Overview of Banking Prof. Ganga S (TIMSR)

1. Overview of BankingProf. Ganga S (TIMSR)

2. Guess What

3. Guess What

4. Guess What

5. Indian Financial System Financial Intermediaries Investments Savings Unorganised Organised

6. Types of Financial Intermediaries

7. Types of Financial Intermediaries • Banks • Investment companies, • Domestic Financial Institutions • Mutual Funds • Insurance Companies • Non Banking Finance Companies • Pension Funds

8. Activities Financial Intermediaries

9. Banking Sector

10. Journey So far • Phase 1 :Early phase from 1786 to 1969 of Indian Banks • Phase 2 :Nationalization of Indian Banks and up to 1991 prior to Indian banking sector Reforms. • New phase of Indian Banking System with the advent of Indian Financial & Banking Sector Reforms after 1991.

11. Journey So far -1786 to 1969 • 1786- General Bank of India • The East India Co. established three banks – Bank of Bengal (1809), The Bank of Bombay (1840) and Bank of Madras (1843) • Merged as Imperial Bank of India in 1921 • State Bank of India Act, 1955 • 1959: Nationalisation of SBI subsidiaries • Reserve Bank started functioning in the Private Sector in the year 1935 (by the passing of the Reserve Bank of India Act, 1935) • RBI was nationalised in the year 1949 as Central Bank of Country • 1949- Banking Regulation Act

12. Journey So far -Nationalisation • Objectives: • Class Banking to Mass Banking • Reach out to unbanked areas • Growth in deposit mobilisation, credit disbursals • loan portfolio to sectors identified as “priority sectors”. • 1969- Nationalization of 14 major banks • 1971- Credit guarantee corporation • 1975- Creation of Regional Rural Bank • 1980- Nationalization of 6 more commercial banks

13. Narasimha Committee • Progressive reduction in pre-emptive reserves (CRR and SLR) • Liberalisation of branch expansion policy • Introduction of Prudential norms – Capital Adequacy, Asset Classification, Provisioning, Income Recognition • Decrease in the emphasis laid on directed credit • Phasing out concessional rate of interest to priority sector

14. Narasimha Committee • Deregulation in the entry norms for private and foreign banks • Reduction of government stake in banks to 33 percent • Greater emphasis on asset-liability management • Setting up of Asset Reconstruction Funds to takeover NPAs • Consolidation of banking industry by merging strong banks

15. Liberalisation (1991) • Lowered Entry Barriers • Deregulating the Interest Rates • Lowered Regulations • Technological Revolution, • Better customer service, • Automated teller machines, • plastic money, telebanking, • Electronic Funds Transfer, Anywhere banking

16. Liberalisation-Challenges • Competition levels- PSB • Profitability with optimal risk return matrix • Non Performing Assets , Income recognition standards • Greater transparancy norms • Capital Adequacy norms • Off Balance Sheet items

17. Liberalisation-Challenges • Role of CIBIL • Areas of Risks • Credit Risk • Operations Risk • Interest Rate Risk • Liquidity Risk • Currency Risk

18. Performance Review - Scheduled Commercial Bank • Bank Credit (growth rate-%) • May 2007 May 2008 • Non food credit 26.4 24.1 • Agriculture and allied activities 32.2 19.3 • SME 26.4 26.9 • Personal loans 23.9 15.9 • Services 26.1 31.3 • Interest income growth 26.2% as compared to 40% • Provisioning increased resulting in reduced PAT growth • SBI,ICICI Bank, Canara Bank,Central Bank of India • Improvement in Capital adequacy ratio- more than 11% • Banking sector yields 6.7%

19. Banking Sectors

20. Banking Sector • Corporate Banking • Retail Banking • International Banking • Rural Banking

21. Corporate Banking(large corporates) • Financial services and products for large corporate house • Working Capital • Foreign curreny loans • Term loans • CMS • Take over finance • Derivatives • Corporate Deposits • Advisory services • Buyer’s credit/Supplier’s credit • External Commercial borrowings • Internet based banking • Sales Model- Focus relationship manager • Service Model- Focused service desks in Branches • Monitoring- Focused Credit Managers

