E BANKING

Online banking is an electronic payment system that enables customers of a financial institution to
conduct financial transactions on a website operated by the institution, such as a retail bank, virtual
bank, credit union or building society. Online banking is also referred as internet banking, e-
banking, virtual banking and by other terms.

To access a financial institution's online banking facility, a customer with internet access would need
to register with the institution for the service, and set up a password and other credentials for
customer verification. The credentials for online banking is normally not the same as for telephone
banking. Financial institutions now routinely allocate customers numbers, whether or not customers
have indicated an intention to access their online banking facility. Customers' numbers are normally
not the same as account numbers, because a number of customer accounts can be linked to the
one customer number. The customer number can be linked to any account that the customer
controls, such as cheque, savings, loan, credit card and other accounts.

To access online banking, a customer visits the financial institution's secure website, and enters the
online banking facility using the customer number and credentials previously setup. Online banking
services usually include viewing and downloading balances and statements, and may include the
ability to initiate payments, transfers and other transactions, as well as interacting with the bank in
other ways.

FEATURES

Online banking facilities offered by various financial institutions have many features and capabilities
in common, but also have some that are application specific.

The common features fall broadly into several categories:

A bank customer can perform non-transactional tasks through online banking, including -

Viewing account balances

Viewing recent transactions

Downloading bank statements, for example in PDF format

 Viewing images of paid cheques

Ordering cheque books

Download periodic account statements

Downloading applications for M-banking, E-banking etc.

Bank customers can transact banking tasks through online banking, including -

Funds transfers between the customer's linked accounts

Paying third parties, including bill payments (see, e.g., BPAY) and third party fund
transfers (see, e.g., FAST)

Investment purchase or sale

Loan applications and transactions, such as repayments of enrollments

Credit card applications

Register utility billers and make bill payments

Financial institution administration

Management of multiple users having varying levels of authority

Transaction approval process

Some financial institutions offer special internet banking services, for example:

Personal financial management support, such as importing data into personal accounting
software. Some online banking platforms support account aggregation to allow the customers to
monitor all of their accounts in one place whether they are with their main bank or with other
institutions.

Advantages
There are some advantages on using e-banking both for banks and customers:
 Permanent access to the bank

Lower transaction costs / general cost reductions

Access anywhere

Security[

Five security token devices for online banking.

Security of a customer's financial information is very important, without which online banking could
not operate. Similarly the reputational risks to the banks themselves are important. [5] Financial
institutions have set up various security processes to reduce the risk of unauthorized online access
to a customer's records, but there is no consistency to the various approaches adopted.

The use of a secure website has been almost universally embraced.

Though single password authentication is still in use, it by itself is not considered secure enough for
online banking in some countries. Basically there are two different security methods in use for online
banking:

The PIN/TAN system where the PIN represents a password, used for the login and TANs
representing one-time passwordsto authenticate transactions. TANs can be distributed in
different ways, the most popular one is to send a list of TANs to the online banking user by
postal letter. Another way of using TANs is to generate them by need using a security token.
These token generated TANs depend on the time and a unique secret, stored in the security
token (two-factor authentication or 2FA).
More advanced TAN generators (chipTAN) also include the transaction data into the TAN
generation process after displaying it on their own screen to allow the user to discover man-
in-the-middle attacks carried out by Trojans trying to secretly manipulate the transaction data
in the background of the PC.[6]
Another way to provide TANs to an online banking user is to send the TAN of the current
bank transaction to the user's (GSM) mobile phone via SMS. The SMS text usually quotes
the transaction amount and details, the TAN is only valid for a short period of time. Especially
in Germany, Austria and the Netherlands many banks have adopted this"SMS TAN" service.
Usually online banking with PIN/TAN is done via a web browser using SSL secured
connections, so that there is no additional encryption needed.
 Signature based online banking where all transactions are signed and encrypted
digitally. The Keys for the signature generation and encryption can be stored on
smartcards or any memory medium, depending on the concrete implementation
(see, e.g., the Spanish ID card DNI electrnico[7]).
Attacks

Attacks on online banking used today are based on deceiving the user to steal login
data and valid TANs. Two well known examples for those attacks
are phishing and pharming.Cross-site scripting and keylogger/Trojan horses can also be
used to steal login information.

A method to attack signature based online banking methods is to manipulate the used
software in a way, that correct transactions are shown on the screen and faked
transactions are signed in the background.

A 2008 U.S. Federal Deposit Insurance Corporation Technology Incident Report,

compiled from suspicious activity reports banks file quarterly, lists 536 cases of
computer intrusion, with an average loss per incident of $30,000. That adds up to a
nearly $16-million loss in the second quarter of 2007. Computer intrusions increased by
150 percent between the first quarter of 2007 and the second. In 80 percent of the
cases, the source of the intrusion is unknown but it occurred during online banking, the
report states.[8]

Another kind of attack is the so-called man-in-the-browser attack, a variation of the man-
in-the-middle attack where a Trojan horse permits a remote attacker to secretly modify
the destination account number and also the amount in the web browser.

