Section 5(b) of the Banking Regulation Act,1949 defines Banking as ACCEPTING, FOR THE PURPOSE OF LENDING OR

INVESTMENT, OF DEPOSITS OF MONEY FROM THE PUBLIC, REPAYABLE ON DEMAND OR OTHERWISE AND WITHDRAWABLE BY CHEQUE, DRAFT, ORDER OR OTHERWISE.

Primary / Principal Functions:

1.Accepting

deposits 2.Lending advances

1.Discounting

Secondary / Ancillary Functions:

of bills and cheques 2.Collection of bills and cheques 3.Remittance 4.Safe custody of articles 5.Safe deposit lockers 6.Issue of Letter of Credit and Guarantees.

Section 13 of the Negotiable Instruments Act, 1881defines a negotiable instrument as a

promissory note, bill of exchange or cheque, payable either to order or to bearer

Bill

of Exchange Cheque (Drawer, Drawee, Payee) Difference between Cheque and Exchange

Bill

of

Demand

Time

Saving Deposits Current Deposits

Deposits

Deposits

Non Resident Indian (NRI) Accounts:

Non

Resident External rupee accounts - NRE Non Resident Ordinary rupee accounts - NRO Foreign Currency Non Resident (Banks) accounts FCNR(B)

1)

2)

3) 4)

5)

6)

NRO and NRE accounts can be kept in the form of current, savings or term deposits, but FCNR (B) deposits can be kept in the form of term deposits for a period ranging from 6 months to 3 years. Remittances from abroad can be credited to any of these accounts. But, the earnings of NRIs on the property held by them in India, which are non repatriable, can be credited to only NRO accounts. Money from an NRO account is non repatriable, but NRE and FCNR deposits are repatriable. The entire interest earned on NRO accounts is eligible for repatriation. Persons of Indian nationality who have been NRIs for a period of not less than one year and have returned to India are eligible to open a RFC (Resident Foreign Currency) account. An NRO account may be jointly held with residents. NRE and FCNR accounts cannot be jointly held with residents, but, resident power of attorney is permitted for local payments and investments in India. Balances held in NRE/FCNR are exempted from wealth tax and interest earned is exempted from income tax. There are no tax exemption on interest earned on NRO accounts.

Mandate: It is an unstamped letter signed by the customer, authorizing a person to operate the account on his behalf. Signature of the mandatory should be obtained in the letter of mandate. A letter of mandate is generally issued for a short and temporary period. Power of Attorney: It is a stamped document and generally executed in the presence of a notary/magistrate of a court. Two types of powers are granted special and general power of attorney. Special power of attorney is often for a single transaction and general power of attorney confers an agent very extensive powers. Lien: It is the right of the creditor to retain possession of the goods and securities owned by the debtor until the debt due from the latter is paid.

Retail lending refers to the lending by banks to non corporate borrowers i.e. individuals and small and medium businessmen. The size of these advances would be small, but the number of accounts would be high. A simplistic definition could be banking catering to

the multiple requirements of individuals relating to deposits, advances and associated services

Why focus on Retail Banking? Financial disintermediation Advent of Economic Liberalization Instant solution for the ills in banking

Advantages of retail lending:

The yield is normally high. The risk for the bank is diversified. Advancing to a greater number of customers and helping them in increasing their standard of living. The level of NPA is generally low. Ease of processing the loan proposals.

Dis advantages of retail lending:

The

follow up is difficult since the number of customers is high. Cost of maintenance is high. Personal attention cannot be given.

Knowing the customer Technology issues Product innovation Pricing of product Issues related to human resources. Low-cost and No-cost deposits.

CRM: Basic Concepts:

CRM has three application areas. They are:

Customer Acquisition Customer Value Maximization Customer Retention

CRM: Strategies/ Steps:

Appeal to the self interest of the customers during discussions. Make use of logic and emotional appeal to motivate the customer. Be patient (have self control) with difficult customers. It will pay off in the long run. Formulate more strategies for customer satisfaction. (SWOT) Smile while serving the customer. Importance of Greeting and Meeting.

