2. Financial System
• An institutional framework existing in a country to
enable financial transactions
• Three main parts
• Financial instruments/assets (bonds, equities, commercial papers,
• Financial institutions (banks, mutual funds, insurance companies,
• Financial markets (money market, capital market, forex market,
• Regulation is another aspect of the financial system
(RBI, SEBI, IRDA, FMC)
3. Financial assets/instruments
• Enable channelising funds from surplus units to deficit units
• There are instruments for savers such as deposits, equities,
mutual fund units, etc.
• There are instruments for borrowers such as loans,
• Like businesses, governments too raise funds through issue of
bonds, Treasury bills, etc.
• Instruments like PPF, KVP, etc. are available to savers who
wish to lend money to the government
4. Money Market Instruments
• Call money- money borrowed/lent for a day. No collateral is
• Inter-bank term money- Borrowings among banks for a period
of more than 7 days
• Treasury Bills- short term instruments issued by the Union
Govt. to raise money. Issued at a discount to the face value
• Certificates of Deposit- Issued by banks to raise money.
Minimum value is Rs. 1 lakh, tradable in the market
• CDs can be issued by banks/FIs
5. Financial Institutions
• Includes institutions and mechanisms which
• Affect generation of savings by the community
• Mobilisation of savings
• Effective distribution of savings
• Institutions are banks, insurance companies, mutual
funds- promote/mobilise savings
• Individual investors, industrial and trading
6. Financial Markets
• Money Market- for short-term funds (less
than a year)
• Organized (Banks)
• Unorganized (money lenders, chit funds, etc.)
• Capital Market- for long-term funds
• Primary Issues Market
• Stock Market
• Bond Market
8. Call money market
• It deals with one-day loans (overnight, to be precise)
called call loans or call money
• Participants are mostly banks. Also called inter-bank
call money market.
• The borrowing is exclusively limited to banks, who
are temporarily short of funds.
• On the lending side, besides banks with excess cash
and as special cases few FIs like LIC, UTI
• All others have to keep their funds in term deposits
with banks to earn interest
9. Bill Market
• Treasury Bill market- Also called the T-Bill market
– These bills are short-term liabilities (91-day, 182-day, 364-
day) of the Government of India
– They are issued at discount to the face value and at the
end of maturity, the face value is paid
– The rate of discount and the corresponding issue price are
determined at each auction
• Commercial Bill market- Not as developed in India as
the T-Bill market
10. Indian Banking System
• Central Bank (Reserve Bank of India)
• Commercial banks
• Co-operative banks
• Banks can be classified as:
• Scheduled (Second Schedule of RBI Act, 1934)
• Scheduled banks can be classified as:
• Public Sector Banks
• Private Sector Banks (Old and New)
• Foreign Banks
• Regional Rural Banks
11. Progress of banking in India (1)
• Nationalisation of banks in 1969: 14 banks were
• Branch expansion
• Population served per branch
• A rural branch office serves
12. Progress of banking in India (2)
• Deposit mobilisation:
• 1951-1971 (20 years)- 700% or 7 times
• 1971-1991 (20 years)- 3260% or 32.6 times
• 1991- 2006 (11 years)- 1100% or 11 times
• 2006 - 2016
• Expansion of bank credit: Growing at 20-30% thanks
to rapid growth in industrial and agricultural output
• Development oriented banking: priority sector
13. Progress of banking in India (3)
• Diversification in banking: Banking has moved
from deposit and lending to
• Merchant banking and underwriting
• Mutual funds
• Retail banking
• Anywhere banking
• Internet banking
• Venture capital funds
14. Financial System
The financial system or the financial sector of any country consists of
(a) Specialized and non specialized Financial Institutions,
(b) Organized or unorganized Financial Markets, and
(c) Financial instruments and services which facilitate transfer of funds.
The main function of financial system is
– the collection of savings and,
– their distribution for industrial investment,
– thereby stimulating the capital formation, and to, that extent,
– accelerating the process of economic growth.
The process of capital formation has three activities: Savings (Resources set aside),
Finance (Assembling of resources) and Investments(4 production).
16. Financial Intermediaries
• A major constituent of organization of financial system is an
array of financial intermediaries.
• The financial intermediaries makes one type of contract with
lenders and other type of contract with borrowers.
• As per Gurley and Shaw, the principal function of financial
“To purchase primary securities from ultimate borrowers and to
issue indirect debt for the portfolio of the ultimate borrowers
and to issue indirect debt for the portfolio of ultimate lenders”
Primary securities are securities issued by Non-financial economic
Indirect securities are financial assets issued by financial
• It started functioning from April 1, 1935 on the terms of RBI
Act,1934. It was a private shareholders institution till jan’1949,
after which it became a state-owned institution under the RBI Act
• As the central of the country, it is the nerve of the financial and
monetary system and the main regulator of the banking system.
• Main functions
– It was constituted to regulate the issue of the bank notes and to keep
reserves to secure monetary stability and generally to operate the
currency and credit system of the country.
– It has been gradually diversifying it business in recent times.
1. To maintain monetary stability so that the biz and
economic life can deliver welfare gains.
2. To maintain financial stability and ensure sound
financial institutions so that monetary stability can
be safely pursued and economic units can conduct
their business with confidence.
3. To maintain stable payments systems so that
financial transaction can be safely and efficiently
4. To promote the development of the financial infrastructure in
terms of markets and systems, and to enable it to operate
efficiently, that is, to play a leading role in developing a
sound financial system so that it can discharge its
regulatory function efficiently.
5. To ensure that credit allocation by the financial system
broadly reflects the national economic priorities and
6. To regulate the overall volume of the money and credit in the
economy, with a view to ensuring a reasonable degree of
• Note issuing Authority (15 full fedged issue offices
and 2 sub-offices and 4127+ currency chests)
• Government banker.
• Banker’s bank (lender of last resort)
• Supervising authority.
• Exchange control authority.
