SLBK605 OB /1008

Semester-III Comprehensive Examinations Class of 2009 SLBK605 - Overview of Banking Part-A

1.

The money markets in India consists of two sectors, namely the organized sector and unorganized sector. Which of the following do no fall under organized sector? a. b. c. d. e. Reserve Bank of India, State Bank of India and Commercial Banks Life Insurance Corp. of India and General Insurance Corp. of India. Unit Trust of India Small Industrial Development Bank of India and Industrial Finance Corp. of India. Indigenous Bankers

2.

Scheduled Bank means a bank a. b. c. d. e. Incorporated under the companies Act, 1956 Authorized to Transact Government Business Governed by the Banking Regulation Act, 1949. Included in the Second Schedule to the Reserve Bank of India Act, 1934. Both (c) & (d) above.

3.

Banker-Customer relationship is governed by :a. b. c. d. e. The RBI Act, 1934 The Bank Regulations act, 1949 Negotiable Instrument Act, 1881 The Companies Act, 1956 The Indian Contract Act, 1872

4.

A cheque payable to bearer can be converted into an order one with a. b. c. d. e. Drawers signatures. Drawees Signatures No Signature required Payees Signature With the consent of Bank.

5.

In the case of Cash Credit Accounts a. Drawing power is fixed but limit is variable. b. Limit is fixed but drawing power is variable. c. Both limit and drawing power are variable. d. Both limit and drawing power are fixed. e. Drawing power can be increased or decreased at the discretion of the bank irrespective of value of stocks with the borrower.

SLBK605 OB /1008 6. Net Interest Income is a. Interest earned on advances b. Interest earned on investments c. Total interest earned on advances and investment d. Difference between interest earned and interest paid e. Interest earned on advances less interest earned on investment. Which of the following is termed as non fund based limit. a. Cash credit and overdraft b. Purchase and discounting of bills. c. Demand loans and term loans d. Consortium advance e. Guarantees and letter of credit. Which of the following described a contingent liability? a. It arises when a bank grants a loan to the borrower. b. There is an obligation on the bank to provide funds to a third party upon happening or non happening of an event. c. Irrespective of whether the contingency is realized or not, the bank will have to show the contingent liability as a part of total liabilities d. Asset sales with recourse cannot be considered as contingent liabilities. e. None of the above. The lending rates of banks for loans and a. Bank Rate b. Inter Bank rate c. Prime Lending Rate d. Spot Rate e. Libor Rate advances of over Rs. 2 lakh are linked to:

7.

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9.

10. Who is the natural guardian of Hindu Minor in terms of section 6 of the Hindu Minority and Guardianship Act 1956 a. Father and after his death grand father. b. c. d. e. Father and after his death mother. Father and after his death brother. Court appoints guardian in every case. Father and after his death maternal grandfather.

11. CAMELS includes a. Capital Adequacy, Asset Quality, Management, Earning, Liquidity and Sensitivity to Market Risk b. c. d. e. Capital, Assets, Management, Earning, loans and Surplus. Cash, Assets, Money, Earnings, Lending and Surplus. Costs, Advances, Management, Earning, Losses, Surplus Capital Adequacy, Asset Quantity, Management, Earning, Liquidity, and Surplus.

SLBK605 OB /1008 12. Funds Flow Statement means a. b. c. d. e. A statement of funds flowing into banking industry. A statement showing aggregate deposits of funds. A statement of sources and application of funds is an unit. A statement of expenses and income of a bank A statement of cash and bank balance in hand of an unit.

13. A commercial paper is. a. A paper issued by RBI on trade and commerce. b. A issuance promissory note issued by a company, negotiate by endorsement and delivery, discount on face value as may be determined by issuing company. c. A document issued by IDBI for seeking refinance facilities from RBI d. A paper issued by Commercial Banks e. A paper issued by SEBI. 14. Special purpose vehicle (SPV) may be formed under:a. The companies Act, 1956 b. Indian Trust Act c. (A) & (B) d. SEBI Rules e. None of the above. 15. If any member bank in Consortium considers an advance as non performing asset, then a. All the member banks including the leader, should treat the advance granted by them as a NPA b. Such decision is not binding on the other members of the consortium c. Such decision should be satisfied by the leader of the consortium before implementations. d. The consortium arrangement comes to an end. e. No membership is granted to such bank in future consortium advances. 16. The processions of Income Tax (Second Amendment) Act 1981 regarding mode of re-payment of deposits held by an account holder aggregating to Rs 20000/- or more are applicable in the case of a. Saving accounts b. Current accounts c. Time deposits only d. Call deposits only e. Time deposits and call deposits. 17. Credit Risk Assessment of the borrower units is for a. Assessing the repayment capacity. b. c. d. e. To fix the pricing of the product. To review the units performances None of the above. All of the above. 3

SLBK605 OB /1008 18. CDR is a. b. c. d. e. Capital Debt Ratio Corporate Debt Restructuring Capital Debt Restructuring Corporate Debt Ratio Cash Discount Ratio

19. The credit flow to small enterprises with plant and machinery upto Rs. 5.00 lacs is presently around a. 40% of Total Bank credit of SSI b. c. d. e. 30% of Total Bank credit 18% of Total Bank credit 8% of Total Bank credit 2% of Total Bank credit

20. The term gilt-edged securities refer to :a. Shares of private limited companies b. c. d. e. Shares issued by cooperative societies. Securities which carry fixed rate of interest. Their prices generally fluctuate violently. Securities or investments where risk is marginal i.e. capital repayments and interests are almost certain.