Customers deposit is a debt for a bank given by him/her and repayable on demand. Firstly, the bank is an customer's debtor and the customer is an unsecured creditor having no claim over banks security. So, the relationship is of Debtor and Unsecured Creditor.

Secondly, when customer takes loan, he/she will become the banks debtor. However, as bank obtains security for the loan, the bank becomes a secured creditor for the customer.
Here, the relationship is of Secured Creditor and Debtor.

Thirdly, when customer deposits securities, valuables for safe custody, the bank is the trustee of these assets and customer remains as owner of these assets.

Relationship here is of a trustee and owner.

Fourthly, when the bank buys or sells securities or pays the utility bills of the customers, the bank becomes customers agent.
Here, the relationship is of agent and principal.

creditor to retain the goods and securities owned by his/her debtor until the debt is repaid.
When bankers lien is applies to a specific debt it is known as particular lien. Ex: Lien on FDs.

Rights of general lien: It is the right of a

to the same customer, the bank may use the credit balance of other account even held in different branches. The bank should take letter in advance from the customer.

Right of setoff: If two or more accounts belong

a customer avails several loans from the bank and when the banker receive payment from the customer, the deciding authority on appropriation lies with debtor (customer). However, in absence of instructions, the bank, as the creditor can exercise the right.

Right to appropriation: Under this right, when

banker has the implied right to charge interest on loans given to customers. Normally, the customer account is debited on and when interest is due from respective accounts. The bank has also right to charge incidental expenses incurred on a current account.

Right to charge interest and levy charges: The

filled to impose this obligation. Such as, - There must be sufficient funds. - All details/rules of cheque should be fulfilled. - Must be presented in proper time.

To honour cheques: Certain conditions to be

Dishonour of cheques should be justified with; If cheque is post-dated/stale cheque. - Crossed, but presented for cash payment. - Bearing alteration. - Presented after banking hours, receipt of stop payment letter, receipt of information regarding death, insolvency, unsound mind.

reflect customers reputation, the banker should - Not disclose any information of the account to a third party. - ensure no such information is leaked. - Prevent such disclosure after closure of accounts. Exceptions: - Required by law. - Practice and usage among bankers.

To maintain secrecy: As financial position can

close the account until or unless he gets a comply with a written directive form the customer to close his/her account. The banker should ask to return unused cheques. When a bank receives any notice on death, insanity, insolvent of customer, it can close the accounts.

to not to close the account: Banker should not

act as a trustee and should oblige the customers in case of collection of cheques and bills. All the documents/procedures should be followed accordingly or otherwise banker has the right to not to collect. Bank should act in good faith without negligence.

To collect cheques and bills: The bank should

Commercial Banks

Scheduled

Non-Scheduled

S B I & its Associates Nationalized Banks IDBI Private Banks Foreign Banks RRBs Co-operative Banks Old Private Banks New Private Banks

1949 1955

REGULATION NATIONALIZATION PHASE - I NATIONALIZATION PHASE - II

INSURANCE COVER TO DEPOSITS

BANKING COMPANIES ACT 1949 SBI SBI SUBSIDIARIES DEPOSIT INSURANCE CORP. NATIOINAL CREDIT COUNCIL 14 MAJOR COMMERCIAL BANKS

1959
1961 1968 1969

SOCIAL CONTROL NATIONALIZATION PHASE - III

1971
1975 1980 1985 1996 1998

CREDIT GUARANTEE
NEW RURAL BANKS NATIONALIZATION PHASE - IV REORGANISATION OF BANKING NEW BANKS REVIEW

CREDIT GAURANTEE CORP.

