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INTRODUCTION TO BANKING EXAMINATION PAPER - MAY 2009 SUGGESTED SOLUTIONS (MARKING SCHEME) QUESTION 1 a. Banking business means the business of accepting deposits of money, withdraw able or payable on demand, or after a fixed period of notice, and the employment of those deposits in whole or in part by lending or any other means at the risk of the person accepting such deposits 5 marks b. A banker would divulge information on the customer’s account ignoring the general rule of confidentiality in any of the following circumstances i. Where the bank is compelled to do so by order of the law. Examples include receipt of a garnishee order or an ACB search warrant. 2 marks ii. If it is in the interest of the bank as a matter of pursuing a certain cause. An example is where a customer has defaulted and the bank sues the customer. It may be necessary for the bank to produce evidence of the debt and prove that the customer has breached the conditions of the loan agreement. 2 marks iii. Where the transactions would pose threat to national security. For instance if the client is associated with terrorists and is involved in money laundering, or is connected with purchase of fire arms or is involved in funding criminals. 2 marks iv. Where there is implied or express consent. Written instructions to the bank to allow external auditors to obtain account details and statements or if customer gives a phone to a third party while talking to the bank officer 2 marks c. The difference between ancient banks and the modern banks is that i. The old banks were unincorporated entities which simply aimed at making exorbitant profits and did not care about maintaining reputation i.e. they were corrupt. 1 mark ii. The modern banks are incorporated, well regulated and operate within a formalised environment. 1 mark QUESTION 2 (a) i. Both of them have committed money laundering offence. (1 mark) ii. Mr Mwale is the first offender who brings the proceeds of crime to the bank to disguise his crime and make the proceeds look like they were legitimately earned. (1mark) Miss Banda is charged with the same offence because she knowingly lets Mr Mwale process the proceeds of crime without alerting the bank to take appropriate action. The court can assume that the actions of Miss Banda were to assist Mr Mwale to successfully convert illegitimate money (1 mark) (b) (c) Any two of the following. i. Money laundering causes inflation ii. It erodes the integrity of the financial system iii. It distorts economic data and complicates government efforts to manage economic policy iv. Brings adverse consequences for interest and exchange rate volatility (2 marks) Any four of these i. a customer is able to access half of the funds before maturity of investment ii. a maximum of 3 calls can be made before maturity iii. interest rate is fixed iv. interest plus principal is payable on maturity v. minimum investment amount is K1million (d) Brief summary to support the statement that laundered money do not assist in the development of a country. Students need to demonstrate that they understand that proceeds of money laundering come from illegitimate sources. These include sale of fire arms, illicit drags, human trafficking etc. All these are evil acts which deprive other people of their well earned money. 2 marks These proceeds are not transferred for purposes of investment but to afford a way of disguising the source of funds and the culprits behind the money 2 marks Laundered money creates distortions in the market since huge sums of money would flow into an economy and create inflation and yet in no time the money 2 will be moved out marks 2 Usually the investments are for speculative means in which case the money will be for short periods 1mark QUESTION 3 a) i. Speed of service delivery. Customers want to spend as little time in banking halls as possible so that they can get along with their day to day activities. (The common saying that time is money holds). Banks that offer faster services have an edge over others. (2 marks) Contact Personnel. These are the actual bank officers who deliver the service to customers. The manner in which they deliver the service varies from bank to bank. Customers want friendly and decent contact with bank officers (2 marks) Service environment. This relates to the physical facilities that the bank has put in place to carry out its operations. Customers need clean and decent premises. That way, they feel that their money is safe. (2 marks) Interest rates offered on deposits. This is the reward that customers get on their investments. Customers want a better return that justifies the need to place a deposit with a particular bank (2 marks) b) Customer service relates to customer–impinging activities while as customer care focuses on issues that emphasise the concept or policy of attending to customer- impinging activities. Or 3 Customer service is concerned with routine and mechanistic acts involved in service delivery while as customer care is concerned with staff attitudes towards and relationship with customers. (3 marks) (c) Three major external factors that have influenced changes in the way banks have structured their operations in modern times Deregulation and liberalisation which has resulted into foreign banks opening doors in other countries have compelled all banks to adopt international standards in order to keep abreast with competition. 2 marks Customers have become more demanding because of the increased knowledge which they have acquired through dealings with other banks. This has ended up creating pressure on the banks to provide what customers are demanding. 2 marks Technological advancement has also influenced change in the way business operations are carried out. 2 marks QUESTION 4 1. Current account 1 mark 2. Savings Account 1 mark 3. Fixed Deposit account 1 mark Advantages for holding a current account - Can borrow money by way of overdraft - The account has a cheque book which offers convenience for making payments 1 mark - Once a cheque is issued, it can be stopped if lost 1 mark - No requirement to maintain a minimum balance. 