21. Basle II have identified the following risk a. Credit Risk b. c. d. e. Operational Risk Market Risk Reputation Risk (a), (b) & (c) as above.

22. Which of the following is not the objective of monetary policy of a country. a. b. c. d. e. Price stability Regulating the saving and expenditure Regulating the monetary expansion Interest Rate Stability. Exchange Rate Stability.

23. Reverse Mortgage is a. b. c. d. e. Assuming a steady stream of income by mortgaging self occupied property of banks. Taking back the property mortgaged to bank by paying back the loan. Bank mortgaging its property to raise funds. Resisting bank that is taking possession of the property of recovery of its loan. All of the above.

SLBK605 OB /1008 24. Under section 42 (1) of RBI Act, 1934 the RBI is empowered to prescribe CRR of Scheduled Bank ranging between. a. b. c. d. e. 3% to 15% 5% to 20% 8% to 38% 0% to 10% 5% to 7 %

25. CIBIL is a. b. c. d. e. Customers Information Bank of India Ltd., Credit Investment and Banking India Ltd., Credit Information Bureau India Limited Customers Investment Behaviour in Lending None of above.

26. An asset where loss has been identified by the banker or internal / external auditors or RBI inspection but the amount has not been written off wholly, is classified as : a. b. c. d. e. Doubtful asset Sticky asset Irrevocable asset Loss asset Impaired asset.

27. Which of the following do not fall in the functions of RBI? a. b. c. d. e. Regulation of currency. Control of credit Bankers Bank, Bankers of GOI and lender of last resort Accepting deposit and making loans and advances. Supervision of Bank Sector in the Country.

28. In order to compensate the lending banker for loss caused due to non utilization of limits to full extent by the borrower the banker sometimes impose a levy on unutilized portion of credit limit sanction which is known as a. b. c. d. e. Service Charges Non-Availment Charges Commitment Charges Up-front Charges Processing Charges.

SLBK605 OB /1008 29. In a small scale service business enterprise (SSSBE) the investment ceiling in fixed assets excluding land and business is:a. Rs. 20.00 lacs b. c. d. e. Rs. 3.00 lacs Rs. 5.00 lacs Rs. 10.00 lacs Rs. 15.00 lacs

30. Bankers are allowed to invest in shares/ convertible delineators of private corporate bodies and public sector undertakings upto a. Rs. 50 crore b. RS. 200 crore c. d. e. 5% of their incremental deposits in the previous year. 7% of gross deposits as on 31st March of the previous year. 30% of their total deposits.

Part B
Problems testing, Conceptual Understanding and Application, Analytical Ability, Caselets, Situational Analysis / Applications of concepts
1. What is credit policy of bank a. b. What is the need thereof Describe the components of effective credit policy of a bank. (3+7=10 marks) Suggested Answer: COMPONENTS OF CREDIT POLICY While developing a credit policy, a bank needs to address certain significant issues that are to be incorporated in the policy. A few considerations that the loan policy may address are. i. OBJECTIVES The first step in farming a credit policy is the formulation of objectives of proposed policy. With diverse objectives like profitability, liquidity, volume of business, risk factors, etc, being present, there is a need to prioritize these objectives. In the wake of emergency of conflicting objectives, reconciliation between different objectives has to be done. Essentially, the credit policy should within the framework of regulatory norms e.g. capital adequacy norms. Considering the importance of adherence to the regulatory prescriptions, it will appropriate to state the related regulatory aspects within the policy. This step would enable the loan officers to be aware of such requirements. ii. VOLUME AND MIX OF LOANS The policy should specify the targeted composition of the loan portfolio. Such composition being in terms of industry / location size/ interest rate/ security. Decisions regarding the loan portfolio will depend on the size of the bank, credit requirements in its operational areas and the expertise available within the bank an agrarian type of economy, most of the loan demands may come from the farmers. Likewise, if the banks size is small, it may have to put a limit to individual loan proposals to be in proportion to its total loan portfolio.

SLBK605 OB /1008 iii. GEOGRAPHICAL SPREAD There will be various locations from where a bank conducts its operations. Of these locations, some may be weak credit demand areas with a considerably high deposit potential and vice versa. The policy should thus, state the key trade areas of the bank for extending credit. Further, within the trade areas, there may be certain areas with a primary focus and a few others, which may be given to the secondary focus. iv. LOAN EVALUATION PROCEDURES The policy document shall specify a process for evaluation of loan proposals, which will enable uniform evaluation across areas/ people. Industry Prospects To study the prospects of the industry, an industry level credit analysis needs to be performed which most importantly includes a study of the following. Industry cycles Threat form substitutes. Shifts in consumer demands Regulatory environment.

Operational Efficiency The company level credit rating is conducted to assess the operational efficiency of the client company. The critical aspects that are to be evaluated I this process fall into the following categories. Operating Margins Stability and growth of market share. Access to key raw materials Benefit from economics of scale

Financial Efficiency Repayment of the loan by the clients depends greatly on their financial soundness. Hence, financial analysis becomes an imperative part of credit risk analysis. It includes an analysis of the following. v. Financial leverage Coverage ratios Cost of capital Ability to raise funds Working capital management Interest rate risk management

MANAGEMENT EVALUATION While the above mentioned factors assess the ability of the client to repay, the management evaluation to a certain extent, throws light on the willingness of the client to repay. Thus, evaluation of management includes a study on the performance of the promoter, top management and also the performance of the group companies under the same management.

