fi 2st assignment

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Muhammad Danish | www.knowledgedep.blogspot.com

Directorate of Distance Learning

Education

G.C University Faisalabad

FORM FOR ASSESSMENT OF ASSIGNMENT

(This part will be filled by Student)

Name of student: MUHAMMAD DANISH

Name of Tutor: Sir Muhammad Sajid SB

Roll No. 119467 Address of Tutor:

_________________________________

_________________________________

Contact No._______________________

Semester: 2nd

Year: 2015 To 2017

Address:

H # P – 802 G M ABAD NO.1 FSD

Name of course: Financial Market & Institutions Assignment No. 2st Code No._____

Last date of submission of Assignment: 31-08-2016

Date of submission of Assignment: 31-08-2016

Signature of Student: M.DANISH

(This part will be filled by Tutors) Nameof study Center:_____________________ District:___________ Date of receiving Assignment: _______________

Q.No. 1 2 3 4 5 6 7 8 9 10

Cumulative Obtained

Marks

Marks Obtained

Total Marks

Tutors’ comments:

____________________________________________________________________________________________________________________________________________

Date of Assignment Return: _________ Signature of Tutor

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Q1:- Explain Pension funds in detail also discuss regulatory

framework of pension funds under the Supervision of SECP.

Answer:

Pension Fund:

A pension is a fund into which a sum of money is added during an employee's

employment years, and from which payments are drawn to support the person's retirement from

work in the form of periodic payments. A pension may be a "defined benefit plan" where a fixed

sum is paid regularly to a person, or a "defined contribution plan" under which a fixed sum is

invested and then becomes available at retirement age.

Different types of pension fund:

There are two basic types of pension fund as under:

1. Private Pension Funds:

“The private pension funds are those funds administered by a private corporation

(e.g. insurance company, mutual fund.)”.

“Any pension plan set up by employers, groups, or individuals”.

2. Public Pension Funds:

“Public pension funds are those funds administered by a federal, state, or local

government (e.g. social security)”.

“Any pension plan set up by a government body for the general public.”

Regulation of Pension Plans:

For many years, pension plans were relatively free of government regulation.

Many companies provided pension benefits as rewards for long years of good service and

used the benefits as an incentive. Frequently, pension benefits were paid out of current

income. When the firm failed or was acquired by another firm, the benefits ended. During

the Great Depression, widespread pension plan failures led to increased regulation and to

the establishment of the Social Security system.

Employee Retirement Income Security Act:

SECP set certain standards that must be followed by all pension plans. Failure to

follow the provisions of the act may cause a plan to lose its advantageous tax status. The


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motivation for the act was that many workers who had contributed to plans for years were

losing their benefits when plans failed. The principal features of the act are the following:

SECP established guidelines for funding.

It provided that employees switching jobs might transfer their credits from one

employer plan to the next.

Plans must have minimum vesting requirements. Vesting refers to how long an

employee must work for the company to be eligible for pension benefits. The

maximum permissible vesting period is seven years, though most plans allow for

vesting in less time. Employee contributions are always immediately vested.

Pension Benefit Guarantee Corporation:

SECP also established the Pension Benefit Guarantee Corporation, a government

agency that performs a role similar to that of the PFDIC. It insures pension benefits up to

a limit if a company with an underfunded pension plan goes bankrupt or is unable to meet

its pension obligations for other reasons.

When the market prices were high, most defined-benefit pension plans were

adequately funded. Many firms with defined-benefit plans find it hard to compete against

firms with much lower cost defined-contribution plans. This competitive disadvantage

increases the possibility that the firms may not survive to pay down their deficits.

Individual Retirement Plans:

The Pension Reform Act of 1978 updated the Self-Employed Individuals Tax

Retirement Act of 1962 to authorize individual retirement accounts (IRAs). IRAs

permitted people (such as those who are self-employed) who are not covered by other

pension plans to contribute into a tax-deferred savings account. Legislation in 1981 and

1982 expanded the eligibility of these accounts to make them available to almost

everyone. IRAs proved extremely popular, to the extent that their use resulted in

significant losses of tax revenues to the government.

Future of Pension Funds:

We can expect that pension funds will continue their growth and popularity as the

population continues to grow and age. Workers in their early years of employment often

find discussions of retirement investing creeping into their conversations. This

heightened attention to providing for the future will result in an increased number of

pension funds as well as a greater variety of pension fund options to choose among. We

can also expect to see pension funds gain increased power over corporations as they

control increasing amounts of stock.


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Q2:- Explain commercial banks, different services and departments of

commercial banks.

Answer:

Commercial Bank:

A Commercial Bank is a financial institution that provides various financial services,

such as accepting deposits and issuing loans. Commercial bank customers can take advantage

of a range of investment products that commercial banks offer like savings accounts and

certificates of deposit.

Services of Commercial Bank:

1. Accepting Deposit

Accepting deposit from savers or account holders is the primary function of bank.

Banks accept deposit from those who can save money, but cannot utilize in profitable sectors.

People prefer to deposit their savings in a bank because by doing so, they earn interest.