1 mark 1 mark Disadvantages - No interest is payable on current account 1 mark - Cheques can be prone to frauds 1 mark - Depositor of a cheque has to wait for three days for the cheque to clear before accessing funds 1 mark 4 - No interest is payable or where its paid the interest rate is very low 1 mark Savings accounts Advantages - Account holder earns interest on the account - The minimum balances are static and therefore provide the bank with steady deposit balances which can safely be loaned to needy customers. 1 mark - Savings accounts offer a safe way for keeping money 1 mark 1 mark Disadvantages - The minimum amount may be too big for others and prohibit some from saving 1 mark - Interest on the account may not be sufficient to cover inflation in which case the depositor will have a declining purchasing power on the deposits 1 mark - It is not possible to use it as a current account to pay bills and other payment obligations Fixed Deposits Advantages - Fixed deposits offer higher interest rates as compared with savings account or current account 1 mark - The bank has more freedom to loan out the funds because the deposit remains with the bank for a determinable future period. 1 mark - Customer can pledge funds in this account as collateral/ security for borrowing from the banks 1 mark Disadvantages - Once a fixed deposit is created, customer is not expected to withdraw the funds on demand but has to wait until the maturity date 1 mark - Interest rate payable may still be below inflation - Account holder may be charged a penalty if funds are withdrawn earlier mark 1 mark 1 5 QUESTION 5 a) A good answer should start by describing the kind of commodities that were used as early forms of money such as cattle, sheep, slaves, tobacco, tea and salt. These forms of money posed problems because they were not universally acceptable, not durable, too bulky and did not homogeneous in terms of quality. The present day form of money has seven attribute of money which individually addresses the above shortfalls as follows: I. Acceptability – Money must be widely acceptable in order to perform its function as a medium of exchange. The early forms of money were in form of commodities and not widely acceptable 2 marks II. Divisibility – some of the commodities could not be divided, for instance the slaves or cattle. Present day money is in various denominations and the sum of the small denominations will equal the value of one larger denomination. 2 marks III. Homogeneity – the form of money used is of uniform quality – This addresses the shortfalls of old forms of money which could have inconsistent quality. For instance it is difficult to expect tobacco to be of the same quality through and through. 2 marks IV. Indestructibility – This refers to durability. Money ought to be reasonably durable. The animals such as sheep and cattle, the slaves would fall sick and die. Equally the other commodities such as salt, tobacco and tea would lose quality if exposed to bad whether condition. The present day form of money is of good quality and coins take so many years without being destroyed. 2 marks V. Portability – Easy to carry around and compares favourably old forms of money which were very bulky and difficult to carry around. 2 marks VI. Cognoscibility – Present day money is easy to recognize while old forms of money could not. 2 marks VII. Stability in Value – because of the inconsistency in value old forms of money could not maintain the same value over time. Present day money does not value in the sense that K100 today will remain the same over time ignoring the concept of reduction in the purchasing power as a result of inflation. 2 marks 6 b) Banks are considered to be major custodians of money because the major component of the definition of money refers to bank deposits. Notes and coins in circulation form a small part of the total money available in an economy. The definition of M3 – Notes and coins in circulation, private sector demand deposits, private sector time deposits, all public sector deposits and all deposits of nationals in foreign currencies. 6 marks QUESTION 6 (a) The question is asking candidates to demonstrate their understanding of the advantages that are available to a current account holder The first point refers to the point that paid cheques can be used as evidence of settlement of a debt. Chimwemwe can use his statement which has images of the paid cheques or call for the original cheque from the bank to prove that he has actually settled the debt. Investigations can be instituted if the bank has paid the cheque to a wrong party by tracing the actual account that was credited. 2 marks The lost cheque can be stopped by asking the bank to place a stop-payment against the cheque. It is only the drawer who can give such instructions to the bank by giving full particulars of the cheque. 2 marks A current account holder can arrange with his bank to have an overdraft is he is creditworthy. In this regard, Chimwemwe is a successful businessman who has been with the bank for 10 years and would likely qualify for an overdraft. 