Introduction A financial system plays a vital role in the economic growth of a country. It intermediates with the flow of funds b/w those who save a part of their income to those who invest in productive assets. It mobilizes & usefully allocates scarce resources of a country. A financial system is a complex, well- integrated set of sub-systems of financial institutions, markets, instruments, and services which facilitates the transfer & allocation of funds, efficiently & effectively.
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Introduction
A financial system plays a vital role in the economic growth of a country. It intermediates with the flow of funds b/w those who save a part of their income to those who invest in productive assets.
It mobilizes & usefully allocates scarce resources of a country.
A financial system is a complex, well-integrated set of sub-systems of financial institutions, markets, instruments, and services which facilitates the transfer & allocation of funds, efficiently & effectively.
INDIAN FINANCIAL
SYS.
FORMAL FINANCIAL
SYS.
INFORMAL FINANCIAL
SYS.
REGULATORS:MoF,
SEBI, RBI, IRDA
FIANANCIAL INST.
(INTERMED-IARIES)
FINANCIAL MKT.
FINANCIAL INSTRUMENTS
FINANCIAL SERVICES
MoneylendersLocal Bankers
TradersLandlords
Pawn Brokers
Financial Inst.
(Intermediaries)
Banking Inst.Non-Banking
Inst.Mutual Funds
Insurance&
Housing Finance co.
ScheduledCommercial
Banks
ScheduledCooperative
Banks
Non-BankingFinance
Co.
DevelopmentFinancial
Inst.
PublicSector
Pvt.Sector
ScheduledCommercial
Banks
PublicSectorBanks
PrivateSectorBanks
ForeignBanks
InIndia
RegionalRuralBanks
DevelopmentFinancial
Inst.
All-India FinancialInst.: IFCI, IDBI, IIBI,
SIDBI, IDFC, NABARD
EXIM Bank, NHB
State-levelInst.:
SFCs, SIDCs
OtherInst.:
ECGC, DICGC
FinancialMkt.
CapitalMkt.
MoneyMkt.
EquityMkt.
DebtMkt.
Treasury Bills,Call Money mkt.Commercial Bills,
Commercial papers,Certificates of Deposit
Term Money
Private Corporate debtPSU Bond Market
Government SecuritiesMarket
Primary Mkt.-Public issues-Privateplacement
SecondaryMkt.
NSE,BSEOTCEI,ISERegional
Stock Exchanges
DomesticMkt.
InternationalMkt.
Types of Money Broad Money Narrow Money Fiat Money
Others:
a) Gold & Silver Coins (Ginni)
b) Metal Money
c) Paper Money
d) Plastic Money
e) Virtual Money
Capital Formation The "capital stock" is one of the basic determinants of an economy's ability to produce income for its members. Composed of equipment, buildings and intermediate goods not themselves directly consumed,
"Capital formation" is simply the enlargement of the capital stock. The higher the rate of capital formation, the more rapid is the growth of the economy's productive capacity and, hence, the more rapid the growth of aggregate income.
PoolIn capital budgeting, the concept that investment
projects are financed out of a pool of bonds, preferred stock, and common stock, and a weighted-average cost of capital must be used to calculate investment returns.
In insurance, a group of insurers who share premiums and losses in order to spread risk.
In investments, the combination of funds for the benefit of a common project, or a group of investors who use their combined influence to manipulate prices. Cont…
A temporary affiliation of two or more people in an attempt to manipulate a security's price and/or volume.
The pool is necessary in order to acquire the capital needed to manipulate a stock having a large market value.
Pools were especially popular in the 1920s and early 1930s but now have been regulated out of existence
Netting
Reducing transfers of funds between subsidiaries or separate companies to a net amount.
Netting is a process the National Securities Clearing Corporation (NSCC) uses to streamline securities transactions.
To net, the NSCC compares all the buy and sell orders for each individual security and matches purchases by clients of one brokerage firm with corresponding sales by other clients of the firm.
Cash flows before netting
Germansubsidiary
U.S.subsidiary
U.K.parent
£100m
£200m
£60m
£100m
£100m
£40m
Cash flows after netting
Germansubsidiary
U.S.subsidiary
U.K.parent
£60m £140m
Leading and lagging
• Refers to altering the timing of cash flows within the corporation to offset foreign exchange exposures
–Leading - If a parent firm is short euros, it can accelerate euro payments from its subsidiaries
–Lagging - If a parent firm is long euros, it can accelerate euro payments to its subsidiaries
Banking Institutions
The mobilization of deposits & disbursement of credit to various sectors of the economy
Functions of Banking Inst.
• Transfer of funds
• Collection
• Foreign Exchange
• Safe deposit locker
• Gift Cheques &
• Merchant Banking.
Public Sector Banks
Major Govt. holding
• SBI and its associates
• Nationalized Bank
Objective of nationalization
• banking facilities on a large scale.• Rural and sub-urban areas.• To promote agricultural finance and to
remedy the defects in the system of agricultural finance.
• To help the reserve banks in its credit policies.
• To help the govt. to pursue the broad economic policies.
Nationalised Bank
The nationalisation was effected by an ordinance which was later replaced by an Act of Parliament, known as the Banking Companies (Acquisition & Transfer of Undertakings) Act, 1970.