2. Advancing Of Loans

Banks are profit oriented business organizations. So they have to advance loan to

public and generate interest from them as profit. After keeping certain cash reserves, banks

provide short-term, medium-term and long-term loans to needy borrowers.

3. Discounting Of Bill Of Exchange

Discounting bill of exchange is another function of modern commercial bank. Under

this, banks purchase bill of exchange from holder in discount after making some marginal

deduction in the form of commission. The banks pay the deducted value to the holders when

traders discount it into bank.

4. Cheque Payment

Banks provide Cheque pads to the account holders. Account holders can draw

Cheque upon bank to pay money. Banks pay for cheques of customers after formal

verification and official procedures. .

5. Remittance


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Remittance is a system, through which cash fund is transferred from one place to

another. Banks provide the facilities of remittance to the customers and earn some service

charge.

6. Collection And Payment Of Credit Instruments

In modern business, different types of credit instruments such as bill of exchange,

promissory notes, cheques etc. are used. Banks deal with such instruments. Modern banks

collect and pay different types of credit instruments as the representative of the customers.

7. Foreign Currency Exchange

Banks deal with foreign currencies. As the requirement of customers, banks exchange

foreign currencies with local currencies, which is essential to settle down the dues in the

international trade.

8. Consultancy

Modern commercial banks are large organizations. They can expand their function to

consultancy business. In this function, banks hire financial, legal and market experts, who

provide advices to customers in regarding investment, industry, trade, income, tax etc.

9. Bank Guarantee

Customers are provided the facility of bank guarantee by modern commercial banks.

When customers have to deposit certain fund in governmental offices or courts for specific

purpose, bank can present itself as the guarantee for the customer, instead of depositing fund

by customers.

Departments of Commercial bank:

To begin, a bank is structured like any other business that provides services to its

customers. It consists of the front office and the back office.

Front Office of a Bank:

Employees who are involved in external activities with customers who transact

business with a bank.

Back Office of a Bank:

Employees who perform internal activities to affect the operational functions of a

bank. Some activities include interaction with customers, some do not.

Types of departments of Front and back office department


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1. Saving bank

2. Current account

3. Fixed deposit

4. Remittances

5. Clearing

6. Staff salary

7. Pension payment

8. Security department

9. Stationery department

10. Loan section

Loan department may be have separate departments such as

1. Retail loan

2. Housing loan

3. MSME

4. Government sponsored schemes loan processing center

5. Agricultural finance department

6. Gold loan department

7. Foreign exchange – deposits/ remittances/loans/guarantees etc.

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Q3:- Explain insurance, importance of insurance and types of

insurance policies.

Answer:

Insurance:

An arrangement by which a company or the state undertakes to provide a guarantee of

compensation for specified loss, damage, illness, or death in return for payment of a specified

premium.

Risk-transfer mechanism that ensures full or partial financial compensation for the

loss or damage caused by event(s) beyond the control of the insured party. Under an insurance

contract, a party (the insurer) indemnifies the other party (the insured) against a specified

amount of loss, occurring from specified eventualities within a specified period, provided a

fee called premium is paid.

Importance of Insurance:

There are some points of importance of insurance.

1. Provide safety and security:

Insurance provide financial support and reduce uncertainties in business and human

life. It provides safety and security against particular event. There is always a fear of sudden

loss. Insurance provides a cover against any sudden loss. For example, in case of life

insurance financial assistance is provided to the family of the insured on his death. In case of

other insurance security is provided against the loss due to fire, marine, accidents etc.

2. Generates financial resources:

Insurance generate funds by collecting premium. These funds are invested in

government securities and stock. These funds are gainfully employed in industrial

development of a country for generating more funds and utilised for the economic

development of the country. Employment opportunities are increased by big investments

leading to capital formation.

3. Life insurance encourages savings:

Insurance does not only protect against risks and uncertainties, but also provides an

investment channel too. Life insurance enables systematic savings due to payment of regular

premium. Life insurance provides a mode of investment. It develops a habit of saving money


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by paying premium. The insured get the lump sum amount at the maturity of the contract.

Thus, life insurance encourages savings.

4. Promotes economic growth:

Insurance generates significant impact on the economy by mobilizing domestic

savings. Insurance turn accumulated capital into productive investments. Insurance enables to

mitigate loss, financial stability and promotes trade and commerce activities those results into

economic growth and development. Thus, insurance plays a crucial role in sustainable growth

of an economy.

5. Medical support:

A medical insurance considered essential in managing risk in health. Anyone can be a

victim of critical illness unexpectedly. And rising medical expense is of great concern.

Medical Insurance is one of the insurance policies that cater for different type of health risks.

The insured gets a medical support in case of medical insurance policy.

6. Spreading of risk:

Insurance facilitates spreading of risk from the insured to the insurer. The basic

principle of insurance is to spread risk among a large number of people. A large number of

persons get insurance policies and pay premium to the insurer. Whenever a loss occurs, it is

compensated out of funds of the insurer.

7. Source of collecting funds:

Large funds are collected by the way of premium. These funds are utilized in the

industrial development of a country, which accelerates the economic growth. Employment

opportunities are increased by such big investments. Thus, insurance has become an important

source of capital formation.