• Promoter of the financial system, and
• Regulator of money and credit (formulating
25. Monetary policy
• There are two pillars of Macroeconomic Policy- Fiscal policy and Monetary policy.
• Monetary policy refers to the use of instruments within the control of the central
bank to influence the level of aggregate demand for goods and services or to
influence the trends in certain sectors of the economy.
• Monetary policy operates through varying the cost and availability of credit, these
producing desired changes in the assets pattern of credit institutions, primarily
•Volume of credit
Vital parameter that determine Liquidity & Capital formation in the economy
26. Monetary policy
• Money supply is the total quantity of money in the economy. In narrow
sense, it is the currency in circulation in the economy plus demand deposits
• Measures of money stock: The RBI employs four measures of money stock
M0, M1, M2 & M3.
• M0: currency in circulation + Banker’s deposits with RBI + other deposits with
RBI. (reserve money with central bank from banks)
• M1: currency with public + Current deposit with banks + Demand liability
with portion of saving deposits with banking system + other deposits with
• M2: M1 + Time liabilities portion of savings deposits + CDs issued by banks +
Term deposits (upto 1 year)
• M3: M2 + Term deposits with banks (Above 1 year) + Call borrowing from
non depository financial corporation..
27. Techniques of Regulation and Rates
Instruments of monetary policy
• General (Quantitative) methods
• Bank rate
• Variable Reserve requirements (SLR & CRR)
• Selective (Qualitative) methods: It refers to regulations of
credit for specific purpose or branches of economic activity. It
relates to the distribution or direction of available credit
• In India such controls have been used to prevent speculative
hoarding of commodities like food-grains and essential raw
materials to check an undue rise in their prices.
28. Techniques of Regulation and Rates
• The techniques of selective credit controls used generally are in three forms:
– Minimum margins for lending against specific securities,
– Ceilings on the amounts of credit for certain purposes, and
– Discriminatory rates of interest charged for certain types of advances.
• Credit Rationing: It involves the shortening the currency of and the limiting of
the amount made available to banks so as to allocate funds among financially
sound credit aspirants in accordance with a definite plan.
• Moral suasion: It involves friendly persuasion and advice so as to influence
the lending policy of banks.
• Direct Action: It involves coercive measures against particular banks so as to
penalize recalcitrant units of the banking units.
29. Regulator of money and credit
• Some of the important techniques/ instruments of
monetary control that are adopted by RBI include:
– Open Market Operation (OMOs)
– Bank Rate
– Cash Reserve Ratio
– Statutory Liquidity Ratio
– Liquidity Adjustment Facility
– Repo rates
30. Open Market Operations (OMOs)
• It refer the sale and purchase of securities of the Central and
state Governments and Treasury Bills (T-bills).
• The multiple objectives of OMOs, inter-alia, are
– To control the amount of and changes in bank credit and money
supply through controlling the reserve base of banks,
– To make the bank rate policy more effective,
– To maintain stability in the in the government securities/T-bills market
– To support the government’s borrowing programme and
– To smoothen the seasonal flow of funds in the bank credit market.
31. Open Market Operations (OMOs)
• Inspite of wide power of RBI, the OMOs is not a widely used
technique of monetary control in India.
• The RBI is continuously in the market, selling Government
securities on tap and buying them mostly in ‘switching
operations’, it does not ordinarily purchase them against
• The OMOs has helped in regulations of bank credit is two
– When they are conducted for switching operations, they lengthen the
maturity structure of the government securities which, in turn, has a
favorable impact on monetary policy.
– The net sales of Government securities has increased over the years
which has helped in regulating the flow of bank credit to the private
32. Bank Rate
• The bank rate (B/R) is the standard rate at which the
RBI buys/rediscounts bills of exchange/other eligible
• It is also the rate that the RBI charges on advances
specified collaterals to banks.
• The interest rate on different types of
accommodation from the RBI, including refinance
are now linked to B/R.
• The change in B/R has been reflected in primary
lending rates of banks.
• There are two refinance schemes available to banks.
• Export credit refinance (ECR): It is extended to banks against
their outstanding export credit eligible for refinance.
• General refinance: It is provided to surge over temporary
liquidity shortages faced by banks. It has now been replaced
by a Collateralized Lending Facility (CLF) within the overall
framework of liquidity adjustment facility (LAF).
• CLF is available to banks against their collateral of excess
holdings of Government dated securities and T-bill over and
34. Cash Reserve Ratio
• It refers to the cash which banks have to
maintain with the RBI, as a percentage of their
demand and time liabilities.
• The objective of CRR is to ensure the safety
and liquidity of bank deposits.
• The RBI is empowered to impose penal
interest on banks in respect of their shortfall
in the prescribed CRR.
35. Statutory Liquidity Ratio
• It is the ratio of cash in hand (excluding CRR), balances in
current account with banks and RBI, gold and approved
securities to total Demand and Time liabilities of the banks.
• The objectives of SLR can be cited as;
– To restrict the expansion of bank credit,
– To augment bank’s investment in Govt. securities, and
– To ensure solvency of banks.
• While the CRR enables the RBI to impose primary reserves
requirements; the SLR enables it to impose secondary and
supplementary reserve requirements on the banking system.
36. Liquidity Adjustment Facility
• The LAF is a new short term liquidity management
• It is a flexible instrument in the hands of the RBI to
adjust or manage short-term market liquidity
fluctuations on a daily basis and to help create
stable or orderly conditions in the overnight/call
• The LAF operations combined with OMOs and B/R
changes, have become the major technique of
• A Repo/ reverse Repo /buyback is a transaction in which
two parties agree to sell and repurchase the same
• The seller sells specified securities, with an agreement
to repurchase the same at mutually decided future date
• The same transaction is Repo from the viewpoint of
seller and reverse Repo from viewpoint of buyer of
• The difference between the price at which the securities
are bought and sold is the lenders profit/interest earned
for lending money.
• Repos/reverse repos are used to
• Meet a shortfall in the cash position
• Increase returns on funds held
• Borrow securities to meet regulatory (SLR) requirements
• By the RBI to adjust the liquidity in the financial system under LAF.
