Introduction to

Bank and Insurance

Lecture 01

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Risk & Its Relation

with Insurance

Lecture 02

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Insurance

• A system to protect persons, groups, or businesses against the risks of financial loss;

• by transferring the risks to a large group who agree to share the financial losses in exchange for premium payments.

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Insurance

• A written contract between two parties;• providing a promise of reimbursement;• in the case of loss; • for goods or services or contingency covered

by contract of insurance;• for which premium is duly paid.

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Universe of Risk

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Risk Management

• Insurance works as a tool for Risk Management, it involves;– Identifying the source of risk.– Measurement of risk.– Treatment of risk.– Selection of suitable method.– Implementing the method.– Evaluation.

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Methods of Risk Mgmt.

• Avoiding the risk.

• Preventing the risk.

• Assumption of risk.

• Shifting of risk.

• Insurance of risk.

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Risk Mgmt. & Insurance

• Risk Management: • systematic way of ensuring protection of

business resources and income against losses

• so that the aim, goals and vision of the company can be reached.

• Thus Risk Management creates stability and contributes to growth and assures profitability of the Organization.

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Risk Mgmt. & Insurance• Insurance guarantees;

– Peace of mind– Asset protection– Balance sheet protection

• Requirement of:– Lender– Regulatory Body– Lease– Contracts

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Insurance

• All Risks are not Insurable• Essentials of Insurance

• Insurable Interest• Utmost good faith

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Procedure for Insurance• Identification of Risks• Quantify the Insurable value• Evaluate the choices• Proposal • Payment of premium• Policy Documentation• Claims• Administration System

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Insurable Risks

• Property Risk• Damage to

Physical Assets• Acts of God• Accidents• Break down

• Financial Risks• Monetary Loss

from• Theft and

Burglary• Business

interruption• Bad credit

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Insurable Risks

• People Risks• Loss to Employees

• Ill Health and accident

• Death • Overseas travel

• Liabilities risks • Loss from Operations

• Product liabilities• Public liability• Directors & Officers

liabilities• Errors & Omissions

liabilitiesDeepesh Mahajan

Focus Areas• Identification of Internal & External Pure Risks

– Existing Risk Control Measures Review– Risk inspection– Risk Audit

• Scrutiny of Existing Insurance Covers– Coverage– Rates & Deductibles (Compulsory self

insurance)• Defining Standard SOP for Claims Control

– Guidelines on documentation

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Key Areas of Consideration

• Choice of Insurer– Industry Rating, Claims Settlement ability– Sustainability of the company– Service levels & infrastructure

• Choice of Intermediary– Representation of the insurance market– Knowledge of insurance amongst all

industry segments– Service levels & infrastructure

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Emerging Challenges

• De regulation of Indian Insurance market.

• Global markets impact on Local market.

• Options for self insurance.

• Market driven pricing.

• Cyber Risk.

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Concept and Significance of Insurance

Lecture 03

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Functional Concept

• Insurance is a cooperative device to spread the risk.

• System to spread risk among the persons insured against risk.

• The principle to share the risk of loss of each member of the society on the basis of probability of loss to their risk.

• A method to provide security against loss.

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Contractual Concept

• A contractual agreement among the parties to contract of indemnity against payment of premium.

• To pay management expenses.• To pay agency commission.• To pay the claims.• To invest the surplus money in Government

Security.

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Functions of Insurance

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Characteristics

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Role of Insurance in Economy

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Principles of Insurance

• Principle of utmost good faith.• Principle of insurable interest.• Principle of causa proxima.• Principle of indemnity.• Principle of subrogation.• Principle of contribution.

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Elements of Insurance

• Insurance as a Transfer System - transferring of risks from Insured to IC which is financially sound and has capacity and willingness to take risks.

• A Loss exposure can give rise to three types of losses, namely:

• Property loss (including net income loss),• Liability loss, and• Human and personnel loss.

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Elements of Insurance

• Insurance as a Business - insurance primarily attempts to meet its costs and expenses from premium that it earns and also make a reasonable margin of profit for its own sustainability.

• Other benefits to society as a whole such as:• Payments for the costs of covered losses• Reduction of the insured’s financial

uncertain

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Elements of Insurance

• Efficient use of resources• Support for credit• Satisfaction of legal requirements• Satisfaction of business requirements• Source of investment funds for

infrastructure development• Reduction of social burden

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Elements of Insurance• Insurance as a Contract - an insurance policy is

a legally enforceable contract. The contract is between IC and the Insured.

• An insurance contract must meet these four requirements:

• Offer and acceptance.• Consideration.• Capacity.• Legal purpose.

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Advantages • Transfer of risk from one person (Insured) to

another (Insurer)• Sharing (Pooling) of losses on some equitable

basis such that • fortuitous (random) losses will be

indemnified (paid)• Reduction in tension and fear• Credit multiplication• Avenue for investment

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Classification of

Insurance

Lecture 04

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ClassificationINSURANCE INDUSTRY IN INDIA

Public Sector Private Sector

Life General Life( 16 Companies)

General(09 Companies)

GIC and its Four

subsidiaries

LIC of India Post Office Insurance

Life Insurance

• Contract of Insurance: A contract of insurance is a contract of utmost good faith technically known as uberrima fides.

• Protection: • Savings through life insurance guarantee full

protection against risk of death of the saver.• In case of demise, life insurance assures

payment of the entire amount assured (with bonuses applicable) or amount agreed is payable.

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Economics of Life Insurance

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Types of L.I. Policies

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Types of L.I. Policies

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According to Premium

1. Single premium policy- whole premium is paid at the beginning of the policy.

2. Level premium policy- regular and equal premiums are paid at a definite interval.ACCORDING TO PARTICIPATION IN PROFIT:

1. Without profit or non-participating policies.-2. With profit or participating policies-

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As per number of Persons

1. Single Life Policy- life of one individual is covered.

2. Multiple life policies- more than one life is insured.

3. Joint life policy- covers two or more lives.4. Last survivorship policy- policy amount is

payable at the last death.

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As per mode of Payment

1. Lump Sum policies- sum assured is paid in one installment.

2. Installment or annuity policies- policy amount paid in several installments.

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Non-Conventional Policies

• These policies generally gives more features of investment. They are also termed as structured products.

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Classification of

Insurance

Lecture 05

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Non Life Insurance

• Started in 13 th Century by a person LombardLombard.• Fire Insurance came in force in 16681668 in

LondonLondon.• In India in 1850 Triton Insurance Calcutta

started business in non life segment.• In 1972 Government of India Nationalized th

General Insurance Business.• All 106 Insurers were merged in to Big 4.

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Big 4 Companies

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Non Life Business

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Miscellaneous Insurance

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Insurance Business Growth

IRDA 2011-12

Advantages

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Weaknesses

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Vital Aspects of GI

• Who can Insure?• Documents:

– Proposal– Cover Note.– Certificate of Insurance.– Policy.

• Warranties.

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Vital Aspects of GI

• Construction of Policy.• Duration of contract.• Alterations.• Assignment.• Termination of contract.• Refund of premium.• Claim & its settlement.

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Life Insurance Plans

Lecture 06

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Agenda

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Basic Concepts

• Life Insurance can be termed as an agreement between the policy owner and the insurer,

• Where the insurer for a consideration agrees to pay a sum of money upon

• The occurrence of the insured individual's death or

• Any other event, such as terminal illness, critical illness or the maturity of the policy.