Types of Insurance Policies:

1. Gap insurance

Guaranteed Auto Protection (GAP) insurance is also known as GAPS and was

established in North American financial industry. GAP insurance is the difference

between the actual cash value of a vehicle and the balance still owed on the financing (car

loan, lease, etc.).

2. Health insurance

Health insurance is a type of insurance coverage that covers the cost of an insured individual's medical and surgical expenses. Depending on the type

of health insurance coverage, either the insured pays costs out-of-pocket and is then reimbursed, or the insurer makes payments directly to the provider.


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3. Income protection insurance

Income Protection Insurance (IPI) is an insurance policy, available

principally in Australia, Ireland, New Zealand, South Africa, and the United Kingdom, paying benefits to policyholders who are incapacitated and hence unable to work due to illness or accident.

4. Casualty insurance

Casualty insurance is a problematically defined term, which broadly

encompassesinsurance not directly concerned with life insurance,

health insurance, or propertyinsurance. It is mainly liability coverage of an

individual or organization for negligent acts or omissions.

5. Life insurance

Insurance that pays out a sum of money either on the death of the insured

person or after a set period.

6. Burial insurance

“Burial insurance” usually refers to a whole life insurance policy with a

death benefit of from $5,000 to $25,000. As its nickname implies, people buy this

type of policy to provide money for funeral and burial costs for themselves and/or

family members.

7. Property insurance

Property insurance is a policy that provides financial reimbursement to the

owner or renter of a structure and its contents, in the event of damage or

theft. Property insurancecan include homeowners insurance, renters insurance,

flood insuranceand earthquake insurance.

8. Liability insurance

Liability insurance is a part of the general insurance system of risk

financing to protect the purchaser (the "insured") from the risks

of liabilities imposed by lawsuits and similar claims. It protects the insured in the

event he or she is sued for claims that come within the coverage of

the insurance policy.

9. Credit insurance

Credit insurance is a type of life insurance policy purchased by a borrower

that pays off one or more existing debts in the event of a death, disability, or in

rare cases, unemployment.

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Q4:- Explain in detail important laws/rules issued in insurance act

1938 and insurance ordinance 2000 to conduct insurance

business in Pakistan.

Answer:

The Insurance Act, 1938 is a law originally passed in 1938 in British India to

regulate the insurance sector. It provides the broad legal framework within which the

industry operates.

The President of Pakistan had promulgated the Insurance Ordinance, 2000 on 19

August 2000 repealing the Insurance Act 1938.

The new ordinance has divided Life Insurance Businessand Non Life Insurance Business

into following classes:

LIFE INSURANCE BUSINESS:

1. Ordinary Life Business.

2. Capital Redemption Business.

3. Pension Fund Business.

4. Accident and Health Business.

NON-LIFE INSURANCE BUSINESS:

1. Fire and Property Damage Business.

2. Marine, Aviation and Transport Business.

3. Motor Third Party Compulsory Business.

4. Liability Business.

5. Worker’s Compensation Business.

6. Credit and Surety-ship Business.

7. Accident and Health Business.

8. Agriculture Insurance including Corp, Insurance.

9. Miscellaneous Business.

A public company or a body corporate can start insurance business in Pakistan. A

certificate of registration as insurer will be obtained within six months for life business

and non- life business separately. The registered insurer will meet the requirements of

minimum paid up capital, statutory deposits, solvency, requirements, and reinsurance:

arrangement appointment of auditors and to comply with Provisions of this Ordinance.A


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registered insurer shall have to pay an annual supervision fee to SECP at the ra te of R.s. 1

per thousands of gross premium written in Pakistan during the calendar year with a

minimum of R.s. 100,000.

LIFE INSURANCE BUSINESS: 150 MILLION RUPEES.

100 Million Rupees will be attained up to 31st December 2002.


NON-LIFE INSURANCE BUSINESS: 80 MILLION RUPEES.



Every insurer will maintain a minimum deposit equal to 10% of its Paid-Up-Capital with

State Bank of Pakistan. The deposit in excess of amount required can be asked for with

permission from SECP for refund.

Reinsurance Arrangements:

The insurers will maintain assets in excess of liabilities to meet solvency

requirement as per this Ordinance. Insurance companies will maintain adequate

reinsurance arrangements.

The insurers will submit the quarterly returns on the prescribed form to SECP.

The auditors shall be appointed by the commission to audit the accounts of insurer’s.

Actuary report for life insurance business shall be necessary. If any return is considered

inaccurate or defective the Commission can call for further information, call upon

insurer; examine any officer of insurer (or decline to accept the return).

The process of implementation of new insurance law is very slow. In fact, the new

law is the outcome of the findings and recommendations of the National Insurance

Reforms Commission which worked in 1988-89 and presented its reports in 1990. Under

the Capital Market Development Program, the ADB supported Pakistan and consultants

were engaged in 1997. The consultants presented the draft bill of Insurance Act, 1999 in

July 1999. At lasts on 19th August 2000 the President of Pakistan Promulgated the

Insurance Ordinance, 2000 repealing the Insurance Act, 1938.