22. Corporate Banking(SMEs) • SME classification based on networth or turnover • Corporate Linked business structure • Financial services and products for SME • Working Capital • Term loans • CMS • Derivatives • Corporate Deposits • Advisory services • Private equity • Buyer’s credit/Supplier’s credit • External Commercial borrowings • Internet based banking • Sales Model- Outsourced to DMAs/DSAs (for small exposures) • Focused relationship manager • Monitoring Model- Call centre for small exposures and asset relationship manager for large exposures

23. Rural Banking • Customer profile- farmers, Village Level aggregators, co-operative societies, wholesale markets, mandies • Corporate SME linked to Agri sector • Micro finance loans • Corporate Linked business structure • Financial services and products for SME • Working Capital and overdraft • Commodity based financing • Term loans • Sales Model- Outsourced to DMAs/DSAs (for small exposures) • Focused relationship manager • Monitoring Model- Call centre for small exposures and asset relationship manager for large exposures

24. International Banking • Target countries- UK, Russia Singapore, Bahrain, Hong Kong, Sri Lanka, Dubai, United States etc • Target customers- Non Resident Indians, Advisory services such as loan syndication, fund based non fund based loans etc to Indian companies setting new venture overseas • Transaction banking such as internet banking, deposits etc • Private equity funding • Sales Model- Focused relationship manager • Monitoring Model- Focused Credit managers and relationship managers both in Indian branches and overseas branches

25. Risk Management

26. Basel II • 26th June 1974 a German Bank, Bankhaus Herstatt, with total assets of around US $800 million, was ordered by the West German authorities to close its doors after suffering foreign exchange and other losses which were eventually put at over $ 450 million, bringing to the fore “Herstatt risk” or “settlement risk” in the forex transactions. • 1975 a standing committee of Bank supervisors, “Committee on Banking Regulations and Supervisory Practices” (now known as Basel Committee on Banking Supervision)

27. Basel II • The G 10 supervisors joined, in resulting in the historic Basel Capital Accord agreement of July 1988 viz International Convergence of Capital Measurement and Capital Standards” which unified capital adequacy among their banks. • The ability of a bank to absorb unexpected shocks and losses rests on its capital base. Basel II norms are centered on sustained economic development over the long haul and include • promotion of safety and soundness in the financial system • the enhancement of competitive equality • the constitution of a more comprehensive approach to address risk

28. Basel II Existing Accord 1)Focus on single Risk measure • 2)One size fits all • 3)Broad brush structure New Accord 1)More emphasis on Banks own internal methodology, supervisory review and market discipline 2)Flexibility, menu of approaches, incentive for better Risk Mgmt. 3)More Risk Sensitivity

29. Basel II • The new risk sensitive approach seeks to strengthen the safety and soundness of the industry by focusing on: • Risk based capital (Pillar 1)- assessment of minimum capital requirement for banks • Risk based supervision (pillar 2)- supervision to review banks capital adequacy and internal assessment process • Risk disclosure to enforce market discipline (Pillar 3)- use of market discipline for greater transparency and disclosure and encouraging best international practices.

30. First pillar- Minimum Capital Requirement • Minimum capital requirement of 12 percent of risk assets • Calculation is based on credit, market and operational risk. • Capital Adequacy? • It is cushion against unexpected losses • Total Capital =(Tier I+Tier II+Tier III) • Tier I Capital: Tier I capital is the core capital and provides the most permanent and readily available support to a bank against unexpected losses, the Tier II consists elements that are less readily available.

31. Principles of sound lending

32. Application of Funds • Principles of sound lending • Principle of liquidity • Principle of safety and security • Principle of profitability • Principle of purpose • Principle of diversification of Risks • Principle of Social Responsibility

33. Credit Risk • Key principles: • Evaluation • Pricing • Monitoring • Macro Level credit risk management- Capital Adequacy Ratio • CAR= C/RWA where in C= Capital, RWA= Risk Weighted Assets • Synergy Banking Services Ltd has an asset based of Rs 1000 crores out of which 60% carry 50% percent risk weight, 30 percent carry 20% percent risk weight and the remaining zero percent risk weight. Compute the CAR of SBSL if it has a capital of Rs150 crore. Comment on the credit risk position of the company

34. Credit Risk Capital Adequacy= Capital/Risk Weight of Assets = 150 --------------------------------------- = 41% (600*0.5+300*0.2+100*0)

35. Credit Risk • Credit Risk Model • Expert systems, • Capital structure • Capacity • Collateral • Cycle/Economic conditions • Character • Rating systems, and credit scoring system

36. Credit Risk • Credit rating/scoring • Determine the loss probability of default and the recovery rate (as opposed to repayment) • It allocates a potential or existing borrower into either a good group (higher rating) or a bad (lower rating) based on a score and a cut off point.

