Banking and Insurance
Content
BANKING AND INSURANCE
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Learning Objectives
1. 2. What finance is and what is involved in the study of finance. How financial securities can be used to provide financing for borrowers and simultaneously to provide investment opportunities for lenders. 3. How financial systems work in general. 4. The channels of intermediation and the role played by market and financial intermediaries within this system. 5. The basic types of financial instruments that are available and how they are traded. 6. The importance of the global financial system. 7. Why are banks needed . 8. Is it a curse or beneficial for the Economy 9. How are banks and Insurance interrelated. 10. What issues you find in Banking and Insurance sector to be developed CHAPTER 1 - An Introduction to Finance
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The Financial System
CHAPTER 1 - An Introduction to Finance
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Introduction To Banking
Money is a medium of exchange—an agreed upon system for measuring values of goods and services. Money shows how much something is worth.
A bank is a financial intermediary for the safeguarding, transferring, exchanging, or lending of money.
An intermediary is a facilitator acting between parties. Banks facilitate the flow of money throughout our economy. An efficient and sound banking system plays a vital role inn economic growth, intermediating financial flows, supporting the payment system and in the conduct of monetary policy.
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WHAT IS A BANK?
• A bank is a business. • Banks sell their services to earn money. • Banks must earn a profit to survive.
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History Of Banks In the ancient days there existed Goldsmiths, the moneylenders and the merchants, each of these was closely concerned in dealing of money which in the early period was in the form of coins made of precious metals. As these money changers transacted their business sitting on benches they came to be known as ‗banks‘. In India our historical .cultural ,social and economic factors have resulted in the Indian Money market being characterized by the existence of both the unorganized and the organized sectors.
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Unorganized sector- The unorganised sector comprises moneylenders and indigenous bankers which cater to the needs of a large number of people especially in the rural areas.
Organized sector- the organised sectorof the money market comprises specialised banking institutuions like IDBI.SIDBI,NABARD,. This sector also includes the public sector banks,privatesector banks and foreign banks.
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Definition of Banks Banks are institutions that accept various types of deposits and use those funds for granting loans. According to Banking Regulation Act 1949, ―Banking means the accepting ,for the purpose of lending or investment , of deposits of money from the public ,repayable on demand or otherwise, and withdraw able by cheque,draft, order, or otherwise.
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Role of Banks in an Economy
Facilitates the development of trade and industry Facilitates the development of agriculture sector Facilitates the development of service sector Contributes for the balanced growth Encouragement of international trade Implementation of monetary policy Social service
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Structure of Indian Banking System The Indian financial system comprises a large number of commercial and cooperative banks, specialized developmental banks for industry, agriculture ,external trade and housing ,social security institutions, collective investment institutions,. The Indian banking system has the RBI at the apex. It is the central bank of the country under which there are the commercial banks including public sector and private sector banks, foreign banks and the local area banks.
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INDIAN BANKING SYSTEM Reserve Bank Of India
Commercial banks
Regional Rural banks
Cooperative banks State co-operative banks Central/District Cooperative banks
Public sector banks
Private sector banks
Old banks
New banks
Local area banks Primary credit Societies. Nationalized Banks. © South-Western Publishing
State Bank Of India
Growth & Developments in banking Industry
The financial sector reforms introduced strict prudential norms for higher operational efficiency and improved productivity and profitability. They also ushered in healthy competition by allowing new banks in the private sector .These banks brought a paradigm shift in service standards in terms of choices of services offered , the speed of delivery , the superior technology employed by them and their market orientation .
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Recent Developments are:
Banking Sectors: banks have come up with a
whole range of banking products and services to suit the requirements of their clients. Banking sectors include corporate banking , retail banking, international banking and rural banking.
Corporate Banking: Corporate banking typically
serves the financial needs of large corporate houses both domestic and multinational public sectors and governments . Corporate banking services includes: i. Working capital and term loans, overdrafts, bill discounting , project financing.
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ii. Cash management both short term holdings of cash as well as funds held for longer periods. iii. Financing of exports and imports including export credit arrangements. iv. Project finance v. Transmission and receipt of money vi. Handling foreign currency and hedging against changes in value. Retail Banking: Retail banking encompasses deposit and asset linked products as well as other financial services offered to numerous personal banking
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Customers and small businessmen. Retail banking includes : 1.Large number of small customers 2.Multiple products 3.Multiple delivery channels.
