25 Essential Banking Terms You Must Know

05-Sep-2024

When you step into the world of banking, it is like entering a new universe filled with its own language and regulations. Whether you are opening your first savings account, diving into the realm of investments, or trying to manage your debt, understanding key banking terms can make traversing this space a lot easier. Let us break down 25 essential banking terms across various segments. By the end of this journey, you will not only know what these terms mean but also how they can impact your financial decisions.

1. Personal Banking

• Savings Account 

What it is: Deposit account that allows you to earn interest on your balance while keeping your money accessible.    

Use: It is used for saving money with the added benefit of earning interest, while also offering easy access to funds. 

Example: You deposit a portion of your monthly salary into your savings account and earn interest annually.

Pro tip: Prefer a savings account with a higher interest rate and minimal maintenance charges. 

• Current Account

What it is: Designed for frequent transactions and is typically used by businesses and individuals who require regular access to their funds.   

Use: It is ideal for managing day-to-day business transactions and often comes with features such as overdraft facilities.

Example: A small business owner uses their current account to manage payments to suppliers and receive payments from clients.

Pro tip: Ensure your account is suited to your transaction needs and check for any charges associated with the account. 

• Fixed Deposit (FD)

What It Is: Financial instrument where you deposit a lumpsum amount for a fixed tenure at predetermined interest rate.    

Use: It is a safe investment option that offers decent interest rates when compared to other savings options that offer higher interest rates but are slightly risky.

Example: Opt for a fixed deposit with a bank that offers the best interest rate and flexible tenures that match your financial goals.

Pro Tip: If you have INR 1 lakh lying in your savings account then it is better to shift that fund to fixed deposit to attract better returns.

• Recurring Deposit (RD)

What It Is: Savings scheme where you deposit a fixed amount regularly for a predetermined period, earning interest on your total deposits. 

Use: It is useful for individuals who want to save a specific amount of money over time with regular contributions.

Example: Select an RD plan that offers competitive interest rates and allows for flexible monthly deposits.

Pro Tip: You contribute INR 5,000 each month into a recurring deposit for two years, earning interest on your cumulative savings that is higher than savings account rate.

• Know Your Customer (KYC)

What It Is: KYC is a process banks use to verify the identity of their customers to prevent fraud and comply with regulations such as anti-money laundering (AML).   

Use:  It ensures that the bank knows who its customers are and helps prevent identity theft and money laundering.

Example: Keep your KYC documents such as PAN card, Aadhaar card, voter ID, proof of residence and contact details updated to avoid any disruptions in your banking services.

Pro Tip: Reserve Bank of India (RBI) has prescribed updating KYC records of the customers depending on the risk perception of the bank.

2. Loans and Mortgages

• Personal Loan

What it is: An unsecured loan that you can use for various personal expenses, like medical bills, vacations, or debt consolidation.    

Use: It is typically used for short-term financial needs without the need for collateral. 

Example: Assume you avail personal loan of INR 1,00,000 with an interest rate of 15% for 5 years to cover unexpected medical expenses. Your monthly EMI will be INR 2,379 per month.

Pro tip: Compare interest rates and terms from different lenders and check for any hidden fees before taking out a personal loan. 

• Home Loan

What it is: It is a financial product taken to purchase, build, or renovate a house, with the property itself serving as collateral.   

Use: It helps individuals purchase or renovate their homes by borrowing a substantial amount with the property as security.

Example: You secure a home loan of INR 30 lakhs to buy a new apartment and repay it over 20 years at interest rate of 10%. Your monthly EMI will be INR 28,951.

Pro tip: Consider fixed vs. floating interest rates and look for lenders offering low processing fees and flexible repayment options.

• Loan Against Property (LAP)

What it is: Loan where you can borrow money by mortgaging your property, whether it’s residential or commercial.     

Use: It’s used for larger financial needs and typically offers lower interest rates compared to unsecured loans.

Example: You take a loan against your residential property to fund a business venture.

Pro tip: Ensure you can meet the repayment obligations, as defaulting on the loan could result in losing the mortgaged property.

• Equated Monthly Installment (EMI)

What it is: EMI is the fixed monthly payment you make to repay a loan, including both principal and interest.   

Use: It helps you manage loan repayments in a structured manner over the loan tenure.

Example: If your monthly EMI for a loan is INR 10,000 then it consists of 2 components i.e. interest and principal repayment.

Pro tip: Use EMI calculators to plan your budget and ensure your monthly payments are manageable within your financial constraints.

• Prepayment

What it is:  Prepayment is the act of paying off a loan before its scheduled maturity date, either partially or in full.

Use: It helps reduce the total interest paid and shorten the loan tenure.

Example: You make an additional payment of INR 50,000 towards your home loan to reduce the outstanding balance. 

Pro tip: Check for prepayment penalties or conditions in your loan agreement before making extra payments.

3. Investment 

• Systematic Investment Plan (SIP)

What it is: SIP is a method of investing a fixed amount regularly in mutual funds, allowing you to benefit from rupee cost averaging.

Use: It helps in disciplined investing and averaging out the cost of investments over time.

Example: SIP of INR 5,000 invested for 10 years at 12% rate would become INR 11,61,695 at maturity.

Pro tip: Start with a small SIP amount and gradually increase it as your financial situation improves. Evaluate the mutual fund’s performance regularly.

• Public Provident Fund (PPF)

What it is: PPF is a long-term savings scheme with tax benefits, offering guaranteed returns and safety of principal.

Use: It’s a popular investment choice for retirement planning and tax saving.

Example: Maximize your annual contributions up to the limit to enjoy the benefits of compounding and tax exemptions.

