FUNDS TRANSFER PRICING
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University Of Johannesburg
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Abstract
Today, many businesses have been profit-oriented. For a company to remain in the market for a long period, it must find ways in which it acquires funds which are in turn used to sustain it. The funds are often used to counter her competitors in various ways such as intense advertisements, giving more offers as well as providing quality and better services to her customers. The banking sector is a major department within the treasury filed have also not been left behind in the business world where stiff competition has become the order of the day. Today in comparison to the last few decades, there are so many banks existing in the market. This has contributed to stiff competition in the market therefore when a bank decides to provide better services to her customers, it benefits a lot and thus is not affected by the competition from other banks. The basic question which everyone ought to ask himself or herself is, how do the banks get funds to finance all those quality services? Such is a basic question which this paper examines closely to determine how banks can use funds transfer to make profits and thus remain profit centers.
Introduction
According to Kawano (2005), "Fund transfer pricing is a way to value the margin contribution from each loan and deposit that a bank has on their books. The way each instrument is valued is by calculating a funds transfer charge on the asset side (loans) and funds transfer credit to the liability side (deposits)".Often, people deposit funds in the bank to gain interest, some people choose to withdraw their finances from the bank due to some reasons and the bank also lends money to some individuals. The main business in the banking sector is money transfer and exchange, as stated out earlier, how banks get profits from this money exchange processes is a broad area of discussion. It is not an easy task for someone to take out his or her own money and use it to provide better services for the bank's customers. It is the role of the bank to use her profits to provide better working conditions for her employees, to improve the services it offers to her customers and more importantly to ensure that it makes a profit. To achieve this, a financial institution must come up with the best ways through which maximum profit can be generated. Cravens (1997) outlines that banks have preferred pooling of funds from different customers or individuals in order to generate a large number of funds, the funds generated are then invested in various ways and different sectors of the economy, the investments are also managed by highly skilled professionals in order to ensure that they yield the maximum amount of profit. This kind of investment has proven to be less risky and it is easier to invest as sufficient funds are coming from different individuals. This paper is, therefore, seeks to examine various ways a banking institution can use to achieve the maximum profit possible as well as to ensure the financial institution remains a profit-generating center.
Increasing interest rates on loans
As stated previously, one of the basic outstanding bank transfer methods is giving loans to customers. When discussing banks giving loans to her customers, it is important to ask, where do banks get all these funds from. Posner (2015) answers the above question in his writing, he says, "Banks get all finances from the depositor's money". Some of the common loans offered by banks include: personal loans where the money acquired by a customer can be used to settle his or her own expenses such as electricity bills, rent and other basic human needs, education loans whereby students are given loans to support them during their studies at higher levels, mortgage loans where a customer may acquire a loan in order to build a home and loans against the insurance schemes. When a customer borrows any of the above-mentioned loans or any other type of loan. He or she is expected to return the borrowed amount after a specified period. In many instances, the specified time depends on the amount of money borrowed and the type of loan. During the return, the customer ought to pay an extra amount which is known as interest. Interest is the fee charged for the borrowed amount, the amount of interest incurred by an individual depends on several variables such as, the interest rate which is often constant depending on the type of loan borrowed, period and the amount of money borrowed.
Different financial institutions have different interest rates, this difference in interest rates combined with other factors such as the quality of service that a bank provides to her customers can either make a given bank to have more customers or less. When a bank chooses to increase her borrowing interest loans it is a good idea to provide better services to her customers such as increasing interests on deposited money. By so doing it will have more funds to lend out thus making more profit. Besides, note that the amount of interest a bank charges on deposited funds is often lower than the amount of money charged on borrowed funds. The difference in interest is what constitutes the profit that a bank acquires from the money transfer. Also, to increase the profit margin, banks encourage the borrowing of funds from various individuals and organizations to pool all those profits together.
