Why Banks Need Credit Rating

Bank rating is arising from the fact that the banks and financial institutions are highly leveraged. A bank with an average owner’s equity and undertaking a liability of guarantees to repay in timely manner. The fund collected through the above guarantees is invested with full potential risk to earn a net interest margin through undertaking high credit risk, operational risk and market risk. The above situation puts the banks and financial institutions in such a vulnerable position that any mistake in the process may put the bank in a distress situation. Keeping in view the above globally banks ate managed through a very cautious asset liability management system (ALM).  

The objective of commercial bank rating is to provide an opinion on the relative inherent quality of the equity instrument contemplated to be issued at public offer. The rating opinion is reflected by the earnings prospects, risk and financial strength, associated with the specific bank. Rating of commercial bank for the purpose of public offer does not predict the future market price of the share; rather it rates the fundamentals of a bank, which ultimately act as important inputs in the price behavior of the share of the bank over the medium and long term perspectives. In the short term, commercial bank rating facilitates the reconciliation of the market attitude with respect to the share of company to the long-term fundamentals as reflected by the equity rating.

The benefits of Credit Rating to Banks are:

• Rating of a Public Offer issued by Commercial Bank would ensure due compliance with the relevant legal regulatory provision of the Securities & Exchange Commission (SEC) and Central Bank.
• Rating would facilitate the issuer bank to effect of credibility among potential investors.
• CRA opinion would help the issuer company to broaden the market for their equity. As name recognition is replaced by objective opinions, the issuer company may access the equity market more comfortably.
• Equity Instrument Rating may help in establishing issuer access to the equity market even when the market price of listed equities is relatively unfavorable in the prevailing market conditions.
• Rating would facilitate a bank with fundamental strength an extended level of confidence from the depositors. Syndication partners, other banks and financing companies, international financial market and regulatory agencies.
• CRA rating would provide the Commercial Bank with an in depth analysis of the overall position and performance of the bank in comparison with its competitors in the peer group and give a guideline for areas of improvement.
• Commercial Bank Rating would give market participants timely access to unbiased, objective, independent, expert, professional opinion on the equity quality in a user friendly manner that may be relied upon for investment decisions.
• Rating opinion would facilitate the investors to decide their portfolios by choosing investment options in the equity market according to their profiles and preferences.
• Equity Instrument Rating would affect significant contribution towards developing the stock market investor confidence and enhancing the quality and perfection of the securities markets, through provision of credible information for guidance of institutional and individual investors.

What Types of Payment Mode Generally Used in Foreign Trade

An export contract can be deemed to be successfully completed when the exporter gets paid for the goods shipped by him, how he has to negotiations between which is to be decided during earlier negotiations between the exporter and the importer. There are five methods of payment which involve varying degrees of risk for the exporters are as follows:

Payment Mode Generally Used in Foreign Trade

• Cash in Advance: In this method of payment buyer pays seller before goods are shipped. Its generally used in case of new relationships and for smaller Transactions where buyer is unable to obtain an L/C. there is no advantage for buyer - Pays prior to receipt of goods and documents. Its adventurous for seller as eliminates risk of non-payment

• Open Account: In open account method Buyer pays seller subsequent to receipt of an invoice, normally after goods are shipped. Its used when there is high trusts relationships between buyer and seller and in inter-company transactions. It allows buyer to delay payment until goods have been examined, and/or goods have been sold. It doesn’t give any Advantage to seller - Risks non-payment.

• Documentary Collections: Documents (representing title to the goods) are exchanged through a bank for payment or acceptance (promise to pay). It is used for ongoing business relationships and transactions not requiring the protection and expense of L/C's. Its adventurous for buyer as delays payment until receipt of documents and buyer can be financed directly by seller through use of time drafts. Its benefit able for seller as they can retains title to goods until payment or acceptance.

• Shipment on Consignment Basis: In this method the exporter makes shipment to the overseas consignee/ agent, but the title to the goods, as also the risk attendant thereto, even through the overseas consignee will have the physical possession of the goods. The payment is only made when the overseas consignee ultimately sells the goods to other parties; this producer is rather costly and risky to the exporter.

• Documentary credit under Letter of Credit: The most popular from in recent times, as the credit and payment risks of the exporter can be eliminated under appropriate forms of documentary credit. Documentary credit is any agreement, however named or described whereby a bank (the issuing bank) acting at the request and in accordance with the instructions of the customer (the applicant for the credit) (i) is to make payment to or to the order of a third party (the beneficiary) or is to pay, accept or negotiate bills of exchange (drafts) drawn by the beneficiary or (ii) authorizes such payment to be made or such drafts to be paid, accepted or negotiated by another bank against stipulated documents, provided that the terms and conditions of the credit are compiled with.

