Page 43 - PakAccountant-April_June-2017

Banking personal guarantees while Secured Advances are made against Tangible and ▪ Variable Components of the Markup is Marketable Securities. the spread that banks keep on top of their base component or cost of funds 3. Legal Forms of Securities for Advances when lending to customers. The size Legal Forms of Securities are as under of spread generally depends on three Now we move forward towards legal forms of securities that are available to factors: banks/financial institutions to secure its advance. They may take the forms of: 1. Type of Customer (corporate/ wholesale/retail) A. Lien (Contract Act, 1872) 2. Customer Credit Rating (based on profile) ▪ Lien is the banker’s right to withhold property until claim on property is paid. A 3. Banks Balance Sheet Mix (and its lien may be either a particular lien or a general lien: a) Particular Lien: arises from the particular transaction, connected with the need for deposit or loans at a given property subject to lien e.g., a carrier’s lien for his charges on goods carried. point in time) b) General Lien: arises out of general dealings between the two parties, e.g., Bank’s Lien. 4.2 Fixed and Floating Rates of Markup ▪ Fixed and Floating Rates: Markup rate B. Charge (Transfer of Property Act 1882, S100) given to a customer can be floating or ▪ A charge is security for the payment of a debt or other obligation that does not fixed: pass ‘title of the property’ or any right to its possession to the person to whom a) Floating Rate: also known as variable the charge is given. or adjustable rate refers to a rate on any type of credit that does not have C. Pledge (Contract Act, 1872) a fixed rate of markup or interest over the life of that credit. It is charged on ▪ Pledge is a bailment of goods as security for payment of a debt or performance a periodic basis and usually tied to the of a promise. movement of an outside indicator or ▪ Bailment means delivery of goods by one person to another for some purpose, the prime rate/discount rate. One of the under a contract that the goods shall, when the purpose is accomplished, be most common rates used as the basis for returned or otherwise disposed of according to the directions of the person applying interest rates is the KIBOR. delivery them. b) Re-pricing Interval: measures the period from the date the loan is made until it D. Hypothecation first may be re-priced. For floating rate ▪ When property in goods is charged as security for a loan but ownership loans that are subject to re-pricing at as well as possession remains with the borrower, the goods are said to be any time the re-pricing interval is zero. ‘hypothecated’. c) Fixed Rate: that does not fluctuate during the fixed rate period. This allows E. Guarantee (Contract Act, 1872) the borrower to accurately predict their ▪ A guarantee (oral or written) is a promise by one person, called ‘guarantor/ future payments. surety’ to another for answering the present or future debts of a second person called ‘principal debtor.’ 4.3 Other Methods of Pricing a) Risk Based Pricing: in the simplest terms, F. Indemnity (Contract Act, 1872) is alignment of loan pricing with the expected loan risk. It’s a manifestation of ▪ A contract of Indemnity by which one party (indemnitor) promises to save the the risk reward concept – higher the risk, other (indemnitee) from loss caused to him by the conduct of the promisor higher the reward; in this case higher the himself, or of any other person. risk, higher the price of credit i.e., markup. b) Risk Reward Pricing: is the ratio used G. Mortgage (Transfer of Property Act 1882, S58) by lenders to compare expected ▪ Transfer of an interest in specific immovable property for securing payment returns of a loan to the amount of risk of money advanced or to be advanced by way of loans and this transfer is undertaken to capture these returns. actual. Ratio is calculated mathematically by dividing amount of profit the lender 4. Pricing of Loan Products expects to have made when the position 4.1 Pricing Mechanisms of Loan Products is closed (i.e. the reward) by the amount he stands to lose if price moves in ▪ Pricing Mechanisms: pricing of the loan is the markup rate and such markup unexpected direction (i.e. the risk). rate has two components: c) Relationship Yield Pricing: is pricing the ▪ Base Component of Markup: can be derived from: credit based on the overall customer a) Internal cost of funds: can be in terms of (i) rate of return promised to the relationship rather than on a stand- depositor; (ii) the administrative cost of generating, processing and servicing alone product basis. the deposit/depositor. d) Opportunity Cost: is the cost of an b) Market based cost of funds: bank can also borrow from other banks and that alternative that must be forgone in order involves such costs, e.g. Karachi Inter Bank Offer Rate (KIBOR), Treasury Bills, to pursue a certain action. Put another Pakistan Investment Bonds (PIBs), Repurchase Agreement (REPO) and Reverse way, the benefits you could have received REPO rates are generally used as benchmark indicators in the Pakistan market. by taking an alternative action. April-June 2017 The Pakistan Accountant 41