RRBs 6 COMMERICAL BANKS WITH OVER DEPOSITS OF Rs.200 Cr. PRIVATE BANKS RE-EXAMINATION

1)

2)

Deposit Sources of Funds: Current accounts, Saving accounts and Term deposits etc. Non Deposit Sources of Funds: Capital, Borrowings, Service fees, Cash handling charges, Penalties and Interests etc.

Maturity Cost of Funds Tax Implications Regulatory Framework Market Conditions

Deposit Insurance and Credit Guarantee Corporation (DICGC) was established in 1962. It covers up to Rs.1,00,000 of deposits per customer per bank Certificates of Deposits, Government Deposits, Inter-bank deposits and illegal deposits are not covered.

Current Deposits Savings Deposits Term Deposits Recurring Deposits

Primarily for convenience of operations (for payment & collection). Targeted at business class / institutions / organizations etc. Continuous running A/c. Almost no restrictions on withdrawals. No interest is paid on the balance. Used for routing borrowings. No pass book, only statement. Cheque book facility available.

Targeted at individuals Minimum balance stipulations Limits on number of withdrawals/week Interest paid on balance (at a lower rate (5%) compared to Term Deposits). Pass book facility available Cheque book facility available

Amount deposited for a fixed term (ranging from 7 days to 120 months) The term decided by the customer Interest rates differ from bank to bank Interest rate depends on time/amount slabs (slots) defined by the bank Interest rates may be fixed or floating Interest can be paid quarterly/semiannually/annually or at maturity

Deposits cab be renewed on/or before maturity Normally interest is not paid if the deposit remains with the bank after maturity. However banks have the discretion to pay interest from the date of maturity, if it is renewed later with effect from the maturity date. Penalty for pre-mature closure Loan facility available

A fixed amount is deposited every month Term Deposit Interest Rates apply Term ranges from 12 to 120 months Minimum monthly installments Rs.100 No maximum limit Loan facility up to 90% of value Premature withdrawal attracts penalty

Capital & Reserves Call/Notice Money Domestic Borrowing ECB & FCCB Refinancing - SIDBI for SME - NABARD for Agriculture - IDFC for Infrastructure & - RBI for Export

It is the difference b/w current and projected credit and deposit flows.

Non Deposit sources are costly and risky.

Any changes in cost of funds, indeed requires changes in assets yield to uphold spreads. It could alter the liability mix of banks and expose the bank to liquidity constraints. It could leave the bank less competitive in the market.

Servicing costs versus minimum balance requirements. Deposit volumes and their costs in relation to profits. Lending and investment avenues. Relationship with customers. Promotional Pricing (new product). Product differentiation in a competitive market.

Impact of explicit and implicit prices on Bank Revenues and Costs Bank Cash flows Bank Costs Explicit Prices Interest Payments Gift to customers Implicit Prices Below cost services (e.g. free cheque book issues). More convenience to customers such as branch offices, ATMs and business hours). Minimum balance requirements.

Bank Revenues Service fees such as charges per cheque issued Other fees such as on overdrafts

Restrictions such as limited cheque writing privileges.

1.
2. 3.

4.
5.

Cost plus margin deposit pricing. Market penetration deposit pricing. Conditional pricing. Upscale target pricing. Relationship pricing.

Credit risk

Counterparty default risk Equity risk Securitization risk Concentration risk Interest rate risk Equity price risk Foreign exchange risk Compliance / legal risk Documentation risk Term liquidity risk Withdrawal/Call risk Structural liquidity risk Contingent liquidity risk Market liquidity risk Strategic risk Reputation risk Capital risk Earnings risk Outstanding risk

Market risk

Operational risk Liquidity risk

Other risks

Refers to the negative consequences associated with defaults or non-fulfillment of concluded contracts in lending operations due to deterioration in the counterpartys credit quality.
Counterparty default risk: Refers to the possibility that the other party in an agreement will default. Equity risk (participations): Refers to the possibility of depreciation in the banks investment in the stock market due to adverse price movements of the equity due to company specific factors. Securitization risk: The risk arising out of securitized assets. Securitization is a process of distributing risk by aggregating debt instruments in a pool and then issuing new securities backed by the pool. Concentration risk: A concentration risk is any single exposure or group of exposures with the potential to produce losses large enough to threaten banks health or ability to maintain its core operations.