Types of Repos
Interbank Repos: T-bills, all Central govt. dated securities, state govt.
securities are eligible for Repo.
RBI Repos: Its repos auctions are conducted on all working days except
saturdays and are restricted to banks and Primary dealers (PDs).
Types of auctions:
• Discretionary price Repo auction: Multiple price bids with
volume. (till 1997)
• Fixed rate Repo/uniform price auctions: Price are pre-
announced and bids are submitted with volume.
39. Fiscal policy
• Governments use fiscal policy to influence the level of aggregate
demand in the economy, in an effort to achieve economic
objectives of price stability, full employment, Income
distribution, capital formation and economic growth.
• It is a part of govt. policy which is concerned with raising
revenue through taxation and deciding on the level and pattern
• It operates through budget.
– Union budget
– State budget
40. Fiscal policy
• The three possible stances of fiscal policy are neutral,
expansionary and contractionary.
– A neutral stance of fiscal policy implies a balanced
economy. This results in a large tax revenue. Government
spending is fully funded by Tax revenue and overall the
budget outcome has a neutral effect on the level of
– An expansionary stance of fiscal policy involves
government spending exceeding Tax revenue.
– A contractionary fiscal policy occurs when government
spending is lower than Tax revenue.
41. Fiscal policy
– Highly acceptable for developing countries
– Emphasis on overall economic growth
– Takes care of Revenue & Expenditure
– Helps in Planning
– Easy to target specific sector
– For the Social Welfare
– Subject to time lags
– Subject to corruption
43. Foreign Exchange Market
• As per the, Foreign Exchange Management Act, 1999 or FEMA, foreign
exchange means foreign currency and it includes:
1. All deposits, credits and balances payables in any foreign currency, and
any drafts, Traveller’s cheques, Letter of credit and Bills of exchange
expressed or drawn in Indian currency but payable in foreign currency.
2. Any instrument payable at the option of the drawee or holder thereof or
any other party thereto, either in Indian currency or in foreign currency or
partly in one and partly in the other.
The market in which national monetary units or claims are exchanged for
the foreign monetary units is known as the foreign exchange.
44. Foreign Exchange Market
• The foreign exchange market India is regulated by the RBI through the Exchange
• The Authorized Dealers (Authorized by the RBI) and the accredited brokers are
eligible to participate in the foreign Exchange market in India. These authorized
dealers have formed an organization called Foreign Exchange Dealers Association
of India (FEDAI).
• The main center of foreign exchange transactions in India is Mumbai. There are
several other centers for foreign exchange transactions in the country including
Kolkata, New Delhi, Chennai, Bangalore, Pondicherry and Cochin.
• Apart from the Authorized Dealers and brokers, there are some others who are
provided with the restricted rights to accept the foreign currency or travelers
cheque. Among these, there are the authorized money changers, travel agents
and certain hotels.
46. Foreign Exchange Market
• Retail market: It involves the exchange of bank notes, bank
drafts, currency, ordinary and traveller’s cheques between
private customers, tourists and banks.
• The RBI has granted two types of money changers licences.
• Full-fledged money changers (Purchase and Sale transactions
with the public),
• Restricted money changers (Purchase of Foreign currency
• Wholesale market: It is primarily an inter-bank market in
which major bank trade in currencies held in different
currency-denominated bank accounts
48. BANKING INDUSTRY IN INDIA,
●The capital market size has expanded substantially since
financial liberalization, the Indian financial system is
dominated by financial intermediaries.
●The bank market structure in India can be classified into
(d)Co-operative credit institutions.
●The commercial bank holds the major share of the total
assets of the financial intermediaries.
49. BANKING INDUSTRY IN INDIA,
●Public Sector Banks
●Private Sector Banks
●Regional Rural Banks
50. Scheduled Commercial Banks
● As at end-March, 2016, there were 71 SCBs were operational in India.
SCBs in India are categorized into the five groups based on their
ownership and/or their nature of operations.
● Nationalised banks (19), SBI and associates (5), IDBI and Bharatiya
Mahila bank together form the public sector banks (27) and control around
70% of the total credit and deposits businesses in India.
● Private banks are 20 out of which 13 are categorised as old private sector
bank and 7 are categorised as new private banks.
● Foreign banks are present in the country either through complete
branch/subsidiary route presence or through their representative offices.
● At end-June 2009, 32 foreign banks were operating in India with 293
51. PUBLIC SECTOR BANKS
●At the end of 2009, there were 27 public sector banks in India,
comprising of SBI and its associate banks and 20 nationalized
banks (including IDBI).
●The public sector bank are regulated by statues of parliament
and some important provisions under section 51 of banking
Regulation Act, 1949.
●SBI regulated by SBI act, 1955.
●Subsidiary banks of SBI regulated by SBI (subsidiary
Banks) Act, 1959.
●Nationalized banks regulated by Banking companies
(Acquisition and Transfer of Undertakings) Act, 1970 and
52. List of Public Sector Banks
There are 19 nationalized banks in India as follows:
Allahabad Bank, Andhra Bank,
Bank of Baroda, Bank of India,
Bank of Maharashtra, Canara Bank,
Central Bank of India, Corporation Bank,
Dena Bank, Indian Bank,
Indian Overseas Bank, Oriental Bank of Commerce,
Punjab & Sind Bank, Punjab National Bank,
Syndicate Bank, UCO Bank,
Union Bank of India, United Bank of India,
53. PRIVATE SECTOR BANKS
●In private sector banks, most of the capital is in private
hands. There are two types of private sector banks in
India viz. Old Private Sector Banks and New Private
●There are 13 old private sector banks. There are 7 new
private sector banks.