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Life Insurance – Reasons for

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Term Life Insurance

• Increasing/Decreasing term policies

• Convertible Term Assurance Policy

• Level Term Life Insurance

• Renewable term life Insurance

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Endowment Insurance

• Joint life endowment plan

• Money back endowment plan

• Marriage endowment plan

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Permanent Life Insurance

• Ordinary whole life plan

• Limited payment whole life plan

Unit Linked Plans

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Term Life Insurance• Sum assured is payable only in the event of death

during the term.• In case of survival, the contract comes to an end

at the end of term.• Term Life Insurance can be for period as long as

40 years and as short as 1 year.• No refund of premium• Non-participating policies• Low premium as only death risk is covered.

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Types of Term Insurance

Increasing Term Insurance• Life insurance cover under this plan goes on

increasing periodically over the term in a predetermined rate. (Riders)

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Types of Term Insurance

Decreasing Term Insurance• The sum assured decreases with the term of

the policy. • Normally decreasing term assurance plan is

taken out for mortgaged protection, under which outstanding loan amount decreases as time passes as also the sum assured.

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Types of Term Insurance

• Convertible term assurance policyUnder this plan a policyholder is entitled to exchange the term policy for an endowment insurance or a whole life policy.Conversion can be done at any time during the term except last 2 years.

• Level Term Life InsuranceThe sum assured throughout the term of the policy does not change.

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Types of Term Insurance

Renewable Term Life Insurance

• With renewable term insurance, the insurance company automatically allows you to renew your coverage after the term of the policy is over (generally 5 to 20 years)

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Endowment Insurance

• Endowment insurance plans is an investment oriented plan which not only pays in the event of death but also in the event of survival at the end of the term.

• Is a contract underwritten by a life insurance company to pay a Fixed term plus Accumulated profits that are declared annually.

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Endowment Insurance

• Premium includes 2 elements -mortality element & investment element• Minimum age at entry : 12years• Maximum age at entry: 65years• Maximum age at maturity : 75years

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Types of Endowment Ins.

Joint Life Endowment Plan:

• Under this plan, two lives can be insured under one contract.

• The sum assured is payable at the end of the endowment term or death of either of the two.

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Types of Endowment Ins.

Money Back Endowment Plan:

• In this plan, there is an additional advantage of receiving a certain amount of money at periodic intervals during the policy term.

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Types of Endowment Ins.

Marriage Endowment Plan:• This plan has the specific condition that the

sum assured is payable only after the expiry of the term even if death of the life assured takes place earlier.

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Types of Endowment Ins.

Educational Endowment Plan:• These plans are specially designed to meet

educational expense of children at a future date.

• If the insured parent dies before the date of maturity the installment is paid in lump sum with immediate effect which helps to meet the educational expenses.

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(Whole) Life Insurance

• Whole life plans are another type of endowment plan, which cover death for an indefinite period.

• When the policy holder dies, the face value of the policy, known as a death benefit, is paid to the person or persons named in the life insurance policy (the beneficiary or beneficiaries).

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(Whole) Life Insurance

• It can be with or without profits.• If you cancel the policy after a certain amount

of time has passed, the insurance company will surrender the cash value to you.

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Types of Whole Life Insurance

• Ordinary Whole Life Plan:This is a continuous premium payment plan. The insured pays premium throughout his life. It provides dual facility of protection plus savings.

• Limited Payment Whole Life Plan:It provides the same benefit as above but premiums are paid for a limited period. Premiums are sufficiently higher to cover the risk.

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Children’s Life Insurance

• Since last few years insurance companies have started offering risk cover plans like limited payment whole life, and endowment assurance plan from the age of 12years and money back plan from age of 13 years(completed).

• New plans have been specifically designed for children where the risk of the child starts much earlier say 7 years.

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Children’s Life Insurance

• Policies on the lives of children are taken out by other elders.

• After some time when the child becomes major and is competent to contract, the child may assume the ownership of the policy. The policy is then said to ‘vest’ in child.

• The date on which this happens is called the ‘testing date’.

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Children’s Life Insurance

• The risk begins when the child attains 18 years of age.

• This is called the ‘deferred date’ and the period between the deferred date and the date of commencement of policy is called the ‘deferred period’.

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Unit Linked Plans

• It has emerged as one of the fastest growing insurance products.

• It is a combination of an investment fund(such as mutual fund) and an insurance policy.

• The premium amount is invested in the stock market and returns better income on the maturity period.

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Unit Linked Plans

• Better for long-term investment option.• ULIPs generally provide higher returns as large

portion of the funds are invested in equities.• There is also flexibility and the assured can

choose levels and extent of cover needed.• There is also option of switching over from

one fund to another if it does not seem to be profitable.

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Unit Linked Plans

• ULIPs can be classified as – Unit linked – equities, bonds, real estate &

money market instruments– Equity linked – only in equities– Index linked – equity, bonds or money

market instruments.

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Pensions, Group Insurance,

Lecture 07

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Pension….. Why…?

Pension

Retire …….Rich….

• Tax benefit Tax benefit on such plans is limited to Rs. 10,000.

• Pension plans (also referred to as retirement plans) are offered by insurance companies to help individuals build a retirement corpusretirement corpus.

• On maturity this corpus is invested for generating a regular income streamregular income stream, which is referred to as pension or annuitypension or annuity.

Pension

• Pension plans are distinct from life insurance plans, which are taken to cover risk in case of an unfortunate event.

• Conventional pension plans invest a major portion of the premium monies in bonds and government securities (G-Secs). That is why the returns are on the lower side.

Pension

• And if one were to factor into the equation an annual inflation figure of approximately 5%-6% per annum, then the real return figures look even more unimpressive.

• This is where ULIPs ULIPs can play an important role in the retirement planning exercise.

• ULIPs have a mandate to also invest a portion of the premium in the stock market apart from bonds and G-Secs.

Pension

• Studies have shown that from a long-term perspective, equities are equipped to give a higher return vis-à-vis other fixed income instruments like Bonds and G-SecsBonds and G-Secs.

• And since retirement planning is a long-term exercise, individuals would do well to consider investing a portion of their retirement money in pension ULIPs.

Pension

• The 'with cover' pension plans offer an assured life cover (i.e. sum assuredi.e. sum assured) in case of an eventuality.

• Under the 'without cover' pension plan, the corpus built till date (net of deductions like expenses and premiums unpaid) is given out to the nominees in case of an eventuality. There is no sum assured in this case.There is no sum assured in this case.

‘With and Without Cover’ Plans

• In case of immediate annuity plans, the annuity/pension commences within one year of having paid the premium (which is usually a one-time premium).

• The premium paid for the immediate annuity policy is also known as the purchase price. Currently in India, very few life insurance companies offer immediate annuity plans. LIC's Jeevan Akshay IILIC's Jeevan Akshay II

'Immediate Annuity’ Plans

• In case of deferred annuity, the annuity/ pension does not commence immediately; it is 'deferred' up to a time, which is decided upon by the policyholder

‘Deferred Annuity' Plans

• Lifetime annuity without return of purchase price.

• Annuity for life with a return of the purchase price.

• Lifetime annuity guaranteed for a certain number of years.

• Joint life/ Last survivor annuity.

Options Available in PP

• “An arrangement to provide insurance coverage

• for a group of persons under a single contract,

• without individual risk selection, and

• under terms and conditions more favorable

than those otherwise obtainable by these

persons as individuals.”

Group Insurance

• Nobody expects to be injured, or become ill tomorrow or expects a fire loss tomorrow.

• However, if this does occur it can cause However, if this does occur it can cause a a catastrophic financial losscatastrophic financial loss..

