Credit

This paper provides a brief analysis of the financial trading situation prevailing in Ethiopia. The paper deals with issues that Trade Financing activities must know about. The general economic situation of Ethiopia and the risks prevalent in trading with Ethiopian customers is discussed in the essay below. The essay also talks about some of the methods by which the risks of trading and financing trade can be mitigated when dealing with Ethiopian counterparts. Ethiopia, a predominantly agricultural economy, started the quest for development around a decade ago.

This African country has a very low per capita income and very low levels of health, education and nutrition. For Ethiopia, trade integration into global economy means to exploit the diverse resource base and potential. Country’s integration into multilateral trade system requires study of both supply and demand factors that enhance its competitiveness. In order to evaluate the trade issues, a thorough understanding of the domestic demand and supply is essential.

The Foreign Direct Investment, Legal and regulatory environment must support higher levels of investment and savings to be able to increase the current 5 % GDP to at least 8% in order to address poverty issues on sustained basis. The political situation in Ethiopia is not very conducive for carrying out trade, especially as a foreign trader. Ethiopia has been dealing with the resurrection of a number of armed groups which threaten to pull the already fragile government into conflicts. These issues have further weakened the government’s efforts to bring about a stable banking system in the country.

The banking system is primarily government owned and hence any destabilization in the government may also result in destabilizing the banking system. This does not help trade financing, as any trader would be wary of selling goods to a customer whose letter of credit or bank guarantees may not be rock solid. In the recent years, Ethiopia has been undertaking various economic reforms and has adopted some market oriented economic policies. These improvements have resulted in a consistent growth for the last six years and have improved the countries foreign exchange revenue.

It is now in a position to finance its import bills for at least six months (Forbes Global Magazine, 1999). The macro economic scenario, though encouraging, still does not give enough confidence and hence it becomes difficult to finance any trade deal or capital intensive projects which have a longer payback period. The country rating of Ethiopia is C, which means that the economic outlook and business environment does not guarantee a payback for the financing of trade and corporate projects (Tradingsafely. com, 2008).

Ethiopia’s currency follows a managed floating path with no pre-announced path for exchange rate. This means that the government’s monetary authority influences the exchange rate by actively intervening in the market (mof. go. jp, 2008). This kind of managed exchange rate presents problems for the trade financer as the exchange rate at which the money is to be paid by the customer is not guaranteed and hence any steep upward revision of the currency due to government intervention may result in getting lesser amount than the financier is expecting (Businesslink. gov, 2008).

It may be very difficult to acquire credit worthiness data of the potential buyers in Ethiopia because the banking system is not wide-spread. There are virtually no private banking companies and hence any data that a trade financier may receive will be government regulated and may not be a true picture. Getting paid for any trade of goods or supplies is not very easy in Ethiopia. There are not many large credit worthy banking institutions so any kind of Banker’s cheque or international money orders are not easy to come by. The best way to receive payments in Ethiopia is to have the money deposited in the sellers account by the buyer.

The problem in this method of accepting payment is that the seller has to have an account in Ethiopia and getting the entire amount to the financier’s own country is again dependent on the exchange rate fluctuations. The transfer of money from Ethiopian bank account to foreign bank account is also regulated, though some of the modern practices such as electronic transfers using SWIFT system is being adopted (bankofAbyssinia. com, 2008). Credit and Debit cards are issued to public in Ethiopia and hence online payments which can be safely routed to the merchant’s accounts using a VISA or a MasterCard kind of gateway is also not possible.

Like with any other country trading with partners based in Ethiopia requires one to do due diligence and evaluate the risks involved. To make sure that the payments regarding the goods and services arrive on time one must adopt the time tested method of buying insurance against any payment default or loss of payment. Insurance is the most effective method of transferring one’s risk. Credit insurance is a major risk management tool and it typically costs range from 0. 35 % to 0. 65 % of the amount insured. To insure against payment defaults by the customers in Ethiopia a banking instrument called documentary credit can be used.

This allows the financier to receive payment as per the established terms and conditions of any deals. The documentary credit must be issued by a well capitalized Ethiopian bank where the buyer has an account. Financiers may also insure timely and correct payment for trade financing by agreeing into a forfeiting agreement with a bank. The bank will buy the entire invoice amount from the financier at a discount. This way the financier’s money is safe and he receives the entire amount minus the discount at which he entered into the agreement with bank.

The entire responsibility of realizing the payment from customer is then with the bank, which will make a profit when the payment comes in from customer (Businesslink. gov, 2008). Ethiopia is Africa’s second most populous country and as such provides great opportunities for growth and trade. There is potential for enhanced trade with the world and this must be exploited with caution. Due diligence must be done in assessing the buyers payment potential and the safe passage of money from Ethiopia to the financier’s bank account must be ensured before any trading activity begins.

In last five years Ethiopia has been on a growth path clocking at least 5% growth annually, this momentum is likely to carry further resulting in more trading contacts with the world, ensuring that these engagements are safe for the financiers will be beneficial for all stake holders. References Ethiopia, @rating, reteived on 7 November, 2008 from http://www. trading-safely. com/ Exchange Rate arrangements of respective countries and regions, retrieved on 7 November 2008 from http://www. mof. go. jp/english/if/if043k. htm.

Information of Ethiopians in the diaspora on BOA services, Bank of Abbysinia, reteived on 7 November, 2008 from http://www. bankofabyssinia. com/Information%20to%20Ethiopians%20in%20the%20Diaspora. htm Making a Stride Economy, Ethiopia, World Investment News, Forbes Global Magazine, July 1999 retrieved on 7 November 2008 from http://www. winne. com/ethiopia/cr00. html SITPRO, Simplifying International Trade, Managing the risks of International Trade Advice retrieved on 7 November 2008 from http://www. sitpro. org. uk/trade/managingrisk. html

1.  Evolution of Banking: Bank-Meaning, Definition, Features & Classification, Concept of Different Types of Banking System, Overview of Indian Banking System
2. Commercial Bank: Basic Concept of Commercial bank, Role of Commercial bank in Financial System, Credit Control by Central Bank
3. Central Bank: Meaning, Functions, Methods of Credit Control
4. Monetary Policy: Meaning, Objectives and Instruments
5. Customer Relationship: Definition, Features of Contractual Customer Relation, Customer Orientation, Retail Banking
6. E-Banking: Concept, ATM, Core Banking, Virtual Banking, Electronic Payment System Reference Books:
7. Banking Law and Practice- P. N. Varshney
8. Indian Banking- P. Parameswaran & S. Natarajan
9. Money, Banking & International Trade- M. C. Vaish
10. Banking Concepts & Practices- Shekhar & Shekhar

DEFINITION:

Dictionary gives multiple meanings of a BANK-

• It is a heap or storage of goods.
• It is the shallow edge of the sea.
• It is the raised edge of a river or a road.
• It is a blockage of sandbags to a flow of water.

Though none of these explanations speak directly about financial dealings, all of them give a common meaning that it is a sort of CUSHION provided to PROTECT something. Hence, there can be a grain bank, a blood bank, a sperm bank, a question bank, a river bank, money bank, etc. The exact origin of the word bank is not certain. Some trace its origin to German word ‘Banck’ which means heap or mound, others trace it to Italian word ‘Banco’ which means heap of money while some others trace it to the French word ‘Banque’ which means a bench for keeping things. Jewish bankers and money changers transacted their business of lending and exchanging money on benches in the marketplace in Lombardy and so the bench became the banking counter.

Bible has a reference to money changers who were transacting business on their benches inside the Jewish temple and Jesus throws their benches and scatters them. If a banker failed by losing all his money, his bench was broken up by the people which gave birth to the word ‘bankrupt’ Monetary banks derive their meaning from all the above concepts. They provide facility to the customers to ‘store’ their wealth and give ‘protection’ to it and in the mean time they lend it to others to ‘gain’ some returns.

• According to Kent, “bank is an organization whose principal operations are concerned with the accumulation of the temporarily idle money of the general public for the purpose of advancing to others for expenditure.
• According to Crowther, “bank is one that collects money from those who have it to spare or who are saving it out of their incomes and lends the money so collected to those who require it. ”
• According to Hart, “banker is one who in the ordinary course of business honors cheques drawn upon him by persons from and for whom he receives money on current accounts. ”
• According to John Paget, “no person or body corporate otherwise can be a banker who does not take deposit, does not take current accounts, does not issue and pay cheques and does not collect cheques for his customers. ” All these definitions have described the meaning of a bank but have not given a precise definition.

Banking Regulation Act of 1949 u/s 5(1) has given the meaning of banking as follows- “Banking means accepting for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheque. ” Hence, bank in the technical sense can be defined as “an institution that accepts refundable deposits for lending or investing. ” The concept of offering fee based services has no direct connection to traditional banking; it evolved much later due to the financial expertise available with the banks.

A2. HISTORY OF BANKING:

The concept of banking is as old as the authentic history of humanity. ANCIENT WORLD: The system was started by the Babylonians before 2000 BC. The practice of granting credit was widely prevalent in ancient Greece and Rome.

Credit by compensation and by transfer orders is traced to Assyria, Phoenicia and Egypt even before its development in Greece and Rome. EUROPE: Many European countries established public banks either for facilitating commerce or to serve the government. Begun as an office for transfer of public debt, The Bank of Venice [1157] is the most ancient bank. The Bank of Amsterdam was established in 1609 to meet the needs of the merchants of the city. It accepted all kinds of specie deposits to be withdrawn or transferred to another account later using a certificate valid for six months. These written orders in the course of time got transformed into modern day cheques.