However, now the economic environment of the country is changing. The foreign

exchange remittances have been increased and the exchange rates have been stabilized.

The sick industries are being revived through CIRC (corporate and Industrial

Restructuring Corporation). The public and private sectors are expected to be involved in

the reconstruction of Afghanistan. The Motorway and other highway projects are being


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completed. The construction of the third seaport at Gwadar has also been started. Foreign

investments are also anticipated.

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Q5: - Explain mutual fund and its types in detail

Answer:

Mutual Fund:

A mutual fund is an investment vehicle made up of a pool of funds collected from

many investors for investing in securities such as stocks, bonds, money market

instruments and similar assets.

Types of Mutual Funds:

There are four primary types of mutual funds are available for investors, which are

following.

1. Equity Funds:

A stock fund or equity fund is a fund that invests in stocks, also

called equitysecurities. Stock funds can be contrasted with bond funds and

money funds. Fundassets are typically mainly in stock, with some amount of cash, which

is generally quite small, as opposed to bonds, notes, or other securities.

General equity funds include:

Aggressive growth funds, which seek maximum capital appreciation and may

use speculative strategies.

Small-company funds, which invest in companies with relatively small market

capitalizations.

Growth funds, which invest in larger, established but growing companies. They

generally emphasize capital appreciation.

Growth and income funds, which invest in larger, established companies

that offer the potential for capital appreciation but also pay regular dividends.

Equity-income funds, which primarily invest in dividend-paying stocks.

2. Bond Funds:

A bond fund or debt fund is a fund that invests in bonds, or other debt

securities.Bond funds can be contrasted with stock funds and money funds. Bond


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fundstypically pay periodic dividends that include interest payments on

the fund's underlying securities plus periodic realized capital appreciation.

Types of Bond Funds:

There are three basic types of bond funds, which are following;

(i) Government Bonds:

Government bonds funds invest in debt securities that are issued by

the Pakistan government and its agencies. These funds are regarded as the

safest of the bond funds because the underlying securities are backed by

the full faith and credit of the Pakistan government.

(ii) Municipals Bonds:

Municipal bond funds invest in debt securities issued by state and

local governments to pay for local public projects, such as bridges,

schools, and highways. These bond funds are popular among investors

with high incomes because they are exempt from federal taxes and, in

some cases, from state taxes as well.

(iii) Corporate Bonds:

Corporate bond funds are comprised of bonds issued by

corporations. Any government institution does not back the bonds in a

corporate bond fund. Thus, it is more likely that the underlying bonds

could default if the companies that issue them run into financial trouble.

(iv) Other Bonds:

There are many other types of bond funds. Zero-coupon bond

funds invest in zero coupon bonds; international bond funds invest in

bonds issued by foreign governments and corporations; convertible

securities funds invest in bonds that may be converted into stock. Finally,

if you are looking to diversify your holdings even more, there are multi-

sector bond funds that invest in all different types of bonds: corporate

bonds, municipal bonds, international bonds and so on.

3. Hybrid Funds:

A hybrid fund is a category of mutual fund that is characterized by

portfolio that is made up of a mix of stocks and bonds, which can vary

proportionally over time or remain fixed. Morningstar separates hybrid funds into

domestic hybrid and international hybrid categories.


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4. Money Market Funds:

A money market fund (also called a money market mutual fund) is an

open-ended mutual fund that invests in short-term debt securities such as US

Treasury bills and commercial paper. Money market funds are widely (though not

necessarily accurately) regarded as being as safe as bank deposits yet providing a

higher yield.

Q6:- Explain regulatory framework of mutual funds under the

rules of SECP.

Answer:

Mutual Funds:

A mutual fund is an investment vehicle made up of a pool of funds collected from

many investors for investing in securities such as stocks, bonds, money market instruments

and similar assets.

REGULATORY FRAMEWORK FOR MUTUAL FUNDS:

Board of Directors

A management investment company (mutual fund company) has a CEO, a team of

officers and a board of directors. Each one of these entities is responsible for serving the

interests of the shareholders. The primary responsibility of the officers and the board of

directors is to handle the investment company's administrative matters.

The investment company’s shareholders elect the board of directors. The board

defines the type of funds that will be offered to the public. For example, it will suggest

offering a selection of funds - growth funds, international funds, income funds and soon to

meet the investment needs of many individuals. It will also define each fund's objectives.

The board will also approve and hire the investment advisor, transfer agent and custodian

(defined below) for each fund.

Sponsor

The principal underwriter of a mutual fund is called a distributor, or more

commonly, the sponsor. The sponsor has a written contract with the investment company

that allows it to purchase fund shares at the current net asset value and resell the shares to

the public at the full public offering price, through either outside dealers or through its own

sales force. The contract with the mutual fund company is subject to annual renewal, but as

long as the sponsor is distributing and marketing the shares in a satisfactory manner, there

is no reason why the sponsor's contract should be discontinued.


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Custodian

The custodian is responsible for the possession of the securities purchased by the

investment company for its portfolio. The custodian also handles most of the investment

company's clerical functions. Once securities are transferred to the custodian for

safekeeping, the custodian must keep the assets physically segregated at all times, restrict

access to the account to officers and employees of the investment company, and allow

withdrawal only according to SEC rules.