International Banking: it is a logical
extension of domestic banking . International banking are delivered for the benefit of nonresidents Indians ,Exporters ,importers ,tourists, foreign entities and banks. It includes:
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1. Banking activities are carried across different geographical borders. 2. Risks in international banking are both pecuniary as well as political. 3. Non-interest income is substantially more than interest income Before nationalization cooperative system was the only agency for dispensing rural credit .In order to address the need of the rural sector, numerous attempts were made including setting up of regional rural banks , schemes for micro finance, primary credit societies
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Rural Banking:
Factors Responsible for Growth of Banking
Banks have taken a new role because of the following reasons: New directions Use of technology Internet banking Mergers and acquisitions Foreign exchange services Corporate ethics and governance. Human Resource Management
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Structural issues Risk management and regulatory implications.
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Reserve Bank of India The central bank of the country--Reserve Bank of India (RBI). Established in April 1935 with a share capital of Rs. 5 crores on the basis of the recommendations of the Hilton Young Commission. The share capital was divided into shares of Rs. 100 each fully paid up which was entirely owned by private shareholders in the beginning.The Government held shares of nominal value of Rs. 2,20,000.Reserve Bank of India was nationalized in the year
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Need for the Reserve Bank
The Bank was constituted for the need of following: To regulate the issue of banknotes To maintain reserves with a view to securing monetary stability and To operate the credit and currency system of the country to its advantage.
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Functions of Reserve Bank of India
Bank of Issue-Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of all denominations. Banker to Government-The second important function of the reserve bank of India is to act as government banker, agent and adviser. RBI carries out banking operations (e.g. to receive and make payments, carry cash reserves) for all governments except J&K—acts as advisor to govt. on all monetary and banking matters.
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Functions of Reserve Bank of India
Bankers' Bank and Lender of the Last Resort The scheduled banks can borrow from the Reserve Bank of India on the basis of eligible securities or get financial accommodation in times of need or stringency. Banks have been asked to keep cash reserves equal to 3 percent of their aggregate deposit liabilities.
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Functions of Reserve Bank of India Controller of Credit-The Reserve Bank of India is the controller of credit i.e. it has the power to influence the volume of credit created by banks in India. It can do so through changing the Bank rate or through open market operations. Controller of money market -The Reserve Bank of India is armed with many more powers to control the Indian money market Custodian of foreign exchange reserves Besides maintaining the rate of exchange of the rupee, the Reserve Bank has to act as the custodian of India.
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Custodian of foreign exchange reserves- Besides maintaining the rate of exchange of the rupee, the Reserve Bank has to act as the custodian of India's reserve of international currencies.
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What is monetary policy? A macroeconomic policy tool used to influence interest rates, inflation, and credit availability through changes in the supply of money available in the economy. In India it is also called the Reserve Bank of India‘s ‘Credit Policy’ as the stress is primarily on directing credit.
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There are two kinds of tools:
Quantitative tools –control the volume of
credit and inflation, indirectly.
Qualitative tools –they control the supply
of money in selective sectors of the economy.
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Bank Rate-Bank Rate is the rate at which RBI allows
finance to commercial banks. Bank Rate is a tool, which RBI uses for short-term purposes. It is the rate at which RBI rediscounts certain defined bills. It has been defined as the varying of the terms and of the conditions, in the broadest sense ,under which the market may have temporary access to the central bank through secured advances. Thus by varying the bank rate upwards or downwards , the central bank can maintain equilibrium in the balance of payments. CRR All scheduled commercial banks are required to maintain a fortnightly minimum average daily cash reserve equivalent with RBI .
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The apex bank is empowered to vary this ratio between 3 and 15 per cent. RBI uses CRR either to impound the excess liquidity or to release funds needed for the economy from time to time.RBI uses CRR to freeze a part of the lendable resources of the banks in order to neutralize the expansionary impact of large fiscal deficits and consequent generation of inflationary pressures. SLR : Every bank is required to maintain at the close of business every day, a minimum proportion of their Net Demand and Time Liabilities as liquid assets in the form of cash, gold and un-encumbered approved securities.
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The ratio of liquid assets to demand and time liabilities is known as Statutory Liquidity Ratio (SLR). RBI is empowered to increase this ratio up to 40%. An increase in SLR also restrict the bank‘s leverage position to pump more money into the economy. SLR stands for Statutory Liquidity Ratio. This term is used by bankers and indicates the minimum percentage of deposits that the bank has to maintain in form of gold, cash or other approved securities. Thus, we can say that it is ratio of cash and some other approved securities to liabilities (deposits) It regulates the credit growth in India.
