Video Transcript: Banks and Financial Institutions

Hi, welcome. We're going to discuss banks and financial institutions. First, we'll  start with commercial banks. Commercial Bank is a type of financial  intermediary and a type of bank, an institution which accepts deposits, makes  business loans and offers related services. Commercial banks also allow for a  variety of deposit accounts, such as checking savings and time deposits known  as CDs. These institutions are run to make a profit and are owned by a group of  individuals. Commercial Banks occupy a vital position as they provide funds for  different purposes, as well as for different time periods. Banks extend loans to  firms of all sizes and in many ways, like cash credits, overdrafts, term loans,  purchasing, discounting of bills and issue letter of credit. So banks play an  integral role in capitalizing operations throughout any economy. So when people need capital to run their business or to start up their business or to continue  operations, they're going to come to the bank, and the bank can service them in  different ways, like cash credits and different loans and lines of credit right to  help them maintain business operations. The interest rate charged by banks  depends on various factors, such as the characteristics of the firm and the level  of interest rates in the economy. In previous videos, I think we talked about  Treasury interest rates determined by the Federal Reserve and banks have their interest rates, take their interest rates off a measurement of a 10 year treasury  bill, and then that's your basis for your cost of debt. And then you know your  credit worthiness will increase your interest rate moving forward, the loan is  repaid either in lump sum or in installments. So lump sum or installments, you  can pay it over a number of years, or you can pay it back in a specified time.  However, you and the bank work it out. So bank credit is not a permanent  source of funds, though, banks have started extending loans for longer periods.  Generally, they are just used for short to medium term loans. My experience in  the banking industry. We my segment in banking was funding construction loans in commercial real estate, and a lot of times we would fund three to five years in  hopes that the loan would be taken out in agency Freddie Mac and Fannie Mae. So, so we would, we would short term financing three to five years, hopefully it  would get taken out by agency. It would then extend out 15 to 30 year  repayment terms. The borrower is required to provide some security or create a  charge on the assets of the firm before a loan is sanctioned by a commercial  bank, okay, merits information supplied to the bank by the borrower is kept  confidential, therefore maintaining secrecy of business you want, if you are  working for a bank. You want your clients information to be kept confidential,  kept secret, so that you can have a reputation of trust and people want to do  business with you because you are maintaining their confidentiality, it is an  easier source of funds as formalities such as issue of prospectus and  underwriting are not required for raising loans from a bank. Most banks will  underwrite your loan at some in depth analysis. Some loans will get scrutinized  greater than others, but most loans will go through some form of underwriting, 

since the loan amount from a bank can increase according to business needs  and can be repaid in advance when funds are not needed, it is considered as  flexible as a flexible source of finance, tightly timely assistance provided by  banks to businesses by providing funds as and when needed. So let's look at  the demerits of a commercial bank. Extension or renewal of funds is uncertain  and difficult, as they are generally available for short periods. The procedure of  obtaining funds is slightly difficult as banks make detailed investigation of the  company's affairs, financial structure, etc, and may also ask for security of  assets and personal sureties, right? A lot of times they're going to have  covenants inside of a loan that says you have got to perform by this date and  have this debt service coverage, and you need to make sure that we're not  leveraged at a too high debt to equity ratio things of that nature, and if you are,  you will have to probably put more equity into the game, because the bank will  not surpass usually, a certain debt to equity ratio. In some cases, difficult terms  and conditions are imposed by banks for the grant of a loan. For example,  restrictions may be imposed on the sale of mortgage goods, thus making normal business operations difficult, right? So they want to make sure they have  collateral. They want to make sure that they are going to get repaid. Financial  institutions, both central and state government have established a number of  financial institutions all over the country to provide financing to businesses. They provide both owned capital and loan capital for long and medium term  requirements and supplement the traditional financial agencies like commercial  banks. These are called development banks, as these institutions and promote  the industrial development of a country. In addition to providing financial  assistance, these institutions also conduct market surveys, provide technical  assistance and managerial services to people who run enterprises. So the  merits of financial institutions, unlike commercial banks, financial institutions  provide long term financing, just like agency Freddie Mac Fannie Mae, these  institutions also provide financial, managerial and technical advice and  consultancy to business firms, besides providing funds, so they're they're more  beneficial than just providing Money, providing capital, right? They're going to  give you guidance, forward guidance, on how to run the operation goodwill of  the borrowing company increases the capital market by obtaining a loan from a  financial institution. Consequently, it is easier for such a company to raise funds  from other sources as well, right? It does not prove to be much of a burden on  the business. As repayment of a loan can be made in easy installments known  as an amortization schedule, again, demerits for the financial institution, rigid  criteria is followed for the grant of a loan by financial institutions. Very rigid right.  They want to make sure that they can get paid back. That is the biggest thing  that they are worried about, is getting their principal amount paid back. The  procedure becomes time consuming and expensive due to many formalities.  They want to make sure that you are strong candidate for long term financing, 

that you have a strong business model in place, and that if your loan is for 30  years, that are you going to be in business for 30 years? Restrictions are  imposed on the powers of the borrowing company by the financial institution.  Institutions, such as a restriction on dividend payments, financial institutions  may restrict the powers of the company by having their nominees on the board  of directors of the borrowing company. So they may have a board spot right.  These long term financial institutions may have a board spot right, and they can  navigate how the board votes right, and they can make sure that the board  votes in favor of the financial institution over the borrowing organization.