Investment Advisor

The board of directors hires an investment advisor to invest the cash and securities

held in the fund's portfolio, implement the objectives outlined by the board, manage day-to-

day trading of the portfolio, and handle other tasks that involve the tax implications of the

share. For these services, the investment advisor is acting as a fund advisor or fund

manager, and earns a management fee paid from the fund's net assets. Usually, the fund

manager earns an annual percentage of the fund's value, plus an incentive bonus if he or she

exceeds certain performance goals.

Transfer Agent

The mutual fund contracts with a transfer agent to issue, redeem and cancel fund

shares, handle the distribution of dividend and capital gains to shareholders, and send out

trade confirmations. In certain instances, the custodian will act as transfer agent. The fund

company usually pays the transfer agent a fee for services rendered.

Dealers

As mentioned before, the sponsor usually distributes shares of the mutual fund

through dealers. The dealers purchase shares from the sponsor at a discount to the public

offering price and fill their customers' orders. It is important to note that dealers cannot buy

shares for their own inventory to sell at a later date. They may purchase shares to fill

customer orders or for their own investment, but any purchase that occurs for a dealer's

own investment must be redeemed when sold; it cannot be sold to an investor.

Restrictions on Mutual Fund Operations

The SEC prohibits a mutual fund from engaging in the following activities unless it

meets strict financial and disclosure requirements:

Selling securities short

Buying securities on margin

Participating in joint investment or trading accounts

Distributing its own securities, except through a sponsor


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Otherwise, the fund must disclose these activities and the extent to which it plans to

participate in these activities in its prospectus.

Affiliated and Interested Parties

The 1940 act and its amendments identify two types of people, defined as affiliated

and interested parties, who may influence the investment company's management and

operations and whose actions must be regulated and restricted by the SEC. They may not

borrow money from the investment company or sell any security or property to the

investment company or companies the management company controls.

An affiliated person is someone who controls an investment company's

operations in any way.

An interested person includes those individuals who have a relationship with

an affiliated person that the SEC deems influential in matters of fund operation.

These people would include immediate family members of affiliated parties,

legal counselors, broker-dealers, and so on.

Furthermore, the board of directors must have 40% outside representation: that is, at

least 40% of the board must be made up of individuals who do not have a position with, or

affiliation to, the fund. This restriction includes anyone associated with the underwriter,

investment advisor, custodian or transfer agent.

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Q.7: Explain important functions of commercial banks.

Answer:

1. Primary Function:

i. Accepting Deposits:

It is the most important function of commercial banks. They accept deposits in

several forms according to requirements of different sections of the society.

The main kinds of deposits are:

a) Current Account Deposits or Demand Deposits:

These deposits refer to those deposits, which are repayable by the banks on demand:

Businesspersons with the intention of making transactions with such

deposits generally maintain such deposits.

A cheque without any restriction can draw upon them.

Banks do not pay any interest on these accounts. Rather, banks impose

service charges for running these accounts.

b) Fixed Deposits or Time Deposits:

Fixed deposits refer to those deposits, in which the amount is deposited with the

bank for a fixed period of time.

Such deposits do not enjoy cheque-able facility.

These deposits carry a high rate of interest.

c) Saving Deposits:

These deposits combine features of both current account deposits and fixed

deposits:

The depositors are given cheque facility to withdraw money from their

account. But, some restrictions are imposed on number and amount of

withdrawals, in order to discourage frequent use of saving deposits.

They carry a rate of interest which is less than interest rate on fixed deposits.

It must be noted that Current Account deposits and saving deposits are

chequable deposits, whereas, fixed deposit is a non-chequable deposit.


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ii. Advancing of Loans:

The deposits received by banks are not allowed to remain idle. So, after keeping

certain cash reserves, the balance is given to needy borrowers and interest is charged

from them, which is the main source of income for these banks.

Different types of loans and advances made by Commercial banks are:

a) Cash Credit:

Cash credit refers to a loan given to the borrower against his current assets

like shares, stocks, bonds, etc. A credit limit is sanctioned and the amount is

credited in his account. The borrower may withdraw any amount within his

credit limit and interest is charged on the amount actually withdrawn.

b) Demand Loans:

Demand loans refer to those loans which can be recalled on demand by the

bank at any time. The entire sum of demand loan is credited to the account

and interest is payable on the entire sum.

c) Short-term Loans:

They are given as personal loans against some collateral security. The money

is credited to the account of borrower and the borrower can withdraw money

from his account and interest is payable on the entire sum of loan granted.

2. Secondary Functions:

a) Overdraft Facility:

It refers to a facility in which a customer is allowed to overdraw his

current account upto an agreed limit. This facility is generally given to

respectable and reliable customers for a short period. Customers have to pay

interest to the bank on the amount overdrawn by them.

b) Discounting Bills of Exchange:

It refers to a facility in which holder of a bill of exchange can get the bill

discounted with bank before the maturity. After deducting the commission,

bank pays the balance to the holder. On maturity, bank gets its payment from

the party which had accepted the bill.

c) Agency Functions:

Commercial banks also perform certain agency functions for their

customers. For these services, banks charge some commission from their

clients.

