Retail Banking

L1 Course in Retail Banking
Banking
Version : 1.0
Date : 27-Jul-2004
Foundation Course in Banking
TABLE OF CONTENTS
Introduction to Retail Banking..........................................................................5

Retail Products and Instruments......................................................................7
Deposits and Accounts ...................................................................................10
Bank Accounts..........................................................................................................10
Type of Accounts......................................................................................................11
Product Differentiators..............................................................................................16
Account Processing..................................................................................................18
Credit Cards.......................................................................................................29
Credit Cards – Basic Concepts.................................................................................29
Credit Cards – Processes ........................................................................................31
Credit Cards - Sources of Revenue..........................................................................33
Loans Overview................................................................................................34
Key Players..............................................................................................................35
Generic Loan Process..............................................................................................36
Mortgages..........................................................................................................39
Mortgage products....................................................................................................40
Key mortgage concepts............................................................................................45
Mortgage Market.......................................................................................................48
Mortgage processes.................................................................................................54
Regulations governing the mortgage industry...........................................................63
Market Landscape & Trends.....................................................................................65
Auto Loans........................................................................................................69
Types of Financing options.......................................................................................69
Players Involved.......................................................................................................77
Key Concepts...........................................................................................................77
Auto Loan Process...................................................................................................79
Auto Leases..............................................................................................................83
IT Applications in Auto Loans ..................................................................................91
Regulations governing the Auto Loan Industry.........................................................95
Student Loans...................................................................................................97
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Types of Student Loans............................................................................................98

key Players.............................................................................................................108
Key Concepts.........................................................................................................109
Loan Process..........................................................................................................111
Secondary Market...................................................................................................114
IT Applications in Student Loans.............................................................................116
Regulations governing Student Loans....................................................................116
Agricultural Loans..........................................................................................118
Types of Loans.......................................................................................................118
Major Players Involved............................................................................................118
Process...................................................................................................................120
Secondary Market...................................................................................................122
Recent Trends........................................................................................................123
Technologies in Agricultural Loans.........................................................................123
Regulations Governing Agricultural Loans..............................................................124
Retail Banking Channels................................................................................126
Branch Banking......................................................................................................127
ATM Banking..........................................................................................................131
Internet Banking......................................................................................................133
Telephone / Mobile Banking...................................................................................135
Fee based Services.........................................................................................136
Collection Services.................................................................................................136
Payment Services...................................................................................................138
Investment Advisory Services.................................................................................140
Wires / Fund Transfer Services...............................................................................142
Other Services........................................................................................................143
Regulatory Requirements..............................................................................146
Truth in Lending Act (TILA).....................................................................................146
Fair Credit Reporting Act (FCRA)...........................................................................149
Equal Credit Opportunity Act (ECOA).....................................................................152
Check clearing for the 21st century act (check21 act).............................................154
Trends in retail Banking.................................................................................157
Multi Channel Integration........................................................................................159
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Bancassurance.......................................................................................................161
Market Landscape...........................................................................................163
Key Players............................................................................................................163
Key Retail Banking corporations in the US.............................................................164
Mergers & Acquisitions in Retail Banking................................................................165
Appendix – A Consumer Credit Rating Agencies ......................................167
Appendix – B Mortgage Backed Securities.................................................168
Appendix – C Costs associated with Mortgages........................................172
Appendix – D Securitization of Auto Loans.................................................177
Appendix – E Securitization of Auto loan backed securities.....................179
Securitization of Auto Lease Backed Securities......................................................180
Appendix – F Differences between Leasing and Financing.......................182
Appendix – G Student-loan ABS Structure..................................................186
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INTRODUCTION TO RETAIL BANKING

Retail banking is typical mass-market banking where individual customers use local
branches of larger commercial banks. Services offered include: savings and checking
accounts, mortgages, personal loans, debit cards, credit cards, and so forth.
Retail banking can also be divided into various deposit products—including checking,
savings, and time-deposit accounts such as certificates of deposit—as well as various
asset-based products, such as auto lending, credit cards, mortgages, and home equity
loans. Big banks are likely to be in all of these businesses, and smaller ones mainly
focus on deposit gathering while offering mortgages and home equity loans.
Industry experts estimate that there are about $5 trillion in deposits in the U.S. market.
Since there is no credit risk associated with taking in deposits, banks need less capital to
run this business than, say, mortgage lending. The proper amount of capital required,
according to one of the estimates is about 1%, which translates to about $50 billion for
the industry. The return on this relatively small investment, meanwhile, is 35% to 50%, or
a minimum of $18 billion for the industry, making it a very profitable business.
In contrast, the total outstanding balances in the credit card industry amount to about $1
trillion. Since this business is riskier, it requires more capital to run, and the resulting
profits are about $12 billion to $13 billion for the industry.
However, there is a reason why credit card lending appears to be more of a

moneymaker than deposit gathering. The business is concentrated among the biggest
banks: The top 10 lenders hold 85% of the credit card balances. The business of deposit
gathering, meanwhile, is split up among a large number of banks. The numbers indicate
there is ample opportunity to generate significant profits simply by gathering deposits—
but it also means facing a lot of competition.
While investment banking and commercial lending are related to high value deals, retail
banking is less glamorous and is associated with low value transactions - the sums of
money involved in any one transaction are likely to be in the hundreds—not tens of
thousands, or millions—of dollars.
For years, retail banking has been viewed as a commodity business. Interest rates paid
on deposits often differ so little from bank to bank that they are almost meaningless to
consumers. Also, aside from signage, most bank branches tended to look alike, with
their teller windows on one-side and platform desks on the other.
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In the past couple of years, however, bank managers have been opening their eyes to
greater possibilities in retail banking. A few factors have played into this new attitude.
One is the huge hit to investment banking and trading that many banks took at the end
of the dot-com boom. New York-based J.P. Morgan Chase & Co. is a prime example of
an institution trying to decrease its reliance on investment and trading income by
expanding into retail banking. Towards this, it also acquired Chicago-based Bank One
Corp., a retail banking stalwart in the Midwest in 2004.
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RETAIL PRODUCTS AND INSTRUMENTS

Banks offer lots of financial products for their depositors. The checking account is one of
the most common ones. It's USP is convenience as it lets people buy things without
having to worry about carrying the cash -- or using a credit card and paying its interest.
While most checking accounts do not pay interest, some do -- these are referred to as
negotiable order of withdrawal (NOW) accounts.
Aside from checking accounts, banks offer loans, certificates of deposits and money
market accounts, not to mention traditional savings accounts. Some also allow people to
set up individual retirement accounts (IRAs) and other retirement or education savings
accounts. There are, of course, other types of accounts being offered at banks across
the country, but these are the most common ones.
Savings accounts - The most common type of account, usually require either a low
minimum balance or have no minimum balance requirement, and allow people to keep
their money in a safe place while it earns a small amount of interest each month. In
standard practice, there are no restrictions on when the money can be withdrawn.
Money market accounts - A money market account (MMA) is an interest-earning

savings account with limited transaction privileges. The account holder is usually limited
to six transfers or withdrawals per month, with no more than three transactions as
checks written against the account. The interest rate paid on a money market account is
usually higher than that of a regular passbook savings rate. Money market accounts also
have a minimum balance requirement.
Certificates of deposit - These are accounts that allow depositors to put in a specific
amount of money for a specific period of time. In exchange for a higher interest rate, the
depositor forgoes the option of withdrawing the money for the duration of the fixed time
period. The interest rate changes based on the length of time the depositor decides to
leave the money in the account. One cannot write checks on certificates of deposit. This
arrangement not only gives the bank money they can use for other purposes, but it also
lets them know exactly how long they can use that money.
Individual retirement accounts and education savings accounts - These types of

accounts require the account holders to keep their money in the bank until they reach a
certain age or their child enters college. There can be penalties with these types of
accounts, however, if the money is used for something other than education, or if the
money is withdrawn prior to retirement age
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Apart from the various schemes like these to raise money, banks provide various kinds
of credit products to the individuals. Credit products include loans for house financing,
auto purchases as well as credit cards.
The key types of credit cards include Bank cards, which are issued by banks (for
example, Visa, MasterCard and Discover Card). These can either be debit or credit
cards. In a credit card, the user has a limit up to which she can make purchases (or
borrow) and the bank charges an interest on the used up sum. A debit card is used for
making payments against existing balance in the users checking account.
There are also the “Travel and entertainment (T&E) cards”, such as those issued by
American Express and Diners Club.
Loans – one of the key retail products from banks are loans made to the individuals.
There are for various purposes including mortgages for real estate activity, auto finance
for purchase of cars and automobiles, student loans to meet education expenses, and
agricultural loans. Each of these loans are for a specific requirement and their
repayment terms and criteria to provide the loans vary accordingly.
Mortgages – Mortgages are loans given to individuals for the purchase, construction, or
repair real estate property. Typically, the property is used up as an collateral.
Auto Loans – These are loans given to individuals for the purchase of cars or
automobiles. They are given against the security of the vehicle or in some cases with the
homes as a security.
Student Loans – These are loans provided to students who are pursuing undergraduate
or graduate courses. A majority of them are made available at subsidized interest rates
due to the insurance provided by the US Government to the lending banks.
Agricultural Loans – Agricultural Loans are the loans granted to finance the agricultural
industry. These are loans given to individuals towards acquisition of work animals, farm
equipment and machinery, farm inputs (i.e., seeds, fertilizer, feeds), poultry, livestock
and similar items. It also includes construction and/or acquisition of facilities for
production, processing, storage and marketing; and efficient and effective merchandising
of agricultural commodities.
Fee based Services – Banks also provide various fee based services to the customers.
These usually involve managing the payments that need to be made or to be collected.
They also provide advisory services to help consumers manage their investments and
meet the investment goals. Although most of these services are related to Payments
they can broadly be categorized under the broad headings of Collections Services,
Payment Services, Investment Advisory Services, and Fund Transfer Services.
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DEPOSITS AND ACCOUNTS

Banks provide various kinds of deposits and accounts to the public and use this as the
main source for raising capital. Nearly everyone needs an account to help him or her
manage his or her day-to-day money.
BANK ACCOUNTS
It is possible to manage money using just cash, but putting money in a bank account can
have several advantages as described below
• A bank account enables one to access her money quickly and easily, such as by
writing checks and by withdrawing money from an ATM
• A bank is the safest place to put money, because funds in U.S. bank accounts
are insured against loss by the federal government for up to $100,000 per
depositor
• Some accounts pay interest on the money deposited in them even though the
interest rates may be low
• Most of these bank accounts are "free" accounts if the customer maintains a
substantial balance
Where to Bank
Credit unions, savings and loans, mutual funds, and brokerages offer checking and
savings services similar to what banks offer. Before we discuss banks in more detail,
here is a brief discussion of these other options:
Credit Unions
Credit unions are non-profit, member-owned, financial cooperatives. They are operated
entirely by and for their members. When a customer deposits money in a credit union,
she becomes a member of the union because her deposit is considered partial
ownership to the credit union. To join a credit union, a customer ordinarily must belong
to a participating organization, such as a college alumni association or labor union.
While the accounts are similar to bank accounts, the names are different: share draft
accounts (like checking accounts), share accounts (like savings accounts), and share
certificate accounts (like certificate of deposit accounts). For nearly all credit unions, the
National Credit Union Share Insurance Fund insures most of the deposits up to
$100,000. Interest rates tend to be higher and fees tend to be lower than at commercial
banks, because they exist to serve their member-owners rather than to maximize profits.
On the downside, credit unions usually have very few branch offices and ATMs.
However, to compensate for this, in most states credit unions have formed surcharge-
free ATM networks among themselves.
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Brokerage
Another substitute for a bank account is a cash-management account at a brokerage. A
customer will earn money-market rates, which will usually be significantly higher than the
interest the bank would pay. The fees will generally be less than what the bank would
charge, and the fees might be waived entirely if the customer has a substantial portfolio
at the brokerage. If the customer overdraws her account, the interest rate will be lower
than what the bank would charge, and in addition it's usually tax-deductible because it's
considered margin interest. The customer will be able to perform all the basic banking
functions, such as check writing and using a Visa debit card at any ATM. However, there
are a few downsides. Very few brokerages have ATM networks, so when the customer
uses an ATM she will be charged by that ATM's owner and possibly also by the
brokerage's bank partner (if the brokerage itself isn't a bank). Also, as with credit unions,
brokerages lack some of the bells and whistles that commercial banks offer. Some
brokerages don't allow the customer to drop by a branch to deposit checks, some don't
offer automatic bill paying, and some don't accept checks written to the customer from
someone else.
Mutual Fund
A final banking alternative is a money market account at a mutual fund company. They
offer basic features such as check writing, but lack a lot of the other services banks offer.
The rates tend to be significantly higher than those offered by banks. However, the
accounts aren't FDIC insured against losses.
Banks
Although banks offer a wide variety of accounts, they can be broadly divided into the
following categories:
• Savings accounts
• Checking accounts
• Money market deposit accounts, and
• Certificates of deposit accounts
All these type of accounts are insured by the FDIC (in most cases, up to $100,000 per
account).
TYPE OF ACCOUNTS
In this Section we list down the common types of accounts offered by Commercial Banks
followed by a brief description of each type of account:
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Savings Accounts
The most common type of bank account, and probably the first account a person ever
has, is a savings account. These are intended to provide an incentive for the customer to
save money. These accounts usually require either a low minimum balance or may
require no minimum balance at all. This depends on the bank and the type of account.
Savings accounts allow the customer to keep her money in a safe place while it earns a
small amount of interest each month. They usually pay an interest rate that's higher than
a checking account, but lower than a money market account or a CD (Certificate of
Deposit). The accountholder can make deposits and withdrawals, but usually can't write
checks. Some savings accounts have a passbook, in which transactions are logged in a
small booklet that the customer keeps, while others have a monthly or quarterly
statement detailing the transactions. Some savings accounts charge a fee if the
customer’s balance falls below a specified minimum.
Besides the fact that the customer will be less likely to spend it, putting her money in a
savings account is safer because it is insured (up to $100,000) through the Federal
Deposit Insurance Corporation (FDIC). This means that even if the bank or credit union
goes out of business (which is very rare!) the customer’s money will still be there. The
FDIC is an independent agency of the federal government that was created in 1933
because thousands of banks had failed in the 1920s and early 1930s. Not a single
person has lost money in a bank or credit union that was insured by the FDIC since it
was constituted.
Interest on savings accounts is usually compounded daily and paid monthly. Sometimes,
but not always, banks charge fees for having a savings account. The fee may be low --
like a dollar a month -- or it may be higher or it could even be based on the customer’s
balance. Some of the characteristics of a savings account include:
• Fees and services charges on the account
• Minimum balance requirements (Some banks charge a fee only if the customer
doesn't keep a certain amount of money in her account at all times.)
• Interest rate paid on the balance
Each month, the bank (or credit union) sends the customer a statement of her account
either in the mail or by e-mail depending on her preferences. The statement will list all
the transactions as well as any fees charged to the account and interest that the money
deposited in the account has earned.
Checking Accounts
A checking account is the primary reason why many people use a bank. Probably no
other account offered has as many variables as a checking account.
With a checking account the customer can use checks to withdraw her money from the
account. She may use checks to pay bills, purchase products and services (at
businesses that accept personal checks), send money to friends and family, and many
other common uses. The customer can also use checks to transfer money into accounts
at other financial institutions. The customer has quick, convenient, and, if needed,
frequent-access to her money. Typically, the customer can make deposits into the
account as often as she may choose. Many institutions enable the customer to withdraw
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or deposit funds at an automated teller machine (ATM) or to pay for purchases at stores
with her ATM card.
Some checking accounts pay interest; others do not. A regular checking account -
frequently called a demand deposit account - does not pay interest, whereas a
negotiable order of withdrawal (NOW) account does.
Institutions may impose fees on checking accounts, besides a charge for the checks the
customer orders. Fees vary among institutions. Some institutions charge a maintenance
or flat monthly fee regardless of the balance in the account. Other institutions charge a
monthly fee if the minimum balance in the account drops below a certain amount any
day during the month or if the average balance for the month drops below the specified
amount. Some charge a fee for every transaction, such as for each check the customer
writes or for each withdrawal made at an ATM. Many institutions impose a combination
of these fees.
Although a checking account that pays interest may appear more attractive than one that
does not, often checking accounts that pay interest charge higher fees than do regular
checking accounts.
The various kinds of Checking Accounts offered by Banks are:

Basic Checking Account - Sometimes also called "no frills" accounts, these offer a
limited set of services at a low cost. The customer will be able to perform basic
functions, such as check writing, but they lack some of the bells and whistles of more
comprehensive accounts. They usually do not pay interest, and they may restrict or
impose additional fees for excessive activity, such as writing more than a certain number
of checks per month. This account is for the customer who uses a checking account for
little more than bill-paying and daily expenses, and does not maintain a high balance.
Some basic accounts require direct deposit or a low minimum balance to avoid fees.
Interest-Bearing Checking Accounts - In contrast to "no frills" accounts, these offer a

more comprehensive set of services, but usually at a higher cost. Also, unlike a basic
checking account, the customer is usually able to write an unlimited number of checks.
Checking accounts, which pay interest, are sometimes referred to as negotiable order of
withdrawal (NOW) accounts. The interest rate often depends on how large the balance
in the account is, and most charge a monthly service fee if the balance falls below a
preset level. This account usually requires a minimum balance to open, with an even
higher balance to maintain in order to avoid fees. For example, a bank may require just
$100 to open an account, but will charge $22 in service fees each month if the customer
does not maintain a $10,000 balance. With some accounts, the higher the customer’s
balance, the more interest is earned. Interest is paid monthly, at the conclusion of the
statement cycle.
Joint checking -- An account owned by two or more people, usually sharing a

household and expenses. Each co-owner has equal access to the account. Most types
of accounts, whether it's basic checking, savings or money market, allow for joint use.
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Express -- Designed for people who prefer to bank by ATM, telephone or personal
computer, this account usually boasts unlimited check writing, low minimum balance
requirements, and low or no monthly fees. The catch? The customer pays fees for using
a teller. These accounts are especially popular with students and younger customers
who are on the go and don't want to spend a lot of time on banking transactions.
Lifeline -- These "no-frills" accounts for low-income consumers are typically products
with monthly fees ranging from zero to $6; require a low, if any, minimum deposit and
balance; and allot a certain number of checks per month. Many banks, thrifts and credit
unions offer such accounts. Lifeline accounts are required by law in Illinois,
Massachusetts, Minnesota, New Jersey, New York, Rhode Island and Vermont. In those
states, minimum terms, fees and conditions are set by law, not by individual banks.
Senior/student checking -- Many institutions offer special checking deals if the

customer is a student or age 55 or over. The perks vary from bank to bank, but may
include freebies on checks, cashiers and traveler's checks, ATM use, better rates on
loans and credit cards, or discounts on everything from travel to prescriptions.
A typical Checking account provides some or all of the following features

• Online Banking
• Online Bill Payment
• Direct Deposits
• ATM Banking
• Telephone Banking
• Electronic Statements
• Cash Reserves – Credit Line / Overdraft protection
Money Market Deposit Accounts (MMDAs)

A money market account is a type of savings account offered by banks and credit unions
just like regular savings accounts. These accounts invest the balance in short-term debt
such as commercial paper, Treasury Bills, or CDs. The rates they offer tend to be slightly
higher than those on interest-bearing checking accounts, but they usually require a
higher minimum balance to start earning interest. These accounts provide only limited
check writing privileges (three transfers by check, and six total transfers, per month), and
often impose a service fee if the balance falls below a certain level. Another difference is
that, similar to a checking account, many money market accounts will let the
accountholder write up to three checks each month. Like other bank accounts, the
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Federal Deposit Insurance Corporation (FDIC) insures the money in a money market
account.
Interest on money market accounts is usually compounded daily and paid monthly.
Interest rates paid by money market accounts can vary quite a bit from bank to bank.
That's because some banks are trying harder to get people to open an account with
them than others -- so they offer higher rates. Another difference that is sometimes
found with money market accounts is that the more money a customer has in the
account the higher the interest rate she gets.
Like a basic savings account, money market accounts let the customer withdraw her
money whenever required. However, the customer usually is limited to a certain number
of withdrawals each month. Banks will usually charge a fee (typically around $5) if the
customer doesn’t maintain a certain balance in her money market account. There may
also be a fee (typically around $5-10) for every withdrawal in excess of the maximum
(usually six) the bank allows each month.
Certificates of Deposit Accounts (CDs)

These are also known as "time deposits", because the customer has agreed to keep the
money in the account for a specified amount of time, anywhere from three months to six
years. Because the money will be inaccessible, the customer is rewarded with a higher
interest rate, with the rate increasing as the duration increases. There is a substantial
penalty for early withdrawal, so this type of account is generally not used if the customer
thinks that she might need the money before the time period is over (the "maturity date").
Time deposits are often called certificates of deposits, or CDs. They usually offer a
guaranteed rate of interest for a specified term, such as one year. Institutions offer CDs
that allow you to choose the length of time, or term, that your money is on deposit.
Terms can range from several days to several years. Once a customer has chosen the
term she wants, the institution will generally require that she keeps her money in the
account until the term ends, that is, until "maturity". Some institutions will allow the
customer to withdraw the interest earned even though she may not be permitted to take
out any of your initial deposit (the principal).
Because the customer agrees to leave her funds for a specified period, the institution
may pay a higher rate of interest than it would for a savings or other account. Typically,
the longer the term, the higher the annual percentage yield.
Sometimes an institution allows the customer to withdraw her principal funds before
maturity, but a penalty is frequently charged. Penalties vary among institutions, and they
can be hefty. The penalty could be greater than the amount of interest earned, so the
customers could lose some of her principal deposit as well.
Institutions will notify the customer before the maturity date for most CDs. Often CDs
renew automatically. Therefore, if the customer does not notify the institution at maturity
that she wishes to take out her money, the CD will roll over, or continue, for another
term.
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PRODUCT DIFFERENTIATORS
A list of features and services associated with a bank account are provided below:
Features
Interest Rate: If the account pays interest, what is the rate currently? Usually Banks
signify this in terms of "Annual Percentage Yield", which makes it easier to compare
banks that compound their interest at different frequencies.
Convenience: How close is the nearest branch? How long are the lines when you go?
Is the bank open when you need them, or do they open late and close early as many
banks do?
FDIC membership: Is the Bank a member of the Federal Deposit Insurance
Corporation? If so, all deposits will be insured up to $100,000.
Size: Is the bank large or small? Some people feel more comfortable with a larger bank,
while others believe small banks can offer better customer service.
Minimum deposit: What is the minimum deposit required to open an account (if any)?
Limitations: Are there any limitations imposed on the account? (For example, the
number of checks or transactions per month)
Availability of Funds: How soon after you make a deposit are you able to withdraw
against those funds? Different banks have different rules.
Services
• Direct deposit
• ATMs
• Banking by telephone
• Online banking
• Credit cards
• Debit cards
• Overdraft protection
• Canceled checks
• Loans and mortgages
• Stock and mutual fund trading
• Retirement planning services
• Small business services
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• Access to international money markets

• Copies of previous monthly statements
• Deposit slips and other slips
• Phone support
• Talking to a teller in person
• Debit card fees
• Traveler's checks
• Loan application processing
• Safe deposit box rental
• Stop payment
• Wire transfer
Fees
Banking fees have risen significantly in recent years. The average price of maintaining a
bank checking account is currently about $200 a year. Here are the most common fees
that are charged for maintaining & running a Bank account.
Maintenance fees: Banks charge a small fee for providing the customer with their
service. The fee for a checking account might be waived, if the customer uses direct
deposit for her paychecks, if she is a shareholder of the bank or if she limits her bank
branch visits and/or transactions.
Low-balance penalty: Most big banks offer "free" checking if the customer maintains a
substantial balance, typically $2,000 to $4,000. There is a low-balance penalty in case
the the balance goes below the required amount. The calculation could be based on the
average daily balance, the lowest balance in the month, or the balance on a certain day
of the month, so that she can work the system to her advantage. Sometimes, if the
customer buys CDs from the bank (which yield higher rates than the checking account
does), the bank might include that amount in its minimum balance requirement.
ATM surcharges, "Foreign" ATM fees: Many of the Banks charge the customer for
ATM usage. Also, the customer can use ATMs of other banks at an additional fee from
the Bank that owns the ATM.
Returned check: Banks charge a penalty to customers who deposit bad checks.
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Bounced check: Banks charge an insufficient funds fee (NSF) if the customer doesn’t
have enough funds in her account to cover the checks she has written. To help
customers avoid this fee, banks also provide overdraft protection (described below).
Overdraft Protection: Banks can provide overdraft protection to a customer’s account.
This is done by charging a high rate of interest on the overdrawn money. This is
beneficial to the customers in the cases of a check bounce as well as in cases when the
account balance goes below zero or the low-balance limit.
Check printing: Some banks offer free checks for first-time customer, customer with a
large minimum balance, senior citizens, students, and certain others. Other Banks
charge for providing check leaves.
Per-check charges: Some accounts include a certain number of checks per month and
charge extra for more.
Cancelled check return fees: If the bank doesn't include cancelled checks along with
the monthly statement, they may charge a fee for any cancelled checks a customer
requests.
Closed account: Some banks charge a fee if the customer closes an account that
hasn't been open for a sufficiently long time (such as one year).
ACCOUNT PROCESSING
Account Opening Process

The following diagram depicts a typical Account Opening process with a Bank.
S te p 1 Cu stom e r co m e s to B ra nch Re p
Cu stom e r
S TART fo r a /c O pe n ing
C us to mer De t ail s A c c oun t A TM C a rd C ro ss A cc ount O pe ning

–St ep 2 D e t ail s – P ro ce s sin g S el lin g – C on firma t io n–
Step 3 – S te p 4 S te p 5 S te p 6
G a the r Cu stom e r Colle ct Initia l ATM Ca rd V e rify Applica tion / S ig na ture

De ta ils De po sit De ta ils Issua nce e ligibility for Ca rd P rinting
Cro ss se llin g
S e nd Inform a tio n to
Bra nch Fra u d De te ction (S S N, Colle ct Che ck
Ce ntra l Re po sito ry
Addre ss V e rifica tion ) O rde r De ta ils
EN D
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Ex te rna l
S yste m s S S N a nd Addre ss Che ck Orde ring
V e rifica tion S yste m S yste m
Account Management
Transaction Processing - Tellers

The teller is the person most people associate with a bank. Tellers make up
approximately one-fourth of bank employees and conduct most of a bank’s routine
transactions.
Among the responsibilities of tellers are
• Cashing checks
• Accepting deposits and loan payments
• Processing withdrawals
They also may sell savings bonds, accept payment for customers’ utility bills and charge
cards, process necessary paperwork for certificates of deposit, and sell travelers’
checks. Some tellers specialize in handling foreign currencies or commercial or business
accounts.
Before cashing a check, a teller must verify the date, the name of the bank, the identity
of the person who is to receive payment, and the legality of the document. A teller also
must make sure that the written and numerical amounts agree and that the account has
sufficient funds to cover the check. When accepting a deposit, tellers must check the
accuracy of the deposit slip before processing the transaction.
Prior to starting their shifts, tellers receive and count an amount of working cash for their
drawers. A supervisor—usually the head teller—verifies this amount. Tellers use this
cash for payments during the day and are responsible for its safe and accurate handling.
Before leaving, tellers count their cash on hand, list the currency-received tickets on a
balance sheet, and make sure that the accounts balance, and sort checks and deposit
slips.
In most banks, head tellers are responsible for the teller line. They set work schedules,
ensure that the proper procedures are adhered to, and act as a mentor to less
experienced tellers. In addition, head tellers may perform the typical duties of a teller, as
needed, and may deal with the more difficult customer problems. They may access the
vault, ensure that the correct cash balance is in the vault, and oversee large cash
transactions. Technology continues to play a large role in the job duties of all tellers. In
most banks, for example, tellers use computer terminals to record deposits and
withdrawals. These terminals often give tellers quick access to detailed information on
customer accounts. As banks begin to offer more and increasingly complex financial
services, tellers are being trained to identify sales opportunities. This task requires them
to learn about the various financial products and services the bank offers so that they
can briefly explain them to customers and refer interested customers to appropriate
specialized sales personnel.
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Transaction Pro
Customer
Check Processing & Collection

Checks are written orders the Bank customers use to tell the bank or other depository
institution to pay money or to transfer funds from his account to the check holder. The
check collection system in the United States is efficient, but the collection process a
check goes through may be rather complicated.
Funds on local checks must be made available within two business days according to
the Expedited Funds Availability Act of 1987. Non-local checks must be made available
within five business days. Certain circumstances permit longer holds due to the high risk
of fraud, such as new accounts, deposits over $5,000, repeatedly overdrawn accounts
and/or emergencies.
A check written on a particular bank and cashed by or deposited into the same bank
would be handled and processed within that bank. Checks of this type—called “on-us”
checks—account for nearly one-third of all checks. The remaining two-thirds are known
as “transit checks” because they must move between different banks, sometimes
passing through several in different parts of the country.
A check includes the names of the payer and the payee, the account number, amount of
the check, and the name of the paying financial institution. The MICR line at the bottom
of the check enables high-speed reader/sorter equipment to process checks. Before
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financial institutions process checks, they encode the amount of the check in magnetic
ink at the bottom of the check.
Check Clearing
Check Clearing refers to the movement of a check from the depository institution at
which it was deposited back to the institution on which it was written and the
corresponding movement of funds in the opposite direction.
Banks in large cities often form associations called clearinghouses for exchanging
checks drawn against the members. A clearinghouse may have fewer than a dozen
members, but these banks are usually the largest in the area. Clearinghouse members
group the checks of other member banks, exchange them at a specified time each day,
and settle accounts with each other. Clearinghouses can often collect and process
locally drawn checks faster and more efficiently than do intermediary services, such as
correspondent banks and the Federal Reserve’s check collection network.
Financial institutions clear and settle checks in different ways depending on whether the
checks are “on-us” checks (checks deposited at the same institution on which they are
drawn) or interbank checks (the payer and payee have accounts at different financial
institutions). On-us checks do not require interbank clearing or settlement. Interbank
checks can clear and settle through direct presentment, a correspondent bank, a
clearinghouse, or other intermediaries such as the Federal Reserve Banks.
Financial institutions can also clear checks through a Federal Reserve Bank or an
independent clearinghouse, where they have formed voluntary associations that
establish an exchange for checks drawn on those financial institutions. Typically,
financial institutions participating in check clearinghouses use the Federal Reserve’s
National Settlement Service to effect settlement for checks exchanged each business
day. There are approximately 150 check clearinghouse associations in the United
States. Smaller depository institutions typically use the check collection services of
correspondent banks or the Federal Reserve Banks.
The following diagram depicts the typical interbank check clearing and settlement
process through a Federal Reserve Bank or clearinghouse. The solid lines depict the
flow of information and the dashed lines represent the flow of funds.
In step 1 the consumer uses a check to pay a merchant for goods or services. The
merchant, after authorizing the check, accepts the check for payment. At the end of the
day, the merchant accumulates the checks and deposits them with its financial institution
for collection (steps 2 and 3). Depending on the location of the paying institution, the
funds may not be immediately available. For deposited checks payable at other financial
institutions, the merchant’s financial institution uses direct presentment for processing or
sends the checks to a Federal Reserve Bank, clearinghouse, or correspondent bank
(steps 4 and 6). The check or an electronic presentment file is sent to the consumer’s
financial institution, and the financial institution’s account at the correspondent,
clearinghouse, or Federal Reserve Bank is debited (steps 5 and 7).
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Correspondent Banks
Most banks maintain accounts at other banks for the purpose of collecting checks. A
correspondent bank accepts checks from the bank with which it has a relationship and
processes those checks the same way it processes those for its depositors. It credits the
depositing bank’s account and forwards the checks to the bank on which they were
drawn.
The Federal Reserve’s Check Collection Network

The Federal Reserve is the largest nationwide processor of transit checks, handling
about a quarter of all checks in the United States at 45 Federal Reserve check-
processing facilities across the country.
All financial institutions that accept deposits can purchase Federal Reserve check
collection and other payments services. The Federal Reserve is required by law to
charge these institutions a fee for its services to cover its expenses. But the Fed’s large
volume of checks, extensive automation, and speedy processing allow it to keep check
collection costs and prices low.
Checks are moved efficiently across the country from one Federal Reserve check
processing region to another using the Fed’s check relay network, an air and ground
transportation network of private vendors managed by the Federal Reserve Bank of
Atlanta. The Reserve Banks also are linked electronically to a settlement fund that keeps
track of the districts’ net balances as they exchange checks for settlement.
When a Check Is Returned

Not all checks move easily through the check collection system, however. Sometimes a
check is returned to the bank where it was first deposited. Approximately 251 million
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checks are returned or “bounced” each year, according to the Federal Reserve. This is
0.6 percent of total check volume. The average value per returned check is $701.
A check may be returned for a number of reasons.
• Insufficient funds in the check writer’s account;
• An improper endorsement or date;
• An error in the magnetic ink code imprinted on the check when the check was
first deposited;
• An alteration in the handwritten information on the check that is not initialed by
the check writer;
• A stop-payment order issued on the check;
• A hold placed on the check writer’s account.
If a bank refuses to honor a check, the check must be returned to the bank where the
check was first deposited within a certain period specified by law.
Dealing with Problem Checks

Every time a bank cashes a check or accepts a check for deposit, it is taking a risk.
Some types of checks—such as U.S. Treasury checks—carry a very high guarantee of
payment and so pose little risk to the accepting bank, especially if an established
customer presents these checks.
The degree of risk to the bank is greater for checks presented by new customers
because the risk of fraud is greater. Personal checks are riskier to banks than other
types since they are more likely to bounce because of insufficient funds.
Banks try to guard against fraud by following verification and identification procedures.
They also establish policies to minimize losses from bounced checks.
Banks are protected from some risks by a federal law that allows them to limit a
customer’s access to funds for a specified period after a check is deposited. The
maximum time a bank may limit access to these funds varies with the type of check.
Except in certain circumstances, funds from U.S. Treasury checks and some types of
on-us checks must be made available for withdrawal by the following business day.
Next-day availability may also apply to state and local government checks and certified
and cashier’s checks if specified deposit requirements are met. For a personal check,
the maximum time a bank can put a hold on the funds varies according to whether the
check is drawn on a local or a nonlocal bank.
Stop Payment Orders

Under certain circumstances, a check writer may want to stop payment on a check. A
stop-payment order is an instruction from the check writer to her or her bank that a
particular check—such as one that has been lost or stolen or was made in payment for a
transaction that is now being disputed—should not be paid.
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A check writer may request a stop payment in person, by telephone, or in writing. Many
banks require written confirmation of a telephone request. The order should specify the
check number and the exact dollar amount. Banks usually charge a fee, which varies
from bank to bank, for this service.
How to cash a Check without having a Bank Account