Private Sector Bank
New entry of banks in the Pvt. Sector were revised in Jan 2001. The guidelines prescribed an increase in initial minimum paid-up capital from Rs.100 crore to Rs. 200 crore.
Moreover, the initial minimum paid up capital shall be increased to Rs.300 crore in subsequent 3yrs. After commencement of business.
Foreign Banks in India
Foreign banks are now allowed to set up subsidiaries in India. Such Subsidiaries will have to adhere to all banking regulations, including priority sector lending norms applicable to other domestic banks.
BANKING
What you all understand from the
term Banking???
The Banking Regulation Act,1949, known till 1965 as the Banking Companies Act 1949, defines Banking as:-
“ accepting for the purposes of lending or investment, deposits of money from the public, repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise”
Origin of Banking in India
1683 – East India Company ( By – Madras based officers)banking of western type only.
1779 – The Hindustan Bank
1786 – General Bank of India
Then came 3 presidency banks, in the early part of the nineteenth century, namely:-
1806 – Bank of Bengal
1840 – Bank of Bombay
1846 – Bank of Madras
In the second half of the nineteenth century :-
1) More Exchange banks
2) Indian joint stock banks.
Continued ….
In 1900 –
1) 9 joint stock banks
2) 8 exchange banks
3) 3 Presidency Banks
In 1921 –
Three Presidency banks were amalgamated to form
“Imperial Bank of India (IBI)”
In 1935 – Reserve Bank of India was established.
Till this time IBI functioned as a “Quasi – Central Bank”.
Origin of Commercial Banking
1000 B.C. – Originated from Temples and Royal Palaces in Babylon, as they attract peoples faith.
Then Goldsmiths came – when coins made of precious metals like gold and silver as commonly accepted forms of wealth in 1640.
Structure of Present Indian Banking System Reserve Bank of India
1) Scheduled Bank
a) State Co –operative Banks
b) Commercial Banks Foreign Indian
Public Sector Banks State Bank of India & its Subsidiaries Nationalised Banks Regional Rural Banks (In 1975)
Private Sector Banks
2) Non – Scheduled Banks –
a) Central Co - operative Banks & Primary Credit Societies.
b) Commercial Banks
Conditions to be in category of Scheduled banks –
1) Must have a paid up capital and reserves of not less than Rs.5 lacs.
2) It must also satisfy the RBI that its affairs are not conducted in a manner detrimental to the interests of depositors.
Functions of Commercial Banks
Divided into three parts –
1) Primary Functions –
a) Accepting Deposits Fixed or Time Deposits Current or Demand Deposit Saving Deposit Recurring Deposit
b) Advancing Loans Cash Credit Overdraft Short term loans Demand Loans
c) Credit Creation – i.e. giving more loans than their cash reserves
Continued…
2) Secondary Functions –
a) Agency Functions –Collection & Payment of Various Items Purchase & Sale of SecuritiesTrusteePurchase & Sale of Foreign ExchangeUnderwriting
b) General Utility Services –Locker FacilitiesTravelers' ChequeBusiness Information & StatisticsHelp in Transportation of Goods
Continued…
Social Functions or Role of Banks in Economic Development
1) Capital Formation
2) Inducement to Innovation
3) Investment – friendly Interest Rate Structure
4) Development of Rural Sector
5) Implementation of Monetary Policy
6) Employment Opportunities
Money MarketMoney MarketIt is the market of instruments which are forIt is the market of instruments which are for• Very short PeriodVery short Period• Low ReturnLow Return• Normally safe & SecureNormally safe & Secure
Money market instruments are traded in Discount and Money market instruments are traded in Discount and Finance House of India (DFHI)Finance House of India (DFHI)
Instruments of Money MarketInstruments of Money Market• Call Money Call Money • Treasury Bill Treasury Bill • Commercial PaperCommercial Paper• Certificate of DepositCertificate of Deposit• Money Market Mutual FundMoney Market Mutual Fund
Call MoneyCall Money• It is the market where day to day surplus funds It is the market where day to day surplus funds
of banks are tradedof banks are traded• The call money loans are of very short term in The call money loans are of very short term in
nature ranging from 1 to 15 daysnature ranging from 1 to 15 days• If any bank is having requirement of funds for If any bank is having requirement of funds for
meeting statutory obligations of RBI or for any meeting statutory obligations of RBI or for any other purpose and other bank is having surplus other purpose and other bank is having surplus money for that period, the loan can be taken by money for that period, the loan can be taken by the bank from other bankthe bank from other bank
• The call money rate are 1%-2% generallyThe call money rate are 1%-2% generally
Treasury BillTreasury Bill• Treasury bills are issued by the reserve bank of Treasury bills are issued by the reserve bank of
IndiaIndia• Treasury bills are raised to meet the short- term Treasury bills are raised to meet the short- term
funds required by the government of Indiafunds required by the government of India• T-bills also enables the RBI to perform open market T-bills also enables the RBI to perform open market
operations for regulating money supply in the operations for regulating money supply in the economyeconomy
• T- bills are normally 91 days T-bills, 182 days T-bills, T- bills are normally 91 days T-bills, 182 days T-bills, 364 days T-bills364 days T-bills
• They are highly secured instruments, so interest rate They are highly secured instruments, so interest rate is very low in case of T-Bill.is very low in case of T-Bill.