Why Foreign Remittance is Important for Banks

Foreign remittance means remittance of foreign currencies from one place and persons to another place and person. In broad sense, foreign remittance includes all sale and purchase of foreign currencies on account of Import, Export, Travel and other purposes. However, specifically foreign remittance means sale & purchase of foreign currencies for the purposes other than export and import. As such, this chapter will not cover purchase & sale of foreign currencies on account of Import & Export of goods. Foreign exchange department of commercial banks are responsible to deal with outward and inward remittance other export and import only when remittance are in foreign currency.

Activities of Foreign Remittance Department of Commercial Banks

• Overall supervision of foreign remittance flow
•   Foreign Telephonic Transfer payments and Purchase of foreign drafts, preparations of foreign bill purchased 
•   Issuance of outward Telephonic Transfer payments and foreign demand drafts 
•   Issuance of proceed responding certificate (PRC)
•   Foreign collection, interbank clearing check collection, which comes from various branches
•   Withdrawal from foreign currency account on behalf of its clients 
•   Preparation of related statements including convertible local currency accounts
•   Preparation of balancing of collection and other special assignment as desired by department in charge
•   Balancing of account statements
•   Compliance of audit and inspection
•   Statement of all related works submitted to Central Bank.

All foreign remittance transactions are grouped into two broad categories of remittance for example, Outward remittance and Inward remittance. Foreign remittance department of commercial banks maintains the overall duties and responsibilities of foreign remittance flow for a bank.

Why Banking Settlement is Required

Settlement means fulfilling the commitment of issuing Bank in regard to effecting payment subject to satisfying the credit terms fully. This settlement may be done three separate arrangements as stipulated in the credit

SWIFT Inter-Bank Transfer: Now firmly established as standard practice in the major trading nations. The buyer will instruct their bank to make payment to any bank account specified by the exporter. It is good practice, therefore, for the exporter to include their account details on their invoice heads.

Buyer's Cheque: An unsatisfactory method of settlement for the exporter as it carries the risk of dishonor upon presentation as well as the added inconvenience of being slow to clear. There is also the very real danger of the cheque being lost in transit as well. A cheque is also unsatisfactory if it is in the currency of the buyer, as this will take longer to clear and will involve additional bank charges. Exporters should only use this method if they have an established trading history with their customer or in cases where the profit margin has been increased to offset cash flow problems anticipated by the delay in receiving payment.

Banker's Draft: The buyer who asks their bank to raise a draft on its corresponding bank in the exporter’s country arranges this. Provides additional security to a buyer's cheque, but they can be costly to arrange and they do run the risk of getting lost in transit.

International Money Orders: These are similar in nature to postal orders. They are pre-printed therefore cheaper to obtain than a Banker's Draft, although again there is the risk of loss in transit.

What is the Opening Procedure of Letter of Credit

Opening of letter of credit means, at the request of the applicant (importer) issuance of a L/C in favor of the beneficiary (exporter) by a Bank. The Bank, which open or issue L/C opening Bank or issuing Bank.

L/C Advising: Advising through a Bank is a proof of evident authenticity of the credit to the seller. The process of advising a credit consists of forwarding the original credit to the beneficiary to whom it is addressed. Before forwarding the advising Bank verify the signature (s) of the officer (s) of the issuing Bank & ensure that the terms & condition are not in violation of existing exchange control regulation & the other regulation relating to export. If credit is transmitted via telex, advising Bank will match the test used in the telex.

Amendment of Credit: Parties involved in a L/C, particularly the seller and the buyer, cannot always satisfy the terms and conditions in full as expected due to some obvious and genuine reasons. In such a situation, the credit should be amended.

Presentation of Document: The seller being satisfied with the terms and conditions of the credit proceeds to dispatch the required goods the buyer and after that, has to present the documents evidencing dispatching of goods to the negotiating bank on or before the stipulated expiry date of the credit. After receiving the entire document, the negotiating bank then checks the documents against the credit. If the documents are found in order, the bank will pay, accept or negotiate to the issuing bank. The issuing bank also checks the documents and if they are found as per credit requirements, either effects payment, or reimburse in the pre-agreed manner.

Who are Involved with a Letters of Credit

We've provided you with a comprehensive list of the parties involved in a letter of credit transaction. This page helps you understand the possible players in your scenario.

Advising Bank: Denotes the bank giving notification of the terms and conditions of a letter of credit to the beneficiary (seller). The advising bank also takes reasonable care to check the apparent authenticity of the letter of credit, which it advises.

Applicant: The party who applies to the opening (issuing) bank for the issuance of a letter of credit.

Beneficiary: The party in whose favor the letter of credit has been established. The beneficiary is the party who demands payment under the letter of credit.

Confirming Bank: A bank that at the request of the issuing bank, assures that drawings under the credit will be honored (provided the terms and conditions of the credit have been met).

Drawee Bank: The bank on which the drafts specified in the credit are drawn and from which payment is expected.