• A comprehensive employee benefits program is a low cost solution

• that can provide protection for the Employee and Employer from catastrophic financial losses due to illness or injury

Concept of Group Insurance

Typical Group Benefits• Employee and

dependant term life insurance

• Accidental death & dismemberment

• Critical Illness• Short term

disability• Long term disability

• Medical reimbursement plan (tax loop hole)

• Employee Assistance Program (Contact)

• Healthcare• Dental care• Vision care

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Advantages

Advantages for EmployerAdvantages for Employer• Attract & Retain key

People• Establish a company

policy in the event of the death or disability of an employee

• Tax effective compensation

Advantages for EmployeeAdvantages for Employee• Basic protection for the

EE & family• Less expensive than

individual insurance• Higher standard of

healthcare than otherwise possible

• Cover for “uninsurable”Deepesh Mahajan

• Effective management of benefit costs• Tailored plan design• Streamlined administration• Clear communication material• Accessible and responsive customer service• 1-800 Claims Service• Administrative Support

Meeting Employer Needs

InsuranceRegulatory Development

Authority

Lecture 08

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IRDA

• IRDA was setup in 2000 as an autonomous autonomous bodybody.

• The object was to regulate and develop the business of insurance and reinsurance in the country as per the Insurance Regulatory and Insurance Regulatory and Development Authority Act,1999Development Authority Act,1999.

• The main objective of setting up IRDA was to promote market efficiency market efficiency and ensure consumer protectionconsumer protection.

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IRDA

• IRDA is the controlling and regulatory apex body in the country for Insurance sector.

• Its ChairmanChairman and MembersMembers are appointed by Government of India.

• IRDA’s HQ is located at HyderabadHyderabad.

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IRDA

The Authority is a ten member team of I. A Chairman and every other whole-time

member – 5YRS (Maximum age is 60yrs)II.Five whole-time members (Maximum age is

62yrs)III.Four part-time members (not more than 5yrs)(all appointed by the Government of India)(all appointed by the Government of India)

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Regulatory Framework

Duties & Responsibilities

• According to the Section 14 of IRDA Act ,1999 Section 14 of IRDA Act ,1999 there are certain duties:

• To regulate, promote and ensure orderly growth of the insurance business and re-insurance business.

• To issue a certificate of registration and powers to renew, modify, withdraw, suspend or cancel the registration.

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Duties & Responsibilities

• Protection of the interests of the policy holders.

• To specify qualifications, code of conduct and practical training for intermediaries.

• To specify the code of conduct for surveyors and loss assessors.

• Exercising such other powers as may be prescribed.

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Duties & Responsibilities

• To promote the efficiency in the conduct of insurance business.

• To promote and regulate the organizations connected with the insurance and re-insurance business.

• Levying fees and other charges for carrying out the purposes of this Act.

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Duties & Responsibilities

• To conduct enquiries and investigations for insurers, intermediaries, insurance intermediaries and other organizations connected with the insurance business

• To control and regulate the rates, advantages, terms and conditions that may be offered by insurers.

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Duties & Responsibilities

• To specify the form and manner in which books of account shall be maintained.

• To regulate the investment of funds by insurance companies.

• To regulate the maintenance of margin of solvency.

• Adjudication of disputes between insurers and intermediaries.

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Duties & Responsibilities

• Supervising the functioning of the Tariff Advisory Committee.

• To specify the percentage of premium income of the insurer to finance schemes.

• To specify the percentage of life insurance business and general insurance business to be undertaken by the insurer in the rural or social sector.

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Removal from Office

1. The Central Government may remove from office any member who-– is act as an insolvent.– has become physically or mentally

incapable of acting as a member. – has been convicted of any offence which, in

the opinion of the Central Government, involves moral turpitude.

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Removal from Office2. Has acquired such financial or other interest as

is likely to affect prejudicially his functions as a member.

3. Has so abused his position as to render his continuation in office detrimental to the public interest.

4. No such member shall be removed under clause (d) or clause (e) of sub-section (1) unless he has been given a reasonable opportunity of being heard in the matter.

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Functions of IRDA:

1. Ensure orderly growth of Insurance industry.2. Protection of interest of policy holders.3. Issue consumer protection guidelines to

insurance companies.4. Grant, modify, and suspend license for

insurance companies.5. Lay down procedure for accounting policies

to be adopted by the Insurance companies.

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Functions of IRDA:

6. Inspect and audit of Insurance companies and other related agencies.

7. Regulation of capital adequacy, solvency, and prudential requirements of Insurance business.

8. Regulation of product development and their pricing including free pricing of products.

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Functions of IRDA:

9. Promote and regular self regulating organizations in the insurance industry.

10.Re-insurance limit monitoring.11.Monitor investments.12.Vetting of accounting standards,

transparency requirements, in reporting.13.Ensure the health of the industry by

preventing sickness through appropriate action.

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Functions of IRDA:

16.Publish information about the industry.17.Prescribe qualification and training needs of

agent.18.Monitor the charges for various services by

Insurance companies.19.Regulating intermediaries like;

– Agents, Brokers ,Surveyors , TPA Health Agents, Brokers ,Surveyors , TPA Health services, Web aggregatorsservices, Web aggregators

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Objective

• The objective of this course is to develop an understanding of the Insurance and Banking sector in India.

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• Defining risk, • Nature and types of risk, • Risk management process, • Risk and its relation with insurance. • Concept and significance of insurance. • Classification of insurance - life and non-life.• General insurance principles.

UNIT I

• A probability or threat of • damage, • injury, • liability, • loss, or other negative occurrence that is

caused by external or internal vulnerabilities, and that may be neutralized through preemptive action.

Definition of Risk

• Speculative (dynamic) risk is a situation in which either profit OR loss is possible.

• Pure (static) risk is a situation in which there are only the possibilities of loss or no loss, as oppose to loss or profit with speculative risk.

Definition

• Insurable interest.• Calculable risk.• Pure risk.• Accidental in nature.• Legal object.• Not against Public Policy.• Not great calamity in nature.• Wide spread risk.

Features of Insurance Risk

• Speculative or Dynamic risk.• Pure or static risk.

– Or• Systematic Risk.• Unsystematic Risk.

Types of Risk

• Another classification:Another classification:

• Individual & Group risk.

• Financial & Non Financial risk.

• Pure & Speculative risk.

• Static & Dynamic risk.

• Quantifiable & Non quantifiable risk.

Types of Risk

• Personal risk.• Property risk.• Liability risk.• Business risk.

Types of Pure (Static) Risk

• Premature death.• Sickness or disability.• Old age.• Poor health.• Unemployment.

Personal risk

• Property risk is the risk of having property damaged or loss from numerous perils.

• Property includes movable and immovable property.

• The loss may be direct or indirect.• Direct loss includes physical damage.• Indirect loss includes loss in value.

Property risk

• Internal Risk:– Loss by fire.– Business environment.– Liability of business.– Mismanagement of business.

Business Risk

• External Risk:– Natural Calamities.– Competition.– Price Fluctuation.– Change in Demand.– Government Policy.

Business Risk

• Liability risks are another important type of pure risk that many people face.

• The risk which create financial liability.• The risk arise out of intentional or un

intentional injury to the person or damage to the property.

Liability Risks

Overview of Banking Industry,

Banking structure in India

Lecture 09

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Bank

• A bank is a financial institution whose primary activity is to act as a payment agent for customers and to borrow and lend money.

• An institution where one can place and borrow money and take care of financial affairs.

• The first modern bank was founded in Italy in Genoa in 1406, its name was Bank of St. George.

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Classification of Banking

Functions of Banks• Accepting Deposits from public/others

(Deposits).• Lending money to public (Loans).• Transferring money from one place to

another (Remittances).• Acting as trustees.• Keeping valuables in safe custody.• Government business.

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Acting as Trustees

• Banks also act as trustees for various purposes. • They have expertise in financial matters and

generate confidence in the minds of potential subscribers.

Bank must possess : • A track record of sufficient length. • Facilities for safe keeping. • Legal skills to take necessary steps for the

trusteeship.