People who don’t have a bank account often have a hard time cashing checks they
receive, even Social Security, unemployment, or other kinds of government checks.
Although some states have laws requiring banks to cash such checks for anyone who
provides proper identification, in most states banks have the right to refuse to cash any
checks for non-customers.
A person without a bank account has a few options for cashing checks.
• Providing proper personal identification, present the check at the bank on which it
is drawn. The bank must either pay the check or refuse to pay it before the close
of the business day.
• Ask a friend or relative who has a bank account to endorse the check and cash it.
If the check is bad, though, your friend or relative’s account will be debited for the
check’s amount.
• Use a check-cashing service. Many of these services will not cash personal
checks, which they consider too risky. Most require a photo identification and will
charge a fee, sometimes based on the type and amount of the check. Few states
regulate check-cashing services, so fees can vary widely.
Electronic Checks
An electronic check is a transaction that starts at the cash register with a paper check for
payment, but the payment is converted to an electronic debit, which is processed via the
ACH network. Thousands of retailers are offering this service, and hundreds of
thousands of checks are being converted everyday from paper checks to electronic
checks.
This new electronic check conversion service offers retailers, financial institutions and
consumers an efficient new method to handle payments at the point of purchase. The
consumer still hands a check to the retailer – but the retailer hands the check back after
capturing payment information, obtaining authorization from the customer and stamping
the check VOID. Then the payment flows through the national automated clearing
house network (ACH) to the check writer’s account.
Specifically, here’s how an electronic check payment flows:
• The customer hands the retailer the check intended to pay for the purchase.
Currently, only checks drawn on consumer accounts can be converted.
• The retailer determines that the check is eligible for conversion and then runs the
check through a magnetic ink character recognition (MICR) reader.
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• MICR encoded information, the routing number, account number and check
serial number, is captured by the MICR reader. In addition, the retailer keys in
the payment amount and the name of the retailer is either keyed in or added by
the reader.
• The retailer may choose to run the payment information, including the retailer’s
name, through an internal or external database to authorize, verify or guarantee
the payment, to determine if the routing number can be used for ACH payments,
or to determine if the customer’s address is on file.
• After the customer information is recorded and if used, approval by the database
is obtained, the terminal prepares a written authorization, which is then signed by
the customer. The authorization must contain specific information specified in
the NACHA Operating Rules, which are the rules under which the ACH Network
operates.
• The retailer or its processor formats the payment information as an ACH debit
entry.
• The payment is included in a batch of ACH entries transmitted to the retailer’s
bank. The bank transmits the batch of payments to the ACH Network, which
routes each payment to the bank on which the converted check is drawn.
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• The paying bank posts the check (debit) to the customer’s account, and the
customer receives information about the payment on their statement.
Point of Purchase (POP) Check Conversion
Retailer’s (Collecting) Bank

Check Information (ODFI) Enters Information
Customer Signs
Flows Through Into ACH Network
Authorization
Retailer’s System
ACH
Stat Network
Consumer Receives
Check Information Consumer’s (Paying) Bank
on Statement (RDFI) Posts ACH Entry to
Consumer’s Account
The Electronic check service has several benefits both for the consumer writing it
and for the financial institution processing it. Some of the major benefits are
• It results in faster and less paper-intensive collection of funds.
• It helps to improve efficiency in the deposit process for retailers and their
financial institutions.
• It stems the growth of paper check processing.
• It benefits consumers by speeding checkout, providing more information about
the transaction on their account statement, and removing the consumer from any
negative file much quicker
• It enhances collection of checks that bounce for NSF or uncollected funds
because collection can be started more quickly than with paper checks.
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CREDIT CARDS
Credit Cards have become one of the most ubiquitous things in today’s world and the
preferred mode of payment for all kinds of transactions. As a substitute to money; credit
cards offer to the user a huge amount of flexibility, ease of handling and an option to buy
things from the convenience of your residence. To the various other participants like the
issuers, acquirer’s etc. credit cards have become one of the biggest items of revenue
and profitability. At the risk of overemphasizing the obvious, suffice it to say that credit
cards have now become as integral a part of our everyday existence as money and the
importance is increasing everyday.
There are basically three types of credit cards:

• Bank cards, issued by banks (for example, Visa, MasterCard and Discover Card)
• Travel and entertainment (T&E) cards, such as American Express and Diners
Club
• House cards that are good only in one chain of stores (Sears is the biggest one
of these, followed by the oil companies, phone companies and local department
stores.) T&E cards and national house cards have the same terms and
conditions wherever you apply.
• Affinity card, this card -- typically a MasterCard or Visa -- carries the logo of an
organization in addition to the lender's emblem. Usually, these cardholders derive
some benefit from using the card -- maybe frequent-flyer miles or points toward
merchandise. The organization solicits its members to get cards, with the idea of
keeping the group's name in front of the cardholder. In addition to establishing
brand loyalty, the organization receives some financial incentive (a fraction of the
annual fee or the finance charge, or some small amount per transaction, or a
combination of these) from the credit-card company.
We primarily discuss Bankcards here.
CREDIT CARDS – BASIC CONCEPTS

The credit card industry has become one of the most important revenue grosser for the
financial services industry. The credit card industry revolves around various participants
– each of whom have a niche role to perform in the value chain. Given below is a
comprehensive list of various participants in the industry:
Cardholder - The customer who possesses a credit card and initiates financial
transaction using it as a substitute for cash.
Issuer - The financial institution that extends credit to customers through bankcard
accounts. The bank issues the credit card and receives the cardholder's payment at the
end of the billing period. This is also called the cardholder bank.
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Merchant - A business establishment is considered a "merchant" once they have

authorization from an acquiring bank, ISO or other financial institution to accept credit
cards.
Acquirer - The financial institution that does business with merchants who accept credit
cards. A merchant has an account with this bank and at regular intervals of time deposits
the value of the credit card sales. Acquirers buy the merchant's sales slips (ticket) and
credit the ticket's value to the merchant's account.
Independent Sales Organization (ISO) - In the credit card industry ISOs act as a third
party between the merchant and the acquiring bank. Many businesses (home
based/mail oders) are unable to obtain merchant status through an acquiring bank
because the bank views them as too large a risk. Therefore they need to go through an
ISO to obtain merchant status. Banks are afraid that these might not be able to handle
any chargebacks that hit their accounts.
Schemes (Mastercard & VISA) - These are represented by member financial
institutions from around the world. They provide the operating infrastructure and brand
management for their respective brands. They provide services such as conducting
authorizations, clearing and settlement processing of transactions, supervising the
bankcard processing within member banks and setting and enforcing the bankcard rules
and regulations.
Interchange - Interchange is a network operated by credit card schemes like Master
Card/Visa. Through this network, all the transactions between the issuers and acquirers
are settled. Hence interchange is the network that helps the issuers and acquirers in
clearing and settlement. Through Interchange, Master Card and Visa are at the center of
the transaction process. They maintain the flow of funds between issuers and acquirers
and establish control over the entire transaction process.
A typical process flow diagram involving the various participants is as follows:
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CREDIT CARDS – PROCESSES

The credit cards industry revolves around various processes that clearly define the tasks
at each and every phase. Summary of the various processes and activities involved in a
typical credit card transaction are as elucidated below:
Application Processing
Application Processing verifies the information provided in the Credit Card application,
determines the credit worthiness of the applicant using credit scoring methods and
Credit Bureau reports, approves the card and sets up the account for the customer.
Transaction Processing
The cardholder makes a purchase and pays for it using the credit card. The merchant
sends the credit card transaction to the acquirer, who passes the financial transaction
information to the issuer. The issuer posts the information to the cardholder's account.
The issuer will pay the merchant for the cardholder's purchase. The issuer will settle the
financial transaction by electronically purchasing the cardholder's charges from the
merchant, the acquirer or their banks. The issuer periodically sends a statement to the
cardholder asking for payment of full or partial balance. The cardholder repays the loan
along with any interest or fees assessed.
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The various activities in transaction processing are as follows:
Authorization – Authorization is the first phase in a credit card monetary cycle. A

merchant can accept the card only when the validity of the card and the readiness of the
issuer to pay for the purchase are assured. Authorization is usually performed using a
huge network of telephone lines and computers connecting the merchants to the credit
card processing center.
Settlement – Settlement is the second phase of the credit card monetary cycle. It is the
process adopted between the merchant and the credit card company. The card issuer
reimburses the money to the merchant for the merchandise supplied/shipped to the
cardholder.
Chargeback – A chargeback is a reversal of a previous sales transaction resulting when

a cardholder or card issuer disputes a charge posted to their account. Chargebacks
generally occur after the established dispute resolution process has been completed and
is found in favor of the cardholder or card issuer. Chargebacks happen when an issuer
disputes a transaction (either at the request of the cardholder or for reasons of its own).
Core data processing – To collect the amount due from the cardholder, the credit card
company has to keep track of the cardholder's transaction, balance and credit limit. It
has to keep a log of all the monetary activities of the cardholder. In the case of partial
payment or non-payment, the cardholder will be charged an interest on the accumulated
balance. This is where credit card companies derive their major source of income. When
a cardholder makes huge purchases and pays over a period of time, the interest on her
balance increases proportionately. This process of core data processing is mostly
handled by independent organizations such as First Data Resources (FDR). Every
issuing bank prepares files, which contains all monetary, non-monetary transactions on
each business day.
Collections & Recovery – Collections & Recovery helps collectors to obtain payments
on cardholder accounts and fraud accounts. They help the credit grantors in controlling
their bad-debt portfolios and increase recoveries.
Balance Transfer – This is an introductory incentive offered to customers by new credit

card companies who want to acquire customers by weaning them away from their
present credit card companies. A new credit card company may be willing to take over
up to 75% of the amount outstanding on your old card to your new credit card account
with them at a lower rate of interest. Normally you are given a time limit of six months at
a lower rate of interest to clear this transferred amount. However you could possibly be
charged a higher rate of interest for new purchases. If you are unable to clear your
balance transfer amount within six months, you will end up paying a higher rate of
interest with the new credit card Company.
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CREDIT CARDS - SOURCES OF REVENUE

Any credit card issuer has 3 sources of revenue, which are as follows:
Annual Fees – This is the amount paid by a customer to the credit card issuer every
year for availing of the credit card
Inter-exchange Fees – This is the amount received by a card issuer from another card
issuer on account of a customer swiping the card at the former’s swiping machine. For
e.g., if a customer holding an ABN AMRO credit card swipes the card at a Citibank
machine, then ABN AMRO Bank pays Citibank a certain percentage of the transaction
amount
Interest income – This is the interest amount paid by a customer to the credit card
issuer for revolving the outstanding credit balance over different payment cycles
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LOANS OVERVIEW
Banks traditionally raise funds from communities through deposits and savings accounts
and make revenues by lending it to people to buy homes & cars, to put children through
education, as well as to start and expand businesses.
These loans generally take care of immediate cash requirements for an interest charge;
the repayment is usually in the form of periodic (Monthly, Quarterly etc.) payments.
Some of the classifications for loans can be made based on term, amount or usage of
collateral.
• Long term or Short-term credit: ‘Term’ refers to the duration of time within which the
loan needs to be repaid. Long-term credit refers to loans like mortgages, auto loans
etc. which typically have longer repayment periods. Examples of short-term credit
include credit cards and working capital loans.
• Open ended or Close ended loans: Close ended loans are when the amount of loan
and the term are decided and fixed, as against open ended loans wherein the
borrower takes as much loan as required against an upper limit on the amount. In
this case, interest is charged on the outstanding balance. Examples for open ended
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loans are credit cards and home equity line of credit7, while examples for close
ended loans are auto loans and mortgages.
• Secured or Unsecured debt: A secured loan is the case in which the repayment of
the loan is "secured" by a specific property (also called collateral). The lender can
acquire this property in case the borrower fails to repay the loan.
There are many type of loans designed to meet specific requirements of people and
businesses. The leading loans made to consumer in terms of number and volumes are
mortgages, auto loans, credit card debt and student loans.
The most common types of loans given by banks to businesses are:
• Working capital lines of credit for the ongoing cash needs of the operations
• Corporate Credit cards: higher-interest, unsecured revolving credit
• Short-term commercial loans: with a term of one to three years
• Longer-term commercial loans: term greater than three years, generally secured by
real estate or other major assets
• Equipment leasing: when businesses want assets that they don't want to buy outright
• Letters of credit: for businesses engaged in international trade
KEY PLAYERS
Key players in Loans process include the Borrower, Broker, Lender, Credit Rating
agency, Insurance agency, Securitiser, Government entities and the investor.
Player Function
Borrower Borrower is the entity that requests and obtains a loan; this
could either be an individual or a corporate.
Brokers Brokers are intermediaries or middlemen who help

borrowers in locating the appropriate product and the lender
for their requirements.
Lenders Lenders are the FI’s providing the loan.
7
Home Equity Lines of Credit (HELOC): HELOC refers to the loans provided with home as the
collateral. This is different from mortgage loans, which are for the purpose of purchase or
construction of a home. The borrower is allowed to borrow amounts as per requirement (against a
limit) and the interest is usually charged on the daily balance.
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Credit Rating Credit Rating Agencies provide credit reports on the

Agencies borrowers to help lenders understand the default risk
associated with the borrower. This is used in determining
the conditions of the loan.
Insurance Agencies Insurance Agencies are risk intermediaries who reduce the
risk for the lenders by providing insurance. These include
collateral insurance, default insurance, and title insurance.
Securitisers Securitisers use the loans as assets and issue securities

against them. The market for securitization is known as
secondary market.
Government In some areas of priority including housing loans,

entities agricultural loans, and student loans, the US government
has established agencies that make the borrowing more
affordable & convenient for the borrowers. These
government backed entities typically provide guarantee
against default when the borrowers meet certain predefined
requirements. This guarantee decreases the risk for the
lender, usually leading to a decrease in interest rates
charged to the borrower.
Investors Investors are FI’s who provide capital (funds) to the lenders.
Investors provide capital by purchasing whole loans or
securities backed by loans in the secondary market.
GENERIC LOAN PROCESS

Lets look at a generalized loan process that captures the common entities and key
functions involved with a loan process. Of course, the process varies based on the kind
of loan.
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Lenders Foundation Course in Guarantee
Banking
Underwriting
s
Borrowers Process
Pre-qualification
Brokers
Credit
Bureau
Services
Loan
Loan Closed
Approved
Appraisa
l
Services
Sale in In
secondary Lenders’
market portfolio
• The borrower goes to the lender directly or through a broker.

• Based on information like current income, loan amount required, down
payment willing etc. a pre-qualification is done so that the borrower can identify the
products that suit their requirements
• Underwriting is the process by which the decision whether to make a loan to

a potential borrower based on credit, income, employment history, assets, etc. is
made.
• In some types of loans certain government (or government backed) agencies
provide guarantees against default on part or the entire amount of loan.
• Credit Bureaus help the underwriting process by providing credit reports on
individuals and businesses.
• Appraisal Service providers help in determining the value of the collateral in
the loan (home in mortgages, car in auto finance in case it’s a used car etc.)
• After the underwriting process, the interest rate and other terms are
negotiated between the borrower and the lender, necessary paperwork executed
and the amount granted to the borrower. This process is called ‘closing’ of the loan.
• Once the loan is closed, it can be either retained in the lender’s portfolio, in
which case the lender continues to ‘own’ the loan. Alternately, certain types of loans
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are put for sale in secondary market. In this case, the loans are sold to another entity
so that the lender has money to make more loans.
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MORTGAGES
Mortgages are loans given to consumers for the purpose of purchase, construction or
repair of real estate.
Mortgages were started in the 1930s by insurance companies in the US, primarily with
the hope of gaining ownership of properties if the borrower failed to make the payments
on it. It wasn't until 1934 that mortgages, in their current form, came into being. The
Federal Housing Administration (FHA) played a critical role in this process. In order to
help pull the country out of its economic depression, the FHA initiated a new type of
mortgage aimed at the folks who couldn't get qualify for mortgages under the existing
programs.
At that time, only four in 10 households owned homes, against the current
homeownership levels of close to 70%. Mortgage loan terms were limited to 50 percent
of the property's market value, and the repayment schedule was spread over three to
five years and ended with a single lump sum payment that clears the total outstanding.
Mortgages can broadly be classified into four categories – Home, Multi-family,

Commercial, and Farm mortgages.
• Home mortgage-Also known as 1-4 or single-family mortgages, these are the
mortgages provided for purchase or construction of a home for occupancy of 1 to 4
families. These form the largest chunk of mortgages generated. Most of the
subsequent discussion would be based on the single-family mortgages.
• Multi-family mortgage-Mortgages taken for apartment complexes, which house more
than 4 families.
• Commercial mortgages-these are mortgages for development of commercial
property including shopping complexes, hospitals, and office complexes.
• Farm mortgages-these are mortgages provided for purchase of farmlands.
TOTAL MORTGAGES OUTSTANDING, 1997-2002

($ billions, end of year)
1997 1998 1999 2000 2001 2002
Total
mortgages $5,201.1 $5,712.5 $6,316.6 $6,890.3 $7,600.8 $8,486.0
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Home 3,978.3 4,362.9 4,787.2 5,205.4 5,738.1 6,460.0
Multifamily
residential 300.1 331.5 369.1 405.0 453.3 498.4
Commercial 832.7 921.6 1,057.9 1,171.0 1,293.0 1,401.8
Farm 90.0 96.6 102.3 108.9 116.3 125.8
Source: Board of Governors of the Federal Reserve System.
MORTGAGE PRODUCTS
There are many types of mortgages in the market. These are designed to suit various
requirements of the borrowers including the length of mortgage, capability for initial
payment, the other financial obligations.
Mortgages can be broadly classified into Conventional and Government Insured Loans.
Conventional Loans can be further classified into conforming and non-conforming loans.
Government Loans – These are loans either guaranteed/insured by the Federal

Housing Administration (FHA), which is part of the U.S. Department of Housing and
Mortgages
Conventional
Government
Non-Conforming Conforming
VA FHA RHS
Jumbo Subprime “Alt” A
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Urban Development, the Veterans Administration (VA), and the Rural Housing Service
(RHS), which is a branch of the U.S. Department of Agriculture. These agencies do not
typically originate loans (except for low income and other specific borrowers) directly but
guarantee/insure loans originated by others provided they meet their underwriting
norms.
• The FHA loans offer a mortgage-financing program that insures home loans.
The financial requirements for FHA loans are relaxed compared to traditional
commercial loans. So an individual with an adverse credit limit who is not eligible
for a prime mortgage could be eligible for a FHA loan. Also, the interest rates
charged on a FHA loan are lower than those for conventional loans. However the
FHA loan requires an upfront mortgage insurance payment to be paid, thus
leading to higher closing costs. Also, there are limits on FHA loan amount that
vary based on the state & county and these limits are lower than those for
conventional loans. Based on their requirements, individuals would need to
decide between going for a FHA loan (lower interest rates, lower down payment)
or a sub prime loan (lower closing costs, higher loan limits).
o FHA requirements reduce the debt-to-income ratio from 28/36 to 29/418.
o FHA loans also require a low down payment of 5 percent or less
• VA loans are designed for qualified veterans and offer more relaxed standards
for qualification than either FHA loans or traditional loans. For example in 2002,
loans can be for amounts up to $240,000 and require no down payment.
• RHS offers both guaranteed loans through approved lenders and direct loans
that are government funded. These are offered to low-income families, living in
rural areas or small towns for purchase, construction or repairing homes.
Conventional Loans - A conventional loan is one that is not insured by the Federal
Housing Administration (FHA) or guaranteed by the Veterans Administration (VA). These
are further classified into conforming and non-conforming loans.
• Conforming loans comply with the loan size limitations, amortization periods,
and underwriting guidelines set by Freddie Mac and Fannie Mae in secondary
market. Conforming loans may be sold to the Freddie Mac or Fannie Mae
(Government-sponsored enterprises or GSEs), which, in turn, securitize,
package, and sell these loans to investors in the secondary market.
8
28/36 refers to total monthly mortgage payment being less than 28% of monthly income AND
total monthly debt payment less than 36% of monthly income.
Page 41 of 186
Conventional
75%
VA
3% FHA Jum bo
14% 8%
•
Non-conforming loans (like “Jumbo Loans”) are not eligible for purchase by a GSE,
but can be sold in the secondary market as whole loans, or can be pooled,
securitized, and sold as private-label mortgage-backed securities. Non-
conforming loans comprise Jumbo loans, subprime loans and “Alt” A loans.
• Jumbo loans are the loans in which the loan amount is above the limit set by
Freddie Mac & Fannie Mae. This limit changes annually based on the single-
family home price survey done by the Federal Housing Finance Board. For
example in 2002, a conforming loan limit was $300,700. Loans that are above
that limit are called Jumbo loans. Jumbo loans have interest rates higher by
about 0.25 percent to 0.50 percent than the conventional loans.
• Subprime loans are loans given to borrowers with poor credit history whose
credit characteristics do not meet the requirements of Fannie Mae & Freddie
Mac. These loans typically have higher down payment and higher interest rates.
• "Alt” A mortgage loan is provided to borrowers who have good job stability, good
income, but their credit scores don't fit the "A Credit" guidelines. This could either
be due to a short credit history or due to a slight derogatory hit on the credit
scores such as a 30-day late payment.
Classification of Mortgages based on applicable interest rates is given below. Each of

the loan types discussed above can fall under any one of the following categories:
Page 42 of 186
Fixed-Rate Mortgage (FRM) - This mortgage comes with an interest rate that will never
change over the entire life of the loan irrespective of changes in the market rates and
economic trends. So, a mortgage with a rate of 7 percent that calculates a payment of
$1,247 per month for a 20-year term would imply a monthly payment of $1,247 during
the entire duration. However, there could be a change in the property tax and any
insurance payments included in the monthly payment. The term of the fixed rate
mortgage is usually 15, 20 or 30 years.
Comparing ARMs and FRMs

An FRM requires predetermined and fixed monthly payments, making budgeting far
more predictable for the borrower as opposed to an ARM
In a FRM, the lender requires a premium for the commitment to keep interest rates
fixed over the term of the loan. Longer the term of the loan, greater the premium. In
an ARM, since the borrower takes the risk of fluctuating interest rates, the lender
usually charges an initial rate, lower than the initial rate of an FRM of the same
tenure. Such a rate is called the teaser rate of the ARM.
The major advantage of ARMS is that if interest rates decline and the borrower
does not qualify for a refinance, an ARM will automatically adjust itself to a lower
rate. The disadvantage could be in the rare case when interest rates decline too
sharply, so as to fall below the limit set by the ARM cap (the lifetime cap or the
periodic cap or both). In that case, the ARM interest rate stays above the interest
rate of the FRM. The reverse holds good for rising interest rates, where the rates
may rise beyond the lifetime cap of the ARM, making the ARM rates lower than
those of comparable FRMs.
Adjustable-Rate Mortgage (ARM) - An adjustable-rate mortgage has an interest rate

that changes based on changing market rates and economic trends.
• ARMs usually have an initial period of time during which the rate won't change.
For example, a 5/1 year ARM would mean the initial interest rate would stay the
same for the first five years and then would adjust each year beginning with the sixth
year. A 3/3 year ARM would mean the initial interest rate would stay the same for the
first three years and then would adjust once every three years beginning with the
fourth year. Some of the other ARM products include 5/25 ARM, 7/23 ARM, and 7/1
ARM.
• The interest rates for ARMs can be tied to one-year U.S. Treasury bills, rates on
certificates of deposit (CDs), the London Inter-Bank Offer Rate (LIBOR), COFI or
other indexes. More details on these indexes are given in Appendix C.
All Conventional and Government loans (with the exception of VA loans) are available as
ARMs.
Page 43 of 186
Hybrid Loans - Hybrid loans combine features of a fixed rate mortgage (FRM) and an
adjustable rate mortgage (ARM). The hybrid loan’s interest rate and monthly payments
are fixed over a specified period of time beyond which the loan will convert into and stay
as an ARM for the remainder of the loan term. The initial rate may be fixed for 3, 5 7 or
even 10 years beyond which the ARM takes over. The ARM adjusts every 6 to 12
months. The longer the initial rate stays fixed, the higher will be the rate but the initial
rate of a Hybrid loan is usually lower than that of a 30 year FRM. The initial interest rate
will be higher than an ARM since the rate remains fixed for much longer than that of a
normal ARM. A normal ARM would offer a fixed rate for say 6 to 12 months.
The 7/23 loans may also be considered a form of Hybrid loans. These loans remain fixed
for the first 7 years, then adjust once and remain at that rate for the remaining 23 years.
Balloon Mortgage - A balloon mortgage offers an initial fixed interest rate for five to
seven years and then requires a "balloon" payment. The balloon payment is the final
payment of the loan and pays off the entire balance.
Graduated Payment Mortgages (GPMs) - A GPM would have a fixed interest rate with
monthly payments that gradually increase by predetermined amounts during the early
years of the loan and then level off, say after 5 years. A GPM would be useful for
borrowers who expect their incomes to increase significantly over a period of time.
However, GPMs carry the risk of having the loan principal to actually increase during the
early years when payments are low and inadequate to meet the entire interest payment.
Reverse Mortgages - Reverse mortgages pay money to the borrower as long as the
borrower lives in her/her home. These loans are designed for people aged 62 and above
who own their homes and need an inflow of cash. The loan is against the equity of home
and isn't paid off until the borrower sells or moves out of the home.
The payment can be a single lump sum, regular monthly payments, or a as a "creditline"
account that lets the borrower decide when and how much of the available cash is paid.
Against this, the lender gets an equivalent amount of ‘equity’ in the home, which they
can claim once the home is liquidated after the borrower does or moves away. All types
of Conventional and Government loans (except VA loans) are available with ARM
options.
80-10-10 Financing
When the mortgage amount is more than 80 percent of the purchase price of the home,
lenders require the borrowers to take insurance on the extra amount. It is called PMI
(Private Mortgage Insurance) and the borrower pays for the premium. The cost varies
but it can be equivalent of an additional 1/2 to 1 percent of the loan amount per year.
Furthermore, this cost is not tax-deductible. With 80-10-10 financing, the borrowers
Page 44 of 186
make cash down payment of 10 percent of the purchase price. They take out two
mortgages: a new first mortgage for 80 percent of the price and 10 percent second
mortgage. Often the first and second mortgages are from the same lender.
The interest rate on the second mortgage will be about 2 percent higher than the going
rate on first mortgages. This allows the borrowers to save money spent on the PMI.
Bridge Loans - Borrowers who plan to take a new home before selling their current one
can go in for a bridge loan to span the gap between the two transactions.
Bridge loans can either be structured to completely pay off the old home's mortgage or
to add the financial obligation of the new home to the existing mortgage. Typically, the
loan is structured with a short term (often one year) and hefty prepaid interest (perhaps
six month's worth).
Most often, a bridge loan is used to pay off the existing mortgage, with the remainder
(minus closing costs and prepaid interest) going toward the down payment on the new
home. If after six months the old home has not sold, the borrower begins making
interest-only payments on the loan. When the home sells, the bridge loan is paid off. If it
sells within the first six months, any unearned interest payments will be credited to you.
KEY MORTGAGE CONCEPTS
Definition
Concept
Interest This determines the amount of interest paid on the mortgage loan. The
Rate interest rates for loans of different terms are discussed in Appendix C.
Closing These are the costs, which are incurred by the borrower in order to
costs obtain the mortgage. These may include points, taxes, settlement
agent fees and more. The various costs that are a part of closing costs
are discussed in Appendix C.
Annual APR is commonly used to compare loan programs from different

Percentage lenders. The APR is the average annual finance charge (which
Rate (APR) includes fees and other loan costs) divided by the amount borrowed,
and is expressed as an annual percentage rate. The APR will be
slightly higher than the interest rate the lender is charging because it
includes all the other fees that the loan carries with it, such as the
origination fee, points, PMI premiums, etc. The various costs that are
included in APR calculation are discussed in Appendix C.
Down The down payment is the contribution of the borrower towards the
payment home purchase or construction and is to be paid initially while taking
the loan. The down payment can be anywhere from three to twenty
percent of the home's value.
Down payments can be lower for some special, first-time buyer loans,
Page 45 of 186
and veterans or those on active military service can obtain loans with
no down payment at all.
Mortgage Mortgage payment is the monthly payment made by the borrower

payment towards the repayment of the mortgage. A mortgage payment is made
up of three basic parts;
• A payment on the principal of the loan
• A payment on the interest, and
• Payments into the escrow account. These are payments
towards various insurances (flood, title etc.) and the taxes that
need to be paid for the property
Amortization A mortgage payment has two parts (if we exclude insurance and
taxes), the interest and the principal. The sum of these two make the
EMI. A mortgage payment received is first applied to the interest and
then to the principal. This causes the principal balance outstanding to
decrease. For the next installment, the interest portion of the payment
decreases since interest is always computed on the principal balance
outstanding and the principal balance outstanding decreases with each
payment. So initial mortgage payments go more towards servicing the

interest component and latter ones towards the principal component
(assuming equal installments).
This process of reduction in the principal balance outstanding is known
as amortization.
Negative If the payment structure is so designed that the installment payments

Amortization are inadequate to meet the interest component, then the unpaid portion
of the interest is added to the principal amount, causing the principal
Page 46 of 186
balance outstanding to actually increase. This would require an even

greater interest component to be paid off in the next installment. With
installment amounts remaining constant, an even great amount of the
interest remains unpaid, causing the principal balance outstanding to
increase with each successive installment. Such a loan, theoretically,
can never be paid off (amortized) if the installment amounts remain
constant. This is negative amortization. Lenders, who design such
loans, ensure that installment amounts rise subsequently to break the
negative amortization or design a balloon payment. Such a situation is
not desirable for the borrower.
Prepayment Prepayment penalty is the charge or a fee for paying all or part of the
penalty loan before payment is due. These are usually expressed as a percent
of the outstanding balance at time of prepayment, or a specified
number of months of interest.
Foreclosure Foreclosure is the process by which the lender takes possession of the
borrower’s home and sells it in order to get its money back in case of
payment defaults. The other options available for borrowers in case of
default include:
• Special forbearance – This is the process by which the
borrower can set up another repayment plan with the lender to
fit their current financial situation. Sometimes, if the borrower
has recently lost a job or another source of income, the lender
might be willing to temporarily reduce or suspend the payments.
• Mortgage modification – The borrower might have the option
of refinancing the amount owed or extend the term of the loan.
• Partial claim – In some cases where the borrowers meet
special qualification criteria, HUD could provide an interest free
loan in order to close on the default.
• Pre-foreclosure sale – The borrower can sell the property in
order to pay off the mortgage if the appraised value of the
property is at least 70 percent of the amount owed. There are
certain requirements for this including the fact that the sale
price has to be at least 95 percent of the appraised value.
• Deed-in-lieu of foreclosure - As foreclosure damages the
borrower’s credit record, the borrowers may be able to "give"
the property to the lender in order to avoid the credit problems
associated with regular foreclosure. Here again, there are
requirements that the borrower must meet in order to qualify for
this option.
Mortgage If the interest rates go down after the borrower has taken a mortgage,
Refinance they can go in for a refinancing option. The borrower can use
refinancing to reduce the interest rate on their mortgage, leading either
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to lower payments or shorter term to close the mortgage. There has

been a huge refinance boom in the US mortgage industry 2000 – 2003
due to cuts in the interest rates.
Cash-out refinancing - Cash-out refinancing involves refinancing a

mortgage for more than what is owed, to pocket the difference.
Here's an example: Let's say Mr. Jones owes $80,000 on a $150,000

house, and wants a lower interest rate. Mr. Jones also wants $20,000
cash, maybe to spend on her kid's first semester at Princeton. Jones
can refinance the mortgage for $100,000. That way, she gets a better
rate on the $80,000 that’s still owed on the house, and also a check for
$20,000 to spend on her kid’s education.
MORTGAGE MARKET
There are various players who participate in the functioning of the mortgage banking.
The two obvious players are the borrower and lender. Traditionally lenders have
managed all the required functions of prospecting a customer, providing the loan,
servicing the loan, and managing the risk by themselves. However, as the market
matured, the functions of origination, servicing, risk management and funding are
unbundled and managed by different specialized entities.
Risk
Risk
Intermediaries
Intermediaries
Borrower
Borrower Originator
Originator Servicer
Servicer Investor
Investor
Settlement
Settlement
Providers
Providers
Participants • Mortgage Brokers

• FHA • Realtors • Mortgage Bank •Agency
• Mortgage Banks
• VA • Appraisers • Depository • Pension Fund
–Correspondents
• PMI agencies • Escrow Agents • Insurance Co.
–Wholesale
• Insurance firms • Credit Rating • Depository
• Depositories
Agencies • Mutual Fund
Functions • Marketing • PMI • Closing • Payment Processing• Funding

• Processing • Default Guarantee • Credit rating • Collections • Risk Mgmt.
• Underwriting • Flood insurance • Property • Foreclosure
• Closing • Title insurance appraisal Page 48 of 186
• Warehousing
• Pipeline Risk Mgt.
Originators perform the role of accessing the prospect’s credit worthiness and deciding
on the best product to suit their needs and ability to pay. These are the entities that
actually provide the mortgage loans. The borrower can directly contact an originator or
go through an intermediary like a broker or a correspondent lender.
Risk intermediaries provide insurance to make the loan process more viable. There are
private insurance entities that provide Private Mortgage Insurance (PMI), Flood
Insurance, Title Insurance, Hazard Insurance, etc. Some example include,
• Private Mortgage Insurance (PMI) is provided in cases where the borrower makes a
low down payment. In this case, the norm of 80% for the Loan to Value (LTV) ratio is
exceeded. The insurance is provided for the amount over and above the value that
meets the LTV ratio of 80%.
• Flood Insurance is provided to protect against losses due to floods.
• FHA, VA, and RHS are the government-backed agencies that provide insurance in
mortgages.
Settlement Services Providers provide various services required for underwriting and
closing a loan. These services include Credit Reporting 9, Property Appraisal, and Loan
Closing.
Loan Servicing firms provide the servicing of a loan – collecting the monthly payments,
reporting to the investors, and handling the cases of delinquency. Some of the mortgage
origination firms outsource the servicing function to focus on origination. Also, some
firms purchase pools of loan after origination and manage the servicing function.
Investors provide liquidity to the mortgage market by purchasing securities issued

against mortgages (Mortgage Backed Securities). These securities are used as an
investment option.
Secondary Market
As noted earlier, banks raise deposits and use the money to provide loans & mortgages.
So the ability of a bank to provide loans is limited by the extent to which it can raise
deposits. This on an aggregate scale also limits the total demand the mortgage market
can manage.
In order to increase this limit, the concept of secondary market was introduced. In the
secondary market, investors looking for investment avenues purchase loans from the
lenders. This provides lenders with additional cash to make more mortgages.
9
Refer to Appendix A on Credit Rating Agencies
Page 49 of 186
Once the lender originates a mortgage loan, they may either retain the loan in their
portfolio or sell it in the secondary market. In secondary market, they can sell whole
loans or package it with other loans and exchange for Mortgage Backed Securities 10
(MBS).
The loans are ‘pooled’ into groups with similar characteristics – could be region,
seasoning (time elapsed since the loan started), credit rating of the borrowers etc. These
loan pools are used as collateral against which securities are issued. These securities
(MBS) provide an ownership in the underlying pool of loans.
There are various types of MBS that are available in the market for investors.
Pass-throughs or Participation Certificates (PCs): The most common form of MBS,

here the issuer or the servicer collects the monthly payments from borrowers whose
loans are in the given pool and “passes through” the payments minus charges to the
investors. The monthly payments contain both the interest and principal components.
Most pass-throughs are issued and/ or guaranteed against default by Ginnie Mae,
Fannie Mae, and Freddie Mac. Though, they are guaranteed against default, these
securities carry with them risks of prepayments.
Most pass-throughs are backed by FRM pools though ARMs are also pooled to create
securities. Due to the higher volatility associated with the variations in the interest rates
with ARMs, they typically have higher yields11.
Possible cash flows for a pass-through are illustrated. Principal

and interest are paid to investors. Servicing fees are deducted
from interest payments and are paid to the servicer.
There also other more evolved form of MBS including Collateralized Mortgage Obligation
(CMO), Z-bonds, PAC bonds, Reverse floaters etc. Details on these can be found in
Appendix – B.
10
Security: A security is an instrument with a financial value. Securities are by definition tradable
and can be bought or sold in an exchange.
11
Yield: Yield is the return on any investment, calculated as the amount of interest paid divided by
the price. This is usually expressed as an Annual Percentage Rate.
Page 50 of 186
The majority of mortgage securities is issued/ and or guaranteed by an agency of the US

government the Government National Mortgage Association (Ginnie Mae), or by
Government Sponsored Entities (GSEs) such as Federal National Mortgage Association
(Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). Some
private institutions also package loans and issue securities. These securities are known
as “private label” mortgage securities.
Key players
The key players in the secondary market are Fannie Mae, Freddie Mac, and Ginnie
Mae.
The Federal National Mortgage Association (FNMA or Fannie Mae) has its genesis
in the Reconstruction Finance Corporation (RFC), which was created in 1935. In 1938 a
wholly owned subsidiary, the National Mortgage Association of Washington was formed,
which was soon renamed the FNMA. This was the first federal attempt to establish and
assist a national mortgage market. From its beginning until 1970, Fannie Mae only
purchased FHA/VA mortgages. In 1970, Congress, in the same bill, which created the
Federal Home Loan Mortgage Corporation, authorized Fannie Mae to purchase certain
other mortgages. These “conventional” mortgages now represent the bulk of the loans
purchased by Fannie Mae.
Page 51 of 186
Fannie Mae today performs the following functions:
• Portfolio Investment Business

o Buys Mortgages originated by lenders in exchange for cash
o Buys MBS from Investors
• Mortgage Credit Guarantee Business
o Converts a pool of Mortgages with similar characteristics (interest rate, tenor)
for a lender into securities (called FNMA MBS), which it guarantees and gives it
back to the lender for a fee.
On an average, Fannie Mae buys about 25% of conventional mortgages originated in

