Sources of Bank Funds (2024)

Brief Introduction aboutBank:

Abankis a financial institution and a financialintermediary that accepts deposits and channels those deposits into lendingactivities, either directly or through capital markets. A bank connectscustomers with capital deficits to customers with capital surpluses

Sources Of Banks Funds:
A bank is a businessfirm. Its main aim is to earn profit. In order to achieve this objective itprovides services to the customers. It offers a variety of interest bearingobligations to the public. These obligations are the sources of funds for thebank and are shown on the liability side of the balance sheet of a commercialbank. The main sources which supply funds to a bank are as follows:

A Bank’s Own Funds.
B Borrowed Funds.

Bank’s own funds are mainly of three types;

(a) Paid up capital.

(b) Reserve fund.

(C) Portion of undistributed profit.

(A) Banks Own Funds.

1. Paid up capital

Bank’s own paidup capital. The amount with which a banking company is registered is callednominal or authorized capital. It is the maximum amount of capital which ismentioned in the capital clause of the memorandum of association of thecompany. Capital is further divided into (i) paid up capital and (ii)subscribed capital. The banks in Pakistan raise authorized capital by issuingordinary shares of Rs. 10 each which are fully paid up.

2. Reserve fund.

Reserve is anothersource of fund which is maintained by all commercial banks. At the time ofdeclaring dividend, a certain portion of the profit is transferred to thereserve fund. This reserve belongs to the .shareholders and at the time ofliquidation, the Shareholders are entitled to these reserves along with thecapital.

The main purpose of setting aside part of profit is to meet unforeseen expensesof the bank. The Banking Companies Ordinance has made it obligatory (binding)for every banking company incorporated in Pakistan to create a reserve fund.

3. Profit.

Profit is another source to a bank for the purpose of business.Profits signify the credit balance of the profit and loss account which has notbeen distributed. The accumulated profits over the years increase the workingcapital of the bank and strengthens its financial position.

(B) Borrowed Funds.
The borrowed capital isa major and an important source of fund for any banking business. It mainlycomes from deposits which are accepted on varying terms in different accounts.
Bank’sborrowing is mostly in the form of deposits. Bank collects three kinds ofdeposits from its customers (1) current or demand deposits (2) saving depositsand (3) fixed or time deposits. The larger the deposits of bank, the largerwill be its (use) fund for employment and so higher are its profit.

1. Borrowing from central bank.

The commercial banks in times of emergency borrow loans from the centralbank of the country. The central bank extends help as and when financial helpis required by the commercial banks.

2. Other sources.

Bank also raise funds by issuing bonds, debentures, cash certificatesetc. etc. Though it is not common but is a dependable source of borrowing.

a.Bonds

Infinance, abondis a debt security, in which the authorizedissuer owes the holders a debt and, depending on the terms of the bond, isobliged to pay interest (the coupon) to use and/or to repay the principal at alater date, termed maturity. A bond is a formal contract to repay borrowedmoney with interest at fixed intervals

b.Debenture

Atype of debtinstrument that is not secured by physical asset or collateral.Debenturesare backed only by the generalcreditworthinessandreputationof the issuer.Both corporations and governments frequently issue thistype of bond in order to secure capital.Like other types of bonds,debentures are documented in an indenture.

c.Cashcertificates

Cash certificates andrecurring deposits are similar types of banking investments. The terms are usedmost often in relation to the services that Indian banks provide theircustomers. These deposits are not directly related to stock market or bondspeculation, but instead give investors a way to earn interest on money in asafer setting.

3. Deposits.Public deposits are a powerful source offunds to a bank. There are’ three types of bank deposits (i) current deposits(ii) saving deposits and (iii) time deposits. Due to the spread of literacy,banking habits and growth in the volume of business operations, there is amarked increase in deposit money with banks.

i.CurrentDeposit:

Indeposit terminology, the term Current Deposit refers to a deposit to a bankaccount or financial institution without a specified maturity date. These typesof Current Deposit account generally only earn demand deposit interest.Interestis very low for current account.

ii.Saving deposits:

A depositaccount held at a bank or other financial institutionthat providesprincipal security and a modest interest rate. Depending on the specific typeof savings account, the account holder may not be able to write checks from theaccount (without incurring extra fees or expenses) and the account is likely tohave a limited number of free transfers/transactions. Savings account funds areconsidered one of the most liquid investments outside of demand accounts andcash. In contrast to savings accounts, checking accounts allow you to writechecks and use electronic debit to access your funds inside the account.Savings accounts are generally for money that you don't intend to use for dailyexpenses

iii.Time Deposit:

Atime depositalso known as atermdeposit, is a money deposit at a banking institution that cannot bewithdrawn for a certain "term" or period of time (unless a penalty ispaid). When the term is over it can be withdrawn or it can be held for anotherterm. Generally speaking, the longer the term the better the yield on themoney. A certificate of deposit is a time-deposit product

Factors determinethe cost of sourcing of bank funds :

1).Costof funds:

Cost of funds are the expenses incurred onobtaining funds from various sources in the form of share capital, reserves,deposits, and borrowings.

Thus, it generallyrefers to interest expenses .

Lower the cost of funds,higher the profitability.