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Types of Banks

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Public Sector Banks

• SBI• Central Bank of India • Corporation Bank • Dena Bank • Bank of India• Indian Overseas Bank • Oriental Bank of Commerce • Punjab & Sind Bank

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Private Sector Banks

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Co-operative Banks

• The Co-operative banks in India started functioning almost 100 years ago.( COSMOS)

• They are very important constituent of the Indian Financial System.

• They are setup to provide easy loans to farmers or other persons to set up his business.

• They are not-for-profit banks.

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Functions of Coop. Banks

Cooperative banks in India finance rural areas Cooperative banks in India finance rural areas under: under:

– Farming – Cattle – Milk – Hatchery – Personal finance

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Dev. Banks / Fin. Institutions

These banks are mainly used for developing These banks are mainly used for developing industries and countriesindustries and countries

Some Examples-•HDFC•IFCI•LIC HFC•LIC•GIC HFC

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Reserve Bank of India

• History:-• Became operational on April 1,1935• Nationalized in the Year 1949.• Major objectives:-• Regulate the issue of banknote.• Maintain reserves with a view to securing

monetary stability.• To operate the credit and currency system of

the country to its advantage.

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Functions of RBI

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Traditional Functions

• Monopoly of currency notes issue.• Banker to the Government (both the central

and state). • Fight against economic crisis and ensures

stability of Indian economy.• Controller of FOREX and credit. • Maintaining the external value of domestic

currency.

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Promotional Functions

• Extension of the facilities for the small scale industries

• Innovating the new banking business transactions.

• Extension of the facilities for the provision of the agricultural credit through NABARD.

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Supervisory Functions

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Controlling Economy

TOOLS:-• CRR( CASH RESERVE RATIO): 4%• REPO RATES(RR):7.25%• REVERSE REPO RATE(RRR): 6.25%• STATUTORY LIQUIDTY RATIO (SLR):23%• BANK RATE: 10.25.0%

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Glimpse of Banking Sector

• 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 • Phase-3• New phase of Indian Banking System with the

advent of Indian Financial & Banking Sector Reforms after 1991

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Phase-1

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Phase-2

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Phase-3

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Challenges

• Lack of product expertise– Traditionally focused on limited range of

products• Primarily for corporate clients

– Need for acquiring skills in • Retail, structured finance

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Challenges

• Lack of distribution expertise– Reliance on branch channel and human

intervention– Relatively high unit cost of delivery given

small transaction sizes• Limited use of technology

– Across both customer-facing and internal functions

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Challenges

• Inefficient capital allocation• Competition in market

– Post office– Insurance– Financial Institution– Foreign Banks

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Opportunities

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Highlights

• Indian banking sector has 6th rank in all over the world.

• SBI is the largest PSU Bank.• The growth rate of ATM`s is 28%• India has 23+ ATMs per million people, China

has 55+ ATMs and South Korea has 1600+ ATMs per million people.

• ICICI bank has largest no. foreign branches.

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RBI, Its Role , Significance &

Functions

Lecture 10

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Reserve Bank of India (RBI)

• It is the central bank of India. • Established in the year 1935, RBI was

nationalized in the year 1949• Its headquarters is located in Mumbai. • It monitors, formulates and implements

India’s monetary policy.• Owned fully by the Government of India.• 22 regional offices in the various state capitals

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History of RBI• It was set up on the recommendations of

Hilton Young Commission.• It was started as share-holders bank with a

paid up capital of 5 crores.• Initially it was located in Kolkata.• It moved to Mumbai in 1937.• Initially it was privately owned.• Since 1949, the RBI is fully owned by the

Government of India.

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Main Functions

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Functions

• Monetary Authority• Main monetary authority of the country.• It formulates, implements and monitors the

monetary policy as well as it has to ensure an adequate flow of credit to productive sectors.

• Objectives are maintaining price stability and ensuring adequate flow of credit to productive sectors.

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Functions

• The RBI controls the;– monetary supply, – monitors economic indicators like the gross

domestic product;– and has to decide the design of the rupee

banknotes as well as coins.

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Functions

• Manager of exchange control• The central bank manages to reach the goals

of the Foreign Exchange Management Act, 1999.

• Objective: to facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India.

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Functions• Issuer of currency• The bank issues and exchanges or destroys

currency and coins not fit for circulation. • The objectives are giving the public adequate

supply of currency of good quality and to provide loans to commercial banks to maintain or improve the GDP.

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Functions

• The basic objectives of RBI are to issue bank notes, to maintain the currency and credit system of the country to utilize it in its best advantage, and to maintain the reserves.

• Minimum Reserve System - Principle of Currency Note Issue.

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Functions

• RBI can issue currency notes as much as the country requires, provided it has to make a security deposit of Rs. 200 crores, out of which Rs. 115 crores must be in gold and Rs. 85 crores must be FOREX Reserves.

• This principle of currency notes issue is known as the 'Minimum Reserve System'.

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Functions

• Development• The central bank has to perform a wide range

of promotional functions to support national objectives and industries.

• The RBI faces a lot of inter-sectoral and local inflation-related problems. Some of this problems are results of the dominant part of the public sector.

Deepesh Mahajan

Related Functions• The RBI is also a banker to the government and

performs merchant banking function for the central and the state governments, acts as their banker.

• There is now an international consensus about the need to focus the tasks of a central bank upon central banking.

• RBI is far out of touch with such a principle, owing to the sprawling mandate described above.

Deepesh Mahajan

Roles of RBI

Deepesh Mahajan

Credit Creation• The most important function of the central

bank is to control credit by commercial banks as they have become the important source of money .

• Money and credit represent a powerful force for good evil in the economy.

• It is the duty of the central bank to ensure that money and credit is properly managed so that inflation and deflationary pressures can be controlled in the economy.

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Quantitative Credit Control

• The quantitative methods aim to control the total quantity and cost of re created by banks.

• The quantitative methods are traditional and indirect.

• This include bank rate policy, open market operations and variable reserve ratio.

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Qualitative Credit Control

• The qualitative controls are direct which constitute;– regulation of consumer credit, – margin requirements, – rationing of credit, – direct action, – moral suasion and publicity.

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Rural and Co-operative Banks,

Lecture 11

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Rural Banks

• The RRBs came to be set up under the act of 1976.

• A RRB is sponsored by a public sector bank which also subscribes to its share capital.

• The RRBs meet the credit requirements of weaker sections, small and marginal farmers, landless laborers, and small entrepreneurs.

• RRBs have been excellent in meeting the credit needs of rural poor.

Deepesh Mahajan

Service Requirements

LoansSavings

Risk Mitigation Products

Risk Mitigation Products

RemittancesRemittances

pensionspensions

Financial Counseling Credit

Cards

Insurance

Features and Significance

• Wide network among rural areas.• Spreading local and rural credit.• Crop finance and insurance.• Kissan credit and card system.• Easy loans and aid to farmers.• Farming and equipment loans.• Subsidy and seed loans.• Agriculture credit and loans.

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Cooperative Banks

• Cooperative Banks in India are registered under the Co-operative Societies Act.

• The cooperative bank is also regulated by the RBI.

• These banks are governed by the Banking Regulations Act 1949 and Banking Laws (Co-operative Societies) Act, 1965.

Deepesh Mahajan

Principles of Co-Op. Banking

• Voluntary and open membership.• Democratic member control.• Member economic participation.• Autonomy and independence.• Education, training and information.• Co-operation among Co-operatives.• Concern for Community.

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Features of Co-Op. Banking

• Customer's owned entities. • Democratic member control.• Profit sharing by members.• Concept of mutual benefit.• Local governance.• Serves at micro finance level.• Promotes the banking culture.