Refers to the risks which result from price changes in the money and capital markets.
Interest rate risk: Refers to the changes in banks portfolio value due to interest rate fluctuations.
Repricing risk (Fluctuations in interest rate levels that have differing impacts on bank assets and liabilities) Yield curve risk (Changes in portfolio values caused by unanticipated shifts in the slope and shape of yield curve) Basis risk (Imperfect correlation between index rates across different interest rate markets for similar maturities) Optionality risk (Risk arising from interest rate options embedded in a bank asset, liabilities and off balance sheet positions)

Equity price risk: This risk arises due to fluctuations in market price of equity due to general market related factors. Foreign exchange risk: This risk arises due to fluctuations in exchange rates.

The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events is called operational risk. This definition includes legal risk, but excludes strategic and reputational risk.
Compliance / legal risk: This includes, but not limited to exposure to fines, penalties or punitive damages resulting from supervisory actions as well as private settlements. Documentation risk: The unpredictability and uncertainty arising out of improper and insufficient documentation which gives rise to ambiguity regarding the characteristics of the financial contracts.

Liquidity risk arises from a banks inability to meet its obligations when they become due, and refers to situations in which a party is willing but unable to find counterparty to trade on asset. Term liquidity risk: This risk arises due to an unexpected prolongation of the capital commitment period in lending transactions (Unexpected delays in repayments). Withdrawal/call risk: The risk that more credit lines will be drawn or more deposits withdrawn than expected is referred to as withdrawal / call risk. This brings about the risk that the bank will no longer be able to meet its payment obligations without constraints. Structural liquidity risk: This risk arises when the necessary funding transactions cannot be carried out (Or can be carried only on less favourable terms). Contingent liquidity risk: Contingent liquidity risk is the risk associated with finding additional funds or replacing maturing liabilities under potential, future stressed market conditions. Market liquidity risk: This risk arises when positions cannot be sold within a desired time period or can be sold only at a discount.

Strategic risk: Strategic risk refers to negative effects on capital and earnings due to business policy decisions, changes in the economic environment, deficient or insufficient implementation of decisions. Reputation risk: Reputation risk refers to the potential adverse effects which can arise from banks reputation deviating negatively from its expected level. Capital risk: Capital risk results from an imbalance internal capital structure in relation to the nature and size of the bank or from difficulties associated with raising additional risk coverage capital quickly, if necessary. Earnings risk: Earnings risk arises due to the inadequate diversification of a banks earnings structure or its inability to attain a sufficient and lasting level of profitability. Outsourcing risk: Important outsourcing risks are operational disruption risk, data risk, quality risk and reputation risk.

Since risk is statistically defined as the adverse deviation of actual results from expected results, the likelihood of potential adverse outcomes can be modelled using mathematical / statistical techniques. The capital that is estimated to cover the probabilistic assessment of potential future losses is called Economic Capital. Economic capital can be defined as the amount of capital considered necessary by banks to absorb potential losses associated with banking risks such as credit, market, operational and other risks.

Depositors Need assurance that the bank has enough liquid assets to meet all demand made by depositors. There are four ways to provide this assurance. They are: Adequate equity capital Deposit insurance Lender of last resort, and Subordinated debt The Basel Committee on Banking Supervision (BCBS) and the regulators recognized that the capital adequacy is required for the long term stability of the banks.
The two concepts reflects the need of different stakeholders the banks shareholders look to economic capital, while the depositors look to adequacy of regulated capital.