As a reaction to advanced security processes allowing the user to cross-check the

transaction data on a secure device there are also combined attacks
using malware and social engineering to persuade the user himself to transfer money to
the fraudsters on the ground of false claims (like the claim the bank would require a "test
transfer" or the claim a company had falsely transferred money to the user's account
and he should "send it back").[9][10] Users should therefore never perform bank transfers
they have not initiated themselves.

Countermeasures

There exist several countermeasures which try to avoid attacks. Digital certificates are
used against phishing and pharming, in signature based online banking variants
 (HBCI/FinTS) the use of "Secoder" card readers is a measurement to uncover software
side manipulations of the transaction data.[11] To protect their systems against Trojan
horses, users should use virus scanners and be careful with downloaded software or e-
mail attachments.

In 2001, the U.S. Federal Financial Institutions Examination Council issued guidance
for multifactor authentication (MFA) and then required to be in place by the end of 2006.
[12]

In 2012, the European Union Agency for Network and Information Security advised all
banks to consider the PC systems of their users being infected by malware by default
and therefore use security processes where the user can cross-check the transaction
data against manipulations like for example (provided the security of the mobile phone
holds up)SMS TAN where the transaction data is send along with the TAN number or
standalone smartcard readers with an own screen including the transaction data into the
TAN generation process while displaying it beforehand to the user (see chipTAN) to
counter man-in-the-middle attacks

What is the difference between loan syndication and a consortium?

In a very general sense, a consortium is any group of individuals or entities that decides
to pool resources toward a given objective. A consortium is usually governed by a legal
contract that delegates responsibilities among its members. In the financial world, a
consortium refers to several lending institutions that group together to jointly finance a
single borrower. These multiple banking arrangements are very similar to a loan
syndication, although there are structural and operational differences between the two.

Loan Syndication

While a loan syndication also involves multiple lenders and a single borrower, the term
is generally reserved for loans that involve international transactions, different currencies
and a necessary banking cooperation to guarantee payments and reduce exposure. A
loan syndication is headed by a managing bank that is approached by the borrower to
arrange credit. The managing bank is generally responsible for negotiating
conditions and arranging the syndicate. In return, the borrower generally pays the
bank a fee.

The managing bank in a loan syndication is not necessarily the majority lender, or
"lead" bank. Any of the participating banks may act as lead or assume the
responsibilities of the managing bank depending on how the credit agreement is
drawn up.

Consortium lending

Like a loan syndication, consortium financing occurs for transactions that might not take
place with a single lender. Several banks may agree to jointly supervise a single
borrower with a common appraisal, documentation and follow-up. Consortiums are not
built to handle international transactions such as a syndication loan; instead, a
consortium may arise because the size of the project at hand is simply too large or too
risky for any single lender to assume. Sometimes the participating banks form a
newconsortium bank that functions by leveraging assets from each institution and
disbands after the project is complete.
Consortium Lending is that type of lending in which two or more banks come together to finance the
big projects requiring huge amount of money. Consortium lending is usually done by banks to
distribute the risks among the group of banks ,it is also used by smaller banks to use as an
opportunity to be a part of the big project financing and to gain expertise in this area. Big banks by
resorting to consortium lending not only saves their prospective customers but also builds good
relations with other banks.

DEFINITION of 'Universal Banking'

A banking system in which banks provide a wide variety of financial services, including both
commercial and investment services. Universal banking is common in some European
countries, including Switzerland. In the United States, however, banks are required to
separate their commercial and investment banking services. Proponents of universal
banking argue that it helps banks better diversify risk. Detractors think dividing up banks'
operations is a less risky strategy.
Universal Banking - Meaning

Universal banking is a combination of Commercial banking, Investment banking, Development

banking, Insurance and many other financial activities. It is a place where all financial products
are available under one roof. So, a universal bank is a bank which offers commercial bank
functions plus other functions such as Merchant Banking, Mutual Funds, Factoring, Credit cards,
Housing Finance, Auto loans, Retail loans, Insurance, etc.
Universal banking is done by very large banks. These banks provide a lot of finance to many
companies. So, they take part in the Corporate Governance (management) of these companies.
These banks have a large network of branches all over the country and all over the world. They
provide many different financial services to their clients.
ln India, two reports in 1998 mentioned the concept of universal banking. They are, the
Narasimham Committee Report and the S.H. Khan Committee Report. Both these reports
advised to consolidate (bring together) the banking industry through mergers and integration of
financial activities. That is, they advised a combination of all banking and financial activities.
That is, they suggested a Universal banking.
In 2000, ICICI asked permission from RBI to become a universal bank. RBI wants some big
domestic financial institutions to become universal banks.