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Critical Factors

• Supply Side factors:• Pressure of un bankable according to bankers.• Small loan amount.• Long distance for services/ branches.• High transaction cost.• Lack of collateral.• Information asymmetry.• Human resource constraints.

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Critical Factors

• Demand Side factors:• High transaction cost for clients.• Documentation.• Lack of awareness.• Lack of social capital.• Non availability of specialty products.• Convenience of informal lending.• Prior rejection by formal banking system.

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Cooperative Banks

• Cooperative banks in India finance rural areas under: – Farming– Cattle– Milk– Hatchery– Personal finance

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Cooperative Banks

• Cooperative banks in India finance urban areas under: – Self-employment– Industries– Small scale units– Home finance– Consumer finance– Personal finance

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Challenges….

• There are many challenges like;– Literacy.– Technological infrastructure.– Basic infrastructure.– Belief in the system.– Dependence of agro industry on monsoon.– Lack of innovative farming.

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Challenges….

– Poor communication.– Increasing NPA.– Structured and region specific reforms.– Macro irrigation system.– Resource conservation system.

Deepesh Mahajan

SLR, CRR, Banking Ratios

Lecture 12

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SLR

• OBJECTIVE 1) To restrict expansion of bank credit. 2) To augment investment of the banks in

Government securities.3) To ensure solvency of banks.

• Commonly used to contain inflation and fuel growth, by increasing or decreasing it respectively

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SLR

• MAINTAINED IN THE FORM OF :a) Cashb) Gold – marked to market (M2M)c) Unencumbered approved securities or Gilts -

valued at a price as specified by RBI• CURRENT SLR – 23%• SLR RATE = Total Demand/Time Liabilities x

100%

Deepesh Mahajan

CRR• Banks required to hold a certain proportion of their

deposits in the form of cash, deposited with RBI/currency chests

• Considered as equivalent to holding cash with themselves.

• This minimum ratio (that is the part of the total deposits to be held as cash) is stipulated by RBI and is called Cash Reserve Ratio.

• Also known as - Cash Asset Ratio or Liquidity Ratio.

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CRR

• PURPOSE – • Higher the ratio (i.e. CRR), lower is amount

that banks will be able to use for lending and investment.

• EXISTING CRR is 4% (2013)

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REPO Rates• Repo (Repurchase) rate is the rate at which the

RBI lends shot-term money to the banks against securities.

• When the repo rate increases borrowing from RBI becomes more expensive.

• When the repo rate decreases borrowing from RBI becomes cheaper.

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Reverse REPO Rates• This is the rate at which banks park their short-

term excess liquidity with the RBI. • Banks use this tool when they feel that they are

stuck with excess funds and are not able to invest anywhere for reasonable returns.

• An increase in the reverse repo rate means that the RBI is ready to borrow money from the banks at a higher rate of interest. As a result, banks would prefer to keep more and more surplus funds with RBI.

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Vital Banking Ratios

• Loan Growth.• Deposit Growth.• Loan Deposit Ratio.• Efficiency Ratio.• Capital Adequacy Ratio.• Return on Assets.

– Return on Average Assets = ( Net Operating Income/ Total Assets )

Deepesh Mahajan

Banking Ratios

• Return on Equity = ( Net Income/Stockholder Equity )

• Credit Quality (NPA)• Interest Cover Ratio.• Rate Paid on Funds = Total Interest Expense /

Total Earning Assets• Net Interest Margin = Net Interest income/

Average Earning Assets

Deepesh Mahajan

Banking Ratios

• Long Term Debt to Total Liabilities and Equity = ( Long Term Debt / Total Liabilities plus Equity )

• Loans to Assets = ( Loans / Total Assets).• Leverage Ratio = ( Stockholders Equity /

Average Total Assets )• Tier 1 Capital = ( Stockholder Equity/ Risk-

Adjusted Assets )

Deepesh Mahajan

Banking Ratios• Capital adequacy ratio: A bank's capital ratio is the

ratio of qualifying capital to risk adjusted (or weighted) assets.

• The RBI has set the minimum capital adequacy ratio at 9% for all banks.

• A ratio below the minimum indicates that the bank is not adequately capitalized to expand its operations.

• The ratio ensures that the bank do not leverage without having adequate capital.

Deepesh Mahajan

SLR, CRR, Banking Ratios

Lecture 12

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SLR

• OBJECTIVE 1) To restrict expansion of bank credit. 2) To augment investment of the banks in

Government securities.3) To ensure solvency of banks.

• Commonly used to contain inflation and fuel growth, by increasing or decreasing it respectively

Deepesh Mahajan

SLR

• MAINTAINED IN THE FORM OF :a) Cashb) Gold – marked to market (M2M)c) Unencumbered approved securities or Gilts -

valued at a price as specified by RBI• CURRENT SLR – 23%• SLR RATE = Total Demand/Time Liabilities x

100%

Deepesh Mahajan

CRR• Banks required to hold a certain proportion of their

deposits in the form of cash, deposited with RBI/currency chests

• Considered as equivalent to holding cash with themselves.

• This minimum ratio (that is the part of the total deposits to be held as cash) is stipulated by RBI and is called Cash Reserve Ratio.

• Also known as - Cash Asset Ratio or Liquidity Ratio.

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CRR

• PURPOSE – • Higher the ratio (i.e. CRR), lower is amount

that banks will be able to use for lending and investment.

• EXISTING CRR is 4% (2013)

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REPO Rates• Repo (Repurchase) rate is the rate at which the

RBI lends shot-term money to the banks against securities.

• When the repo rate increases borrowing from RBI becomes more expensive.

• When the repo rate decreases borrowing from RBI becomes cheaper.

Deepesh Mahajan

Reverse REPO Rates• This is the rate at which banks park their short-

term excess liquidity with the RBI. • Banks use this tool when they feel that they are

stuck with excess funds and are not able to invest anywhere for reasonable returns.

• An increase in the reverse repo rate means that the RBI is ready to borrow money from the banks at a higher rate of interest. As a result, banks would prefer to keep more and more surplus funds with RBI.

Deepesh Mahajan

Vital Banking Ratios

• Loan Growth.• Deposit Growth.• Loan Deposit Ratio.• Efficiency Ratio.• Capital Adequacy Ratio.• Return on Assets.

– Return on Average Assets = ( Net Operating Income/ Total Assets )

Deepesh Mahajan

Banking Ratios

• Return on Equity = ( Net Income/Stockholder Equity )

• Credit Quality (NPA)• Interest Cover Ratio.• Rate Paid on Funds = Total Interest Expense /

Total Earning Assets• Net Interest Margin = Net Interest income/

Average Earning Assets

Deepesh Mahajan

Banking Ratios

• Long Term Debt to Total Liabilities and Equity = ( Long Term Debt / Total Liabilities plus Equity )

• Loans to Assets = ( Loans / Total Assets).• Leverage Ratio = ( Stockholders Equity /

Average Total Assets )• Tier 1 Capital = ( Stockholder Equity/ Risk-

Adjusted Assets )

Deepesh Mahajan

Banking Ratios• Capital adequacy ratio: A bank's capital ratio is the

ratio of qualifying capital to risk adjusted (or weighted) assets.

• The RBI has set the minimum capital adequacy ratio at 9% for all banks.

• A ratio below the minimum indicates that the bank is not adequately capitalized to expand its operations.

• The ratio ensures that the bank do not leverage without having adequate capital.

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General Insurance

Lecture 13

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General Insurance

• Definition: Insurance contracts that do not come under the ambit of life insurance are called general insurance.

• The different forms of general insurance are fire, marine, motor, accident and other miscellaneous non-life insurance.