ENGLAND: English banking began with the London Goldsmiths who accepted customer’s valuables for safe custody and issued ‘payable to bearer’ receipts which in course of time enjoyed considerable circulation. Actual growth of private commercial banking began with the establishment of Bank of England in 1694. INDIA: The first reference to banking in India is found in the book ‘Arthashastra’ by Chanakya in the year 300 BC. He mentions about guilds of merchant bankers who received deposits and advanced loans. The traditional indigenous bankers and money lenders were active in India since time immemorial. The first bank in today’s understanding to be established in India was Bank of Hindustan in 1770. Unfortunately it failed subsequently.

Presidency Bank established in 1806 which then became Imperial Bank and finally State Bank of India is the first successful bank in India. Co-operative credit banks started playing significant role since II world war.

A3. FEATURES OF A BANK:

Features of a bank are the services they offer to their customers. Traditional banks have just two features: accepting deposits and lending money on credit. Modern banks have introduced a third feature of fee based services. A3a. DEPOSITS are basically of two types- Demand deposits & Time Deposits. Demand deposits are in the form of running accounts like Savings Bank A/c, NRE A/c, Current A/c and Overdraft A/c depositing or withdrawing money without any advance notice.

On Savings Bank A/c and NRE a/c banks offer interest on the balance amount where as for an overdraft a/c they charge interest on the money overdrawn. Current A/c and the credit balance in Overdraft A/c fetch no interest to the account holders. All these accounts will have cheque book and passbook facility. Now one can do banking transactions from the comforts of ones own office or room or while traveling even without entering the bank premises, pay bills anywhere and anytime and draw cash from ATM day and night and even during holidays through e-banking. Time deposits are always accepted to mature on a due date. Banks give interest on time deposit. Longer time deposits usually [but not necessarily] fetch higher interest.

All banks allow pre-maturity withdrawals of time deposits and give whatever interest is applicable for the duration the deposit was with the bank with or without a penalty interest for pre-maturity withdrawal.

A3b. CREDITS

can be further sub-grouped duration-wise or security-wise: Duration-wise credits can be short term for less than a year or medium term for one to three years or long term for beyond three years. Banks usually prefer short term credits as they give better liquidity. Long term credits are usually given for capital requirements. Customers are charged interest on credit which is little higher than the interest banks give on deposit. Security-wise credit may be secured, partially secured or clean. When credit is given against a collateral tradable security of at least equal value it is termed as secured credit.

If the securities offered against the credit do not cover the credit amount completely then it is partially secured credit. If personal guarantees are offered instead of any tradable securities, it is a clean credit. Banks usually prefer secured credit to ensure the capital safety.

A3c. FEE BASED SERVICES

may or may not be linked directly to banking activities. These features are unique to commercial banks and are on offer because of the expertise they have and also because their primary aim is profit. Cooperative banks usually do not offer such services except cheque book and bill collection facility. Some of the fee based services offered by them are- Financial Services are those involving money through the customer’s accounts like Cheque, Bill Pay, Bill Collection, Debit Card, Fund Transfer, etc. Free availability of sufficient funds in the account is pre-condition for these services.

• Utility Services are those financial services which are provided by the bank to the general public even without having an account in the bank like Foreign exchange, Bank Pay Order, Bank Drafts, Traveler Cheque, etc. Funds and the bank charges have to be provided at the time of availing these services.
• Agency/Fiduciary Services are those services in which the bank acts like an agent/trustee on behalf of its customers like Letter of Credit, Bank Guarantee, Originator/ Underwriter of Capital Issues, Safe Deposit Locker, Safe Custody, etc. Investment Services are those agency services where bank guides the customers in making investments outside the bank for higher returns like D-Mat A/c, Brokerage and Advisory Service.

B. CLASSIFICATION OF BANKS: There are various types of banks depending on the purposes of their businesses. But such a classification may or may not be exclusive since some overlapping is always possible-

B1. COMMERCIAL BANKS by their very name mean business and so perform all kinds of banking functions such as accepting deposits, advancing credits, offering fee based ancillary services including foreign exchange and foreign currency remittances. They are organized in the manner of joint stock companies.

Their main aim is to maximize profit from their banking business. Hence, they have expanded their network through branches wherever there is a possibility of better banking business. In many developing countries like India, commercial banks are obliged to contribute to the economic growth of the country through various regulations of the regulatory authorities. These banks may be govt. owned, public sector or private sector or even foreign banks. Private sector and foreign banks vie with each other in providing personalized services in order to expand business. B2. FOREIGN EXCHANGE BANKS are specialized in foreign exchange and financing foreign trade in addition to the normal banking services.

They also offer other information collecting services to their customers on foreign trade prospects, foreign agents, and foreign collaborators and provide foreign currency remittance facilities. Foreign exchange banks usually have their head offices outside the country. Their branch network is usually bare minimum; restricted only to big urban centers with great potential for foreign exchange business.

B3. INDUSTRIAL BANKS are also known as development banks and are specialized in providing long term loans to industries for the purchase of assets. They are usually not into ordinary banking services; they basically underwrite shares and debentures of industries and also subscribe to them.

Some of the industrial banks are- Industrial Finance Corporation of India-IFCI, Industrial Development bank of India-IDBI, Industrial Credit & Investment Corporation of India-ICICI [now merged with ICICI Bank Ltd. ] and Small Industries Development Bank of India-SIDBI. These are more of finance companies set up by government than banks.

B4. AGRICULTURAL BANKS like State Cooperative Banks-SCB, District Central Cooperative Banks-DCCB, State Cooperative Agricultural & Rural Development Banks-SCARDB, Primary Cooperative Agricultural & Rural Development Banks-PCARDB and Regional Rural Banks-RRB provide all types of agricultural credits to the farmers for their short term, medium term and long term agricultural needs. They also offer limited ordinary banking services that are required by the farmers.

Land Development Bank of India-LDBI gives long term loans on mortgage of agricultural land and National Bank of Agriculture & Rural Development-NABARD gives refinance to other institutions which give direct agricultural loans to the farmers. Both these banks do not provide retail banking services.

B5. COOPERATIVE BANKS work on the principle of cooperation among a group of shareholding members usually confined to a small geographical locality and the purpose of their cooperation. Their activities are largely restricted to their own members. They do not come under the strict regulatory controls of Central Bank since they are separately covered under Cooperative Societies Act. But they do have regulatory norms to satisfy, though not of the same level as that of the commercial banks. Cooperative banks are basically of two types- Urban Cooperative Banks that cater to the needs of urban population and • Rural Cooperative Banks which cater to the needs of the rural population.

B6. SAVINGS BANKS promote small savings and mobilization of resources. They may not lend on credit; they may invest the entire sum to produce returns enough to pay good interest to their deposit holders. They are very successful in Japan, Germany and India. Post Office Savings Bank, Employee Provident Fund and Public Provident Fund are some examples of Savings Banks. B7. INVESTMENT BANKS are financial organizations which assist business houses to raise funds for their long term capital requirements from the market hrough the sale of their shares and bonds. Hence, they certainly conduct other ordinary banking business in order to collect funds for their business. These banks act basically as middlemen or agents. They function in two ways-

Originator- They act as originators of the capital issue by bringing out the new issue and managing it until the shares are finally allotted for a fee for the services provided by them. They have nothing to do with the gain or loss of the capital issue which goes directly to the company.

Underwriter- They under-write the entire capital issue for a mutually agreed price and re-issue the shares to the public for the market price.

The entire gain or loss made in the process is the gain or loss of the bank and not of the issuing company. Commercial Banks are also eager to provide investment banking facilities since these are basically wholesale banking activities with definite sources of large gain in a short p of time with or without committing one’s own funds. B8. MERCHANT BANK is a loosely used term. Some merchant banks may neither be a merchant nor a bank. Merchant banks mainly deal with corporate financial advice such as share issue, capital re-construction, mergers and acquisitions. Merchant banks also accept deposits and are involved both in money market operations and foreign exchange dealings. They also manage funds on behalf of their clients. B9.

CENTRAL BANK is not a commercial bank; it is the apex bank of a country which controls nation’s monetary and banking structures, like Reserve Bank of India. It is owned by the central government in most of the countries but not necessarily always. For example, in USA it is owned collectively by the member banks. Central banks work in the national interest in developing the nation’s economy. Central bank does not deal with ordinary banking activities. It issues and regulates currency, provides banking services only to the central government, the state governments and the member banks, keeps cash reserves of the member banks, holds gold reserves of the country and nation’s forex reserves, acts as clearing house and acts as a lender of last resort. C.

SYSTEMS OF BANKING: There is no uniform system in commercial banking. They have evolved based on the needs of a particular place. Philosophically there are two banking systems- Capital based Western Banking System and Service based Islamic Banking System. Islamic banking system is the only banking system in the world that is totally fee based and does not pay or give interest. Islamic banks collect fees for all the services offered by them since giving or receiving interest is against the Islamic Law- Shariat. Most commercial banks follow capital based banking systems: they accept deposits from the public at lower interest rate and give out credit on higher interest.

The difference in interest rate is their profit which is gained by from their capital. They also charge a fee for all the value added services rendered by them. In practical sense we come across three major western banking systems worldwide- C1. GROUP BANKING is commonly found in USA. It is a federal system favored mostly by banks in USA. Under this system, a group of banks come under a centralized management of a holding company may or may not be affiliated to a larger bank or any government controlled agency. Holding company exerts control over all the subsidiary banks though each subsidiary bank maintains its own distinctive identity. The group may also include non banking financial corporations.

In some cases instead of a holding company, individuals or a group of individuals take the control over administration of the member banks through ownership of their stocks. Such a system is known as CHAIN BANKING. For all practical purposes, both mean the same except for their ownership pattern. MERITS-

1. Parent bank pools the resources and helps the member banks.
2. Large credits more than a member’s capital can be handled through consortium basis.
3. CRR, SLR and capital requirement is centrally maintained by the parent bank.
4. Parent bank provides service on research, legal matters and investments, reducing individual member bank’s cost.