Advantages of Universal Banking

The benefits or advantages of universal banking are:-

Investors' Trust : Universal banks hold stakes (equity shares) of many companies. These
companies can easily get other investors to invest in their business. This is because other
investors have full confidence and faith in the Universal banks. They know that the Universal
banks will closely watch all the activities of the companies in which they hold a stake.
Economics of Scale : Universal banking results in economic efficiency. That is, it results in
lower costs, higher output and better products and services. In India, RBI is in favour of
universal banking because it results in economies of scale.
Resource Utilisation : Universal banks use their client's resources as per the client's ability to
take a risk. If the client has a high risk taking capacity then the universal bank will advise him to
make risky investments and not safe investments. Similarly, clients with a low risk taking
capacity are advised to make safe investments. Today, universal banks invest their client's money
in different types of Mutual funds and also directly into the share market. They also do equity
research. So, they can also manage their client's portfolios (different investments) profitably.
Profitable Diversification : Universal banks diversify their activities. So, they can use the same
financial experts to provide different financial services. This saves cost for the universal bank.
Even the day-to-day expenses will be saved because all financial services are provided under one
roof, i.e. in the same office.
Easy Marketing : The universal banks can easily market (sell) all their financial products and
services through their many branches. They can ask their existing clients to buy their other
products and services. This requires less marketing efforts because of their well-established
brand name. For e.g. ICICI may ask their existing bank account holders in all their branches, to
take house loans, insurance, to buy their Mutual funds, etc. This is done very easily because they
use one brand name (ICICI) for all their financial products and services.
One-stop Shopping : Universal banking offers all financial products and services under one
roof. One-stop shopping saves a lot of time and transaction costs. It also increases the speed or
flow of work. So, one-stop shopping gives benefits to both banks and their clients.

Disadvantages of Universal Banking

The limitations or disadvantages of universal banking are:-

Different Rules and Regulations : Universal banking offers all financial products and services
under one roof. However, all these products and services have to follow different rules and
regulations. This creates many problems. For e.g. Mutual Funds, Insurance, Home Loans, etc.
have to follow different sets of rules and regulations, but they are provided by the same bank.
Effect of failure on Banking System : Universal banking is done by very large banks. If these
huge banks fail, then it will have a very big and bad effect on the banking system and the
confidence of the public. For e.g. Recently, Lehman Brothers a very large universal bank failed.
It had very bad effects in the USA, Europe and even in India.
Monopoly : Universal banks are very large. So, they can easily get monopoly power in the
market. This will have many harmful effects on the other banks and the public. This is also
harmful to economic development of the country.
Conflict of Interest : Combining commercial and investment banking can result in conflict of
interest. That is, Commercial banking versus Investment banking. Some banks may give more
importance to one type of banking and give less importance to the other type of banking.
However, this does not make commercial sense.

Definition: Maximum Permissible Banking Finance(MPBF)

MPBF stands for Maximum Permissible Banking Finance in Indian Banking Sector.
As per the recommendations of Tandon Committee, the corporate are discouraged
from accumulating too much of stocks of current assets and are recommended to
move towards very lean inventories and receivable levels.

Depending on the size of credit required, two methods are in practice to fund the
working capital needs of the corporate.
Method I: For corporate whose credit requirement is less than Rs.10 lakhs, banks
can find the working capital required. Working capital is calculated as difference of
total current assets and current liabilities other than bank borrowings (called
Maximum Permissible Bank Finance or MPBF). Banks can finance a maximum of 75
per cent of the required amount and the rest of the balance has to come out of
long-term funds.

Method II: For corporate with credit requirement of more than Rs.10 lakhs this
method is used. In this method, the borrower finances minimum of 25% of its total
current assets out of long term funds. The rest will be provided by the bank
through MPBF. Thus, total current liabilities inclusive of bank borrowings could not
exceed 75% of current assets.

For determining the maximum permissible bank finance (MPBF), the methods suggested were :
Method I : 0.75 (CA - CL)

LOAN PRICING

Methods of Loan Pricing followed by Commercial Banks

Loan pricing is not an exact science- get adjusted by various
quantitative as well as qualitative variables affecting demand
for and supply of funds.Banks are the major financial institutions,
which inter mediate between actual lenders and actual borrowers.
For the inter-mediation, banks are to pay to the fund providers as
ultimate lenders and charge actual borrowers.

A bank acquires funds through deposits, borrowings ,antiquity

recognizing the costs of each source and the resulting average cost
of funds to the bank. The funds are allocated to assets, creating an
asset mix of earning assets such as loans and non-earning assets
such as banks premises.

The price that customers are charged for the use of an earning
asset represents the sum of the costs of the banks funds the
administrative costs e.g salaries, compensation for non-earning
assets and other costs. If pricing adequately compensates for these
costs and customer to be fair .based on the funds and service
received.

The price of loan is the interest rate the borrowers must pay to the
bank, in addition to the amount borrowed(principal).The
price/interest rate of a loan is determined by the true cost of the
loan to the bank(base rate)plus profit/risk premium for the banks
services and acceptance of risk.

The components of true cost of a loan are:

1. Interest expense,

2. Administrative cost, and

3. Cost of capital

These three components add-up to the banks base-rate .Risk is the

measurable possibility of losing or not gaining the value .The
primary risk of making loan is repayment risk, which is the
measurable possibility that a borrower will not repay the obligation
as a agreed.

A good lending decision is one that minimizes repayment risk .The

price a borrower must pay to the bank for assessing and accepting
this risk is called the risk premium. Since past performance of a
sector, industry or company is the strong indicator of future
performance, risk premiums are generally based on the historical
quantifiable amount of losses in that category.

Price of loan(Interest Rate Charge)=Base Rate + Risk

Premium.
Loan pricing is not an exact science- get adjusted by various
qualitative as well as qualitative variables affecting demand for and
supply of funds. These are several methods of calculating loan
prices.

