Understanding Key Banking Operations and Financial Instruments
Understanding Key Banking Concepts
Differences and Similarities Between Loans and Credit Facilities
Here’s a breakdown of the key distinctions and commonalities between bank loans and credit facilities:
Similarities
- Both are funds that the bank provides to customers.
- In both, interest and various expenses are charged.
- There is a contractual relationship that specifies the agreed-upon debt and interest terms.
- In both, a guarantee is typically required.
Differences
- In a loan, the bank delivers the full awarded amount, whereas in a credit facility, the customer draws funds from the granted amount as needed.
- Loan interest rates are generally lower, while credit facility interest rates are considerably higher.
- In a loan, the total capital is repaid over agreed periods. In a credit facility, only the drawn capital is repaid according to the indicated terms.
- For a loan, costs incurred include study fees, formalization fees, notary fees, and Land Registry fees. For a credit facility, charges incurred are typically study fees, formalization fees, and commissions.
- Loans are typically for larger amounts and longer terms, while credit facilities are for smaller amounts and shorter terms.
- A loan is usually for fixed assets, while credit facilities are for liquidity and cash flow.
Bank Operations: Short-Term vs. Long-Term Focus
What interests a bank: a short-term active operation?
Short-term operations interest a bank because they offer the following advantages:
- Ability to serve more clients.
- Increased profitability through commissions.
- Distribution of default risk among a larger number of borrowers.
- Ability to increase market penetration by granting more financial facilities.
- Increased interest profitability, due to rapid recovery of lent money, which allows for more profitable reinvestments.
When is a bank interested in performing a long-term active operation?
A bank is interested in long-term active operations in periods when the cost of money decreases (low interest rates). This is because it guarantees a return that might not be available in future operations, especially when using a fixed interest rate.
Key Banking Processes and Risk Management
What can happen if there is a gap between loan repayment dates and bank disbursement dates?
A gap between the dates of loan repayment to a bank and the bank’s disbursement dates can lead to liquidity issues. The bank may not have sufficient funds to meet its obligations or disburse new loans to customers.
What forms of compensation do clients offer banks for services or favorable terms?
Clients offer banks various forms of compensation to secure services or favorable terms, including:
- Salary direct debits
- Foreign trade transaction transfers
- Maintaining accounts with certain balances
- Obtaining insurance products
- And other financial activities that generate revenue for the bank.
When a bank is presented with a letter for discount, does it perform the operation without further checks?
No. When a bank is presented with a letter for discount, it needs to perform several checks. These include:
- Checking the creditworthiness of the customer.
- Taking into account whether the letters are endorsed.
- Verifying the maturity dates.
- Assessing the ratio of bad debt.
What is a credit scoring assessment?
A credit scoring assessment is an instrument used by bank directors to ensure prompt attention in active operations with customers and reduce the risk of default. It consists of a balanced assessment of a series of personal data, which objectively indicates the client’s capacity to meet their financial obligations.
Understanding Financial Guarantees
Financial guarantees are crucial for mitigating risk in banking operations. Here are common types:
- Personal Guarantee: When no particular asset is assigned, the guarantee is unsecured, relying on the individual’s promise to pay.
- Real Guarantee: A specific asset is specified and documented as collateral.
- Endorsement: Any personal or property right can be submitted as a form of guarantee.
Types of Real Guarantees:
- Pledge:
- With displacement (physical transfer of the asset)
- Without displacement (asset remains with the debtor)
- Mortgage:
- Movable (e.g., vehicle mortgage)
- Real Estate (e.g., property mortgage)
- Surety (Aval): A third party’s promise to fulfill the obligation if the primary debtor defaults.