US each year and is largest player in the secondary market.
The Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) supports
conventional mortgage lending by purchasing and securitizing Mortgage Banking loans.
It was created to provide secondary market facilities for members of the Federal Home
Loan Bank System, but its charter was later modified to include all mortgage lenders.
Freddie Mac was the first issuer of mortgage backed securities based on conventional
mortgages in 1971 when it sold participation certificates backed by mortgages
purchased from savings and loan associations. Freddie Mac performs the following
functions:
• Credit Guarantee Program

o Freddie Mac like FNMA converts a pool of mortgages into securities
securitizes mortgages by issuing (called Mortgage Participation Certificates -
PCs), which it guarantees and gives it back to the lender for a fee.
• Portfolio Investment
o Freddie Mac purchases mortgage loans and mortgage-related securities
and holds such securities for investment purposes in its retained portfolio and
provides cash in return to the Originator.
o It also generates fee based Income from REMICs
Fannie Mae as well as Freddie Mac cannot originate mortgages, purchase

nonconforming mortgages, or purchase Conventional Mortgages with LTV above 80%
without Insurance. On an average, Freddie Mac buys 20% of conventional mortgages
originated in the US each year.
Page 52 of 186
The Government National Mortgage Association (GNMA or Ginnie Mae) Ginnie Mae
came into being in 1968, when Congress enacted legislation to partition Fannie Mae into
two separate corporations: a residual Fannie Mae and the new Ginnie Mae. After that
partition, Ginnie Mae offered the special assistance and loan liquidation functions
formerly provided by Fannie Mae, as well as a mortgage-backed securities program.
Ginnie Mae is located in the Department of Housing and Urban Development (HUD).
Ginnie Mae business comprises

• Converting a pool of mortgages (issued by approved Issuers, which are backed by
loans with the guarantee of VA/ FHA/ RHS and the HUD’s office of Public and Indian
Housing (PIH)) for an Originator into GNMA MBS for a fee. In the process, it also
provides guarantees to these securities and is the ONLY agency whose guarantee is
backed by the US Government (FNMA & FHLMC MBS/PCs don’t have the implicit
guarantee of the US government)
• Administering the Real Estate Mortgage Investment Conduits (REMICs) program.
Since GNMA is only in the fee business of providing guaranteed MBS in exchange for
mortgage loans and due to its focus on only FHA/VA and other government guaranteed
loans, it is the smallest of the three entities.
Page 53 of 186
MORTGAGE PROCESSES
Mortgage banking involves four major areas of activities: Loan Production, Pipeline and
Warehouse management, Secondary marketing, and Servicing.
Secondar
Pipeline
y Servicin
Loan Manageme g
Marketin
Production nt
g
• Marketing • Pipeline mgmt. • Pricing

• Payments
• Origination • Risk mgmt. • Delivery of
loans • Accounting
• Underwriting
• Investor Reporting
• Processing &
• Customer Service
• Loan Production involves origination, processing, underwriting, and closing

mortgage loans.
• Pipeline and Warehouse Management involves managing price risk from loan
commitments and loans held-for-sale.
• Secondary Marketing involves developing, pricing, and sale of loan products along
with delivery of loans to permanent investors.
• Servicing or loan administration involves collection of monthly payments from
borrowers; remitting of payments to the permanent investors or security holders;
handling contacts with borrowers regarding delinquencies, and escrow accounts; and
paying real estate tax and insurance premiums as they become due.
Loan Production
Mortgage loan production consists of origination, processing, underwriting, and closing.
Banks commonly create mortgage origination through retail (internal) as well as

wholesale (external) sources.
• Retail sources for mortgage loans include bank-generated loan applications,

sourced from brokers, and contacts with real estate agents and homebuilders. In
addition to face-to-face customer contacts, many banks also have telemarketing and
direct mailing units that provide additional ways to solicit applications.
Page 54 of 186
• Wholesale sources for loans include loans purchased from bank correspondents12 or
other third-party sellers. These mortgages close in the third party’s name and are
subsequently sold to the bank. The wholesale production of mortgage loans allows
banks to expand volume without increasing related fixed costs.
Once a mortgage loan application is generated, it goes through a process to verify

information supplied by a mortgage applicant, such as income, employment, and down
payment sources. Also an appraisal of the financed property is carried out along with
along with preliminary title insurance. The loan application files are prepared in a
complete manner before the files are delivered to the underwriting unit.
The Underwriting Process is used to decide on going ahead with mortgage as well as
the acceptable terms to go ahead. Each lender has its own Underwriting process. Also,
to ensure loans made are eligible for sale to the secondary market, most lenders apply
underwriting and documentation standards that conform to those specified by the GSEs
or private label issuers.
The common underwriting procedures include:
• Reviewing appraisals for completeness, accuracy, and quality

• Evaluating the repayment ability of the borrower based on income, financial
resources, employment, and credit history
• Determining if the borrower has sufficient funds to close (down payment etc.)
• Checking the accuracy of all calculations and disclosures
• Identifying any special loan requirements, and
• Ensuring adherence to appropriate fair lending regulatory requirements.
After the underwriting unit approves a loan, the loan is properly closed and settled.
Closings may be performed by an internal loan-closing unit or by title companies or
attorneys acting as agents for the bank. The individual who performs the closing,
whether bank employee or agent, obtains all required documents before disbursing the
loan proceeds. Obtaining all front-end documents, (e.g., note, preliminary title insurance,
mortgage assignment(s), insurance/guaranty certificate), is the responsibility of the
closing function.
Production Quality Control
12
Correspondent lenders: These lenders provide the loan to the borrower and then sell the loan
soon afterwards (usually with 30 – 45 days).
Page 55 of 186
HUD, Freddie Mac, Fannie Mae, Ginnie Mae, and most private investors require the
lender to have a quality control unit that independently assesses the quality of loans
originated or purchased. The quality control function tests a sample of closed loans to
verify that underwriting and closing procedures comply with laid down policies or
practices, government regulations, and the requirements of investors and private
mortgage insurers. The unit confirms property appraisal data and borrower employment
and income information. It also performs fraud prevention, detection, and investigation
functions. It also checks for compliance with various regulations.
Pipeline, Warehouse, and Hedging

A mortgage commitment is said to be in the “pipeline” when an application is taken from
a prospective borrower. Commitments remain in the pipeline throughout the processing
and underwriting period. When the loan is closed, it is placed on the bank’s books in a
warehouse account where it remains until sold and delivered to an investor. The loans
that the bank plans to retain are transferred to the permanent loan portfolio after closing.
Pipeline Management
When a consumer submits a loan application, a mortgage bank normally grants the
consumer the option of “locking in” the rate at which the loan will close in the future. The
lock-in period commonly runs for up to 60 days without a fee. If the consumer decides
not to lock-in at the current established rate, the loan is said to be “floating.”
Interest rate fluctuations affect mortgage pipeline activities. Changes in rates influence
the volume of loan applications that the bank closes, the value of the pipeline
commitments, and the value of commitments to sell mortgages in the secondary market.
Pipeline Management Reporting systems typically monitor the volume of loan

applications that will continue through the various aspects of the origination process,
become marketable loans, and be delivered to investors. The reports also monitor the
status of delivery commitments to investors, the effectiveness of hedges, and historical
fallout rates (% of loans which do not get closed from the “floating” state) for each
specific loan category (e.g., 8 percent, 30-year fixed rate FHA loans or 7.50 percent, 15-
year conventional loans). The bank also may use a pipeline hedge model to estimate
fallout volumes under various interest rate scenarios.
Warehouse loans are closed mortgages awaiting sale to a secondary market investor.
Uncertainty regarding the delivery of a warehouse loan to an investor is limited to a
determination of whether the loan meets investor underwriting, documentation, and
operational guidelines. As a result, 100 percent of warehouse loans are normally sold
forward into the secondary market. A mortgage bank normally holds a loan in the
warehouse account for no more than 90 days.
Page 56 of 186
Hedging the price risk associated with loans awaiting sale: The overall objective of this
function should be to manage the operation’s price risk and minimize market losses.
Secondary Marketing
A bank’s secondary marketing department, working with origination management, is
responsible for developing, pricing, selling, documenting, and delivering mortgage
products to investors. A bank must consistently demonstrate reliable performance in
underwriting, documenting, packaging, and delivering quality mortgage products to
remain in good standing with secondary market participants.
A bank can sell mortgages in the secondary market as an individual (whole) loan or as
part of a pool of loans. Banks that originate a substantial number of mortgage loans
normally pool them to sell because it produces a higher price and reduces transaction
costs.
Investors
Mortgage Secondary Market
Originators Conduits
• Pension Funds
• Commercial • Fannie Mae
• Insurance
Banks • Freddie Mac companies
• Thrifts • Ginnie Mae • Commercial Banks
• Mortgage • Private Investment • Thrifts
brokers Conduits
• Fannie Mae
Investor
Sell loans
Sell whole
Originate loans to
loans investors
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Page 57 of 186
Loans also may be “swapped” for pass-through certificates issued by investors. In this
transaction, the bank gives up a portion of the interest income on the loan (generally
0.25 percent) in return for a more liquid asset and more favorable risk-based capital
treatment. The bank retains servicing of the loans, which back the certificate.
A bank’s relationship with an investor is usually based on a commitment from the

investor to purchase a specific dollar volume of loans. A “master sales commitment”
details the dollar amount and/or maturity of the obligation. This document also describes
investor-mandated underwriting standards as well as delivery and mortgage servicing
requirements.
To fulfill its delivery responsibilities, the banks obtain all mortgage documents for its
investors. Front-end documents are obtained before, or at, closing. Post-closing
documents such as mortgages, assignments, and title policies must be recorded by local
authorities or issued by the title company. Post-closing documents may normally be
received up to 120 days after closing.
Servicing
Servicing revenue is a primary source of income for many banks engaged in mortgage
banking. To be successful, the servicer must comply with investor requirements and
applicable laws, have strong internal controls, and manage costs. Loan servicing
involves several areas of responsibility:
• Cash management
• Investor accounting and reporting
• Document custodianship
• Escrow account administration
• Collection
• Other real estate owned (OREO)
• Loan setup and payoff
• Customer service
Page 58 of 186
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• Other servicing arrangements
Cash management consists of collecting borrowers’ mortgage payments and depositing

those funds into custodial accounts. Subsequently, the principal and interest portion of
each payment is separated from the portion set aside for escrow items (insurance &
taxes). These custodial accounts require daily balancing and monthly reconciliation,
control over disbursements, and the deposit of funds into appropriate financial
institutions.
Investor accounting and reporting consists of performing various recordkeeping

functions on behalf of investors.
• Servicers process borrowers’ loan payments and remit principal and interest to
investors according to the specifications.
• Servicing adjustable-rate mortgage loans requires ensuring that the interest rate
adjustments are properly performed and documented, and that customers are
notified in accordance with investor guidelines.
• A servicer’s investor reporting responsibilities involve preparing monthly reports to
investors on principal and interest collections, delinquency rates, foreclosure actions,
Page 60 of 186
property inspections, chargeoffs, and OREO. Servicers also report information to

consumer credit bureaus on the past-due status of a homeowner’s loan.
Document custodianship consists of adequately safekeeping loan documents. Original

documents are usually stored in a secured and protected area such as a fireproof vault.
Copies of critical documents (i.e., a certified copy of the note) are maintained in a
separate location. In some cases, a third-party custodian is used to safeguard the
documents.
Escrow account administration consists of collecting and holding borrower funds in

escrow to pay real estate taxes, hazard insurance premiums, and property assessments.
The escrow administration involves setting up the account, making timely payments of
tax and insurance funds received as part of the borrower’s monthly mortgage payment,
analyzing the account balance in relation to anticipated payments annually, and
reporting the account balance to the borrower annually.
Collection consists of obtaining payment on delinquent loans by sending written

delinquency notices to borrowers, making telephone calls and arranging face-to-face
contacts, conducting property inspections, and executing foreclosure actions.
Other real estate owned (OREO) administration consists of managing and disposing of
foreclosed properties.
Loan setup and payoff consists of inputting information into the automated servicing
system and processing loan payoffs.
• The loan setup involves inputting information regarding the borrower, the type of loan
and repayment terms, and the investor into the servicing system.
• The function also involves sending a letter to the borrower introducing the company’s
services and includes the first payment coupon.
• Loan payoff involves the functions to be carried out once a loan is completely repaid,
including recording the mortgage satisfaction and returning the original note to the
borrower.
Customer service creates and maintains a positive relationship with borrowers.

Customer service efforts are especially important before and after servicing portfolio
purchases or sales, or during periods of high business activity.
Other servicing arrangements that are important to mortgage servicing include data
processing systems and outside vendors and subservicers.
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A servicer may employ outside vendors and subservicers to perform various servicing
tasks such as making real estate tax and insurance payments, performing lock-box13
services, conducting property inspections, and performing custodial duties for loan
documents.
Servicing Quality Control

Banks sometimes have a quality control function that independently reviews the work
performed by each servicing function. The quality control unit tests a representative
sample of transactions, and reports its findings to appropriate levels of management,
and require written responses for significant findings.
13
Lock-box services involve collecting all the payment checks mailed to a particular mailbox
address and depositing them into an account.
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REGULATIONS GOVERNING THE MORTGAGE INDUSTRY

There are many regulations governing the way banks providing mortgage products need
to conduct their business. Most of them have been put in place to ensure that the
borrower has sufficient transparency on the charges for the mortgage. Couple of key
regulations are:
• Fair Lending - Regulations related to prohibited discriminatory lending practices.

• Consumer Affairs Laws and Regulations - Protecting the customer in
transactions with financial transactions
Fair Lending
These regulations prohibit discrimination in lending and other services on basis of age/
location/ color/ religion etc and provide for
• Nondiscriminatory Appraisal and Underwriting

• Nondiscrimination in Application Processing
• Nondiscriminatory Advertising
• Availability of Equal Housing Lender Poster in all offices
• Mandatory to maintain loan registers and file them with the compliance
orgnizations
The key laws that form a part of the Fair Lending Regulations are:
Equal Credit Opportunity Act (ECRA): This Act prohibits discrimination with respect to
any aspect of a credit transaction on the basis of race, color, religion, national origin,
sex, marital status, age etc. Hence the mortgage origination firms need to record data on
all applications processed so that this can be verified.
Fair Housing Act: This Act makes it unlawful for any lender to discriminate in its
“residential real estate-related” activities against any person because of race, color,
religion, sex, handicap, familial status, or national origin.
Home Mortgage Disclosure Act (HMDA): HMDA is a disclosure law to provide the
public with information that will help show whether financial institutions are serving the
housing credit needs of the neighborhoods and communities in which they are located.
Mortgage firms need to collect and disclose data on applicant and borrower
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characteristics so that disparate lending patterns can be identified and reviewed for
compliance with HMDA goals.
Consumer Affairs Laws and Regulations

These regulations ensure that customers taking loans for personal reasons are provided
with sufficient safeguards against unfair practices. The key regulations include:
Fair Credit Reporting Act (FCRA): FCRA indicates that consumer reporting agencies
generating and transmitting customer data need to have permissible reasons for
generating or using the data. Since Mortgage origination firms typically are users of this
data and they need to follow guidelines on when they can ask for customer data. These
organizations also need to maintain data justifying the use of customer data & also
consent from the customer to obtain this data (credit reports etc.).
Truth In Lending Act (TILA): TILA ensures that credit terms are disclosed in a
meaningful way so that consumers can compare credit terms more knowledgeably. This
serves to protect consumers against inaccurate and unfair credit billing practices. TILA
provides tolerance limit for errors in calculating annual percentage rates or charges as
well as guidelines for making disclosures on various transactions (high value, low value,
variable rate, fixed rate mortgages).
Restitution: Financial institutions that violate certain provisions of the TILA law might be
required to reimburse borrowers for faulty disclosures. This could be for
understatements of the annual percentage rate (APR) or finance charge disclosures
resulting from a clear and consistent pattern or practice of disclosure errors, a gross
negligence or a willful violation of the Act.
OTS Mortgage Regulations: These provide that sufficient disclosures regarding the
interest rate and the adjustments (in case of ARMs) need to be provided before the
processing fee is paid for a mortgage. The information to be disclosed includes the fact
that the interest rate may change, the index or formula for these adjustments, and the
breakup of interest rate & principal. This is applicable only to Thrifts14.
Real Estate Settlement Procedures Act (RESPA): RESPA requires lenders, mortgage
brokers, or servicers of home loans to provide borrowers with pertinent and timely
disclosures regarding the nature and costs of the real estate settlement process.
Homeowners Protection Act: This Act addresses homeowners’ difficulties in canceling

private mortgage insurance (PMI) coverage. This act established rules for mortgages
14
In the US Depository institutions are classified into Commercial Banks, Thrifts (Comprising
Savings banks Saving & Loans associations), and Credit unions. Each of these have their own
regulatory organizations and regulations.
Page 64 of 186
signed on or after July 29, 1999, that require the automatic termination of PMI after the
borrower reaches 22% equity in the home, based on the original property value.
Apart from terminating PMI, it also established disclosure and notification requirements,
and requires the return of unearned premiums.
Consumer Leasing Act (CLA): CLA assures that meaningful and accurate disclosure of
lease terms is provided to consumers before entering into a contract. This enables
consumers to easily compare one lease with another, as well as compare the cost of
leasing with the cost of buying on credit or the opportunity cost of paying cash.
Electronic Fund Transfer Act: EFTA framework establishing the rights, liabilities and
responsibilities of consumers who use electronic fund transfer (EFT) services and
financial institutions that offer these services.
Flood Disaster Protection Act: FDPA requires federal financial regulatory agencies to
adopt regulations prohibiting their regulated lending institutions from making, increasing,
extending or renewing a loan secured by improved real estate or a mobile home located
or to be located in a SFHA (Special Flood Hazard Areas) in a community participating in
the NFIP unless the property securing the loan is covered by flood insurance.
Right to Financial Privacy Act (RTFPA): RTFPA provides customers reasonable

amount of privacy for their financial transactions. It requires that the customer must
receive a written notice of the agency's intent to obtain financial records, an explanation
of the purpose for which the records are sought, and a statement describing procedures
to use if the customer does not wish such records or information to be made available.
Fair Debt Collection Practices Act: This is designed to eliminate abusive, deceptive
and unfair debt collection practices for a consumer loan taken for personal, family or
household purposes.
Homeownership Counseling Procedures: A creditor or mortgage servicer must

provide notification of the availability of homeownership counseling to a homeowner,
eligible for counseling, who fails to pay any amount by the due date under the terms of
the home loan. The eligibility is in cases where the borrower has problems with the
capability to pay and the house mortgaged is the primary residence.
MARKET LANDSCAPE & TRENDS

The key trends in the mortgage market include:
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Due to the interest rate cuts in 2000 and later, there has been a boom in mortgage
refinances, which accounted for most of mortgage originations in till end 2003.
There has been a consolidation of mortgage firms with multiple mergers and
acquisitions. The top 10 originators accounted for 61% of originations in 2001 as against
21% of originations in 1990.
Along with the consolidation, there has been an unbundling of Mortgage activities with
vertical disintegration into Originating firms, Servicing firms, and Investors. There also
has been consolidation in the servicing space wherein the market share of the top ten
firms rose from over 11 percent in 1990 to over 49 percent in 2002, while the market
share of the top 25 firms rose from 17 percent to nearly 62 percent during the same
period. The scale economies achieved through automation of servicing operations have
allowed the most efficient lenders to increase the size of their servicing portfolios.
There has also been an increase in the securitization of loans in the market providing
greater liquidity to the lenders. This has also led to a increase in the market size for
mortgages.
Increased regulations including TILA, RESPA etc. governing the mortgage processes
are causing additional load to the processes.
IT applications in the Mortgage industry

Like most industries that have a long history of automation, mortgage too has its
computing foundation built on systems whose functionality is department centric. The IT
systems in the mortgage industry can be classified very broadly using the various
phases of loan processing of
• Loan Origination & Production

• Loan Servicing
• Secondary Market Sales
Loan Origination Systems support functionality required for prospecting, application

capture, underwriting, and closure of a loan. The various systems that come under her
classification include
• Contact Management, CRM tools

• POS applications
• Automated Underwriting systems, Electronic Underwriting Networks
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• Document Management Systems (Imaging & workflow software) for closing &
loan documentation
All the above are not available in a single system and most of these are off the shelf
products.
Loan Servicing Software provides the functionality required for servicing the loan. The
functionalities supported include
• Payment processing
• Escrow administration
• Accounting
• Status reporting
• Delinquency & collection
The processes for servicing are backend, standardized and rigid. Hence the applications
generally used are home grown systems giving almost all the above features.
Secondary Sales Systems are used in the sales of mortgage loans in the secondary
market. The functionality supported includes:
• Pipeline management & Settlement

• Accounting (Mark-to-market)
• Loan Pricing & Profitability Analysis
• Risk management analysis & reporting
The key trends in IT systems in the mortgage industry include
• Automation in the origination systems: This is primarily in the fields of scoring

technology for generating credit reports for borrowers, Automated Underwriting
Systems that ensure that the loans confirm with the standards of secondary market,
and Automated Valuation Models that are property-level databases and
sophisticated modeling techniques to estimate the market values for properties.
• Electronic Partner Networks: These are the B2B networks that automate the
settlement process by connecting the lenders and various settlement providers.
Some of the key systems include Loanprospector.com from Freddie Mac and
MornetPLus from Fannie Mae.
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• Internet as the sourcing channel: Increasingly more and more mortgages are being
originated on the Internet. The players include full service providers like Countrywide,
WaMu, JPMC, IndyMac, as well as referral sites like lendingtree.com and
MortgageIT.com
• End to end automation: There are initiatives aimed at standardization of the common
business transactions in the mortgage industry. The initiatives by MISMO (Mortgage
Industry Standards Maintenance Organization) aim to provide a XML based
architecture for mortgage origination, servicing and secondary market transactions.
Page 68 of 186
Auto loan pricing varies widely

from lender to lender, with
AUTO LOANS differences in rates of two
percentage points or more in
Auto loans are given to consumers for the purchase of some areas.
new or used Automobiles i.e. cars or motorbikes. With
prices averaging more than $20,000 for a new car and New Auto Loan Averages
$9,500 for a four-year-old car, most consumers need Selected Metropolitan Areas -
financing to acquire a vehicle. About 70% of all vehicles March 2004
purchased in the U.S are financed in some way. This New York City, NY 6.96%
gives an indication of the total market size of Auto
Los Angeles, CA 7.23%
loans.
Chicago, IL 6.23%
TYPES OF FINANCING OPTIONS Philadelphia, PA 7.28%
There are two financing options that the buyer can use Detroit, MI 6.55%
to procure a car. These are Washington, DC 6.40%
Dallas, TX 6.21%
Direct Lending
San Francisco, CA 6.68%
In direct lending loans are furnished directly from the
financing company. Buyer contacts the finance Rates apply to a $15,000 fixed-
company either through their website or otherwise for rate loan made to good credit
the disbursement of the loan. Buyer uses the loan quality borrowers.
proceeds from the financing company to pay the
dealership for the vehicle. Increasingly consumers are
using the Internet to arrange for vehicle loans.
Dealer Financing
This is the most common type of financing option used. In this case, the buyer and a
dealer enter into a contract wherein the dealer finances the automobile to the buyer. The
dealership may retain the contract, but usually sells it to an assignee (such as a bank,
finance company or credit union), which services the account and collects the payments.
The other option commonly used by buyers is leasing. Apart from this, hire purchase and
refinancing are also used to a smaller extent.
Car Leasing
This is the option wherein the borrower pays monthly payments towards using the
automobile for the term of the lease. At the end of the lease the lessee returns the
vehicle to the leasing company such that it meets the agreed standards on wear and
tear.
The options available with car leasing are similar to the ones available with financing.
However, the monthly payments associated with a lease are normally lower than for a
purchase. This is because the borrower only pays for the depreciation on the car. At the
Page 69 of 186
end of the lease term, the lessee needs to turn in the car or purchase the car at the
agreed price.
Hire Purchase agreement is simply a contract where the 'owner' of the automobile
allows the 'hirer' the right to possess and use the automobile in return for regular
payments. When the final payment is made, the title to the car is transferred to the
borrower.
Zero Interest loans

One of the types of loans available to customers is a Zero interest loan. In these loans,
the lenders provide loans where the repayment does not include any interest
component. In this case, the manufacturer or the dealer (or a combination of both)
finance the interest component upfront.
However, there are additional charges that need to be paid up-front by the buyer for this
kind of loan. Credit scores of the borrowers is also a major driver affecting this rate. The
lowest rates are reserved only for those with the best credit.
Using this kind of loan, a buyer cannot buy any kind of a car. Many car models are
excluded. Generally the most popular, high demand vehicles and new models are not
included. In most cases, vehicles must be taken from dealer stock, limiting the choice of
vehicle options. The length of loan term also affects the rate offered. Most interest-free
financing offers require short terms of 24 to 36 months. This results in significantly higher
monthly payments.
Virtual Check
Some banks also provide the option of getting a blanket loan for the purchase of a
specific automobile. This is known as virtual draft or a virtual check and can be used like
a check to procure a vehicle after negotiating with the dealer. This again can be
considered a kind of direct lending.
Auto Refinance
This is a loan that settles the borrower’s existing car loan. The auto refinancing process
is very similar to refinancing a mortgage. Normally, people refinance so that they can
receive loans at a reduced interest rate thereby reducing the total interest costs and the
monthly payments.. The new lender pays off borrower’s existing car loan and the title to
her automobile is turned over to the new lender. This is not used as often as in
mortgages as the value of the collateral – the car – decreases with time unlike the case
of a home and hence the interest rates on a loan for cars are higher than those for a new
car.
Page 70 of 186
Auto loan basics

All auto loans are secured loans and a collateral needs to be submitted by the borrower
as a guarantee against default. This collateral can be either home equity or the
automobile purchased. Auto loans are available for 3-year, 5-year, 6-year & 7-year loan
terms. Average Auto loan term is 63 months.
The term of new auto loans can be from 3 to 7 years while used car loans normally have
shorter terms depending on the type and age of the vehicle being purchased. Interest
rates charged for vehicle loans can vary based on the term, the lender and the credit
rating of the purchaser. Auto loans are available under both - fixed and variable interest
rates. Variable-rate auto loans aren't widely available, and where available are likely to
be based on the prime-lending rate.
The closing costs involved with an Auto loan include:

• Sales taxes. State and local sales taxes are typically assessed on the full
purchase price. However, if a vehicle is traded as part of the purchase, sales tax
may be assessed on only the purchase price less the trade-in value, depending
on state laws.
• Vehicle license and registration fees
• Vehicle title fee
• Dealership documentation fee
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• Credit application fee.
The monthly loan payment in Auto loans consists of four items:

• Principal Amount - the purchase price of the vehicle plus up-front sales tax and
other amounts chosen to be financed, less any down payment.
• Interest charged by the creditor on the amount financed
• Other finance charges such as payments for credit report fees or required credit
life insurance, which together with interest determine the annual percentage rate
(APR)
• Any other fees associated with the purchase.
Payoff methods. There are different formulas for calculating finance payoff amounts.
The payoff amount will depend on the method the lender uses to compute interest on the
loan. These methods include
Simple Interest method

Example:
Amount financed $18,800.00
Term 48 months
APR 9.00%
Monthly payment $467.84 (Calculated using the PMT function in MS excel)
First payment interest = $18,800 × 9% ÷ 12 = $141.00
First payment principal = $467.84 – $141.00 = $326.84
End of month 1 net loan balance = $18,800.00 – $326.84 = $18,473.16
Second payment interest = $18,473.16 × 9% ÷ 12 = $138.55

Dealer Loans
Second payment principal = $467.84 – $138.55 = $329.29
The other kind of financing in the automobile sector are dealer loans. These are loans given
End ofby
to Auto Dealers month
the 2lenders
net loanfor
balance = $18,473.16
buying – $329.29
automobiles or to =be$18,143.87
used as working capital.
However, these areinterest
Full-term not retail or consumer
= ($467.84 loans.= $3,656.32
× 48) – $18,800 These come under the category of
commercial loans provided to businesses and can be classified into:
If an additional $1,000 principal is paid at the end of the first month, the loan balance is
Wholesale Financing: These
reduced from are loans
$18,473.16 provided toMonth
to $17,473.16. dealers to finance
2 interest the purchase
charges of vehicle
will be based on this
inventory and are also known as floor plan financing.
reduced balance, so more principal will be credited from each payment. If the remaining
payments
Other Financing: areinclude
These made on timetoordealers
loans within for
the working
grace period, themaking
capital, loan will be repaid in 45
improvements to
months rather
dealership facilities, and tothan 48 months
purchase andbecause
financeofdealership
the extra $1,000 principal payment in month 1.
real estate.
The total interest paid will be $3,224.84 instead of $3,656.32, a savings of $431.48 in
interest.
Page 74 of 186
over the loan term. The Simple Interest method is usually the least expensive
way of computing the finance charge, and an early payoff will usually be less
expensive than under the other methods of computing interest. It is always less
than under the Rule of 78 method.
• Rule of 78 Method - For some loans, lenders "precompute" the interest. That is,
they compute the amount of interest that will accrue based on the entire loan
amount. That interest becomes part of the total amount owed. With this kind of
loan, the borrower is contractually obligated to repay the principal plus all the
precomputed interest. However, the borrower receives a rebate of the portion of
interest paid that is considered "unearned," or this unearned amount is deducted
when the payoff amount is calculated. Under this method, when the borrower
pays off the loan early, even if each payment is made on the due date or within
any grace period, she usually will pay more interest than under the other
methods described in this section. This "overpayment" results because the
lender earns the interest faster, so that less of each payment during the earlier
months of the loan reduces the principal balance. Therefore, the early payoff will
Rule of 78 Method
Example:
Term 48 months
APR 9.00%
Monthly payment $467.84 (Calculated using the PMT function in MS excel).
Hence, Full-term interest = ($467.84 × 48) – $18,800 = $3,656.32
So, the First payment interest = $3,656.32 × (48 ÷ (1+2+3...48)) = $149.23
Second payment interest = $3,656.32 × (47 ÷ (1+2+3...48)) = $146.13
Additional payments do not reduce the loan balance in the month paid. If an additional
$1,000 is paid at the end of the first month, it is treated as prepayment of the monthly
payments due at the end of months 2 and 3. If the remaining payments are made on time
or within the grace period, there is no savings of the full-term projected interest because
the amount of interest in each payment is precomputed. If the loan is prepaid after 24
payments, the balance will be $54.81 higher than it would be under the Constant Yield
(Actuarial) method. This method does not provide any benefits for prepayments.
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be higher than under the other methods, assuming that all payments are made
on time.
• Constant Yield (Actuarial) method - As an alternative to the Rule of 78 method,

the Constant Yield (Actuarial) method can be used to calculate the rebate
amount in a precomputed finance agreement. Under this method, the amount of
each payment allocated to interest is generally determined by multiplying the
outstanding principal balance by the monthly interest rate (the remainder of each
monthly payment is credited to principal). Under this method, the lender earns
interest at an equal rate over the term of the loan.
Constant Yield (Actuarial) method
Example:
Term 48 months
APR 9.00%
Monthly payment $467.84 (Calculated using the PMT function in MS excel)
First payment interest = $18,800 × 9% ÷ 12 = $141.00
Second payment interest = $18,473.16 × 9% ÷ 12 = $138.55
Full-term interest = ($467.84 × 48) – $18,800 = $3,656.32
•
Daily Simple Interest method - The Daily Simple Interest method enables lenders
to accrue interest on loans daily by applying a periodic rate to the outstanding
balance. Under this method, the lender's calculations and the borrower’s paying
habits determine the amount of total interest due and the amount of the final
payment.
For example, if the borrower makes any periodic payment before its due date (for
example, on the 12th when the scheduled due date is the 15th) and then makes
each subsequent payment on the same date every month, she will pay less
interest and should get a rebate after her last payment. This advantage occurs
because the loan balance declines more rapidly and less interest accrues daily.
In contrast, if the payments are made after the scheduled due date (for example,
on the 18th of the month when the scheduled due date is the 15th), even if they
are made during a grace period, she'll end up paying more and will owe an
additional amount after the last scheduled payment. Depending on state law, the
borrower may or may not be subject to late charges for payments after any grace
period in addition to the interest that has accrued.
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PLAYERS INVOLVED
Auto Dealers Dealers sell new and used cars and are most common
origination points for auto loans. Dealers provide buyers with
options from various lenders and insurance firms. In some
cases, they also provide financing.
Insurance Agencies Car Insurance providers provide insurance in case of a vehicle

damage or theft. The top car insurance vendors are ERIE
Insurance, All State, and State Farm Insurance.
Lenders Lenders provide the financing for the purchase of the vehicle.
They can be Banks, Credit Unions, Online Direct Lenders &
Auto Finance Companies. Lenders have different Financing
products to offer to customers & Auto dealers based on their
requirements. Lenders sometimes sell their loan portfolios to
other lenders for servicing. Their funding sources include debt
and sales of receivables in Securitizations.
Servicers Servicing is about managing the payments from the buyers and
providing reports to the investors. Servicers can also resell their
loans to other servicing agents.
Credit Rating Credit Rating Agencies help Lenders to decide the interest rate
Agencies on auto loans by providing them with a credit report on each
borrower.
KEY CONCEPTS
Concept Definition
APR Annual Percentage Rate, this is based on the total interest

payment made during the loan and is calculated to the way it is
done in mortgages.
M.S.R.P The total Manufacturer's Suggested Retail Price. This may not
include the accessories and other items that are added to a
typical car purchase such as security systems, Vehicle
Identification Number (VIN) etching, etc.
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The total Base M.S.R.P. is the suggested retail price with no

options. The total Base M.S.R.P. plus Options price includes all
options. The consumer typically pays for more than “M.S.R.P
plus Options” due to additional accessories (over and above the
basic items listed above) that are a part of the purchase.
Backend This is a dealer profit center that includes financing, insurance,

warranties, VIN etching, and other value adds/ accessories that
are added to the deal that requires financing.
Factory invoice The invoice from the manufacturer to the dealer that is
supposed to be their purchase price. It is not the dealer’s actual
cost because of holdbacks, advertising fees, gasoline charges,
dealer discounts, rebates, and other such dealer incentives.
Holdback: Money/ incentive the dealer gets from the

manufacturer if the car is sold within a specified time (usually
three months)
Prepayment Penalty A fee that some loans charge if the loan is paid off before the
end of the term.
Simple Interest Also known as "flat rate interest," simple interest is calculated
Loans only on the initial amount of the loan by multiplying the principal
balance by the rate of interest andthe term of the loan. This
number is then divided by the number of months of the loan for
the amount of interest to be paid each month.
Trade-in allowance The amount of money taken off the purchase price of the new
car in case the buyer does a trade-in of her old car.
Upside-down Loan An upside down loan is a situation wherein the amount owed by
the borrower is more than the value of the car. In this case,
selling off the vehicle cannot close the loan, as the money
realized on selling will not be sufficient to close the loan.
Credit Insurance Optional insurance that pays the scheduled unpaid balance if
the borrower dies or scheduled monthly payments if she
becomes disabled.
Guaranteed Auto Optional protection that pays the difference between the amount
Protection (GAP) owed on the vehicle and the amount received from the
insurance company if the vehicle is stolen or destroyed before
the repayment of the loan. This is necessary as the vehicle
depreciates very fast in the initial stages of a loan.
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AUTO LOAN PROCESS