2 marks (b) The four important details which a customer would provide include the following: i. Postal address – where he obtains mail from and to which correspondence from the bank would be channelled to. 1 mark ii. Physical address i.e. the location where the customer is staying. This should be evidenced by a current utility bill 1 mark iii. Identity – i.e. passport , driving licence, birth certificate or any other acceptable identity such as letter from the DC 1 mark iv. Source of funds or nature of business 1mark 7 (c) Some of the key points to remember in respect of the technical features on a cheque vi. Date – it should bear a current date. Not post dated or overdue (stale) vii. Payee – All cheques should be paid to the account of the named payee, He is the only person who can transfer to a third party by way of endorsement for order cheques or simple delivery for bearer cheques viii. Signature – this is the authority for the bank to pay from the customers account. That a forgery is a nullity and if not detected, the bank would be liable to refund the customers account. ix. Cheque serial numbers assist in enhancing the security cheques on the customers account. The bank host system validates cheques being processed to ensure that only cheques issued by the customer are passing through the account. QUESTION 7 The question is calling students to explain the tools which the central bank uses in the implementation of its monetary policy and these include: a. b. c. d. Open Market Operations Discount Rate Liquidity Reserve Requirement Moral suasion Open Market Operations Open Market Operations (OMO) is used on continuous basis as and when necessary in the economy. Using this tool, the central bank goes directly into the market to buy and sell securities. When there is inflation, the central bank will endeavour to reduce money supply – it will sell securities which will have the effect of mopping excess liquidity and thereby reduce general demand for goods and services. Similarly, when there is deflation, central bank buys securities so as to help and inject more liquidity into the economy. When the government sells securities in the market, liquidity is reduced and the capacity of banks to create money is reduced. Discount Rate The discount rate is the cost at which banks can borrow money from the central bank as a lender of last resort. Using this tool, the discount rate would be raised to restrict borrowing and thereby affect the capacity of the banks to lend more money and in the process reduce the rate of inflation. On the other hand the discount rate would be reduced to invite banks to borrow more and have enough liquidity for more lending – effectively rejuvenating the economy and therefore fight deflation. 8 Liquidity Reserve Requirement Increasing this rate has the effect of reducing money available in the market for lending and therefore curtails credit creation and inflation Reducing the rate has the effect of providing more liquidity for banks to lend out and therefore fight deflation Moral Suasion These come in form of recommendations which are not directives and therefore adherence is dependent on the loyalty which the banks want to portray towards the central bank. An example is where the central bank asks Commercial banks to refrain from lending to a particular sector of the economy or asking banks to concentrate their lending to a particular sector. In view of the fact that these are only recommendations, there are no penalties to those who choose to defy them however compliance would help to reduce or increase demand for money and thereby have an impact on inflation or deflation. QUESTION 8 (a) The main objective of monetary policy is to prevent price instability which is associated with inflation and deflation. Both inflation and deflation is evil as it negatively affects economic activity in a country and leads to unequal distribution of wealth. Deflation refers to the decline in prices which is not supported by general decline in prices of other factors of production. This slows down the economy and leads to poor performance of most organisations that are not able to fully recover costs incurred in the production process. Inflation on the other hand is caused by unprecedented increase in prices of commodities which is not supported by general increase in productivity levels within the economy. For instance, if the central bank decides to increase the money supply and as a result of this the amount of money in circulation exceeds demand, then such action will lead to inflation. Since monetary policies are implemented by the central bank, it goes without question that it is the responsibility of the central bank to monitor and control the two dimensions. 4 marks (b) The question is asking students to mention the three motives for holding money which include the following: i. Transaction motive ii. Liquidity Motive iii. Speculative motive 9 The facts in the problem already give the answer away to students who will know the three motives. The fact that investment were made on the belief that prices will go up and interest rates will fall is an element of speculation. 4 marks Lender of last Resort – (c) - The central bank plays this role to provide funds to banks on short term basis usually overnight to alleviate liquidity problems of banks. The central bank does so only when banks are unable to raise the required funds on the money market. The central bank uses deposits in the LRR account and therefore each bank can not borrow more than what it can in this account 3 marks Liquidity Reserve Requirement - mandatory for all banking institutions – currently pegged at 15% of total deposits funds are kept in non-interest earning account can be use as a tool for implementation of monetary policy LRR also serves as a deposit protection fund for depositors in times of trouble i.e. if a bank goes into liquidation. 3 marks Credit expansion - - The capacity of banks to create more money in an economy which is through loans and advances Since banks are able to lend more money based on total deposits, and each loan granted has the likelihood of coming bank into the banking system as a fresh deposit, total money supply grows without further printing of money by the authorities. Credit expansion can be curtailed by implementation of monetary policy tools such as LRR 3 marks Bank Rate - The rate at which banks borrow from the central bank as lender of last resort. The rate is used as an indicator of the direction of short term interest rates which the central bank would like to pursue. Banks are not directly under obligation to be guided by the bank rate. 3 marks 10