Commercial PaperCommercial Paper• They can be issued by the companies having They can be issued by the companies having
minimum net worth of 4 crores and minimum minimum net worth of 4 crores and minimum working capital of 4 croresworking capital of 4 crores
• They are issued in multiples of 5 LakhsThey are issued in multiples of 5 Lakhs• Their maturity varies from 15 days to one yearTheir maturity varies from 15 days to one year• They are unsecured in natureThey are unsecured in nature• They are transferable by endorsement & They are transferable by endorsement &
deliverydelivery• They normally have buy back facilityThey normally have buy back facility
Certificate of depositCertificate of deposit• These can be issued by all scheduled Bank These can be issued by all scheduled Bank
• The Maturity period for a certificate of deposit The Maturity period for a certificate of deposit is not less than 15 days and not more than is not less than 15 days and not more than 12 months12 months
• They are issued in multiples of 1 lakh but They are issued in multiples of 1 lakh but subject to minimum size of 5 lakhssubject to minimum size of 5 lakhs
• They are always issued at a discount to face They are always issued at a discount to face valuevalue
• They can be issued to individuals alsoThey can be issued to individuals also
Money Market Mutual FundMoney Market Mutual Fund• MMMF are mutual funds that Invest Primarily MMMF are mutual funds that Invest Primarily
in money market instruments in money market instruments • Can be open ended or close endedCan be open ended or close ended• Minimum lock in period 15 yearsMinimum lock in period 15 years• Minimum size 50 croresMinimum size 50 crores• Should not exceed 2% of last years deposits Should not exceed 2% of last years deposits
in case of bank and 2% of domestic in case of bank and 2% of domestic borrowings in case of financial institutionsborrowings in case of financial institutions
Forex MarketForex Market• The forex market is the market where The forex market is the market where
foreign exchange are traded like Dollar, foreign exchange are traded like Dollar, Pound, Euro et.Pound, Euro et.
• The exchange rate are determined by the The exchange rate are determined by the forex market on the basis of demand and forex market on the basis of demand and supply for the particular currency.supply for the particular currency.
• It is controlled by FEMA It is controlled by FEMA
Bullion MarketBullion Market• Bullion Market is the market where metals Bullion Market is the market where metals
are tradedare traded
Like Gold, Silver, Aluminum etcLike Gold, Silver, Aluminum etc
• The rates for bullions depends upon the The rates for bullions depends upon the demand & supply for that particular metal. demand & supply for that particular metal.
Government Securities MarketGovernment Securities Market• They are issued by the GovernmentThey are issued by the Government• They are also known as gilt edged securities as They are also known as gilt edged securities as
the repayment of principal and interest are the repayment of principal and interest are highly secure.highly secure.
• The interest rate is very lowThe interest rate is very low• The short term govt. securities ranges from 1 – 5 The short term govt. securities ranges from 1 – 5
years, medium term govt. securities ranges from years, medium term govt. securities ranges from 5 – 10 year and5 – 10 year and
long term govt. securities are having maturity long term govt. securities are having maturity period exceeding 10 yearsperiod exceeding 10 years
Financial InstitutionsFinancial Institutions
• Development InstitutionsDevelopment Institutions
• Investment InstitutionsInvestment Institutions
• Regulatory InstitutionsRegulatory Institutions
• Banking InstitutionsBanking Institutions
• Non Banking Finance Institutions /Companies Non Banking Finance Institutions /Companies (NBFC)(NBFC)
Explain the reasons for imposing the social control over the commercial banks
of India. How far has it succeeded in achieving the
GOAL?
What are excess reserves with the banks? What is their Utility?
If banks happen to keep cash reserves beyond the Reserve Bank’s requirement of cash reserve ratio, they are having excess reserves.
Example : -
CRR – 10%, Demand Deposits = Rs. 10,000.
Actual Cash Reserves = Rs. 1500
Required cash Reserves = 10 % of Rs. 10,000 i.e. Rs.1,000
Excess Reserves = Rs.(1500 – 1000) = Rs. 500
Banks can utilize these excess reserves whenever it desires to make more loans. It can make more loans 10 times of its excess reserves, assuming CRR = 10% and Credit Multiplier = 1 / 10% = 10.
“Real utility of excess reserves is realized by the banks when the central bank tries to squeeze their liquidity through higher Bank Rate or through the sale of securities during inflation”.
Banking in USA
StartingThe U.S. banking industry can be categorized into five
eras.1st Era => 1791 to 1832In most states of early federal union, banks organizers
needed special permission from the government to open and operate banks, A central bank founded in 1791 and second bank in 1816 and operated until 1832.
2nd Era => 1832 to 1864In 1832 state government took over the job of supervising
banks. In those days, banks made loans by issuing their own currency. These bank notes were supposed to convertible, on demand, to cash i.e. to gold or silver. By 1860, more than 10000 different bank notes circulated throughout the country. Then congress passed the National Currency Act in 1863. Cont…
Cont…3rd Era => 1865 to 1914
National bank notes were the mainstay of the nations money supply until Federal Reserve notes appeared in 1914.
The 1907 crisis, also called the Wall Street Panic, was severe. The panic caused what was at that time the worst economic depression in the US’s history. The unemployment rate reached 20% in the fall of 1907.
4th Era => 1929 to 1933. The onset of the worldwide depression In end 1931, more than 1000 U.S. banks failed. In June 1933, Federal Deposit Insurance act was enacted.