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G. I. explained……

• Usually tangible assets are susceptible to damages and a need to protect the economic value of the assets is needed.

• General insurance products are bought as they provide protection against unforeseeable contingencies like damage and loss of the asset.

• General insurance products come at a price in the form of premium.

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Features & Challenges

• Simple products catering to basic needs.• Low market penetration.• More direct business and lesser dependence on

intermediaries.• Ever growing middle class component in

population.• Growth of consumer movement with an

increasing demand for better insurance products.

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….Continued

• Inadequate application of Information Technology for business.

• Government support in the form of tax incentives to the insured.

• Majority of the current demand for general insurance comes from the corporate segment.

• Some products are made mandatory like vehicle insurance.

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….Continued

• Enhanced awareness through education and publicity.

• Greater use of information technology• Better products.• Better service to customers.• Benchmarking with global standards.

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Principles of Gen. Insurance

1. Principle of Uberrimae fidei (Utmost Good Faith).

2. Principle of Insurable Interest.3. Principle of Indemnity.4. Principle of Contribution.5. Principle of Subrogation.6. Principle of Loss Minimization.7. Principle of Causa Proxima (Nearest Cause).

Deepesh Mahajan

Types of General Insurance

Lecture 14

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Auto Insurance

• Auto Insurance is the most popular and demanded insurance all over the world.

• Insurance company covers all vehicle or motor with insurance against theft, loss or accident.

• In cases of claim, insurance company will pay back the insured amount to the owner of the vehicle or motor.

Deepesh Mahajan

Health Insurance

• Health is the main concern these days as people have to spend big part of their income on the medical and hospital expenses.

• Insurance companies cover an individual or a group of individuals (such as a family or employees) against health concern.

• This cover guarantees to bear total hospital and medical expenses incurred by the insured individual or the group.

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Liability Insurance

• This insurance is specially designed for corporate organizations.

• Under this insurance plan, insurer covers the liability of the insured corporate.

• In case of bankruptcy, insurer is liable to clear all the debts and liabilities of the company or individual.

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Home Insurance

• Under this insurance plan, insurer provide cover or protection to the insured person’s house against disaster and hazards such as fire and natural hazards.

• In case of destruction of house under proclaimed norms, the insurer is liable to pay the cost of house reestablishment.

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Marine Insurance

• Marine Insurance is generally taken by such corporate organizations who operate on seas such as cargo, logistics and many other.

• This insurance cover, insurer guarantees to pay the amount of loss due to voyage or water while shipment to the insured company or individual.

Deepesh Mahajan

Fire Insurance

• Fire Insurance is one such insurance plan which one can commonly find in any organization or home.

• This insurance plan, insurer is liable to pay the compensation for losses due to fire to the insured house or organization.

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Property Insurance

• This is a new insurance plan which defines to offer protection to the insured person’s property against natural hazard, theft, mishap or accidents.

• This plan is for both movable and immovable properties.

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Pecuniary Insurance

• In this plan, an individual or group get insured for his wealth or money against any such loss, theft, mishap.

• Insurer guarantees to pay for the value of his insured wealth in such mishaps in future.

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Aviation Insurance

• Aviation Insurance could be for• an individual or for an organization. • Under this plan for an individual, one gets

insured for his or her air travel and insurer pays the insured amount against the loss in case of any mishaps during the air travel.

• As an organization, aviation companies gets the insurance for their flights against any accident in air or land.

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Cattle Insurance

• Cattle insurance is for the agricultural or rural individuals who get this insurance for the cattle such as cow, bull, sheep and many other against their losses in future.

• It helps them to minimize their loss due to the loss of their productive cattle.

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Accidental Insurance

• Accident insurance is another most popular and demanding insurance in market.

• Under this insurance plan, insurer guarantees to bear all the expenses occurred on medical and pathological of the insured person due to accident.

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Group & Burglary insurance

Lecture 15

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Group Insurance

• A group insurance is a product designed to provide life insurance to a group of people under a single master policy.

• It can be taken by any group of people, big or small, that comes together for any reason, apart from that of specifically benefitting from an insurance scheme.

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Group Insurance

• It extends to anyone irrespective of their age, gender, profession, social background and such factors.

• Group insurance is not limited to only employer-employee groups, but is extended to other homogenous groups too.

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Functions

• Gratuity.• Superannuation.• Term.• Savings.• Credit Protection.• Low cost impact.

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Benefits

• Default insurance cover.• Employer benefit.• Ease of premium payment.• Employee welfare.• Experienced fund management.• Tool of social welfare.• Tax benefit to employer.

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Burglary Insurance

• Burglary Insurance policy covers property contained in business premises, stocks owned, or for which insured is responsible or held in trust and/or commission.

• It also covers cash, valuables, securities kept in a locked safe or cash box in locked steel cupboard on specific request.

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Benefits

• Policy provides protection against:• Loss of or damage to insured property due to

burglary and housebreaking.• Loss or damage due to theft following upon an

actual, forcible and violent entry to or exit from the insured premises.

• Damage to the premises themselves by burglars and such incidents.

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Coverage of Policy

• In Burglary Policy, the Sum Insured should be fixed on current market prices for stocks.

• For other items such as furniture, fixture, equipments etc., it can be fixed either on Market Value or on Reinstatement Value basis.

• Floater options are also available for variation in the value of assets due to the business or economic cycles.

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Features

• Useful for individuals as movable items are included.

• For goods held in trust unless specifically insured are not covered.

• Due to shop lifting, acts involving individual or his family members / employees not included.

• Loss caused by using a key or duplicate key, and on additional premium unless it is obtained by violence or threat not covered.

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Banking Risk and

Recent Development

Lecture 20

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The Technology Revolution

• The impact of technology on the real & financial world around the central banks E-governance . Choice of Channels , Confidence and

Convenience to the end-user. Efficiency . Facilitating growth of products and

services.

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Impact of Technology

Wide BranchNetwork

Global Operations

Complex Credit Calculations

Innovative RiskManagement

Banking and Technology

Mass Transaction& Items Processing

Technology & Central Banks

Technology Has Affected every CoreCentral Banking Function

The potentialTechnology Offers to improveInternal processes

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Core Central Banking FunctionsBan

king

Super

visio

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Financial &Monetary

Stability

CurrencyManagement

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Technology & Central Banks

• The widespread adoption of technology by the banking industry.

• The impact of technology on every single core central banking function.

• Supervision and Regulation.• Currency Management.• Monetary & Financial Stability. • The potential technology offers to central

banks for rendering more effective its internal processes and functions.

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Technology and Banking

• Harmonization of mass transaction & items processing – Pervasive branch network.– Global Operations.– Complex credit calculations.– Innovative Risk Management.

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RBI Initiatives

•Offsite Supervision & Monitoring (OSMOS)

•COSMOS (Non banking Financial Companies / Development Financial Institutions)

• UBD Soft ( Urban Bank Dept.)

•Credit Information Bureau (CIBIL)

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• Currency Management is a formidable task in India given.

• The Clean Note Policy (1999).• ECS System.• RTGS.• NEFT.• Central Depositary System.

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Challenges of Regulation

• Technology has;– opened up new markets, products, services,

delivery channels.– opened up a market for “risks” derivatives.– thrown up the challenge of financing tech

firms & IT innovation and not without implications for the stability of banks and of the economy.

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Contd….

• Technology has also;– provided regulators with the wherewithal

to meet the challenge.– been the cornerstone of all recent financial

sector reforms.– enabled the emergence of non-intrusive,

focused supervision with a view to prevent frauds and disturbances to financial stability.