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An instrument of monetary policy. It involves buying and selling of govt. securities by the RBI to influence the volume of cash reserves with commercial banks and thus influence their loans and advances .To contract the flow of credit ,RBI starts selling govt securities. To increase the credit flow RBI starts purchasing the govt securities. It implies the purchases and sales of Govt. Securities. In addition they are employed for creating and maintaining cheap money conditions on grounds of public policy, as a means of absorbing excess liquid cash or for raising the necessary funds to finance the developmental activities of the state .
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Suppose RBI purchases securities through open market operation this will have effect of injecting more money into circulation. Sellers of the securities will deposit the sale proceeds in their banks thereby increasing the cash reserves of the banks. Conversely sales of securities will be followed by absorption of excess of money in circulation.
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Specifies minimum margins for lending against specific securities Ceiling on amt of credit for certain purposes to stem the flow of credit to speculative and non productive sectors Charges discriminatory rate of interest on certain types of advances
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Credit Rationing
It is employed by central banks as a temporary expedient or an abnormal pressure dictated by special circumstances ,or as a part of comprehensive scheme of national economic planning. Under this method , the central bank rations credit by limiting the amount available to each applicant and restricting rediscounts. The setting of credit quotas is the only decisive method which the central bank has in order to prevent excessive credit demands on the part of business.
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• Direct Action : implies the coercive measures taken by the central bank against individual units of the banking system . it involves direct dealing with individual banks. • Moral Suasion: It implies the friendly persuasion by the central bank . And advice so as to influence the lending policy of banks.
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Risk Management in Banks
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The potential loss an asset or a portfolio is likely to suffer due to a variety of reasons. A condition in which there is a possibility of an adverse deviation from a desired outcome that is expected or hoped for.
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Importance of Risk Management
The importance of risk management can be discussed as follows: 1.For developing appropriate business policies and strategies 2.For effective management of resources. 3.For evaluating and appraising events that can have a bearing on the operation of the business. 4.For qualitative and quantitative assessment of such risks with a view to assist top management make effective decisions concerning innovation.
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Necessity of Risk Management in banks
1.Authority to banks 2.Increased competition 3.Globalization 4.Automation 5.Market disclosure /Tranparency
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RISKS
FINANCIAL RISK NON FINANCIAL RISK
OPERATING RISK
CREDIT RISK
MARKET RISK
SYSTEMATIC RISK POLITICAL RISK
TRANSACTION RISK
INTEREST RATE RISK
HUMAN RISK
PORTFOLIO RISK LIQUIDITY RISK
TECHNOLOGY RISK
FOREX RISK
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Risks Faced by Banks
Credit Risk Market Risk Liquidity Risk Interest Rate Risk Foreign Exchange Risk Operational Risk Solvency Risk
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College of Agricultural Banking, RBI,
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CREDIT RISK Risk that the counterparty will fail to perform or meet the obligation on the agreed terms . It refers to the possibility of the issuer of a debt instrument being unable to honour his interest payments and/or principal repayment obligations . The primary cause of credit risk is poor credit management.
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TYPES OF CREDIT RISKS
Transaction Risk
Risk relating to specific trade transactions, sectors or groups.
Portfolio Risk
Risk arising from lending to sectors non related to the core competencies of the Bank / concentrated credits to a particular sector / lending to a few big borrowers.
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MARKET RISK
Market risk is the risk to a bank’s financial condition that could result from adverse movements in market price. The risk that an un-expected happening ,which is extreme sudden or dramatic will cause an all-round fall in market prices. It signifies the the adverse movement in the market value of trading portfolio during period required to liquidate the transaction
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TYPES OF MARKET RISK Interest Rate Risk
Risk felt, when changes in the interest rate structure put pressure on the net interest margin of the Bank. This risk is
the possibility that assets or liabilities have to be repriced on account of changes in the market rates and its impact on the income of the bank.
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Liquidity Risk: Risk arising due to the potential for
liabilities to drain from the Bank at a faster rate than assets. Liquidity risk is when the bank is unable to meet a financial commitment arising out of a variety of situations. However, there are times when an FI can face a liquidity crisis. When all or many FIs are facing similar abnormally large cash demands, the cost of additional funds rises as their supply becomes restricted or unavailable. Such serious liquidity problems may eventually result in a run in which all liability claimholders seek to withdraw their funds simultaneously from the FI. This turns the FI‘s liquidity problem into a solvency problem and could cause it to fail.