2)CostInterest Rate Risk:

Theriskoflossdue to a change ininterestrates. Interest rate risk is importanttotransactionslikeinterest rate swaps. In such a transaction,the party receiving thefloating ratewill receive a smaller amountshould the floating rate decrease. Interest rate risk is also importanttobonds; if interest rates rise,thepricesofbondsfall. This affects thesecondarymarketfor bonds; for example, if one purchases a bond with a 3% interestrate and the prevailing rate rises to 5%, it becomes difficult or impossible toresell the bond at aprofit. Finally, interest rate risk is important alsoa factor which influenced the cost of sourcing of bank funds.

2).Yieldon funds;

The funds raised by the bank through varioussources are deployed in various assets.

These assets yieldincome in the form of interest.

So, higher the interest,greater the profitability and if yield of fund is good then cost of fund willlow.

3).Spread:

Spread isdefined as the difference between the interest received (interest income ) andthe interest paid (interest expense ) in funding.

Higher spread indicatesmore efficient financial intermediation and higher net income so if theinterest income is more then cost of capital will low and banks always sourcesfund for gaing certain profit.

Thus, higher spreadleads to higher profitability and decrease the cost of funding.

4)Levelof technology:

Use of upgraded technologynormally leads to decline in the operating costs of banks and it also affectsthe cost of funding. This improves the profitability of banks.

5)Natureof Deposits:

Deposits trade with the banksare of various types like time deposits, demand deposits, short – termdeposits, etc. larger demand deposits /short – term deposits also influencedthe cost of funding

Cost of funding isalways been calculated by banks by keeping all above elements in mind becauseall these elements affects the cost of funding by bank directly or indirectly.

Analysis of cost insource of bank funds:

Cost arises in eachand every source ofbanks funding but in some it is high and some itis less as per our analysis CRR and SLR also influenced on the cost of bankfunding if they borrow money from the central bank then they have to repos onborrowing and cost of funding is high the minimum cost of funding is very lowif bank uses their owns fund (Paid up capital, Reserve fund, Portion ofundistributed profit) but it is not possible for the bank to use always theirowns fund they have to borrow fund from the external parties So as per ouranalysis Public deposits are a powerful source of funds to a bank where cos offunding is nominal .

Sources of Banks fundwhere Cost is minimum-

The primary source of funding of banks accepting deposits by the public’sis the best source of funding and it also have very low cost in comparison toall other sources so:-

Current Deposit

Saving Deposits

Recurring Deposits

To justify that let weanalyzed some of the key factors through which it is cleared that acceptingpublic deposits having a minimum cost in source of banks funding

ØExpenses incurredon obtaining funds from accepting a deposits, generally low. Lower the cost offunds, higher the profitability.

ØThe funds raisedby the bank through deposits are deployed in various assets. These assets yieldincome in the form of interest. So, higher the interest, greater theprofitability and then cost of fund will low.

ØBank allows verylow rate of interest on deposits and charged high rate of interest on lendingso spread is also higher. Higher spread indicates more efficient financialintermediation and higher net income so if the interest income is more thancost of capital will low and banks always sources fund for gaining certainprofit. It results in decreasing the cost of funding.

ØDeposits tradewith the banks are of various types like time deposits, demand deposits, short– term deposits, etc. larger demand deposits /short – term deposits alsoinfluenced the cost of funding. Means as per the types of deposit cost may bediffer.

ØInterest rate risk is important at the time of sourcing ofbank funding. Theriskoflossdue to a changeininterest rates. Interest rate risk is importanttotransactionslikeinterest rate swaps. In such a transaction,the party receiving thefloating ratewill receive a smaller amount should the floating rate decrease. So riskinvolvement cost is also a major concern of thinking for banks at the time offunding.

If we analyze otherssources of funding then they are more risk full and risk involvement is alsohigh and bank have to pay high rate of interest for funding so as per ouranalysis the primary source of funding accepting public deposits is the goodsource of banks funding and it also involved very less operating and riskinvolvement cost.

Current rate of interest giving by the bank ondeposits:

Saving Account-

The interest rate of savingsbank account in India varies between 2.5% and 4%. In Savings Bank account, bankfollows the simple interest method.The rate of interest may change fromtime to time according to the rules of Reserve Bank of India.One canwithdraw his/her money by submitting a cheque in the bank and details of theaccount, i.e the Money deposited, withdrawn along with the dates and thebalance, is recorded in a passbook.

Fixed Deposit-

The rateof interest for Bank Fixed Deposits varies between 4 and 11 per cent, dependingon the maturity period (duration) of the FD and the amount invested. Interestrate also varies between each bank. A Bank FD does not provide regular interestincome, but a lump-sum amount on its maturity. Some banks have facility to payinterest every quarter or every month, but the interest paid may be at adiscounted rate in case of monthly interest. The Interest payable onFixed Deposit can also be transferred to Savings Bank or Current Account of thecustomer. The deposit period can vary from 15, 30 or 45 days to 3, 6 months, 1year, 1.5 years to 10 years.

Recurring Deposits-

The rate of interest varies between 7 and 11 percentdepending on the maturity period and amount invested. The interest is calculatedquarterly or as specified by the bank.