SLBK605 OB /1008 vi. FUNDAMENTAL ANALYSIS The fundamental factors that influence the working of the client company are analyzed. These factors are listed below: Capital Structure Asset/ liability position Asset quality Profitability Sensitivity to interest rate structure, tax policies etc.

a. Loan Administration Efficient administration is the key to the success of the lending policy. And for improving its efficiency, the authority of the loan executives should be clearly stated as also their responsibilities. The loan policy should state the sanctioning powers of the loan officers regarding the credit limits. b. Credit Files The detail regarding the borrower are not only essential during the loan appraisal time but they are also required throughout the tender of the loan. This is essential especially since there may always be probability of default or as change in the risk return profile of the customer value of the same, details of compensating, balances etc. Moreover, since most of the customer are non one time borrowers, it will be more necessary for the bank to maintain such credit files. c. Lending Rates The interest charged should reflect the credit risk present I the credit disbursal. The major issue will thus be to adjust the rate charged to the risk perception. A loan policy is actually a function of the size of the bank. Hence , apart from the above mentioned considerations, depending on the banks; own requirements, there may be several other issues/ parameters that may be included in its loan policy. Given below are some of the other issues/ parameters that the loan policy may contain. i. ii. iii. iv. v. vi. vii. viii. ix. x. xi. xii. xiii. Type and extent of collaterals Compensating balances/ margin Statutory limits for different types of loans Monitoring mechanism Loan Deposit ratio. Incentive schemes for the loan officers Loan repayment pattern Communication practices Extension of renewals of past-due installment loan (rescheduling of loan) Loan Loss reserves Consumer laws and regulations Role of Credit Department Role of Recovery Department.

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2.

What is present scenario of Retail banking in India? Formulate strategy for success in Retail Banking Sector. (3+7=10 marks)

Suggested Answer: a. Retail Banking Scenario Retain banking includes a comprehensive range of financial products viz. deposits products, residential mortgage loans, credit cards, auto finance, personal loans, consumer durable loans, loans against equity. There products provide an opportunity for banks to diversity the asset portfolio with high profitability and loan NPAs. Today the most proactive banks have entered the retail banking segment and have identified it as a principal growth drive. Till recently consumer finance was not encouraged, however over the past few years, tierce competition among the banks lowered the spreads and profitability on commercial loans. With dereguarization and increase in consumer loan rates the risk adjusted return in retail sector have exceeded the returns on commercial loans Competition, automation and regulation are the major forces that are driving and shaping consumer lending. The enormous competition has led to innovative retail banking products that the extremely customer friendly and plug the loopholes in the existing similar products. ATMs have merged as an alternate banking channel which facilitate low cost transactions vis--vis traditional branches. b. Strategy for success in Rental Banking Retail Banking is a composite activity encompassing the banking products and services specially designed for meeting the ongoing requirements of individual customer. An individual customer develops banking habit mainly for there purposes, namely. For making investments For raising loans and For availing any of the subsidiary services. Retail banking, therefore, becomes complete only when all these financial needs of an individual customers are met to his utmost satisfaction under one roof. Retail banking is being increasingly focused in Indian Banking Industry today mainly due to high margin and low risk nature of the business coupled with the increasing pace of consumerism in India. Other factors, such as increased economic activity, increase in purchasing power of the consumers, especially that of the younger generation, a huge middle class population, innovations in technology and low interest rate regime have contributed to growth of the retail financing. With increasing competition, spread in the Indian Banking industry is under strain. As such, banks need to shift their focus to innovating products and services, which are profitable. If banks intend to proper, profitability of products and customer should become buzz ward for them. c. MARKETING STRATEGIES Marketing is a composite activity, which includes market study, designing of products, delivering and ensuring proper after sales services. In a race it is the pace that counts and for attaining a winning pace, marketing strategies have to be designed. Latest technology can be used by banks to target products to the right potential customers, by maintaining a database of customer profiles and their likely financial needs. Data mining has to be strengthened, as it will help banks in formulating products for specific stet of costumers. The first step in designing the strategy is to identity the target customers and target products for which market segmentation exercise has to be undertaken. 9