DEMERITS- 1.

It is a step towards monopoly, not healthy from economic point of view. 2. Decline in business of one member in the group affects the entire group. 3. If the parent body is not a bank, it may divert funds to further its own interest. C2. UNIT BANKING system is an individualistic system also favored largely in USA. In this system each bank is a centralized unit without branches; it may have service centers like ATM at multiple convenient places or even a few branches within a strictly limited area. All functions of the bank are performed at one centralized place. For remittances they are linked through correspondent banks.

MERITS-

• Every type of banking service is available under one umbrella
• It is competitive and highly efficient. It can take prompt decisions. 3. Continuity in personal relation helps in customer care. 4. Even unique local needs are addressed by this system.

DEMERITS-

1. Being localized, it can not spread risk and its resources are limited.
2. They can not diversify services, can not have large scale operations
3. Mobilization of funds is limited to their own area and so fear of failure exists.
4. They have to depend upon their correspondent bank for remittances, increasing cost.
5. Very difficult to run unit banking in rural areas since rural resources are limited.

C3. BRANCH BANKING system is followed almost universally.

In this system banks will have their head office at one place and branches at multiple convenient places. Each branch functions like any other full fledged bank and yet is fully controlled by the head office. They even have specialized branches to take care of specific requirements of customers, like NRI branch, SSI branch etc. This is very convenient to the customers. In some branches even the weekly holiday is changed to suit the people of the area.

MERITS-

1. This system can spread risk, diversify services, can have large scale operations.
2. It can have specialized branches for exclusive purposes.
3. They can move cash reserve from less required branch to more required branch.
4. Remittance through branch system is easy, cheap and efficient.
5. Brings uniformity in the functioning supported by centralized system.
6. There will be an efficient head office control and less fear of failure due to its size.

DEMERITS-

1.  Centralization of command delays decision making process.
2. Every branch may not be in a position to offer all banking services
3. Administration tends to be bureaucratic, sticking to the rules at the cost of the need.
4. More the branches, difficult will be monitoring and supervision
5. Unique local needs may not be well taken care of From the above analysis we can safely conclude that branch banking system is the best system and so is favored world over.

NOTE: State Bank of India is planning to bring itself and its subsidiary banks with all their branches under one Holding Bank which will be like a Central Bank with full policy control over its member banks and yet with administrative freedom given to each of the member bank to maintain their unique identity. This will also be a group banking system with an important change that the holding company is a bank whose majority stake is held by the government. Hence, this system is going to combine the advantages of all the three systems discussed above.

INDIAN BANKING: PROFILE In India, ancient scripts as old as ‘Manu Smriti’ deal with regulations on credit like- credit instruments, judicial proceedings on credits, renewal of commercial papers, interest on loans, etc. Chanakya’s Arthashastra refers to accepting deposits for lending.

It is a monopoly of certain castes among Multanis and Marwaris, in the West, Gujratis and Bengalis in the East and Chettis and Brahmins in the South. The interest rates of these bankers range from 6% to 150% depending on the nature of the security. Many of them have trading interests and control the marketing of the borrower’s products. They operate mainly in big trading centers with their offices and branches. A2. MONEY LENDERS are individuals usually from Mahajan, Sowcar and Pathan communities. They do not accept deposits and their methods of business are not uniform. Others with surplus funds too are involved in money lending occasionally.

Money lenders usually lend small amounts on personal security without any written agreement with prohibitive interest ranging from 75% to 300%, invariably quoted and collected on a monthly basis. They operate mainly among peasants and urban labor class. The lenders in both these categories are not interested in increasing productivity through credit. They are not even bothered about the principal amount as long as the interest keeps coming on time. Most of their credit goes for non-productive consumption activities. They are willing to give fresh credit to pay off the old credit with interest as it enhances their earning. There are enough cases where illiterates get cheated by them.

Money lending now requires a govt. license and has a cap on interest rates. In spite of such restrictions, money lending business it still continues illegally among the low income groups because of easy access, absence of paper work and familiarity with the lenders.

B. NON BANKING FIN. INSTITUTIONS or NBFI consist of development finance institutions, non-banking finance companies and mutual funds governed under SEBI. They do not come under direct RBI control like the commercial banks.

B1. DEVELOPMENT FINANCE INSTITUTIONS: established by the central government for specific priority sector developmental activities. They are EXIM Bank, NABARD, NHB & SIDBI. EXIM Bank derives its name from Export-Import and its main activity is direct lending by way of long term loans and investments in export and import activities.

• NABARD is abbreviation for National Bank for Agriculture & Rural Development and is involved in refinancing banks and non banking financial institutions for agricultural and rural developmental activities.
• NHB stands for National Housing Bank refinancing banks and non banking finance institutions on housing credits.
• SIDBI is short form for Small Industries Development Bank of India and it extends refinance to banks and non banking finance institutions for small scale industries.

B2. NON-BANKING FINANCE COMPANIES: come under the regulations and supervision of RBI since 1998 but not under the II schedule like the scheduled banks.

They are private or public limited companies and are allowed by RBI to accept deposits and offer 1% higher interest than the banks. They give credit only for the specific activities for which they are established like- equipment leasing companies, hire purchase finance companies, investment companies, loan companies, housing finance companies, etc.

B3. MUTUAL FUNDS: are trusts that accept funds from the investors and redeploy them both in equity market as well as non-equity securities in a pre-determined pattern made available to the investor in advance and fully share the accrued profits with the investors after deducting their legitimate expenses.

Hence, gain from mutual funds depends on the types of securities purchased by them. Broadly speaking there are three types of Mutual Funds. Equity Funds invest at least 65% of their funds in various equities and may give superlative returns or make one lose one’s own money depending on the market situation. Debt Funds invest in non equity securities and give low but steady returns. Balanced Funds are combination of both equity & debt funds. For a detailed discussion on Mutual Funds please see appendix at the end.

C. BANKING SYSTEM consists of both cooperative and scheduled banks.

C1. COOPERATIVE BANKS received momentum after the 2nd World War.

They are formed by the cooperation of any group under the Co-op Societies Act. Such groups are largely localized and the success depends on their own expertise. Urban Co-op Banks catering to the needs of the urban population and Rural Co-op Banks such as State Co-op Banks and District Central Co-op Banks catering to the needs of the rural population fall in this category. Co-op Banks are not listed under the second schedule of RBI Act, 1934 but they come under RBI supervision separately. They are required to allocate 40% of their credit to the priority sector of the government like any other commercial bank, work within the jurisdiction of their state and are primarily into short term credit to its members.

They are allowed to offer cheque book facility and interest 1% higher than commercial banks on deposits, but they do not offer all the banking and other ancillary facilities of a full fledged bank. All co-op banks/ credit societies have to be registered under Cooperative Societies Act of the respective states. They work on the basis of cooperation and can be established by any group of people by forming a co-op society and subscribing for their shares. The main difference between a co-op bank and a co-op credit society is that the former can receive deposit from general public and give cheque book facility but give credit only to the members where as the latter provides its services and benefits only to its members.

Besides these, there are also Primary Agricultural Credit Societies, Primary Cooperative Agriculture & Rural Development Banks and State Cooperative Agriculture & Rural Development Banks in the cooperative sector. Cooperative banking structure, particularly the rural sector cooperative banking is quite complex in India. It can be broadly classified as follows- Urban Cooperative Banks alone have a single tier structure catering to all types of needs of the urban population through their branches in major cities spread all over the state, just like any other bank. Rural Cooperative Banks have three tier structures of delivery- State Cooperative Bank at the Apex level, District Central Cooperative Bank at the Intermediary level and Primary Agricultural Credit Societies at the Base level.

Long Term Cooperative Credit Societies usually have two tier system- Primary Cooperative Agriculture & Rural Development Banks at the base level and State Cooperative Agriculture & Rural Development Banks at the state level. Some states have unitary system with State level banks working through their own branches and some other states have a mixture of both systems.

C2. SCHEDULED BANKS are those which are registered as joint stock companies under Indian Companies Act and are also listed under 2nd schedule of the RBI Act, 1934. They are licensed by RBI to have branches all over India or even abroad and perform all banking activities including foreign exchange.

They are required to lend 40% of their credit to the priority sectors of the government. They directly come under RBI regulations and supervision. RBI control over the scheduled banks is so efficient that we do not have any example where a scheduled bank has ever applied for liquidation since the inception of RBI. Scheduled banks are basically of two types-

• a. SCHEDULED COOPERATIVE BANKS are those cooperative banks with a large capital base and listed under the 2nd schedule of RBI Act of 1934. They can offer all banking facilities just like any other commercial bank.
• b. SCHEDULED COMMERCIAL BANKS are those private or public limited joint stock companies listed under the 2nd schedule of RBI Act of.

They are further classified into 4 groups: Public Sector Banks, Private Sector Banks, Foreign Banks and Regional Rural Banks.

• b1.PUBLIC SECTOR BANKS are public limited companies whose majority shares are held by the government. Hence, their board of directors is fully controlled by the govt. and they come directly under govt. regulations. They are further classified into State Bank of India, Subsidiary Banks of SBI and Nationalized Banks.

STATE BANK OF INDIA: The East India Company established three banks- Presidency Bank of Bengal in 1809, Presidency Bank of Bombay in 1840 and Presidency Bank of Madras in 1843 as bankers to the respective Presidency Governments.

In 1921 they were amalgamated into Imperial Bank of India which also functioned as the central bank till RBI was formed in 1935. In 1955 it was nationalized and re-named as State Bank of India, popularly known as SBI. It also acts as the banker to the government wherever RBI does not have its offices.