3. Some of the agency functions are:

a. Transfer of Funds:

Banks provide the facility of economical and easy remittance of funds

from place-to-place with the help of instruments like demand drafts, mail

transfers, etc.


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b. Collection and Payment of Various Items:

Commercial banks collect cheques, bills,’ interest, dividends,

subscriptions, rents and other periodical receipts on behalf of their customers

and also make payments of taxes, insurance premium, etc. on standing

instructions of their clients.

c. Purchase and Sale of Foreign Exchange:

Some commercial banks are authorized by the central bank to deal in

foreign exchange. They buy and sell foreign exchange on behalf of their

customers and help in promoting international trade.

d. Purchase and Sale of Securities:

Commercial banks buy and sell stocks and shares of private companies as

well as government securities on behalf of their customers.

e. Income Tax Consultancy:

They also give advice to their customers on matters relating to income tax

and even prepare their income tax returns.

f. Trustee and Executor:

Commercial banks preserve the wills of their customers as trustees and

execute them after their death as executors.

g. Letters of Reference:

They give information about the economic position of their customers to

traders and provide the similar information about other traders to their customers.

4. General Utility Functions:

Commercial banks render some general utility services like:

a. Locker Facility:

Commercial banks provide facility of safety vaults or lockers to keep

valuable articles of customers in safe custody.

b. Traveler’s Cheques:

Commercial banks issue traveler’s cheques to their customers to avoid risk

of taking cash during their journey.

c. Letter of Credit:

They also issue letters of credit to their customers to certify their

creditworthiness.

d. Underwriting Securities:

Commercial banks also undertake the task of underwriting securities. As

public has full faith in the creditworthiness of banks, public do not hesitate in

buying the securities underwritten by banks.


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Q.8: Explain different prudential regulations for corporate and

commercial banks issued by SBP for reporting and to perform

banking services.

Answer:

Regulations:

The rules or directives made and maintained by an authority to manage and run

the activities of the corporation or entity. The Prudential Regulations for Corporate /

Commercial Banking do not supersede other directives issued by State Bank of Pakistan

in respect of areas not covered here. Any violation or circumvention of these regulations

shall render the bank/DFI/officer(s) concerned liable for penalties under the Banking

Companies Ordinance, 1962.

Prudential regulations for corporate and commercial banks:

GUARANTEES:

1. All guarantees issued by the banks / DFIs shall be fully secured, except in the cases

mentioned at Annexure-III where it may be waived up to 50% by the banks / DFIs at

their own discretion, provided that banks / DFIs hold at least 20% of the guaranteed

amount in the form of liquid assets as security.

2. In case of back to back letter of credit issued by the banks / DFIs for export oriented

goods and services, banks / DFIs are free to decide the security arrangements at their

own discretion subject to the condition that the original L/C has been established by

branches of guarantee issuing bank or a bank rated at least A by Standard & Poor,

Moody’s, Fitch-Ibca or Japan Credit Rating Agency (JCRA).

3. The guarantees shall be for a specific amount and expiry date and sha ll contain claim

lodgment date. However, banks / DFIs are allowed to issue open-ended guarantees

without clearance from State Bank of Pakistan provided banks / DFIs have secured

their interest by adequate collateral or other arrangements acceptable to the bank /

DFI for issuance of such guarantees in favor of Government departments,

corporations / autonomous bodies owned/controlled by the Government and

guarantees required by the courts.

CLASSIFICATION AND PROVISIONING FOR ASSETS LOANS / ADVANCES:


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Banks / DFIs shall observe the prudential guidelines given at Annexure-IV in the

matter of classification of their asset portfolio and provisioning there-against.

At the time of rescheduling / restructuring, banks / DFIs shall consider and examine the

requests for working capital strictly on merit, keeping in view the viability of the project /

business and appropriately securing their interest etc.

All fresh loans granted by the banks / DFIs to a party after rescheduling/

restructuring of its existing facilities may be monitored separately, and will be subject to

classification under this Regulation on the strength of their own specific terms and

conditions.

Banks / DFIs shall classify their loans / advances portfolio and make provisions in

accordance with the criteria prescribed above.

Banks are allowed to take the benefit of 30 percent of FSV of pledged stocks

and mortgaged commercial and residential properties held as collateral against

all NPLs for three years from the date of classification for calculating

provisioning requirement i.e. 31–12–2008. For the purpose of determination of

FSV, revised Annexure-V of PR for Corporate/Commercial Banking shall be

followed.

Banks/DFIs may avail the above benefit of FSV subject to compliance with the

following conditions:

he additional impact on profitability arising from availing the benefit of FSV

against pledged stocks and mortgaged commercial and residential properties

shall not be available for payment of cash or stock dividend.

Heads of Credit of respective banks/DFIs shall ensure that FSV used for taking

benefit of provisioning is determined accurately as per guidelines contained in

PRs and is reflective of market conditions under forced sale situations.