The Auto loan process can be divided into Loan origination, Servicing, and Secondary
marketing.
Loan Origination
The borrower goes to the lender directly (Direct Lending) or through a dealer (Indirect
Lending). The borrower decides on the automobile, she wants to purchase & asks dealer
about the loan options available. The dealer makes a commission on the loan (by
regulation the commission cannot be more than 3%).
The borrower fills a loan application and hands it to the dealer. The application typically
Credit
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has information including the name, Social Security number, date of birth, current and
previous addresses and length of stay, current and previous employers and length of
employment, occupation, sources of income, total gross monthly income, and financial
information on existing credit accounts. Based on these and additional information like
loan amount required and down payment willing to be paid, a pre-qualification is done.
Some lenders also allow the borrower to have a co-signee in the loan. A co-signer
assumes equal responsibility for the contract, and the account history will be reflected on
the co-signer’s credit history as well.
Dealers typically sell the contract to a lender, such as a bank, finance company or credit
union. The dealership submits the credit application to one or more of these potential
lenders to determine their willingness to purchase the contract from the dealer.
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The lender passes the loan application through its underwriting process. It contacts a
credit rating agency to check the creditworthiness of the borrower. Credit rating Agency
generates a credit report (containing the credit score) of the borrower based on her past
debt history. The level of sophistication ranges from simply using the generic credit
score or bankruptcy score on the credit bureau to implementing customized scorecards
that have been developed and tested with the lender’s own credit applications. Some of
the scorecards, called regional scorecards are also designed for particular markets.
Appraisal Service providers help in determining the value of the collateral in the loan, in
the case of a used car. For some cases a manual review is done. After the underwriting
process, the lender decides whether it is willing to buy the contract, notifies the
dealership of its decision and, if applicable, offers the dealership a wholesale rate at
which the assignee will buy the contract, often called the “buy rate.”
Dealers also route the borrowers application to different Insurance Agencies. To protect
their interest in the collateral, most automobile lenders require physical damage
insurance coverage equal to the loan amount, with the lender named as loss payee on
the policy.
Dealers collect all the necessary documents (salary slips, car insurance, residence
proofs etc.) form the borrower for all the verifications. After the underwriting process, the
interest rate and other terms are negotiated between the borrower and the lender
through the dealer, necessary paperwork executed and the amount granted to the
borrower. This process is called ‘closing’ of the loan.
In case the Loan is turned down (due to bad credit history), the lender might forward the
loan application to a sub-prime lender, for a fee (the sub-prime lender pays the fee).
Sub-prime lenders are financial institutions that give credit to borrowers with bad credit
history on a high interest rates.
Once the loan is closed, it can be either retained in the lender’s portfolio, in which case
the lender continues to ‘own’ the loan. Alternately, certain types of loans are put for sale
in secondary market. In this case, the loans are sold to another entity so that the lender
has money to make more loans.
Loan servicing
Lenders can service the loans themselves or sell them to a servicing firm. In cases
where third-party servicers are employed, the fee paid is traditionally a percentage fee
which ranges from 1% for prime quality pools to 3.5% for sub-prime pools. In certain
arrangements, the fee can also be charged on a monthly dollar-per-contract basis.
Typical servicing duties in car loans include the following
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Payment management - Applying monthly payments from customers, and passing

them back to the investors.
Managing security interest - Monitoring insurance coverage for lease vehicles. Some
companies have systems to track continuance of coverage and notify borrowers of any
lapses. Many lenders also have backup insurance in case the obligors’ insurance
policies lapse. Some lenders pay for or require the borrower to pay for vendor single
interest (VSI) coverage at time of financing. This protects the lender for the outstanding
loan amount in case of a skip, or if the car is repossessed and there is uninsured
damage to the vehicle. Other lenders will self-insure (through special-loss reserves), or
will force-place insurance. Many companies, however, have moved away from force-
placing insurance due to recent lawsuits over the excessive premiums that were
charged.
Investor reporting - Providing billing statements to customers, responding to customer

inquiries, and releasing security interests on paid-off finance contracts.
Collection management - This function involves managing accounts that have

delinquency by collecting the payments. It also includes providing lease extensions or
payment deferrals to cure delinquencies for borrowers who have suffered temporary
unemployment or some other unexpected financial hardship. This function is sometimes
carried out by the servicer or is outsourced to a firm that specializes in this.
Most collection departments are organized in one of two ways — stage-of-delinquency
or cradle-to-grave. Departments organized by stage-of delinquency typically have junior
collectors on early stage delinquencies and senior collectors for more serious late stage
delinquents. Departments could also be organized with a cradle-to-grave philosophy
wherein one collector works on an account from its earliest stage of delinquency all the
way up to assignment for repossession.
Delinquencies and losses are especially acute in the sub-prime segment. Sub-prime
companies generally call delinquent obligors within the first 10 days of delinquency, with
some companies calling as early as the first day.
Chargeoff, Repossession, and Disposition - This function involves repossession of

the leased vehicle in case the payments cannot be made and disposing the vehicle to
close the lease. Each lender has a Charge-off policy that writes off a receivable after a
set period of days of delinquency, and the timelines for repossessing and liquidating the
asset. The captives and other prime lenders generally repossess between 60- to 90-
days of delinquency, but most “C” quality finance companies that provide loans to
subprime lenders repossess between 45- to 60-days of delinquency. Early repossession
prevents further depreciation and gives delinquent obligors little time to skip town with
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the vehicle or damage it. Most auto finance companies auction repossessed vehicles to
used-car dealers, some remarket the vehicles on either their own used car lots or on the
lots of unaffiliated dealerships. The major benefit of this method is in higher recovery
proceeds. This results from selling vehicles to the end user at retail prices, versus selling
them to other dealers at auction prices.
Lenders might also use a backup servicer in case of sub-prime loans. There could be an
active backup servicer that can serve as an independent reviewer of monthly servicing
reports and adherence to performance criteria. The backup servicer could also step in as
a successive servicer in case there are performance issues with primary servicer.
Secondary marketing
Auto loans Asset Backed Securities (ABS) are securities whose underlying securities are
Auto loans. However, auto leases, agricultural machinery loans, and car dealer floor-
plan securitizations are also often included under the umbrella of Auto ABS.
With close to $190 billion outstanding at the end of 2001, auto ABS makes up the
second largest non-residential ABS sector. The primary players in the origination of
these securities are
Comparing Auto Loan collateral with Residential Mortgages

Some characteristics of the underlying loans and assets which distinguish
auto loans ABS from RMBS.
First, auto loan terms are significantly shorter than mortgage loans. Terms
typically range from three to five years, with some in the six to eight year
maturity ranges.
Second, automobiles are depreciating assets. This has important
consequences for refinancing behavior, default and recovery of losses. For
a refinancing to occur, the future lender must see some equity left in the
vehicle, or the borrower must put up additional cash. In addition, since
equity in the vehicle can become negative, the default option is more
attractive to borrowers. And if a default occurs, recovery levels can be low,
as the vehicles need to be auctioned.
•
The captive finance firms – This market is dominated by wings of the big three
automakers GM, Ford, & DiamlerChrysler
• Commercial banks
Auto loan lenders create a pool of loans and sell it to a bankruptcy-remote special
purpose subsidiary. This subsidiary then establishes a separate Special Purpose Entity
(SPE), usually a trust, and transfers the receivables to the SPE in exchange for the
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proceeds from securities issued by the SPE. The SPEs are used as bankruptcy-remote
vehicles that hold collateral on behalf of investors and administer the distribution of cash
flows. This is helpful to the investors as even if an issuer becomes bankrupt, the trust,
which is a separate entity continues to pay the proceeds to investors.
SPEs issue securities, most of which are sold to investors (Pension Funds, Insurance
Companies and Commercial Banks) in public offerings or private transactions.
The vast majority of loans in auto securitizations are dealer-financing loans, although
some securitizations contain direct loans as well. Further information can be found in
Appendix E.
AUTO LEASES
Leasing continues to be an important segment of the automobile finance market,
accounting for nearly one-third of all new retail vehicle sales over the past two years.
Once, leasing was a way to finance new high-end luxury cars; however, recently it has
become a common financing method for all types of automobiles, including used
vehicles. Leasing owes its popularity to the rapid increase in new car prices in the late
1980s and the 1990s, as leases allow consumers to drive cars that ordinarily would be
too expensive to purchase and puts them in new cars every few years.
Both individuals and businesses use leases to finance their vehicle acquisition.
Consumers lease which we focus on here is defined as a lease of personal property to
an individual to be used primarily for personal, family, or household purposes for a
period of more than 4 months and with a total contractual obligation of no more than
$25,000.
In a typical consumer auto lease transaction, the lessor purchases a vehicle from the
manufacturer or dealer and leases it to the consumer. The consumer, or lessee, pays
the lessor for the right to use the vehicle during the term of the lease. The lessee’s
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monthly payment is a function of four variables, each of which is determined at the time
the contract is written
• The net capitalized cost of the vehicle: The net capitalized cost of the vehicle
is the negotiated purchase price plus fees and taxes, less any down payment.
• The residual value of the vehicle: This represents an estimate of a leased
vehicle’s resale value at the end of a lease, typically figured as a percentage of
the manufacturer’s suggested retail price.
• The term of the lease: Lease terms can vary from 12–60 months, typically in
increments of six or 12 months.
• The money factor: The money factor is analogous to an annual percentage rate
(APR) on a retail auto loan in the sense that it essentially represents a financing
charge. The money factor on a lease contract can be converted to an
approximate APR by multiplying by 2400. This approximate APR is not directly
comparable with auto loan APR’s since it is applied to an average rather than an
amortizing balance; however, it does allow consumers to differentiate among
lease offers.
Calculation of a Lessee’s Monthly Payment ($)
1 Manufacturer’s Suggested Retail Price (MSRP) 25,000

2 Negotiated Purchase Price 22,500
3 Down Payment 500
4 Taxes and Fees 800
5 Net Capitalized Cost (2 + 4 – 3) 22,800
6 Residual Value at 65% MSRP (0.65 x 1) 16,250
7 Lease Term (Months.) 36
8 Money Factor 0.00316
9 Monthly Payment 305.53
10 Approximate Annual Percentage Rate (%) (2400 x 8) 7.60
The table above provides a numerical example of the calculation of a lessee’s monthly
payment, which is equal to the sum of:
• The difference between the net capitalized cost and the residual value, divided by the
lease term, and
• The sum of the net capitalized cost and the residual value, multiplied by the money
factor.
The first part of this equation represents the principal component of the monthly
payment, while the second part represents the “interest” portion.
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Benefits of leasing
Leasing provides multiple benefits to all the parties involved in the transaction -
consumers, manufacturers, and finance companies.
Consumers
• In most instances, leasing results in a lower monthly payment for consumers
because, under a lease contract, consumers pay only for that portion of the
vehicle actually being used (i.e. the depreciation of the vehicle over the life of the
lease contract). As a result of the lower monthly payments, consumers are able
to get more car for their money and drive a new car every two to four years,
depending on the term of the lease contract.
Advantage Captive Finance companies

Any company involved in auto leasing may end up involved in the
used car business due to off-lease vehicle returns, which must be
disposed of in a timely and efficient manner to realize the greatest
residual value on the vehicle. The captive finance subsidiaries have
significant advantages over their competitors in this area due to the
relationship with their manufacturing parent. In times of high vehicle
returns, such as the current environment, the captives can look for
support from the manufacturers and their dealers for vehicle
disposition. The manufacturers and dealers can ship the vehicles to
areas of high demand, resulting in maximum residual value
realization.
Most banks and independents do not have this luxury and must find
other solutions, such as wholesale auctions or developing their own
relationships with dealers.
•
Most leases require little or no down payment, and, in most states, sales tax is
charged on the monthly payment rather than on the initial vehicle price (as is the
case with auto purchases).
• An additional benefit to leasing is low maintenance costs and other used
vehicle headaches, since by selecting a lease term that coincides with the length
of the manufacturer’s warranty, most major repairs and maintenance will be
covered.
• At lease termination, the lessee has the option to purchase the vehicle or return
it to the leasing company and, therefore, the lessee is not required to remarket or
sell the used vehicle. Moreover, the lessee can obtain a new vehicle by “rolling
over” the lease.
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Manufacturers: Leasing allows manufacturers to maintain sales and customer loyalty

and market a wider variety of vehicles to a more diverse client base. Through leasing,
manufacturers are able to sell a larger number of high-end, higher margin vehicles.
• Manufacturers are able to take advantage of the affordability of leasing by
targeting a wider array of customers with different income levels for a given
vehicle price range.
• A consumer who ordinarily could not buy a vehicle outside of a specific price
range is a potential customer for a higher priced vehicle through leasing.
Similarly customers that previously could afford only to purchase a used vehicle
may now qualify for leasing a new vehicle.
Finance firms - Auto leasing benefits finance companies by providing higher finance
charges than traditional auto loans — primarily because rent charges on a lease are
calculated from the adjusted capitalized cost over the life of the contract, whereas
interest on an auto loan is based on the amortizing balance of that loan.
Lease Types
The two main kinds of leases are close-ended and open-ended leases.
Closed-end lease ("walk-away" lease) - A lease in which the lessee is not responsible
for the difference if the actual value of the vehicle at the scheduled end of the lease is
less than the residual value. The lessee may however be responsible for excess wear,
excess mileage charges and for other lease requirements.
Open-end lease - A lease agreement in which the amount owed at the end of the lease
term is based on the difference between the residual value of the leased property and its
realized value. The lease agreement may provide for a refund of any excess if the
realized value is greater than the residual value.
In this case, the liability of the lessor is limited by the three-payment rule. According to
this rule, assuming the lessee has met the mileage and wear standards, the residual
value is considered unreasonable if it exceeds the realized value by more than 3 times
the base monthly payment (called the "three-payment rule").
On the other hand, if the lessee believes that the amount owed at the end of the lease
term is unreasonable and refuses to pay, she cannot be forced to pay the excess
amount unless the lessor brings a successful court action and also pays reasonable
attorney's fees.
This type of lease is seldom used today for non-commercial leases.
Single-payment
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A single-payment lease is a lease agreement that requires a single large payment made
in advance rather than periodic payments made over the term of the lease. Because the
lessor is making this payment in advance, this lump-sum payment should be less than
the sum total of periodic payments over the term of the lease.
Multiple-payment
A multiple-payment lease is a lease agreement in which the lessor makes payments
periodically, usually monthly. Most leases are multiple-payment leases.
Full maintenance lease - A lease in which the lessor or assignee assumes

responsibility for all manufacturer-recommended maintenance and service on the
vehicle. The lease may also cover additional mechanical repairs and servicing during the
term of the lease. The cost of this service is usually included in the gross capitalized cost
or is added to the base monthly payment.
In all the leases, the lessee is responsible for the vehicle’s maintenance and insurance
for the duration of the lease. However, as most lease terms coincide with the
manufacturer’s warranty, maintenance is a minor concern for the lessee. At the maturity
of the lease, lessees typically have an option to purchase the vehicle for the stated
residual value. If the actual retail value of the vehicle is greater than the contractual
residual value, the lessee is likely to purchase the vehicle. Otherwise, the lessee will
return the vehicle to the dealership from which it was leased, and the dealer will have the
option to purchase it. The dealer will compare the vehicle’s stated residual value to
wholesale used auto prices in making a purchase decision. If the dealer also chooses
not to buy the vehicle, the lessor takes possession and assumes responsibility for
vehicle disposition and residual value realization.
Key Concepts
Concept Definition
Capitalized Shortened term for either gross capitalized cost or adjusted

cost capitalized cost, both of which are required disclosures under Federal
law. Some states in the US also require that the term "capitalized
cost" be used in state lease disclosures.
Gross capitalized cost: The agreed-upon value of the vehicle, which

generally may be negotiated, plus any items you agree to pay for over
the lease term (amortized amounts), such as taxes, fees, service
contracts, insurance, and any prior credit or lease balance.
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Adjusted capitalized cost: The amount capitalized at the beginning

of the lease, equal to the gross capitalized cost minus the sum of any
down payment, net trade-in allowance, and rebate (this sum is
referred to as capitalized cost reduction). This amount is sometimes
referred to as the net cap cost.
Acquisition A charge included in most lease transactions that is either paid up-
fee front or is included in the gross capitalized cost. It usually covers a
variety of administrative costs, such as the costs of obtaining a credit
report, verifying insurance coverage, checking the accuracy and
completeness of the lease documentation, and entering the lease in
data processing and accounting systems. This may also be called a
bank fee, an administrative fee, or an assignment fee.
Gross cap cost
Assignee A third party that buys a lease agreement from a lessor. The lessee
- Reductions
becomes obligated to the assignee, and the assignee generally
assumes the=responsibilities
Adjusted of
capthe lessor, although some obligations
cost
may remain with the lessor. An assignee may be a lessor for purpose
- Residual value
of Regulation M when the assignee has substantial involvement in the
lease. = Depreciation
Regulation M,+ a part
Rentof the Consumer Leasing Act, ensures that
lessors provide all relevant information on the lease to lessees to
prevent any malpractices.
= Total forIt calculating
also specifies,
Base the content of information
to be disclosed, how it needs to be segregated, and that it needs to
monthly payments
be provided before the start of the lease.
÷ Lease term in months
Residual The estimated wholesale value of a leased vehicle at the end of the
Value =
lease term. This Base the
is what monthly
lessorpayment
believes the vehicle will be worth
when it is returned to them. Excessive mileage or wear and tear is not
factored into the residual value.
Base The portion of the monthly payment that covers depreciation, any
monthly amortized amounts, and rent charges. It is calculated by adding the
payment amount of depreciation, any other amortized amounts, and rent
charges and dividing the total by the number of months in the lease.
Monthly sales/use taxes and other monthly fees are added to this
base monthly payment to determine the total monthly payment.
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Excess Amount charged by a lessor or assignee to cover wear and tear on a

wear-and- leased vehicle beyond what is considered normal. The charge may
tear charge cover both interior and exterior damage, such as upholstery stains,
body dents and scrapes, and tire wear beyond the limits stated in the
lease agreement.
Excess When a lease is originated, a predetermined mileage cap is

Mileage established on the total mileage that the vehicle is contracted to be
driven during the lease term (usually 15,000 miles per year). If the
Charge
lessee exceeds this mileage cap, they will be charged a
predetermined amount for every mile they drive the vehicle in excess
of the mileage cap.
Note: The lessee can usually "buy" extra miles at lease inception for
a cost that is much less than the "excess mileage charge" per mile.
Sales/use Sales/use taxes are the mandatory additional sales taxes collected by
taxes vehicle dealers and leasing companies on all vehicle sales, rental and
leases. These vary from state to state and often from county to
county and are assessed on both leased and purchased vehicles.
There are often differences in what amounts are taxed and when the
taxes are assessed. In a lease, sales/use taxes may be assessed on
(1) The base monthly payment
(2) Any capitalized cost reduction, and
(3) In a few states, the adjusted capitalized cost.
In most states, the sales/use tax on the base monthly payment is paid
monthly; in some states, however, the tax is due at lease inception.
Sales/use taxes on the capitalized cost reduction and the adjusted
capitalized cost are usually due at lease inception.
Payoff Also known as "purchase price." At the end of the lease, if the lessee
Amount intends to purchase the vehicle, the payoff amount includes:
• The specified purchase amount of the vehicle, as stated in the
lease agreement
• Outstanding property taxes, as applicable in the state
• Any outstanding monthly payments
• Any official fees or state taxes due
Termination A fee charged by a lessor to cover the costs of taking possession of

or Turn-In the leased vehicle at the end of the lease.
Fee
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The Gap The gap is the difference between the early termination payoff
amount -the top line in the graph - and the insured value of the
vehicle - the bottom line in the graph - at any point in time during the
Early Termination Payoff

$
Gap
Insured
Value
Number of months
lease.
An example:
A car is totaled in an accident halfway through the lease. The
adjusted lease balance is $16,000. The insurance company estimates
the book value of the car to be $15,000, and the lessee has a $500
deductible; the insurance company pays $14,500. The difference
between the $16,000 owed on the lease and the $15,000 insured
value is “the gap.”
If there is no gap coverage, the lessee is responsible for the $1,000
gap and the $500 deductible. In case gap coverage exists, it will
cover the gap and the lessee is only responsible for the $500
deductible.
Many lessors will “waive” gap liability and the lessees wouldn’t have
to pay anything extra to have gap coverage. This type of gap
coverage is “paid for” in the fees the lessor charges. Other lessors
might not waive the gap liability but may offer gap coverage at an
additional charge (usually in the $400–$500 range).
Key Players
Lessors
The major players in the auto lessor market include the captive finance subsidiaries of
major auto manufacturers, banks, and independent leasing companies. The captives
have traditionally dominated auto leasing with more than two-thirds of the market;
however, banks and independents have been gaining market share.
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Most car firms have businesses selling certified used cars and this provides the captives
good cost advantage when they dispose off the vehicles after leases. Due to this, the
captives are typically more aggressive in setting residual values on leased vehicles to
make monthly payments more competitive, a practice referred to as subvention.
Independent Lease Company

Independent leasing companies lease directly to consumers and businesses and can
often offer a variety of leasing options. They are affiliated with several banks and/or
lenders and almost always work with several local dealers (to supply the vehicles). They
are to cars what mortgage brokers are to houses.
The other players including credit rating agencies, appraisal firms, and servicers play
similar roles as in auto financing.
Servicing of Auto leases involves the functions of Cash management, Investor
Reporting, and collections and is similar to the function for auto loans.
Secondary Market for Auto Leases

The World Omni 1994-A Automobile Lease Securitization Trust transaction marked the
first public term securitization backed by auto lease contracts. Since the debut of this
asset class, World Omni, as well as Ford Motor Credit Co. (Ford Credit), American
Honda Finance Corp. (Honda), and Toyota Motor Credit Corp. (Toyota) have completed
additional public securitizations. These four issuers have brought 15 publicly offered
lease transactions to market since August 1994, totaling approximately $15.7 billion.
While auto lease securitization’s share of the total auto ABS market has been limited, it
has grown from approximately 5.5% of total prime public auto ABS issuance in 1994 to
11.1% in 1999. For more details on the securitization process of auto lease backed
securities, refer to Appendix E.
IT APPLICATIONS IN AUTO LOANS

Technology Applications in auto loans can be split into two categories. Applications used
by lenders and the ones used by dealers.
Automation used by Lenders

Lenders typically use automation in the fields of loan origination and servicing. Loan
Origination Systems support functionality required for loan application capture,
underwriting, and closing of a loan. Loan Servicing Software provides the functionality
required for servicing the loan:
The technologies used for generating & underwriting loans typically include the following:
• Automated Underwriting
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• Automated bureau access, scoring, and analysis functions.

• Decision tools.
• Contract Administration.
• Document Imaging
The key functions in Loan Servicing where IT systems are used include:
• Administration & Payment Processing

• Delinquency
• Accounting & Status Reporting.
• Asset Management
• Portfolio Management.
Technologies used by Dealers

Typically, Dealers are required to record all the customer information in a credit
application, do a prequalification and forward the reports to the lenders and insurance
agencies. These applications are:
Reporting tools
Reporting for Lender Activity – view summaries of loan applications and contracts-in-
transit from electronically connected financing sources.
Reporting for Credit Bureau Activity - review how many credit reports dealership has
requested through a B2B network by credit bureau provider and credit score.
User Activity – view the number of applications submitted, credit reports pulled, and
additional activities by DealerTrack user within the dealership.
F & I (Finance & Insurance)

This Package is used by Dealers to record all the information about the potential
borrower and forward the same to financial institutions and insurance agents. The
applications typically routes the customer, financial & vehicle information to preferred
financing sources based on a customer’s credit profile. It is connected with a credit rating
agency to get the credit rating scores.
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A sample application provided by ProMaxOnline (ADP ,Reynolds & Reynolds) is shown

below:
For Leasing
This is primarily in the fields of Point-of-sale, Web enabled Forms and interfaces that
automate Lease Origination.
For Special Finance (Sub Prime Market)

These are packages that in view of low creditworthiness of the borrower, transfers
customer, financial and vehicle information instantly to all the preferred sub-prime
lenders and receives credit decisions immediately.
Multi Dealership Groups

Multi-dealership group gives all the dealerships within the group the ability to share data
in real time. Inventory data can be shared to make sure that a sale isn’t missed at one
dealership, if the desired vehicle is at another dealership. If a prospect goes from one
dealership to another group dealership, their information, including the credit application,
can be accessed for fast, making up for a consistent working of the deal. The trade-in
values from the first dealership are included to help maintain gross profit on the deal.
The various technology vendors who specialize in providing IT applications to different
Auto Lenders and dealers are:
• ProMaxOnline
• DealerSuite (ADP)
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• DealerTrack
• Fiserv
• Lending Tree
• Reynolds & Reynolds
• First American CMSI
• Digital Insight.
Recent IT Trends
Electronic Networks
These are B2B networks that automate the Loan origination process by connecting the
lenders and various dealers. Some of the key B2B networks include DealerTrack.
Selecting a car & obtaining finance online

More and more people are using the Internet as a channel for making their purchase
decisions as well as making the actual purchases.
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REGULATIONS GOVERNING THE AUTO LOAN INDUSTRY

Within the United States, Financial Institution’s operations are subject to regulations and
supervision under various federal regulations. These laws require these institutions to
provide certain disclosures to prospective borrowers in consumer retail financing
transactions and prohibit discriminatory credit practices.
The key regulations are:
Truth-in-Lending Act
The principal disclosures required under the Truth-in-Lending Act for retail finance
transactions include the terms of repayment, the amount financed, the total finance
charge and the annual percentage rate.
Equal Credit Opportunity Act

The Equal Credit Opportunity Act prohibits creditors from discriminating against credit
applicants on a variety of factors, including race, color, sex, age or marital status.
Pursuant to Regulation B promulgated under the Equal Credit Opportunity Act, creditors
are required to make certain disclosures regarding consumer rights and advise
consumers whose credit applications are not approved of the reasons for being denied.
In addition, any of the credit scoring systems that Financial Institutions use during the
application process or other processes must comply with the requirements for such
systems under the Equal Credit Opportunity Act and Regulation B.
Fair Credit Reporting Act

The Fair Credit Reporting Act requires Lenders to provide certain information to
consumers whose credit applications are not approved on the basis of a consumer credit
report obtained from a national credit bureau.
Federal Consumer Leasing Act (FCLA)

FCLA requires the leasing company (dealership, for example) to disclose certain
information before a lease is signed, including: the total amount of the initial payment;
the number and amounts of monthly payments; all fees charged, including license fees
and taxes; and the charges for default or late payments. For an automobile lease, the
lessor must additionally disclose the annual mileage allowance and charges for
excessive mileage; whether the lease can be terminated early; whether the leased
automobile can be purchased at the end of the lease; the price to buy at the end of the
lease; and any extra payments that may be required at the end of the lease.
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Regulation M: Regulation M
applies only to "consumer The specific content of disclosures required under Regulation M
leases" defined as contracts includes:
meeting each of the following
elements: • Description of property • Early termination
conditions and penalties
• Amount due at lease
signing or delivery • Maintenance
• The lease is for the use
responsibilities
of personal property, • Payment schedule and
such as an automobile; total amount of periodic • Purchase option
payments
• The lease has a term of • Statement referencing
more than four months; • Disclosure of other "non-segregated”
anticipated charges during disclosures
• The contractual normal execution of the
obligation does not • The right of appraisal
lease agreement
exceed $25,000. • Liability at the end of the
• Total of payments
lease term
• Payment calculation
Regulation M mandates that a • Fees and taxes
specific set of terms in any • Lease term • Insurance and warranties.
lease contract be disclosed so
that all the legal and financial
obligations between the lessor and the lessee are clear.
Reasonableness standard - The requirement of the Consumer Leasing Act that

charges for delinquency, default, or early termination be reasonable in light of the
lessor's or assignee's (1) anticipated or actual harm caused by such delinquency,
default, or early termination; (2) difficulties in proving loss; and (3) inconvenience in
obtaining a remedy.
Predatory Auto Lending Act

Predatory auto lending is the practice of charging consumers excessively high interest
rates for auto loans. This is a state law put in place in many states that requires dealers
to keep their sales records on file for at least seven years, showing how the credit
worthiness was determined.
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STUDENT LOANS
Education spending worldwide is over $2 trillion and it is a $750 billion market in the
United States. Of this, Higher education is a $250 billion market in the United States.
Education is a big industry in the U.S with more money being spent on education than in
any other industry with the exception of healthcare.
Student loans are available to students entering higher education to help them meet
their educational expenses. Once the student’s course has finished - and they are
earning enough money - they can start to pay back the loan.
Federal funding for post-secondary education began in 1944 with the Serviceman's
Readjustment Act. There are three categories of federal student aid:
Grants – This is financial aid that students don’t have to repay. To be eligible, the
student must be an undergraduate student, and the amount of aid received depends on
the need determined by parental /self contribution, cost of attendance and enrollment
status (full time or part time).
Maximum amounts available vary yearly as determined by Congress. During the 2003-
2004 school year, the amounts for Pell grant15 ranged from $400 to $4,050. Besides
financial need, the amount of a Pell grant also depends on costs to attend school, the
student's status as a full- or part-time student, and the student's plans to attend school
for a full academic year or less. Pell grant funds are paid directly to the student by the
school at least once each semester, trimester, or quarter.
Campus based programs like the Federal Supplemental Educational Opportunity Grant
(FSEOG), Federal Work-Study (FWS), and Federal Perkins Loan programs are
administered directly by the financial aid office at each participating school. Federal
funds for these programs are given to the schools and distributed to students at the
schools' discretion. Amounts students can receive depend on individual financial need,
amounts of other aid the student receives and the total availability of funds at the school.
Not all schools participate in all three programs. Unlike the Federal Pell Grant Program,
which provides funds to every eligible student, the campus-based programs provide a
certain amount of funds for each participating school to administer each year.
Federal Supplemental Educational Opportunity Grants (FSEOG) are gift aid
for undergraduates with exceptional financial need. Pell Grant recipients with the
lowest Expected Family Contribution (EFC) will be the first to get FSEOGs, which
don't have to be paid back. The students can get between $100 and $4,000 a
year, depending on when the application is made, the financial need, and the
15
The two federal grants given for eduation are (a) Federal Pell Grant: Assists undergraduate
students with financial need who are attending an eligible public or private postsecondary school.
And (b) Federal Supplemental Education Opportunity Grant: Assists undergraduate students with
financial need who are attending an eligible public or private postsecondary school.
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funding available at the school. These grants are awarded only to undergraduate
students who have not earned a bachelor's or a professional degree.
If a student is eligible, her school will credit her account, pay her directly (usually
by check), or use a combination of the two. The school must pay the student at
least once per term (semester, trimester, or quarter).
Federal Work-Study (FWS) provides part-time jobs for undergraduate and

graduate students with financial need, allowing them to earn money to help pay
education expenses. The program encourages community service work and work
related to the recipient's course of study. Federal Work-Study can help a sudent
get valuable experience in her chosen field before she leaves school.
Loans – This is borrowed money that a borrower must repay with interest. The borrower
can be an undergraduate or graduate student. Parents may also borrow to pay the
educational expenses of their dependent undergraduate students. Maximum loan
amounts depend on the student’s grade level in school.
TYPES OF STUDENT LOANS

Student loans are provided by both the private and public sectors and are available for
both undergraduate and graduate students, as well as to parents who are helping to pay
the educational expenses of dependent undergraduate students. Because student loans
are entitlement programs, any student who applies and who meets program eligibility
requirements can receive a student loan. Maximum loan amounts depend on the
student's year in school and on whether a student is independent from her parents. The
educational institutions for which a student may avail finance are: four-year or two-year
public or private educational institution, a career school, or a trade school.
A Student can avail of many different types of loans available in the market. These loans
can be classified into varous categories as described in the diagram below.
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Student
Loans
Federal
Loans Private
Loans
FFELP FDLP
Staffor PLUS Consolidati

d loans loans on loans
Federal Student Loans

In 1965 Congress passed the Higher Education Act (HEA) creating the Guaranteed
Student Loan Program (GSLP), providing funding for federal financial aid programs and
encouraging college enrollment. Guaranteed Student Loan Program was renamed the
Federal Family Education Loan Program (FFELP) in the 1992 HEA reauthorization.
Today, FFELP is a public-private partnership that provides affordable private sector
financing for students and their families seeking postsecondary education. After one
year as a pilot program in the 1992 HEA reauthorization, the Federal Direct Loan
Program (FDLP) became a full-scale program in 1993. In FDLP, the federal government
finances loans.
Federal student loans are loans guaranteed by the Federal Government against default
to finance a student’s education. The guarantee is via principal insurance of 98% or
100%, and is ultimately guaranteed by the Dept Of Education (DOE). Federal student
loans are made up of three primary programs:
• The Federal Family Education Loan Program (known as FFELP)

• The Federal Direct Loan Program (known as FDLP or Direct Loans)
• The Perkins Loan Program
Federal Family Education Loan Program (FFELP)

These are the student loans given by private sector lenders (mostly banks) to students
and their parents in partnership with school financial aid offices. These loans are
guaranteed against default by the US government. These loans also come with special
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benefits like a student who is in school at least half time is not required to make any loan
payments while they are in school.
The interest rates for the loans are capped (The Interest rates were capped at 8.25% in
2003) and taxpayers subsidize all federal student loans so that borrowers pay below-
market interest rates. Federal loan guarantees also lower the cost of borrowing for
higher education by making federal student loans available to any eligible borrower.
The interest rate on the majority of FFELP loans are floating, and reset only once a year
— effective from July 1 to June 30. The index for the interest rates is usually the 91-day
US Treasury bill (For ex, it was 91 T-bill + 1.7% in school and + 2.3% during repayment)
The closing costs for FFELP Loans include:

 Three percent is paid to the federal government to pay for the cost of the subsidized
federal student loan program.
 Loan fees - there is a limit of four percent for the amount that can be charged as the
loan fees.
 A fee that amounts to one percent of the principal borrowed is paid into a federally
owned reserve fund held by the guaranty agency to reimburse lenders in the event of
default and to pay for default prevention activities.
Loans made under the FFELP include:
Subsidized Federal Stafford Loans

These loans are provided to students who pass the financial needs criteria. The US
Department of Education, based on financial information submitted by the student,
calculates the EFC (Expected Family Contribution) of the borrower. The EFC is a
measure of borrower’s family’s financial strength and is based on her family’s income
and assets. The EFC indicates how much money borrower and her family are expected
to contribute towards cost of attendance in the school. If borrower’s EFC is below a
certain number, she’ll be eligible for this loan. This loan is the largest component of the
FFELP, due to the interest subsidy during the in-school period. The aggregate limit for
borrowing is $23,000 for undergraduate students and $65,500 for graduate students.
The federal government pays all interest costs for subsidized Stafford loan borrowers,
while borrowers are in school and during grace and deferment periods.
The interest rate on these loans change annually but is capped at a maximum rate of
8.25%.
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Unsubsidized Federal Stafford Loans

These are for students who do not pass the financial needs criteria or who need to
supplement their subsidized loans.
Year Rate Formula
Although borrowers may defer payment of
interest during school grace, and 2004-05 3.37% (1.066 + 2.3%, cap 8.25%)
deferment periods, they are responsible
for all interest that accrues. The interest 2003-04 3.42% (1.121 + 2.3%, cap 8.25%)
rate on these loans also changes annually 2002-03 4.06% (1.760 + 2.3%, cap 8.25%)
and is capped at a maximum rate of
8.25%. During the 2002 fiscal year almost 2001-02 5.99% (3.688 + 2.3%, cap 8.25%)
$12 billion in unsubsidized FFELP loans 2000-01 8.19% (5.893 + 2.3%, cap 8.25%)
were made. Undergraduate students can
borrow up to $46,000 and the loan limit 1999-00 6.92% (4.621 + 2.3%, cap 8.25%)
stretches to $138,500 for graduate Historical Interest rates on Stafford loans

students.
The amount students can borrow each year for Stafford Loans depends on whether they
are dependent students or independent students. An independent student is at least 24
years old, married, a graduate or professional student, a veteran, an orphan, a ward of
the court, or someone with legal dependents other than a spouse. A student who does
not meet any of the criteria for an independent student is a Dependant student. The total
debt outstanding that can be had from all Stafford Loans combined is
• $23,000 as a dependent undergraduate student
• $46,000 as an independent undergraduate student (only $23,000 of this amount
may be in subsidized loans)
• $138,500 as a graduate or professional student (only $65,500 of this amount
may be in subsidized loans). The graduate debt limit includes any Stafford Loans
received for undergraduate study.
Federal PLUS Loans

Federal PLUS Loans are for parents of dependent undergraduate students. Parents may
borrow up to the cost of attendance per child, minus financial aid from other sources.
The interest rate is variable, with a maximum of 9%. During the 2002 fiscal year more
than $3 billion in PLUS loans were made.
Federal Consolidation Loans

Loan Consolidation, also called a Consolidation Loan, combines several student or
parent loans into one bigger loan from a single lender, which is then used to pay off the
balances on the other loans. Consolidation loans are available for most federal loans,
some lenders offer consolidation loans for private loans as well.
Consolidation loans often reduce the size of the monthly payment by extending the term
of the loan beyond the 10-year repayment plan that is standard with federal loans.
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Depending on the loan amount, the term of the loan can be extended from 12 to 30
years.
• 10 years for less than $7,500;
• 12 years for $7,500 to $10,000;
• 15 years for $10,000 to $20,000;
• 20 years for $20,000 to $40,000;
• 25 years for $40,000 to $60,000; and
• 30 years for $60,000 and above.
The reduced monthly payment may make the repayment easier for some borrowers.
However, by extending the term of a loan the total amount of interest paid is increased.
In certain circumstances (for example, when one or more of the loans was being repaid
in less than 10 years because of minimum payment requirements), a consolidation loan
may decrease the monthly payment without extending the overall loan term beyond 10
years. In effect, the shorter-term loan is being extended to 10 years. The total amount of
interest paid will increase unless you continue to make the same monthly payment as
before, in which case the total amount of interest paid will decrease.
The interest rate on consolidation loans is the weighted average of the interest rates on
the loans being consolidated, rounded up to the nearest 1/8 of a percent and capped at
8.25%.
Thus, the key benefits of a consolidation loan include the following:
• Replacing payments on multiple loans with a single payment on the consolidation
loan
• Access to alternate repayment plans, such as extended repayment, graduated
repayment, and income contingent repayment. Although these plans may be
available to unconsolidated loans, the term of an extended repayment plan
depends on the balance of the loan, which is higher on a consolidation loan
• The ability to lock in the interest rate, including the ability to lock in the lower in-
school interest rate during the grace period.
However, there are a few drawbacks to consolidation:
• When a borrower consolidates during the grace period, the borrower has to begin
repayment immediately and loses the remainder of the grace period, including
possibly interest benefits on subsidized loans
• The borrower may lose some of the favorable loan forgiveness provisions on the
Perkins loan when it is included in the consolidation loan
• Extending the repayment term may increase the total interest paid over the
lifetime of the loan.
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• Current laws allow a borrower to consolidate loans only once. So if interest rates
go down, a borrower who has already consolidated will not be able to take
advantage of the lower interest rates.
Federal Direct Loan Program (FDLP)

Under FDLP, loans are made directly by the federal government to students and
parents. Like the FFELP, the Direct Loan program consists of the
• Direct Stafford Loans,
• Direct PLUS Loans, and
• Direct Consolidation Loans.
Most terms of FDLP student loans are the same as FFELP student loans. During the
2002 fiscal year, 3 million FDLP loans, worth more than $20 billion in loans made to
eligible students. This includes approximately $6 billion in subsidized Stafford loans,
over $4 billion in unsubsidized Stafford loans, more than $1 billion in PLUS loans, and
almost $9 billion in direct consolidation loans. The student has to pay a fee of up to 4
percent of the loan, deducted proportionately from each loan disbursement. The entire
fee goes to the government to help reduce the cost of the loans. Also, if the student
doesn’t make her loan payments when scheduled, she may be charged collection costs
and late fees.
The loan limits for FDLP loans for various years are given below.
The overall limits for all subsidized and unsubsidized loans (including a combination of
FFELPs and Direct Loans) are given below:
• $23,000 for a dependent undergraduate student

• $46,000 for an independent undergraduate student
• $138,500 for a graduate or professional student (including loans for
undergraduate study)
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Perkins Loan Program

The third major federal student loan program is the Perkins Loan Program. Perkins
Loans are campus-based loans offered by participating schools to undergraduate and
graduate students with the greatest financial need (i.e. Expected Family Contribution is
way less than Cost of Attendance). Participating schools add their own funds to federal
contributions, disburse funds to students, service and collect the loans. Loan
repayments are recycled into new loans. Annual loan limits are $4,000 for
undergraduate students, and $6,000 for graduate students.
Private Student Loans

Private Loans are for students who have received their financial aid award letters from
the school (specifying the amount and type of loan for which they qualify) but still need
additional funds for college and are seeking alternative lending options. Many students
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and parents take Private student loans to pay for all college expenses, from tuition to
every day college expenses such as off campus living expenses, school supplies, travel,
etc. Both Public and Private Sector Lenders provide Private Loans.
Most borrowers typically take a combination of different loans to meet their
requirements. The calculation below illustrates a couple of scenarios that require the
borrowers to opt in for a combination of loans.
Loan Repayment
There are various kinds of repayment options to the borrowers of education loans. Lets
take a look at the repayment options for FFELP and FDLP loans separately.
The FFELP loan program generally offers following repayment options:
• The Standard Repayment Plan: Borrower pays a fixed amount each month—at
least $50—for up to 10 years, not including deferment and forbearance periods.
The length of her repayment period depends on the loan amount.
• The Graduated Repayment Plan: Borrower’s payments will be lower at first and
then increase, usually every two years. The length of the repayment period will
generally range from 12 to 30 years, depending on the loan amount. Borrower’s
monthly payments will never increase to more than 1.5 times what she’d pay
under the Standard Repayment Plan. She will repay a higher total amount of
interest, though, because the repayment period is longer than under the
Standard Repayment Plan.
• The Income Sensitive Repayment Plan: Borrower’s monthly payment is based on
her yearly income and her loan amount. As her income rises or falls, so do her
payments. Each payment must at least equal the interest accrued (accumulated)
on the loan between scheduled payments.
• The Extended Repayment Plan is available only to FFEL borrowers who received
the first loan on or after October 7, 1998, and who have FFELs totaling more
than $30,000. Under this plan, borrower’s payments will be fixed or graduated
(lower at first and then increased over time) over a period of up to 25 years.
The repayment plans with the Direct Loan Program are on similar lines:
• The Standard Repayment Plan: Same as in the case of FFELP loan.
• The Extended Repayment Plan: Borrower repays the loan over a period that is
generally 12 to 30 years, depending on the loan amount. Her monthly payment
might be lower than under the Standard Repayment Plan, but she will repay a
higher total amount of interest over the life of her loan because the repayment
period is longer. The minimum monthly payment is $50.
• The Graduated Repayment Plan: Same as in the case of FFELP loan.
• The Income Contingent Repayment Plan: Borrower’s monthly payment is based
on her yearly income, family size, interest rate, and loan amount. As her income
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rises or falls, so do her payments. After 25 years, any remaining balance on the
loan will be forgiven, but she’ll have to pay taxes on the amount forgiven.
Apart from these custom repayment options, two other options available for postponing
repayment of student loans are deferments and forbearances. These options can be
availed of before the loan goes into default. Once the loan is default, the borrower is no
longer eligible for deferments and forbearances.
Deferment
During deferment, the lender allows the borrower to postpone repaying the principal of
the loan for a specific period of time.
Most federal loan programs allow students to defer their loans while they are in school at
least halftime. For Perkins Loans and Subsidized Stafford Loans, no interest accrues
during the deferment period because the federal government pays the interest. For other
loan programs, such as the unsubsidized Stafford loan, the interest still accrues during
the deferment period. Students can postpone the interest payments on such loans by
capitalizing the interest. It needs to be noted that capitalizing the interest adds it to the
loan principle, increasing the size of the loan.
Deferments are commonly granted for
• Students who are enrolled in undergraduate or graduate school,
• Disabled students who are participating in a rehabilitation training program,
• Unemployment and
• Economic hardship
These deferments are for the FFELP and FDSLP loans and not for Perkins loan.
Deferments are not granted automatically, the borrower needs to submit an application
and provide documentation to support the request for a deferment.
Forbearance
During forbearance, the lender allows the borrower to postpone or reduce the payments,
but the interest charges continue to accrue. The federal government does not pay the
interest charges on the loan during the forbearance period. The borrower must continue
paying the interest charges during the forbearance period.
There are limits on the length of forbearance and they are typically granted in 12-month
intervals for up to three years.
Forbearances are granted at the lender's discretion, usually in cases of extreme financial
hardship or other unusual circumstances when the borrower does not qualify for a
deferment.
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As in the case of Deferment, the borrower needs to submit an application to be eligible

for deferment.
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KEY PLAYERS
Federal Government The U.S. Department of Education (ED) administers the federal
student loan programs. As discussed later, it also serves as the
lender under certain loan programs.
Borrower This means the student or the parent—the person who receives
the student loan and is responsible for repaying the loan.
Lender This is the entity that lends the money for your student loan.
Most schools have developed working relationships with single
lenders or multiple lenders (a.k.a. "preferred" lenders). Schools
often provide a list of lenders. A lender can be:
• A bank.
• A savings and loan association.
• A school.
• A credit union.
• A pension fund.
• An insurance company.
• A consumer finance company.
• The federal government.
Guarantors Guarantors provide guarantee to the lenders against loan

default. The guarantee agencies are non-profit institutions or
state agencies that provide protection to the lender against loss
due to
• Borrower default / Death of borrower
• Total and permanent disability
• Bankruptcy
• Closed school
• Ineligible borrower
Third Party Firms like Nelnet Loan Services Inc. provide services in Loan
Origination & Origination. They originate all types of student loans. These firms
Servicing Firms also buy loans from other lenders and service them during their
full term. Services include: payment processing, accounting,
reporting, delinquency reporting etc.
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KEY CONCEPTS
School A school needs to be certified by the Department of Education as
Concept Definition
an eligible school to participate in the FFELP OR the FDLP loan
Free Application programs.
The Schools
form used by thehave the option
students of going
to apply in for anneed-based
for financial FFELP or
for Federal an FDLP program. A school, may be one of the following
aid. As the name suggests, no fee is charged to file a FAFSA
Student Aid • Common College
(FAFSA)
• University
Promissory Note The legal and binding
• Graduate contract signed between the lender and the
college
borrower (student/parents) stating that the borrower will repay the
loan •as agreed
Professional
upon incollege
the terms of the contract.
• Vocational /Technical college
Student Aid A report sent to a student by the government 4 – 6 weeks after
Report (SAR) • Correspondence
submitting a FAFSA. The college
report informs the student of the
Expected Family Contribution (EFC) and the financial aid for which
the student is eligible. College financial aid offices use the report
information to build a financial aid package for a student.
Origination The process whereby the lender, or a servicing agent on behalf of

the lender, handles the initial application processing and
disbursement of loan proceeds.
Disbursement The release of loan funds to the school for delivery to the borrower.
This is first credited to the student's account for payment of tuition,
fees, room and board and other school charges. Any excess funds
are then paid to the student in cash or by check. Also, unless the
loan amount is under $500, the disbursement will be made in at
least two equal installments.
Delinquent If the borrower fails to make a payment on time, the borrower is

considered delinquent and late fees may be charged. If the
borrower misses several payments, the loan goes into default
Default The failure to repay a loan in accordance with the terms of the
promissory note. A loan becomes default when the borrower fails
to pay several regular installments on time (i.e., payments overdue
by 270 days).
Deferment A deferment means there are no payments required on the student

loan during an approved period. For subsidized Stafford Loans,
there is no interest that accrues during a deferment period. The
common types of deferment include:
• In-school Deferment - As long as the student borrower is
enrolled at least half-time, no interest accrues and no
payments are required until after a six-month grace period
after the student ceases to be enrolled at least half-time.
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• Unemployed Deferment - Up to three years after leaving

school. A special deferment form will be required each year
• Economic Hardship Deferment - If the student borrower is
not eligible for one of the above two deferments, she may
be eligible for this deferment. A borrower can not have
earnings beyond the low standard of living as determined
by the Bureau of Labor Statistics (BLS)
Forbearance These are adjustments to the repayment terms when the borrower
is having financial difficulty. It must be explicitly applied for and
usually runs for 6 to 12 months. Forbearance provisions vary by
loan type and are at lender’s discretion. Key differences between
deferment and forbearance are
• Interest accrues and may be capitalized on all loans during
forbearance, including loans that were formerly subsidized
• Interest rate goes up .6% on variable rate Stafford's during
forbearance
Lender’s Request The letter that the lender sends to the guarantee agency (GA) after
Assistance (LRA) a student fails to repay the loans properly. After getting this letter
the GA tries to persuade the student to pay up the loan.
Notice Of Default If the student doesn’t repay even after the GA’s persuasion then
(NOD) the lender sends a Notice of default to the GA. On receipt of a
NOD, the guarantor gives the guarantee money to the lender and
informs the Department of Education and the NSLDS for necessary
updation and action.
Cohort Default The percentage of loan borrowers who default before the end of
Rate the academic fiscal year following the fiscal year in which they
entered repayment on their loans.
Loan Forgiveness Under certain circumstances, the federal government will cancel all
Programs or part of an educational loan. This practice is called Loan
Forgiveness. The qualification criteria are
• Student performs certain volunteer work;
• Student performs military service;
• Student teaches or practices medicine in certain types of
communities; or,
• Meets other criteria as specified by the forgiveness
program.
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LOAN PROCESS
FFELP Loan Process
Loan Repayment
Loan
Disbursement
Student Lender
IOI
Loan
Application Choice of
Disbursement
School & Sign
Financial Lender
US Dept Edu Aid Promissory Note
Eligibility
Approval
SAR
School Lender Guarantor
Promissory
IOI – Indication of Interest Note
SAR – Student Aid Report
Obtaining a federal student loan begins when a student files the Free Application for
Federal Student Aid (FAFSA). The information supplied on the FAFSA is analyzed to
estimate what is the expected family contribution (EFC) toward higher education costs.
The Student submits Application (FAFSA) to US Department of Education. This
application contains the financial contribution of the family along with the list of schools
applied to.
There are three regular formulas for the calculation of EFC16 (A) for the dependent
student, (B) for the independent student without dependent(s) other than a spouse, and
(C) for the independent student with dependent(s) other than a spouse.
The US Department of Education then creates a Student Aid Report (SAR) and sends it
to the borrower & all the schools mentioned in FAFSA. The SAR serves to indicate a
student’s expected financial contribution (EFC), which is required by school’s financial
aid professionals to calculate Financial Aid Eligibility.
Based on the SAR, School financial aid professionals compare the EFC to the total cost
of attendance for a school and fashion the financial aid package that typically includes
16
EFC = Total Student & Parent Income (Taxed + Untaxed) + Contribution from Assets –
Allowances against Income. Factors such as number of family dependents, number of children in
college, etc. is also included in the calculation.
Page 111 of 186
grants and loans. Schools send Financial Aid Award Letter to the prospective students
and families outlining the type and amount of Financial Aid for which they qualify.
Based on this letter, student selects the school and the loan type, best suited for him.
Schools have their list of preferred lenders. Student may choose any one of these or a
lender outside this list. Student may also apply for a loan through a student loan
origination and servicing firm associated with the school. These firms typically offer the
entire federal student loan options and have a list of lenders associated with them. The
student selects a lender based on parameters such as: loan amount, interest rate,
repayment options, lender servicing options, etc.
Loan Origination
After deciding on the Lender, student informs the school and signs a Master Promissory
Note (MPN) with the school, which the student gets from her lender. The school uses it
to apply for a guarantee against default. The guarantor is usually a state agency. The
guarantor approves the loan and directs the Lender to proceed with Loan disbursement.
When a student signs the Master Promissory Note, she is confirming her understanding
that the school may make new loans for her for the duration of student’s education (up to
10 years) without having her to sign another promissory note. Student is also agreeing to
repay the lender, all loans made to her under the terms of the MPN. The lender checks
all the documents and the loan amount is sent to the school. The school will disburse
student’s loan in at least two installments; no installment will be greater than half the
amount of the loan. The loan money must first be used to pay for tuition, fees, and room
and board. If loan funds remain, student will receive them by check or in cash, unless
the student give the school written permission to hold the funds until later in the
enrollment period.
Loan Servicing
Repayment generally begins six months after a student leaves school. FFELP and FDLP
borrowers have several repayment options, including equal monthly installments,
payments that gradually rise over the loan term, and payment amounts linked to the
borrower’s income. FFELP and FDLP borrowers may also consolidate student loans into
a single monthly payment with a single lender.
If the borrower fails to make payments for nine months, the loan is in default and the
lender presents a claim for partial payment (98 percent of the outstanding balance) to
the guaranteeing agency. Once the guaranteeing agency determines that the claim is
valid, the loan is purchased from the lender and the guaranteeing agency applies to the
U.S. Department of Education for partial reimbursement (95 percent of the claim value).
Some lenders manage the servicing process for their borrowers in-house, while others
contract this work out to third party loan servicers who receive payments, track balances
and keep in contact with the borrowers.
The servicing activity is similar to the process followed in other loans and the activities
include - collecting payments, answering customer service phone calls, reporting and
collecting delinquent accounts.
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FDLP Loan
The process here works in the same fashion as in the case of a FFELP loan, with the
exception being that no lender or state guarantee agency is contacted. The federal
government raises the loan funds through its regular Treasury bill auctions.
The US Department of Education calculates EFC, creates a Student Aid Report (SAR)
and sends it to the borrower & all the schools mentioned in FAFSA.
School Financial Aid Office compares the expected family contribution to the total cost of
attendance for a school and in case of extreme financial needs fashion a FDLP loan
package. Schools send Financial Aid Award Letter to the prospective students. The
student selects a school & signs the Lender Promissory Note with the school, which in
turn is forwarded to the US Department of Education.
Loan Origination
Upon receiving the promissory note, the Loan proceeds are sent directly to the school by
the US Department of Education.
Loan Servicing
Repayment generally begins six months after a student leaves school. The servicing
process is similar to that followed for FFELP loans. Direct Loan Servicing Centre does
loan Servicing; performing the same servicing functions as in other loans.
Private Loans
In case of private loans, student, guarantor and the lender are the only players involved
working for the disbursement of the loan. US Department of Education does not figure in
the picture. Most private loans are unsecured loans. The Process works as:
• After the FAFSA is processed, school will send student a financial aid award
notice detailing the amounts and types of federal and school-based aid for which
the student is eligible.
• The difference between the student’s total financial aid and the school’s cost of
attendance is the amount parents or students may be eligible to borrow as
Private Loan.
• The student applies to lenders for the private loans with a loan application
containing personal & financial information.
• After submitting a completed loan request, the Lender will perform a credit check
through a credit rating agency and notify student of the credit status.
• Based on loan term & interest rates offered by the lenders, the student selects a
lender.
• The lender provides the borrower with a promissory note.
• The student signs the Lender promissory Note with the school, which acts as a
school certification & submits it to the Lender.
• The loan is approved and upon completion and signing of the approved loan
application, lender sends the Loan proceeds to the school.
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SECONDARY MARKET
Some lenders sell their student loans to investors through a student loan secondary
market. By purchasing loans, secondary markets ensure that there is always a ready
supply of capital available to assist other students. In 2002, student loan providers raised
over $50 billion in new capital from the private sector to meet the growing demand for
student loans. Sallie Mae is the biggest player in Secondary Market. Apart from Sallie
Mae, there are state sponsored Secondary Market Players and private educational
finance companies like Nelnet and EdSouth.
Security Issuers
Student-loan ABS issuers have distinct origination and funding strategies. Sallie Mae
and Brazos Student Finance Corporation purchase FFELP collateral from a network of
diversified lenders. Supplemental lenders such as Chela Financial USA, Inc., and PNC
originate supplemental loans, primarily from students at private, four-year institutions.
Access Group provides one-stop shopping to professional school students, primarily law
students, originating both their FFELP and private supplemental loans.
Student loans have lower gross margins than credit card or home equity loans, but can
generate high gains on sale because of low expected losses and long maturities.
Although these characteristics make student loans prime candidates for securitization,
other factors have limited the value of student loan securitization to many banks. These
factors include complex security structures and investor reporting requirements. In
addition, many potential issuers and lenders have the ability to sell assets to Sallie Mae
and other secondary markets at attractive prices. Active securitizers, in addition to Sallie
Mae, generally include private non-profit specialized student loan lenders and for-profit
lenders with roots in the non-profit sector. Consequently, the student loan issuance has
been concentrated among few large players.
Further information on the Student ABS structures is available in Appendix
Recent Market Scenario

Over the past decade, the growth of borrowing to finance education has outpaced the
growth of grant aid. Much of the growth in the student loan program, however, has been
due to increased borrowing by middle and upper income borrowers in the unsubsidized
program, which has grown at an average annual rate of 13 percent since 1994 – three
times the rate of growth in the subsidized program.
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According to the Institute for Higher Education Policy, the use of private student loans
has been rapidly increasing since the mid-1990s. Under the FFELP, students can only
borrow up to fixed loan amounts per academic year. Loan limits have not risen since
1992. As a result, more students are turning to private credit student loans to meet their
education financing needs.
The total volume of private loans exceeds the amounts awarded annually under the
Perkins Loan program, federal work-study, and the Federal Student Educational
Opportunity Grant program combined. Private loans help make school choice possible
for students who have exhausted all other sources of financial aid, including federal
student loans.
Sallie Mae
Sallie Mae is the largest private source of funding, delivery and servicing support for
education loans in the United States primarily through its participation in the Federal
Family Education Loan Program (‘‘FFELP’’). They provide a wide range of financial
services, processing capabilities and information technology to meet the needs of
educational institutions, lenders, students and their families, and guarantee agencies.
Their primary business is to originate and hold student loans, but the Company also
provides fee-based student loan related products and services and earns servicing fees
for student loan servicing and guarantee processing, and student loan default
management and loan collections.
Sallie Mae from time to time securitizes some of its student loan assets by selling
student loans to SLM Student Loan Trusts. The asset-backed securities are issued by
the Trusts.
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Sallie Mae manages the largest portfolio of FFELP student loans, serving over 7 million
borrowers through their ownership and management of $79 billion in student loans, of
which $73 billion or 92 percent are federally insured.
IT APPLICATIONS IN STUDENT LOANS

Student loans are different from many other types of consumer loans in that they
represent a “three-cornered” transaction that includes the lender, the borrower and the
school attended by the borrower. The typical technology applications used in student
loans include the following:
• Automated Loan Origination This application gives lenders direct control over
the loan origination process and enables them to customize many of the services
they provide with features including on-line reporting, on-line loan application,
guarantee, disbursement, and servicing data, and on-line loan counseling.
• Format Standardization A system that facilitates the electronic exchange of
data files among lenders, guarantors, and those who service the loans
• An online financial aid package tool This application automatically generates
different financial aids (grants, loans) available to students and informs them
online.
• An electronic bill presentment and payment service for campus business offices
• A directory service To manage files across lenders, guarantors and servicers.
This includes E-Signature capabilities to generate considerable evidence in
support of the transaction.
• Operating System To track all of the Federal Family Education Loan Program
(FFELP) loan origination and guarantee activities that a Lender administers on
behalf of their customers.
REGULATIONS GOVERNING STUDENT LOANS
Higher Education Act

The HEA authorizes programs and activities most of which fall into four main categories:
 Student Financial Aid
 Support services to help students complete high school and enter and succeed in
postsecondary education
 Aid to strengthen institutions, and
 Aid to improve K-12 teacher training at postsecondary institutions.
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Student Aid - The student aid program authorized under Title IV, is a part of the HEA
and provides grant aid, loans, and work-study assistance. It is aimed at expanding
educational opportunity.
As part of the Higher Education Act, the student loan program is periodically amended to
regulate the yields paid to the lenders – origination fee chargeable.
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AGRICULTURAL LOANS
Agricultural Loans are the loans granted to finance the agricultural industry. These are
loans given to individuals towards acquisition of work animals, farm equipment and
machinery, farm inputs (i.e., seeds, fertilizer, feeds), poultry, livestock and similar items.
It also includes construction and/or acquisition of facilities for production, processing,
storage and marketing; and efficient and effective merchandising of agricultural
commodities.
Bank credit has played an important role in farm activities throughout U.S. history. The
financing supplied by banks over the years has been essential to many individual farm
operators and to the development of new agricultural technologies and techniques. The
structural reorganization of Federal Agricultural lending institutions in the early 90’s
strengthened the market and helped in increasing agricultural loans among the farmers.
TYPES OF LOANS
The types of Agricultural loans available include
Operating Loans
Operating loans are loans made for general operating expenses such as labor, feed,
seed, fertilizer, grove caretaking, repairs, veterinary costs and small capital purchases.
These loans are granted for generally, one year or within an operating business cycle.
Operating loans require crop liens in addition to other underlying security.
Equipment Loans
Equipment loans are made for purchases of machinery, equipment, vehicles, and
breeding stock. The loan term extends up to 10 years.
Real Estate Loans

These loans are made for real estate purchases, debt consolidation, farm improvements,
building construction and grove development and rehabilitation. Real estate loans are
generally, longer than 10 years. These loans require a first lien on real estate security.
MAJOR PLAYERS INVOLVED
Brokers
Brokers help borrowers in disbursement of the loan. They help in the preparation of the
Loan Application. A well-thought-out and detailed application is one of the most
important items a borrower can bring to a lender. This application will serve as the basis
for borrower’s financial details.
Lenders
Lenders for Agricultural Loans include:
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Farm Credit System

The Farm Credit System (FCS) is a network of federally chartered, borrower-owned
cooperatives specializing in agricultural loans. At the end of 2001, the FCS included 7
banks and 110 associations serving every region of the country and providing long- and
short-term credit for farmers, farm cooperatives, farm-related businesses, fisheries, rural
housing, rural utilities, and agricultural exports.
FCS originates and services the vast majority of the loans it holds. Most of its loans are
made directly to individual farmers for farm production and real estate purchases or to
farmer cooperatives providing inputs, marketing, and processing services to farmers.
FCS institutions compete directly with commercial banks and other farm lenders within
their service areas (each bank has a geographic scope of its charter), but they generally
do not compete with other FCS institutions.
Farm service Agency

Federal credit programs specifically designed to serve agriculture are administered by
USDA's Farm Service Agency (FSA). FSA farm loan programs are the Federal
Government's primary credit safety net for agricultural producers, and are meant to
serve family farms unable to obtain credit from conventional sources at reasonable rates
and terms.
FSA farm loan programs target certain groups by reserving a portion of loan funding for
use by socially disadvantaged (SDA) family farmers and beginning farmers (those with
10 years or less experience owning or operating a farm). A SDA farmer is one that may
have been subject to racial, ethnic, or gender prejudice.
FSA credit assistance is delivered to farmers through two mechanisms: loan guarantees
and direct loans. FSA county staff makes and service direct program loans and provide
needed advice and supervision concerning credit and farm financial needs. Guaranteed
loans are originated and serviced by qualified commercial, cooperative, or nonprofit
participating lenders. Under a guarantee, FSA covers up to 90 percent (in certain cases,
95 percent) of the losses sustained if the loan defaults.
Life Insurance Companies

Historically, agricultural real estate mortgages have been an important investment for life
insurance companies, which have been a key source of farm real estate loan funds. Life
insurance companies only make farm loans secured by a real estate mortgage.
The six insurance companies (AEGON USA, Citigroup Investments AgriFinance Group,
Lend Lease Agri-Business, Metropolitan Life, MONY Life Insurance, and Prudential)
currently active in farm lending account for about 85 percent of the industry's farm
mortgages and generally have high total assets and large farm mortgage portfolios.
They have virtually pulled out of the small- to medium-sized farm mortgage market in
favor of loans to agribusiness, timber, and specialty enterprises. These companies
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emphasize larger ($500,000 or more) agricultural loans with an industry average of

$847,148 as on December 31, 2000.
Commercial Banks
In spite of continuous and rapid changes faced by the banking industry during the last
two decades, commercial banks retain the lead market share among lenders to the farm
sector. Though individual banks may specialize their agricultural loans (by type of crop,
farm size, etc.), banks as a group are important lenders to all segments of the farm
economy. They make loans to small and large farms, to agribusiness firms, and for both
farmland and production purposes. At the end of 2001, the commercial banking system
held 32 percent of outstanding farm real estate debt and 51 percent of outstanding non-
real estate farm debt. Most of this debt was in medium-sized farm loans.
Other lenders include parents financing their children into agriculture, landlords
providing self-financing for their tenant farmers, and captive lenders. Captive lenders,
such as equipment dealers, seed companies, and retailers normally provide limited-
purpose credit to enhance market penetration for their primary products, such as farm
machinery and seed.
Guarantors
Generally, a Collateral acts as a guarantee against default but for loans with high loan to
value ratio, lenders require a guarantee. Farm Service Agency and other state funded
institutions are the major guarantors of agricultural loans. FSA provides lenders (e.g.,
banks, Farm Credit System institutions, credit unions) with a guarantee of up to 95
percent of the loss of principal and interest on a loan. Farmers and ranchers apply to an
agricultural lender, which then arranges for the guarantee. The FSA guarantee permits
lenders to make agricultural credit available to farmers who do not meet the lender's
normal underwriting criteria.
PROCESS
Origination
The process begins with a preparation of a Loan proposal. A detailed business proposal
is one of the most important items required for the loan disbursement. The proposal
should include a description of the business, the amount of funds requested, and the
purpose of the funds. The proposal should also include a description of collateral and the
sources of repayment. This proposal will serve as the basis for financing application.
Usually, a broker helps the borrower with the preparation of this. The borrower submits
this application for approval to the lender.
Lender checks the documents submitted by the borrower, gets credit rating from the
credit rating agencies and property appraisal for collateral. In case of insufficient
collateral or loans with high loan to value ratio, commercial banks require a guarantee by
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the Farm Service Agency or other guarantors. To obtain a guarantee by these

institutions, a loan applicant must:
• Be a citizen of the United States (or legal resident alien), which includes Puerto
Rico, the U.S. Virgin Islands, Guam, American Samoa, and certain former Pacific
Trust Territories.
• Have an acceptable credit history as determined by the lender.
• Have the legal capacity to incur the obligations of the loan.
• Be unable to obtain a loan without a guarantee.
• Not have caused FSA a loss by receiving debt forgiveness on more than 3
occasions.
• Be the owner or tenant operator of a family farm after the loan is closed. For an
Operating Loan, the producer must be the operator of a family farm after the loan
is closed.
• Not be delinquent on any Federal debt.
The borrower and lender complete the guaranteed application and submit it to the
guarantor. The guarantor reviews the application for eligibility, repayment ability,
security, and compliance with other regulations. It approves and obligates the loan. The
lender receives a conditional commitment indicating funds have been set aside, and the
loan may be closed. The borrower and lender negotiate prices, loan term and interest
rates before the final approval. The lender closes the loan and advances funds to the
borrower. After this, the guarantor issues the guarantee.
In cases where the lender is Farm Credit System, Farm Credit System Insurance
Corporation provides guarantee.
Lenders usually retain operating and equipment loans and continue to service them but
loan, which extend for more than 10 years (real-estate loans) are sold to other lenders
for servicing. These include: Washington Mutual, Countrywide credit industries, Bank of
America, Southtrust mortgage Corp.
Lenders are responsible for servicing the entire loan in a reasonable and prudent
manner, protecting and accounting for the collateral, and remaining the mortgagee or
secured party of record.
The lender’s responsibilities regarding borrower supervision include, but are not limited
to the following:
• Ensuring loan funds are not used for unauthorized purposes.
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• Ensuring borrower compliance with the covenants and provisions contained in

the loan agreement, mortgage, security instruments, any other agreements, and
this part.
• Ensuring the borrower is in compliance with all laws and regulations applicable to
the loan, the collateral, and the operations of the farm.
• Receiving all payments of principal and interest on the loan as they fall due and
promptly disbursing to any holder its pro-rata share according to the amount of
interest the holder has in the loan, less only the lender’s servicing fee.
• Performing an annual analysis of the borrower’s financial condition to determine
the borrower’s progress.
Lenders in some cases sell their loans to Farmer Mac17 to replenish their funds.
Servicing
Servicing for these Farm Loans is separated into Field Servicing and Central Servicing.
Field Servicing is the responsibility of the lender and consists of: Monitoring taxes and
insurance, inspecting collateral, requesting annual financial statements for loans greater
then $500,000 and, in cases of default and collections, acting as contact with the
borrower.
Central Servicing, which is performed by an institution under contract to Farmer Mac,
consists of billing and collecting installment payments, accounting and reporting to the
pool trustee and handling collection/foreclosure/bankruptcy and sale, if needed.
SECONDARY MARKET
The Secondary Market here operates in much the same way as in other Loans.
Secondary Market Conduits purchase qualified loans from lenders, thereby replenishing
their source of funds to make new loans. They fund their loan purchases by issuing debt
or securities backed by pools of loans and selling them into the capital markets. Farmer
Mac is the major player in the securitization process.
Farmer Mac
Congress created Farmer Mac to establish a secondary market for high-quality
agricultural and rural housing mortgages. Authorized by the Agricultural Credit Act of
1987, Farmer Mac is a federally chartered institution that was privately capitalized and is
privately owned. Farmer Mac operates as an independent entity within the Farm Credit
System (FCS) and is regulated by the Office of Secondary Market Oversight within the
Farm Credit Administration. As a government-sponsored enterprise (GSE), Farmer Mac
can access a $1.5-billion direct line of credit to the U.S. Treasury, but only if certain
17
More information on Farmer Mac follows later in the chapter.
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conditions are met. In addition, the securities of this publicly traded corporation have full
government agency status in capital markets.
Farmer Mac is modeled after the secondary markets for home mortgages operated by
Freddie Mac and Fannie Mae. Farmer Mac fulfills its statutory mission by guaranteeing
timely payment of principal and interest on qualified farm and rural housing mortgages or
mortgage-backed securities, or by purchasing loans from retail lenders that own stock in
the corporation. Farmer Mac purchases are financed with funds obtained from the sale
of notes and bonds on the national money market or by selling Farmer Mac-guaranteed
mortgage-backed securities to investors.
The Farmer Mac (often referred to as Farmer Mac I) and Farmer Mac II markets are
meant to serve very different farm clientele. The underwriting standards associated with
Farmer Mac I limit participation to financially healthy farmers. Farmer Mac II, in contrast,
benefits borrowers eligible for certain USDA-guaranteed loans. These borrowers include
farmers who are unable to obtain commercial credit at affordable rates because of
financial problems or lack of creditworthiness.
The various guarantee types of loan volume held by Farmer Mac include:
Swaps: Through a swap, a seller exchanges loans for a Farmer Mac guaranteed
security as an alternative to selling them outright or pledging them as collateral.
Long-Term Standby Purchase Commitment (LTSPC)
: Under an LTSPC, the seller passes the credit risk of qualified loans or groups of loans
to Farmer Mac in exchange for payment of an annual guarantee fee.
Agricultural Mortgage Backed Securities (AMBS): Farmer Mac’s cash window allows
lenders to sell qualified new or existing loans directly to Farmer Mac. Farmer Mac may
issue agricultural mortgage-backed securities from these loans, which may be retained
in portfolio by Farmer Mac or sold directly to investors.
RECENT TRENDS
According to the recent market scenario, Commercial Banks enjoy the largest market
share in farm credit. In the mid-1980s, with U.S. agriculture in a deep recession, the
financial condition of FCS deteriorated, and FCS lost market share to banks. Farm
Service Agency’s share in loan originations decreased drastically during the same
period. FCS has the second largest share in the market closely followed by individuals
and other lenders.
TECHNOLOGIES IN AGRICULTURAL LOANS