5th Era => 1970s to Today Banking has undergone a revolution. Technology has revolutionized the industry. E-Banking, ATMs, plastic cards and many more.
Types of banks in US.
In 1863, with the enactment of the National Banking Act, a dual banking system was created, which gave rise to two types of banks.
a) National banks – can issue currency
b) State Banks – can not issue currency
Commercial bank includes trust companies, stock savings banks, and industrial banks.
Savings banks, savings and loans, cooperative banks and credit unions are actually classified as thrift institutions.
Each originally concentrated on meeting specific needs of people who were not covered by commercial banks.
Savings and loan associations and cooperative banks were established during the 1800s to make it possible for factory workers and other lower – income workers to buy homes.
Credit unions were started by people who shared a common bond, like working at the same company, whose main function was to provide emergency loans for people who could not get loans from traditional lenders.
Commercial banks can offer car loans, thrift institutions can make commercial loans, and credit unions offer mortgages.
The case of Lehman’s Bank, where they have not much reserves, and
resulted into Bankruptcy
Wholesale BankingIt is the provision of services by banks to the like of :
a) Large corporate clients
b) Mid-sized companies
c) Real estate developers and investors
d) International trade finance businesses
e) Institutional customers (such as pension funds and government entities/agencies), and services offered to other banks or other financial institutions.
In essence, wholesale banking services usually involve high value transactions.
Cont… Wholesale banking contrasts with Retail Banking, which
is the provision of banking services to individuals.
(Wholesale finance means financial services, which are conducted between financial services companies and institutions such as banks, insurers, fund managers, and stockbrokers.)
Modern wholesale banks are engaged in: a) Underwritingb) Market makingc) Consultancy, d) Mergers and acquisitionse) Fund management.
Well-known banks offering wholesale banking services - ING & Standard Chartered
Retail Banking
Retail Banking includes:-
Debit & credit cards
Mutual Funds
Bill Paymentservices
Loans for Subscribing
toIPO
Deposit ProductsResidential Mortgage
Loans
Brokerage
Auto Finance
Personal insurance
loans
Consumer DurableLoans
Loans againstEquity shares
Financial ProductsSuch as:
IntroductionBanks across the country are tripping over themselves to
enter new segments like –
a) Car Loansb) Consumer Loansc) Housing Financed) Education loane) Credit Cards
The big bonus for banks came in the form of the Securitization Bill, which gave banks and institutions muscle to recover bad debts.
“Retail Banking is new Mantra for all the banks”
Continued… These products provide an opportunity for banks to
diversify the asset portfolio with high profitability and relatively low NPA’s.
Banks have identified Retail Banking as a “Principle Growth Driver”
The growth in retail banking has been facilitated by the growth in banking technology and automation of banking processes that enable extension of reach and rationalization of cost as introduction of ATM facility.
It also has the advantage of reducing the branch traffic.
Major forces that are driving and shaping consumer lending.
Securitization
Regulation
Automation
Competition
Major ForcesAre
New facilities that banks are using not only to lure customers but also to help them reduce their total operating costs.
Net Banking
Phone Banking ATM ‘ s
Bill Payment
Mobile Banking
New facilities
Critical Success factors of banks which are moving towards retail banking
• Factors are : Good recoveryMechanism
Strong brandpresence
Low cost offunding
Low intermediationOr operating cost
Marketing capabilities Large product
portfolio
Proper creditAppraisal
Mechanism
Flexible technology
Multi distributionchannels
Fast loan processing
Cross - selling
Wider Distribution network
Success Factors
These success factors would ultimately transform into how well banks understand their customers and how effective they are in meeting their new definition of ‘access’, ‘convenience’ and ‘value’.
Retail Banking Strategies
Retail banking covers both asset – side and liability side products.The liabilities side include –
a) ATMsb) E – bankingc) tele – banking
The assets side of the bank has various types of loans made by a retail bank.
Banking services can be divided into three categories from the dimensions of retail banking.
a) Core services – it is the reason for being in the market.
b) Facilitating services – they are needed so that core services can be used.
c) Supporting services – it exactly discriminate the service package from the services of competitors.
Strategies
Market Segmentation Banks have to focus on it to identify differences between groups of
potential customers and decide what kind of products can be served for such groups.
Swadhan – it is a shared payments network system. The future of retail banking lies in mobile banking.
Price Bundling It is a selling arrangement where several different products are
explicitly marketed together at a price that is dependent on the offer. It offers economies of scale, utilization of existing capacities and
reaching wider population of customers. It can be used in order to lengthen the relationship with a customer.
Customer Relationship Management.
BankAssurance: Marriage of Banking and Insurance
• With the insurance sector opening up, there is great interest in knowing how far the expansion of the insurance market will alter the contours of the existing financial structure. The expansion of banking into the insurance industry is inevitable.
• In April 2000, the Reserve Bank of India permitted banks to enter the insurance market.
• In terms of the existing guidelines, commercial banks can take any of the three routes to enter the insurance business, namely
1. Undertake distribution of insurance products as an agent of insurance companies on a fee basis;
2. Make investments in an insurance company for providing infrastructure and services support;
3. Set up a joint venture company for undertaking insurance business with risk participation.
• It has been well recognised by the RBI that there could be a competitive as well as complementary relationship between banks and insurance companies.