INVESTMENTS AND OTHER ASSETS:

1. The banks shall classify their investments into three categories viz. ‘Held for

Trading,’ ‘Available for Sale’ and ‘Held to Maturity.’ However, investments in

subsidiaries and associates shall be reported separately in accordance with

International Accounting Standards as applicable in Pakistan and shall not be subject

to mark to market.

2. Investment portfolio in ‘Held for Trading’ and ‘Available for Sale’ and other assets

will be subject to detailed evaluation for the purpose of their classification keeping

in view various subjective and objective factors given as under

Quoted Securities:

Government Securities will be valued at PKRV (Reuter Page). TFCs, PTCs and

shares will be valued at their market value. The difference between the market value and

book value will be treated as surplus/deficit.

Un-quoted Securities:


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PTCs and TFCs will be classified on the evaluation / inspection date on the basis

of default in their repayment in line with the criteria prescribed for classification of

medium and long-term facilities. Shares will be carried at the cost. However, in cases

where the breakup value of such shares is less than the cost, the difference of the cost and

breakup value will be classified as loss and provided for accordingly by charging to the

Profit and Loss account of the bank / DFI.

Treatment of Surplus/deficit:

The measurement of surplus/deficit shall be done on portfolio basis. The

surplus/deficit arising as a result of revaluation of ‘Held for Trading’ securities shall be

taken into Profit & Loss Account. The surplus/deficit on revaluation of ‘Available for

Sale’ category shall be taken to “Surplus/Deficit on Revaluation of Securities.”

Impairment in the value of ‘Available for Sale’ or ‘Held to Maturity’ securities will be

provided for by charging it to the Profit and Loss Account.

Other Assets:

Classification of Other Assets and provision required there-against shall be

determined keeping in view the risk involved and the requirements of the International

Accounting Standards.

Submission of returns:

Banks / DFIs shall submit the borrower-wise annual statements regarding

classified loans /advances to the Banking Inspection Department.

Facilities to Private Limited Company:

Banks / DFIs shall formulate a policy, duly approved by their Board of Directors,

about obtaining personal guarantees of directors of private limited companies.

Banks/DFIs may, at their discretion, link this requirement to the credit rating of the

borrower, their past experience with it or its financial strength and operating

performance.

Payment of dividend:

Banks / DFIs shall not pay any dividend on their shares unless and until:

They meet the minimum capital requirements as laid down by the State Bank of

Pakistan from time to time;

All their classified assets have been fully and duly provided for in accordance

with the Prudential Regulations and to the satisfaction of the State Bank of

Pakistan; and

All the requirements laid down in Banking Companies Ordinance, 1962 relating

to payment of dividend are fully complied.


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Q9:- What are different Financial Risks? Explain in detail Credit

risk and its types.

Answer:

Financial Risks:

Financial risk is the possibility that shareholders will lose money when they invest in a

company that has debt, if the company's cash flow proves inadequate to meet its financial

obligations. When a company uses debt financing, its creditors are repaid before its shareholders

if the company becomes insolvent. Financial risk also refers to the possibility of a corporation or

government defaulting on its bonds, which would cause those bondholders to lose money.

Types of Financial Risks:

1. Market Risk:

This type of risk arises due to movement in prices of financial instrument. Market

risk can be classified as Directional Risk and Non - Directional Risk. Directional risk is

caused due to movement in stock price, interest rates and more. Non- Directional risk on

the other hand can be volatility risks.

2. Credit Risk:

This type of risk arises when one fails to fulfill their obligations towards their

counter parties. Credit risk can be classified into Sovereign Risk and Settlement Risk.

Sovereign risk usually arises due to difficult foreign exchange policies. Settlement risk on

the other hand arises when one party makes the payment while the other party fails to

fulfill the obligations.

3. Liquidity Risk:

This type of risk arises out of inability to execute transactions. Liquidity risk can

be classified into Asset Liquidity Risk and Funding Liquidity Risk. Asset Liquidity risk

arises either due to insufficient buyers or due to insufficient sellers against sell orders and

buys orders respectively.

4. Operational Risk:

This type of risk arises out of operational fa ilures such as mismanagement

or technical failures. Operationa l risk can be classified into Fraud Risk and Model

Risk. Fraud risk arises due to lack of controls and Model risk arises due to

incorrect model application.

5. Legal Risk:

This type of financia l risk arises out of legal constraints such as lawsuits.

Whenever a company needs to face financia l loses out of legal proceedings, it is

legal risk.


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Credit risk:

A credit risk is the risk of default on a debt that may arise from a borrower failing to

make required payments. In the first resort, the risk is that of the lender and includes lost

principal and interest, disruption to cash flows, and increased collection costs.

How is credit risk assessed?

Credit risks are calculated based on the borrowers' overall ability to repay. To assess

credit risk on a consumer loan, lenders look at the five C's: an applicant's credit history, his

capacity to repay, his capital, the loan's conditions and associated collateral.

Similarly, if an investor is thinking about buying a bond, he looks at the credit rating of the bond.

If it has a low rating, the company or government issuing it has a high risk of default.

Conversely, if it has a high rating, it is considered to be a safe investment. Agencies such as

Moody's and Fitch evaluate the credit risks of thousands of corporate bond issuers and

municipalities on an ongoing basis.