Typically, the technologies used in agricultural loans for loan origination and servicing
are the same as the ones used in for commercial loans. The key areas include Loan
Origination, Decisioning, Document Storage, and Loan servicing.
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REGULATIONS GOVERNING AGRICULTURAL LOANS
Equal credit Opportunity Act

The Federal Equal Credit Opportunity Act prohibits creditors from discriminating against
credit applicants on the basis of race, color, religion, national origin, sex, marital status,
age etc.
Fair Credit Reporting Act

The Fair Credit Reporting Act requires Lenders to provide certain information to
consumers whose credit applications are not approved on the basis of a consumer credit
report obtained from a national credit bureau.
Freedom of Information Act

The Freedom of Information Act (FOIA) gives any person the right to obtain Federal
agency records unless the records, or portions of the records, are protected from
disclosure by any of the nine FOIA exemptions. The FOIA ensures an informed citizenry,
vital to the functioning of a democratic society. Society's interest in open government can
conflict with other important interests of the general public, such as the public's interests
in the effective and efficient operations of government and in the preservation of the
confidentiality of sensitive, personal, commercial, and governmental information. The
FOIA balances responsible disclosure and appropriately protecting all interests.
Farm Credit Act

Farm Credit Act of 1971 recodified all previous acts governing the Farm Credit System
(FCS, or System). The Act eliminated earlier provisions relating to government
capitalization of the System, and expanded the lending authorities of many System
institutions. The Act, as amended, currently serves as the authorizing statute for the
Farm Credit System.
Major legislation that has modified the 1971 Act in recent years include:
Agricultural Credit Act of 1987 authorized up to $4 billion in federal financial assistance

to FCS institutions to assist in their recovery from the agricultural credit crisis of the
1980s. The Act created a System entity to issue up to $4 billion in federally guaranteed
bonds, required the U.S. Treasury to pay a portion of the interest on these bonds, and
also required FCS to ultimately repay the Treasury for this assistance. The Act also
mandated the merger of certain System banks within each farm credit district and
expanded other merger authorities, and gave delinquent FCS borrowers certain rights. A
separate System institution was established by the Act to insure the timely repayment of
principal and interest on consolidated System wide debt issues.
Farm Credit Banks and Associations Safety and Soundness Act of 1992 October 28,
was designed to enhance the financial safety and soundness of FCS banks and
associations by establishing new mechanisms to ensure repayment of Farm Credit
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System debt resulting from federal financial assistance provided to the System under the
1987 Act.
The Farm Credit System Reform Act of 1996 includes numerous provisions that provide
regulatory relief for the FCS.
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RETAIL BANKING CHANNELS

The landscape of retail banks has changed dramatically over the past 10 years. Shifting
customer demographics and developments in new technology are bringing major
changes to retail banking. Throughout the world, financial service providers are looking
towards a new concept of ‘anytime, anywhere, anyhow’ banking, which demands that
retail banks of the future find better ways of delivering a complete set of lifestyle-based
financial services which simplify their customers’ lives and allow them more personal
time — an increasingly precious commodity.
Financial institutions are looking to improve their delivery of product and service through
the most cost-effective means. Traditional brick and mortar offices are being replaced
with convenience centers or in-store outlets, ATM, telephone banking, Internet and other
less expensive options.
The Emergence of New Channels

Historically, individuals have interacted with their banks by visiting the nearest branch.
Some transactions may have involved the transfer of documents by post and perhaps
the wealthiest and most important customers may have been able to solicit a response
by telephone. However, as with most industries, the face-to-face approach prevailed.
Many of today’s financial services organizations still rely on legacy systems that were
established in that customer environment.
In the 1970s the automated teller machine (ATM) began to proliferate. Machines that
were connected via networks to a bank’s central computers and used a plastic card with
a magnetic strip to identify customer accounts soon replaced early off-line versions.
By the early 1990s, dedicated call centers were providing bank customers with a range
of services and by the mid to late 1990s Internet banking was becoming popular. Now,
even more channels for the delivery of financial services are emerging, including third
generation mobile telephony devices and digital television.
As technology makes the dissemination of information easier, an increasing variety of
distribution channels are starting to make the source of retail banking products
transparent. The ever-increasing use of multiple retail banking delivery channels is
helping banks to provide their customers with fast, easy ways to manage their finances.
Customers are now banking more than ever on their home PCs and at ATMs that
provide them with convenient hours and access. However, this increased use of
multiple, easily accessed banking capabilities has not necessarily steered customers
away from more traditional means like branches and call centers. Instead, the availability
of new retail banking channels has created a more versatile, multi-channel using
consumer with higher expectations of its financial services provider.
There is now a process of choice for the retail-banking customer; which delivery channel
to use and for which banking transaction. The retail banking industry today is using
delivery channels, which range from branch banking, telephone banking, ATM banking,
Internet banking to mobile banking and interactive TV.
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Bank’s View Point

The promise of lower transaction costs, increased sales productivity, and more
convenient service has lured banks into setting up new delivery channels. Earlier, vast
brick and mortar branch network has been considered as an inherent advantage of
established banks and new entrants were at huge disadvantage vis-à-vis the established
players in terms of customer reach. However, post 1990s new players are effectively
taking on the branch network advantage of the established players by optimally
leveraging technology and cost-effective delivery channels.
Banks may invest heavily in new delivery channels, but the success and sustainability of
these channels critically lie in the ability to convert that investment into lower distribution
costs. The steps to be followed in making a new distribution channel successful:
 Understand customers’ current channel/transaction behavior and their underlying
attitude
 Use sophisticated experimental customer research to assess the economic impact of
tactics designed to change that behavior;
 Develop an integrated channel migration plan which blends economic and non-
economic incentives to ensure that right initiatives are targeted at the right
customers;
 Protect sales effectiveness by utilizing the ability of non-branch channels to select
amongst prospects and differentiate the marketing message;
 Design non-branch channels to emphasize personalized interaction to counteract
decreased loyalty among remote customers;
 Develop tracking mechanisms to allow you to assess and revise your migration
strategy on an ongoing basis.
The retail banking industry today is using delivery channels, which range from branch
banking, telephone banking, ATM banking, Internet banking to mobile banking and
interactive TV.
BRANCH BANKING
Throughout much of the last decade, retail banks have re-engineered their organizations
to improve efficiency and move customers to lower cost, automated channels, such as
ATMs and Internet Banking. However, banks are now realizing that one of their best
assets for building profitable customer relationships is the branch — branches are in fact
a key channel for customer retention and profit growth.
Today 70% of customers use more than one contact channel, but as channels
proliferate, customers remain loyal to branches—51% of customers say they prefer
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branch banking according to a Financial Insights report. As a result, the industry is

renewing its focus on the branch level, looking for ways to integrate branch activities with
other banking channels, boost productivity, enhance customer service, and cut costs.
Today, U.S. banks are enthusiastically announcing the opening of hundreds of new
branches – 550 over three years at Bank of America, 100 over five years at JPMorgan
Chase, and 250 this year alone at Washington Mutual.
In addition to a blurring of distinctions between channels, revitalized branch networks
have re-emerged as combined centers for advice-based product sales and service, as
well as more traditional banking transactions. Customers want more than just a place to
complete transactions. They want a full-service center for all their needs -- from banking
products to brokerage services.
To maximize the value of this resource, banks are transforming their branches from
transaction processing centers into customer-centric into financial sales and service
centers. This transformation helps to achieve bottom line business benefits, such as
increased customer profitability, retention of most profitable customers, increased
branch revenue, increased staff productivity, and reduced operational costs.
At a Retail branch Banks typically provide two primary functions:
 Teller Operations - Accept and process customer transactions at the teller
window.
 Sales and customer service Operations - Tasks, such as new account opening,
account maintenance and product sales.
Through Teller operations Banks typically process customer transactions, access
customer account information, manage the teller transactions and activities and
generate reports.
Teller Operations
Accounts Types of accounts supported:

 Checking Accounts
 Cash management accounts
 Demand deposit accounts (DDA)
 Line of credit accounts
 Savings
 Time deposits
Transactions Teller functionality includes the following types of transaction

processing for supported accounts:
 Bait list log which tracks cash used to populate each
cashbox and automatically totals and balances
cashbox
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 Cash advances
 Consumer and mortgage loan payments
 Currency and coin orders
 Deposits, including commercial deposits
 Fee collection
 Foreign currency exchange
 Payments
 Stop payments
 Transfers
 Wire transfers
 Withdrawals
Customer & Account Teller applications usually offer the following types of features
Service and functions:
 Branch-office locator
 Customer and account setup
 Customer and account inquiries
 Customer identification
 Multiple transactions for single customer
 Interfaces to third-party fraud and signature
verification applications
 Interfaces to check-order vendors
 Transactions
Peripheral Support Interfaces to a variety of peripherals enable the teller to

automate some tasks. Peripherals to which teller applications
interface include:
 Check and money order printers
 MICR readers
 Magnetic stripe readers
 Passbook printers
 Personal identification number (PIN) pad
 Teller cash and coin dispensers
 Check image and data capture devices
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Sales and customer service Operations
Functionality of sales  Account and contact histories

and service platforms
 Bank information and fee schedules
includes the following:
 Business rules definition for cross-sells
 Campaign management
 Complaint reporting and tracking
 Customer contact and event tracking and
management
 Customer profile and relationships
 Decision tracking
 Lead generators
 Marketing and sales planners
 Online analytical processing tools
 Profiling
 Referral processing
 Sales lead managers
 Selling prompts
 View of the customer
 What-if calculations
Functions of a Branch
The branches of a bank are generally authorized by regulators to perform all the normal
banking functions, which a bank is permitted to perform.
 Accepting Deposits
o Demand Deposits
o Time Deposits
 Lending Money
o Whole-sale Lending
o Retail Lending
 Remittances
o Mail transfers, Telegraphic transfers, electronic funds transfer, Demand
Drafts etc
 Safety Lockers Facility
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o Safe Keeping of Valuables

o Fee based income
 Foreign Exchange Business
o Money Changer
o Fund based as well as non fund based financing for Foreign Trade
o Lines of Credit
o Customer Interface
Multi Branch Banking

Banks are now looking to provide “Multi Branch Banking” service to customers through a
network of the Bank’s branches. Under this service, the customer of one branch is able
to transact on her account, from any other networked branch of the Bank.
Typical services provided through “Multi Branch Banking” include
 Cash Deposits
 Cash Payments
 Transfer of funds
 Balance Inquiry
 Marking Stop Payment of a Cheque
ATM BANKING
The U.S. payments system is going through a period of rapid change. Paper checks are
increasingly giving way to electronic forms of payment, which themselves are being
transformed as new products, new players, and new industry structures arise. Some of
the most dramatic changes are being seen in the automated teller machine (ATM) and
debit card industry.
Installation of ATMs has been particularly rapid in recent years. ATM growth was 9.3
percent per year from 1983 to 1995 but accelerated to an annual pace of 15.5 percent
from 1996 to 2002. Much of the acceleration is due to placing ATMs in locations other
than bank offices. These off-premise ATMs accounted for only 26 percent of total U.S.
ATMs in 1994, but now account for 60 percent.
On the debit card side of the industry, growth has been extremely rapid in point-of-sale
(POS) debit card transactions. With an annual growth rate of 32 percent from 1995 to
2002, POS debit is the fastest growing type of payment in the United States. Today it
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accounts for nearly 12 percent of all retail noncash payments, a fivefold increase in just
five years.
Automated Teller Machines (ATMs) have made banking available 24 hours a day, 7
days a week. ATM banking is also considerably cheaper than other methods of
payment, such as issuing cheques or doing transactions over the counter inside the
bank. A banking customer gets access to an ATM by means of a card, which is issued
when she opens a bank account such as a checking account or a savings account.
Banks can substitute cheaper ATM transactions for more expensive human teller
transactions because their customers are willing to use the machines, which are more
convenient because more banks are placing machines on the network.
ATMs were the first electronic banking service to be introduced to consumers. ATM and
debit card transactions take place within a complex infrastructure. To the consumer and
merchant, they appear to be seamless and nearly instantaneous. But, in fact, a highly
complex telecommunications infrastructure links consumers, merchants, ATM owners,
and banks. The common attribute of all ATM and debit card transactions is that the
transaction is directly linked to the consumer’s bank account—that is, the amount of a
transaction is deducted (debited) against the funds in that account. An ATM card is
typically a dual ATM/debit card that can be used for both ATM and debit card
transactions. Many ATM/debit cards offer the consumer both types of debit card
transactions, online and offline.
Apart from the monthly service fee that is charged on a customer’s bank accounts, she
may also be charged a fee for every transaction done at an ATM. But it is a lot cheaper
to bank at an ATM than it is to do your banking at a teller inside the bank. This is the
banks' way of encouraging consumers to use ATMs. Fees vary between banks and
according to the type of transaction. For cash withdrawals and cash deposits, the fees
depend on the amount involved in the transaction, while there tend to be set fees for
account payments and money transfers, irrespective of the amount involved. Mini
statements and balance inquiries are generally free if you use your bank's own ATM
network (it doesn't have to be the ATM outside your specific branch), but a fee is
charged for these transactions at the ATMs of other banks because your bank will have
to pay the other bank because you used the other bank's ATM.
There are three types of ATM systems: proprietary, shared/regional, and
national/international.
 A proprietary system is operated by a financial institution that purchases or
leases ATMs, acquires the necessary software or develops it in-house, installs the
system and markets it, and issues cards of its own design (proprietary systems are
less prevalent today).
 A shared/regional system is a network that comes into being when customers
of one or more financial institutions have access to transaction services at ATMs
owned or operated by other financial institutions. A common type of sharing is the
joint venture with other financial institutions, featuring common access and
cooperative control.
 A national/international system is also a network, one that enables an ATM
machine in New York to connect with another in Los Angeles. Through service
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agreements with regional and proprietary networks, national networks link ATM
machines coast to coast.
Typical services provided through ATMs include:

 Cash withdrawal against Account ATM/ Credit/ Debit Card: The maximum
amount that can be withdrawn in a day is restricted by the respective bank guidelines
 Money Transfer between accounts: An individual can transfer money between
his different accounts.
 Cash/ Cheque Deposits
 Utility Bill Payments
 Balance enquiry /Account Statements
 Marketing: Advertising new products from Banks/ Others.
 Cross-selling. ATMs can help market bank products such as home mortgages
and insurance policies.
 One-to-One marketing. ATMs can be used for customer relationship
management (CRM) strategies.
ATMs also provides additional options like selction of language of choice, change of pin
code, request for new cheque books, drafts etc.
Kiosk Banking/ Super ATM’s/ Web ATM’s:

With advancement in technology and increased acceptance of ATM banking, banks
have tried to explore further interactive options to enhance the user experience while
transacting through the ATM terminals. Super ATM’s, Kiosk Banking and Web ATM’s
have been born out of such experiments. These terminals serve as a multi function
machine going beyond the basic cash deposit withdrawal features of the standard
ATM’s. Among other things, the new ATMs are capable of cashing checks, printing
statements, copies of canceled checks and maps and issuing money orders, postage
stamps or phone cards. Also certain ATM’s are Web-enabled, providing the customers
convenience of Online banking without having to use the Internet.
INTERNET BANKING
Internet banking enables a customer to do banking transactions through the bank's
website in the Internet. This is also called virtual banking, or net banking, or anywhere
banking.
For banks, the biggest advantage is reduced operational costs, compared to any other
form of banking distribution channel. Against $1.07 for branch banking, it costs only
$0.13 in Internet banking. It is still cheaper than ATM where the cost is around 0.30
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cents. The additional advantage is that the bank need not invest in infrastructure and
staff management. Internet banking essentially encompasses two broad aspects, “PC
Banking” and “Internet Banking”.
“PC Banking” allows an owner of personal computers to access account information
using a modem connection to a traditional bank or financial service provider’s corporate
computer network. This access allows consumers to transfer funds within an established
bank, to pay bills, and to transact other traditional financial services without entering a
traditional branch office.
“Internet banking” is similar to “PC banking” in that it allows the delivery of traditional
financial services to customers through a home PC. What differentiates “Internet
banking” from “PC banking” is the nature of the financial institution delivering the
services to customers, and the importance of the public Internet to the provision of these
products to the customers. Traditional banks have historically used private networks to
deliver services to customers through personal computers or via the telephone. Internet
banks may not possess a physical branch network at all. Instead, these entities may
operate secure network servers in a variety of locations, with only a small number of
human personnel to handle customer queries. Internet banks may deliver financial
services to customers from almost any location, and to almost any location, thus posing
potentially onerous tasks for regulatory authorities.
Internet banking allows Banks to minimize transactions costs in their business

operations. Transactions costs - the costs of delivering products (e.g., checking and
savings account services, credit and debit cards) to their customers - are a significant
drag on profit margins in business and reduce the overall efficiency of an enterprise.
Costs fitting into this category include the expense of buildings, personnel, and whatever
physical infrastructure is necessary for the delivery of retail banking services through a
network of branches. Because Internet banking notionally requires a lower personnel
level for the delivery of basic financial services, it offers a potentially dramatic reduction
in bank operating costs and a parallel potential increase in profitability.
Typical services provided through Internet Banking include

 Check up-to-date account balance summaries & running totals
 View / download / print transactions or statements & request paper statements
 Transfer money (Fund Transfers)
 Verify deposits and withdrawals
 Make payments or pay bills to virtually anyone
 Set up new Payees and Standing Orders
 View / Cancel Direct Debits
 Stop cheques, Order new cheque books
 Contact customer service / Get your queries answered
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TELEPHONE / MOBILE BANKING

Phone Banking enables one to conduct virtually the entire spectrum of banking
transactions without traveling to and from the bank. It greatly helps Banks in reducing
time for transaction, reducing activities in banking branches and of course save money.
With phone banking Banks are equipped to deliver true 24 hours services and 7 days in
a week, 365 days a year, number of transactions could be done by tipping your
customers’ fingers executed through phone. Timeless, borderless and very efficient to
deliver are the characteristic of phone banking services.
Tele banking can be carried out through an ordinary mobile phone. m-Banking (Mobile
Banking) is provided by the Bank, in association with cellular service providers. Mobile
Banking could either be done through SMS of WAP. In SMS m-Banking, the customer
does not call the bank. Instead, she keys in short key words, on the mobile and transmits
this information to the Bank via SMS. The Bank responds to this SMS enabling the
customer to get the required information without any manual exercise. Unlike SMS m-
banking, WAP enabled m-banking, actually allows the customer to log on to the bank's
website and perform transactions, similar to Internet banking.
Typical services provided through Telephone / mobile Banking includes:

 Perform inquiry on accounts, Check account balances
 Fund Transfers
 Request for Check book / Statements / Demand Drafts
 Make bill payments
 Stop cheques
 Arrange standing orders
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FEE BASED SERVICES
Although bankers still talk of "relationships," their services have been unbundled. Each
service must stand alone as a profit center. This results in higher costs for banking
services formerly provided as either part of the relationship or subsidized by other high-
margin services. As a result of the banking industry's intense competition, rapid rate of
product development, evolving technology, and continuing consolidation, most Banking
businesses have started to offer several fee based services which were earlier being
provided as part of the overall relationship with a customer. These fee based services
today account for a substantial portion of a Bank’s revenue.
Bank Management sets fees and charges for banking services to ensure that the bank is
adequately compensated for the services it provides. When setting fees and charges,
Bankers take into consideration the possible exposure to loss, which may be incurred for
providing the service, the effort required of the Bank and the amount of time required
performing the service properly. Some of the more common fee based services being
offered by Banks to retail customers today are described in this section. Although most
of these services are related to Payments they can broadly be categorized under the
following broad headings
 Fee from Collections Services

 Fee from Payment Services
 Fee from Investment Advisory Services
 Fee from Fund Transfer Services
 Fee from Other Services
COLLECTION SERVICES
Lockbox
Using lockbox banking is a cash flow improvement technique in which the Bank has its
Clients' payments delivered to a special post office box instead of the business address.
The difference between this special post office box and a regular post office box is that
only the Bank’s Clients' payments are delivered to the box. Instead of the Client picking
up the payments, the bank's couriers have a key to the post office box, and they remove
its contents and deliver the payments to the bank. The bank opens the payments and
then processes the payments for deposit directly into the Client’s bank account.
Depending on the nature of the business, the contents of the Clients’ lockbox can be
removed and processed once a day, or more often if required.
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The Client can establish lockboxes in several different post offices or cities. A basic rule
is that lockboxes should be set up nearest to the Client’s customers to reduce the
amount of time between the customers' mailing their payments and the deposit into the
Clients’ bank account.
Lockbox banking accelerates the payment and deposit portion of the Clients’ cash
conversion period in two different ways. First, lockbox-banking cuts down on any postal
delays caused by having the Clients’ customers' payments delivered to your business
address. Mail delivered to the Client’s place of business entails some extra sorting so
that the mail gets into the hands of the correct carrier, not to mention the added time it
takes the carrier to actually deliver it to the Client’s address. Second, using a lockbox
shortens the amount of time necessary to process the Clients’ customers' payments, by
having the Clients’ bank open the payment envelopes and deposit them directly into the
Clients’ bank account. Since the payment processing is done at the bank, the Clients’
customers' payments are received and deposited all within the same day. If the Client
were to do this work himself it can delay the deposit of the payments anywhere from one
to two days (depending on how long it takes you to process the customers' payments for
deposit, and to actually make the deposit at the bank).
A sample Lockbox process is described below:
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PAYMENT SERVICES
Bank Drafts
A Bank Draft is an instrument, comparable with a cheque, signed by a drawer to a
drawee requesting payment for a fixed amount at a future time to a named beneficiary
(third party).
Bank drafts are a safe and convenient method of paying. Paying through a bank draft
means the Client’s money stays in her account until the day her payment is due. The
Client will never need to worry about remembering to make her payment, nor will she be
concerned with late payment charges or lost payments due to unpredictable mail
service. And in addition to the convenience, the Client can save costs related to checks
and postage.
Benefits of a Bank Draft

 Can be used by anyone
 Can be issued in any amount, in any currency
 Receipts are provided at the place of issue
 Bank drafts usually do not incur a fee when deposited in the same currency. For
example a US seller receiving a bank draft in US$ usually will not have to pay fee's
for the exchange of currency
 Bank drafts are traceable
Risks involved
 Drafts may be lost or stolen
 If fraud occurs, there is no recourse to claim lost money
 Drafts are not easily replaceable
 It is costly to sort out queries on lost or stolen drafts
There are essentially two different kinds of Bank Drafts

Time Draft – A draft which is payable at a specified point in the future
Date Draft – A draft that matures a specified number of days after its issue date,
regardless of the date of acceptance.
Most banks charge the person requesting the draft to pay a fee. If the item is of low
value, this fee could be more than the value of the draft.
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Money Orders
A Money Order is a financial instrument, issued by a bank or other institution, allowing
the individual named on the order to receive a specified amount of cash on demand.
Money Orders are a convenient, safe and economical alternative to personal and bank
cheques. It is often used by people who do not have checking accounts.
Benefits of a Money Order

 Traceable to a particular mailing address
 Easy to buy and encash
 Accepted as a form of currency
 No bank account needed
 They provide the customer with the security of a bank cheque, at a lower price. As
there’s no need for a bank account the customer doesn’t need to wait days for it to
clear
 Some Banks offer the option to stop a Money Order if problems arise before the
payment is cashed
 As well as being cashed on the spot, money orders can be deposited directly into a
bank account, subject to a clearance period.
Overdrafts
An overdraft is an instant extension of credit from a lending institution. For example, if a
customer has an overdraft account, her bank will cover checks, which would otherwise
bounce. The customer is required to pay interest on the outstanding balance of the loan
much like any other loan. It is essentially a loan linked to a current account. The loan
amount varies in that the customer can draw as much as she needs up to the agreed
limit. It is an ideal solution for those unforeseen expenses.
The amount that the customer can borrow depends on how much she may need and
how fast she can repay it. The Bank reviews the amount every year with a view to either
increasing or decreasing it, depending on how well the customer has managed it.
An overdraft facility can be renewed on an annual basis and the customer only pays for
what she uses.
Overdraft protection
This is a checking account feature in which a person has a line of credit to write checks
for more than the actual account balance. Instead of getting charged for bouncing a
check, overdraft protection will in effect provide the account holder with an instant loan.
The interest rate will be extremely high, but if it is paid off quickly it is usually much less
expensive than the bounced check fee.
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Check Coverage
Check Coverage automatically transfers available funds from the customer’s designated
savings or money market accounts to cover checking account overdrafts. Check
Coverage also gives the customer immediate access to checks deposited at the ATM,
up to daily cash withdrawal limit, if she has available balances in your savings, money
market accounts, or CDs and allows customers to write checks against the deposits
made on the same day.
Certified Check
It is a special kind of Check issued by a Bank for which the bank guarantees payment.
This is issued by a bank, which certifies that the maker of the check has enough money
in her account to cover the amount to be paid. The bank sets aside the funds so that the
check will remain good even if other checks are written on the particular account. Like a
cashier's check, a certified check guarantees that it is immediately good since it is
guaranteed by the bank and the recipient does not have to wait until it "clears."
Cashier's Check
It is a check, which cannot bounce because its face amount is paid to the bank when it is
issued, and the bank then assumes the obligation. The check is received as cash since
it is guaranteed by the bank and does not depend on the account of a private individual
or business. Cashiers' checks are commonly used when payment must be credited
immediately upon receipt for business, real estate transfers, tax payments and the like.
Travellers Cheques
A travelers cheque is a form of negotiable instrument, which entitles the check’s holder,
provided the Terms relating to the travelers cheque, have been properly followed, to
payment of the check’s face value on presentation of the cheque for payment by the
holder. The face value of a travelers cheque is the amount specified in a particular
currency on the cheque as payable to the cheque holder. The customer may request
travelers checks in a wide range of currencies and for a range of predetermined
amounts.
A travellers' cheque is the equivalent to cash but is more secure in that the person using
them will be refunded if they are stolen. The have a value in the currency they were
issued.
INVESTMENT ADVISORY SERVICES

Retail Banks also provide Wealth Management services to some of their designated
affluent customers. Within this spectrum Banks provide relationship-based advisory,
sales, service and product solutions to the full spectrum of wealth-building clients. Banks
deliver a wide selection of investment products and services - full-service brokerage,
discount brokerage, asset management, private banking, trust services, and a broad
selection of investment and credit services through its branch-based sales force.
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The Investment Advisory Services programs in Banks are generally designed keeping in
mind needs of customers who seek distinct financial solutions, information and advice on
various investment avenues. Banks have dedicated financial consultants at their branch
offices who provide need based advisory services to the customers. These financial
consultants design and implement a unique asset allocation strategy for each customer
that is determined based on the customer’s investment objectives, which could be any of
the following
 Capital Appreciation
 Reliable Income
 Wealth preservation
These financial consultants periodically review the customer’s portfolio to help the
customer weather economic and market changes, and also leverage possible growth
opportunities.
In addition to providing these Investment Advisory Services, Banks also cater to the
needs of customers by providing tailor made solutions through the various products they
have on offer. These products / services may include one or more of the following
 Stocks - If the customer wishes to implement a portion of her investment plan

using individual stocks, the financial consultant can recommend equities, or analyze
the existing portfolio and make recommendations.
 Bonds – The financial consultant would advise to invest in a broad array of fixed
income products including U.S. Treasury and Federal Agency bonds, corporate
bonds, municipal bonds and mortgage backed securities.
 Mutual Funds – The financial consultant can recommend mutual funds selected
by the Bank’s mutual fund research team using a proprietary mutual fund screening
and selection model.
 Annuity and Insurance Services - To assist the customers in tax and

retirement planning, the financial consultant provides alternatives from many of the
industry's annuity providers. Help is also provided in addressing protection, estate
planning and other insurance related concerns through insurance programs,
available from firms evaluated and approved by the Bank’s Insurance Group.
 Managed Mutual Fund Portfolios - Through the bank’s managed mutual funds
portfolio program, the consultant determines asset allocation strategy that best
matches with the customer’s long term needs and attitudes toward risk, and
structures a professionally managed mutual fund portfolio.
 Professional Portfolio Management - The consultant works with the customer

to combine a mix of investments with appropriate strategies tailored to suit the
customer’s specific needs to help the customer grow and preserve her assets.
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 Retirement Planning Services - The financial consultant works with the

customer to establish the appropriate tax-advantaged retirement account for either
business or personal use, including IRAs, SEP-IRAs, Qualified Retirement Plans and
Money Purchase and Profit Sharing plans
WIRES / FUND TRANSFER SERVICES

A wire transfer is a transaction that a customer can initiate via her bank, authorizing the
bank to transfer funds across a network administered by hundreds of banks around the
world. A wire transfer provides for immediate, irrevocable availability of funds by
eliminating the uncertainties of mail and check collection time. There are wire transfer
networks / systems that are only domestic, others that are international.
FEDWIRE
Fedwire stands for Federal Reserve Wire Network. It is a high-speed electronic
communications network that links the Federal Reserve Board of Governors, the 12
Federal Reserve Banks and the 24 branches, the U.S. Treasury Department, and other
federal agencies. Fedwire enables transfer of funds throughout United States. It is used
by Federal Reserve Banks and Branches, the Treasury and other government agencies,
and some 9,500 depository institutions.
A Fedwire is an electronic transmission. The transmission contains inter-bank codes that
are changed continually, a reference number, the names of the sending and receiving
banks, the transfer amount, and the name and account number of the sending account
holder and the receiving account holder.
Fedwire is used for all large dollar time-sensitive payments and funds transfers between
reserve banks. The following diagram depicts a typical FEDWIRE transaction.
Customer A
Customer B
Debit Customer Credit Customer

A Account B Account
 Bank A Bank B 
Debit Bank
Credit Bank
Payment A Account
B Account
Request
Inter District
Reserve Fund
Reserve Bank Reserve Bank

District A District A
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Fedwire Clearing System

Transactions sent through FEDWIRE are domestic, where the beneficiary, and often the
originator, is located in the US. All participants maintain an account at their local Federal
Reserve district bank. All movements of funds are between these accounts. It is a Real
Time Gross Settlement Systems (RTGS) in that it settles each transaction individually
rather than accumulating transactions and settling on a net basis.
CHIPS
CHIPS means Clearing House Interbank Payment System. CHIPS, Clearing House
Interbank Payments System, is the premier bank-owned payments system for clearing
and settling large value payments. CHIPS is a real-time, final payments system for U.S.
dollars that uses bi-lateral and multi-lateral netting for maximum liquidity efficiency.
CHIPS is the only large value system in the world that has the capability of carrying
extensive remittance information for commercial payments. CHIPS processes over
267,000 payments a day with a gross value of over $1.37 trillion. It is a premier
payments platform serving the largest banks from around the world, representing 22
countries worldwide.
OTHER SERVICES
Fee charged on Accounts

The average price of maintaining a bank checking account is currently about $200 a
year. Although different Banks may offer a customer the same services in terms of the
accounts they support and the facilities provided through those accounts, the fees that
may be charged may differ considerably from one Bank to the other. So for customers it
makes sense to take a close look at the fees associated with the account, and try to
estimate what it will cost. When comparing the expected fees of one account with
another, a customer must also factor in any difference in the interest rate the two
accounts offer. If one account pays sufficiently higher rates than another, it might more
than offset the additional fees that account charges. Here are some of the most common
fees associated with Bank accounts:
 Maintenance fees: Some Banks may charge a small annual fee for maintaining the
customer’s account. Certain other Banks may not charge any maintenance fee at all.
The maintenance fee might also vary from customer to customer for the same Bank.
A customer might even be able to get a free checking account, if she uses direct
deposit for your paychecks, if she is a shareholder of the bank or if she limits her
bank branch visits and/or transactions.
 Low-balance penalty: While most Banks offer "free" checking if the customer
maintains a substantial balance (the customer is though paying the opportunity cost
of tying up her money in a low- or no-yield account while the bank lends it out at a
hefty interest rate) some other Banks might charge a penalty if the account balance
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falls below a pre-defined threshold. The threshold limit might be based on the
account’s average daily balance, the lowest balance in the month, or the balance on
a certain day of the month, so it is up to the customer to satisfy the threshold criterion
so that there is no low-balance penalty for her account.
 ATM surcharges, "Foreign" ATM fees: Banks may also charge their customers for
ATM usage. Mostly if the customer is using an ATM, which is not owned by the
Bank, the Bank charges a surcharge, part or all of which is paid by the Bank to the
Bank owning the ATM.
 Returned check: A Bank may also charge a Customer for a check that has been
presented by this Customer, if the check bounces.
 Bounced check: If a Customer has written a check for an amount, which cannot be
covered by the available funds in the customer’s account, an insufficient funds fee
(NSF) will usually be imposed by the Bank. The only recourse to this is if the
Customer gets an overdraft protection.
 Check printing: Some banks offer free checks for first-time account holders,
account holders with a large minimum balance, senior citizens, students, and certain
others. Most of the other Banks, however, charge a small fee for making checks
available to the customers.
 Per-check charges: Some Bank accounts include a certain number of checks per
month and charge a fee for the number of checks used above the free check limit.
 Closed account: Some banks charge a fee if the Customer closes an account that
hasn't been utilized for a sufficiently long time (usually two years).
Safe Deposit Boxes