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Monetary Policy Challenge

• The spread of IT has…– redefined the toolkit of economic indicators

used in implementing monetary policy.– Rendered more complex, the task of

compiling statistical information.– rendered difficult the task of capturing the

impact of IT on price levels.– raised issues in respect of the possible

proliferation of digital money.

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Monetary Policy Challenge

– Faster payment and settlement mechanism.– Development of Government Security

market.– Elimination of risk in financial system.

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Monetary Policy Opportunity

• The proliferation of IT has also set the stage for improving and managing risks in payment systems– Electronic Trading Systems.– RTGS.– Secured Netting Systems.– Continuous Linked Settlement.

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IT and Payment and Settlement D

emat

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l iza

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Of

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Del

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Pay

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Con

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Lin

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Dea

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RBI Initiatives

• The IDRBT– Network Externalities

• The Indian Financial Network (INFINET)– Messaging Solutions

• The Structured Financial Messaging System (SFMS)

– Security• Public Key Infrastructure

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Technology Vision of the RBI

Centralised DatabaseManagement System

EnterpriseEnterprise KnowledgeManagement System

Integrated Accounting System

Integrated GovernmentAccounting System

Currency OperationsSystem

Desk Top Decision Making Capability

Desk Top Analytical Capability

Desk Top Transactional Capability

Securities SettlementSystem

Integrated EstablishmentSystem

Offsite Supervisory Systems

Integrated Forex Management System

Human ResourceInformation System

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Credit, Liquidity, Market Operations, Interest Rate,

Solvency

Lecture 21

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Credit

• Credit has to do with the amount of funds that an individual or a business may be able to borrow from one or more lending institutions.

• In effect, it is a measure of how much in the way of cash loans may be issued, based on the credit history and the assets of the company or person.

• It is useful in making financial decisions.

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Liquidity

• Liquidity is an organization’s ability to meet its short-term obligations.

• In business, economics or investment, market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value.

• Money or cash are the best form of liquidity.

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Open Market Operations

• OMOs are the market operations conducted by the Reserve Bank of India for;

• Sale and purchase of securities.• Controlling liquidity.• As a strategic move.• For raising funds.• For controlling inflation.

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Interest Rates

• It is the rate which is usually charged for borrowings.

• Interest-rate targets are a vital tool of monetary policy and are taken into account when dealing with variables like;

• investment, • inflation, and • unemployment.

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Interest Rates

• The central banks of countries generally tend to reduce interest rates when they wish to increase investment and consumption in the country's economy.

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Factors influencing • Liquidity preference.• Inflation concern.• Alternative investments.• Taxation.• Short term gains.• Seasonal variations.• Festive seasons.• Investment opportunity.• Foreign investments.

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Solvency

• Solvency is the ability of an organization to meet its long-term financial obligations.

• Solvency is essential to staying in business, but a company also needs liquidity to thrive.

• Business risk directly affects solvency.• Cash rich business usually have high degree of

solvency.

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Business Risk

• Credit Risk• Market Risk• Operational Risk

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Universal Banking

Lecture 22

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Types

Universal Banking

• A Universal Banking is a superstore for financial products under one roof.

• Corporate can get loans and avail of other handy services, while can deposit and borrow.

• It includes not only services related to savings and loans but also investments.

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Definition

• A system of banking where banks are allowed to provide a variety of services to their customers.

• In universal banking, banks are not limited to just loans, checking and savings accounts, and other similar activities, but are allowed to offer investment services as well.

• It is a concept of Banking Supermarket.

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Services offered

• Private Banking• Merchant Banking Products and Services• Investment Banking• Traditional Banking• Economies of Scale. • Profitable Diversions. • Resource Utilization.

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Benefits

• Investors' Trust.• Economics of Scale.• Resource Utilization.• Profitable Diversification.• Easy Marketing.• One-stop Shopping.• Participation in Investments• Savings and Loans

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Benefits

• Development of Private Sector• Cutting the Costs

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Limitations

• Different Rules and Regulations.• Effect of failure on Banking System.• Monopoly.• Conflict of Interest.• No Expertise in Long term lending. • NPA Problem Remained Intact.

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E - Banking

Lecture 23

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E- Banking

• E-banking refers to electronic banking.• It is like e-business in banking industry. E-

banking is also called as "Virtual Banking" or "Online Banking".

• E-banking is a result of the growing expectations of bank's customers.

Deepesh Mahajan

E-banking Services• Automated Teller Machines,• Credit Cards,• Debit Cards,• Smart Cards,• Electronic Funds Transfer (EFT) System,• Cheques Truncation Payment System,• Mobile Banking,• Internet Banking,• Telephone Banking, etc.

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Advantages

• The operating cost per unit services is lower for the banks.

• It offers convenience to customers as they are not required to go to the bank's premises.

• There is very low incidence of errors.• The customer can obtain funds at any time

from ATM machines.

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Advantages

• The credit cards and debit cards enables the Customers to obtain discounts from retail outlets.

• The customer can easily transfer the funds from one place to another place electronically.

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Challenges

• Managerial challenges.• Business challenges.• Macroeconomic challenges.• Demographic challenges.

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Mobile Banking

• Mobile banking is the performing of finance related functions on a mobile device like a Smartphone or Tablet.

• With the use of a mobile device, the user can perform mobile banking via call, text, website, or application support banking provided by the banks.

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• Mobile banking gives your customers the privilege of managing their finances anytime they need to no matter their location.

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Features

• Portable device or small device is required.• Least power consumption.• Instant utility.• Perfect mobility.• Cost efficient.• 24 x 7 availability.• Easy to operate.• Number of security layers.

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Challenges

• Literacy issues.• Network security.• Device security.• Connectivity or network issues.• Requirement of smart phone.• Server side issues.• Operating system issues.

Deepesh Mahajan

ALM Asset

Liability Management

Lecture 24

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Bank Balance Sheet Liabilities Assets

1. Capital2. Reserve &

Surplus3. Deposits4. Borrowings5. Other Liabilities

1. Cash & Balances with RBI2. Bal. With Banks & Money

at Call at Short Notices3. Investments4. Advances5. Fixed Assets6. Other Assets

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Banks P/L Account

A bank’s profit & Loss Account has the following components:

I.Income: This includes Interest Income and Other Income.II. Expenses: This includes Interest Expended, Operating Expenses and Provisions & contingencies.

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Evolution

• 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.

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• 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.

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Reasons for ALM

• The process by which an institution manages its balance sheet in order to allow for alternative interest rate and liquidity scenarios

• Banks and other financial institutions provide services which expose them to various kinds of risks like credit risk, interest risk, and liquidity risk

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• Asset-liability management models enable institutions to measure and monitor risk, and provide suitable strategies for their management.

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• 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.

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• It is aimed to stabilize short-term profits, long-term earnings and long-term substance of the bank. The parameters for stabilizing ALM system are:

1. Net Interest Income (NII)2. Net Interest Margin (NIM)3. Economic Equity Ratio

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Tools used by Banks for ALM

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ALM Information Systems• 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 branches

– The data and assumptions can then be refined over time as the bank management gain experience

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• The spread of computerisation will also help banks in accessing data.

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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.

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ALM Organization

– 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 liabilities,

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ALM Organization– It will have to develop a view on future direction

of interest rate movements and decide on a funding mix between fixed vs. floating rate funds, wholesale vs. retail deposits, money market vs. capital market funding, domestic vs. foreign currency funding.

– It should review the results of and progress in implementation of the decisions made in the previous meetings.

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ALM Process

Lecture 25

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ALM Process

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Categories of Risk• Risk is the chance or probability of loss or damage

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ALM Risk Management

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Liquidity Risk• Liquidity risk arises from funding of long term

assets by short term liabilities, thus making the liabilities subject to refinancing.