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Forex Risk: To the extent that the returns on domestic and foreign investments are imperfectly correlated, there are potential gains for an FI that expands its asset holdings and liability funding beyond the domestic frontier. One potential benefit from an FI becoming increasingly global in its outlook is the ability to expand abroad directly or to expand a financial asset portfolio to include foreign securities as well as domestic securities. Even so, undiversified foreign expansion exposes an FI to foreign exchange risk in addition to interest rate risk and default risk.
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It offers enormous scope for making profits the other side of the coin is the risk of big losses from unexpected swings in exchange rates.
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NON-FINANCIAL RISKS
Operational Risk :arises as a result of failure of operating system in the bank due to certain reasons like fraudulent activities, natural disaster, human error, omission etc. Systemic Risk: is seen when the failure of one financial institution spreads as chain reaction to threaten the financial stability of the financial system as a whole. Political Risk arises due to introduction of Service tax or increase in income tax, freezing the assets of the bank by the legal authority etc. Human Risk: Labour unrest, lack of motivation, inadequate skills, problems faced by the bank after implementation of VRS lead to Human Risk. Technology Risk: Obsolescence, mismatches, breakdowns, adoption of latest technology by competitors, etc, come under technology risk
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Technology risk: occurs when technological investments do not produce the anticipated cost savings in economies of scale or scope. Diseconomies of scope arise when an FI fails to generate perceived synergies or cost savings through major new technology investments. Operational Risk: Operational risk is partly related to technology risk and can arise whenever existing technology malfunctions or back-office support systems break down. Even though such computer glitches are rare, their occurrence can cause major dislocations in the FIs involved and potentially disrupt the financial system in general.
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Sources Of Risk There are variety of situation that give rise to risk.They are: 1.Decision/Indecision 2.Business Cycles/Seasonality 3.Economic /Fiscal Changes 4.Market preferences 5.Political compulsions 6.Regulations 7.Competition
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8. Technology 9.Non availability of information
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Risk Management Process
The process involves the following steps: 1.Identify risk by each functional area and /corporate policy: to properly identify the risks, the bank must recognize and understand existing risks or risks that may arise from new business initiatives. It should be identified at each transaction and portfolio levels. 2.Categorize risk by Risk profile 3.Anticipate the direction the risk is expected to take within the next twelve months: Direction of risk is the probable change in the aggregate level of risk over the next twelve months and is characterized as decreasing ,stable or increasing.
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If the risk is decreasing , aggregate risk should decline over the next twelve months. If the risk is stable the aggregate risk should remain unchanged. If the risk is increasing , aggregate risk should be expected to be higher in the next twelve months. 4.Elaborate on systems established to monitor risk and the frequency of monitoring: Banks should monitor risk levels to ensure timely review of risk positions and exceptions. Monitoring reports should be timely accurate, and informative and should be distributed to appropriate individuals , to ensure action, when needed .
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5.State policy and /or procedure to control the risk identified: Banks should establish and communicate risk limits through policies ,standards, and procedures that define responsibility and authority.
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Measures to Control Risks
• Market risk- this risk includes the interest rate risk measure Which can be measured by • Gap analysis- it indicates the gap between repricing assets and liabilities and hence indicates the interest rate sensitivity of the entire balance sheet. A typical gap statement would divide the time into buckets of different time periods. These buckets represent the values of maturing and repricing of assets and liabilities.
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Liquidity risk : it is the most difficult risk to measure it can be measured if the risk manager plan for the known demands on the bank regarding scheduled deposit repayments ,tax payments and known loan repayments by different ratios i.e. the ratio of liquid assets of a bank to its total assets ,the ratio of liquid assets to demand deposits and short term borrowings, the ratio of net loans to total deposits which measures the quantum of deposits,etc, ratios must be derived to control liquidity risk. Credit Risk : the risk of counter party defaults has a number of measures:
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Exposures as a percentage to total outstanding, credit ratings also serve as an indicator of the credit risk,& the ratio of impaired loans to total loans serves as an indicator of the credit risk. • Operational Risk: It is harder to quantify and model than market and credit risks, over the past few years improvements in Management information systems and computing technology have opened the way for improved operational risk measurement.
