CHAPTER 1: LITERATURE REVIEW 1.1: Overview of commercial bank 1.1.

1 Definition of commercial bank Banking occupies one of the most important positions in the modern economic world. It is necessary for trade and industry. Bank is one of the results of the Industrial Revolution and the child of economic necessity. Its presence is very helpful to the economic activity and industrial progress of a country. The definition of commercial banks is various. In Vietnam, Banking Ordinance issued on May 23rd 1990 by State Committee stated: Commercial banks are money dealing organizations whose main and usual activities are accepting deposits from customers with the responsibility of repaying and using them for lending activities or performing discounts, making as means of payment. As it is revealed by Basel Accord, commercial banks are defined as financial institutions that provide a list of various financial services, especially credit, savings, payment services and perform financial functions. In U.S, commercial banks are considered as money dealing enterprises that specialize in supplying financial services and operate in financial service industry. 1 In France,commercial banks as enterprises whose usual functions are accepting money through different forms and using those resources for their own sake in discount, credit and financial activities.2 According to Vietnam Law on Banking promulgated in 1997, commercial bank is a form of oriented profit- seeking business institution entitled to carry out all banking activities and other related activities. In general, commercial bank is a

1 2

American Commercial Law French Banking Law in 1941

profit-seeking business firm, dealing in money and credit. It is a financial institution dealing in money in the sense that it accepts deposits of money from the public to keep them in its custody for safety. 1.2 Functions of commercial banks Banks play an important role in a nations economy. The main functions of commercial banks consists of accepting of deposits and granting of loans to other banks and businesses and receiving a return on their investments through interest rates charged to these clients. However, besides these functions there are many other functions which these banks perform. All these functions are under the following heads: -Accepting deposits: is the most important function of commercial banks. The amount of deposits depends on the variety sections of society, according to the demand and economic condition. For example, fixed and low income group people deposit their savings in small amounts from the points of view of security, income and saving promotion. On the other hand, traders and businessmen deposit their savings in the banks for the convenience of payment. Therefore, keeping the needs and interests of various sections of society, banks formulate various deposit schemes. Generally, there are three types of deposits which are as follows: current deposits, fixed deposits, and saving deposits. -Giving loans: The second important function of commercial banks is to advance loans to its customers. Banks advance loans not only on the basis of the deposits of the public but also advance loans on the basis of depositing the money in the accounts of borrowers. They charge interest from the borrowers and this is the main source of banks income. In other way, they create loans out of deposits and deposits out of loans. This is called as credit creation by commercial banks. Modern banks give mostly secured loans for productive purposes. Generally, the value of security or collateral is equal to the amount of loan. This is done mainly

with a view to recover the loan money by selling the security in the event of nonrefund of the loan. Banks generally give following types of loans and advances such as cash credit, demand loans, and short-term loan. -Overdraft: Banks advance a certain loans to its customer through over-drafts, if there are no deposits in the current account. This type of loan requires a security from the customers and charge very high rate of interest. -Discounting of Bills of Exchange: is the most popular and important way of advancing loans to the traders of commercial banks for short-term purposes. According to this function, banks advance loans to the traders and business firms by discounting their bills. In this way, traders get loans on the basis of their bills of exchange before the deadline. -Investment of Funds: The banks invest their surplus funds in three types of securities. They are government securities, other approved securities, and other securities. Government securities include both central and state govern-ments, such as treasury bills, national savings certificate. -Agency Services: Banks function in the form of agents and representatives of their customers. They often collect cheques, drafts, bills of exchange and dividends of the shares for their customers; make payment for their clients; pay insurance premium of their customers; purchase and sell securities, shares and bonds on behalf of their customers. -Miscellaneous Functions: Banks perform many other functions of general utility which are as follows: protect valuable assets of their custom-ers such as gold, silver, legal documents; collect necessary and useful data relating to trade and industry; sell and buy foreign exchange; advise their clients relating to investment decisions; issue letters of credit.

Other services through their subsidiaries: merchant banking services, leasing, housing finance, factoring services, insurance services.3

2: Efficiency of deposit mobilization in commercial banks 2.1 The roles of capital in banking activity According to the book Professional modern banking in VietNam (2012), capital of commercial banks4 is the monetary value created by the Bank or raised, used to lend, invest or perform other business services. In essence, the capital of the Bank is a division of national income temporarily idle during the production, distribution and consumption, our owners send to the Bank for the purpose of payment, saving or investment. In other words, they are entitled to attend the transfer of capital to the Bank, the Bank returns to them an income. The Bank has taken the role of fund pooling and redistribution of capital in the form of currency, accelerating the flow of capital, stimulating all economic development activities. At the same time, the capital decides the existence and development of business activities of the Bank. 2.1.1. Capital plays an important role in the formation of Commercial Banks For any business, business activities must have: Technology - Labor Capital, which is an important factor. It mainly reflects the capacity to determine their sources of business. For banks, capital is an indispensable factor in the business of banking. As the basis for commercial banks and business organizations, banks cannot carry out business activities without the funds.