• For instance, in the life insurance business where the insurance contract (policy) is for a long period, the premium can be split up into two parts: (a) for risk coverage and (b) towards savings. The latter obviously is something that banks target as part of their core business.
Cont…• Banks are the chief purveyors of the financial services to a large number
of individuals and small borrowers. On account of their geographical reach and access to customers, banks could logically be a channel for the distribution of insurance products.
• On the other hand, bank services (as they are understood today), insurance selling and fund management are all inter-related activities having inherent synergies. Therefore, selling of insurance by banks could be beneficial for both banks and insurance companies.
• In Europe, this synergy between banking and insurance has given rise to a novel concept called ``BankAssurance''.
• Simply stated, bankassurance means that a package of financial services that fulfil both banking and insurance can be offered at the same time and at the same place.
Cont…• This concept in turn impacts on the ongoing debate over ``Universal
Banking''. In an extended sense, universal banking will include not only a combination of commercial and investment banking but insurance as well.
• In the evolving nature of RBI guidelines, regulatory concerns will be of paramount importance. As of now the RBI has said the banks can neither take up insurance business departmentally nor set up a separate subsidiary. There has to be an ``arms length'' relationship between the bank and the insurance entity so that risks inherent in the insurance business do not enter the banks' balance sheets.
• Second, the guidelines make a distinction between banks that can set up a joint venture and hence share in the risks and those which merely distribute insurance products.
• The authority to grant case-by-case permission to banks to enter insurance business is vested with the RBI.
Universal Banking
Universal BankingIt is opposite of Narrow Banking.
Narrow Banking:
Its legislation would require banks to back their liabilities with safe assets, such as government securities.
The benefits of narrow banking are:
1) By locking bank assets in high-quality instruments, narrow banking regulation would minimize bank liquidity and credit risk.
2) Confidence in the value of their liabilities.
3) With payment system access restricted to narrow banks, payments would be fully secure.
Non Banking Financial Company (NBFC)
“A non-banking financial company (NBFC) is a company registered under the Companies Act, 1956 and is engaged in the business of loans and advances, acquisition of shares/stock/bonds/debentures/securities issued by government or local authority or other securities of like marketable nature, leasing, hire-purchase, insurance business, chit business, but does not include any institution whose principal business is that of agriculture activity, industrial activity, sale/purchase/construction of immovable property”.
NBFCs are doing functions similar to banks. What is difference between banks & NBFCs ?
NBFCs are doing functions akin to that of banks, however there are a few differences:
(i) NBFC cannot accept demand deposits (demand deposits are funds deposited at a depository institution that are payable on demand -- immediately or within a very short period -- like your current or savings accounts.)
(ii) It is not a part of the payment and settlement system and as such cannot issue cheques to its customers;
What are the different types of NBFCs registered with RBI?
With effect from December 6, 2006 the above NBFCs registered with RBI have been reclassified as
(i) Asset Finance Company (AFC) (ii) Investment Company (IC) (iii) Loan Company (LC)
PRINCIPLES OF LENDING PRINCIPLES OF LENDING
Principles of Safety of Funds.
Principles of Profitability.
Principles of Liquidity.
Principles of Purpose.
Principles of Risk Spread.
Principles of Security.
PRINCIPLES OF LENDINGPRINCIPLES OF LENDING
Principles of Safety of
Funds:
Willingness.
Honesty.
Integrity.
Character.
Financial Standing.
PRINCIPLES OF LENDINGPRINCIPLES OF LENDING
Principles of Profitability
Must Cover
Cost of Funds.
Cost of its Administration.
Risk Cost.
PRINCIPLES OF LENDINGPRINCIPLES OF LENDING Principles of Liquidity
Problem may include:
Liquidity Crises.
ALM mismatch.
Bank’s inability to meet its obligations.
Account turning NPA.
PRINCIPLES OF LENDINGPRINCIPLES OF LENDING Principles of Purpose Productive Purpose:
Helps generate additional income. It works like incentive for pursuing
the activity.Generate cash and builds capacity
to repay.Unproductive purpose acts like a
burden.
PRINCIPLES OF LENDINGPRINCIPLES OF LENDING
Principles of Risk Spread:
Sector wise.
Industry wise.
Geographical Area wise.
Borrower wise.
PRINCIPLES OF LENDINGPRINCIPLES OF LENDING
Principles of Security
To fall back upon in case of:
Unwillingness of the borrower.
Absence of capacity of the
borrower.
Circumstances turning
unfavorable.
PRINCIPLES OF LENDINGPRINCIPLES OF LENDING
Features of Good
Security:
Marketability.
Ascertainability.
Stability.
Transferability.
PRINCIPLES OF LENDINGPRINCIPLES OF LENDING
Marketability:
Ready Market.
Regular Transactions.
Locally available.
PRINCIPLES OF LENDINGPRINCIPLES OF LENDING
Ascertainability:
Physically
identifiable.
Monetarily Valuable.
PRINCIPLES OF LENDINGPRINCIPLES OF LENDING
Stability:
Physically not
perishable.
Monetarily not
diminishing (in value)
PRINCIPLES OF LENDINGPRINCIPLES OF LENDING
Transferability:
Legally.
Physically to
prospective buyers.