A. Interest Based Loans by traditional

banks

Pricing method Characteristics

Fixed rate The loan is written at fixed interest rate which is negotiated
at an origination. The rate remains fixed until maturity.

Variable rate The rate of interest changes basing on the minimum rate
from time to time depending on the demand for and supply
of fund.

Prime rate Usually, relatively low rate offered to the highly honored
clients for track record.

Rate for general This rate is applied for general borrowers .This rate is
customer usually higher than the prime rate.

Caps and Floors For loans extended at variable rates, limits are placed on
the extent to which the rate may vary. A cap is the upper
limit and a floor is the lower limit.

Prime times This special rate is number of times greater than the prime
rate. If the maturity of the loan is increased or decreased,
this rate will also be increased or decreased in a multiple.

Rates on other The interest rate can also be determined on the basis of
basis current interest rate of debt instruments or the regional
index of change of interest/price.

This rate is similar to prime rate except that the base is

different a rate can be a bit lower or higher than prime rate.
Examples include regional index or other market interest
rate such as the CD rate.
B. Determining loan price without
interest
Pricing method Characteristics

Compensating Deposit balances that a lender may require to be

balances maintained throughout the period of the loan. Balances
are typically required to be maintained of average rather
than at a strict minimum.

Fees ,charges etc. After sanctioning credit but before disbursing the amount
to the borrower, a charge is taken for this interim
period .This charge helps to prevent the loan taker from
making unnecessary delay in taking loan.

This apart, on special/priority cases, no interest but 3% -

5% service is charged on small loans.

Loan Pricing Methods of Commercial Banks

At present, there are numerous loan pricing methods in the world. And the following
three are the representative pricing methods now.
2.1 Cost-plus loan pricing method
The leading thought of this method is that the loan price should remedy the cost of the
bank offering the financial service and can obtain certain target profit from it, so the loan
price includes four parts: (1) the cost of raising loan fund; (2) expenses related to loan,
which are the non-interest costs caused by banks M & D FORUM 227 issuance of loan
and the maintenance of debtor-creditor relation with customers; (3) the risk premium of
loan, namely the necessary compensation for the probable default risk of loan; (4) target
profits of loan. Among them, each one can be expressed by the percentage of credit
amount. The basic formula is as follow: Loan interest rate = fund cost rate of loan
+administrative expenses rate of loan + risk premium rate of loan + target profit rate This
is the comparatively traditional pricing method. This method is mainly from the banks'
perspective, providing loan pricing by considering the banks own cost, risk and expected
profit. This method can guarantee that the bank is lucrative on the loan, but it doesnt
consider some factors, such as competition in the bank trade, relations with customers,
customers' demand, etc., and it will lead to the fact that market share drops and the
customer runs off easily and cause to bank passively. This method is suitable for loan
market possessing the characteristics of seller, for instance loan of small and medium-
sized enterprises, peasant household's loan, etc.
2.2 Price leadership loan pricing method
The pricing method is a kind of pricing method which is widely used by international
banking industry. Its core is the benchmark interest rate. This method chooses a widely
influential benchmark interest rate as base price. On the basis of the benchmark interest
rate, the bank gives different risk premium to customers who have different credit levels
or risk levels so that commercial banks can make different loan interest rates according to
various customers and loans. The formula is as follow: Loan interest rate= benchmark
interest rate+ risk premium points Or Loan interest rate=benchmark interest rate risk
premium multiplier In the formula above, the benchmark interest rate is the market
interest rate or the prime rate set by the bank itself. The risk premium includes default
risk premium and term premium. They can be regarded as the compensation for some
risks. Compared with the cost-plus pricing, the price leadership loan pricing is based on
the general interest rate and combined with the degree of risk of loan. It considers not
only the risk of the market interest rate, but also the default risk. So, the price made
through this method is more reasonable and can be accepted by the banks and the debtors
easily, and it will also improve the market competitiveness. However, with the
competition becoming fiercer, many commercial banks will select the money market
interest rate as the benchmark interest rate. Of course, it may reduce the profit level of
commercial banks.
2.3 Customer profitability analysis pricing method
Customer profitability analysis pricing requires that the bank should take full
consideration of the overall relationship between the banks and the customers and have a
comprehensive analysis of the contribution of each debtor. These contributions can
include the assets, the liabilities and intermediate businesses and so on. Based on
calculating the cost and the profit of various businesses, the bank can give the appropriate
loan pricing according to the banks target profit and the customers' risk level. Its formula
is as follow: Loan interest rate= (target profitthe total cost of providing servicethe
income other than loan interest)the loan amount The total cost includes the interest cost
of deposits, management cost, risk cost, transaction cost and all other expenses, and the
income consists of interest income, service charge income and investment income. This
kind of pricing method reflects the business philosophy of customer-centric. It attempts
to find the optimal loan price from all the businesses between the bank and its customers
in order to make loan pricing more competitive. Nonetheless, this method presents high
requirements for cost accounting, and requires a perfect customer relationship and
management system, so it is more suitable for the important customers who contact with
the bank closely and can do great contribution to the bank.
What is securitization?
Securitization is the process of taking an illiquid asset, or group of assets, and
through financial engineering, transforming them into a security.