37. Credit Risk What is Loan review, administration and management (LRM)

38. Credit Risk Basel II proposes three principle options: • Standardised approach • Under this approach preferential risk weights in the range of 0%, 20%, 50% 100% and 150% are assigned for different categories of assets on the basis of external ratings by approved rating agencies. Claims past due over 90 days require a risk weight of 150%. • Internal rating based (IRB). • Under this approach, banks, which comply with certain requirements, would be allowed to internally assess and derive the risk weights, which are then used to compute capital requirements. The risk weights are derived as a continuous function of Probability of Default (PD), LGD (loss given default) and EAD (exposure at default). The migrations in ratings in different rating grades are tracked over a period of 5 to 7 years to arrived at a representative PD. • Securities Frame work

39. Operational Risk

40. Operational Risk • Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. • Internal fraud, External fraud, Employment practices & workplace safety, Clients, products & business practices, Damage to physical assets, Business disruption & system failures, Execution, delivery & process management‹ Includes legal risk. • ‹Excludes reputational and business/strategic risk.

41. Operational Risk Case Study: A man draws a cheque for Rs 50 and inadvertently leaves blanks before the amount both in words and in figures. The cheque is fraudulently raised by the payee. With how much can the bank debit the customer?

42. Operational Risk Three approaches have been proposed for the measurement of operational risks under Basel II • Basic Indicator approach- It utilizes one indicatory of operational risk for a bank’s total activity. Bank needs to keep 15% of its Gross Revenues in reserves to cover all it loans out • Standardized approach: It specifies different indicators for different business lines such as 12%, 15% and 18% • Advanced measurement- It requires the banks to utilize their internal loss data in the estimation of the required capital.

43. Market Risk

44. Market Risk Framework: managing liquidity, interest rate, foreign exchange, equity and commodity price risk. RBI guidelines on market risk in June 2004 • Computing capital charge for interest rate related instruments • Equities • Foreign exchange risk (including gold and precious metals) Trading Book • Securities included under the “Held for Trading”Category • Securities included under the “Available for Sale” category • “Open Gold” position limits • “Open foreign exchange position limits”

45. Market Risk Minimum capital requirement is expressed in terms of: • Specific Risk • Investment in government securities, claims on banks, investment in mortgage backed securities, securitised paper • General Market Risk • General market changes • Standaridised method • Internal Management Model method

46. Liquidity risk

47. Liquidity risk management • Capital Reserves and surplus: Over 5 years • Demand Deposits current and savings bank account: These may be classified into volatile and core portions. While the volatile portion is placed in o1-14 days the cored portion may be placed in over 1-3 year bucket • Term deposits: Respective maturity date • Certificates of deposits, borrowings and bonds:Respective maturity buckets. • Other liabilities(Bills payable)Core component shown under 1-3 years, balance may be placed in 1-14 days • Interoffice adjustment:Net credit balance 1-14 days • Provision other than for loan loss and depreciation in investment:respective buckets • Export finance-availed: Respective maturity date • Export finance-unavailed:1-14 days

48. Liquidity risk management • Cash:1-14 days • Balances with RBI: Excess balance over CRR/SLR in 1-14 days. • Balance in CRR/SLR: respective maturity period • Balances with other banks: Current account, Non withdrawable portion on account of stipulation of minimum balances may be show under 1-3 years and remaining balances may be shown under 1-14 days • Money at call: Respective maturity bucket • Investments (net of provisions) Approved securities: Respective maturity bucket • Corporate debentures, bonds, CDs, CPS etc:Respective maturity bucket • NPA to be classified under 3-5 years bucket • Share/units of mutual: Over 5 years bucket • Investment in subsidiaries: Over 5 years • Securities in trading book1-14 days, 15-28 days 29-90 days

49. Liquidity risk management • Advances (performing) Bills purchased and discounted: Respective maturity bucket • CC, overdraft, demand loan: Based on the past data, the buckets to be determined • Term loans: Respective maturity bucket • NPA: Over 3-5 years • Fixed Assets: Over 5 years • Contingent liability: Lines of credit committed from institutions 1-14 days • Unavailed CC/overdraft etc: Empirical data

50. Currency Risk