Balance Sheet
Components of a Bank Balance sheet
Liabilities Assets1. Capital
2. Reserve & Surplus
3. Deposits4. Borrowings
5. Other Liabilities
1. Cash & Balances with RBI
2. Bal. With Banks & Money at Call and Short Notices
3. Investments
4. Advances5. Fixed Assets
6. Other AssetsContingent Liabilities
Components of Liabilities
1.Capital:Capital represents owner’s
contribution/stake in the bank.
- It serves as a cushion for depositors and creditors.
- It is considered to be a long term sources for the bank.
Components of Liabilities
2. Reserves & SurplusComponents under this head includes:I. Statutory ReservesII. Capital Reserves III. Investment Fluctuation Reserve
IV. Revenue and Other ReservesV. Balance in Profit and Loss Account
Components of Liabilities
3. Deposits
This is the main source of bank’s funds. The deposits are classified as deposits payable on ‘demand’ and ‘time’. They are reflected in balance sheet as under:
I. Demand Deposits
II. Savings Bank Deposits
III. Term Deposits
Components of Liabilities
4. Borrowings
(Borrowings include Refinance / Borrowings from RBI, Inter-bank & other institutions)
I. Borrowings in India
i) Reserve Bank of India
ii) Other Banks
iii) Other Institutions & Agencies
II. Borrowings outside India
Components of Liabilities
5. Other Liabilities & ProvisionsIt is grouped as under:
I. Bills Payable II. Inter Office Adjustments (Net) III. Interest Accrued IV. Unsecured Redeemable Bonds (Subordinated Debt for Tier-II Capital) V. Others(including provisions)
Components of Assets
1. Cash & Bank Balances with RBI I. Cash in hand
(including foreign currency notes)
II. Balances with Reserve Bank of India
In Current Accounts
In Other Accounts
Components of Assets2. BALANCES WITH BANKS AND
MONEY AT CALL & SHORT NOTICE I. In India
i) Balances with Banks a) In Current Accounts b) In Other Deposit Accounts
ii) Money at Call and Short Notice
a) With Banks b) With Other InstitutionsII. Outside India a) In Current Accounts b) In Other Deposit Accounts c) Money at Call & Short Notice
Components of Assets3. Investments
A major asset item in the bank’s balance sheet. Reflected under 6 buckets as under:
I. Investments in India in : * i) Government Securities
ii) Other approved Securities
iii) Shares iv) Debentures and Bonds v) Subsidiaries and Sponsored Institutions vi) Others (UTI Shares , Commercial Papers, COD & Mutual Fund Units etc.)II. Investments outside India in ** Subsidiaries and/or Associates abroad
Components of Assets
4. AdvancesThe most important assets for a bank.A. i) Bills Purchased and Discounted
ii) Cash Credits, Overdrafts & Loans
repayable on demand
iii) Term Loans
B. Particulars of Advances :
i) Secured by tangible assets
(including advances against Book Debts)
ii) Covered by Bank/ Government Guarantees
iii) Unsecured
Components of Assets5. Fixed Asset I. Premises
II. Other Fixed Assets (Including furniture and fixtures)
6. Other Assets I. Interest accrued
II. Tax paid in advance/tax deducted at source
(Net of Provisions)
III. Stationery and Stamps
IV. Non-banking assets acquired in satisfaction of claims
V. Deferred Tax Asset (Net)
VI. Others
Contingent Liability
Bank’s obligations under LCs, Guarantees, Acceptances on behalf of constituents and Bills accepted by the bank are reflected under this heads.
COMPONENTS OF PROJECT COMPONENTS OF PROJECT APPRAISALAPPRAISAL
Technical feasibility.
Economic viability.
Financial feasibility.
Managerial capacity.
Marketing possibilities.
COMPONENTS OF APPRAISALCOMPONENTS OF APPRAISAL
Technical feasibility: Quantity, quality, timely implementation of
project and timely delivery of products.Suitability of machinery and equipment.Availability of inputs - power, skills:Whether locally available.Whether scares.Whether dependent on foreign suppliers.Whether depended on a few suppliers.Whether dependent up on vagaries of
nature.
COMPONENTS OF APPRAISALCOMPONENTS OF APPRAISAL Technical feasibility - as to
Technology employed - whether latest or
proven in medium/long term Whether
advantageously located.Pollution/Environment risk if any.Whether dependent up on job work,
unbranded items.Whether in sensitive sector.Product range and product mix.Present economic scenario whether
favourable
COMPONENTS OF APPRAISALCOMPONENTS OF APPRAISAL
Economic viability:Profitability & cash generation:Interest Coverage ratio -
(PBDIT)/Interest) Return on Capital employed.
(PBDIT/Capital Employed)
(Capital employed = capital + reserve &
surpluses + long term debt - investment in
subsidiaries or associated firms)Profitability - Net Profit/Sales.
COMPONENTS OF APPRAISALCOMPONENTS OF APPRAISAL Managerial viability:
Adequacy and suitability of management structure.
Whether technically/ professionally qualified.
Reputation in the market and experience
Ability to withstand competition.Financial standing.Bargaining power with suppliers.Whether cost conscious.
COMPONENTS OF APPRAISALCOMPONENTS OF APPRAISAL
Managerial viability:
Parameters to be considered are:
Whether management is broad based and
controlled by professionals/ experienced
persons.
Whether it is run by a few family members.
Whether controlled by two or one key person
Conduct of Account - whether irregular, cause of
irregularity.
Compliance of terms and conditions of Sanction.