A typical example of securitization is a mortgage-backed security (MBS), which is

a type of asset-backed security that is secured by a collection of mortgages. The
process works as follows:

First, a regulated and authorized financial institution originates numerous

mortgages, which are secured by claims against the various properties
the mortgagors purchase. Then, all of the individual mortgages are bundled
together into a mortgage pool, which is held in trust as the collateral for an MBS.
The MBS can be issued by a third-party financial company, such a large
investment banking firm, or by the same bank that originated the mortgages in
the first place..

Regardless, the result is the same: a new security is created, backed up by the
claims against the mortgagors' assets. This security can be sold to participants in
the secondary mortgage market. This market is extremely large, providing a
significant amount of liquidity to the group of mortgages, which otherwise would
have been quite illiquid on their own. (For a one-stop shop on subprime
mortgages, the secondary market and the subprime meltdown, check out
the Subprime Mortgages Feature.)

Furthermore, at the time the MBS is being created, the issuer will often choose to
break the mortgage pool into a number of different parts, referred to as tranches.
These tranches can be structured in virtually any way the issuer sees fit, allowing
the issuer to tailor a single MBS for a variety of risk tolerances. Pension funds will
typically invest in high-credit rated mortgage-backed securities, while hedge
funds will seek higher returns by investing in those with low credit ratings
special types of securitization

Master trust

A master trust is a type of SPV particularly suited to handle revolving credit card balances, and has
the flexibility to handle different securities at different times. In a typical master trust transaction, an
originator of credit card receivables transfers a pool of those receivables to the trust and then the
trust issues securities backed by these receivables. Often there will be many tranched securities
issued by the trust all based on one set of receivables. After this transaction, typically the originator
would continue to service the receivables, in this case the credit cards.

There are various risks involved with master trusts specifically. One risk is that timing of cash flows
promised to investors might be different from timing of payments on the receivables. For example,
credit card-backed securities can have maturities of up to 10 years, but credit card-backed
receivables usually pay off much more quickly. To solve this issue these securities typically have a
revolving period, an accumulation period, and an amortization period. All three of these periods are
based on historical experience of the receivables. During the revolving period, principal payments
received on the credit card balances are used to purchase additional receivables. During the
accumulation period, these payments are accumulated in a separate account. During the
amortization period, new payments are passed through to the investors.

A second risk is that the total investor interests and the seller's interest are limited to receivables
generated by the credit cards, but the seller (originator) owns the accounts. This can cause issues
with how the seller controls the terms and conditions of the accounts. Typically to solve this, there is
language written into the securitization to protect the investors and potential receivables.

A third risk is that payments on the receivables can shrink the pool balance and under-collateralize
total investor interest. To prevent this, often there is a required minimum seller's interest, and if there
was a decrease then an early amortization event would occur.[18]

Issuance trust

In 2000, Citibank introduced a new structure for credit card-backed securities, called an issuance
trust, which does not have limitations that master trusts sometimes do, that requires each issued
series of securities to have both a senior and subordinate tranche. There are other benefits to an
issuance trust: they provide more flexibility in issuing senior/subordinate securities, can increase
demand because pension funds are eligible to invest in investment-grade securities issued by them,
and they can significantly reduce the cost of issuing securities. Because of these issues, issuance
trusts are now the dominant structure used by major issuers of credit card-backed securities. [18]

Grantor trust

Grantor trusts are typically used in automobile-backed securities and REMICs (Real Estate
Mortgage Investment Conduits). Grantor trusts are very similar to pass-through trusts used in the
earlier days of securitization. An originator pools together loans and sells them to a grantor trust,
which issues classes of securities backed by these loans. Principal and interest received on the
loans, after expenses are taken into account, are passed through to the holders of the securities on
a pro-rata basis.[22]

Owner trust

In an owner trust, there is more flexibility in allocating principal and interest received to different
classes of issued securities. In an owner trust, both interest and principal due to subordinate
securities can be used to pay senior securities. Due to this, owner trusts can tailor maturity, risk and
return profiles of issued securities to investor needs. Usually, any income remaining after expenses
is kept in a reserve account up to a specified level and then after that, all income is returned to the
seller. Owner trusts allow credit risk to be mitigated by over-collateralization by using excess
reserves and excess finance income to prepay securities before principal, which leaves more
collateral for the other classes.

Motives for securitization

Advantages to issuer

Reduces funding costs: Through securitization, a company rated BB but with AAA worthy cash flow
would be able to borrow at possibly AAA rates. This is the number one reason to securitize a cash
flow and can have tremendous impacts on borrowing costs. The difference between BB debt and
AAA debt can be multiple hundreds of basis points. For example, Moody's downgraded Ford Motor
Credit's rating in January 2002, but senior automobile backed securities, issued by Ford Motor Credit
in January 2002 and April 2002, continue to be rated AAA because of the strength of the underlying
collateral and other credit enhancements.[18]

Reduces asset-liability mismatch: "Depending on the structure chosen, securitization can offer
perfect matched funding by eliminating funding exposure in terms of bothduration and pricing
basis."[23] Essentially, in most banks and finance companies, the liability book or the funding is from
borrowings. This often comes at a high cost. Securitization allows such banks and finance
companies to create a self-funded asset book.

