One of the most common examples of financial crisis is banking crisis. Banking crisis is defined as the situation when the bank is facing bankrupt due to the insufficient of cash flow. Banks usually gain their profit by providing deposit accounts to users, and uses those deposits to provide loans that are paid in a long period of time and gain profit through interest. Try to imagine that if all of the depositors wishes to withdraw their money at the same time, the bank will not be able to return all of the money because part of the money has been used to give out loans or investments. This situation is known as a bank run.
1. The main function of a bank is to take in funds from surplus units, whom are persons that have excess funds (depositors) and lend to deficit units, whom are persons who are in need of funds to finance a need (borrowers).The main reason for a bank to lend is to make a profit. Banks take in deposits and in turn pay interest on these deposits. A bank is unable to pay interest if they do not have a source of income or a way of making a profit. Apart from paying interest, a bank has a demand to staff, shareholders and society.
Therefore some banks are trying to concentrate on their more profitable activities (i.e. advisories, debt and equity sales, mergers and acquisitions). But to be able to extract this sort of business requires banks to engage in loans. Without loans customers have no incentive to do business with them, since one of their primary needs is to finance their commercial activities through debt. Portfolio theory gives these lending institutions a tool to minimize the risks and hazards of lending.
Another option is to allow some of the people who have far overstepped the range of their finances to default on their loans instead of spending even more money trying to bail them out of their loans. The Banking industry must begin to check much more closely into the finances of the people to whom they are considering loaning money. Not everyone is qualified to receive these loans, and they should not be loaned money that they have little chance of repaying. Contrary to the opinions of many politicians, not everyone can own a home. Some people can simply not afford to buy a home, and these people must be screened out during their evaluation to keep the bank from having to foreclose on them in the future.
Small banks placed their excess reserves in large central reserve banks. Whenever a bank’s depositors wanted their funds, the smaller banks would be covered by the central banks. The system worked well during normal conditions. Some banks would draw down on their reserves as other banks would be building up their reserves. In times of excessive demand, however, the problem became quite serious.
• Instrument of Investing Money: The trend to save deposits with banks have been changed as the rates are quite low, so investors are moving towards other options like stock market. But because of inadequate knowledge and complexities of stock markets, investors are not ready to invest in it and hence mutual funds helps investors to understand the market and assures a good return. • Protection to Small Investors: Small investors enjoy the benefit of diversification as Mutual funds help to reduce the risk of investing in stocks by spreading or diversifying investments which assures fixed returns to the investors. • Tax Benefit: As per the existing rules and regulations, investment in mutual funds enjoy wealth tax exemption within the overall limit of Rs. 5 lakhs and no tax shall be charged on gifts of mutual fund units up to Rs.
Such statements help in credit risk control. Diversification is another way of managing credit risk. With diversification, commercial banks can look for 4 different types of borrowers and invest in different businesses. A commercial bank that concentrates on lending heavily to salaried people of a particular company may suffer heavy losses when such a company closes down and all borrowers are unable to pay their loans. With diversification therefore, commercial banks can lend to different people, salaried people, manufacturers, farmers, technology experts, mining industry employees.
A bank on the other hand, has only a limited capacity to do so, and will not do so if it will compromise the profitability of the institution. Greater Likelihood of Loan Approval All of these advantages make it more likely that your loan will be approved at a credit union. Because you are a member – and not just a customer – the credit union will have more incentive to work with you, even if your situation does not easily fit within lending guidelines. For example, credit unions are known to be more flexible in regard to people with credit problems. In banks, it’s all about credit scores, and your loan application will typically be denied if your credit report shows a major credit issue, such as a bankruptcy, foreclosure, or tax lien.
The internal causes that are attributed to an absence or lack thereof of PLS modes of finance are those factors that are within an Islamic financial institution. Whilst many reasons have been cited including a lack of human resources and management issues, it is evident that a recurring them of information asymmetry, would be identified as the optimal cause as to why Islamic banks refrain from using profit and loss sharing contracts as a means of finance. The information asymmetry concern arises when one party in a transaction is ignorant to vital information, which could result in the second party taking advantage of the former parties lack of knowledge. Thus, the presence of such asymmetry results in three usual negative factors, these are; adverse selection, moral hazards, and agency costs. These will be explained further below.
Therefore, the amount of cash the ... ... middle of paper ... .... There are mainly two incentives for the application of ABS transactions by banks. Firstly, banks use credit securitization as an alternative funding mode to emitting deposits.15 The second motive for the application of asset-backed securities is that they enable banks to transfer both market risks and credit risk out of the bank. Blythe Masters, the inventor of credit derivatives states she does believe CDSs have been miscast, much as poor workmen tend to blame their tools. Tools that transfer risk can also increase systemic risk if major counterparties fail to manage their exposures properly.