54. PRIVATE SECTOR BANKS
Old private banks
• Catholic Syrian Bank
• City Union Bank
• Dhanlaxmi Bank
• Federal Bank
• ING Vysya Bank
• Jammu and Kashmir Bank
• Karnataka Bank
• Karur Vysya Bank
• Lakshmi Vilas Bank
• Nainital Bank
• Ratnakar Bank
• South Indian Bank
• Tamilnad Mercantile Bank
New private banks
• Axis Bank
• Development Credit Bank (DCB
• HDFC Bank
• ICICI Bank
• IndusInd Bank
• Kotak Mahindra Bank
• Yes Bank
55. FOREIGN BANKS
●As of December 2014, there are 43 foreign banks from
26 countries operating as branches in India and 46
banks from 22 countries operating as representative
offices in India.
●Most of the foreign banks in India are niche players.
RBI policy towards presence of foreign banks in India is
based upon two cardinal principles viz. reciprocity and
single mode of presence.
56. Abu Dhabi Commercial Bank Limited
American Express Banking Corporation
Antwerp Diamond Bank N.V.
Arab Bangladesh Bank Limited.
Bank Internasional Indonesia
Bank of America NA
Bank of Bahrain and Kuwait B.S.C.
Bank of Ceylon
Barclays Bank PLC
Chinatrust Commercial Bank
Credit Agricole Corporate & Investment
Deutsche Bank AG
JPMorgan Chase Bank
JSC VTB Bank
Krung Thai Bank Public Company
MIZUHO Corporate Bank Ltd.
Oman International Bank S.A.O.G.
Standard Chartered Bank
State Bank of Mauritius Ltd.
The Bank of Nova Scotia
The Bank of Tokyo-Mitsubishi UFJ Ltd.
The Development Bank of Singapore Ltd.
The Hongkong and Shanghai Banking
The Royal Bank of Scotland NV
FirstRand Bank Ltd.
Commonwealth Bank of Australia
United Overseas Bank Ltd.
57. REGIONAL RURAL BANKS
●Regional Rural Banks were started in 1970s due to the fact
that even after nationalization, there were cultural issues
which made it difficult for commercial banks, even under
government ownership, to lend to farmers.
●Each RRB is owned by three entities with their respective
shares as follows:
●Central Government → 50%
●State government → 15%
●Sponsor bank → 35%
●They are regulated by NABARD.
58. Evolution of the Indian Banking
● The Indian banking industry has its foundations in the 18th century, and has had a
varied evolutionary experience since then. The initial banks in India were primarily
traders’ banks engaged only in financing activities.
● The Bank of Calcutta (a precursor to the present State Bank of India) was founded on June 2,
1806, mainly to fund General Wellesley's wars against Tipu Sultan and the Marathas. It was
renamed Bank of Bengal on January 2, 1809.
● The Bank of Calcutta, and two other Presidency banks, namely, the Bank of Bombay and
the Bank of Madras were amalgamated and the reorganized banking entity was named the
Imperial Bank of India on 27 January 1921.
● Major strides towards public ownership and accountability were made with
nationalization in 1969 and 1980 which transformed the face of banking in India. .
59. Evolution of the Indian Banking
● In the evolution of this strategic industry spanning over two
centuries, immense developments have been made in terms of
the regulations governing it, the ownership structure, products
and services offered and the technology deployed.
● The entire evolution can be classified into four distinct phases.
● Phase I- Pre-Nationalisation Phase (prior to 1955)
● Phase II- Era of Nationalisation and Consolidation (1955-1990)
● Phase III- Introduction of Indian Financial & Banking Sector Reforms
and Partial Liberalisation (1990-2004)
● Phase IV- Period of Increased Liberalisation (2004 onwards)
62. Capital & Liabilites
Commercial bank uses various categories of sources to
raise the funds.
The major source of commercial bank funds are
summarized as follows:
Capital- Primary and Secondary capital
1. Paid-up capital
2. Reserve fund
1. Current deposit
2. Saving deposit
3. Fixed deposit
63. Capital & Liabilites
1. From central bank
2. From interbank market:
i) Interbank deposit
ii) Call money market
iii) Repurchase agreement
3. From international financial institution
The bank capital represents the net worth of the bank
or its value to investors.
A bank's capital can be thought of as the margin to
which creditors are covered if a bank liquidates its
Loan-loss reserves or loan-loss provisions are amounts
set aside by banks to allow for any loss in the value
of the loans they have offered.
65. Capital can be classified as-
1.Primary capital: Primary capital result from issuing
common or preferred stock.
2. Secondary capital : Secondary capital results from
issuing subordinated notes and bonds
• Deposits from public represent by far the
most powerful source of fund to a bank,
accounting for over 90% of the total.
• These deposits are key to a bank s potential‟
– Current Deposits
– Fixed Deposits
– Recurring Deposits
– Saving Deposits
• The Central Bank will provide liquidity to the
banks and other institutions when sour aces
• They may grant accommodation to scheduled
banks by way of-
i) Rediscounting or purchase of eligible bills; and
ii) Loans and advances against certain securities
• Borrowing from interbank
• The interbank lending market is a market in
which banks extend loans to one another for a
• Such loans are made at the interbank rate (also
called the overnight rate if the term of the loan is
– 1. Interbank deposit sources
– 2. Interbank call money
– 3. Repurchase agreement
70. WHY REGULATE BANK CAPITAL?
Two typical justifications
The risk of systematic risk.
The inability of depositors to monitor the banks.
The liquidity will have to primarily come from the periodic liquidation of
assets. But, if the assets start losing value the bank would have to turn
to its capital to keep its liability commitments.
If the capital is not augmented with fresh infusion of funds, the bank
would run out of cash and face the most serious risk of all - liquidity and
hence solvency risk.
71. WHY REGULATE BANK CAPITAL?
Conceptually, greater the (bank’s) capital funds, the greater
the amount of assets that can default before the bank becomes
insolvent and lower the bank’s risk.
Thus, regulating the amount of capital that a bank should
hold, though seen to constrain growth to some extent, is aimed
at reducing the risks of banks expanding their ability of taking
72. WHY REGULATE BANK CAPITAL?
The banking regulation ensures that depositors are
given enough assurance that they will be paid in future.