Types of Credit Risk:

1. Credit default risk:

The risk of loss arising from a debtor being unlikely to pay its loan obligations in

full or the debtor is more than 90 days past due on any material credit obligation; default

risk may impact all credit-sensitive transactions, including loans, securities

and derivatives.

2. Concentration risk:

The risk associated with any single exposure or group of exposures with the

potential to produce large enough losses to threaten a bank's core operations. It may arise

in the form of single name concentration or industry concentration.

3. Country risk:

The risk of loss arising from a sovereign state freezing foreign currency payments

(transfer/conversion risk) or when it defaults on its obligations (sovereign risk); this type

of risk is prominently associated with the country's macroeconomic performance and its

political stability.

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Q.10: Explain credit risk management framework for banks.

Answer:

Credit Risk Management Framework:

Credit risk management:

Credit risk is the potential for loss due to the failure of counterparty to meet its

obligations to pay the Group in accordance with agreed terms. Credit exposures arise from

both the banking and trading books.

Credit risk is managed through a framework that sets out policies and procedures

covering the measurement and management of credit risk. There is a clear segregation of

duties between transaction originators in the businesses and approvers in the Risk function.

All credit exposure limits are approved within a defined credit approval authority

framework. The Group manages its credit exposures following the principle of

diversification across products, geographies, and client and customer segments.

Credit policies:

Group-wide credit policies and standards are considered and approved by the GRC,

which also oversees the delegation of credit approval and loan impairment provisioning

authorities.

Authorized risk committees within Wholesale and Consumer Banking establish policies

and procedures specific to each business. These are consistent with our Group-wide credit

policies, but are more detailed and adapted to reflect the different risk environments and

portfolio characteristics.

Credit rating and measurement:

Risk measurement plays a central role, along with judgment and experience, in

informing risk taking and portfolio management decisions. It is a primary area for sustained

investment and senior management attention.

Credit approval:

Major credit exposures to individual counterparties, groups of connected

counterparties and portfolios of retail exposures are reviewed and approved by the Group

Credit Committee (GCC). The GCC derives its authority from the GRC.

All other credit approval authorities are delegated by the GRC to individuals based

both on their judgment and experience and a risk-adjusted scale that takes account of the


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estimated maximum potential loss from a given customer or portfolio. Credit origination

and approval roles are segregated in all but a very few authorized cases. In those very few

exceptions where they are not, originators can only approve limited exposures within

defined risk parameters.

Credit concentration risk:

Credit concentration risk may arise from a single large exposure or from multiple

exposures that are closely correlated. This is managed within concentration caps set by

counterparty or groups of connected counterparties, and having regard for correlation, by

country and industry in Wholesale Banking; and by product and country in Consumer

Banking. Additional concentration thresholds are set and monitored, where appropriate, by

tenor profile, collateralization levels and credit risk profile.

The responsible risk committees in each of the businesses monitor credit

concentrations and concentration limits that are material to the Group are reviewed and

approved at least annually by the GCC.

Credit monitoring:

A system that monitors a consumer’s credit reports for signs of possible fraud.

Credit monitoring services notify consumers when new information, such as a new account

or credit inquiry, shows up on one or more of their credit reports. The consumer can then

follows up and make sure the new information is legitimate. Consumers can also use a

credit monitoring service to keep track of their credit scores, a feature that can be useful for

someone who plans to apply for a mortgage or other credit-based loan in the next few

months to a year.

Internal risk management reports are presented to risk committees, containing

information on key environmental, political and economic trends across major portfolios

and countries; portfolio delinquency and loan impairment performance; and IRB portfolio

metrics including credit grade migration.

Credit risk mitigation:

Potential credit losses from any given account, customer or portfolio are mitigated

using a range of tools such as collateral, netting agreements, credit insurance, credit

derivatives and other guarantees. The reliance that can be placed on these mitigates is

carefully assessed in light of issues such as legal certainty and enforceability, market

valuation correlation and counterparty risk of the guarantor.

Where appropriate, credit derivatives are used to reduce credit risks in the portfolio.

Due to their potential impact on income volatility, such derivatives are used in a controlled


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manner with reference to their expected volatility. Collateral is held to mitigate credit risk

exposures and risk mitigation policies determine the eligibility of collateral types.

Securities:

Within Wholesale Banking, the Underwriting Committee approves the portfolio

limits and parameters by business unit for the underwriting and purchase of all predefined

securities assets to be held for sale. The Underwriting Committee is established under the

authority of the GRC. Wholesale Banking operates within set limits, which include

country, single issuer, holding period and credit grade limits.

Traded Credit Risk Management whose activities include oversight and approval

within the levels delegated by the Underwriting Committee carries out day-to-day credit

risk management activities for traded securities. Wholesale Banking Risk controls issuer

credit risk, including settlement and pre-settlement risk,, while price risk is controlled by

Group Market Risk.

The Underwriting Committee approves individual proposals to underwrite new

security issues for our clients. Where an underwritten security is held for a period longer

than the target sell-down period, the final decision on whether to sell the position rests

with the Risk function.

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