COMPONENTS OF APPRAISALCOMPONENTS OF APPRAISAL
Managerial viability:
Parameters to be considered are:
Past Track record.
Composition of Management.
Quality of Management.
Relationship with the Bank - whether
satisfactory - for how much period.
Experience - how much, in which business.
COMPONENTS OF APPRAISALCOMPONENTS OF APPRAISAL
Market Appraisal:Availability or creation of
market - whether diversified.Demand forecasting based on
Future Growth Potential.Government Policies in Pricing.Pollution.Custom and excise duties.Pricing.
COMPONENTS OF APPRAISALCOMPONENTS OF APPRAISAL Market Appraisal:
Competition - how much & with whom.
Export potential.Product range and Product mix.Life cycle of products.Distribution set - up - whether any
tie-up arrangement for long term/ assured off take.
COMPONENTS OF APPRAISALCOMPONENTS OF APPRAISAL
Market Appraisal:Quality of Product whether
consistent.Multi locational advantage -
whether available.Import threat - if any.Product - whether perishable.Demand of product: Whether adequate.Whether increasing.
COMPONENTS OF APPRAISALCOMPONENTS OF APPRAISAL
Financial Appraisal:Consideration of various costs:Cost of land, its development.Construction of building/sheds.Acquisition of plant and machinery and other fixed assets.Preliminary and pre - operative
expenses.Technical fee.Contingencies.Margin for working capital.
COMPONENTS OF APPRAISALCOMPONENTS OF APPRAISAL Financial Appraisal:
Means of Finance:Promoters contribution.
Equity Subordinated loans.
Secured loans raised from financial institutions or banks.
Lease finance or equipment acquired on hire purchase basis.
Debentures.Supplier’s credit.Internal cash accrual in case of existing firm
COMPONENTS OF APPRAISALCOMPONENTS OF APPRAISAL
Financial Parameters to be considered:
Current Ratio
Interest Coverage ratio - (PBDIT/ Interest)
Return on Capital Employed(PBDIT/Capital Employed)(Capital employed = capital+reserve &
surpluses+long tern debt - investment in subsidiaries or associated firms).
COMPONENTS OF APPRAISALCOMPONENTS OF APPRAISAL
Financial Parameters to be considered:
Past commitment with respect to net
sales.
Past commitment with respect to net
profit.
Development of LC/ Invocation of
Bank Guarantees/ Payment of Bills.
COMPONENTS OF APPRAISALCOMPONENTS OF APPRAISAL
Financial Parameters to be considered:
Trend Analysis:
Net Current Assets.
Tangible Net Worth.
Profitability - Net Profit/Sales.
Cost are reasonable.
COMPONENTS OF APPRAISALCOMPONENTS OF APPRAISAL
Financial Parameters to be considered:
For new units only:
Repayment Period.
Return on Project Tangible Net worth
Asset Coverage Ratio.
(Primary + Collateral)/ Aggregate
Secured Loans.
The Narasimham Committee1990s India had traumatic moments
1) Banks were burdened with large percentage of non-performing loans
2) Customer service had suffered and out-mode practices were in vogue
3) Overall re-hauling was needed for entire financial systems in general and banking sector in particular
The Narasimham Committee was set up to recommend changes in financial system
Committee Recommends– Overall emphasis upon ‘de-regulation’– No further nationalization to be adhered to– No distinction between ‘public’ and ‘private’ sector
banks– Control of banking sector to be centralized (and not
to be divided between RBI and Dept. of Banking)– SLR and CRR should be reduced to prudent levels– Concessional lending to be phased out– The capital base of banks should meet international
standards– The appointment of Chief Executive of the banks to
be de-politicized
ALM – Asset-Liability Management
Definition – It is associated with strategic balance sheet management that takes into account risks caused by changes in the interest rates, exchange rates & the liquidity position of the banks.
It is a tool to manage:- Interest rate risk The price risk. Exchange rate risks Commodity price risk Share price risk.
Gap Analysis
=> It is the basic technique used for analyzing the interest risk.
This technique helps to find out the gap between banks assets & liabilities, maturing after certain time periods.
IF RSA > RSL then there is a positive gap, which indicates that institution is in a position to benefit from rising interest rates.
IF RSA < RSL then there is a negative gap, which indicates that institution is in a position to benefit from declining interest rates.
Therefore the gap is used to measure interest rate sensitivity.
Purpose & Objective of ALMAn 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 ration.
It is aimed to stabilize short-term profits, long-term earnings and long-term substance of the bank.
Significance of ALM
• Volatility
• Product Innovations & Complexities
• Regulatory Environment
RBI DIRECTIVES• Issued draft guidelines on 10th Sept’98.
• Final guidelines issued on 10th Feb’99 for implementation of ALM w.e.f. 01.04.99.
• To begin with 60% of asset & liabilities were covered; 100% from 01.04.2000.
• Gap Analysis to be applied in the first stage of implementation.
Liquidity Management
Bank’s liquidity management is the process of generating funds to meet contractual or relationship obligations at reasonable prices at all times.
New loan demands, existing commitments, and deposit withdrawals are the basic contractual or relationship obligations that a bank must meet.