There are 3 ways to provide assurance
Adequate bank equity
Lender of last resort
Basically, the Regulatory and Economic capital are
concerned with bank’s financial strength.
73. CAPITAL CONCEPTS
Regulatory capital depends on the confidence
level set by the regulator.
Economic capital can be defined as the amount
of capital considered necessary by banks to
absorb potential losses associated with banking
risk such as – credit, market, operational and
74. RISK-BASED CAPITAL
In early 1980s, concern about international bank’s
financial health increased. It was then BCBS began
thinking in terms of setting capital standards for banks.
The international convergence of bank capital regulation
began with 1988 Basel Accord I on capital standards.
The accord was adopted as a world standard in 1990s
with more than 100 countries applying the Basel
framework to their banking system.
75. RISK-BASED CAPITAL STANDARDS
The revised framework (Basel Accord II)
issued in June 2006, included a spectrum of
approaches ranging from simple to advanced
from the measurement of risks,:
76. CAPITAL ADEQUACY TO BANKS IN
The Basel framework was adopted by the RBI in 1992,
prescribing a higher norm of 9% on risk weighted assets
for all banks.
In accordance with the Basel II norms, the RBI required
that the commercial banks in India adopt the
Standardized approach for Credit risk
Standard approach for Market risk, and
Basic indicator approach for Operational risk
77. CAPITAL ADEQUACY
In step with BIS norms and in consonance with
international practice, RBI prescribed new capital norms
for banking institutions in April 1992.
BIS standards specify capital into tiers, Tier I capital
and Tier II capital.
Tier I otherwise known as ‘core capital’, consists of the
most permanent and readily available resources to a
bank in the event of unexpected losses.
78. CAPITAL ADEQUACY
According to the norms by RBI,
Tier I capital consists:
Paid up capital
Other free reserve, if any.
From Tier-I capital, items such investment in
subsidiaries, intangible assets and losses are
79. CAPITAL ADEQUACY
Tier II capital consists:
Undisclosed reserves and cumulative. preferential
General provision and loss reserves.
Hybrid debt capital instruments.
Investment fluctuation reserve, consisting of
realized gains from sale of investment.
80. CAPITAL FUNDS OF BANKS
OPERATING IN INDIA
RBI requires banks in India to maintain at minimum, Capital to
Risk-weighted Assets Ratio (CRAR) of 9%.
Though the CRAR of 9% will have to be held continuously by
banks, RBI also expects banks to operate at a capital level
well above the minimum requirement.
Within the overall minimum CRAR of 9%, banks should also
maintain a Tier I CRAR of at least 6%, computed as,
Eligible Tier I capital funds
Credit RWA + Market RWA + operational risk RWA
82. Credit appraisal
• Credit appraisal means an investigation or assessment
done by the bank prior before providing any loans &
• The bank checks the
1. Commercial viability,
2. Financial viability
3. Technical viability of the project
4. Proposed funding pattern
5. Collateral security
• Credit Appraisal is a process to ascertain the risks
associated with the extension of the credit facility.
83. BASIC TYPES OF CREDIT
1. Service credit: It is monthly payments for utilities such as
telephone, gas, electricity, and water. You often have to
pay a deposit, and you may pay a late charge if your
payment is not on time.
2. Installment credit: It may be described as buying on time,
financing through the store or the easy payment plan.
Cars, major appliances, and furniture are often purchased
this way. You usually sign a contract, make a down
payment, and agree to pay the balance with a specified
number of equal payments called instalments. The item
you purchase may be used as security for the loan.
84. BASIC TYPES OF CREDIT
3. Loans: Loans can be for small or large amounts
and for a few days or several years. Money can
be repaid in one lump sum or in several regular
payments until the amount you borrowed and
the finance charges are paid in full.
4. Credit cards: These are issued by individual retail
stores, banks, or businesses. Using a credit card
can be the equivalent of an interest-free loan--if
you pay for the use of it in full at the end of each
85. CREDIT APPRAISAL PROCESS
Receipt of application from applicant
Receipt of documents
(Balance sheet, KYC papers, Different govt. registration
no., MOA, AOA, and Properties
Pre-sanction visit by bank officers
Check for RBI defaulters list, willful defaulters list, CIBIL
data, ECGC caution list, etc.
86. CREDIT APPRAISAL PROCESS
Title clearance reports of the properties to be obtained from
Valuation reports of the properties to be obtained from
Preparation of financial data
Assessment of proposal
87. CREDIT APPRAISAL PROCESS
Sanction/approval of proposal by appropriate
Documentations, agreements, mortgages
Disbursement of loan
Post sanction activities such as receiving stock
statements, review of accounts, renew of
accounts, etc(On regular basis)
88. CREDIT RISK ASSESSMENT
RISK: Risk is inability or unwillingness of borrower-customer or counter-party
to meet their
repayment obligations/ honor their commitments, as per the stipulated
• Identify the risk factors, and
• Mitigate the risk
RISK ARISE IN CREDIT: In the business world, Risk arises out of
• Deficiencies / lapses on the part of the management (Internal factor)
• Uncertainties in the business environment (External factor)
• Uncertainties in the industrial environment (External factor)
• Weakness in the financial position (Internal factor)
89. CREDIT RISK ASSESSMENT
TO PUT IN ANOTHER WAY, SUCCESS FACTORS
BEHIND A BUSINESS ARE
• Managerial ability
• Favorable business environment
• Favorable industrial environment
• Adequate financial strength
90. CREDIT RISK ASSESSMENT (CRA) –
MINIMUM SCORES / HURDLE RATES
1. The CRA models adopted by the Bank take into account all possible factors
which go into appraising the risks associated with a loan. These have been
categorized broadly into financial, business, industrial & management
risks and are rated separately. To arrive at the overall risk rating, the
factors duly weighted are aggregated & calibrated to arrive at a single
point indicator of risk associated with the credit decision.
