Download INTRODUCTION TO BANKING MAY 2 009 SOLUTION.do c

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