Lower capital requirements: Some firms, due to legal, regulatory, or other reasons, have a limit or
range that their leverage is allowed to be. By securitizing some of their assets, which qualifies as a
sale for accounting purposes, these firms will be able to remove assets from their balance sheets
while maintaining the "earning power" of the assets.[22]

Locking in profits: For a given block of business, the total profits have not yet emerged and thus
remain uncertain. Once the block has been securitized, the level of profits has now been locked in
for that company, thus the risk of profit not emerging, or the benefit of super-profits, has now been
passed on.

Transfer risks (credit, liquidity, prepayment, reinvestment, asset concentration): Securitization

makes it possible to transfer risks from an entity that does not want to bear it, to one that does. Two
good examples of this are catastrophe bonds and Entertainment Securitizations. Similarly, by
securitizing a block of business (thereby locking in a degree of profits), the company has effectively
freed up its balance to go out and write more profitable business.

Off balance sheet: Derivatives of many types have in the past been referred to as "off-balance-
sheet." This term implies that the use of derivatives has no balance sheet impact. While there are
differences among the various accounting standards internationally, there is a general trend towards
the requirement to record derivatives at fair value on the balance sheet. There is also a generally
accepted principle that, where derivatives are being used as a hedge against underlying assets or
liabilities, accounting adjustments are required to ensure that the gain/loss on the hedged instrument
is recognized in the income statement on a similar basis as the underlying assets and liabilities.
Certain credit derivatives products, particularly Credit Default Swaps, now have more or less
universally accepted market standard documentation. In the case of Credit Default Swaps, this
documentation has been formulated by the International Swaps and Derivatives Association (ISDA)
who have for a long time provided documentation on how to treat such derivatives on balance
sheets.

Earnings: Securitization makes it possible to record an earnings bounce without any real addition to
the firm. When a securitization takes place, there often is a "true sale" that takes place between the
Originator (the parent company) and the SPE. This sale has to be for the market value of the
underlying assets for the "true sale" to stick and thus this sale is reflected on the parent company's
balance sheet, which will boost earnings for that quarter by the amount of the sale. While not illegal
in any respect, this does distort the true earnings of the parent company.
Admissibility: Future cashflows may not get full credit in a company's accounts (life insurance
companies, for example, may not always get full credit for future surpluses in their regulatory
balance sheet), and a securitization effectively turns an admissible future surplus flow into an
admissible immediate cash asset.

Liquidity: Future cashflows may simply be balance sheet items which currently are not available for
spending, whereas once the book has been securitized, the cash would be available for immediate
spending or investment. This also creates a reinvestment book which may well be at better rates.

Disadvantages to issuer

May reduce portfolio quality: If the AAA risks, for example, are being securitized out, this would
leave a materially worse quality of residual risk.

Costs: Securitizations are expensive due to management and system costs, legal
fees, underwriting fees, rating fees and ongoing administration. An allowance for unforeseen costs is
usually essential in securitizations, especially if it is an atypical securitization.

Size limitations: Securitizations often require large scale structuring, and thus may not be cost-
efficient for small and medium transactions.

Risks: Since securitization is a structured transaction, it may include par structures as well as credit
enhancements that are subject to risks of impairment, such as prepayment, as well as credit loss,
especially for structures where there are some retained strips.

Advantages to investors

Opportunity to potentially earn a higher rate of return (on a risk-adjusted basis)

Opportunity to invest in a specific pool of high quality assets: Due to the stringent requirements
for corporations (for example) to attain high ratings, there is a dearth of highly rated entities that
exist. Securitizations, however, allow for the creation of large quantities of AAA, AA or A rated bonds,
and risk averse institutional investors, or investors that are required to invest in only highly rated
assets, have access to a larger pool of investment options.

Portfolio diversification: Depending on the securitization, hedge funds as well as other institutional
investors tend to like investing in bonds created through securitizations because they may
be uncorrelated to their other bonds and securities.
Isolation of credit risk from the parent entity: Since the assets that are securitized are isolated (at
least in theory) from the assets of the originating entity, under securitization it may be possible for
the securitization to receive a higher credit rating than the "parent," because the underlying risks are
different. For example, a small bank may be considered more risky than the mortgage loans it
makes to its customers; were the mortgage loans to remain with the bank, the borrowers may
effectively be paying higher interest (or, just as likely, the bank would be paying higher interest to its
creditors, and hence less profitable).

Risks to investors

Liquidity risk

Credit/default: Default risk is generally accepted as a borrowers inability to meet interest payment
obligations on time.[24] For ABS, default may occur when maintenance obligations on the underlying
collateral are not sufficiently met as detailed in its prospectus. A key indicator of a particular
securitys default risk is its credit rating. Different tranches within the ABS are rated differently, with
senior classes of most issues receiving the highest rating, and subordinated classes receiving
correspondingly lower credit ratings.[19] Almost all mortgages, including reverse mortgages, and
student loans, are now insured by the government, meaning that taxpayers are on the hook for any
of these loans that go bad even if the asset is massively over-inflated. In other words, there are no
limits or curbs on over-spending, or the liabilities to taxpayers.