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ASSET LIABILITY MANAGEMENT
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ASSET & LIABILITY MANAGEMENT (ALM) DEFINITION
ALM is continuously arranging and rearranging the assets and liabilities of the bank without infringing the liquidity and safety of the bank and with the purpose of maximizing the bank‘s profits.
ALM [email protected]
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Assets Liability Management
It is a dynamic process of Planning, Organizing & Controlling of Assets & Liabilitiestheir volumes, mixes, maturities, yields and costs in order to maintain liquidity and NII.
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Scope of ALM
Liquidity Risk: Risk arising out of unexpected fluctuation in cash flows from the assets and liabilities – both in banking and trading books. Interest Rate Risk: Risk arising out of fluctuations in the interest rates on assets and liabilities in the banking book. Market Risk: Risk of price fluctuations due to market factors causing changes in the value of the trading portfolio.
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ALM PILLARS
ALM process rests on three pillars: • ALM information systems 1.Management information systems 2.Information availability, accuracy, adequacy and expediency • ALM organization 1.Structure and responsibilities 2.level of top management involvement
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• ALM process 1.Risk parameters 2.Risk identification 3.Risk measurement 4.Risk management 5.Risk policies and tolerance level
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ALM Information Systems ALM has to be supported by a management philosophy which clearly specifies the risk policies and tolerance limits. The central element for the entire ALM exercise is the availability of adequate and accurate information with expedience. It involves analyzing the behavior of asset and liability products in the sample branches accounting for significant business and then making rational assumptions about the way in which assets and liabilities would behave in other branches.
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Yesterday
Tomorrow
Arena
Services Organizatio n & Reporting Data
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ALM [email protected]
ALM Organization
Three-tier organizational set-up for ALM Implementation : 1. Management Committee of the Board (MC) Oversees the ALM implementation by ALCO Reviews the ALM implementation periodically Funding strategies for correcting the mismatches in ALM Statements.
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ALM Organization
2. ASSET-LIABILITY MANAGEMENT COMMITTEE (ALCO): Headed by Executive director. GM ( Nodal officer). GMs : Central Accounts, R&D, Credit, Risk Management, International Banking Division are the members. GM (IT) & AGM (Economist) are the invitees for ALCO meetings.
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3. ALM Support Group:
Consisting of operating staff. Responsible for analyzing. monitoring and reporting the risk profiles to ALCO, prepare forecasts/ simulations on possible changes in market conditions and recommend action on banks limits.
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ALM Process The scope of ALM function can be described as follows: • Liquidity risk management • Management of market risks • Trading risk management • Funding and capital planning • Profit planning and growth projection
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Functions of ALCO:
Monitor the risk levels of the Bank. Articulate the Interest Rate Position & fix interest rate on Deposits & Advances. Fix differential rate of interest rate on Bulk Deposits. Facilitating and coordinating to put in place the ALM System in the Bank.
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I manage
Assets!
% rates, due dates...
RISKS
Liabilities
% rates, due dates...
ALM [email protected]
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Internet
Personal Training Office Automation Computerization
Management Reorganization GAAP
SC of Accounts Deregulations
ALM [email protected]
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Tools of Asset-Liability Management: • • • • Gap Analysis. Duration Gap Analysis. Value at Risk (VaR). Simulation.
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Gap analysis
• The Gap Analysis addresses the problem of impact on net interest income and as such is carried out for the Planning Horizon(one quarter, half year or one year) and confines itself to possible changes in the interest rates occurring during such time horizons. • The starting point for Gap Analysis is to decide on time buckets and identification of interest rate-sensitive assets and liabilities.
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Duration Gap Analysis
Matching the duration of assets and liabilities ,instead of matching the maturity of repricing dates is the most effective way to protect the economic values of the banks Model focuses on managing economic value of banks by recognizing the change in the market value of assets ,liabilities .
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Value at Risk Estimation of maximum potential loss on a given position for a given holding period. Value-at-Risk is a measure of Market Risk, which measures the maximum loss in the market value of a portfolio with a given confidence
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Simulation
Many of the international banks are now using balance sheet simulation models to gauge the effect of market interest rate variations on reported earnings /economic values over different time zones. The simulation involves detailed assessment of the potential effects of changes in interest rate on earnings and economic value.