Adequacy of liquidity position for a bank
Analysis of following factors throw light on a bank’s adequacy of liquidity position:
a. Historical Funding requirementb. Current liquidity positionc. Anticipated future funding needsd. Sources of fundse. Options for reducing funding needsf. Present and anticipated asset qualityg. Present and future earning capacity andh. Present and planned capital position
Funding Avenues
To satisfy funding needs, a bank must perform one or a combination of the following:
a. Dispose off liquid assetsb. Increase short term borrowingsc. Decrease holding of less liquid assetsd. Increase liability of a term naturee. Increase Capital funds
Statement of Structural Liquidity
All Assets & Liabilities to be reported as per their maturity profile into 8 maturity Buckets:
• Places all cash inflows and outflows in the maturity ladder as per residual maturity
• 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.
CAMELS – Ratings for Banks
For evaluation and rating of Indian Banks Six parameters were used.
C – Capital Adequacy
A – Asset Quality
M – Management
E – Earning Performance
L – Liquidity & Systems
employed by the Supervisory Authorities in U.S.A. considering the growing supervisory concerns on the need for adequate systems of risk management and operational controls in banks operating in India.
Component Ratings
Each of the six components in CAMELS( for Indian Banks)
Or 4 components in CACS (for foreign banks operating in India) are assigned a rating on a scale of 1 to 5 in order of performance.
C = Capital Adequacy
A – Asset Quality
C – Compliance
S – Systems
Composite RatingsIt is used by the supervisors as the Prime indicator of
bank condition, assigned on a scale of A to E.
Cross Selling?
Corporate BankingCorporate banks or wholesale banks normally supply capital for business ventures and construction activities on a long – term basis.
Wholesale banking is an umbrella term encompassing the products and services that a commercial bank provides to its corporate customers.
In today's technological, competitive and pressure packed environment, wholesale bankers have two basic choices-:
1) either ensure their current operation at peak efficiency so as to effectively meet its customer need’s.
2) or develop alternative strategies outside their current operations requirement.
Long Term Commercial Loans. Corporate banking mainly deals with these loans A loan that is structured and supported specifically by
the operation and performance of a specific business or enterprise is called a commercial loan.
The lender requires a record of 2 yrs of profitability and a plan that can demonstrate the continued performance of the loan.
The purpose for longer commercial loans vary greatly, from purchases of major equipment and plant facilities to business expansion or acquisition costs.
Such long term and big league financing is usually done through consortium financing or loan syndication.
Consortium FinanceEvery advance however safe it may be suffers from undefined
risks. These risks may be business or economy risks.
Consortium banks are specialist banks that are jointly owned by other banks and operate in the wholesale financial market. This practice is also known as participation financing or joint financing.
Consortium is entered into for project financing (long term and working capital requirement), deferred payment guarantees.
Lending
Introduction
Lending is an indispensable aspect of banking, and a banker earns bulk of his income through lending.
It adds value to Bank.
The lending decisions of a bank are guided by its loan policy or credit policy.
Credit policy outlines the crucial lending decisions of a bank.
Credit policy Lays down
Credit Riskassessment
Documentationstandards
TakeoverOf
AdvancesPricing
Delegation Of
Powers
Credit appraisalstandards
Exposure Levels
PolicyLays down
Need for Credit Policy
The credit policy document is a document that carefully specifies the do’s and dont’s while sanctioning the loan proposals.
1) To screen out loans
2) Which can be outrightly rejected
3) Loans that can be sanctioned without any reference.
Analyzing
Selecting
Sanctioning
Monitoring
Components of Credit Policy
GeneralPolicies
SpecificLoan
Categories
QualityControl
OtherSpecificissues
MiscellaneousLoan
policies
Components
Significant issues that are to be incorporated in the policy
1) Objectives:-Formulation of objectives of the proposed policy.
With diverse objectives, we have to prioritize them:like:-
a) profitabilityb) liquidityc) volume of businessd) risk factors
Essentially, the credit policy should fit within the framework of regulatory norms.
2) Volume and Mix loans:- The policy should specify the targeted composition of
the loan.
3) Geographical spread –
There will be various locations from where a bank conducts its operation.
Some may be weak credit demand areas with a considerably high deposit potential.
4) Loan Evaluation Procedure
Banks need to consider the following variables while evaluating a loan proposal.
a) Industry ProspectsIndustry cyclesThreat from substitutesShifts in consumer demandsRegulatory environment
Continued…
b) Operational Efficiency Operating margins Stability & growth of market shares Benefit from economies of scale Access to key raw materials.
c) Financial Efficiency Working capital management Ability to raise funds Cost of capital Financial Leverage
5) Management Evaluation
6) Fundamental Analysis.a) Capital structure
b) Asset / liability position
c) Profitability
d) Sensitivity to interest rate structures, tax policies
Rating Criteria for Banks
The criteria for rating the bank are normally based on:-
a) Assets
b) Equity
c) Profits
If the criteria for rating a bank were return on equity then the bank would easily compromise profitability for safety.
If the criteria is total assets then it is of less significance as it tells very little about either profitability or creditworthiness.
If the criteria is equity, then only the well – capitalized banks may be safe, but they may not be profitable.
Drawback with these ratings are – that they do not take into consideration the environment in which the bank operate.
Credit Rating
It is the main tool, which helps in measuring the credit risk and facilitates pricing of a loan.
It gives vital indications of weakness in a borrower’s profile.
It involves evaluating and assessing an institution’s risk management, capital adequacy and asset quality.