SUBSIDIARY BANKS OF SBI or SBI Group was formed by SBI with majority shareholding in them. State Banks of Saurashtra / Indore have merged with SBI in 2008 & 2010 respectively. State Banks of Mysore / Travancore / Hyderabad / Patiala / Bikaner & Jaipur are in the process of merger. SBI European Bank is their foreign subsidiary bank.

NATIONALIZED BANKS: 14 commercial banks were nationalized in 1969.

They are- Allahabad Bank, Bank of India, Bank of Baroda, Bank of Maharashtra, Canara Bank, Central Bank of India, Dena Bank, Indian Bank, Indian Overseas Bank, Punjab National Bank, Syndicate Bank, United Commercial Bank, United Bank of India and Union Bank of India. 6 more were nationalized in 1980. They are Andhra Bank, Corporation Bank, New Bank of India, Oriental Bank of Commerce, Punjab & Sind Bank and Vijaya Bank. b2.

PRVIATE SECTOR BANKS do not have any govt. stake in their share holdings. Most of them are owned and controlled by business groups and follow aggressive corporate culture in their functioning to maximize their profits. The promotion prospects of their employees are directly linked to the business they promote unlike in public sector.

Hence, they are far ahead of public sector banks in value added services, customer care and at the same time they also charge a host of hidden costs unlike the public sector banks.

b3. FOREIGN BANKS are those banks whose head offices are located outside India and are allowed to do banking business under certain conditions. Prominent among them is lending 32% of their credit to the priority sector including export credit. Financing foreign trade remains their main business in India. They can fulfill their priority sector lending requirement by lending to priority sector export business and investing in priority sector government financial institutions.

b4.REGIONAL RURAL BANKS were created to provide institutional credit and other facilities to the small and marginal farmers, agricultural laborers, artisans and small entrepreneurs in rural areas under 20 point Economic Program of the central government. 19 such banks were established in 1976, one in each state. They were given a jurisdiction to work, freedom to have branches or agencies within their jurisdiction and were put under the sponsorship of a nationalized bank. Ownership pattern of the capital was 35% with sponsor bank, 50% with the central govt. and 15% with the state govt.

D. CHANGING PROFILE: Indian economic policy has been founded on the philosophy of economic growth and social justice. Indian banking sector has undergone a dynamic change over the years based on the needs of its economy. Most important among them are

REACH- The branch network of Indian banking system in so extensive, it covers almost all remote corners of India. It is one of the largest networks in the world.

DEVT- The diversification and development of our economy and its rapid growth is all because of our banking system’s credit to various priority sectors. These achievements have become a reality because of the changing profile of our banking system over the years. We shall discuss the major changes in the profile as under-

D1. CHANGE IN SECURITY ORIENTATION: Traditionally personal creditworthiness of the borrower mattered a lot for any credit to be released. It meant, safety of the credit alone mattered for the banks and this safety came from the wealth the customers possessed.

It effectively meant that only moneyed people could borrow from the bank. Now, banks have now changed their orientation from safety to purpose. Credit is now made available to make them creditworthy. Hence, technical competence of the borrower, operational flexibility and economic viability of the project has become more important than the security offered by the borrower.

D2. CHANGE IN REGIONAL IMBALANCES: Private Banks opened their branches in urban locations because of the business potential. As a result Rural India remained unconnected by the banks. For example, pre-nationalization of banks there were only 12555 branches of banks in the entire country and they were located mainly in the urban centers.

Post nationalization of banks number of branches has rapidly risen and as of Mar-09 it stands at 82408 branches. It is important to note that over 49% of these branches are now in the rural areas. It gives evidence that banking network has now spread uniformly to cover the entire nation without rural-urban bias.

D3. CHANGE IN BANKING HABIT: As a natural corollary to the development in the field of branch banking, development of baking habits in India have grown at an unparalleled pace. Banks have successfully induced the customers to save a part of their earning in banks for the future. Some banks even sent their agents door to door to collect the savings. This helped the banks to diversify their lending portfolio considerably.

If the deposits & advances counted for 13% & 10% of GDP respectively in 1969 they shot up to a whopping 50% & 25% respectively in 2002.

D4. CHANGE IN BANKERS ATTITUDE: A welcome change is the change in the attitude of the bankers. Earlier lending had a wholesale character coupled with the security of the credit. This attitude of the bankers made the banking facilities almost the exclusive prerogative of the elite classes. With the branches reaching the rural areas banking went retail and for the ordinary masses. Grant of credit no more became a matter of privilege; it became available for genuine production need based purely on technical norms.

D5.CHANGE IN BANKING PRODUCTS: As the focus got shifted from wholesale to retail banking, private banks in particular came up with novel products to suit the needs of the retail customers, like- home loan, auto loan, credit card, etc. Pigmy deposit introduced by Syndicate Bank and imitated by others in its various forms for example aimed at pooling idle money and inculcate saving habits among people. Banks sent their agents door to door to collect the deposit money on a daily basis and without setting a minimum. Bank deposits grew substantially because of this scheme. Such innovative products were considered a tough proposition earlier by the banks due to the volume of operations involved. Now, computerization of banking system has removed this difficulty.

Some of the banks have started offering even auto FD where amounts above a pre set limit gets converted automatically into FD to fetch higher interest and gets redeemed automatically when cheques are presented and the account runs short of balance.

D6. CHANGE IN MODE OF BANKING: When the banking system was manually operated, almost all services were time consuming except depositing money into the account in the base branch where the account is maintained. Computerization of banking has made service faster; the entire country is made to appear like one branch and even the necessity to go to the bank during banking hours for transactions is becoming redundant. Cash can be drawn from ATM anytime, even during holidays and bills can be paid directly to the account from one’s own office.

D7.CHANGE IN NON-BANKING ACTIVITIES: Many banks have diversified their activities beyond traditional banking activities like equipment leasing, hire purchase financing and factoring [acting as agents for the customers. ] A major step in this direction is the merger of ICICI with ICICI Bank D8. CHANGE IN APPROACH TO CREDIT: As a corollary to the shift from security orientation to purpose orientation, bank’s approach to credit also changed from lending to development in the recent past. Banks started lending for the purpose of industrial development, providing access to capital market and long term savings of the economy. They even started specialized branches to cater to the specific needs of the customers, like- NRI Branch, Overseas Branch, SSI Branch, Recovery Branch, etc.

D9.CHANGE IN CUSTOMER SERVICE: Private Banks started giving more focus to customer care in order to win more business. They even gave free collection and delivery facilities to HNI customers. To cope with the increasing banking habit, RBI too came up with a Banking Ombudsman scheme to redress the customers’ complaints.

E. CHALLENGES AHEAD: Banks have sacrificed some qualitative aspects of growth while expanding the banking system to achieve development and increase its reach. Prudent regulations have no doubt helped to ensure systemic stability, but enhanced efficiency would necessitate institutional changes in the internal functioning of the banks in the following fields-

E1.ORGANISATIONAL STRUCTURE: Centralized structures work wonders under uniform conditions. As the banks diversify their business into the field of agriculture, rural development and other priority sectors they have to deal with different types of customers who need different kind of treatment. They can not afford to force the standard sophisticated practices on all the customers uniformly. For example, to finance rural development it is very much essential that banks evolve simple and meaningful procedures to the comfort of the rural folks. The most common complaint against banks is the under-financing and non-availability of timely credit to meet the borrowers’ need based requirements.

Hence, banks must revamp their organizational structures by delegating power, decentralizing control and monitoring performance.

E2. EXCELLENCE IN MANAGEMENT: Quality of management is another challenge in the face of fast expansion. Here are ten critical characteristics of a good bank management-

1. An open culture and extensive vertical and horizontal communication,
2. Strong shared values,
3. Profit performance as a value,
4. Customer focused business orientation,
5. Willingness to invest in new products,
6. Strong sense of direction and consistent leadership,
7. Commitment to recruit best persons,
8. Investment in training,
9. Product information system and
10. . Strong credit risk management.

E3.CORPORATE GOVERNANCE: There are instances where the boards have shown reluctance to ratify and adopt RBI circulated covenants on professinalization of bank boards. Corporate governance can not be enforced through regulations, it must spring from within.

E4. EMPLOYEE COMPETENCY: Together with the change in organizational structure there is a need to increase employee competency also. When new entrants into the market like Mutual Funds are cutting into the business of the banks, contemporary banking is becoming more and more skill sensitive and information technology is throwing new challenges to the banking systems, employee competency has become all the more important to retain the existing business of the banks and expand it.

E5.APPROPRIATE TECHNOLOGY: Well established banks are facing stiff competition from the new entrant banks in terms of use of appropriate technology that makes banking convenient. The established banks do use modern technology but are way behind in maintaining pace and are challenged by these new entrants in order to remain in business.

E6. NONPERFORMING ASSETS: These are popularly known as NPA, the loans that do not perform- loans under litigation or bad loans that are doubtful of recovery. 6. 2% of loans of scheduled commercial banks were NPA and the public sector banks had to write off 42. 5% of the NPA as on 31. 3. 2002. It reflects on the quality of the loan portfolio. At 5% NPA, 17 out of 21 major banks in Japan were on the red.

As per developed country standards it has to be around 2%. Hence, banks have to bring down the NPA ratio drastically.

E7. DIRECTED CREDIT: NPA as discussed above is a direct result of the quality of the loan portfolio of the banks. The system of directed credit to priority sector has no doubt brought impressive performance in quantitative terms but qualitatively it has brought more loan delinquencies since the relation between credit expansion and productivity has become weak. Political interference in credit decision-making is pointed out as a factor. The populist phenomenon of ‘loan mela’ is certainly contrary to the professional appraisal of bank credit needs.