2. FINANCIAL PARAMETERS: The assessment of financial risk involves
appraisal of the financial strength of the borrower based on performance
& financial indicators. The overall financial risk is assessed in terms of
static ratios, future prospects & risk mitigation (collateral security /
3. INDUSTRY PARAMETERS: The following characteristics of an industry
which pose varying degrees of risk are built into Bank’s CRA model:
• Industry outlook
• Regulatory risk
• Contemporary issues like WTO etc.
91. CREDIT RISK ASSESSMENT (CRA) –
MINIMUM SCORES / HURDLE RATES
4. MANAGEMENT PARAMETERS: The management of an enterprise /
group is rated on the following parameters:
• Integrity (corporate governance)
• Track record
Managerial competence / commitment
• Structure & systems
• Experience in the industry
• Credibility: ability to meet sales projections
• Credibility: ability to meet profit (PAT) projections
• Payment record
• Strategic initiatives
• Length of relationship with the Bank
94. Banks profit and loss account
A bank’s profit & Loss Account has the
I.Income: This includes Interest Income and
II. Expenses: This includes Interest
Expended, Operating Expenses and
Provisions & contingencies.
• In the 1940s and the 1950s, there was an abundance of funds in banks in
the form of demand and savings deposits. Hence, the focus then was
mainly on asset management
• But as the availability of low cost funds started to decline, liability
management became the focus of bank management efforts
• In the 1980s, volatility of interest rates in USA and Europe caused the
focus to broaden to include the issue of interest rate risk. ALM began to
extend beyond the bank treasury to cover the loan and deposit functions
• Banks started to concentrate more on the management of both sides of
the balance sheet
96. What is Asset Liability Management??
• The process by which an institution manages its balance
sheet in order to allow for alternative interest rate and
• Banks and other financial institutions provide services which
expose them to various kinds of risks like credit risk, interest
risk, and liquidity risk
• Asset-liability management models enable institutions to
measure and monitor risk, and provide suitable strategies for
97. An effective Asset Liability Management Technique aims to manage
the volume, mix, maturity, rate sensitivity, quality and liquidity of
assets and liabilities as a whole so as to attain a predetermined
acceptable risk/reward ratio
The parameters for stabilizing ALM system are:
1. Net Interest Income (NII)
2. Net Interest Margin (NIM)
3. Economic Value of Equity Ratio
99. ALM Information Systems
Usage of Real Time information system to gather the
information about the maturity and behavior of loans and
advances made by all other branches of a bank
ABC Approach :
Analysing the behaviour of asset and liability products in the top
branches as they account for significant business
Then making rational assumptions about the way in
which assets and liabilities would behave in other
The data and assumptions can then be refined over
time as the bank management gain experience
The spread of computerisation will also help
banks in accessing data.
100. ALM Organization
The board should have overall responsibilities and should set the limit for
liquidity, interest rate, foreign exchange and equity price risk
The Asset - Liability Committee (ALCO)
ALCO, consisting of the bank's senior management (including
CEO) should be responsible for ensuring adherence to the limits
set by the Board
Is responsible for balance sheet planning from risk - return
perspective including the strategic management of interest rate
and liquidity risks
The role of ALCO includes product pricing for both deposits and
advances, desired maturity profile of the incremental assets and
It should review the results of and progress in implementation of
the decisions made in the previous meeting.
102. Categories of Risk
• Risk is the chance or probability of loss or
damageCredit Risk Market Risk Operational Risk
Transaction Risk /default
risk /counterparty risk
Commodity risk Process risk
Interest Rate risk Infrastructure risk
Settlement risk Forex rate risk Model risk
Equity price risk Human risk
104. Liquidity Risk
• Liquidity risk arises from funding of long term assets by short term
liabilities, thus making the liabilities subject to refinancing
105. Liquidity Risk Management
Bank’s liquidity management is the process of generating funds to
meet contractual or relationship obligations at reasonable prices at
Liquidity Management is the ability of bank to ensure that its
liabilities are met as they become due
Liquidity positions of bank should be measured on an ongoing basis
A standard tool for measuring and managing net funding
requirements, is the use of maturity ladder and calculation of
cumulative surplus or deficit of funds as selected maturity dates is
106. Statement of Structural Liquidity
All Assets & Liabilities to be reported as per
their maturity profile into 8 maturity Buckets:
i. 1 to 14 days
ii. 15 to 28 days
iii. 29 days and up to 3 months
iv. Over 3 months and up to 6 months
v. Over 6 months and up to 1 year
vi. Over 1 year and up to 3 years
vii. Over 3 years and up to 5 years
viii. Over 5 years
107. Statement of structural liquidity
Places all cash inflows and outflows in the maturity ladder as per
Maturing Liability: cash outflow
Maturing Assets : Cash Inflow
Classified in to 8 time buckets
Mismatches in the first two buckets not to exceed 20% of outflows
Shows the structure as of a particular date
Banks can fix higher tolerance level for other maturity buckets.
108. An Example of Structural Liquidity
3 Mths -
6 Mths -
1Year - 3
3 Years -
Capital 200 200
Liab-fixed Int 300 200 200 600 600 300 200 200 2600
Liab-floating Int 350 400 350 450 500 450 450 450 3400
Others 50 50 0 200 300
Total outflow 700 650 550 1050 1100 750 650 1050 6500
Investments 200 150 250 250 300 100 350 900 2500
Loans-fixed Int 50 50 0 100 150 50 100 100 600
Loans - floating 200 150 200 150 150 150 50 50 1100
Loans BPLR Linked 100 150 200 500 350 500 100 100 2000
Others 50 50 0 0 0 0 0 200 300
Total Inflow 600 550 650 1000 950 800 600 1350 6500
Gap -100 -100 100 -50 -150 50 -50 300 0
Cumulative Gap -100 -200 -100 -150 -300 -250 -300 0 0
Gap % to Total Outflow-14.29 -15.38 18.18 -4.76 -13.64 6.67 -7.69 28.57
109. Addressing the mismatches
• Mismatches can be positive or negative
• Positive Mismatch: M.A.>M.L. and Negative Mismatch M.L.>M.A.
