Some common essential banking terms

banking terms

Since banking is an essential and critical part of our day to day business and personal life, it is helpful for consumer and students of finance to be familiar with some common banking terminology.

Here are 10 essential banking terms one must be familiarized with.

  1. Overdraft: – This occurs when a customer withdraws more money from their bank account than the available balance. It is, thus “over withdraw” which is another form of short term borrowing from the bank. Since it is an unsecured loan, it attracts a handsome fee. You may not need it often if you have some personal savings.
  2. Collateral: – This is a type of tangible assets which is kept with the bank in order to raise a secured loan. The bank has the right to retain this security as long as your loan is outstanding. The bank also has the right to seize and sell this security, after giving due notices to the borrower, in the event he fails to make repayment of the loan along with the interest.
  3. Working Capital cycle: – It explains the mechanism of short term cash flows that occur during the normal operations of a business. This cycle is a circular process which starts from the purchasing of the inventories to the selling of such inventories including the amount receivables and conversion of the receivable to the final proceeds of the inventories.

    When the receivables are paid back, the firm can use the proceeds to either repay the debt or to start the fresh cycle again by purchasing new inventories. It is normally desirable to keep this as short as possible in order to enhance the efficiency of the working capital cycle
  1. Working Capital:- It normally represents the funds required for day to day business operation of the firm. It is also defined as the amount by which the current assets of the firm exceeds its current liability. In other words, it is the money which is required while completing the full working capital cycle.
  2. Warehouse receipt:- It is written documented evidence of goods held in a warehouse operated by a third party. This warehouse may be public, private or other field warehouses. They are also called collateral receipts which may be transferable or negotiable or not negotiable. Negotiable warehouse receipts can be sold to anyone who then owns the goods covered by the receipts.
  3. Money laundering:- This is a process by which the money which is illegally sourced from illegal activities or unaccounted sources is put into an apparent legal business cycle with the purpose of converting it into a legal profit income. Generally, this illegal money comes out from activities like terrorism and drugs/arms trafficking.
  4. Standing instructions:- It is an order given by a person for making a fixed amount of payment from one account to another account or any particular beneficiary on a regular basis. These orders are mainly used to pay rent and salaries or transfer of funds from the main account to an escrow account after reaching a fixed limit.
  5. Available Bank balance: – It is described as the amount of money in your account which is available for immediate use. If there are no uncleared funds or a blocked fund in the account the available balance is equal to book balance.
  6. Book Balance: – It describes the amount of money in the account before making any adjustments for unlearned cheques or ear making or blocking of funds. It is sometimes also called ledger balance.
  7. Variable Interest Rates: – It is the floating rate that fluctuates during the term of the loan, credit or deposit account. Such variations may be due to changes in index rate like prime lending rate or reference rates like LIBOR or SIBOR which are London interbank borrowing rates and Singapore interbank borrowing rate. Such variations occur due to demand and supply mechanism of credit availability in the financial market.
  8. The time or fixed deposits: – This is an agreement through which the money is deposited with Bank for a fixed period of time with a fixed interest rate. This rate of interest is fixed at the time of the deposit which remains the same during the entire period of deposit. The bank can levy a penalty if the fixed deposit is withdrawn before the date of its maturity of the term.
  9. Inoperative account / dormant account: – There are the types of account which remain inoperative for an extended period of time (normally two years). Such non-operations do not include the Bank’s internal transaction like interest and other charges. Generally, if the dormancy of the account is continued for a period of more than 10 years, the amount in the account is classified as an unclaimed deposit.
  10. Debit Card / Credit Cards: – These are the alternate delivery channels of making payment to the customers and to the other beneficiary through their use at different point of sales. The debit card is used to withdraw the available amount in the account whereas credit card is used to draw an additional amount over the available funds in the account up to a certain prefixed limit. Any excess withdrawn after the permitted billing cycle attracts heavy usage charges.
  11. Cost of funds: – The interest paid by the financial institution on the depositors, forms the cost of the fund. It is the most important input cost that generates better returns when such deposits are used for short term and long term lending. The spread between the cost of fund and interest rate charged to the borrowers represent the main source of profit for any financial institution.
  12. Trust Receipts: – It is the notice to release merchandise to a buyer from a bank. However, the bank retains the ownership title to the released goods. In this arrangement, the buyer is allowed to hold the merchandise in trust with the bank and the title remains with the bank till the proportionate part of the debt is settled off. The buyer holds the merchandise for manufacture or sale purpose and is required to remit the ultimate proceeds of the sale of merchandise in proportion to the outstanding debt of the bank.
  13. Cash Reserve: – Bank’s reserves are the deposits which are not lent out to the borrowers. A small fraction of deposits is internally held by the bank and deposited with the Central Bank of the country. This minimum reserve requirement is established by the Central Bank in order to ensure that the financial institutions are able to provide cash to its customer upon their request.

 The cash reserve is held by the Central Bank of the country for the purpose of sustaining the solvency of the financial institutions.

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