Issuing Bank (Opening Bank): The bank, which issues the letter of credit on behalf of the applicant.

Negotiating Bank: Bank, other than the issuing bank, which elects to "negotiate" (advance funds or give value to the beneficiary) against presentation of complying documents.

Paying Bank: The bank authorized in the letter of credit by the issuing bank to honor sight or deferred payments under the terms specified in the credit. (If this bank is the advising bank, it has no obligation to honor documents; however, if this is a confirming bank, it is obligated to pay against complying documents.)

Presenting Bank: The bank that forwards the documents directly to the issuing bank to obtain settlement.

Reimbursing Bank: The bank authorized by the issuing bank to reimburse the drawee bank or other banks submitting claims under the terms of the credit.

Transferring Bank: A bank authorized by the issuing bank as specified in the credit that can transfer the issuing bank's documentary credit from one beneficiary to another at the request of the first beneficiary.

Who are the Foreign Exchange Market Participants

There are four types of market participants—banks, brokers, customers, and central banks. Banks and other financial institutions are the biggest participants. They earn profits by buying and selling currencies from and to each other. Roughly two-thirds of all FX transactions involve banks dealing directly with each other.

Brokers act as intermediaries between banks. Dealers call them to find out where they can get the best price for currencies. Such arrangements are beneficial since they afford anonymity to the buyer/seller. Brokers earn profit by charging a commission on the transactions they arrange.
Customers, mainly large companies, require foreign currency in the course of doing business or making investments. Some even have their own trading desks if their requirements are large. Other types of customers are individuals who buy foreign exchange to travel abroad or make purchases in foreign countries.

Central banks, which act on behalf of their governments, sometimes participate in the FX market to influence the value of their currencies.

Foreign Exchange Transactions:
Conversion of currencies or exchanges is known as foreign exchange transactions. The conversion may arise from a transaction between a bank and another bank at home or abroad. The transactions involve at least two currencies. For a bank in Bangladesh, the process of conversion frequently involves conversion of Bangladesh Taka into foreign currency and vice versa.

Types of FX Transactions: There are different types of FX transactions:
1. Spot transactions: Spot market - deals with currency for immediate delivery (within one or two business days). Two parties agree on an exchange rate and trade currencies at that rate. This expresses only a potential interest in a deal, without the caller saying whether he wants to buy or sell. Although spot transactions are popular, they leave the currency buyer exposed to some potentially dangerous financial risks.

Forward transaction: One way to deal with the FX risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future and the transaction occurs on that date, regardless of what the market rates are then.

Futures: Foreign currency futures are forward transactions with standard contract sizes and maturity dates — for example, 500,000 British pounds for next November at an agreed rate.
Swap: The most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date.

 
Foreign Accounts of Banks:There are generally three types of inter-bank foreign accounts, which are discussed briefly in below:

Nostro Account: Nostro account is a Latin word means ‘ours’. In order to follow the exact position of the foreign currency accounts maintained by the bank concerned in Bangladesh with bank abroad, banks maintained ‘Nostro Account’ their own bank. In the Nostro Account bank will show the foreign currency accounts of each transaction and alongside the respective items of domestic currency equivalents are indicated.

Vostro Account: The word Vostro means ‘yours’. It is also called a local currency account. Foreign banks maintained current accounts in domestic currency in local banks and such accounts are called Vostro Account. Generally the Vostro Account are maintained by the foreign banks on a reciprocal basis to effect payment of as well as to receive payment on behalf of their clients.

Loro Account: The word Loro means ‘their’. Foreign bank accounts of any third party, whether in foreign currency or in home currency is treated as Loro Account.

Why Small and Medium Enterprise Loan is Important for Banks

The main focus of commercial banks is to develop human and economic position of a country. Its function is not limited only to providing and recovering of loan but also try to develop the economy of a country. So for this reason, SME program of commercial banks bears number of significance importance. 

• Support Small Enterprise: The small enterprise, which requires small amount of  loan, but they have no easy access to the banks and financial institutions.

• Economic Development: Economic development of country largely depends on the small and medium sales enterprises. Such as, if we analyze the development history of Japan, the development of small & medium sales enterprises expedites the development of that country.

• Employment Generation: The commercial bank gearing employment opportunities by two ways: Firstly, by providing loan to the small enterprises expanding, these businesses require more workers. Secondly, Small & Medium Enterprise (SME) program requires educated and energetic people to provide support to entrepreneurs. 

• Promote Micro Enterprise: Throughout the Union, more and more micro enterprises are being created. The new definition takes this development into account by setting financial thresholds for them. This refinement aims to encourage the adoption of measures addressing the specific problems micro enterprises face, especially during the start-up phase.

• Encourage Manufacturing: A focus of commercial bank is to encourage manufacturing by the entrepreneurs who are producing by purchasing various types of materials. CROs try to educate them to produce material, if possible because if they can produce in line of purchase profits will be high.