SLBK605 OB /1008 i. Market Segmentation: Segmentation of existing as well as potential retain clientele into housewives, professionals, salaried personnel, workers, company executives, businessmaen, farmers be done to identity the needs of the target group and facilitate structuring financial products/ services to match their needs. Further, the same data can be utilized for evolving different techniques of marketing depending on the target groups . ii. Central Data Base: Bank should built up a central database to contain the profile of all high value retain clientele. Communication (either as seasonal greetings or for highlighting the significant measures for improved services, new products) through e mail/ postal mode should be sent at regular intervals from the corporate office itself directly to those high value customers identified by the marketing team stationed at all key delivery units. iii. Financial Super Market: In view of the exposure of Indian customers to global products and services they have become more demanding and they want fast, convenient and hassle free services from bank in India . The traditional loyalty and inertia associated with the Indian consumer is changing very fast. As such the success of retail marketing largely depend on how banks understand its customers and the market. Development of skills for managing customers has become of crucial importance (if banks of today have to survive) Bank should become a one shop for all the banking needs and services. For the retailers investing in low cost deposit schemes, add-on benefits like demand drafts, funds transfer facility, anywhere banking, ATM cards, name printed cheque books, monthly statement of accounts (direct to residence/ office). Customer terminal (installed at their premises), concessional collection charges, mobile banking, internet banking, depository services, portfolio management service, standing instructions, insurance products should be extended either at concessional or nil cost. A cost study should be conducted to introduce a business linked tariff structure for all these. All these services with technology should instill in the customer a sense of pride in banking with us. iv. Retail Financing as Core Activity: Bank should prepare a list of preferred areas of retail finance town wise, keeping the potential in view. SWOT analysis will help in identifying high profile towns from retail lending point of view. This will help in making focused attention on retail financing by bank in specific potential areas. Ground work required for retail financial will invoice. Operational Manuals : to ensure uniformity and facilitate faster appraisal and decision making, operational manuals has to be developed by banks. With this staff members at the grass roots level will not violate norms and bypass system and procedures. Credit Scoring and Loan Pricing Model: To enable the frontline staff to take quick credit decisions, an efficient credit scoring and loan pricing system has to be designed. This will strengthen credit appraisal and post sanction monitoring system. Centralized Processing : To have a competitive edge and gain he critical mass in the high volume game, the processing activity can be centralized. Processing excellence is crucial to sales and service quality. Portfolio Management Services: A retail investor still prefers safety to returns and hence banks are the ultimate choice. String of failures elsewhere have already made the investors lean towards the. Non Cash Incentives: Norms for non cash incentives be evolved, teams doing excellent business in retail banking. Frill Benefits / Add Ons: All schemes under Retail Lending be insurance linked and procedural formalities to be reduced. Norms for Back ended interest rebate for prompt repayments be also evolved to make the schemes still more attractive and customer friendly.

3.

What do you understand by exposure limits of lending by banks? Discuss consortium finance in detail 10

SLBK605 OB /1008 (10 marks) Suggested Answer: Exposures in Banks Lending. In order that the banks maintain their financial health and soundness and do not put the depositors at stake, the Reserve Bank of India, has been recommending exposure limits or ceiling from time tot time. Simply speaking, such limits are for allowing funds based and non funds based credit to big borrowers and banks investments in relation to its own net worth. Types of Credit and investments covered under exposure Exposure ceilings contain all types of funds and non funds based credits, forward rate contract bookings, options, booking, rates/ interests swaps and other similar derivatives. On investment side, banks/ investment in shares, debentures, bonds, commercial papers and under writings are covered under exposures. Items not covered under Exposure Limits. Advances against banks own deposits are excluded from exposures. Advances which have been guaranteed by the Govt. of India.

LIMITS OF EXPOSURES a. b. c. d. e. Single Borrower (other than for infrastructure financing) Single borrower for infrastructure borrowings Public Sector Undertakings Borrowing by the Group as a whole (other than infrastructure) Borrowings by the group as a whole (infrastructure) : : : : : 15% of Banks Net worth 20% of Banks Net worth 15% of Banks Net worth 40% of Banks Net worth 50% of Banks Net worth

CONSORTIUM FINANCE Concept When two or more banks or term lending institutions collectively join to meet the entire credit needs of a single borrowing unit, it is known as consortium financing i.e. by forming a consortium by banks and or financial institutions. Such type of financing is made to corporate borrowers where the amount of finance required is big and a single bank is hesitant to undertake exposure of large amount of finance to a single borrower. The participating banks provide finance against common security offered by the borrower and the same is charged to them on pari-passu basis. It is a concept to promote collective application of banking resources Background: In order to enable corporate borrowers meet their funds based needs, RBI appointed a committee in 1974 under the chairmanship of Lakshmi Narayanan to recommend suitable criteria for consortium approach to lending. This committee suggested ground rules to be observed by the banks which formed the guidelines. It was observed that banks were not adhering to the discipline, which were recommended as per Lakshmi Narayanan Committee. As such, RBI appointed another committee under the chairmanship of J.V. Shetty to review the guidelines and suggest fresh measures. This committee submitted its report in August, 1994. keeping in view the various problems being 11

SLBK605 OB /1008 faced by the borrowers and the banks participating in the consortium, Shetty Committee recommended Banks syndication alongwith the continuance of consortium on the market driven banking. Present Status Consortium financing was earlier obligatory where the fund based needs of a borrower were Rs. 5 Crore or above and this limit was later on enhanced to RS. 50 Crore, but at present, it is not obligatory for banks. This means, banks can go in for consortium formation at their own, or can meet the entire borrowing needs individually. Where consortium is necessary Under RBI guidelines, Banks exposure to a single borrower should not exceed 15% of the net work of the bank. In case of a group (all the units or branches of the borrower), the same should not exceed 40% of the net worth of the bank. As such, where the borrowing requirements of the corporate from its bankers exceed these prudential norms, the banks go in for consortium lending. Number of Banks There is no ceiling on the number of bankers participating in consortium finance. No new bank will extend credit facilities to the borrower availing facilities under consortium arrangement. Appraisal of the Credit Limits There is a one lead bank or consortium leader, who is usually the main bank of the borrower, but could be some other bank as well. The bank providing term loan for capital goods has also to participate for financing the working capital requirements The lead bank convenes a meeting of appraising officials of participating banks for discussions on preparation of the appraisal note, and finalize the appraisal note. Thereafter, the lad bank circulates the appraisal note among other consortium member banks and asks for their comments and recommendations within the specified date. The appraisal note finalized as Principal sanction forms the basis for preparation of sanction note which is conveyed to lead bank within the stipulated period. The lead bank has the right to charge a free per annum towards various functions it has to do during the currency of the loan. This free borne by the borrower. Time Frame for Disposal of Loan Application Type of Limits Fresh sanction/ enhancement Renewal Adhoc Limits Single Window Concept The borrowers had to face several operational difficulties in consortium finance. They had to submit separate papers as per the requirements of individual banks and to complete documentation with all the banks participating in the consortium. To address such difficulties, Single window concept was evolved upon the recommendations of Mahadevan committee. Documentation Under the single window concept, the borrower has to execute only one set of documents with the lead bank instead of with each participating bank. Export Credit 45 days 30 days 15 days Other limits 60 days 45 days 30 days