• In case of +ve mismatch, excess liquidity can be deployed in money
market instruments, creating new assets & investment swaps etc.
• For –ve mismatch, it can be financed from market borrowings
(Call/Term), Bills rediscounting, Repos & deployment of foreign
currency converted into rupee.
110. Currency Risk
• The increased capital flows from different nations following
deregulation have contributed to increase in the volume of
• Dealing in different currencies brings opportunities as well as risk
• To prevent this banks have been setting up overnight limits and
undertaking active day time trading
• Value at Risk approach to be used to measure the risk associated
with forward exposures.
• Value at Risk estimates probability of portfolio losses based on the
statistical analysis of historical price trends and volatilities.
111. Interest Rate Risk
Interest Rate risk is the exposure of a bank’s financial conditions
to adverse movements of interest rates
Though this is normal part of banking business, excessive
interest rate risk can pose a significant threat to a bank’s
earnings and capital base
Changes in interest rates also affect the underlying value of the
bank’s assets, liabilities and off-balance-sheet item
• Interest rate risk refers to volatility in Net Interest Income (NII) or
variations in Net Interest Margin(NIM)
• NIM = (Interest income – Interest expense) / Earning assets
113. • Re-pricing Risk: The assets and liabilities could re-price at different dates
and might be of different time period. For example, a loan on the asset
side could re-price at three-monthly intervals whereas the deposit could
be at a fixed interest rate or a variable rate, but re-pricing half-yearly
• Basis Risk: The assets could be based on LIBOR rates whereas the
liabilities could be based on Treasury rates or a Swap market rate
• Yield Curve Risk: The changes are not always parallel but it could be a
twist around a particular tenor and thereby affecting different maturities
• Option Risk: Exercise of options impacts the financial institutions by giving
rise to premature release of funds that have to be deployed in
unfavourable market conditions and loss of profit on account of
foreclosure of loans that earned a good spread.
115. Maturity gap method (IRS)
• A) Rate Sensitive Assets>Rate Sensitive
Liabilities= Positive Gap
• B) Rate Sensitive Assets<Rate Sensitive Liabilities
= Negative Gap
• C) Rate Sensitive Assets=Rate Sensitive Liabilities
= Zero Gap
116. Gap Analysis
Simple maturity/re-pricing Schedules can be used to generate
simple indicators of interest rate risk sensitivity of both earnings
and economic value to changing interest rates
- If a negative gap occurs (RSA<RSL) in given time band, an increase
in market interest rates could cause a decline in NII
- conversely, a positive gap (RSA>RSL) in a given time band, an
decrease in market interest rates could cause a decline in NII
The basic weakness with this model is that this method takes into
account only the book value of assets and liabilities and hence
ignores their market value.
117. Duration Analysis
It basically refers to the average life of the asset or the liability
It is the weighted average time to maturity of all the preset values
of cash flows
The larger the value of the duration, the more sensitive is the
price of that asset or liability to changes in interest rates
As per the above equation, the bank will be immunized from
interest rate risk if the duration gap between assets and the
liabilities is zero.
Basically simulation models utilize computer power to
provide what if scenarios, for example: What if:
The absolute level of interest rates shift
Marketing plans are under-or-over achieved
Margins achieved in the past are not sustained/improved
Bad debt and prepayment levels change in different interest
There are changes in the funding mix e.g.: an increasing
reliance on short-term funds for balance sheet growth
This dynamic capability adds value to this method and
improves the quality of information available to the
119. Value at Risk (VaR)
Refers to the maximum expected loss that a bank can suffer in
market value or income:
Over a given time horizon,
Under normal market conditions,
At a given level or certainty
It enables the calculation of market risk of a portfolio for which no
historical data exists. VaR serves as Information Reporting to
It enables one to calculate the net worth of the organization at any
particular point of time so that it is possible to focus on long-term
risk implications of decisions that have already been taken or that
are going to be taken
An asset, including a leased asset, becomes non-
performing when it ceases to generate income for the bank.
A ‘non-performing asset’ (NPA) was defined as a credit
facility in respect of which the interest and/ or instalment of
principal has remained ‘past due’ for a specified period of
The specified period was reduced in a phased manner as
Year ending March 31 Specified period
1993 four quarters
1994 three quarters
1995 onwards two quarters
122. NPAs categorizes
Depending upon the record of repayment of
borrowers, Banks assets or Loans are
123. Assets categorizes
A sub-standard asset was one, which was classified as
NPA for a period not exceeding two years. With effect from
31 March 2001, a sub-standard asset is one, which has
remained NPA for a period less than or equal to 18
In such cases, the current net worth of the borrower/
guarantor or the current market value of the security
charged is not enough to ensure recovery of the dues to
the banks in full.
124. Doubtful asset
A doubtful asset was one, which remained NPA for a period
exceeding two years.
With effect from 31 March 2001, an asset is to be classified as
doubtful, if it has remained NPA for a period exceeding 18
A loan classified as doubtful has all the weaknesses inherent in
assets that were classified as sub-standard, with the added
characteristic that the weaknesses make collection or liquidation in
full, – on the basis of currently known facts, conditions and values –
highly questionable and improbable.
125. Loss asset
A loss asset is one where loss has been identified by the
bank or internal or external auditors or the RBI
inspection but the amount has not been written off
In other words, such an asset is considered uncollectible
and of such little value that its continuance as a
bankable asset is not warranted although there may be
some salvage or recovery value.
126. Preventing occurrence of New
Following measures prove useful in this regard:
Very careful selection of new borrowers based on their credit
worthiness and risk analysis.
Post sanction follow-up must be done at all levels.
All big borrowal accounts (Rs.50 Lacs) falling in the category of
‘Standard Assets’ must be reviewed on a quarterly basis and
prompt action taken if any adverse feature is noted.
Those borrowal accounts at lower-end the category of ‘Standard
Assets’ deserve special attention for pro-active steps should be
taken, if they show any sign of weakness.