A Customer may lease a safe deposit box from a Bank for safekeeping valuables,
important documents, securities etc. Safe box services offered by Banks feature high
safety, privacy and convenience. Usually Banks maintain a safe box warehouse, which
is built according to the standards for a bank vault. The Banks lease the boxes to
customers with no obligation of confirming the amount and the value of the goods.
Safe box holders may visit the Bank vault at any convenient time during the Bank’s
business hours, with their safe boxes being at their full disposal. The Bank disregards
the contents of the safe box, its rights not applying to such contents. In providing this
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Service, the Bank charges fees for holding safe boxes in accordance with the applicable
fee schedule and depending on their size.
Typical items that can be protected in a safe deposit box with a Bank include, but are not
limited to:
 Lease Agreements
 Birth Certificates
 Confidential Items and Documents
 Income Tax Records
 Insurance Policies
 Jewelry
 Loan Documents
 Property Deeds
 Stock Certificates
 Savings Bonds
 Trust Documents
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REGULATORY REQUIREMENTS
TRUTH IN LENDING ACT (TILA)

Congress passed the Truth in Lending Act (TILA), originally in 1968. It provides a
uniform manner of calculating and presenting the terms of consumer loans to enable the
borrowers to compare costs to make informed choices about credit. Prior to TILA there
were no generally required definitions of loan terms and consumers were unable
compare interest rates and other loan costs. The law is designed to protect consumers
in credit transactions by requiring clear disclosure of key terms of the lending
arrangement and all costs. The Act covers both "open ended" and "closed ended" credit
transactions.
The Truth in Lending Act is intended to ensure that credit terms are disclosed in a
meaningful way so that consumers can compare credit terms more readily and
knowledgeably. Before its enactment, consumers were faced with a bewildering array of
credit terms and rates. It was difficult to compare loans because they were seldom
presented in the same format. Now, all creditors must use the same credit terminology
and expressions of rates. In addition to providing a uniform system for disclosures, the
act is designed to:
 Protect consumers against inaccurate and unfair credit billing and credit card
practices
 Provide consumers with rescission rights
 Provide for rate caps on certain dwelling-secured loans, and
 Impose limitations on home equity lines of credit and certain closed-end home
mortgages
Regulations
The Federal Reserve Board has implemented TILA through two key regulations:
Regulation Z – This explains how to comply with the consumer credit parts of the law.
Regulation Z applies to each individual or business that offers or extends consumer
credit if four conditions are met:
 The credit is offered to consumers.
 Credit is offered on a regular basis.
 The credit is subject to a finance charge (i.e. interest) or must be paid in more
than four installments according to a written agreement.
 The credit is primarily for personal, family or household purposes.
If credit is extended to business, commercial or agricultural purposes, Regulation Z does
not apply.
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Regulation M – This includes all the rules for consumer leasing transactions. Regulation
M applies to contracts in the form of a bailment or lease where the use of personal
property by a person primarily for personal, family or household purposes. The lease
period must exceed four months, and the total contractual obligations must not exceed
$25,000, regardless of whether the lessee has the option to purchase the property at the
end of the lease term.
Other Agencies
In addition to the Federal Reserve Board, other federal agencies may have regulations
for certain special lines of business. For example, the Department of Transportation has
certain Truth In Lending Act regulations applicable to airlines. The Veterans
Administration, the Department of Housing and Urban Development, the Federal Home
Loan Bank Board and the National Credit Union Administration are also involved in the
enforcement of the Truth In Lending Act. The Truth In Lending Act is designed to reduce
confusion among consumers resulting from the different methods of computing interest.
It does not require creditors to calculate their credit charges in any particular way.
However, whatever alternative they use, they must disclose certain basic information so
that the consumer can understand exactly what the credit costs.
Home Mortgages
One of the biggest lending transactions any individual is likely to enter is borrowing to
purchase a home. These transactions have become more complicated in recent years.
The Federal Reserve Board and the Federal Home Loan Bank Board have published a
book entitled "Consumer Handbook on Adjustable Rate Mortgages" to help consumers
understand the purpose and uses of adjustable rate mortgage loans. Regulation Z
requires that creditors offering adjustable rate mortgage loans make this booklet, or a
similar one, available to consumers.
Disclosure
Disclosure is generally required before credit is extended. In certain cases, it must also
be made in periodic billing statements. Regulation M includes similar rules for disclosing
terms when leasing personal property for personal, family or household purposes, if the
obligations total less than $25,000.
Truth in Lending Act disclosures must be made

 "Clearly and conspicuously"
 In meaningful sequence
 In writing, and
 In a form the consumer may keep
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There are five terms that are considered to be "material" disclosures required by TILA.
While other disclosures are required, these are deemed to be so important that a failure
to give any one of them gives you the right to rescind the loan transaction
1. Finance Charges - This is perhaps the most important disclosure made. The
"finance charge" is defined as the cost of credit over the life of the loan,
expressed as a dollar amount. This includes, not only interest, but also any other
charge that is required as a condition of receiving credit. Examples include:
"points", document preparation fees and other fees, which are excessive,
compared to their purpose (like excessive fees for notaries, appraisals, credit
reports, title examinations, etc.).
2. Annual Percentage Rate - This is the measure of the cost of the credit, which
must be disclosed on a yearly basis. APR is the cost of credit expressed as a
percentage. For example, a loan with an interest rate of 17% may have an APR
of 25% (all finance charges are rolled into the APR).
3. Amount Financed - This is the amount that is being borrowed in a consumer loan
transaction, or the amount of the sale price in a credit sale that is expressed as a
dollar amount. It is calculated by taking the principal amount of the loan and
subtracting those amounts that are financed as part of the principal that are
considered part of the finance charge. For example: you take out a $100,000
note and deed of trust on your home. The 5 points ($5,000) charged on this loan
are financed and are therefore included in the $100,000 principal on the note.
However, since the five points are defined as part of the finance charge, they are
subtracted from the $100,000 in determining the amount financed ($100,000-
$5,000 = $95,000).
4. Total of Payments - This includes the total amount of the periodic payments by
the borrower/buyer that is expressed as a dollar amount. It represents the total
dollar cost of the loan to you, assuming all payments are made on time. The total
of payments is calculated by adding up all payments disclosed in the schedule of
payments.
5. Total Sales Price - This is the total cost of the purchase on credit, including the
down payment and periodic payments.
Evidence of compliance with the Truth In Lending requirements must be retained for at
least two years after the date of disclosure. Disclosures must be clear and conspicuous
and must appear on a document that the consumer may keep.
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Other Features of the Truth in Lending Act

The Truth In Lending Act has other important features. It requires disclosure of key
lending terms when the bank advertises credit terms. Also, the law entitles the consumer
the right to rescind certain credit transactions within a short period, such as home equity
loans. To assist creditors, sellers and lessors, the Federal Reserve Board has provided
a series of model disclosure forms and clauses for Regulation Z and Regulation M.
The penalties for failure to comply with the Truth In Lending Act can be substantial. A
creditor who violates the disclosure requirements may be sued for twice the amount of
the finance charge. In the case of a consumer lease, the amount is 25% of the total of
the monthly payments under the lease, with a minimum of $100 and a maximum of
$1000. Costs and attorney's fees may also be awarded to the consumer. The consumer
must begin a lawsuit within a year of the violation. However, if a creditor sues more than
a year after their violation date, violations of the Truth In Lending Act can be asserted as
a defense.
FAIR CREDIT REPORTING ACT (FCRA)

Companies that gather and sell credit rating information are called Consumer
Reporting Agencies (CRAs). The most common type of CRA is the credit bureau.
The Fair Credit Reporting Act (FCRA), enforced by the Federal Trade Commission, is
designed to promote accuracy and ensure the privacy of the information used in
consumer reports. Recent amendments to the Act expand the consumer’s rights and
place additional requirements on CRAs. Businesses that supply information about
consumers to CRAs and those that use consumer reports also have new responsibilities
under the law. The Fair Credit Reporting Act (FCRA) requires credit bureaus to report
information accurately and to remove or correct credit report information that is outdated
or inaccurate. This federal consumer protection law also requires credit-reporting
agencies, under certain conditions, to provide the borrower with a free credit report.
The Fair Credit Reporting Act (FCRA) (15 USC 1681) became effective on April 25,
1971. The FCRA is designed to regulate the consumer reporting industry; to place
disclosure obligations on users of consumer reports; and to ensure fair, timely, and
accurate reporting of credit information. It also restricts the use of reports on consumers
and, in certain situations, requires the deletion of obsolete information. Banks may be
subject to the FCRA as:
 Credit grantors
 Purchasers of dealer paper
 Issuers of credit cards
 Employers
Generally, the FCRA does not apply to commercial transactions, including those
involving agricultural credit.
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Bank as a User
Few banks are consumer-reporting agencies. Most banks are users of information
obtained from them. As a user, a bank must identify itself to the consumer-reporting
agency and certify that the information requested will be used as specified in the act and
for no other purpose. A written blanket certification may be given by the bank to cover all
inquiries to a particular consumer-reporting agency. Banks also rely on information from
sources other than consumer reporting agencies. As a user, a bank must disclose
different information depending on its source.
Information from a Consumer Reporting Agency

If consumer credit is denied or the cost of credit is increased, partially or wholly on the
basis of information from a consumer-reporting agency, the bank must disclose, orally or
in writing, that information in the report was used in the credit decision. It must inform the
consumer of the name and address of the consumer-reporting agency from which it
received the information. It is recommended that the disclosure be made in writing.
Information from a Source Other Than a Consumer Reporting Agency

If consumer credit is denied or the cost of credit is increased, partially or wholly on the
basis of information obtained from a source other than a consumer reporting agency, the
user must disclose the applicant’s right to file a written request for the nature of the
information within 60 days of learning of the adverse action. Alternatively, the bank may
disclose the nature of the information and must do so, if it receives a request from the
consumer. That information should be sufficiently detailed to enable the consumer to
evaluate its accuracy. The source of the information need not be, but may be, disclosed.
In some instances, it may be impossible to identify the nature of certain information
without also revealing the source.
General – Required Disclosures

The obligations imposed on users of credit information are intended to allow applicants
to correct erroneous reports. The disclosures required of users of credit information also
apply to outside information on co makers, guarantors, or sureties. Disclosures should
be made to the party to whom they relate.
In addition, denial of an overdraft or refusal to authorize a credit card purchase based on
information from any outside source would trigger the need for disclosures, assuming
the information bears upon the consumer’s creditworthiness, credit standing, credit
capacity, character, general reputation, personal characteristics, or mode of living.
The requirements for disclosures by users of information apply to the general type of
consumer credit transactions covered by Regulation Z.
Banks may disclose orally the information required under the FCRA. However, in certain
cases when the credit is denied, the bank must make additional written disclosures to
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the consumer (Regulation B). The required disclosures for both the FCRA and
Regulation B may be provided on the same disclosure form, but they are independent
and one cannot substitute for the other.
Bank as Consumer Reporting Agency

The term consumer-reporting agency applies to any organization that might render a
consumer report as defined previously. Certain banks function as consumer reporting
agencies and, to the extent that they issue consumer reports, are covered by the FCRA.
A bank may become a consumer-reporting agency if it regularly furnishes information
about a consumer to, for example, other creditors, correspondents, holding companies,
or affiliates, other than information on its own transactions or experiences.
All consumer-reporting agencies must:
 Make required disclosures to consumers upon request and proper identification.

 Ensure that obsolete information is not reported
 Resolve accuracy disputes with customers
 Provide reports only for legitimate purposes
 Keep a dated record of each recipient of information about a consumer, even
when the inquiry is oral
 Train personnel sufficiently to explain information furnished to customers
Bank as a Purchaser of Dealer Paper Required Disclosures

The bank must make to the consumer disclosures required of a user, whenever it,
because of information from an outside source, denies or increases the cost of credit
requested by a merchant to be extended directly or indirectly to a consumer. However,
the merchant must have advised the consumer of the bank’s name and address before
contacting it to prevent the bank from becoming a consumer-reporting agency.
Investigative Consumer Report

When an investigative consumer report is requested from a consumer reporting agency,
the bank must inform the consumer not later than three days after such request that a
report may be made. An investigative consumer report is one in which a consumer’s
character, general reputation, personal characteristics, or mode of living is ascertained
by interviewing persons who may know him or her. The consumer also must be informed
that a written request may be made for the nature and scope of the investigation. If a
request is received, the bank has five days to furnish the required information.
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Penalties and Liabilities

Banks may be liable for negligent noncompliance as either users of information or as
consumer reporting agencies. Civil liability may include actual damages, court costs, and
attorney’s fees. In addition, the court may award punitive damages in cases of willful
noncompliance. Any bank officer or employee who obtains a credit report under false
pretenses will be subject to a penalty of not more than $5,000 or imprisonment of not
more than one year, or both.
EQUAL CREDIT OPPORTUNITY ACT (ECOA)

The Equal Credit Opportunity Act (ECOA) ensures that all consumers are given an equal
chance to obtain credit. This doesn’t mean all consumers who apply for credit get it:
Factors such as income, expenses, debt, and credit history are considerations for
creditworthiness.
The law protects the borrowers when they deal with any creditor who regularly extends
credit, including banks, small loan and finance companies, retail and department stores,
credit card companies, and credit unions. The law also covers anyone involved in
granting credit, such as real estate brokers who arrange financing.
The types of credit transactions that are protected by the ECOA include, but are not
limited to:
• Business loans
• Consumer leases
• Consumer loans
• Auto loans
• Credit cards
• Agricultural loans, and
• Loans to purchase, improve, refinance or construct residential or commercial real
estate.
If the credit transaction provides for the deferral of payment of the debt, it is also covered
by ECOA and Regulation B even though it may not be defined as a credit transaction by
the Truth in Lending Act.
When a consumer applies for credit, a creditor may not...

• Discourage from applying because of the sex, marital status, age, race, national
origin, or due to the receipt of public assistance income
• Ask the consumer to reveal their sex, race, national origin, or religion. (A creditor
may ask for voluntarily disclosure of this information - except for religion – in the
case of a real estate loan. This information helps federal agencies enforce anti-
discrimination laws.
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• Ask if you’re widowed or divorced. When permitted to ask marital status, a

creditor may only use the terms: married, unmarried, or separated
• Ask about your marital status if you’re applying for a separate, unsecured
account. A creditor may ask you to provide this information if you live in
"community property" states: Arizona, California, Idaho, Louisiana, Nevada, New
Mexico, Texas, and Washington. A creditor in any state may ask for this
information if you apply for a joint account or one secured by property
• Request information about your spouse, except when your spouse is applying
with you; your spouse will be allowed to use the account; you are relying on your
spouse’s income or on alimony or child support income from a former spouse; or
if you reside in a community property state
• Inquire about your plans for having or raising children
• Ask if you receive alimony, child support, or separate maintenance payments,
unless you’re first told that you don’t have to provide this information if you won’t
rely on these payments to get credit. A creditor may ask if you have to pay
alimony, child support, or separate maintenance payments
When deciding to provide credit, a creditor may not...

• Consider your sex, marital status, race, national origin, or religion
• Consider whether you have a telephone listing in your name. A creditor may
consider whether you have a phone
• Consider the race of people in the neighborhood where you want to buy,
refinance or improve a house with borrowed money
When evaluating the consumer’s income, a creditor may not...

• Refuse to consider public assistance income the same way as other income
• Discount income because of your sex or marital status. For example, a creditor
cannot count a man’s salary at 100 percent and a woman’s at 75 percent. A
creditor may not assume a woman of childbearing age will stop working to raise
children
• Discount or refuse to consider income because it comes from part-time
employment or pension, annuity, or retirement benefits programs
• Refuse to consider regular alimony, child support, or separate maintenance
payments. A creditor may ask you to prove you have received this income
consistently
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CHECK CLEARING FOR THE 21ST CENTURY ACT (CHECK21 ACT)

The Check Clearing for the 21st Century Act (Check 21) was signed into law on October
28, 2003, and will become effective on October 28, 2004.
Check 21 is designed to foster innovation in the payments system and to enhance its
efficiency by reducing some of the legal impediments to check truncation. The law
facilitates check truncation by creating a new negotiable instrument called a substitute
check, which would permit banks to truncate original checks, to process check
information electronically, and to deliver substitute checks to banks that want to continue
receiving paper checks. A substitute check would be the legal equivalent of the original
check and would include all the information contained on the original check. The law
does not require banks to accept checks in electronic form nor does it require banks to
use the new authority granted by the act to create substitute checks.
When a check is "truncated," that means an image is created from the original paper
check and the original paper check is then removed from the check collection or return
process. Under Check 21, the truncating bank has two possible options.
Option 1 does not require any sort of agreement between the parties. Option 1 allows a
"substitute check" to be sent to a recipient, in lieu of the original paper check. The
"substitute check" is a crucial component of the new law. A substitute check is a paper
reproduction of the original check. To qualify as a substitute check, the reproduction
must:
 Contain an image of the front and back of the original check;
 Bear a MICR line containing all the information appearing on the MICR line of the
original check;
 Conform, in paper stock, dimension, and otherwise, with generally applicable
industry standards for substitute checks; and
 Be suitable for automated processing in the same manner as the original check.
Option 2 allows data taken from the MICR line of the original check or an electronic
image of the original check to be sent to a recipient in lieu of the original check, so long
as there is an agreement between the parties to allow it. [These "agreements" may be
between multiple parties, rather than individual bank to individual bank. For example,
there may be a network agreement, or clearinghouse rules that constitute the
"agreement.]
Obviously, the efficiency of the payment system will not be greatly enhanced if parties in
the chain insist upon paper. If a recipient demands paper, a substitute check must be
created and couriers will be needed to transport the item from point A to point B. If an
image can instead be exchanged, it can be digitally transported, with resulting savings in
time and money.
If a bank must produce a substitute check (because the next person in the chain refuses
to agree to accept an image), it will incur costs as a result, so it is anticipated that an
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institution required to produce a substitute check will want to be compensated with a fee.
Check 21 is applicable to all deposit accounts.
While Check 21 applies to all deposit accounts, there are special protections built into
the Act for consumers. One protection is a notice/disclosure that consumer depositors
must be given. The second protection consists of an expedited process for recrediting
the account of a customer who makes a covered claim relating to a substitute check.
The law mandates that the notice to consumer customers cover two areas: the legal
equivalence of a substitute check and a description of what the consumer’s expedited
recrediting rights are in the event of certain problems with substitute checks.
The second component of the consumer protection measures in Check 21 is an error
resolution/ investigation procedure, which revolves around substitute checks, and
problems that a consumer may experience with them. Its goal is to resolve errors in a
speedy manner so that the customer is not wrongly without the use of disputed funds for
an extended period of time. In order for the procedure to apply:
 It must be a consumer making a claim for expedited recredit;
 The claim must be in connection with a substitute check
 Not an image, not a copy, not an original;
 The bank must have charged the consumer's account for a substitute check that was
provided to the consumer;
 The consumer must make a claim in good faith;
 The claim must be made before the end of the 40-day period beginning on the later
of l) the date on which the statement was mailed or delivered; or 2) the date on which
the substitute check was made available;
 The customer must have suffered a loss; and
 The production of either the original check or a better copy of the original must be
necessary to determine the validity of the claim;
 The claim must relate to one of the following two grounds:
• The check was not properly charged to the consumer's account; or
• The consumer has a warranty claim with respect to the substitute check.
Proper grounds for claims

There are only two permissible grounds a consumer may use to invoke the expedited
recrediting procedure. The consumer must allege in good faith either that the check was
not properly charged to the consumer's account, or that the consumer has a warranty
claim with respect to the substitute check. In terms of the first basis, the customer may
seek to prove the item was not actually drawn on her account, for example, and
mistakenly debited to it. In terms of the consumer asserting a warranty claim, it is crucial
to understand the nature of the substitute check warranty. The substitute check
warranties are contained in Section 5 of the Act. Under that section, the substitute check
warranties are made:
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 By a bank that transfers, presents or returns a substitute check and receives

consideration for the check warrants, as a matter of law, or
 To the transferee, any subsequent collecting or returning bank, the depositary bank,
the drawee, the drawer, the payee, the depositor and any endorser
Timing for the consumer's claim

A claim for expedited recrediting under Check 21 must be submitted by the consumer
before the end of the 40-day period beginning on the later of the date the statement,
which contains the relevant information, was mailed or delivered to the consumer, or the
date on which the substitute check is made available to the consumer. Interestingly, the
statute offers an extension for "extenuating circumstances," giving the consumer a
longer period of time in which to make a claim in the event of extended travel or illness
of the consumer.
Required content for claim

There are four required components for a proper claim:
 The consumer must describe her claim, explaining why the substitute check was not
properly charged to her account or what the warranty claim is with respect to the
check;
 There must be an allegation that the consumer suffered a loss, and the consumer
must estimate what the loss amount is;
 The consumer must state the reason why production of either the original check or a
better copy is necessary to determine the validity of the charge to the consumer's
account or the warranty claim; and
 Sufficient information must be provided to allow the bank to identify the substitute
check and investigate the claim.
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TRENDS IN RETAIL BANKING

Banking is known worldwide for predictable business practices and measurable
evolution. At the same time, the industry is facing sweeping and unprecedented change.
The lines between financial service segments are blurring, creating new opportunities
while exposing institutions to new channels. Customers demand new levels of personal
service and expect it fast. The competition is only a mouse click or street corner away.
These issues, compounded by mega-mergers, decreasing margins, regulatory changes,
and fierce competition, have lead to some very tough challenges for the banking
industry. Some of the key trends in retail banking include:
Empahsis on delivering service through the Branch

More banks are recognizing that the branch is still the cornerstone of retail banking. As
banks focus their efforts on growing revenues through sales of more complex higher-
margin services and products, they are finding that the branch is the most effective
delivery channel. The direct personal interaction provided at the branch creates the best
environment for selling these products. Banks' ability to leverage the branch, however,
has been impeded by legacy systems and outdated applications that are no longer
sufficient to support innovative delivery strategies. Consequently, in order to successfully
harness the branch's sales potential, banks will increasingly implement upgrades in
branch technology.
Multi-channel Integration
Multi-channel integration is garnering the attention of a growing number of banks.
Although it is far from becoming a mainstream exercise, it is moving away from the
early-adopter phase to being a feasible initiative for most banks to undertake. The
question is not if but when. Second-wave adopters are moving gradually, due to the
complexity and cost of integration. Many of these banks are gaining additional fortitude
to move forward by relying on third-party solution providers. Internet banking and call
center platforms are proving to be ripe targets for integration.
Increased emphasis on Check Imaging

With the signing of Check 21 into law, the full potential of check imaging technology can
be realized. Check processing in the U.S. is at an historical watershed. Check imaging,
which had an ignominious start in the 1990s, has been staging an incredible comeback
driven by economic and technological factors. It began generating ripples in the late
1990s with re-pass image capture and is currently propelling a tidal wave, which will
sweep in check truncation and image exchange.
Improvements in Internet Banking
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Banks are increasingly convinced that Internet banking's ROI can extend beyond simple
cost-to-serve equations and direct revenue models. Driven by enhancements in Internet
banking's user-friendliness, Internet banking's ROI now encompasses generating
revenues indirectly by improving customer satisfaction with Internet banking, which in
turn, has proven to translate into greater customer retention and higher balances. Banks'
demands also include lowering cost-to-serve through self-service features with broad
appeal (e.g., check image access and e-statements) and customer support features that
not only improve customer service representatives' effectiveness but also their efficiency
(e.g., online chat).
Increased automation of the Loan Process

As interest rates inch up, banks are scrambling to develop marketing and technology
strategies geared towards maintaining strong growth in originations. Next-generation
solutions will provide users with greater work process automation capabilities and better
integration with third parties, thereby eliminating many of the manual processes still in
place today. A large portion of the typical loan process is still conducted via phones and
faxes, creating bottlenecks and unhappy customers, who expect greater speed. New
solutions will also be better integrated with the front end, creating greater straight-
through processing.
Increased focus on the Small Business market

Until recently, small businesses have been chronically underserved by banks. The
classic example is the application of a retail Internet banking solution to serve these
businesses, which has been the leading cause of low adoption to date. Banks, however,
are increasingly recognizing they could garner a larger share of small businesses'
financial services spending if they implement appropriate technology. In an effort to
better serve them and attract their business, banks will deploy at an increasing rate
Internet banking solutions built specifically for small businesses. Small business online
banking adoption is therefore expected to grow beyond its current 12 percent level to
reach over 20 percent by 2005.
Increased Spend on Compliance Solutions

Much confusion regarding the USA PATRIOT Act and its implied affect on the banks has
resonated through the banking industry over the past two years. Today, however, the
confusion has subsided as final regulations have been posted for many sections of the
Act and speculation is no longer needed. Although a clearly defined roadmap is still
missing for financial institutions, we are beginning to see banks revise or implement their
compliance procedures. Banks will focus on solutions that will assist them in detecting
money laundering both at the account and transaction levels. Much emphasis will also
be placed on ID verification procedures to assist them with correctly identifying and
authenticating their customers across channels.
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MULTI CHANNEL INTEGRATION

The retail banking industry is going through a period of business and technical evolution
with the commoditization of banking services and products. The convergence of
brokerage firms, insurance companies with traditional banking entities adds to this
revolution. The proliferation of the Internet and mobile access not only provides new
business opportunities for banks to reach their customers but also raises concerns on
how to obtain a unified view of the customer. The economic downturn has led to cost
reductions and a renewed focus on customer retention. The value of customer retention
and loyalty is a leading factor for many retail banks to seriously address improving the
customer access to their offerings. How are banks addressing the challenges of
reaching the mass customer market to drive business opportunities for customer
retention, cross selling, and up selling products and banking services?
Banks are attempting to generate new sources of revenue by expanding the channel
options available to its customers. Increasingly Banks are using the multi channel
integration approach as a key component of a viable customer relationship management
strategy. These multi-channel accesses include the traditional ATM/kiosk, branch, and
call centers and newer channels like Web access, interactive TV, and wireless.
Mulit channel integration allows the customer to choose the most convenient access to
the bank’s offerings. A key proposition of multi channel integration is that regardless of
channel entry, the customer will be delivered a consistent set of information and banking
services. To achieve this leading Banks have developed a channel delivery solution that
shares a common view of the customer information and available banking services.
Banks are looking to maximize the value of each customer interaction, regardless of the
channel, due to the commoditization of many financial services and products. This
requires developing a single view of the customer that can be delivered consistently to
all customer touch-points, and the delivery of banking products and services consistently
across all channels.
Multi-channel Banking is aimed to provide customers with common banking services
across all touch-points. A major pre-requisite is a seamless and real-time interaction
between the customer and the retail bank. Banks need to solve the interaction of
requests from customer facing applications - determine appropriate banking services,
initiate the banking services to access the information source, and return the results in a
timely manner. The following figure shows the essential elements for multi-channel
banking.
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Multi-channel Banking involves the integration of:

• Interaction Channels - Customer communication entry to a bank’s products and
services. Examples are branch services that may include ATM/kiosk, call center
services via direct customer service representative/voice response units, and
Internet services using Web banking. Banking services may be unique to a
particular interaction channel - the branch and ATM can both dispense cash, for
example, but that banking service is not available via the Internet or telephone
• Channel Services - Provide customers with individual custom experiences with
the bank based on customer preferences and interaction history. Banks are able
to leverage this information to provide banking services and products that are
meaningful to the customer. Channel services can be further separated into front-
end services (such as Customer Preferences, Interaction History, Advisement)
and back-end services (such as Funds Transfer, Account Balance, Stop
Payment)
• Back Office Services - Represent the bank’s core processing systems. Examples
include Deposit Processing System, Loan Accounting and Service System, and
Credit Processing System
• Analytical Services - Provide banks with insights and information on customer
behavior and demographics, enabling banks to proactively advise and offer
customers qualified products and banking services
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In the world of multichannel banking, customers can check account balances on the
Web, replenish cash from an ATM, or talk to a call center to see if a check has cleared.
Customers are embracing multiple channels and banks are responding by connecting
channels to employees, wherever they may be located. The employees can access and
share up-to-date information, thereby providing better customer service.
In addition to gaining a unified view of the customer, a multichannel approach helps a
bank present itself to the customer as a single organization rather than a series of
separate channels. Customers then can feel at ease switching from one channel to
another depending on their needs, knowing their needs will be met, regardless of which
channel they choose.
There is a growing portfolio of channels that retail banks are using to provide their
customers access to required information, such as Branch offices, Wireless devices
Internet or intranet, ATMs, POS terminals, Kiosks and Call centers.
BANCASSURANCE
Bancassurance in its simplest form is the distribution of insurance products through a
bank's distribution channels. In concrete terms bancassurance describes a package of
financial services that can fulfill both banking and insurance needs at the same time. It
takes various forms in various countries depending upon the demography and economic
and legislative climate of that country. Demographic profile of the country decides the
kind of products bancassurance shall be dealing in with, economic situation will
determine the trend in terms of turnover, market share, etc., whereas legislative climate
will decide the periphery within which the bancassurance has to operate.
The motives behind bancassurance also vary. For banks it is a means of product
diversification and a source of additional fee income. Insurance companies see
bancassurance as a tool for increasing their market penetration and premium turnover.
The customer sees bancassurance as a bonanza in terms of reduced price, high quality
product and delivery at doorsteps. Actually, everybody is a winner here.
By leveraging their strengths and finding ways to overcome their weaknesses, banks
could change the face of insurance distribution. Sale of personal line insurance products
through banks meets an important set of consumer needs. Most large retail banks
engender a great deal of trust in broad segments of consumers, which they can leverage
in selling them personal line insurance products. In addition, a bank’s branch network
allows the face-to-face contact that is so important in the sale of personal insurance.
Another advantage banks have over traditional insurance distributors is the lower cost
per sales lead made possible by their sizable loyal customer base. Banks also enjoy
significant brand awareness within their geographic regions, again providing for a lower
per-lead cost when advertising through print, radio and/or television. Banks that make
the most of these advantages are able to penetrate their customer base and markets for
above-average market share.
Other bank strengths are their marketing and processing capabilities. Banks have
extensive experience in marketing to both existing customers (for retention and cross
selling) and non-customers (for acquisition and awareness). They also have access to
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multiple communications channels, such as statement inserts, direct mail, ATMs,

telemarketing, etc. Banks' proficiency in using technology has resulted in improvements
in transaction processing and customer service.
Distribution is the key issue in bancassurance and is closely linked to the regulatory
climate of the country. Over the years, regulatory barriers between banking and
insurance have diminished and has created a climate increasingly friendly to
bancassurance. The passage of Gramm-Leach Bliley Act of 1999 in US has further
stimulated the growth of bancassurance by allowing use of multiple distribution channels
by banks and insurance companies.
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MARKET LANDSCAPE
The retail banking services market in the US has been growing steadily with a growth of
∗
approximately 4% to US$1.2 billion in 2002.
The retail banking services market remains fragmented, with many small regional
players and the five largest companies accounting for only 35% of the total market value
in 2002.
Real estate loans remained the largest sector in the retail banking services market with a
growth rate of 18.5% over the 5-year review period of 1998-2002, from US$638.6 billion
in 1998 to US$757 billion in 2002 to capture approximately 63% of the market.
The retail banking services market is expected to grow approximately 11.1% from
US$1.3 billion in 2003 to US$1.4 billion in 2007.
Real estate loans are expected to remain the largest sector in the retail banking services
market with an expected growth of 9.5% over the forecast period from US$787.2 billion
in 2002 to US$862.3 billion in 2006, accounting for 61.6% of the total market value.
KEY PLAYERS
The following a list of the leading US Bank and thrift holding companies in terms of their
deposits.
Name of the company 2003 2002 2001 2000 1999
1 Citigroup Inc. New York $474,015,000 $430,895,000 $374,525,000 $300,722,000 $261,091,000
2 Bank of America Corp. Charlotte 414,181,105 386,458,000 373,495,000 364,244,000 347,273,000
3 J.P. Morgan Chase & Co. New York 326,492,000 304,753,000 293,650,000 279,365,000 241,745,000
4 Wells Fargo & Co. San Francisco 247,527,000 216,916,000 187,266,000 169,908,000 133,001,000
5 Wachovia Corp. Charlotte 224,451,000 192,602,000 188,337,000 143,776,000 142,463,000
6 Bank One Corp. Chicago 164,621,000 170,008,000 167,530,000 167,077,000 162,136,000
7 FleetBoston Financial Corp. 137,764,000 125,814,000 129,337,000 101,290,000 114,896,000
8 Washington Mutual Inc. Seattle 119,590,576 112,846,677 79,515,850 64,937,919 67,051,989

Statistics from report “Retail Banking Services in the USA 2003” by CMS Info
(www.cmsinfo.com)
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9 U.S. Bancorp Minneapolis 119,052,000 115,534,000 105,219,000 53,257,000 51,530,000
10 SunTrust Banks Inc. Atlanta 81,189,519 79,706,628 67,536,422 69,533,337 60,100,529
11 National City Corp. Cleveland 63,930,030 65,118,768 63,129,932 55,256,422 50,066,310
12 BB&T Corp. Winston-Salem, N.C. 59,349,785 51,280,016 44,733,275 38,014,501 27,251,142
13 Fifth Third Bancorp Cincinnati 57,081,988 52,214,109 45,714,895 30,948,780 25,886,075
14 Bank of New York Co. Inc. 56,407,686 55,386,576 55,711,190 56,376,046 55,750,348
15 KeyCorp Cleveland 50,857,853 49,333,238 44,775,781 48,973,557 43,221,621
The following table ranks the top 10 Retail Banks in the US on the basis of the size of
their assets. (As on March 2004, all figures in USD million)
Si no. Company Name Total Assets Total Deposits

1 Citigroup, Inc. 1,317,877 499,189
2 J.P. Morgan Chase & Co. 1,120,668 502,826
3 Bank of America Corporation 1,016,247 573,356
4 Wachovia Corporation 410,991 232,338
5 Wells Fargo & Company 397,354 248,369
6 U.S. Bancorp 192,093 118,964
7 SunTrust Banks, Inc. 148,283 96,661
8 National City Corporation 128,400 77,122
9 ABN AMRO North America
Holding Company* 127,154 53,289
10 HSBC North America Inc.* 125,950 86,248
KEY RETAIL BANKING CORPORATIONS IN THE US