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SLBK605 OB /1008 4. What is rural finance? Discuss various sources of rural finance and problem being faced by commercial bank and multi agency system of delivery of credit in rural settings. (10 marks) Suggested Answer: Credit is one of the critical inputs for agricultural production; and lack of adequate and cheap source of finance has been a major factor for the depressed condition of Indian agriculture till now. Since independence, various steps have been taken to increase credit facilities to the rural sector. Depending upon the requirements and purpose, the funds needed by the Indian farmers can be categorized into three types. Short terms loans are issued to farmers for the purpose of cultivation or domestic expenses such as buying seeds, manure and fodder for cattle etc. these loans usually are a for a period of 12 to 15 months. Medium term loans are given to farmers to purchase cattle, agricultural implements and to make improvements on land; these loans are limited upto three to five years. Long term loans are given to farmers to purchase land, make improvements on land, pay off old debts and purchase useful machinery for long term usage. These loans are for comparatively longer period since the farmers can repay them gradually over a number of year, say, for 15 to 20 years. The two credit sources available to the farmers are institutional and private. Institutional sources consist of the cooperatives and commercial bank including Regional Rural Banks (RRBS. Non intuitional or private sources include money lenders, traders, commission agents and landlords. Non-institutional sources or private source of farm credit refer to credit supplied by money lenders, landlords and traders. Money lending is often combined with farming by the village money lenders as they lend to farmers for both the productive and non productive purposes charging high rate of interest. They enter larger than actually borrowed sums through false pretences by obtaining promissory notes and give no receipts for repayments and often deny such repayments. The commit give no receipts for repayments and often deny such repayments. They commit many other rogueries and have been responsible for many of the ills of Indian agriculture. Their main interest has been to exploit the farmers and grab their lands. Institutional credit has been introduced to stop such activities of the money lenders. Credit delivery mechanism in Rural Finance : Multi Agency Approach: In all agricultural development programs agricultural credit is one of the most crucial inputs. Private money lenders are the major source for agricultural finance, which is inadequate and highly expensive and exploitative. Since independence, a multi agency approach consisting of cooperatives, commercial banks, and Regional Rural Banks (RRBs) has been adopted to provide timely, adequate and relatively cheap credit to farmers; this is known as institutional credit. The major objective of the credit policy of the Government of India is to provide increasingly institutional credit to small sand marginal farmers to enable them to adopt modern technology and improve agricultural practices and thus increase agricultural production and productivity. Institutional Source of Finance At present three agencies supply institutional finance to farmers. They are to cooperatives, commercial banks and the RRBs The primary agricultural credit societies (PACSs) provide mainly short term loans, and land development banks (LDBs) these are now called cooperative Agricultural and Rural Development Banks (CARDBs) provide long term and medium term loans to the agricultural sector. Agricultural credit to farmers and refinancing to above mentioned banks is provided by the National Bank for Agricultural and Rural Development (NABARD), which is the apex institution for 13

SLBK605 OB /1008 agricultural for agricultural credit at the national level. RBI as the central bank of the country plays a crucial role by giving over all direction to rural credit and financial support to NABARD for its operations. Superiority of Institutional Finance Weaknesses and inadequacy of private agencies to supply credit to farmers aroused the need of institutional credit. Private finance, for example is defective because. a. b. c. it is based on profit motive and, therefore, it is always unfair; It is very expensive, money lenders charge very high rates of interest, and it is not related to productivity of land and; It does not flow into the most desirable channels and is not available to the most needy persons.

The motive of institutional credit is always to maximize the farmers income and raise his productivity. The rate of interest is relatively low compared to money lenders and can be different for different purposes. Institutions also make a clear distinction between short term credit and long term requirements and give loans accordingly. Evolution of Multi Agency Approach in India Much was expected of the cooperative credit movement. As the movement was led by and was for farmers, it was expected to cover all the needs of the farmers. The cooperatives were expected to protect the farmers from the clutches of the moneylenders. A survey for the year 1950-51 shows that the cooperatives met only 3.3 percent of the total requirement of the farmers. Then, State Bank of India (SBI) was set up in 1955 after taking over the imperial bank of India to show special concern for agricultural credit. All India Rural Credit Review Committee (1969) recommended that the adoption of Multi agency Approach was necessary to the rural sector, as banks and societies alone could not meet the needs of farmers. So commercial banks have to play an important role in the rural sector also. This is one of the main reasons for the nationalization of the 14 top commercial banks in 1969. Later in 1976,m the commercial banks were asked to set up RRBs to held the small and marginal farmers and the rural artisans. Thus the multi agency approach to institutional credit to agriculture cooperative societies and cooperative banks, commercial banks and RRBs evolved over a number of years. Problem of Multi Agency Approach Under the chairmanship of C.E. Kamath the committee brought out the problems of Multi Agency approach through it was thought that the approach was the real solution to the emancipation of the poor farmers from the clutches of money lenders. This problems were: There was multiple financing, over-financing in some areas and under financing due to lack of coordination between the agencies in the same area. Despite the adoption of lead bank scheme and district credit plans, the different agencies often failed to formulate and develop meaningful agricultural programs in given blocks and districts. Despite guidelines issued by RBI, different agencies adopted different procedures and policies in the matter of providing loans and their recovery. Role of RBI In Rural Credit The RBI has been taking keen interest in expanding rural credit. It has been taking a series of steps for providing timely and adequate credit through NABARD. The capital base of NABARD has been strengthened with both Government of India and RBI contributing to it. Scheduled commercial banks excluding foreign banks have been forced to supplement NABARD efforts 14

