INTERNAL CONTROL MECHANISM OF BANK

GUARANTEE

BY SAMYAK JAIN

L.L.M – BANKING & FINANCE

NATIONAL LAW UNIVERSITY, JODHPUR

CONSTITUTION OF SLIDES

The current presentation has been chiefly stratified into three parts;

Meaning of the term ‘Guarantee’

Usage of the term ‘Internal Control Mechanism’

The idea of ‘Risk Management’

THE MEANING OF THE TERM ‘GUARANTEE’

The Term Guarantee has been defined under section 126, Indian Contract Act as;

“A "contract of guarantee" is a contract to perform the promise, or discharge the liability, of a third person in case of his default”.

The term ‘Bank Guarantee signifies the guarantee which is issued by the Bank on behalf of its customer, where bank undertakes to compensate the default occasioned on account of non –performance/default in obligations by the customer.

The current regime of issuing of ‘Bank Guarantees’ is governed by ‘RBI Master – Circular on Guarantees & Co –Acceptances’ dated 1st July, 2014.

HIGHLIGHTS OF RBI MASTER – CIRCULAR ON GUARANTEES & CO –ACCEPTANCES

DATED 1ST JULY, 2014 Banks have been provided with freedom for issuing an ‘unsecured

guarantee’.

Stress upon implementation of Ghosh Committee Recommendations;Guarantees are to be issued in ‘serially numbered forms’

The Beneficiaries of such Guarantee shall be encouraged to ‘cross –check’ the genuineness of such Guarantee with the issuing bank.

The Bank Guarantees in excess of 50,000/- are required to be attested by two officials of the issuing bank.

Note – The said rule may be departed with, only upon exceptional circumstances.

Banks advised to refrain from extending ‘Long Term Guarantees’ in excess of ten year.

INTERNAL CONTROL MECHANISM

The term ‘Internal Control Mechanism’ is chiefly associated with minimisation of ‘Operational Risk’.

The term ‘Operational Risk’ is made with convergence of two factors;

1. Failure of Internal Control Mechanism systems.

2. Risk occasioned through ‘External Factors’.

METHODOLOGIES FOR MEASUREMENT OF OPERATIONAL RISK

BASIC INDICATOR APPROACH

Under this approach, the Capital to be set aside is equal to 15% of three year average positive annual gross income.

STANDARDISED APPROACH

The Banking Activities are divided into 8 subheads.

The capital set aside ranges from 12% -18% depending upon the risk assessment of a certain business.

ADVANCED MEASUREMENT APPROACH Under this approach the

Banks are provided with flexibility to quantify operational risk based upon their own assessment.

Banks are required to demonstrate the operational risk measures meet a soundness standard comparable to one year holding period & a 99.9% confidence level.

IMPLEMENTATION OF METHODOLOGIES FOR OPERATIONAL RISK MANAGEMENT IN

INDIA

BASIC INDICATOR APPROACH Initially, the Scheduled as well

as Non - Scheduled banks were mandated to adopt this approach with BASEL –II Norms coming into force.

STANDARDISED APPROACH The scheduled as well as Non

–Scheduled Banks were given a green signal by the Reserve Bank of India (RBI) to adopt this practice by 30th September, 2010

ADVANCED MEASUREMENT APPROACH This is the sole approach

which is mandated under BASEL –III Norms, which are due for implementation by 31st March, 2019.

The Scheduled & the Non –Scheduled Banks are allowed to follow this approach from1st April, 2012.

RISK MANAGEMENT

The difference between Cash Inflows from Cash Outflows at a definite point of time is the starting point for measurement of Bank’s Liquidity Requirements.

The assessment of Liquidity Profile of a Bank is made under three types of Market Conditions inter alia;Normal Situation

Bank –Specific Crisis

Market Crisis

APPROACHES TO RISK MANAGEMENT

Globally the ‘committee approach’ has been the preferred route for purposes of risk management.

It requires setting up of 2 committees;i. ALCO – Asset Liability Management Committee.

Mandate – Overseeing the Different Kinds of ‘Market Risk’.

ii. CPC – Credit Policy Committee

Mandate – Overseeing the Different Kinds of ‘Credit Risk’.

A vignette for considering the practice assessing ‘Credit Risk’ can be traced to JP Morgan’s portfolio model named as, “Credit Metrics”.

THANK YOU FOR YOUR VALUABLE TIME

THE END.