3 K. UPADHYAYA. 7 main functions of a Commercial bank. Retrieved from:

http://www.preservearticles.com/201104115277/7-main-functions-of-a-commercial-bank.html
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Capital not only means business but also the business object's major commercial banks. Bank is a business organization especially on commodity money market (short-term capital market) and stock market (long-term capital market). The bank has many advantages in the business. Therefore, we can say which is the first point in the cycle of banking business. So in addition to the initial capital needed, for example sufficient statutory capital, the bank must regularly care to the growth in capital during its operation. The typical business of the Bank, which is both a means of business, just as business objects. The bank made the business of "special goods" - the currency on the money market (short-term capital market) and stock market (long-term capital market). Thus, in addition to initial capital requirements established by law, banks must constantly seek ways and measures to increase capital in the business process. 2.1.2. Capital decides solvency and ability of the Bank In market economy, to survive and increasingly expand operation requires banks to have greater credibility in the market. That reputation must be shown first in availability payments. We already know, the majority of the bank's capital as deposits and borrowed funds, so banks have to pay to customers when they request a withdrawal. With a bank with small capital size, loan demand in the market is very large. On the one hand banks fail to meet loan demand. On the other hand, with small-scale lending it will lead to loss of ability to pay. Meanwhile, with a capital market sectors, they do not reserve enough liquidity to satisfy the demand for loans in the economy, thereby create higher and higher prestige. Solvency of the bank is higher than the liquidity of the larger banks. So if you exclude other factors, the solvency of banks is in proportion to the bank's overall capital and the liquidity of banks in particular. With the potential large

capital, banks can operate the business with expanding scale. The conduct of activities aimed at effective competition prestige, while improving the position of the bank. 2.1.3. Capital determines levels of credit activity and other business activities of the Bank Capital of a bank decides to expand or contract the volume of credit. Therefore it affects the ability to attract capital from organizations and economic sectors, even cannot meet the loan need of businesses. They will lose customers and not take advantage of business opportunities. If it is a big bank with abundant capital, it will meet the needs of capital to extend conditional credit relations with many companies and credit markets. Bank capital also helps large businesses with many different types such as: joint ventures, financial leasing services, securities trading ... the form of this business can diversify risks and create more bank capital. At the same time, they enhance reputation and increase competitiveness in the market. Therefore, capital plays decisive role in the business of the bank.
2.1.4 Capital decides competitiveness of the bank

Practice has proved that the size, professionalism, technical facilities of the bank are a prerequisite to attract capital. Simultaneously, large capital is likely favorable conditions for banks to expand credit relationship with the economic sectors including issues of scale, the credit volume, active time. The time limits for loan decisions even moderate interest rates for customers. That will attract more customers. The sale activities of the bank will increase rapidly and the bank will have more advantages in business. This is supplemented with the conditions for the bank's own capital, strengthening material and technical basis and scope of banking activities in all areas. At the same time the capital of big banks will create favorable conditions for the use of synchronization. On that case, the bank will have sufficient financial ability to multi-business market, not just loans but also the form of joint ventures, leasing and business services (leasing ) and trading liabilities, trading on the stock market. The forms of business will contribute to multi-distribute risks in business and generate more capital for banks and increase the competitiveness of banks in the market. Moreover, the bank's capital abundance will enable banks to ensure performance of monetary policy, contributing to a stable currency circulation, ensuring the balance of money - goods in the economy. Starting from the role of capital in the business of banking and the economy in general and capital should be mobilized in particular, capital must be preserved and continuously expanded. Improving efficiency is vital in determining the existence and development of banking activities, which respond to the economy. Thus, improve efficiency funding is needed in the operation of commercial banks in all countries. 2.2 Types of bank capital 2.2.1. Owner equity

Banks own capital is all of the bank owners equity or all the amount of money created by banks. According to Douglas, J. Elliott, bank equity represents the portion of a banks assets which have no associated contractual commitment for repayment. Bank capital consists of authorized capital (statutory capital), reserve funds and portion of undistributed profits. - Authorized capital (chartered capital or statutory capital).It is the maximum capital up to which the bank is empowered to raise capital. In other word, it is the amount with which a bank is registered. In general, the entire statutory capital is not raised from the public. That part of authorized capital which is issued in the form of shares for the public subscription is called the issued capital. Subscribed capital represents that part of issued capital, which is actually subscribed by the public. Finally, paid up capital is that part of the subscribed capital which the subscribers are actually called upon to pay.