What is required to improve the quality of loan is-

1. Serious appraisal of credit need,
2. Potential productive activity and 3. Effective post credit supervision.

E8. RISK MANAGEMENT: Risk is intrinsic to any business; all the more to banking. Risks encountered by banks have increased with the diversity of banking business and growing sophistication of banking operations. The major risks encountered by banks are credit risk, interest rate risk, operational risk, forex risk and liquidity risk. While deregulation has opened up new vistas for banks to shore up more revenue, it has entailed greater competition and greater risks too. Hence, greater attention needs to be iven in strengthening of internal controls of risk management.

E9. SICK INDUSTRIAL UNITS: Funds locked up in industrial sickness has reached a staggering 2% of the entire credit of the banking system in March 2000. When sick units have to be nursed for ‘social objectives’ banks should not be forced to suffer; actual stakeholders must bear the burden of nursing them. When sick units are nationalized for protecting the employment or they are public sector entities, govt. must give adequate compensation to the banks to cover their dues which rarely happens in reality. It is neither legitimate nor practical for the banks to nurse sick units in all circumstances.

E10.PROFIT PLANNING: Banking can not run like other profit making business since excessive and unjustified profits can only be at the cost of development of the society so far as the lending rates push up the production cost and ultimately is passed on to the customer. At the same time strong operating profits allow for allocations to capital and reserves which are very much essential for any bank to maintain its competitive viability. This setback was realized in the 90’s when the nationalized banks posted declining profits. Nevertheless, concerted efforts by these banks improved the situation by 2002. Stiff competition makes the banks to work on thin interest rate margins but to increase their profitability, they have to increase their fee based non-fund services substantially.

E11.CUSTOMER SERVICE: Though entry of new private banks no doubt has increased the quality of customer service, it is by and large confined to urban areas and to wealthy customers. Only the educated and wealthy customers have access to detailed information on all the banking facilities available. Customer care is very much wanting in public sector banks where the unionized employees are sure of not losing their jobs on this count. Efforts must be made to collect customer feedback on regular basis and remedy the defects pointed out if any, at the earliest wherever possible.

E12. GLOBAL STANDARDS: Computerization has revolutionized in banking in India. But it has not yet made much progress in expanding it beyond the ational boundaries. Not many branches of Indian banks are found outside India. Just like its progress in Information Technology and software, India has to make good progress in the banking sector internationally since allocation of capital can not be bound by geographical boundaries.

COMMERCIAL BANK A. FEATURES: Commercial banks are private or public limited joint stock banking companies registered under Indian Companies Act. There are three distinct features of a commercial bank- they accept DEPOSITS on lower cost and give CREDIT on higher cost and the cost difference between deposit and credit is their GAIN. [For more details refer features of a bank]

Its capacity to earn profits depends on its investment policy which in turn depends on the manner in which it manages its investment portfolio. Portfolio management refers to prudent management of a bank’s profit, liquidity and safety. But most commercial banks have gone way ahead of their basic functions introducing a host of fee based ancillary financial services in order to maximize their profits. Thus a commercial bank now may be defined as “an institution that accepts deposits from the public on lower cost and lends it on credit on higher cost as well as offers ancillary services for a fee in order to increase its profits. ”

B. ROLE IN FINANCIAL SYSTEM: Commercial banks strive to earn a profit.

At the same time their entire business of credit depends on public money deposited with them. Hence, they can not afford to risk public money just to increase their own profits. It is common knowledge that national level bank strikes throttle the lifeline of the nation’s economy and inflict heavy losses on the GDP. The significance of banks’ role in the financial system must be understood in the words of Walter Leaf, who says “The banker is the universal arbiter of the world’s economy” Commercial banks have to play a major role in three distinct areas-

• Providing fiscal liquidity to the financial system,
• Giving capital protection to the economy and
• Speeding up economic growth of the nation.

B1.FISCAL LIQUIDITY: By fiscal liquidity we mean the capacity to produce cash on demand. The most important role of any bank is to provide liquidity to the financial system. Banks pool around idle money in small pockets through their wide spread branches into a large capital and redeploy it wherever needed. For better management of credit, banks like to have as much funds in liquid as possible while maximization of gain is possible only by deploying maximum available funds on credit. Both are important for the bank. Hence, bank has to strike an effective balance between them so that neither its profitability suffers nor the liquidity of the market is affected. Liquidity of the assets of the bank is planned in three stages-

• a.CASH is the most liquid asset. But it is an idle asset earning no returns for the bank. Yet certain percent of deposits must be always kept in reserve with the Central Bank in addition to cash in hand to meet immediate withdrawal of deposit. This is known as Cash Reserve Ratio or CRR. It is decided by the Central Bank.
• b. CALL MONEY is the investment in Money Market, Bond Market and Reverse Repo.

Money Market securities include short term securities like Certificate of Deposit [CD] of banks, Commercial Papers [CP] of companies, treasury bills of the govt. which give stable but low returns and long term govt. securities whose yield depend on the interest scenario. Bond Market securities include Medium Term as well as Long Term bonds of any banks or companies tradable in the secondary bond market. They are bought and sold at discount or premium and hence, their yield also depends on interest scenario.  Reverse Repo is the system through which RBI borrows from commercial banks to absorb excess liquidity at lower interest rate. These funds are made available to commercial banks through bills repurchase under repo system on a little higher interest. These securities are the next best liquid assets but the returns from these securities are low. But it is important to select only those securities which give a fairly stable return.

These securities can easily be liquidated in the Market with short notice. RBI prescribes a Statutory Liquidity Ratio or SLR for banks by which banks have to maintain certain percent of their deposits as liquid assets.

• c. CREDIT and investments give maximum gain to the bank but they are the least liquid. Hence, these assets should be created only in required proportion, never as a priority. Among them, short term credits are preferred by banks over long term credits for the sake of liquidity.

B2. CAPITAL SAFETY: Commercial banks strive to earn profit. But this must be done through prudent ways without risking the deposits of their customers. They have an important role to play in the capital protection. Hence,

1. Protection of deposits must be the top priority for the banks. Deposit Insurance and Credit Guarantee Corporation set up by the govt. gives guarantee only up to Rupees one lakh per customer in case a bank fails and has to be closed down.
2. Banks must avoid investing in equity related instruments or giving loan for speculative business since equity market weakens capital safety to a large extent. This is required to increase stability of the capital.
3. Banks have to use self restraint in their credit to other volatile businesses like real estate, film industry, etc. Similarly they must be extra cautious while accepting volatile securities as surety for credit.
4. Banks must restrict long term credits and investments to a small percent since capital safety in short term credits is higher than the long term credits.
5. Before giving clean loans, banks must have a thorough reality check on the creditworthiness of the borrowers to repay the loan on time. 6. Banks must maintain a fair margin between their interest rates on deposits and credits.

B3. ECONOMIC GROWTH: Banks have a greater role to play in the economic growth of the nation through economic development of all the sectors. Hence, they must provide more credit to developmental and productive activities than non-productive or consumption oriented activities.

Basically there are three types of developmental activities- Large capital based corporate activities, medium or small capital based priority sector activities and export activity.

• a. CORPORATE SECTOR- While funding developmental activities, banks find it easy to provide credit to large capital based profit making corporates in industry & trade since timely repayment of credit received by them with interest is almost guaranteed.

Funding is required not only for corporates but also for other sectors like industry, trade, service, infrastructure, transport, housing, power, finance, technology, etc and the banks can not overlook one sector at the expense of the other. Besides, corporate sector companies also have the capacity to increase its capital base or raise funds from the open market by issuing their own bonds.

In other words they do not depend heavily on banks for their capital requirements where as others heavily depend on banks. Hence, banks must use their prudence while deciding percentages for corporate credit. Large capital companies, particularly industry contribute to the economic growth of the nation not only by increasing production but also by increasing job opportunities. But their main drawback is that they are basically profit oriented and development is a byproduct of their activity. They are reluctant to venture into non-profit sectors that are essential for a balanced growth of economy.

• b. PRIORITY SECTOR- For all-round and real development there are certain priority sectors of the nation that require funding assistance by the banks.

They are- infrastructure development like housing, rail and road construction, power, transport, etc. as well as small scale industry, trade, technology, agriculture, etc. From the profit perspective these priority sectors may not be always lucrative. It will not be always easy for these sectors either to increase their capital or borrow from open market; they depend heavily on banks for their capital requirements. RBI has mandated 40% of the total credit of all cooperative & scheduled banks and 32% for foreign banks towards priority sector lending. Banks are allowed to invest in special bonds or investment instruments of these sectors to meet these requirements.

• c. AGRICULTURE SECTOR is surely a super priority sector.

It must attract special attention of the banks since self sufficiency in agriculture has to be a top priority of any nation. Agricultural production is commercially unprofitable at least in Indian context. Small and medium farmers produce just enough to sustain since their personal labor in agricultural production gets them no returns. Any other production can wait, not food; it has to be produced proportional to the population irrespective of the cost. For the same reason, governments are providing subsidy and refinance facilities for agriculture. Banks must ensure that the government benefits really reach the medium and small farmers.

• d. EXPORT SECTOR is not an exclusive sector like corporate or priority sector.

It can pervade both corporate as well as priority sectors. Economies of the world are so interdependent that each country must have enough reserves in the currencies of other countries to pay the bills for supplies received from those countries. In its absence they end up in raising foreign debt which in turn has a cost by way of interest; or else they end up in depleting nation’s gold reserves. If a country depends on foreign supplies, it must give high priority to exports to that country to strengthen their balance of payment. In such a situation banks must step in to provide credit to export activities in a preferred manner to increase county’s reserves in that currency.