However, the credit crisis of 20072008 has exposed a potential flaw in the securitization process
loan originators retain no residual risk for the loans they make, but collect substantial fees on loan
issuance and securitization, which doesn't encourage improvement of underwriting standards.

Event risk

Prepayment/reinvestment/early amortization: The majority of revolving ABS are subject to some

degree of early amortization risk. The risk stems from specific early amortization events or payout
events that cause the security to be paid off prematurely. Typically, payout events include insufficient
payments from the underlying borrowers, insufficient excess spread, a rise in the default rate on the
underlying loans above a specified level, a decrease in credit enhancements below a specific level,
and bankruptcy on the part of the sponsor or servicer.[19]

Currency interest rate fluctuations: Like all fixed income securities, the prices of fixed rate ABS
move in response to changes in interest rates. Fluctuations in interest rates affect floating rate ABS
prices less than fixed rate securities, as the index against which the ABS rate adjusts will reflect
interest rate changes in the economy. Furthermore, interest rate changes may affect the prepayment
rates on underlying loans that back some types of ABS, which can affect yields. Home equity loans
tend to be the most sensitive to changes in interest rates, while auto loans, student loans, and credit
cards are generally less sensitive to interest rates. [19]

Contractual agreements

Moral hazard: Investors usually rely on the deal manager to price the securitizations underlying
assets. If the manager earns fees based on performance, there may be a temptation to mark up the
prices of the portfolio assets. Conflicts of interest can also arise with senior note holders when the
manager has a claim on the deal's excess spread.[25]

Servicer risk: The transfer or collection of payments may be delayed or reduced if the servicer
becomes insolvent. This risk is mitigated by having a backup servicer involved in the transaction. [19]

BANKING NORMS and concepts

The Indian banking sector is broadly classified into scheduled banks and non-scheduled banks.All
banks which are included in the Second Schedule to the Reserve Bank of India Act, 1934 are
Scheduled Banks. These banks comprise Scheduled Commercial Banks and Scheduled Co-
operative Banks. Scheduled Co-operative Banks consist of Scheduled State Co-operative Banks
and Scheduled Urban Cooperative Banks.Scheduled Commercial Banks in India are categorized
into five different groups according to their ownership and/or nature of operation:

State Bank of India and its Associates

Nationalised Banks

Private Sector Banks

Foreign Banks

Regional Rural Banks.

Adoption of banking technology

The IT[revolution has had a great impact on the Indian banking system. The use of computers has
led to the introduction of online banking in India. The use of computers in the banking sector in India
has increased many fold after the economic liberalisation of 1991 as the country's banking sector
has been exposed to the world's market. Indian banks were finding it difficult to compete with the
international banks in terms of customer service, without the use of information technology.

The RBI set up a number of committees to define and co-ordinate banking technology. These have
included:

In 1984 was formed the Committee on Mechanisation in the Banking Industry (1984)
[27]
whose chairman was Dr. C Rangarajan, Deputy Governor, Reserve Bank of India. The major
recommendations of this committee were introducing MICR technology in all the banks in the
metropolises in India.[28] This provided for the use of standardized cheque forms and encoders.

In 1988, the RBI set up the Committee on Computerisation in Banks (1988) [29] headed by Dr.
C Rangarajan. It emphasized that settlement operation must be computerized in the clearing
houses of RBI in Bhubaneshwar, Guwahati, Jaipur, Patna and Thiruvananthapuram. It further
stated that there should be National Clearing of inter-
city chequesat Kolkata, Mumbai, Delhi, Chennai and MICR should be made operational. It also
focused on computerisation of branches and increasing connectivity among branches through
computers. It also suggested modalities for implementing on-line banking. The committee
submitted its reports in 1989 and computerisation began from 1993 with the settlement between
IBA and bank employees' associations.[30]

In 1994, the Committee on Technology Issues relating to Payment systems, Cheque

Clearing and Securities Settlement in the Banking Industry (1994)[31] was set up under Chairman
W S Saraf. It emphasized Electronic Funds Transfer (EFT) system, with the BANKNET
communications network as its carrier. It also said that MICR clearing should be set up in all
branches of all those banks with more than 100 branches.

In 1995, the Committee for proposing Legislation on Electronic Funds Transfer and other
Electronic Payments (1995)[32] again emphasized EFT system
Automated teller machine growth

The total number of automated teller machines (ATMs) installed in India by various banks as of end
June 2012 was 99,218.[33] The new private sector banks in India have the most ATMs, followed by off-
site ATMs belonging to SBI and its subsidiaries and then by nationalised banks and foreign banks,
while on-site is highest for the nationalised banks of India. [30]
Cheque truncation initiative

In 2008 the Reserve Bank of India introduced a system to allow cheque truncation in India,
the cheque truncation system as it was known was first rolled out in the National Capital Region and
then rolled out nationally.

Expansion of banking infrastructure

Physical as well as virtual expansion of banking through mobile banking, internet banking, tele
banking, bio-metric and mobile ATMs is taking place [34] since last decade and has gained momentum
in last few years.

CAPITAL ADEQUACY NORMS

1. Prudential Norms

The norms which are to be followed while investing funds are called "Prudential Norms." They
are formulated to protect the interests of the shareholders and depositors. Prudential Norms are
generally prescribed and implemented by the central bank of the country. Commercial Banks
have to follow these norms to protect the interests of the customers.