Pro tip: You deposit INR 1.5 lakhs annually into your PPF account and earn tax-free interest over a tenure of 15 years.

• National Pension System (NPS)

What it is: NPS is a retirement savings scheme offering tax benefits and a choice of investment options in equity, government securities, and corporate bonds.

Use: It helps in building a retirement corpus with flexibility in investment choices and periodic contributions.

Example: A person can withdraw upto 60% of the total NPS corpus as a lump amount after retirement, with the remaining 40% going into an annuity plan.

Pro tip: Start investing early in NPS to benefit from the power of compounding and consider increasing your contributions over time.

• Equity Linked Savings Scheme (ELSS)

What it is: ELSS is a type of mutual fund that invests primarily in equities and offers tax benefits under Section 80C of the Income Tax Act.

Use: It provides potential for higher returns through equity investments and tax deductions.

Example: You invest INR 50,000 as lumpsum in an ELSS fund or you can invest in form of SIP with amount as low as INR 500 to potentially grow your investment over time.

Pro tip: Invest in ELSS with a long-term perspective to maximize returns and take advantage of tax benefits.

• Fixed Income Securities

What it is: These are investments that provide regular income through interest payments, such as government bonds and corporate debentures.

Use: They offer stability and predictable returns, making them suitable for conservative investors.

Example: Bonds, Certificates of deposit (CDs), Treasury bills, Money market securities, Fixed income ETFs.

Pro tip: Diversify your fixed income investments across different issuers and tenures to manage risk and improve returns.

4. Business Banking 

• Trade Finance

What it is: Refers to financial products and services that support international trade, such as letters of credit.

Use: It helps businesses mitigate risks of cashless trade transactions and finance the export or import of goods.

Example: Letter of credit (LC), Bank guarantee (BG), Invoice discounting, trade credit insurance.

Pro tip: Use trade finance solutions to protect your transactions and optimize working capital when dealing with international trade.

• Business Line of Credit 

What it is: It is a flexible loan that allows businesses to borrow up to a specified limit and only pay interest on the drawn amount.

Use: It provides working capital for short-term needs and helps manage cash flow fluctuations.

Example: Bank overdraft facility

Pro tip: Keep the line of credit for emergencies or short-term funding needs and avoid over-reliance on it for regular expenses.

• Letter of Credit (LC)

What it is: An LC is a document issued by a bank guaranteeing that a buyer’s payment to a seller will be received on time and in full.

Use: It provides security to both buyers and sellers in international trade transactions.

Example: You use an LC to guarantee payment for an overseas supplier, ensuring that they receive funds as per the agreement.

Pro tip: Ensure that the terms of the LC are clear and match the trade agreement to avoid disputes and ensure smooth transactions.

• Merchant Banking

What it is: Involves financial services for businesses, including underwriting, advisory services, issue management and fund-raising. 

Use: It assists companies with raising capital, mergers, and acquisitions, and financial restructuring.

Example: Your company wants to raise funds worth INR 10,000 Crore from the market through preference shares and debenture. Thus, you can take the services of merchant banker to oversee this activity.

Pro tip: Engage with reputable merchant bankers who have expertise in your industry for better results and strategic advice. 

• Cash Credit 

What it is: A short-term loan facility provided to businesses to meet their working capital requirements.

Use: It allows businesses to withdraw funds up to a pre-approved limit.

Example: You have a retail store and use a cash credit facility of ₹5 lakhs to manage inventory purchases and meet short-term financial needs.

Pro tip: Use cash credit judiciously to manage day-to-day business operations and avoid unnecessary interest costs.

5. Financial Planning

• Asset Allocation

What it is: Strategy of dividing investments among diverse asset categories, such as equities, fixed-income assets, and cash and its equivalents.

Use: Diversification of investment portfolio to manage risk and achieve financial goals.

Example: You allocate 60% of your portfolio to equities, 30% to bonds, and 10% to real estate to balance growth and stability.

Pro tip: Regularly monitor and adjust your asset allocation based on changes in your financial situation and market conditions.

• Insurance 

What it is: Legal contract between insurance company (insurer) and insured (individual or company) during uncertain events or contingency.

Use: Helps in providing financial protection during medical emergencies, death, theft or property damage. 

Example: Term insurance, Health insurance, Life insurance, Home insurance.

Pro tip: Consider selecting an insurer with a claim settlement ratio exceeding 80%.

• Insurance Premium

What it is: The amount paid periodically to an insurance company to keep your policy active and receive coverage benefits.

Use: Helps insurance companies to cover policy liabilities and generate returns.

Example: You buy home insurance policy that lasts one year, and you pay your INR 1,000 annual premium up-front.

Pro tip: Compare premiums online from different service providers to get the best deal.

• Tax Planning

What it is: Involves organizing your financial affairs to minimize tax liability while paying tax.

Use: Optimize tax obligations and maximize deductions and exemptions.

Example: ELSS, PPF, NPS, Life insurance, PPF.

Pro tip: Use tax-saving instruments such as PPF, ELSS, NPS and insurance to reduce your taxable income.

• Annuity

What it is: Financial product that provides you with guaranteed regular income.

Use: Common way to provide a steady stream of income for retirement or other purposes.

Example: Payments for insurance, mortgage, pension, investments.

Pro tip: Check for conditions like withdrawal penalties, inheritance for heirs or high annual fees.

Conclusion

Whether you are managing personal finances, navigating the world of investments, or running a business, familiarity with these banking terms can help you optimize your financial strategies and achieve your goals.

essential banking terms you must know top banking terms banking glossary Financial Planning terms