C.MULTIPLE CREDIT CREATION: There are two views on whether banks can create credit-

• One view held by Walter Leaf is that banks can not create money out of thin air. They can lend what they have in cash.
• Another view held by Hartley Withers is that banks can create credit by opening a deposit every time they advance a loan. It is interesting to know that in an effort to maintain lowest possible idle cash, banks end up in increasing the money in circulation without increasing tender cash currency while creating credit! In fact, credit creation is one of the most important functions of a commercial bank. They increase the purchasing power of people. Let us see how does this happen. C1.

METHOD: When bank gives a loan it pre-supposes that bank has cash through deposits. From the deposit bank gives loan which in turn gets deposited in the bank account. It creates an asset as well as a deposit with the bank. The beneficiary customer can issue cheques for payments in addition to the existing customers who have originally deposited the money. Thus money available in circulation superficially becomes more than the actual tender cash currency. This is the view of practical bankers. Concrete Example: Let us presume that our country has only one bank B and all the citizens are heavily into banking making the cash requirement of B just 10%.

Case research project

1.  Chester Charles Sztejn, Plaintiff., v. J. Henry Shroder Banking Corporation, Robert Schwarz Bristle Corp., Transea Traders, Ltd., and the Chartered Bank of India, Australia, and China, Defendants; heard by the Supreme Court, Special Term, New York County, on July 1, 1941; reported as Sztejn v. Shroder Banking Corp., 177 Misc. 719, 31 N.Y.S. 2d 631 (1941).  This case was heard by the Supreme Court of New York County, one of the trial courts in New York State. 

Facts:  Plaintiff Chester Sztejn and his “coadventurer” Schwartz, bought “bristles” from Defendant Transea Traders, Ltd., an Indian Corporation.  They contracted with Defendant J. Henry Schroder Banking Corporation for an irrevocable letter of credit to pay for the bristles.  Sztejn’s agreement with Transea Traders was that Shroder would pay part of the purchase price on shipment and presentation of an invoice and bill of lading made out to the order of Schroder.  It is not stated when the balance was due.  The letter of credit was delivered to Transea in India, which shipped 50 crates of bristles.  Plaintiffs discovered that the crates were full of cowhair and other worthless material.  Transea drew a draft under the irrevocable letter of credit to the order of Defendant Chartered Bank of India, Australia, and China, and presented it for payment with the required documents.

Issues:  Whether or not Schroder Banking Corp. must honor the irrevocable letter of credit according to its terms

Rules of Law:  A letter of credit is independent of the original contract of sale between the parties.  This is a document in which the issuing bank agrees to pay upon presentation of certain documents, not goods.  The bank issuing the letter of credit is not allowed to get involved in disputes over the quality or quantity of the goods shipped unless a provision permitting this is included in its terms.  [This is a case that pre-dates the codified terms of the Uniform Commercial Code, in which Article 9 covers all details of letters of credit.]

Holding:   The seller intentionally defrauded Plaintiffs by not shipping the goods ordered.  The sellers’ fraud was called to the bank’s attention before the drafts and documents were presented for payment, and Plaintiff’s requested that payment be withheld.  The Chartered Bank is in the same country as the Defendants and is the Defendants’ agent for collection of the money.

Other factors the New York Court might have considered:  Plaintiffs are American.  Schroder Banking is American.  World War II has started in Europe.  It is better for American courts to protect Americans now than citizens of India, Australia, and China, even though some of those countries are our allies.

2.  Touche Ross & Co., Plaintiff, v. Manufacturers Hanover Trust Company et al., Defendants;  heard by the Supreme Court, Special Term, New York County, on October 29, 1980; cited at 107 Misc.2d 438, 434 N.Y.S. 575 (1980).  This case was also heard by the New York Supreme Court, a New York Trial Court.

Facts:    Touche Ross, a partnership of C.P.A.’s, contracted with the Imperial Iranian Government to audit military contracts being performed by American Contractors.  Touche Ross posted a performance guarantee of 10% of the contract price, or $400,000, by letter of credit issued by Manufacturers Hanover Trust Company and payable to Bank Saderat in Iran.  So if Bank Saderat had to pay the Imperial Government $400,000 because Touche Ross did not perform its contract, Manufacturers Hanover would pay Bank Saderat that sum.  Before work began the Imperial Government of Iran fell and was replaced by the Islamic Republic, which terminated all commercial contracts between the United States and Iran and nationalized a number of American businesses.  In April 1980, President Carter blocked all Iranian assets in the United States, leaving Touche Ross owed $875,000 for services and rendered and also possibly out the $400,000 for the performance guarantee.   The Islamic Republic demanded payment from Bank Saderat, which then made a demand on Hanovers.

Issues:  Whether the change in government constituted “force majeure” such that the contract between Touche Ross and the Iranian Government could be canceled by Touche Ross.  In such case, Hanover’s performance guarantee would be released and no legitimate call could be made on the guarantee or the letter of credit.

Rules of Law:  A revolution is generally accepted by international practice to be force majeure permitting the Touche Ross contract with Iran to be canceled pursuant to its terms.  Once the contract is cancelled, all Bank Guarantees of good performance are released.

Holding:  Since Touch Ross’s contract with the government of Iran can be canceled under Section 6.2 because of the revolutionary change of Iran’s government, and further since it is not clear to the Court whether President Carter’s seizure of Iranian Assets in the United States would include the $400,000 allegedly due as performance guarantee if paid, Plaintiff Touche Ross will probably win at trial on the merits.  The temporary restraining order requested is issued, enjoining Defendant Manufacturers Hanover Trust Company from paying any amount under the letter of credit issued to Bank Saderat either directly or from setting up a potentially “blocked” or seized account of the new Islamic Government of Iran.

Other Factors the Court Might have Considered:   Touche Ross, an American company, was already owed $875,000 by the former government of Iran for accounting services.  Since the letter of performance guarantee was backed by their financial assets, they could be out yet another $400,000 if the Bank of Saderat were able to collect on the guarantee.  Further, the Bank of Saderat was owned by the Republic of Iran.  It could not have legitimately paid on the guarantee since it would be paying itself. This makes any call on the letter of credit fraudulent.

Compare the courts’ decisions in each of the two cases:   Both cases involve the Court’s finding creative ways to avoid complying with the strict contract language of letters of credit and letters of guarantee, which are basically the same documents with slightly different language.  The Court invokes the magic meanings of “fraud” to prevent perceived wrong-doers from profiting.  The cases differ in that the first was decided based on New York contract law and precedents in effect before enactment of the Uniform Commercial Code.  The latter was based on contract law and payment guarantees written after the Uniform Commercial Code was enacted.  While both involve separate documents of guarantee written so as not to prevent payment, special circumstances existed in both cases so that the Court wanted to stop payment by involving “fraud” or intentional cheating and deception to void the guarantees and the contracts.

Sources of law regarding letters of credit:  Normally letters of credit are covered by the Uniform Commercial Code section on “Letters of Credit”.  Since letters of credit are contracts also, the parties can vary the language in them to meet their needs.  A letter of credit is a promise to pay secured by the parties’ cash and liquid assets.  A standby letter of credit is a secondary one available for use if needed, guaranteed by the party’s non-liquid assets, such as stocks, bonds, and other securities.

What is the exception defense used in our cases?  The exception defense in our cases is “fraud” – willful cheating or deception that voids the contracts.  In the first case, the Defendants shipped junk instead of the ordered bristles.  In the second case, the Bank making the payment demand was owned by the Iranian government.   It could not have legitimately paid on the guarantee since it would be paying itself. This makes any call on the letter of credit fraudulent.

Contract Non-legal Implications of a breach of contract would Include: potential loss of creditably In the marketplace and loss of new/return business for the party who breached the contract. Egg, a company selling goods and services, a damaged reputation could result in the loss of new and existing customer contracts. Egg. A breach of a loan contract, the potential loss of credit rating affecting future credit potential and business opportunities. Flow on effects of consequent outcomes for the party against whom the breach has occurred (Ultimate 2013).

Egg. A contract breach by a car components company against a car manufacturing company would mean the car manufacturing company’s inability to meet their customer contracts, potentially leading to a competitive loss In the marketplace and financial ruin if severe enough. A personal example, Is when I pre- booked a hotel for a holiday expecting my car to be serviced on time. However the breech of agreement of the car servicing company by falling to have my car ready on time (2 days late) meant I started my holiday late and lost 2 hotel nights.

Flow on consequences also result in loss of competitive position or opportunity for the party against whom the breach has occurred. Egg. If the contract breech meant a company or individual was not paid the monies due to them, there would be lost opportunity to pursue other avenues for investment with those funds. Emotional distress for both the parties. This could be particularly pertinent in instances Involving individuals and should not be under-estimated if it involves a significant life Impact such as loss of financial position. Self help remedies available: For the party who has breached the contact include:

Pursing consultation and negotiation with the contracted party to discuss alternative arrangements and resolution to avoid litigation. For the party against whom the breach has occurred understand the full term and conditions of the contract to determine whether a case for breech of contact is allowed without legal ramification conduct a cost-benefit analysis of loss of the contract breech vs. the potential legal and non-legal costs before Annihilating any litigation. Document a schedule of projected cots/damages and the potential loss as a result of contract breech should a case for compensation be urged.

Expectation / reliance loss – document and outline the position that would have been attained should the contract have been performed that the plaintiff would outcome but minimize damages and legal costs (Ultimate 2013). Explore preventive strategies to minimize damage in the event of a contract breech. Egg. A landlord taking out tenant protection insurance for loss of rent to non-paying tenants rather than taking legal action against a tenets that is likely to be more costly overall Ultimate, P 2013, Australian Business Law, 32nd Eden, ACH Australia Limited, Sydney, NEWS.