SLBK605 OB /1008 through the stipulation that 40% of the net bank credit should go to the priority sector, out of which at least 18% should flow to agriculture. Besides, it is mandatory that any shortfall in fulfilling the 40% target of the 18% sub target would have to go the corpus of Rural infrastructure Development Fund (RIDF). RBI has also taken steps to strengthen institutional mechanisms such as recapitalization of RRBs and setting up of Local Area Banks (LRBs) 5. Write brief notes on the following. a. b. c. d. Merchant Banking CRR & SLR Priority Sector Landing Camel Rating of Bank. (2.5 * 4=10 marks) Suggested Answer: a. Merchant Banking The increasing industrialization in India, particularly since the last decade has led to higher demands being made on the banking industry as a whole. The enhanced and highly complex, demands placed by indigenous companies on banks and financial institutions have, in turn , caused them to introspect and diversity into new fields. Promotes are often not familiarly with pre/ post establishment formalities, rules, regulations and procedures. Certain aspects relating to availability of finance from All India Financial Institution, import of technology, procedures relating to foreign collaboration etc. may not be clear to the entrepreneur, as he is not always aware of latest developments. As a result of this, merchant banking an entirely new and non traditional field of banking came into existence in this country. Definition : Securities Exchange Board of India (SEBI) defines Merchant Bank as any person who is engaged in the business of issue management either by making arrangement regarding selling, buying or subscribing to securities as a manager, consultant, advisor or rendering corporate advisory services in relation to such issue management. The role of a Merchant banker is seen as a go-getter who represents the clients; i. To the Government authorities for obtaining sanctions and clearances wherever required; ii. To the financial institutions and commercial banks for obtaining sanctions of long term loans and working capital facilities and iii. To the capital market for raising funds from the public. The merchant banker is thus associated with the project right from its conception stage to its successful launching. The genesis of Merchant Banking in India cannot be attributed solely as reaction to increasing industrialization but it was equally a result of efforts made by the banks to augment their profitability. With the spread between income earned as interest on advances and paid on deposits, getting thinner and thinner, banking, the world over is fast moving out of the conventional business of borrowing and lending, looking for more lucrative areas of business which can bring in income by way of fees, brokerage and commission rather than interest margin only. Indian banks are fast diversifying into new activities to augment their profitability, which has been showing a declining tend during the post nationalization era on accounts of various factors comprising regulatory control coupled with the need to comply with social goals. There has been a need to maintain the statutory liquidity ratio and the cash reserve ratio on

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SLBK605 OB /1008 the one hand and the need to comply with the allocation of credit to the priority sector at concessional rates, on the other. Profitability of commercial banks in the public sector also eroded on account of rapid branchy expansion programme and the consequent increase in expenditure on organizational infrastructure. Growing sickness of the Industrial sector and the large increase in non performing assets also contributed heavily towards declining profitability. Public Sector Banks are now given the freedom to innovate themselves in the promotion of variety of financial services by setting up subsidiaries. These services include Merchant Banking, Equipment leasing, venture capital, mutual funds, factoring, housing etc. in their concern toe explore new venues for augmenting their profitability, they have also entered into business areas comprising issuance of credit cards to customers and introductions to consumer credit against consumer durables. The range of services offered by the Merchant Banker in brief are as follows:i. Corporate Finance Services Management of Capital Issues. Credit Syndication ii. Advisory Services Project related services and project counseling. Advising and arranging multi source project finance including offshore finance. Corporate counseling, such as capital restructuring, advising closely held companies on going public Merger / Acquisition with particular reference to sick units

b.

Statutory Liquidity Ratio (SLR) Under Section 24 of the Banking Regulation act 1949 every banking company is required to maintain in cash, gold or unencumbered approved securities an amount not less than 25 percent of its total demand and time liabilities in India. This section was amended in 1983 and after the RBI is empowered to set up this ratio to 40% of net demand and time liabilities so as to compel the scheduled banks to keep a large proportion of their deposit liabilities in liquid assets. SLR is to be maintained on daily basis. SLR has been sued as a credit measure, because it reduces the capacity of commercial banks to create credit and thus help checking inflationary tendencies in the country. By raising SLR, the banks funds get diverted from loans and advances to investment in government and other approved securities. With effect from October 25, 1997, all scheduled commercial banks are required to maintain a uniform SLR of 25%. This change has resulted in the improvement in the profitability of banks as they are able to utilize their funds more profitability in loans and advances. Cash Reserve Requirement A scheduled commercial bank is under an obligation to keep cash reserve with the RBI under Section 42 of the Reserve Bank of India Act, 1934. Every scheduled bank is required to maintain with the RBI an average daily balance of at least 3% of its net demand and time liabilities. RBI is empowered to increase the rate of CRR from 3 to 20% of the net liabilities. CRR has been resorted to credit control measure many times during recent years. This was done to impound the cash resources of the scheduled bank and to reduce their loanable resources. It has not been raised beyond 15% though addition CRR has been imposed for a short period. Presently the CRR is 9%.