Trading securities
Over the last fifteen years, buying and selling of securities have attracted so many investors. Some of the major reason why the trend has risen so fast is, this way of trading involves little risk and it generates a lot of income when it succeeds. Banks wanting to remain profit centers have also indulged in the same money-making business to increase their chances of making more profit and also exploiting different areas within the market. According to Kwan (1998), banks often buy products at the stock market at a lower price, then sell them at a higher price. The difference between the selling price and the buying price which is referred to as the turn becomes the bank's profit. Also, some banks have brokers who link sellers to buyers, in such a scenario, there is some percentage of money that the bank is paid. Putting all these together increase the profits that a bank gains from securities.
Credit cards
This is yet another efficient way through which banks generate a lot of profits and thus making them be profit centers. For the banks to generate more profit, more customers need to be involved so that when all little contributions are combined, the bank gets a substantial amount of profit. Customers using credit cards in their daily transactions are required to repay their balances within a specified time, usually after one month, when a customer fails to clear his or her debt, his account is charged some interest fee. The interest fee is the product of the periodic rate of the card (whereby, periodic rate is the average annual percentage rate divided by 365 days) and the average daily balance and the number of days in the billing period. Apart from that, when a customer shops using a credit card, some percentage of fee goes to the bank where the customer obtained the card from, the percentage of money that goes to the bank is termed as interchange rate. Another way that banks generate income by use of credit cards is, charging the application fee when a customer requests for a credit card. Through this, the profit margin of the bank rises especially when the number of customers using credit cards is high.
Buying and selling of shares
Shares play a major part not only in banks but also in other organization or corporations. To be a member of a given corporation, it is a basic requirement that an individual must have shares in that company. Investors usually buy shares from public companies. Since banks are also public companies and they are widely available, it makes it easy for investors to buy shares from the bank which is usually much cheaper. When banks sell those shares, they gain some money, therefore, the more shares they sell, the more profit the bank generates.
Service charges
In our world today, almost everything has become money-oriented. Each service given to an individual is thus accompanied by some given amount of fees usually called the service fee that one ought to pay. Each day, banks and other institutions receive customers who seek specific services. The banking sector has realized this fact, it came up with strategies to make some profit out of it. Each day, different people go to the bank to either open an account, withdraw money, deposit money or even to process a loan. For those customers to be attended to, there is usually some amount of money that one ought to pay. Ranging from processing fees to loan fees, there exist different kinds of fees which a customer incurs. To the customer's perspective, the fee might seem negligible because it is small, but when all these fees from different customers are consolidated, the bank ends up with a lump sum of money. It is good to note that banks need more money to settle their bills, pay their employees, pay all their expenses and more importantly ensure that they remain profit-centered. Despite the fees that a customer may incur, banks provide personnel whose main role is to provide guidelines and directions to customers on how certain activities should be done such as depositing a large amount of money, opening a bank account, acquiring an ATM card and other basic services. When this is done, it becomes easy for a bank to have more customers thus through the pooling of funds, the profit margin of the bank increases incredibly.
Interbank lending
This is another way through which most banks make money. The banking industry just like any other sector has some policies which provide guidelines and thus making it easier for various banks which may be under different managements to relate well with each other. In many cases, commercial banks are much involved in lending money to their customers. Sometimes, a bank may lend a lot of funds such that there is less amount of money that can support various activities within the bank. In such a scenario, a bank may choose to borrow money from another bank. The money lent attracts some percentage of interest which must be paid upon repayment. When there is a steady flow of funds from the customers into the bank through various ways such as payment of borrowed funds or even through deposits, it makes it possible for a bank to lend money to another bank. However, this kind of lending is usually short-term, sometimes it is just for a day or even for a month. This happens because the borrower bank may not have enough funds to use during its daily transactions or sorting out its bills. So, instead of borrowing from external sources whose interest may be a little bit high, the borrower decides to borrow money from another bank to benefit from low borrowing interest. By so doing, the borrower bank can save more funds which could have negatively affected their balance sheet. Therefore, such kind of money transfer profits both banks since it becomes a source of earning or saving for the two banks.