• J.P. Morgan was the fastest growing company in the retail banking services market
with average annual asset growth of 21.5% over the review period of 1998 to 2002.
• Citigroup's total assets grew approximately 4.4% to US$1.1 trillion in 2002 from
US$1.05 trillion in 2001.
• Bank of America Corporation - In its efforts to become the first nationwide bank, the
company maintained assets of US$660.5 billion in 2002, increasing 6.2% from
US$621.8 billion in 2001.
• J.P. Morgan Chase's total assets increased 9.4% to US$758.8 billion in 2002 from
US$693.6 billion in 2001.
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• Bank One reported total assets of US$277.4 billion in 2002, up 3.7% from US$267.6
billion in 2001.
• Wells Fargo & Company reported a 13.6% increase in its assets over the previous
year, to US$349.3 billion in 2002 from US$ 307.6 billion in 2001, partly attributable to
the increased insurance revenues as a result of the purchase of insurance company
Acordia in 2001.
MERGERS & ACQUISITIONS IN RETAIL BANKING

Financial institutions continue to regard acquisitions as a valid growth strategy, with the
largest firms getting even larger: Wachovia and First Union, Fleet and Bank of America,
and JP MorganChase and BankOne. The same trend is present in Europe and Asia, and
the ability to cross and up-sell intelligently and profitably, be it to the corporate customer
or consumer, remains high on bankers' agendas. History also shows that deals beget
deals. Recent mega-mergers, such as Bank of America with FleetBoston, and J. P.
Morgan Chase with Bank One, could well trigger a new round of intense global M&A
activity as banks attempt to buy growth or cut costs by increasing scale. At the very
least, banks will have to consider their M&A options to stay abreast of the competition,
and window-shopping for opportunities often leads to buying.
The dominance of the US and Europe in the current global financial services landscape
means that most European and American banks enter new markets outside their region
through transatlantic M&As. The Royal Bank of Scotland, for instance, made twenty-six
US acquisitions from 1988 through 2004, and in the process has become the world’s fifth
largest bank by market capitalization. The Royal Bank of Scotland is not alone in its
interest in the US market, which is attracting foreign suitors because of its large size,
profitability, and high level of fragmentation. These primary factors also ensure that for
now, at least, we expect US banks to see more incoming than outgoing transatlantic
M&As.
A fragmented domestic market, such as the US, Italy, or Spain, where nine to twelve
major banks control 50% of the market, clearly provides plenty of scope for
consolidation. In developing markets such as France and Germany, with six to eight key
players accounting for a 50%–80% market share, the number of retail banks is still
decreasing as the market consolidates. In heavily consolidated markets, such as
Canada, Belgium, and the UK, four or five major players hold 80% of the market.
Regulations in such countries often impede further domestic consolidation, and banks
may opt to look further afield at cross-border or transatlantic opportunities.
Half of the top fifteen European banks are reportedly looking at US merger targets.
However, domestic mega-mergers in the US, such as the Bank of America deal with
FleetBoston, or J. P. Morgan Chase with Bank One, have some clear ramifications for
future transatlantic deals on both seaboards. European banks with US operations will
undoubtedly be affected by changes in the competitive landscape, such as Bank of
America’s success in developing a presence in nearly every US regional market. While
competitors may benefit in the short term by picking off any disaffected customers these
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mega-mergers create, they will inevitably face even more intense competition and could
be forced to expand their own geographic reach.
US targets can be expensive. Bank of America’s decision to pay a 42% premium over
FleetBoston’s share price indicates that US banks are unlikely to sell themselves
cheaply, especially as signs of a global economic recovery emerge. The bar has been
raised for acquisition prices in the US, and this could create a strong deterrent to
European banks considering US partners, despite the favorable exchange rate they
enjoy today.
Citigroup appears to be the only large US bank currently looking for merger opportunities
in Europe. Due to the fragmented nature of the US market, most US players are
focusing on domestic consolidation as their immediate priority. Yet unless US regulators
increase the 10% limit on a bank’s market share of US retail deposits, expanding players
like Bank of America will find it difficult to pursue further large US mergers. As the
market evolves, US banks could choose instead to look to Canada for cross-border
deals.
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APPENDIX – A CONSUMER CREDIT RATING AGENCIES

One of the key settlement providers are credit rating agencies. These provide reports
and ratings on the credit worthiness of individuals and businesses. Consumer Credit
rating is the process of generating a composite score to determine the credit worthiness
of an individual. The score is derived from a credit report generated using a scoring
method taking into account a lot of information including the credit history, income, and
current debt burden. The score along with the report is used to determine the credit risk
of the individual.
Although there are several scoring methods, the score most commonly used by lenders
is known as a FICO because of its origins with Fair Isaac and Company. Fair Isaac is an
independent company that came up with the scoring method and software used by
banks and lenders, insurers and other businesses. According to FICO, the various
factors used to calculate credit scores can be grouped into five primary areas:
• Payment history
• Outstanding debt
• Number of years of credit usage
• Pursuit of new credit
• Types of credit in use
The scale runs from 300 to 850. The vast majority of people will have scores between
600 and 800. Credit score also influences the interest rate for loans and the difference in
the interest rates offered to a person with a score of 520 and a person with a 720 score
works out a substantial 3.45 percentage points.
Credit score Percentage of people
499 and below 1 percent
500-549 5 percent
550-599 7 percent
600-649 11 percent
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650-699 16 percent
700-749 20 percent
749-799 29 percent
800 and above 11 percent
Each of the three major credit bureaus (Experian, Equifax and TransUnion) worked with
Fair Isaac in the early 1980's to come up with the scoring method.
The three national credit bureaus have their own version of the FICO score, based on
their individual systems.
Credit Bureau Scoring System
Equifax Beacon system,
TransUnion Empirica system
Experian Experian/Fair Isaac system
Each system is based on the original Fair Isaac FICO scoring method and produces
equivalent numerical results for any given credit report. Some lenders also have their
own scoring methods. Other scoring methods may include information such as your
income or how long you've been at the same job.
APPENDIX – B MORTGAGE BACKED SECURITIES

Apart from mortgage pass-throughs, there are other types of MBS. They are explained
below.
Collateralized Mortgage Obligation (CMO): This is a MBS that comprises several

classes of bonds all backed by a pool of mortgage pass-throughs or mortgage loans.
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CMOs can be backed by the following

• Ginnie Mae, Fannie Mae or Freddie Mac pass-throughs
• Pool of unsecuritized mortgage loans insured by the FHA or guaranteed against
default by the Department of Veteran Affairs.
• Unsecuritized conventional mortgages or
• Combinations of the above
The issuer distributes the cash flow from the underlying collateral over a series of
classes, called “tranches” which make up the CMO issue. Each CMO is a set of two or
more tranches, each having average lives and cash flow patterns designed to meet
specific investment objectives.
Sequential pay structure: There are many kinds of CMO and one of the simplest is a
sequential pay or a pure vanilla CMO. This typically comprises three or four tranches
that mature sequentially. All tranches participate in interest payments from the mortgage
collateral, but initially, only the first tranche receives principal payments. It receives all
principal payments until it is retired. Next, all principal payments are paid to the second
tranche until it is retired, and so on.
Any collateral remaining after the final tranche is retired is called a residual. Sometimes,
the residual is also traded as a stand-alone security.
CMOs entail the same prepayment risk as mortgage pass-throughs. The risk of a
specific bond depends upon how it is structured and the underlying collateral. Many
different structures are used in practice, including
• Z-bonds
• PAC bonds
• IOs and POs
• Floaters and inverse floaters.
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Z-bonds: Z-bond, also known as an accrual bond or an accretion bond, is a type of

CMO. This is often takes the form of a final tranche of a CMO. Holders of these
securities receive no cash until the other tranches are paid in full. During the period that
other tranches are still outstanding, periodic interest payments are added to the face
value of the bond but not paid to the investors. When the prior tranches are retired, Z-
bonds receive interest payments on its higher principal balance and any principal
repayments from the underlying collateral.
Cash flows for a CMO with three sequential pay bonds followed by a
single Z bond are depicted above. Note that interest payments made by
borrowers during the early years of the CMO are treated as principal
payments to the A, B and C bonds. Principal payments made by
mortgagors during the later years of the CMO are treated as payments
of accrued interest to the Z bond.
Planned amortization class (PAC): PAC bonds are a type of CMO bond. They are
designed to largely eliminate prepayment risk for investors. They do this by transferring
all prepayment risk to other bonds in the CMO. Appropriately, those other bonds are
called support or companion bonds.
PAC bonds offer a fixed principal redemption schedule that will be met so long as
prepayments on the underlying mortgage collateral remain within a specific range, which
is called a prepayment protection band.
Various related structures have been devised that offer a form of subordinate
prepayment protection. A PAC II bond is formed from the cash flows of support bonds
for regular PAC bonds. They offer a fixed principal redemption schedule so long as
prepayments remain within another, narrower, prepayment protection band. They are
more risky than PAC bonds, but offer higher yields. Continuing on the theme, PAC III
bonds are formed from cash flows of support bonds for PAC II bonds.
Targeted amortization class (TAC): TAC bonds are analogous to PAC bonds, but are
structured differently. They offer one-sided protection, shielding investors from high
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prepayment rates up to a specified PSA. They do not protect against low prepayment
rates.
Interest only (IO) and principal only (PO): These bonds are obtained by stripping the
interest cash flows from the principal cash flows of mortgage collateral. The interest cash
flows form one bond, which is the IO. The principal cash flows form a second bond,
which is the PO.
Prepayment risk tends to be extreme for IO's and PO's, with one benefiting when the
other suffers. This is because
• Total payments to a PO are fixed—all that is uncertain is the timing of those
payments. Prepayments are desirable because the holder of the PO receives the
money earlier.
• Total payments to an IO are not fixed. Prepayments are undesirable because
they reduce future interest payments
Floater: A floater is a fixed income instrument whose coupon (interest rate) fluctuates
with some designated reference rate. The coupon rate is usually reset each time interest
is paid. A typical arrangement might be to pay interest at the end of each quarter based
on the value of 3-month Libor at the start of the quarter. The coupon rate is calculated as
the reference rate plus a fixed spread, which depends upon the issuer's credit quality
and specifics of how the instrument is structured.
Inverse Floater: If collateral for a CMO comprises fixed rate mortgages, they can be
structured by pairing offsetting floater and inverse floater tranches.
An inverse floater (or reverse floater) is a floater whose coupon fluctuates inversely with
its reference rate—increasing when the reference rate decreases and decreasing when
the reference rate increases. With each coupon payment, the floating rate is reset for the
next period according to the formula:
floating rate = fixed rate – coupon leverage reference rate
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The multiplier is called the coupon leverage. Often, it is equal to 1, but not always. If it
exceeds 1, the instrument is called a leveraged inverse floater.
A typical structure for an inverse floater might have a maturity of five years, pay interest
quarterly, and offer a floating rate of 12% minus two times a reference rate of 3-month
USD Libor. There might also be a cap and/or floor for the floating rate.
Mortgage-Backed Bonds (MBB): MBBs are bonds issued by a Financial Institution that
have mortgages serving as collateral against the bonds. The MBB bondholders receive
a stated rate of interest that is not tied to the cash flows of the mortgage assets. The
issuance of MBBs does not remove the mortgage asset from the balance sheet and the
issuer retains all the liability for making payments to the investors. So, this is like any
other secured corporate debt with the exception that mortgage pools serve as the
collateral.
MBBs and pass-throughs are non-derivative products whereas CMOs are known as
derivative products.
APPENDIX – C COSTS ASSOCIATED WITH

MORTGAGES
There are various costs associated with a mortgage and we look at some of them in
detail here.
ARM Benchmarks – The descriptions of some of the benchmarks used to

determine ARM rates are given below. The ARM rates are typically specified as a
markup above the benchmark rate, say 2.0% + CD.
Some benchmark rates used to determine ARM rates
Treasury bills Treasury bills are issued by the U.S. government in

order to pay for the national debt and other expenses.
CD Banks and other financial institutions usually issue the

Certificates of Deposit, also known as CDs. They pay
a fixed rate of interest for a specific period of time.
LIBOR LIBOR is an average of the interest rate on dollar-

denominated deposits, also known as Eurodollars,
traded between banks in London. The Eurodollar
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market is a major component of the International

financial market.
COFI This index reflects the weighted-average interest rate

paid by 11th Federal Home Loan Bank District savings
institutions for savings and checking accounts,
advances from the FHLB, and other sources of funds.
The 11th District represents the savings institutions
(savings & loan associations and savings banks)
headquartered in Arizona, California and Nevada.
Since the largest part of the Cost Of Funds index is
interest paid on savings accounts, this index lags
market interest rates in both uptrend and downtrend
movements.
FRM Interest Rates – FRM interest rates vary with the term of the mortgage loan. The
rate usually is higher for greater terms. The interest rates for different months in 2003 is
presented below.
US National monthly averages 2003
Month 1-Year ARM 15-Year FRM 30-Year FRM
Jan-03 4.26% 5.48% 6.05%
Feb-03 4.15% 5.36% 5.94%
Mar-03 4.04% 5.25% 5.88%
Apr-03 4.02% 5.28% 5.92%
May-03 3.89% 5.24% 5.65%
Jun-03 3.75% 4.84% 5.43%
Jul-03 3.80% 5.14% 5.80%
Aug-03 4.08% 5.77% 6.47%
Sep-03 4.10% 5.58% 6.29%
Oct-03 3.98% 5.41% 6.12%
Nov-03 3.99% 5.40% 6.07%
Dec-03 3.97% 5.35% 6.03%
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APR Calculation – APR calculation is supposed to help out the borrower in comparing
the loan products of various lenders. But, the fact that there is no single way of
calculating the APR leads to some confusion. The costs that are used for APR
calculation are given below.
Fees included in Fees sometimes Fees not included in

APR included in APR APR
• Points - both • Loan- • Title or abstract fee

discount points application fee
• Escrow fee
and origination
• Credit life
points • Attorney fee
insurance
• Pre-paid (insurance that • Notary fee
interest - interest pays off the • Document
paid from the mortgage in the preparation (charged by
date the loan event of a the closing agent)
closes to the end borrowers death)
of the month. • Home-inspection fees
• Loan- • Recording fee

processing fee • Transfer taxes
• Underwriting • Credit report
fee
• Appraisal fee
• Document-
preparation fee
• Private
mortgage-
insurance
Closing costs – These are the costs that the borrower needs to pay while “closing” the
loan. Sometimes, these can also be included to the principal and be made a part of the
loan. Closing costs include the following:
• Appraisal fee-Is the fee paid to the property appraiser for providing the lender with a
reasonable estimate of property value for loan purposes. FHA and VA loans set a
maximum limit for the fee but conventional loan appraisers can determine their own
charges.
• Attorney/settlement fee-this is a charge for all the paperwork and research required
by the mortgage lender
• Credit report-the cost for reports on credit history so that the lender can verify credit
worthiness. Cost for reports range from $55 to $70.
• Points- fees the borrower pays the lender at the time the loan is closed, expressed
as a percent of the loan. So, 1 point equal to 1% of the loan. Typically higher points
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paid will result in a lower interest rate on the loan of the same tenor. Points are used
as an additional pricing parameter to suit individual borrowers initial down payment
ability. Points comprise origination point and discount point(s)
o Origination point-a fee collected by the lender for obtaining a loan. On FHA
and VA loans, this cannot exceed 1% of the base loan amount; conventional
loans have no such limits.
o Discount point(s)-a one-time charge paid to reduce the interest rate on the
loan. The lower the interest rate, the higher the discount points will be.
However, depending on market conditions, a loan may or may not have
discount points.
• Sales commission-This is usually paid by the seller; this is the charge from the real
estate company or builder's representative who sold the property to the homebuyer.
For the real estate company, the charge is generally a percentage of the sales price;
builders may receive a straight fee per house.
• Survey-Charges for the survey, done by an engineer, shows the lot measurements
and all recorded or unrecorded easements or restrictions against the lot. This
ensures that the house and lot being sold are the same as the current deed.
• Title insurance-This protects the lender from title liens placed upon the new home.
Any claims that would cause problems with the lender's first lien on the property and
that was not detectable through the title search would be protected with this
insurance.
• Recording changes-This is the cost to record mortgage loan papers and the deed at
the county courthouse.
• Termite inspection-checks for wood damage or infestation of any kind from wood
destroying insects.
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APPENDIX – D SECURITIZATION OF AUTO LOANS

An auto loan securitization can currently take one of three forms: a Grantor Trust, an
Owner Trust, or a financial asset securitization trust (FASIT). Grantor and owner trusts
are the most commonly used structures for auto loan receivables.
A grantor trust is the simplest auto ABS issuers, but is rarely used with newer
transactions. A grantor trust is a pass-through structure that requires a pro rata share of
principal and interest from the underlying collateral to be “passed-through” to investors.
Investors, also referred to as certificate holders, are entitled to all of the cash flows from
the auto loan receivables.
A pass-through can be structured as a single tranche or a multiple tranche security. In a

senior/subordinated structure, principal and interest are allocated proportionally
according to original tranche sizes.
Prepayment Rate
The absolute prepayment speed or ABS is the standard measure of prepayment rates in
the auto loan sector. This plays a role similar to the one played by CPR in MBS.
ABS measures the monthly rate of loan prepayments as a percentage of the

original pool balance. ABS is defined by the formula below where SMM
refers to single monthly mortality, which measures the percentage of dollars
prepaid in a given month expressed as a percentage of the scheduled loan
balance.
ABS = (100*SMM)/(100+SMM*(AGE – 1)
The ABS measurement differs from CPR, which measures prepayment as an
annualized percentage of the current pool balance.
Most prepayments on auto loans result from either defaults or trade-ins.
Borrowers rarely refinance existing car loans because interest rates tend to
be higher for used cars than new cars. A loan resulting from a refinancing
would be considered a used car loan. Thus, auto loan prepayments tend to
be fairly predictable and not highly correlated with interest rate changes.
Owner trusts are typically used when the cash flows of the assets must be “managed”
to create “bond-like” securities. Unlike a grantor trust, the owner trust can issue
securities in multiple series with different maturities, interest rates, and cash flow
priorities.
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FASIT is a vehicle to facilitate securitization of a variety of relatively illiquid assets

(primarily debt instruments). FASITs work much like Real Estate Mortgage Investment
Conduits (REMICs) to promote liquidity and permit risk segmentation with multiple series
(tranche) structures. While FASITs were created to repackage cash flows from a variety
of assets, they have not been used to date for auto loans because of the immediate
taxable event they create for issuers.
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APPENDIX – E SECURITIZATION OF AUTO LOAN

BACKED SECURITIES
An auto loan securitization can currently take one of three forms: a Grantor Trust, an
Owner Trust, or a financial asset securitization trust (FASIT). Grantor and owner trusts
are the most commonly used structures for auto loan receivables.
A grantor trust is the simplest auto ABS issuers, but is rarely used with newer
transactions. A grantor trust is a pass-through structure that requires a pro rata share of
principal and interest from the underlying collateral to be “passed-through” to investors.
Investors, also referred to as certificate holders, are entitled to all of the cash flows from
the auto loan receivables.
A pass-through can be structured as a single tranche or a multiple tranche security. In a
Loan Secondary Securi
Investor
Lender s Market ties
s
Conduit/ SPE
senior/subordinated structure, principal and interest are allocated proportionally
according to original tranche sizes.
Owner trusts are typically used when the cash flows of the assets must be “managed”
to create “bond-like” securities. Unlike a grantor trust, the owner trust can issue
Prepayment Rate
The absolute prepayment speed or ABS is the standard measure of prepayment rates in
the auto loan sector. This plays a role similar to the one played by CPR in MBS.
ABS measures the monthly rate of loan prepayments as a percentage of the
original pool balance. ABS is defined by the formula below where SMM
refers to single monthly mortality, which measures the percentage of dollars
prepaid in a given month expressed as a percentage of the scheduled loan
balance.
ABS = (100*SMM)/(100+SMM*(AGE – 1)
The ABS measurement differs from CPR, which measures prepayment as an
annualized percentage of the current pool balance.
Most prepayments on auto loans result from either defaults or trade-ins.
Borrowers rarely refinance existing car loans because interest rates tend to
be higher for used cars than new cars. A loan resulting from a refinancing
would be considered a used car loan. Thus, auto loan prepayments tend to
be fairly predictable and not highly correlated with interest rate changes.
securities in multiple series with different maturities, interest rates, and cash flow
priorities.
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FASIT is a vehicle to facilitate securitization of a variety of relatively illiquid assets

(primarily debt instruments). FASITs work much like Real Estate Mortgage Investment
Conduits (REMICs) to promote liquidity and permit risk segmentation with multiple series
(tranche) structures. While FASITs were created to repackage cash flows from a variety
of assets, they have not been used to date for auto loans because of the immediate
taxable event they create for issuers.
SECURITIZATION OF AUTO LEASE BACKED SECURITIES

Upon the accumulation of a sufficient amount of leases in a titling trust to complete a
securitization, the servicer will direct the origination trustee to segregate a pool of leases
and the related vehicles.
The largest hurdle in securitizing auto leases relates to the difficulty in effecting a true
sale of the assets to be securitized. In the securitization of auto loans, which are
considered financial assets, transfer of the ownership of the loans is achieved by selling
them to the trust issuing the ABS.
However, in the case of auto lease securitizations, both the vehicle and the lease
contract (typically an operating lease) constitute the asset sold to the trust. Thus, the
asset is not considered financial, and, unlike other consumer assets, the Uniform
Commercial Code (UCC) is not applicable to the ownership and transfer.
To overcome vehicle titling problems, the origination, or titling trust, a special purpose
entity (SPE) created by the lease originator to effect the purchase of lease contracts and
the related vehicles directly from dealers, was developed.
Although the titling trust, rather than the originator, is listed on the certificate of title, the
titling trust transfers to the originator a beneficial interest in all vehicles and leases
owned by the titling trust. This beneficial interest is sometimes referred to as an
undivided trust interest (UTI). The holder of the beneficial interest obtains the economic
value for tax purposes (i.e. depreciation), but not ownership for accounting purposes, of
the assets in the titling trust.
The assets underlying the beneficial interest/UTI can be carved up and segregated into
a certificate of beneficial interest, frequently referred to as a special unit of beneficial
interest (SUBI), which can then be transferred to the seller, typically another SPE. The
seller then transfers the certificate of beneficial interest/SUBI in a true sale to a
securitization trust that also obtains a perfected security interest in both the certificate of
beneficial interest/SUBI and the cash flows from the leases.
Three methods have been used to transfer the beneficial interest in the segregated
leases to the securitization trust, each of which results in the transfer of the rights to the
cash flows from the segregated lease contracts and corresponding vehicles to the
securitization trust.
Undivided Trust Interests and Special Units of Beneficial Interests: The more
common method, used by Honda, Toyota, and World Omni, involves the creation of an
UTI and a SUBI.
Page 180 of 186

The UTI represents a beneficial interest in all the unallocated assets of the origination
trust and is sold to an SPE. A separate portfolio within the origination trust is created
from the existing lease contracts and vehicle pool. A SUBI in the newly formed subset is
sold in a true sale to the securitization trust. After the sale, the “discrete portfolio” is no
longer part of the origination trust’s assets encumbered by the UTI. Multiple SUBIs may
be created from a single origination trust, as directed by the SPE, which represent
beneficial interests in unique asset pools as collateral for individual securitizations. Each
SUBI only has a claim on the assets associated with it and has no claim on any other
SUBIs, the remaining assets of the origination trust, or the UTI.
Sale/Leaseback Structure: The second method, used by Ford Credit and The
Provident Bank, involves a sale/ leaseback structure. For example, under Ford Credit’s
structure, unallocated leases represented by exchangeable beneficial certificates (EBC),
equivalent to the UTI, are segregated into individual trust certificates for each
securitization. Each of these trust certificates is then sold in a true sale to a Red Carpet
Lease (RCL) trust, an SPE created by Ford Credit for each securitization. Each RCL
trust then enters into a sale/leaseback transaction with the securitization trust. This
transaction is effected through the sale of the trust certificate to the securitization trust.
Leveraged Lease Structure: Some auto lease originators, including Provident Bank,
find themselves in a position where they are unable to take full advantage of the tax
benefits associated with the depreciation of the leased vehicles because they either
have more deductions than income or are subject to the alternative minimum tax. In
response, the concept of leveraged lease transactions was developed. A typical asset
backed leveraged lease transaction is very similar to a sale/leaseback structure, with the
exception that a portion of the purchase price of the lease contracts and related vehicles
is financed by equity investors and a portion with debt.
Page 181 of 186

APPENDIX – F DIFFERENCES BETWEEN LEASING AND

FINANCING
Leasing Financing
Up-front costs of leasing a vehicle may include Up-front costs of buying a vehicle
the first month’s payment, a refundable security may include the cash price or a
deposit, a capitalized cost reduction (like a down down payment, taxes, registration
payment), registration fees, taxes, and other fees, and other charges.
charges due at lease signing or delivery.
Capitalized cost reduction. A capitalized cost Cash price or down payment. The
reduction is the sum of any cash down payment, full cash price must be paid when
net trade-in allowance, or rebate that is you purchase the vehicle, unless
subtracted from the gross capitalized cost. The you obtain financing. If the vehicle
remainder is the adjusted capitalized cost of the is financed by either the seller or a
lease. A capitalized cost reduction reduces the third party, a down payment is often
monthly payment by (1) decreasing the amount required. The remaining cash you
of depreciation and any amortized amounts that must pay for the purchase or the
are a part of the monthly payment and (2) amount you must finance may be
decreasing the total rent charges by lowering reduced by a net trade-in allowance
the beginning lease balance (the adjusted or a rebate.
capitalized cost), thereby reducing the average
lease balance over the term.
Taxes. Several types of taxes may be due at Sales taxes. State and local sales
lease signing, depending on the taxation rules of taxes are typically assessed on the
the state and the policies of the lessor, such as full purchase price. However, if a
State sales tax on any capitalized cost reduction vehicle is traded as part of the
County or other local taxes State sales tax on purchase, sales tax may be
the adjusted capitalized cost State property tax assessed on only the purchase
on the vehicle. Instead of paying for these taxes price minus the trade-in value,
at lease signing, you may have the option of depending on state law. You may
having the lessor include them in the gross have the option of having the
capitalized cost, thereby increasing your creditor pay the sales tax and
monthly payment. include it in the amount financed,
thereby increasing your monthly
payment.
Other taxes. Several other types of
taxes may be due at purchase,
depending on the taxation rules of
the states, such as County or other
local taxes State property tax on the
vehicle. You may have the option of
Page 182 of 186

having the creditor pay these taxes

and include them in the amount
financed.
Other charges. Several other types of charges Other charges. Several other types
may be assessed at lease signing, such as of charges may be assessed at
purchase, such as
• Vehicle license and registration fees
• Vehicle license and
registration fees
• Documentation fee
• Lessor acquisition fee.
• Dealership documentation
fee Credit application fee.
Optional insurance and services. You may be Optional insurance and services.
offered optional insurance products and other You may be offered optional
services when you lease a vehicle: insurance products and other
services when you purchase a
• Credit life and disability insurance
vehicle:
• Unemployment insurance
• Credit life and disability
• Gap coverage (may already be insurance
included)
• Unemployment insurance
• Vehicle maintenance services
• Gap coverage (usually not
• Vehicle service contract or mechanical included)
breakdown protection
• Vehicle maintenance
• Other services or insurance coverages. services
• Vehicle service contract or
mechanical breakdown
For any products or services you select, you
protection
may be able to purchase them from the lessor or
from a third party. If you purchase them from the • Other services or insurance
lessor, you may have the option of including coverages.
them in the gross capitalized cost (and paying a
For any products or services you
rent charge on them) or paying for them at lease select, you can purchase them from
signing. a third party or from the creditor. If
you purchase them from the
creditor, you may have the option of
including them in the amount
financed (and paying interest on
them) or paying for them at
purchase.
Page 183 of 186

First monthly payment. Most leases (other First monthly payment. Most
than single-payment leases) require you to finance agreements require you to
make monthly payments in advance at the make monthly payments at the end
beginning of each monthly period. That of each monthly period. That
stipulation is why the first monthly payment is stipulation is why the first payment
typically due at lease signing. Some leases is not made at purchase.
require that the last monthly payment or several
of the last monthly payments of the term be paid
at lease signing.
In a special type of lease called a single-
payment lease, you pay a single large payment
at lease signing instead of making monthly
payments over the term of the lease.
Refundable security deposit. Most leases Refundable security deposit.

require a security deposit at lease signing. Finance agreements do not require
However, lessors may waive the security security deposits.
deposit for repeat customers or for those paying
a higher rent charge. The security deposit may
be used by the lessor in case you default or at
the end of the lease to offset any amounts you
owe under the lease agreement. Security
deposits are often set by rounding the first
monthly payment to the next higher $25 or $50,
although the security deposit may be any
amount the lessor establishes. Some lessors
offer the option of obtaining lower rent charges
and a lower monthly payment if you pay a higher
security deposit. Security deposits usually do
not earn interest.
Prior lease balance. The balance due under a Prior lease balance. The balance
previous lease agreement after the value of the due under a previous lease
previously leased vehicle has been credited. If agreement after the value of the
the lessor agrees to buy your previously leased previously leased vehicle has been
vehicle, you will have to pay any prior lease credited. If the seller agrees to buy
balance unless it is included in the gross your previously leased vehicle, you
capitalized cost. will have to pay any prior lease
balance unless it is included in the
amount financed.
Page 184 of 186

Prior credit balance. The amount due under a Prior credit balance. The amount
previous finance agreement after the value of due under a previous finance
the vehicle traded in on the lease has been agreement after the value of the
credited. If you trade your previously financed vehicle traded in on the new finance
vehicle when you lease, you will have to pay agreement has been credited. If
any prior credit balance unless it is included in you trade your previously financed
the gross capitalized cost. vehicle when you finance another
vehicle, you will have to pay any
prior credit balance unless it is
included in the amount financed.
Page 185 of 186

APPENDIX – G STUDENT-LOAN ABS STRUCTURE

The generic student-loan ABS structure is an owner trust that issues one or more
classes of sequential-pay, triple-A rated notes and a single class of single-A rated
certificates.
Entities subject to the federal bankruptcy code generally use a standard two-stage
transfer of assets. An operating company sells loans to a wholly owned, bankruptcy
remote, special-purpose subsidiary, which transfers loans to a trust. Issuers, such as
owner trusts, that are not eligible lenders under FFELP regulations must use an eligible
lender trustee to hold legal title to the loans for the benefit of the trust. The trust holds
the beneficial, or economic ownership, interest in the loans.
Note and certificate rates are reset monthly to one-month LIBOR, or quarterly to three
month LIBOR, or weekly, to the bond-equivalent yield on the 91-day Treasury bill.
Interest on LIBOR-indexed securities is accrued on an actual/360 basis and is paid
monthly or quarterly. Interest on Treasury bill-indexed securities is accrued on an
actual/actual calendar-day basis and is paid quarterly. Both LIBOR- and Treasury bill-
indexed securities are typically subject to available funds rate caps.
The auction rate market has emerged as a very active market for student loan-backed
bonds. This market allows issuers to effectively issue long-term bonds and investors to
have the ability to buy in and out of these same bonds on a monthly basis without the
risk of having to sell the bonds below par. Taxable bonds typically re-price every 7 to 28
days, while tax-exempt bonds re-price every 35 days. Principal is paid monthly or
quarterly, equal to the sum of principal collections (including guaranty claims payments)
and the principal balance of repurchased and liquidated loans. Liquidated loans are
defaulted loans written off because of an uncured, rejected claim.
Credit support for the triple-A rated senior notes comes from excess spread,
subordination of cash flows from the single-A rated certificates, and a small reserve
fund. Credit support for the single-A rated certificates is provided by excess spread and
the reserve fund.
Loan servicers must deposit monthly collections from borrowers to the trust within two
business days of receipt. Guarantor claims payments and DOE special allowance and
interest subsidy payments are made to the eligible lender trustee, who also must deposit
funds to the trust within two business days. Subject to a ratings trigger, most structures
allow highly rated administrators—generally the parents of the sellers—to commingle
collections from the servicer and the eligible lender trustee for up to 90 days.
Many student-loan offerings have used pre-funding accounts. Some structures replace
or supplement pre-funding accounts with short revolving periods. Most structures have a
ten-year auction call or mandatory clean-up call from excess spread.
Page 186 of 186

Retail Banking

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Retail Banking

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L1 Course in Retail Banking

Introduction to Retail Banking..........................................................................5

Types of Student Loans............................................................................................98

INTRODUCTION TO RETAIL BANKING

However, there is a reason why credit card lending appears to be more of a

RETAIL PRODUCTS AND INSTRUMENTS

Money market accounts - A money market account (MMA) is an interest-earning

Individual retirement accounts and education savings accounts - These types of

DEPOSITS AND ACCOUNTS

The various kinds of Checking Accounts offered by Banks are:

Interest-Bearing Checking Accounts - In contrast to "no frills" accounts, these offer a

Joint checking -- An account owned by two or more people, usually sharing a

Senior/student checking -- Many institutions offer special checking deals if the

A typical Checking account provides some or all of the following features

Money Market Deposit Accounts (MMDAs)

Certificates of Deposit Accounts (CDs)

• Access to international money markets

Account Opening Process

C us to mer De t ail s A c c oun t A TM C a rd C ro ss A cc ount O pe ning

G a the r Cu stom e r Colle ct Initia l ATM Ca rd V e rify Applica tion / S ig na ture

Transaction Processing - Tellers

Check Processing & Collection

The Federal Reserve’s Check Collection Network

When a Check Is Returned

Dealing with Problem Checks

Stop Payment Orders

How to cash a Check without having a Bank Account

Point of Purchase (POP) Check Conversion

Retailer’s (Collecting) Bank

There are basically three types of credit cards:

CREDIT CARDS – BASIC CONCEPTS

Merchant - A business establishment is considered a "merchant" once they have

A typical process flow diagram involving the various participants is as follows:

CREDIT CARDS – PROCESSES

The various activities in transaction processing are as follows:

Authorization – Authorization is the first phase in a credit card monetary cycle. A

Chargeback – A chargeback is a reversal of a previous sales transaction resulting when

Balance Transfer – This is an introductory incentive offered to customers by new credit

CREDIT CARDS - SOURCES OF REVENUE

The most common types of loans given by banks to businesses are:

Brokers Brokers are intermediaries or middlemen who help

Lenders Lenders are the FI’s providing the loan.

Credit Rating Credit Rating Agencies provide credit reports on the

Securitisers Securitisers use the loans as assets and issue securities

Government In some areas of priority including housing loans,

GENERIC LOAN PROCESS

• The borrower goes to the lender directly or through a broker.

• Underwriting is the process by which the decision whether to make a loan to

Mortgages can broadly be classified into four categories – Home, Multi-family,

TOTAL MORTGAGES OUTSTANDING, 1997-2002

1997 1998 1999 2000 2001 2002

Home 3,978.3 4,362.9 4,787.2 5,205.4 5,738.1 6,460.0

Commercial 832.7 921.6 1,057.9 1,171.0 1,293.0 1,401.8

Farm 90.0 96.6 102.3 108.9 116.3 125.8

Source: Board of Governors of the Federal Reserve System.

Government Loans – These are loans either guaranteed/insured by the Federal

Jumbo Subprime “Alt” A

Classification of Mortgages based on applicable interest rates is given below. Each of

Comparing ARMs and FRMs

Adjustable-Rate Mortgage (ARM) - An adjustable-rate mortgage has an interest rate

KEY MORTGAGE CONCEPTS

Annual APR is commonly used to compare loan programs from different

Mortgage Mortgage payment is the monthly payment made by the borrower