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SLBK605 OB /1008 c. The concept of priority sector was first formulated in 1972 on the basis of the report submitted by the informal study group on statistics relating to advances to priority sector constituted by RBI in May 1971. a more detail examination of various categories and sub categories of borrowers, now being classified as priority sector, was undertaken by the krishnaswamy Working Group in 1980.. the group was also evovlved the concept of weaker sections within the segments of priority sector. Targets for scheduled commercial banks (Excluding RRBs) RBI benchmark for allocation of credit for scheduled commercial banks (excluding foreign banks)) are . Overall Credit to Priority Sector : % advances to Net Bank Credit (BC) 40% Agriculture : (Direct & Indirect) % of NBC 18% Indirect Agriculture Advance : Should not be more than 25% of total agricultural lending i.e. 4.5 of NBC Credit Deposit Ratio : of Rural and Semi Urban branches should be minimum 60% Weaker Sections: advances should be minimum 10% of NBC or 25% of total priority sector advances. DRI Advances: should be at least 1% of NBC (outstanding) at the end of previous year: Minimum 2/3 of DRI advances should be given by Rural and Semi Urban Branches, and 40% of DRI advances to Scheme Caste Schedule Tribe Small Scale Industry : Out of total finance available to SSI sector, 40% for units with invest in plant and machinery upto Rs. 5.00 lacs, 20% for units with investment in plant and machinery between Rs. 5.0 lacs and Rs. 25 lacs and 40% other SSI units (S.L. Kapur Committee recommendations) Export Credit : should be minimum 12% of net bank credit 9over and above priority sector advances of 40%) Rural Infrastructure Development Fund: In case of non achievement of agricultural advance target scheduled commercial banks will have to contribute the shortfall subject to maximum of 1.5% of net bank credit, towards Rural infrastructure Development Fund of NABARD at specified interest rate for 5 years. Housing Finance : scheduled commercial banks are required to allocate 3% of their increment deposit for last report Friday of the previous year. Women Beneficiaries : Bank advance to Women Beneficiaries 5% of NBC. Shortfall in achievement of targets for agricultural advances by domestic schedule commercial bank: Domestic banks have to contribute the shortfall with maximum of 1.5% of the credit for a tenor upto 5 years with a graded interest rate structured linked to the Bank rate. Net Bank Credit (NBC): Total Bank Credit FCNR and NRNR Deposits

RBI Benchmark for allocation of credit for Foreign Banks Priority Sector Advances 60% Small Scale Industry advances should not be less than 10% of NBC (within 32%) Export Credit should not be less than 12% of NBC (within 32%) Shortfall in achievement of targets by foreign banks The foreign banks will have to deposit the amount of shortfall in priority sector obligations with SIDBI for a tenor of three years with a graded interest rate structured linked to the bank rate. 17

SLBK605 OB /1008 RBI Benchmark for Allocation of Credit for RRBs Priority Sector Advances : 60% Weaker Section within priority sector 15% Priority Sector Concept & Definitions Small Farmers These are farmers having irrigated land upto 2.5 acres and unirrigated land upto 5 acres (i.e. approx 2 hectares). Marginal Farmers Those having irrigated land upto 1.25 acres and un irrigated land 2.5 acres. Agricultural labourers Those who are engaged in farm activities as labourers and derive 50% or more of their income by working on activities related to agriculture. Non Agricultural Labourers : Those who derive Atleast 50% or more of their income from working as labourers in non agricultural activities. Tenant Croppers Those who take land on lease for cultivation purpose. Share Croppers Those who cultivate others land with condition to share the produce with the owner on an agreed.

d.

Camels Rating for Banks Background The system of inspection of banks by RBI was reviewed in 1991 by a working group chaired by Sh. S. Padmanabhan, which suggested method for on site and off site supervision of the banks. The committee suggested that banks be placed in the following two categories for the purpose of examination, depending on the known and reported condition of the banks in financial operational, management and compliance terms. a. Those that need to be examined on an annual cycle and b. Those that may be examined on a wider time scale say within two years from the date of last examination. For evaluation and rating of Indian Bank, The committee has suggested CAMELS ratings model on the lines of rating model (CMEL) employed by the supervisory authorities in the USA. SIX KEY PARAMETERS RATING CRITERIA

C A M E L S

Capital Adequacy Asset Quality Management Earnings Performance Liquidity Systems & Controls

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SLBK605 OB /1008 RATING PARAMETERS

Ratings A B. C D E

Meaning Indicate fundamental soundness of banks Denotes bank fundamentally should, yet may show modest weaknesses Signifies that bank has combination of both the above. Banks with operation and managerial weaknesses For banks showing critical financial weaknesses that shown symptoms of failure.