For international banks, prudential norms were prescribed by the Bank for International
Settlements popularly known as BIS. The BIS appointed a Basle Committee on Banking
Supervision in 1988.

2. Basel Committee

Basel committee appointed by BIS formulated rules and regulation for effective supervision of
the central banks. For this it, also prescribed international norms to be followed by the central
banks. This committee prescribed Capital Adequacy Norms in order to protect the interests of the
customers.

3. Definition of Capital Adequacy Ratio

Capital Adequacy Ratio (CAR) is defined as the ratio of bank's capital to its risk assets. Capital
Adequacy Ratio (CAR) is also known as Capital to Risk (Weighted) Assets Ratio (CRAR).

India and Capital Adequacy Norms

The Government of India (GOI) appointed the Narasimham Committee in 1991 to suggest
reforms in the financial sector. In the year 1992-93 the Narasimhan Committee submitted its first
report and recommended that all the banks are required to have a minimum capital of 8% to the
risk weighted assets of the banks. The ratio is known as Capital to Risk Assets Ratio (CRAR).
All the 27 Public Sector Banks in India (except UCO and Indian Bank) had achieved the Capital
Adequacy Norm of 8% by March 1997.

The Second Report of Narasimham Committee was submitted in the year 1998-99. It
recommended that the CRAR to be raised to 10% in a phased manner. It recommended an
intermediate minimum target of 9% to be achieved by the year 2000 and 10% by 2002.

Concepts of Capital Adequacy Norms

Capital Adequacy Norms included different Concepts, explained as follows :-

Concepts of Capital Adequacy Norms

1. Tier-I Capital

Capital which is first readily available to protect the unexpected losses is called as Tier-I Capital.
It is also termed as Core Capital.

Tier-I Capital consists of :-

Paid-Up Capital.
Statutory Reserves.
Other Disclosed Free Reserves : Reserves which are not kept side for meeting any
specific liability.
Capital Reserves : Surplus generated from sale of Capital Assets.

2. Tier-II Capital

Capital which is second readily available to protect the unexpected losses is called as Tier-II
Capital.

Tier-II Capital consists of :-

Undisclosed Reserves and Paid-Up Capital Perpetual Preference Shares.

Revaluation Reserves (at discount of 55%).
Hybrid (Debt / Equity) Capital.
Subordinated Debt.
General Provisions and Loss Reserves.

There is an important condition that Tier II Capital cannot exceed 50% of Tier-I Capital for
arriving at the prescribed Capital Adequacy Ratio.

3. Risk Weighted Assets

Capital Adequacy Ratio is calculated based on the assets of the bank. The values of bank's assets
are not taken according to the book value but according to the risk factor involved. The value of
each asset is assigned with a risk factor in percentage terms.

Risk Weighted Assets

Suppose CRAR at 10% on Rs. 150 crores is to be maintained. This means the bank is expected to
have a minimum capital of Rs. 15 crores which consists of Tier I and Tier II Capital items subject
to a condition that Tier II value does not exceed 50% of Tier I Capital. Suppose the total value of
items under Tier I Capital is Rs. 5 crores and total value of items under Tier II capital is Rs. 10
crores, the bank will not have requisite CRAR of Rs. 15 Crores. This is because a maximum of
only Rs. 2.5 Crores under Tier II will be eligible for computation.

4. Subordinated Debt

These are bonds issued by banks for raising Tier II Capital.

They are as follows :-

They should be fully paid up instruments.

They should be unsecured debt.
They should be subordinated to the claims of other creditors. This means that the bank's
holder's claims for their money will be paid at last in order of preference as compared
with the claims of other creditors of the bank.
The bonds should not be redeemable at the option of the holders. This means the
repayment of bond value will be decided only by the issuing bank

BANKING CONCEPTS

Banking means accepting for the purpose of lending or investment of deposits of money from the
public Banking deals with withdraw, deposit, cheque and loan. Bank is an institution which deals
money and credit.

Central government is empowered of banking companies. In banking section most important one is
customer. Customer means a person who has an account with a banker. One person cannot be
called as a customer immediately on opening an account but he will be called as after having regular
dealing with a banker.

A customer need not always be an individual. In other words it may be firm, companies, co-
operatives etc. Bank may classified as three type of account

fixed deposit account

 saving bank account

current account

Fixed deposit account

Amount is deposit in fixed periods. In fixed deposit, customer gets more benefit than savings
account. High rate of interest is offered on such deposit.

Saving bank account

It is meant for small savers. Its main objective is to encourage the habit of saving in public. In order
to attract the people to saving the money, some commercial banks have introduced a number of new
saving schemes.

For example

Daily saving scheme, children saving scheme, minors saving scheme.

Current account

A current account is a running account and it can be operated for any number of times without any
restriction. It is only safeguard the customer. Therefore, it is suitable for business concerns,
companies, institutions and public undertakings.

No interests given to current account.

Bank pass book

It is an authorized copy of the customers account with the bank. It is written by the bank and handed
over to the customer for his reference. The customer can get it, updated by banker, each and every
transaction. It is knows as pass book.