When a bank has more assets than it requires, there is no need for those assets to remain dormant without generating any form of income for the bank. Through inter-bank lending, the lending bank may decide to put forth her surplus products in the market or even loan the borrower bank those assets so that both the borrower and the lending bank can benefit from the assets. This is, therefore, the best way of the borrower bank turning the liability into profit while at the same time settling the debt incurred after possessing the asset. Turning non-performing asset into a profit-generating asset is another efficient way through which banks make a lot of profit since when a no-performing asset is not sold, it hinders the growth of the company in some way. This, therefore, shows that inter-bank lending is not only about money, but it also covers even other assets and technical skills (Agarwal, Chomsisengphet and Souleles 2018. It is an important practice for the banks as both the borrower bank and the lending bank benefit.
Charges for valuables
Fear is a common trait that all human being possess. Fear of the unknown, especially when they own some valuable commodities such as expensive jewelry, sophisticated documents such as title deeds, and other precious commodities. Sometimes, it is not a good idea to keep all those values within our own houses as they can be stolen, eaten by rodents, accessed by unauthorized individuals or even be destroyed by a natural disaster such as fire outbreak. Such fear thus makes most people seek for an intervention, during such a period of fear, banks come into our rescue. According to Hunt (2018), banks have developed the best ways and strategies of assuring her customers that all his or her valuables are safe and free from being accessed by an unauthorized individual. For one to obtain such kind of service, the bank has defined vaults of various sizes to cater to the needs of all those customers that need such kind of services. Customers are thus charged some amount of fees annually depending on their valuables. The fee paid by the customer is used for maintenance and monthly rental return. Usually, banks don't require too much manpower to maintain a given value and thus the bank saves money which could have been spent in such areas. Often, customers who have allowed the bank to keep for them their valuable are happy since they do not need to fear about the safety of their documents and jewels anymore. Fortunately, on the other hand, banks use this as an opportunity to increase her profit and thus enable it to remain as a profit center.
Auctioning Assets
When an individual or a company applies for a loan from a bank, there is usually a specific asset which is placed to the hands of the bank as a security. This means, if the borrower fails to repay the loan, the bank takes full control of that given asset, the bank has all rights even of selling the asset to get her loan back. Some of the securities that people place in the bank to borrow a loan may include: car, a title deed, or even precious jewelry and usually, the value of the security asset is higher than the loan being applied for.
Sometimes, the borrower may fail to repay his or her loan within a specified period. The bank thus impounds on the asset given to it as the security and advertises it. Since the bank takes care of the collateral such that it has no damage, the bank can auction the product and in so doing recover the amount of money that had been previously borrowed. This also enables the bank to dispense the security asset and thus enabling it from incurring overhead costs for maintenance of the collateral (Dermine 2013). Sometime, the asset may be sold at a higher price than the defaulted loan, therefore, the extra amount of money becomes a profit to the bank.
Increase the customer base
The banking sector just like any other industry requires customers to run its daily activities. It is the customers who deposit funds which are in turn used by the bank to lend out to her borrowers, also the customers are the ones who borrow funds through which a bank gains interest charged on borrowed funds. Customers, therefore, play an important role in ensuring that the bank is stable, it has enough funds and it makes profits. The increase in the number of banks has led to an increase in competition in the banking sector. Each bank is devising new ways of attracting more customers and since the number of customers is relatively constant, only the bank with the best strategies can outcompete others. For a bank to make more profit, the number of customers transacting using that bank must be high. This is because when the number of customers is high, it is possible to pool together resources and make more profit. Therefore, it is beyond doubt that the amount of money a bank makes is directly proportional to the number of customers that the bank attracts.
Providing financial advice
Before an individual or a company starts up a business or any kind of investment. It has always been a good idea to seek advice from institutions that have been in the investment industry for long such as banks. Some of the basic areas which one must inquire before starting up a business are about finance. This means, how to use the limited amount of available resources to generate more income as well as manage well the generated income. Fortunately, most banks and other treasury sectors have such departments which provide financial advice to new and experienced investors. The writing of Liu, Sun, Wu (2019) outlines that, "For individuals to get such advice, they are usually required to pay some fees which are in turn saved as profits gained by banks or any other treasury department". Financial advice is also applicable to companies which are seeking to explore markets for a follow-on public offering. In such a case, the bank plays an important role in giving advice to such companies in terms of the rate at which such at which such an issue should be priced in order for the company to earn the maximum possible profit, the bank also advises such companies on the number of shares the company should be issued and other important advisory services. Just as stated previously, for the bank to provide such kind of financial advice to individuals or companies there has to be a fee which is payable directly to the bank. If the bank attracts more individuals seeking financial advice and each individual or company pays some small amount of fees, the bank generates more profits when all these fees are consolidated together (Gerding 2015).