Implies Strong Satisfactory Fair Marginal

The rating symbols assigned are A to E which indicate the following. The sum total of the ratings under all six components in aggregate rating. Each of the six parameters is weighted on a scale of 1 to 100 and contain several sub parameters with individual weightage. MICRO ANALYSIS OF PARAMETERS C- Capital Banks capital is rated keeping in view the volume of risk assets, volume of marginal and inferior quality assets, its future prospects and strengths of management. Banks capital rations are also given due consideration. A Asset Quality Asset quality is deemed to be rated in terms of :Asset classification which has been categorized as Sub standard> doubtful and loss; Reduced rates assets; Adequacy of valuation reserve; and Recovery Performance. M Management Factors required for operating a bank within prescribed banking practices and n a safe and sound manner covering aspects like technical competence achievement of corporate mission, adequacy and control. E- Earnings Ability to cover losses and provide capital; Earnings, trends; Comparisons with other peer groups; Quality and compositions of income; and Dividend payment, rate of growth in the retained earnings and adequacy. L Liquidity Rating of Liquidity is reflected by : Volatility of deposits;

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SLBK605 OB /1008 Dependence on interest sensitive funds and level of borrowings; Structure of liabilities and technical competence relating thereto; Availability of assets which are easily convertible into cash; Access to money market and financial resources; Asset liability management Capability of meeting out its liabilities promptly and satisfying legitimate financial requirements of society it serves in accordance with the laid down norms/ policies. FOREIGN BANKS RATINGS While domestic banks are rated on Camels model, foreign banks are rated on CACS Model (Capital adequacy, Assets Quality, Compliance and Systems).

Part C
Case Analysis
6. You are working as a Senior Manager at Regional Office having 30 branches under the jurisdiction of Regional Office. One of the biggest problems being faced is of low profitability. Regional Manager has asked you to design a strategy for your branches highlighting the critical areas; which the branches should focus for increasing profitability.
[

(10 marks) Suggested Answer: Strategy to Increase Profitability With the entry of foreign / private sector banks, competition in the banking sector has intensified putting a severe pressure on profitability, become necessary to focus on profit as a key to survival in the competitive environment. Profitability = Spread + Other Income Other Expenses Where Spread = Interest charges Interest Paid Any exercise on increasing profitability has essentially to concentrate on following critical areas. a. Increasing interest charged. b. Reducing interest paid c. Increasing other income / fee based income

Reducing or rationalization of expenditure. Strategies for increasing interest charged. a. b. change in advances Mix lending to those sectors/ segments where bank can charge higher rate of interest. Reducing NPA and recovery of Bad debts

Plugging of revenue leakages.

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SLBK605 OB /1008 Strategies for Reducing Interest Paid a. Change in deposit Mix (increasing low cost deposits i.e. saving and current deposit) b. Increasing float/ pipe line deposits (as remittance etc.) Strategies for Increasing Other Income a. Increasing non fund based / fee based business. b. Cross Selling of the products. c. Effective Cash Management

d. Investment in high yielding securities. e. Handling of merchant banking business with focus on issue management / float funds and fee based income. Strategies for reducing or rationalization of expenditure a. Regionalizing of expenses such as telephone, electricity, stationary etc.

7.

Discuss and distinguish between the concept of credit and debit cards (10 marks)

Suggested Answer: CREDIT CARDS A credit card can be viewed as a payment mechanism which enables the holder of the card to purchase goods (or services) without parting with immediate cash; and make a one time payment at the end of a specified period (known as the billing cycle which is usually a month) with a provision for spreading this payment over several easy installments. In this way, the card holder manages to postpone the expenditure by usuage of card availing credit from the issuer of the card. It should be noted that credit is given by the issuer of the card and not by the member establishment that had accepted the usage of card on purchase by card holder. Thus we find that credit card is essentially a Pay Later Product along the dimension of time for settlement or payment. Credit cards are a form of consumer loan, a revolving credit account that has a credit line a specific amount that can be borrowed against in part or in full. As the outstanding balance is paid, the available credit line is restored for use again. Debit Card Unlike a credit card which is Pay Later product, a debit card is a Pay now product where the customers account the issuer is immediately debited to the extent of the value of transaction. The debit card program requires a terminal, known as the Point of Sale (POS) terminal, at every point of purchase. The customer, on making the purchases, inserts the card which has a magnetic strip at the back, into the blot of the machine, while the merchant enters the value of transaction. The customer, meanwhile, key in the PIN which is known only to the cardholder and the bank. The machine places an automatic call, checks the balance in the account and the same time, reduces the balance to the extent of the transaction value. The merchants account, in turn, is credited for the transaction value. The merchant benefits by payments which are secured quickly and he has less cash on the premises. For the banks, the advantage lies in minimized risk as the PIN code ensures risk free transactions. Mestro International _a 0:50 joint venture between Euro Pay and Master Card is a major player in the market for debit cards with 200 million debit cards in circulation; and with more than 2,50,000 merchant establishments all over the world. For easy reference, the principal differences between Credit cards and Debit cards are summarized in table below:-

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SLBK605 OB /1008 CREDIT CARDS VS. DEBIT CARDS

Credit Cards Pay later Product Can avail credit for 30-45 days No access to current and saving account Not essential to open a bank account Sophisticated telecommunication network is not required. Holder not required to have amount in the account to the extent of the transaction. Risk of fraud exists

Debit Cards Pay Now Product Instantaneously debits to customers account. Direct access to current and saving account. Essential to open a bank account. Point of sale terminals to be installed at merchant establishment and hence are capital intensive. Bank account must have the required amount to the extent of the transaction.

Risk minimized through PIN based system.

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