Sales budget is a particular budget and involves sales revenue for the particular period i. e. 3 months, 6 months etc. The calculation should be made for each product like ice cream and frozen yogurt products for the period required. The sales budget identifies cash sales, credit sales, amount that will be realized in the specified schedule. It means the cash received in the months includes the amount of current month cash sales and previous month’s credit sales. The sale budget is an estimation of future sales in order to create the company sales goals.

It is meant for the prediction of future sales of particular product for a specified period and will be created by taking consideration of past performance of the product, inflation rates, unemployment, consumer spending, market trends and interest rates. Some of the items of sales budget are as follows.

Cash Budgets

Preparation of cash budge is management plan and it is most important factor that describes the company’s viability. The company’s position intimates that how much suppliers are to be paid and what are the expenses that should be met with immediate effect.

Like other budgets the cash budget is also prepared for particular period i. e. 3 months, 6 months etc. The cash budget inclusive of cash receipts and cash payments. The budgets always indicate the projections and these are not actual figures. The cash budget can be prepared on the basis of time period, desired cash position and estimated sales and expenses. Some of the following terms that will appeal in cash budget. The operating expenses relate that are to be met at the time of manufacturing of the product. These expenses are compulsory and the expenses called indirect expenses.

Some of the following expenses indicate the operating expenses.

• Distribution expenses • Selling and marketing expenses

• General and administrative expenses

Capital Budgets

It is an investment decision. The capital budgets indicate that how amount should be invested and what ratio of investment should be made etc. In order to avoid the idle cash and waste of cash, the investment decisions are taken. Since it is investment decision, the payback calculations are to be found by implementing various techniques like net present value, international rate of return etc.

Capital budgeting is capital expenditure just like current expenditure. The capital budgeting is prepared by taking the considerations like long term goals, new investment opportunities, new projects etc. Hence it should be understand the capital budgeting is linked with return on investment. Some of the following terms indicate the capital budgeting.

• Capital investment and its return

• Future values/compound interest

• Present value

• Net present value

• Internal rate of return

• Payback period’

• Accounting rate of return

Refference:

1.http://www. yocream. com/downloads/YoCream_1-31-09_earnings_release. pdf

2. http://www. lloydstsbbusiness. com/support/businessguides/budget_text. asp

3. http://www. bizhelp24. com/accounting/budgeting-in-small-business-12. html

4. http://www. associatedcontent. com/article/225986/what_types_of_budgets_do_businesses. html

5. http://www. answers. com/topic/sales-forecast

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A wide variety of payment options is enjoyed by very many people in this twenty first century. They include money orders, personal checks, cashier’s check, credit card and debit card. This paper is dealing with credit cards as a payment system and its effectiveness. Technological advancement has played a big role in the effectiveness of credit cards as a payment system. As E-commerce blooms, there is a dire need for payment system that is effective. Internet is becoming a market place of services and goods and this needs payment system that is secure.

This paper has recommendation on mechanisms that need to be incorporated as part of the scheme to combat problems emanating from the use of credit cards such as fraud.

Introduction

Since the twentieth century, there has been high interest in relation to payment schemes and electronic commerce over the internet. There are very many payment systems that are being invented day after day. Many people have proposed payment of internet transactions. There are other payment systems that are still being developed.

Credit cards are widely used all over the world. They are very common in the developed nations. This has been influenced by technological advancement therein. Credit cards are highly effective especially in this twenty first century. (Abrazhevich, 2002)

Background

Scholars assert that credit card usage has increased in the recent years. It is widely used among young people all over the world especially in developed nations. Surveys carried out in colleges in United Kingdom show that college students widely use credit cards.

Many Companies are known to target the younger generation in their marketing strategies. This does not mean that credit cards are only used by young people. This facility is also widely used by old people as a payment system. According to surveys carried out in the year 2001 in United Kingdom, teenagers are also using credit cards as a payment system too. This is because eighteen year olds are eligible for a credit card without their parents consent or regardless of employment status. (Milunovich, 2002) Credit cards actually help consumers to have an easy way to track their expenses.

This is because companies that offer credit cards normally send to the consumer detailed notices showing what products and services were purchased during a certain period of time. This is very essential in monitoring ones personal expenditures. Credit cards since the twentieth century are worldwide accepted. They involve limit in repayment agreement and credit limits. In nations like United Kingdom, France and United States there is normally the limiting of the amount which card holder is held liable because of fraudulent transactions that result from the consumer losing his or her credit card.

In case a credit card is stolen, the card issuers in most cases refund part of the charges or sometimes all that they got from things not purchased. Research shows that such refunds are normally at the expense of the merchant who sold the goods. This is very common if the merchant can’t actually claim the card sight. This means that merchants stand a chance of losing money if they never requested for the person’s ID.

Advantages of Credit Cards

A credit card as a means payment system has got various advantages both to the users and also to the issuers.  Free insurance. When an airline ticket is bought using credit card, the purchaser gets free travel insurance. People using credit cards have to check what is normally on offer during the period they are purchasing in order to make use of such offers. Credit cards also provide platinum cardholder various benefits. They include up to  1,000,000 in travel accident insurance, various emergency and travel assistance services, car rental discounts and auto rental insurance. All these provisions are very important in making life of card users cheaper and easier. (Bernstein, 1998)

Later payments .This is an aspect of credit cards that makes it widely used by many people all over the world. For instance if a card owner pays full balance at the month end, then this means that he or she will have gained some ‘free’ money for approximately two to three months. This actually depends on the type of company offering the credit card and the policies therein. It also depends on when the purchase was made and the customer’s grace period. (Milunovich, 2002) This is very advantageous especially when one wants to purchase a very expensive item.

This can be a new refrigerator, laptop, double bed or a new sofa. This is because one can time his or her purchases so that they can get a maximum amount of grace in between the period when it is purchased and when the bill is actually settled with the company issuing the credit card. This when well calculated can be very advantageous to the person using the credit card. (Hanagandi, 1996) An analysis on the use of credit cards shows that this strategy works quite well. This is if the credit card user strategises by putting all the purchases on one credit card.

In this case the debit balance can then be moved to another credit card that has lower interest on balance. This is normally advantageous if the credit card offers zero percent interest on balances for a specific period. This period is usually between six to twelve months. (Rivest, 2004)

Loss protection. This is quite applicable to many card users and it is a common occurrence. For instance if a person goes shopping with  600 to use it in purchasing goods then the money is lost on the way to the stores, this can be quite inconveniencing. On the other hand if a person has some little cash plus a credit card and loses them then it is not inconveniencing as the former situation. This is because such a person can just communicate to the company that issued the credit card. In such a case the issuing Company will always cancel the card and the card user can issue him another one as soon as possible. This is normally within a period of one week. For this reason credit cards actually help protection loss of money and that is why they are effective payment system.

This actually depends on the issuing Company’s policies and laws but what is illustrated above is what actually happens to most of them. In case the stolen credit card is used before the person reports it to the company, his liability in this case is a token amount or zero. There are also cases where the card number is stolen but the card user still posses it. In such a case the card user’s liability is zero as stated by majority of card issuers. (Rubin, 2001) 4. 4 Cash not allowed With globalization, many businesses are incorporating the use of credit cards.

Many companies nowadays do not accept cash payments because of great risks involved. Many companies such as Car rentals or hotel bookings don’t accept cash payment but credit cards only. This can be quite inconveniencing if one does not have credit card. There are also some businesses that need the purchaser to have a credit card as a deposit even if he or she settles the bill in cash. (Shyamasundar, 2004)

Protection of Purchase

It is very advantageous to use credit card in purchasing goods. This is because there are instances when a person can purchase faulty goods using credit card. Such goods are normally a hundred percent insured for one or two Months. This insurance according to analysis shows that in most cases it covers loss. For instance if a card user purchases goods using credit card and actually losses them n his or her way home, the insurance company normally covers this loss. (Hanagandi, 1996)

No Need of Cash

Credit cards are quite advantageous especially to the users. This is because they actually eliminate the need to carry around cash. Common knowledge tells us that cash is quite bulky to carry around. In this case credit cards are very light and can be carried to any place is visiting. They are very convenience in the sense that they are quite light to carry around. One does not necessarily need a purse to carry a credit card but they easily fit in pockets. For this reason credit cards are very effective payment system that should be used by all despite their social status. Credit cards are quite effective because it plays a big role. Have you ever been out on the streets then you get something you have desired to purchase. Probably when you are out for shopping you never come across it.

I mean the right colour size and even quality of merchandise. In case you come across it by chance and you are without a credit card, it simply means that you cannot purchase it. In case you have a credit card it simply follows that you can purchase the item. That is why is why it is quite advantageous to use credit cards as a payment system. (Carow, 1999)

This is also one of the advantages of using credit cards. For instance if a person decided to travel from United Kingdom to Australia then need he needs to change Sterling pounds to Dollars. In case this is done at a local bank then such a person is likely to get very bad exchange rates. This also can include various commissions charged for exchanging the currency. This can be different in case such a person has a credit card. This is because when credit cards are taken along on holiday, the rate is far much better than when cash is used. Research shows that many nations’ tourist resorts, cities and travel agents accept all the major credit cards. This move has actually been enhanced through globalization.

In case a credit is carried along on a holiday, it normally wins against debit card. This is because of its ability to have better protection safeguards. It is normally wise for travellers to keep each receipt of every purchase made. This can be diligently checked against the card statement issued by the Company. Many credit card companies nowadays offer customers the ability to manage their accounts online.