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TREASURY & FUNDS MANAGEMENT
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Introduction
Traditionally ,the role of the treasury in Indian banks was limited to ensuring the maintenance of the RBI-stipulated norms for cash Reserve ratio (CRR) –which mandates that a minimum proportion of defined liabilities be kept as deposit with the central bank and Statutory liquidity ratio(SLR) –which obliges banks to invest a specified percentages of their liabilities in notified securities issued by the govt. of India and state govt or guaranteed by them .
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An active treasury can arbitrage /earn profit without risk by borrowing cheap and investing high in money,forex and bond markets. Another key function of the treasury is asset –liability management and hedging/insulating the banks balance sheet from interest and exchange rate fluctuations. The sources of profits of treasury are:
1.Investments- where a bank earns a higher yield than its cost of funds. 2.Spreads- Between yields on money market assets and money market funding For eg. The bank may borrow short term for 5% and deploy in commercial paper with returns of 6%
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3.Arbitrage- is a buy / sell swap in the forex market, where the bank converts its rupee funds in to a dollar deposit. 4. Trading – In this the focus is entirely on short term , as opposed to investment which is long term. The aim is to earn trading profits from movements in security and forex prices during a day or a few days of trading 5. Customer services- bank treasuries offer their products and services to customers/non- banking customers
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Bank Treasuries may have the following departments: A Fixed Income or Money Market desk that is devoted to buying and selling interest bearing securities A Foreign exchange or "FX" desk that buys and sells currencies A Capital Markets or Equities desk that deals in shares listed on the stock market.
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Objectives of Treasury
Treasury of a commercial bank undertakes various operations in fulfillment of the following objectives: To take advantage of the attractive trading and arbitrage opportunities in the bond and forex markets. To deploy and invest the deposit liabilities, internal generation and cash flows from maturing assets for maximum return on a current and forward basis To fund the balance sheet on current and forward basis as cheaply as possible taking into account the marginal impact of these actions.
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To effectively mange the forex assets and
liabilities of the bank To manage and contain the treasury risks of the bank within the approved and prudential norms To assess , advise and manage the financial risks associated with assets and liabilities of the bank. To adopt best practices in dealing ,clearing, settlement and risk management in treasury operations .
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To maintain statutory reserves-CRR and SLR as mandated by the RBI on current and forward planning basis. To offer comprehensive value- added treasury and related services to the banks customers To act as profit centre for the bank.
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Organizational Structure Organizational structure of a commercial bank treasury should facilitate the handling of all market operations , from dealing to settlement ,custody and accounting in both domestic and foreign exchange markets. Front Office – Risk taking Mid office : risk management and management information Back –Office : Confirmations,settlements,accounting and reconciliation
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Front Office Front office of a treasury has a responsibility to manage investment and market risks in accordance with instructions received from the banks ALCO. This is undertaken through the dealing room which acts as the banks interface to international and domestic financial markets . It is the clearing house for risk and has the responsibility to manage the treasury risks taken in all areas of the bank , on behalf of customers and on behalf of the bank ,within the policies and limits prescribed by the board and risk management committee.
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MID OFFICE Mid –office is responsible for onsite risk measurement ,monitoring and management reporting. The other functions of Mid-office are: 1.Limit setting and monitoring exposures in relation to limits. 2.Assessing likely market movements based on internal assessments and external/internal research. 3.Evolving hedging strategies for assets and liabilities
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4.Interacting with banks risk management department on liquidity and market risk. 5.Risk –return analysis 6.Stress testing and back testing of investment and trading portfolios.
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Back Office Functions The key functions of back office are: 1.Deal slip verification 2.Generation and dispatch of interbank confirmations 3.Monitoring receipt of confirmations from counterparty banks 4.Effecting/receiving payments 5.Accounting 6.Monitoring receipt of funds in interbank contracts.
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Functions of a Treasurer
Treasury operations of a commercial bank consist mainly of two vital functions: Ensuring strict compliance with the statutory requirements of maintaining the stipulated cash reserve ratio and SLR. Liquidity management by 1.Ensuring the optimum utilization of the residual resources through investments 2.Raising additional resources required for meeting credit demands at optimal cost. 3. Managing market and liquidity risks in the transactions.