Regulation The

of bank capital began with the 1988 Basel Accord on capital standards.
Japan, Netherlands, Sweden, Switzerland, United Kingdom and United States) signed the accord, which was then intended

G10 countries (Belgium, Canada, France, Germany, Italy,

to apply to only internationally active banks. At that time, its focus was the measurement of capital and the definition of capital standards for credit risk. The definition of capital is broadly set in two tiers:

o Tier I: Shareholders equity and retained earnings o Tier II: Additional internal & external sources available to the bank.

The bank has to hold at least half of its measured capital in Tier I form.

The two principal objectives of the Accord were: To ensure an adequate level of capital in the international banking system. To create a more level playing field in competitive terms so that banks could no longer build volumes without adequate capital backing.

Each bank had its own unique way of measuring, mitigating and managing risk. Hence, there was a need to upgrade Basel Accord I. Structure of Basel Accord II: The new accord is based on three mutually reinforcing pillars, which together are expected to contribute to the safety and soundness of the international financial system. First Pillar : Minimum capital requirement (Taking into account credit risk, market risk and operational risk). Second Pillar: Supervisory Review Process (Strengthening internal processes for linking capital to risk). Third Pillar: Market Discipline (Through enhanced disclosure norms)

First pillar: - Credit risk: Standardized approach - Market risk: the risk of losses in on and off balance sheet positions arising from movements in market prices. Standardized approach. - Operational risk: the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events (Legal risk). Basic indicator approach.

Capital to Risk Weighted Assets Ratio (or Capital Adequacy Ratio) is calculated by:
Capital (Credit Risk Market Risk Operationa l Risk)

Indian banks: Paid up capital Statutory reserves Other disclosed free reserves Capital reserves representing surplus arising out of sale proceeds of assets Innovative Perpetual Debt Instruments Perpetual Non-Cumulative Preference share (PNCPS)

Less: Equity investment in subsidiaries Intangible assets and losses Deferred tax asset Gain/Loss from securitization of Standard assets Minority interests 50% of securitization exposures 50% of investment in excess of 10% of capital of other banks/financial institutions.

Foreign banks: Interest free funds Statutory reserves maintained in India Remittable surplus retained, which in not repatriable as long as bank functions in India Capital reserve representing surplus arising out of sale of assets in India. Interest free funds remitted from abroad for acquisition of property IPDI.

Limits: 15 per cent limit on IPDI of Tier I capital 40 per cent limit on PNCPS along with IPDI IPDI and PNCPS can be included under Tier 2 capital, up to limit allowed in Tier 2 capital.

Both Indian and Foreign banks: Revaluation reserves General provision and loss reserves Hybrid debt capital instruments Subordinated debt IPDI and PNCPS

Less: 50% of securitization exposures 50% of equity investment in financial subsidiaries 50% of the regulatory capital shortfall. 50% of investment in excess of 10% of capital of other banks/financial institutions.

Limits: Hybrid instruments (Upper tier 2) should not exceed 100% of Tier 1 Limit on subordinated debt (Lower tier 2) is 50% of Tier 1 capital.

Reserve requirements are mandatory if the liquidity in the banking system is to be preserved and to avoid any default in repayment to depositors.

Section 42(1) RBI Act, 1934 CRR in cash on their liabilities. Section 24 Banking Regulation Act, 1949 SLR in cash or near cash form.

As CRR aims at taking care of immediate liquidity needs, SLR aims to two; to provide profitability along with liquidity.
CRR & SLR are prescribed as a minimum percentage of NDTL of each bank.

NDTL is broadly two categories of liabilities, which are from the banking system and others.

Includes SBI and its subsidiaries, nationalized banks, co-operative banks, all private sector banks, foreign banks operating in India and any financial institution notified by the central government, such as PDs. Excludes RBI, EXIM, NAMBARD, SIDBI and others such as, credit societies, foreign banks having no branch in India and RRBs.

Includes balances with banks in current accounts, balances with banks and notified financial institutions in other accounts, funds made available to banking system by way of loans or deposits repayable at call or short notice of a fortnight or less and loans other than money at call and short notice made available to the Banking System.