- Reserve funds It is the accumulated undistributed profits of the bank. At the time of declaring dividend, a certain portion of the profit is transferred to the reserve fund. This reserve belongs to the shareholders and at the time of liquidation, the shareholders are entitled to these reserves along with the capital. The bank maintains reserve fund by setting aside part of profits to meet unforeseen expense and to tide over any crisis. According to Decree 146/2005/ND- CP dated 23 November 2005 issued by the Government of Vietnam, the Bank is required to make the following allocations before distribution of profits.

Annual allocation Reserve to supplement 5% of profit after tax

Maximum balance 100% share capital

share capital Financial reserve 10% of remaining profit after tax Other equity funds are allocated from profit after tax. The allocation from profit after tax and the utilization of the other equity funds are approved by the shareholders in the Annual General Meeting. The funds are not required by law and are fully distributable. Portion of undistributed profit 25% share capital

Profit is another source to a bank for the purpose of business. Profits signify the credit balance of the profit and loss account which has not been distributed. The accumulated profits increase the working capital of the bank and strengthen its financial position. Bank capital accounts for a small portion in the capital structure of commercial bank but it is a compulsory condition enabling its foundation.

2.2.2. Mobilized deposit Mobilized deposit of the bank is monetary value that the bank raised from the economic organizations and individuals in society, through the implementation of the credit operation, payment and other businesses. Funds mobilized are the property of different owners. Banks may not have the right to use property and is responsible for timely repayment of principal and interest. Thus, mobilized deposit plays very important role for all business activities of commercial banks. Funds mobilized continuously increase to all economic sectors in society. However, this fund is used only for business purposes, and to reserve a reasonable rate to ensure solvency. Capital mobilized includes: capital deposits and valuable papers.

Capital deposits: Cash deposits: The deposits that customers send to the bank but can withdraw at any time (send money to use checks, debit cards or use to make a money transfer service, or service LC collection). Cash deposits are low-interest or no interest paid, including demand deposits and term deposits. Cash deposits are not only for individuals but also for a very stable business. Current accounts (money market): Bank made the payment demands of businesses and individuals within the allowed balance. The cash receipt from the businesses and individuals can be entered into the payment of deposits on demand, with this type of deposit interest rate is very small. The current account is the account balanced at that excess. Demand deposit account: is the account that the withdrawal and payment made by check or bank transfer. However, the Bank always differs between the input and output on each deposit account payments. From there, it creates a temporarily idle fund and can use for a business. Valuable papers: Issuance of valuable papers: Apart from the methods above, banks also issue certificates of deposit, bonds and promissory notes, essentially raising capital by issuing valuable papers. Bills: are banks debentures with a term less than 12 months. It features a manageable interest rate policy in the short term. Bonds: is the bank's debentures with a term greater than 12 months. It features a manageable interest rate policy in the long term. Certificates of deposits: The valuable papers issued by the Bank in waves, depending on the purpose with the approval of the central bank. This form of

commercial banks is to raise capital to pay higher interest rates than normal interest rate. Through the presentation, mobilizing capital is important and major part in business activities of commercial banks. It is the largest proportion of total capital (80%).The banks have to respect the level of capital raised under the provisions of law. 2.2.3. Borrowed capital Borrowed capital: is borrowing more money to meet payments when the ability to raise capital is limited. This is the primary source to combat liquidity risk of banks. Loan is from the Bank to address the urgent needs of the commercial bank payment. This type of principal loan is the central bank rediscount

(refinancing). When a bank needs to bring up the commercial paper, it will rediscount at the central bank. The central bank rediscount only for quality commercial paper as short maturities, high solvency and compliance with the objectives of the central bank in each period. This fund is from a small proportion of the bank, it mostly depends on the monetary policy of central banks. If the central bank tightens monetary policy: higher interest rates. If the central bank expands monetary policy: lower interest rates. Bank loans aim to protect the safety of the banking system and implement policies. With banks have excess reserves required by the outstanding results of the unexpected increase or decrease amount of money raised, they would be willing to lend other banks to find borrowers higher interest rates. 2.2.4. Other equity Other equity is total value of the currency that the bank raised through the provision of payment services and offered investment trust. It includes sources of trust, power and other sources of payment.

Funding source is the trust that the bank has been made possible thanks to customer services, especially services for loans and payment services. This fund usually has a very low cost. The proportion of capital is higher or lower depends on service quality and reputation of our customers. 2.3 Efficiency of deposit mobilization and evaluation standard 2.3.1. Importance of deposit mobilization For the society: To achieve industrialization and modernization of the country, it needs a huge amount of capital as prerequisite materials and capital to build technical facilities, infrastructure, etc For the bank: To be able to conduct business efficiently and diverse forms of business to improve competitiveness and profitability, banks need a large amount of capital raised from domestic sources. Capital in most countries are in the household savings as a backup. Furthermore the capital of the social and economic institutions is not always used by the crop. The amount of idle capital in this area is also very large. Tasks of each bank is to focus and attract large capital to invest in production and business activities. To achieve that, the bank must have the appropriate and effective funding. The effect of raising capital in the bank must be evaluated through the following aspects: Raising capital must come from the business needs of the