Research carried out in many developed nations including United Kingdom and United States shows that credit cards are widely used due to their various advantages. Research findings show that many credit cards actually offer loyalty schemes. They normally point towards reward systems. The loyalty schemes include air miles incentives etc. In case a person often uses credit card and has a good record of paying off the balance, he or she is normally better placed min this case. This is because with the right reward scheme one can accumulate very good savings which can be used for future purchases of goods and services. They include purchases on air flights within and also outside the country. (Dorronsoro, 1997)

Credit cards are far much cheaper than short term loans. This is because such loans will call out for higher instalments. It is therefore far much cheaper to purchase goods using credit card than to obtain a short term loan to purchase the same. Credit cards also offer a high degree of loan flexibility. This means that a credit card user can pay the whole debt or just pay a minimum amount. Another advantage in line with this is that many credit cards offer a free period whereby interest is not charged. There are also no redemption penalties for an early loan repayment.

For this reason credit cards are an effective payment system. (Wigand, 1995) Credit cards are also convenient to use because they allow people to order for purchases by mail or even by phone. This actually saves the time and energy that could otherwise be wasted travelling to stores to buy goods desired.

Disadvantages of Credit Cards

As elaborated above credit cards are very convenient but research shows that when they are not well managed they can cause various problems. These include the following:

When individuals spend more than they can actually afford every month, they always end up having to pay for increased interest rates every month. It is quite easy for an individual to forget purchases that he or she made with the credit card. Such a person can end up getting surprised at the end of the month on seeing the number of purchases signed up. Many companies charge high interest rate on any unpaid balance. If such an individual continues to pay only the minimum amount then the unpaid balance can actually become too much for him to handle. (Carow, 1999)

There are two types of credit card fraud. They include external card fraud and inner card fraud. In inner card fraud the cash is defrauded. It involves collusion between cardholders and merchants. This is where they use false transactions to defraud banks. External involves using counterfeit credit cards to acquire cash in disguised forms. This is one of the problems that are quite common all over the world. This actually involves credit card theft. Someone can steal another person’s credit card and use it to make purchases. This is a problem that is increasing day by day as technology advances in the society.

It is not just the possession of ones physical card by thieves that they can make fraudulent purchases but many criminals can actually obtain credit card numbers through dubious means. (Ghosh, 1994) This means that a person may not know that someone has used his or her credit card until he gets the monthly statement showing the goods purchased. Research shows tat while this payment system is quite convenient, it has high interest rates especially when a person stays with unpaid balance for a long period of time. This implies that card user can easily get into a financial debt.

This issue of credit card theft is a real threat as criminals devise more devious methods of obtaining people’s credit card numbers.

Confusticated

There is a jargon that is normally used to describe the different types of rates charged for credit cards. This is in relation to the different transactions available in this payment system. Research shows that many credit card companies in developed nations have to show an honesty box on advertisements they make.

Interest Charges

Many credit card companies charge extremely high interest fees on credit cards. This is one of the biggest disadvantages of using credit cards. According to surveys carried out in United States, many credit companies therein charge twenty percent on purchases that are not fully paid by the end of every month. These charges are used by credit card companies to help in their day to day running of the business.

Temptation to Overspend

Credit cards are not the best for people who are spend thrifts. This payment system can actually tempt individuals to overspend because they actually don’t have to pay for the purchases there and then. It is possible for an individual to spend more than what he or she has in account.

The purchases can go up to maximum of credit card limit. An individual just signing a document when purchasing doesn’t always feel like one is actually spending money. This makes many credit card users to overspend compared to when they use cash as a payment system. (Markus, 2003) 5. 6 Technical issue The entire process of creation of credit cards and processing is very technical. It involves very many systems put together like the electronic point sale terminal and the transaction terminal. There are the wireless LAN and POS systems which are also included.

This makes the process of fraud detection in use of credit card to be a very technical issue. There is high necessary diagnostic quality that is a major obstacle for using neural network training techniques.

Convenience, Risk and Cost of Payment

Surveys were carried out in relation attitudes that users have in relation to payment systems. This is in relation to security, convertibility of funds and ease of use. Investigations on consumer preferences on cash, debit cards and credit cards showed that convenience played a big percentage in credit card usage.

The results show that payment decisions made by customers depended on privacy, security, convenience and low cost. Results show that credit cards have more protection than money order, cashier’s check and cash. This is because purchasers normally have the right to withhold payment in case the goods are of poor quality. They can also withhold payment if the goods are damaged. In the modern society, convenience is a factor of great importance. In internet commerce, shopping convenience is also important. The reason as to why credit cards are more convenient is that they can be processed electronically.

This is unlike money orders which have to be mailed after being obtained from issuer. In the case of the seller, payments are collected automatically through electronic means. This is very effective for sellers with high selling volume. (Leong, 2003)

Types of Credit Cards and Their Advantages

There bare various types of credit cards that are widely used in the market today. They include secured credit cards and prepaid credit cards.

Prepaid credit cards. In this type the card holder spends deposited money prior to the actual deposit. The money is normally deposited by an employer, a parent or a guardian.

It is normally branded MasterCard or Visa. Due to market demand, credit Companies decided to offer prepaid credit cards. These types of cards have higher interest costs and APR fees. This card is normally purchased and then loaded with any amount of money that the card holder desires. (Rivest, 2004) The card I then used to purchase various items desired by the bearer. This type of credit card has got its own advantages. One of them being that a person does not have to come with a minimum of $500 before opening an account. When using this card one is not charged when no money is borrowed.

This is unlike secured cards which charge credit card user even if the card has not been used to purchase any item. Many companies offering this type of credit cards normally targets the youth who normally shop online without their parents consent on the transaction. (Ghosh, 1994)

Secured credit card. This type of credit card is normally secured by a deposit account which is normally owned by the person who holds the card. The cardholder normally has to deposit a certain amount of credit desired. This is between 100% and 200%. For instance if the cardholder deposits $ 1000, he can access credit ranging from $ 500 to $ 1000.

There are instances when users of credit cards offer incentives especially on their card portfolios that are secured. This means that the required credit limits will more than the required deposit. This can go as low as ten percent of the credit limit. The institution offering credit cards normally holds the deposits in savings account. This is offered by credit card issuers after noticing that it reduces delinquencies. This is because it shows customers that he can lose in case he fails to pay up the balance owed after using credit cards. (Lee, 1996) In this facility the card user has to make payments on a regular basis.

This has to be done just like when one uses regular credit card. The cost of purchases that is paid to merchants out of deposit can be recovered by the card issuer in case the person issued defaults on payment. This secured credit card is quite advantages because it can help rebuild credit history that is quite positive. This is very advantageous for individuals who have had a negative credit history or who don’t have any credit history at all. The deposit in this case acts as security and is normally kept by the credit card issuer just in case the consumer defaults.

This does not mean that deposit is debited in case a consumer misses to pay one or even two payments. When the account is closed, the deposit can be used as an offset. This is normally implemented when a customer requests or when there is delinquency that is so severe like for one hundred and fifty days to one hundred and eighty days. If there is less than one hundred and fifty days delinquency on an account it can just accrue fees and interest. (Lee, 1996) This in most cases results in a balance that is more than that on credit limit on the credit card.

This means that the debt can actually exceed the deposit left by the card holder. This is an option for people with poor credit history or those that do not have any credit history at all. This is a venture that helps such individuals to rebuild their credit. These types of cards normally have a logo of MasterCard or Visa on them. The amount of charges for this type of credit cards exceeds that which is charged on ordinary credit cards that are not secured. Research shows that these secured credit cards are less expensive than secured credit cards.

Recommendation

 More research and inventions should be done in line with development of models to easily detect credit card fraud as fast as possible. More research should be done by issuer companies on the use of credit cards with a view to containing cases of theft. This should be done in relation to credit card numbers which criminals use to make purchases. Financial security is anything a customer of a financial institution will get worried of especially with the use of such electronic devices. This will make many people to use credit cards because potential customers actually fear fraud cases with this payment system.

The jargon used by credit card companies need to be simplified so that people can get to understand the terms clearly.  The current rate charged by the financial institutions to have access to a credit card is so high that majority of potential users are locked out. I recommend that policies be put in place to ensure that banks allow low income earners to use it by lowering the costs. Credit card use can be of important use if it made applicable to all types of purchases and transactions which are at the moment not utilizing it.

Banks are currently dealing with the problem of fraud cases through routine checks to detect any fraudulent applications. There is scrutiny of application forms including the handwriting.  There is the scrutiny of account behaviour by banks and this helps determine fraud cases.  Softwares have been installed such as FDS TM which helps in detection of fraud cases on use of credit cards. This involves the scoring function of FDS every day. This occurs after every transaction has been posted.

Conclusion

Electronic commerce has grown very fast since the last decade. Research shows that micro payments have had positive impacts on this growth. Credit cards have proven to be an effective payment system in this sector. This payment system has various advantages in this twenty first century. One of the major advantages of credit cards is its convenience of use comparing with other payment schemes like money order. This payment system eliminates the need to carry around cash which is more risky especially when it is large sums of money.

This also involves protection of purchase unlike when cash is used. Loss protection and travel are part of the many advantages of credit cards. This does not mean that this facility is perfect. Fraud is one of the disadvantages of using credit cards. This includes both the internal and external fraud. Further research and innovations should be carried out by credit card issuing companies such that the issue of fraud cases is contained.

References

1. Abrazhevich, D. (2002): Electronic Payment Systems: Issues of User Acceptance; Working paper
2. Altman, E. (1994): Corporate distress diagnosis comparisons using linear discriminant analysis and neural networks. Journal of Banking and Finance, 18(3), 505–529
3. Bakos, J. (1991): A Strategic Analysis of Electronic Marketplaces; MIS Quarterly; p. 295-310
4. Benjamin, R. (1990): Electronic Data Interchange: How much Competitive Advantage? Longe Range Planning (23); 1, 29-40
5. Bernstein R. (1998): The Future of Money Management in America; Key issues facing the Mutual Fund Industry
6. Carow, K. (1999): Debit, credit, or cash: Survey evidence on gasoline purchases; Journal of Economics and Business, 51, pp. 409-421

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