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Domestic Operations
1.Maintenance of statutory reserves 2.Managing Liquidity
Forex Operations
1.Extending cover to foreign
2.Funding and managing forex assets and liabilities 3.Providing hedge to forex risks proprietary and for its constituents 4.Trading and arbitrage
3. Profitability deployment reserves
4. Trading and arbitrate
5.Hedge and cover operations 5.Mid/Back office functions
6.Mid/Back- office function
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Responsibilities of a Treasurer In today's highly competitive environment , the treasury plays a vital role in the viability and success of a bank and calls for effective internal and external interface. Balance sheet management Liquidity management Reserves management Funds management Investments management Technology and operations , risk management , Trading activities and offering hedge products.
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Major Reforms /Special issues in the Indian Banking Sector
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NARSIMHAM COMMITTEE I & II
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About the committee • 1991 -RBI proposed the committee chaired by M. Narasimham, former RBI Governor to review the Financial System •‡ Review- aspects relating to the Structure, Organization, Procedures and Functioning of the financial system • Constituted in 1991, the Committee submitted two reports, in 1992 and 1998, which laid significant thrust on enhancing the efficiency and viability of the banking sector • The Narasimham Committee laid the foundation for the reformation of the Indian banking sector
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The main recommendations of the Committee were: • Reduction of Statutory Liquidity Ratio (SLR) to 25 per cent over a
period of five years • Progressive reduction in Cash Reserve Ratio (CRR) to 3-5% • Phasing out of directed credit programme and redefinition of the priority sector • Stipulation of minimum capital adequacy ratio of 8 per cent by March 1996. (Capital adequacy ratios ("CAR") are a measure of the amount of a bank's capital expressed as a percentage of its risk weighted credit exposures.)
• Adoption of uniform accounting practices in regard to income
recognition, asset classification and provisioning against bad and doubtful debts
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CONTD
• Setting up of special tribunals to speed up the recovery process of
loans • Setting up of Asset Reconstruction Funds (ARFs) to take over from banks a portion of their bad and doubtful advances at a discount • Abolition of branch licensing • Liberalizing the policy with regard to allowing foreign banks to open offices in India • Giving freedom to individual banks to recruit officers • Revised procedure for selection of Chief Executives and Directors of Boards of public sector banks • Speedy liberalization of capital market • Enactment of a separate legislation providing appropriate legal framework for mutual funds and laying down prudential norms for such institutions, etc.
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Committee On Banking Sector Reforms 1998
• 1998- Finance minister appointed Mr. Narasimham as
chairman of one more committee. • This committee was asked to ―review the progress of banking sector reforms to date and a programme on financial sector reforms to strengthen India's financial system and make it internationally competitive‖. • The committee submitted its report to the government in April 1998. • The report covered issues like- capital adequacy, bank mergers, recasting bank board, and creation of global sized banks.
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Learning Objectives
1. 2. What finance is and what is involved in the study of finance. How financial securities can be used to provide financing for borrowers and simultaneously to provide investment opportunities for lenders. 3. How financial systems work in general. 4. The channels of intermediation and the role played by market and financial intermediaries within this system. 5. The basic types of financial instruments that are available and how they are traded. 6. The importance of the global financial system. 7. Why are banks needed . 8. Is it a curse or beneficial for the Economy 9. How are banks and Insurance interrelated. 10. What issues you find in Banking and Insurance sector to be developed CHAPTER 1 - An Introduction to Finance
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The Financial System
CHAPTER 1 - An Introduction to Finance
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Introduction To Banking
Money is a medium of exchange—an agreed upon system for measuring values of goods and services. Money shows how much something is worth.
A bank is a financial intermediary for the safeguarding, transferring, exchanging, or lending of money.
An intermediary is a facilitator acting between parties. Banks facilitate the flow of money throughout our economy. An efficient and sound banking system plays a vital role inn economic growth, intermediating financial flows, supporting the payment system and in the conduct of monetary policy.
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WHAT IS A BANK?
• A bank is a business. • Banks sell their services to earn money. • Banks must earn a profit to survive.
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History Of Banks In the ancient days there existed Goldsmiths, the moneylenders and the merchants, each of these was closely concerned in dealing of money which in the early period was in the form of coins made of precious metals. As these money changers transacted their business sitting on benches they came to be known as ‗banks‘. In India our historical .cultural ,social and economic factors have resulted in the Indian Money market being characterized by the existence of both the unorganized and the organized sectors.
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Unorganized sector- The unorganised sector comprises moneylenders and indigenous bankers which cater to the needs of a large number of people especially in the rural areas.
Organized sector- the organised sectorof the money market comprises specialised banking institutuions like IDBI.SIDBI,NABARD,. This sector also includes the public sector banks,privatesector banks and foreign banks.