Demand Liabilities include all liabilities which are payable on demand that include current deposits demand liabilities portion of savings bank deposits margins held against letters of credit/guarantees balances in overdue fixed deposits, cash certificates and cumulative/recurring deposits outstanding Telegraphic Transfers (TTs), Mail Transfer (MTs), Demand Drafts (DDs) unclaimed deposits credit balances in the Cash Credit account and deposits held as security for advances which are payable on demand.

Time Liabilities are those which are payable otherwise than on demand that include fixed deposits, cash certificates, cumulative and recurring deposits time liabilities portion of savings bank deposits staff security deposits margin held against letters of credit, if not payable on demand deposits held as securities for advances which are not payable on demand and Gold deposits.

interest

accrued on deposits, bills payable, unpaid dividends Loans/borrowings from abroad banks Money at call and short notice will come under liability to others Remittance facilities (accepting bank and correspondent bank) Gold borrowed by banks from abroad

Paid up capital, reserves, any credit balance in the Profit & Loss Account of the bank, amount of any loan taken from the RBI and the amount of refinance taken from Exim Bank, NHB, NABARD, SIDBI. Amount of provision for income tax in excess of the actual estimated liabilities. Amount received from DICGC towards claims and held by banks pending adjustments thereof. Amount received from ECGC by invoking the guarantee. Inter bank term deposits/term borrowing liabilities of original maturity of 15 days and above and upto one year.

Scheduled Commercial Banks are exempted from maintaining average CRR on the following liabilities : i) Liabilities to the banking system in India as computed under Clause (d) of the Explanation to Section 42(1) of the RBI Act, 1934. ii) Credit balances in ACU (US$) Accounts. iii) Transactions in Collateralized Borrowing and Lending Obligation (CBLO) with Clearing Corporation of India Ltd. (CCIL). iv) Demand and Time Liabilities in respect of their Offshore Banking Units (OBUs).

Therefore, NDTL is the aggregate of liabilities to others and net interbank liabilities (NIBL).
NIBL = liabilities of banking system assets with banking system.

The prescribed CRR is applied on reservable liabilities. Reservable liabilities are the balance of NDTL after deductions of exempted liabilities.
NDTL is measured on every alternate Friday, which are know as Reporting Fridays.

It has to be maintained only as deposits with the RBI or cash balances in the currency chest.
Currency chest is maintained at individual bank premises, however it is deemed to be part of RBI.

Once requirement for cash reserve is done on a reporting Friday, banks have to maintain the calculated cash balance with RBI for the period of a fortnight.
According to latest directives from RBI, banks are required to maintain minimum CRR balance up to 70 per cent of the total CRR requirement on all days of the fortnight. However, on the last day of the fortnight, the total amount of reserves required for fulfilling the CRR requirement has to be maintained without fail.

In cases of default in maintenance of CRR requirement on a daily basis which is presently 70 per cent of the total CRR requirement, penal interest will be recovered for that day at the rate of 3 per cent per annum above the Bank Rate on the amount by which the amount actually maintained falls short of the prescribed minimum on that day and if the shortfall continues on the next succeeding day/s, penal interest will be recovered at a rate of 5 per cent per annum above the Bank Rate.

This is where a minimum investments by banks has to maintain in near cash items. RBI has proposed this to satisfy not only liquidity but also profitability.

Objectives of SLR: Control money supply for credit purposes. Channel bank investments into Govt. Sec. Ensure solvency of banks.

a)

b)

In cash or In gold valued at a price not exceeding the current market price or in unencumbered investments in SLR Securities. ( Dated securities as given by RBI, GOI, All Treasury bills, any other instruments notified in future by RBI for SLR status

It is similar to that of CRR. However, unlike the CRR, there is no flexibility permitted in SLR. Which implies that 100 per cent of the SLR has to be maintained on a daily basis. Penalties is also similar to that of CRR.