127. Action points in regard to
The top-end list of ‘Sub-standard Assets’ has to be
upgraded and make them ‘Standard Assets’ by recovering
the derecognized interest of last years and current year.
All the securities charged to bank should be ‘revalued’ on a
realistic basis and provision should be made strict.
In case the unsuccessful recovery, the bank has to resort
legal action by going to Debt Recovery Tribunals. For a
smaller loans banks may approach Lok Adalats.
128. Management tools
The tools available are:
Debt Recovery Tribunals (DRTs),
Corporate Debt Restructuring (CDR), and
Securitization and Reconstruction of Financial
Assets through Securitization and Asset
Reconstruction Companies (SCs/ ARCs).
129. Debt Recovery Tribunals
The Debts Recovery Tribunals have been established by the
Government of India under an Act of Parliament (Act 51 of 1993).
The Recovery of debts due to Banks and Financial Institutions
Ordinance, 1993 on 24th June 1993, the Ordinance was replaced
by The Recovery of Debts Due to Banks and Financial Institutions
Act, 1993 (DRT Act) on 27th August 1993.
Immediately Action was initiated by the Government for
establishment of Recovery Tribunals and Appellate Tribunals in the
Presently, there are 29 DRTs functioning all over the country.
A securitization is a financial transaction in which
assets are pooled and securities representing
interests in the pool are issued.
This financial tool is used by financial institutions
and businesses to immediately realize the value of
cash-producing assets like loans, or leases or
132. 2. The SPV is formed
the support of the
or servicer, CRA,
pool of assets
4. Assets to be
to SPV, after legal
5. The CFs to the
assets- interest, principal
collected by originating
bank on due dates.
these amounts are paid to SPV.
6. The SPV
the collected CFs
to the investors
7. If defaults happens,
takes the loss or
against the defaulters
according to terms.
8. Finally, profit made
Is retained by the
The loss is
Banks which were meant for deposits, loans
and transactions, are allowed to provide
insurance policies to people and this feature
of bank is called ‘bancassurance’.
• As per the investigation made by Graham Morris the
opening of insurance industry to private sector
participation in December1990 has led to the entry of
20 new players, with 12 in life Insurance Sector & 8 in
the non-life insurance sector.
• Almost without exception these companies are seeking
to utilize multiple distribution channels such as –
1) Traditional Agencies
3) Brokers &
4) Direct Marketing
• The Bancassurance is the distribution of insurance products
through the bank's distribution channels.
• It is a phenomenon where in insurance products are offered
through the distribution channels of the banking services.
• In the simple term of insurance there are only two parties.
1) The Bank
2) The Insurer &
3) The customer.
• The development of bancassurance in India began
for following reasons:
– To improve the channels through which insurance policies
– To widen the area of working of banking sector having a
network that is spread widely.
– To improve the services of insurance by creating a
competitive atmosphere among private insurance
companies in the market.
• In our country the banking & insurance
sectors are regulated by two different entries.
• They are: -
* Banking is fully governed by RBI &
* Insurance sector is by IRDA
138. Guidelines given by RBI
• 1. Any commercial bank will be allowed to undertake
insurance business as the agent of insurance companies &
this will be on fee basis with no-risk participation.
• 2. The second guideline given by the RBI is that the joint
ventures will be allowed for financial strong banks wishing
to undertake insurance business with risk participation.
• 3. The third guideline is for banks which are not eligible for
this joint venture option, an investment option of
(1) up to 10% of the net worth of the bank or
(2) Rs. 50 crores. Whichever is lower is available.
139. Guidelines given by IRDA
The Insurance regulatory development & Authority has given certain
guidelines for the Bancassurance they are as follows: -
1) Chief Insurance Executive: Each bank that sells insurance must have a
chief Insurance Executive to handle all the insurance matters & activities.
2) Mandatory Training: All the people involved in selling the insurance
should under-go mandatory training at an institute determined by IRDA &
pass the examination conducted by the authority.
3) Corporate agents: Commercial banks, including co-operative banks and
RRBs may become corporate agents for one insurance company.
4) Banks cannot become insurance brokers.
140. Important Bancassurance tie-up in
LIC: The insurance company LIC of India have tie up with the
following bank for Bancassurance.
(A) Corporation Bank
(B) Indian Overseas Bank
(C) Centurion Bank
(D) Sahara District Central Co-operative bank
(E) Janta Urban Co-operative bank
(F) Yeotmal Mahila Sahakari Bank
(G) Vijaya Bank &
(H) Oriental Bank of Commerce
141. Important Bancassurance tie-up in India
• Birla Sun life Insurance Co. Ltd: The Birla Sun life Insurance
Company has a tie-up with the following bank for the
insurance purpose :-
• (a) Bank of Rajasthan
(b) Andhra Bank
(c) Bank of Muscat
(d) Development Credit Bank
(e) Dutch Bank &
(f) Catholic Syrian Bank
142. Benefits of Bancassurance
• It encourages customers of banks to purchase insurance policies and
further helps in building better relationship with the bank.
• The people who are unaware of and/or are not in reach of insurance
policies can be benefitted through widely distributed banking networks
and better marketing channels of banks.
• Increase in number of providers means increase in competition and hence
people can expect better premium rates and better services from
bancassurance as compared to traditional insurance companies.
143. Demerits of bancassurance
• Data management of an individual customer’s identity and
contact details may result in the insurance company utilizing
the details to market their products, thus compromising on
• There is a possibility of conflict of interest between the other
products of bank and insurance policies (like money back
policy). This could confuse the customer regarding where he
has to invest.
Hinweis der Redaktion
An Outright forward transaction is what the name implies, an agreement to exchange currencies at an greed price at a future date.
Swap is a contribution of two simultaneous trades: an spot deal and an opposing outright forward contract . Ex: a bank might “Swap” in six month yen by simultaneously buying spot yen and selling six month forward yen.
Financial intermediaries comprise of commercial banks, urban co-operative banks, rural financial institutions, non-banking finance companies, housing finance institutions, mutual funds and the insurance sectors.