Investing in real estate
Over the last few decades, investment in real estates has attracted not only many organizations but also more investors. There are so many reasons why this trend has risen so high over the last few years but one of the main reason is, when an individual or a company successfully invests in a real estate, the value of the asset increases rapidly over a short period. This fact, therefore, assures the investors of more profit over a short period. According to Zhang et al. (2018 pg. 1333), real estate investment may include buying of lands, the building of modern buildings which can be rent out to tenants as homes, commercial buildings which can be purchased by companies or individuals for use in business and apartment buildings. Banks, therefore, may decide to purchase land cheaply and then sell it to the public or the government at a higher price thus making it generate more profit. Some banks also build commercial buildings and sell them to individuals willing to carry out business thus enabling the bank to make more money within a short period. Also, banks offer loans to her customers who would like to invest in real estate and then the bank become a shareholder in the investment real estate. Such are ways that banks generate more money making them remain profit-centered.
Revenue from insurance
One of the outstanding treasury department which generate more income other than the bank is an insurance company. Many scholars have argued that there is a minor difference between insurance companies and banks. However, in this study, the banking sector and the treasury department dealing in insurance will be judged differently. Insurance is all about sharing of risk. Insurance is contract-based and it happens where the insured and the insurer agrees to share the risk, whereby should the insured suffer a loss for a property that was insured from unforeseen and financially devastating event, he or she does not lose the property completely. The insurer compensates for the loss thus making the insured incurs no loss. As stated earlier, insurance is contract-based, therefore there are certain guidelines or predefined conditions which guide the operation of all activities within the insurance company. These principles assure both the insurer and the insured of being beneficiaries from the contract. The contract defines clearly that when an individual would like to be insured by an insurance company he or she must suffer a significant amount of loss for the property insured, in many cases, the amount of money paid to the insurance company is done on monthly basis and is referred to as the premium. The amount of premium paid by an insured dependent on the value of the property that is being insured and the kind of unforeseen risk that is being insured against.
When the devastating catastrophe occurs, the insurance company chirps in to cater for the losses incurred. However, there are five principles which guide how compensation should be done. Such principles include the principle of utmost good faith whereby the insured need to honestly provide correct information about the property being insured. Secondly, the principle of insurable interest whereby, for an individual to get compensated for the loss, he or she must have the insurable interest in the object of insurance. Thirdly, the principle of indemnity which states clearly that the main role of the insurance company is to compensate for the loss of the risk insured, it is not to benefit the insured in any way. Principle of contribution which states that if someone had insured his or her product in more than one insurance company, then during the occurrence of the risk, all the insurance companies must contribute to compensate for the loss. Principle of subrogation which states that when the insurer compensates for a given property, the ownership of any scrap changes to the insurer. Lastly, the principle of the nearest cause clearly defines which kind of losses can be compensated depending on the risk insured. It states that for compensation to take place, the loss must have been closely related to the risk insured against. Otherwise, the insured is required to pay an extra amount of money to benefit from compensation (Mishra& Mishra 2016).
The basic question is, how these insurance companies make profits. Many are times when the risks insured against do not even occur. When such is the case, then there is no way that the insured can claim back his or her money, all those premiums paid by insured becomes the profit of the company. Moore et al. (2018) outline that in some cases, the amount of premiums paid is higher than the risks the company is legible to compensate. The difference in the amount of premium paid to the company and the amount of money paid out to cater for the losses becomes a profit to the insurance company. Lastly, according to the principle of subrogation, any scrap is owned by the insurance company after the loss has been settled. When all these scraps are sold, they generate a higher income to the insurance company.