bank. Mobilization of deposit must have stable growth in quantity to satisfy the demand for loans, payments and other business activities of the bank. However, raising capital should be stable in time. If the bank raises a large amount of capital, it often has a large cash flow to draw the amount of capital for lending. The investment will not be so efficient and the bank will not have to regularly deal with capital for liquidity. If banks raise capital, the bank stability will be assured to use a majority stake in the high-income activities. However, it does not mean that if

banks have stable funding mobilized vice versa, the bank's funding must come from the actual needs of the bank's capital. If mobilization is low, the bank will not meet customer needs, not diversify the business, not expand, not be competitive and lose customers. If it does not raise more capital, it still have to pay interest and additional costs such as expenses for maintenance, accounting, treasury without any offset account. In short, raising deposit is effective and stable funding to meet the needs of the banking business. 2.3.2. Evaluation standard of the efficiency of deposit mobilization a) Bank solvency: it is the ability of bank to have enough assets to cover its liability (Jean Murray, About.com Guide) Keeping bank solvency is a thorny problem with all of banks. To ensure the solvency of any banks, it requires them to meet the needs of bank reserve requirements. To reach that goal, banks have to mobilize as much money as possible. So, if we want to evaluate the efficiency of short- term capital mobilization, bank solvency is regarded as the first criterion to be mentioned. b) Funding cost: These costs are charges which any banks pay to the lender for taking the loan for its business and workings (BA Accounting & Finance Dur.ar.uk) Funding costs including the payable interest, other things such as staff salaries, money counting machine equipment, money detector machines equipment, office rent, administrative costs ... In particular, the payable interest is primarily part of the funding costs. A bank which mobilizes deposit capital effectively means that bank can raise more and more money with lowest funding cost. This requires all of banks to find the ways to reduce funding cost in process of mobilizing short- term capital such as reforming administration or enhancing the role of service activities.

c) Stable growth rate of short- term capital: This is an important criterion to evaluate the performance of short-term capital mobilized by the bank. If banks have the ability to mobilize a stable short-term funds, which showed that: no movement of downward trend in attracting customers activities of the bank. First requirement for short-term funds of banks are not the number, funding may not increase too much, but it is necessary for funds to be stable in each period. This proves that the bank has kept its loyal customers. Stable source of funds helps banks to conduct their business activities smoothly and uninterruptedly. 3: Factors affecting deposit mobilization 3.1 Objective factors 3.1.1. Political- economic and social situation A national economic development and stability is also facilitating the development of banking system. Stable economy, stable inflation rate increases the likelihood of trust when investors invest in the market. Since then, the Bank has increased the ability to raise capital efficiency as well as diverse forms of mobilization to meet the needs of the economy. Representative in the banking system was the State Bank of Vietnam. If there is reasonable policy, it would promote the banking system, especially the commercial bank system. 3.1.2. The competitiveness of banks in the market The impact of market economy has directly affected the operation of the banking system. Banks always have diversified forms of funding to attract customers. Increasing the quality of credit Increasing the number of transaction Increasing other forms of mobilization with competitive interest rates. 3.2 Subjective factors

3.2.1. Interest rates Interest rates have direct impact in regulating the activities of credit, loans and raising capital of banks, it affects the profit when considering the business results, calculate the interest rate differential between output and input. When interest rates changes, bank has to search the suitable interest rate. In the case of fluctuations of interest rate because of the non-physical factors (psychological factors, unfair competitive factors...), it will have adverse effects on credit activity of banks. In that case, the other banks have to raise interest rates to keep customers. In market economy, the economic phenomenon often changes rapidly. Interest rate factor is also sensitive and frequently change, associated with changes in supply-demand relations of capital. Thus, commercial banks should be monitored closely to fluctuations in operation process to find solutions to stabilize its business situation. 1.3.2.2. Information, research and survey policy To implement this policy, we need to mobilize all the necessary material means to carry out observation, analysis and synthesis of the basic areas related to the banking market. With these information obtained, the bank will offer general business policies to mobilize capital in particular in line with customer needs and demand for capital markets. 1.3.2.3. Distribution policy Distribution policy is a collection of all the material means that giving products and banking services to customers. The diversification of distribution channels, expanding the trading desk (the number of counters, open bar locations, equipment ordered at the counter, levels of staff ...) have a strong influence to the capital mobilization of banks. 1.3.2.4. Development and promotion policy

The bank must consider the communication policy and promotion policy, because the interaction of employees to customers will create the good image of the bank, creating the trust of customers for banks. Good communication will protect the interests of the bank. Besides, advertising is also an important mean to enhance the position of the bank and to attract more customers to the bank.