• Bank’s liquidity management is the process of generating funds to meet contractual or relationship obligations at reasonable prices at all times.

• Liquidity Management is the ability of bank to ensure that its liabilities are met as they become due.

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Liquidity Risk Management• 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 adopted.

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Statement -Structural Liquidity

• All Assets & Liabilities to be reported as per their maturity profile into 8 maturity Buckets:

1. 1 to 14 days.

2. 15 to 28 days.

3. 29 days and up to 3 months.

4. Over 3 months and up to 6 months.

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Structural Liquidity

5. Over 6 months and up to 1 year.

6. Over 1 year and up to 3 years.

7. Over 3 years and up to 5 years.

8. Over 5 years.

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Statement -Structural Liquidity

• 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.Deepesh Mahajan

Example1-14Days

15-28 Days

30 Days-3 Month

3 Mths - 6 Mths

6 Mths - 1Year

1Year - 3 Years

3 Years - 5 Years

Over 5 Years Total

Capital 200 200Liab-fixed Int 300 200 200 600 600 300 200 200 2600Liab-floating Int 350 400 350 450 500 450 450 450 3400Others 50 50 0 200 300Total outflow 700 650 550 1050 1100 750 650 1050 6500Investments 200 150 250 250 300 100 350 900 2500Loans-fixed Int 50 50 0 100 150 50 100 100 600Loans - floating 200 150 200 150 150 150 50 50 1100Loans BPLR Linked 100 150 200 500 350 500 100 100 2000Others 50 50 0 0 0 0 0 200 300Total Inflow 600 550 650 1000 950 800 600 1350 6500Gap -100 -100 100 -50 -150 50 -50 300 0Cumulative Gap -100 -200 -100 -150 -300 -250 -300 0 0Gap % to Total Outflow-14.29 -15.38 18.18 -4.76 -13.64 6.67 -7.69 28.57

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.

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Currency Risk

• The increased capital flows from different nations following deregulation have contributed to increase in the volume of transactions.

• 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.

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• 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.

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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.

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• 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.

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Sources of Interest Rate Risk

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• 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.

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• Yield Curve Risk: The changes are not always parallel but it could be a twist around a particular tenor and thereby affecting different maturities differently.

• 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.

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Risk Measurement Techniques

• Various techniques for measuring exposure of banks to interest rate risks– Maturity Gap Analysis.– Duration.– Simulation.– Value at Risk.

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Maturity gap method (IRS)

THREE OPTIONS:• 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

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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

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• 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.

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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.

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• 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.

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Simulation

• 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.

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– Bad debt and prepayment levels change in different interest rate scenarios.

– 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 management.

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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 stakeholders.

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• 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.

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BASEL I

Lecture 26

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About the BIS

Established on 17 May 1930.The BIS is the world’s oldest international

financial organization.Head office is in Basel, Switzerland and

representative offices in Hong Kong SAR and in Mexico City.

The BIS currently employs around 550 staff from 50 countries.

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BCBS

• Basel committee on Banking Supervision:• A set of agreements.• Regulations and recommendations on Credit

risk , market risk and operational risk.• Purpose – to have enough capital on account

to meet obligations and absorb unexpected losses.

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BASEL - I

• In 1988, the Basel Committee(BCBS) in Basel, Switzerland, published a set of minimal capital requirements for banks, known as 1988 Basel Accord or Basel I.

• Primary focus on credit risk• Assets of banks were classified and grouped in

five categories to credit risk weights of zero ‘0’, 10, 20, 50 and up to 100%.

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• Assets like cash and coins usually have zero risk weight, while unsecured loans might have a risk weight of 100%.

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Capital Adequacy Ratio (CAR)• Expressed as a percentage of a bank's risk

weighted credit exposures. • Also known as "Capital to Risk Weighted

Assets Ratio (CRAR).• CAR = Capital / Risk.• Ratio is used to protect depositors and

promote the stability and efficiency of financial systems around the world.

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Capital Base

Purpose of Basel I

• Strengthen the stability of international banking system.

• Set up a fair and a consistent international banking system in order to decrease competitive inequality among international banks.

• Achievement : To set up a minimum risk-based capital adequacy applying to all banks and governments in the world.

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Basel & Indian Banking System

• Basel Accord I was established in 1988 and was implemented by 1992 in India.

• over 3 years – banks with branches abroad were required to comply fully by end March 1994 and the other banks were required to comply by end March 1996.

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Basel & Indian Banking System

• RBI norms on capital adequacy at 9% are more stringent than Basel Committee stipulation of 8%.

• Commercial Banks , Cooperative Banks and Regional rural banks s have different RBI guidelines.

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Pitfalls of Basel ILimited differentiation of credit risk

(0%, 20%, 50% and 100%)Static measure of default risk

The assumption that a minimum 8% capital ratio is sufficient to protect banks from failure does not take into account the changing nature of default risk.

No recognition of term-structure of credit risk The capital charges are set at the same level regardless of the maturity of a credit exposure.

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Simplified calculation of potential future counterparty riskThe current capital requirements ignore the different level of risks associated with different currencies and macroeconomic risk. In other words, it assumes a common market to all actors, which is not true in reality.

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• Lack of recognition of portfolio diversification effectsIn reality, the sum of individual risk exposures is not the same as the risk reduction through portfolio diversification. Therefore, summing all risks might provide incorrect judgment of risk.

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Conclusion• Basel 1- Milestone in Finance and Banking

History.• It launched the trend toward increasing risk

modeling research.• However, its over-simplified calculations, and

classifications have simultaneously called for its disappearance, paving the way for the Basel II Capital Accord.

• It led to further agreements as the symbol of the continuous refinement of risk and capital.

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BASEL II

Lecture 27

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Basel II Norms• Basel II was intended :

– to create an international standard for banking regulators.

– to maintain sufficient consistency of regulations.– protect the international financial system.

• Addition of operational risk in the existing norms.• Defined new calculations of credit risk• Ensuring that capital allocation is more risk

sensitive.Deepesh Mahajan

First Pillar

• The first pillar sets out minimum capital requirement. The new framework maintains minimum capital requirement of 8% of risk assets.

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Second Pillar

• Supervisory review process has been introduced to ensure not only those banks have adequate capital to support all the risks, but also to encourage them to develop and use better risk management techniques in monitoring and managing their risks.

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Third Pillar

• Market discipline imposes strong incentives to banks to conduct their business in a safe, sound and effective manner.

• It is proposed to be effected through a series of disclosure requirements on capital, risk exposure etc. so that market participants can assess a bank’s capital adequacy.

• This is not introduced in India.

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Risk Approaches

Market Risk Approach

Operational Risk Approach

Objectives of BASEL II

1.Better Evaluation of Risks.2.Better Allocation of resources.3.Supervisors should review each bank’s own

risk assessment and capital strategies.4.Improved Risk management.5.To strengthen international banking systems.

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BASEL II FRAMEWORK

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Failure of BASEL II• Banks defined their own risk metrics and

derivative investments.• Depends on good underlying data.• Most of the institutional cogs in the credit crisis

aren’t covered.• No independent standard.• Wrong assumptions in case of mortgage-related

risk calculations.• Inadequate level of capital required by the new

discipline.Deepesh Mahajan

BASEL Issues & Challenges

Lecture 28

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Issues & Challanges

• Capital Requirement.• Profitability.• Risk Management Architecture.• Rating Requirement.• Choice of Alternative Approaches.• Absence of historical requirement.• Incentive to Remain Unrated.• Supervisory Framework.

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Issues & Challenges

• Corporate Governance Issues.• National Discretion.• Disclosure Regime.• Disadvantageous for smaller banks.• Discriminatory against Developing Countries.• External and Internal Auditors.

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