v.            Diversification of investment:- The banker should diversify the risk involved in investment by investing in wide variety of securities issued by wide variety of business enterprises belonging to different trade and industry.

    vi.            Refinance:- To ensure the liquidity of his investments the banker has to see that the securities is eligible to obtain refinance from the central bank and other refinancing institution.

Q. 5. What do you mean by Letter of credit? What are the characteristics of letter of credit?

Ans:- A letter of credit is a letter from a bank guaranteeing that a buyer’s payment to a setter will be received on time and for the correct amount. In the events that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase, Due to the nature of international dealings, including factors such as distance, differing laws in each country, and difficulty in knowing each party personally, he use of letter of credit has become a very important aspect of international trade.

The following are the characteristics of letter of credit:-

        i.            The letters of credit are generally issued by banks.

      ii.            It is issued for a specified amount of money.

    iii.            It is issued for a specific period of time.

    iv.            There are four parties in a letter of credit viz, the importer or applicant, issuing bank, paying bank and the beneficiary.

      v.            The banker’s obligation to pay arises on the fulfillment of certain conditions.

Q.6. What are the various types of letter of credit?

Ans: - The following are the various types of letter of credit:-

        i.            Traveler’s letter of credit:- These are issued to the travelers for their convenience while travelling.

      ii.            Commercial letter of credit:- these are issued for facilitating trade transactions, specially international trade.

Q.7. Discuss the loans and advances granted by commercial banks?

Ans:- The different form in which the banks normally provide loans and advances are as follows:-

        i.            Loan:- A loan is a receive money from bank or financial institution in exchange for future repayment of the principal, plus interest. The principal is the amount borrowed and the interest is the amount charged for receiving the loan. Loan is given for a certain fixed period of time at an agreed rate of interest. A loan may be repaid in lump sum or in installment.

      ii.            Cash credit:-Cash credit is an arrangement by which a customer can borrow money from the bank through his current account upto a certain limit. The bankers sanction cash credit against some tangible securities which are charged with bank. The borrower is authorized to withdraw money from his credit limit according to his needs and he can also deposit any surplus amount with him in the account. The cash credit account is thus an active and running account to which withdrawals and deposits may be effected frequently.

    iii.            overdraft:- Overdraft means an arrangement with a bank by which a current account holder is allowed to withdrawn more than the balance standing to his credit upto a certain limit. Overdraft account can either be clean overdraft, partly secured or fully secured. The borrower is allowed to withdraw the amount as and when he needs and repay it by means of deposits in his account as and when it is feasible for him.

    iv.            Purchasing and discounting of bills:- Purchasing and discounting of bills is the most important form in which a bank lends without any collateral securities. A customer having bills can obtain immediate cash from the bank and do not have to wait till the bank collects the payments of the bills.

          The bills which are used by the customers to borrow from banks may be demand bills or time bills. Demand bills are payable on demand while time bills after the expiry of a definite period of time.

Q.8. What are the difference between cash credit and loan?   2005

Ans :- The followings are the difference between cash credit and loan:-

Basis of Difference	Loan	Cash credit
Mode	A loan may be given in cash or by credit to the amount of the borrower.	Cash credit is always given through the current account.
Borrower	The borrower of loan may be a customer of the bank or otherwise.	The borrower of cash credit becomes customer of the bank when he open the current account.
Security	A loan may be granted against tangible securities or personal guarantee of the borrower.	Cash credit is always given against some tangible securities.
Interest	Interest is charged in the entire amount of the loan.	Interest is payable only on the amount actually utilized by the borrower.
Maturity	A loan has a specific maturity date and is re-payable after a fixed period of time.	Cash credit do not have a fixed maturity date and it is technically re-payable on demand.

Q.9. What are the differences between cash credit and overdraft?

Ans:- The followings are the difference between cash credit and Overdraft:-

Basis of Difference	Cash credit	Overdraft
Mode	Cash credit is always given through the current account.	Overdraft is granted to the current account holders.
Borrower	The borrower of cash credit becomes customer of the bank when he open the current account.	An existing customer having current account is granted overdraft facility by the bank.
Security	Cash credit is always given against some tangible securities.	Overdraft may be clean, partly secured or fully secured.
Interest	Interest is payable only on the amount actually utilized by the borrower.	Interest is payable on the amount overdrawn from the current account.
Maturity	Cash credit do not have a fixed maturity date and it is technically re-payable on demand.	Overdraft is payable on demand and do not have any maturity date.