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Definition of Banks Banks are institutions that accept various types of deposits and use those funds for granting loans. According to Banking Regulation Act 1949, ―Banking means the accepting ,for the purpose of lending or investment , of deposits of money from the public ,repayable on demand or otherwise, and withdraw able by cheque,draft, order, or otherwise.
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Role of Banks in an Economy
Facilitates the development of trade and industry Facilitates the development of agriculture sector Facilitates the development of service sector Contributes for the balanced growth Encouragement of international trade Implementation of monetary policy Social service
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Structure of Indian Banking System The Indian financial system comprises a large number of commercial and cooperative banks, specialized developmental banks for industry, agriculture ,external trade and housing ,social security institutions, collective investment institutions,. The Indian banking system has the RBI at the apex. It is the central bank of the country under which there are the commercial banks including public sector and private sector banks, foreign banks and the local area banks.
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INDIAN BANKING SYSTEM Reserve Bank Of India
Commercial banks
Regional Rural banks
Cooperative banks State co-operative banks Central/District Cooperative banks
Public sector banks
Private sector banks
Old banks
New banks
Local area banks Primary credit Societies. Nationalized Banks. © South-Western Publishing
State Bank Of India
Growth & Developments in banking Industry
The financial sector reforms introduced strict prudential norms for higher operational efficiency and improved productivity and profitability. They also ushered in healthy competition by allowing new banks in the private sector .These banks brought a paradigm shift in service standards in terms of choices of services offered , the speed of delivery , the superior technology employed by them and their market orientation .
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Recent Developments are:
Banking Sectors: banks have come up with a
whole range of banking products and services to suit the requirements of their clients. Banking sectors include corporate banking , retail banking, international banking and rural banking.
Corporate Banking: Corporate banking typically
serves the financial needs of large corporate houses both domestic and multinational public sectors and governments . Corporate banking services includes: i. Working capital and term loans, overdrafts, bill discounting , project financing.
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ii. Cash management both short term holdings of cash as well as funds held for longer periods. iii. Financing of exports and imports including export credit arrangements. iv. Project finance v. Transmission and receipt of money vi. Handling foreign currency and hedging against changes in value. Retail Banking: Retail banking encompasses deposit and asset linked products as well as other financial services offered to numerous personal banking
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Customers and small businessmen. Retail banking includes : 1.Large number of small customers 2.Multiple products 3.Multiple delivery channels.
International Banking: it is a logical
extension of domestic banking . International banking are delivered for the benefit of nonresidents Indians ,Exporters ,importers ,tourists, foreign entities and banks. It includes:
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1. Banking activities are carried across different geographical borders. 2. Risks in international banking are both pecuniary as well as political. 3. Non-interest income is substantially more than interest income Before nationalization cooperative system was the only agency for dispensing rural credit .In order to address the need of the rural sector, numerous attempts were made including setting up of regional rural banks , schemes for micro finance, primary credit societies
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Rural Banking:
Factors Responsible for Growth of Banking
Banks have taken a new role because of the following reasons: New directions Use of technology Internet banking Mergers and acquisitions Foreign exchange services Corporate ethics and governance. Human Resource Management
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Structural issues Risk management and regulatory implications.
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Reserve Bank of India The central bank of the country--Reserve Bank of India (RBI). Established in April 1935 with a share capital of Rs. 5 crores on the basis of the recommendations of the Hilton Young Commission. The share capital was divided into shares of Rs. 100 each fully paid up which was entirely owned by private shareholders in the beginning.The Government held shares of nominal value of Rs. 2,20,000.Reserve Bank of India was nationalized in the year
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Need for the Reserve Bank
The Bank was constituted for the need of following: To regulate the issue of banknotes To maintain reserves with a view to securing monetary stability and To operate the credit and currency system of the country to its advantage.
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Functions of Reserve Bank of India
Bank of Issue-Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of all denominations. Banker to Government-The second important function of the reserve bank of India is to act as government banker, agent and adviser. RBI carries out banking operations (e.g. to receive and make payments, carry cash reserves) for all governments except J&K—acts as advisor to govt. on all monetary and banking matters.
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Functions of Reserve Bank of India
Bankers' Bank and Lender of the Last Resort The scheduled banks can borrow from the Reserve Bank of India on the basis of eligible securities or get financial accommodation in times of need or stringency. Banks have been asked to keep cash reserves equal to 3 percent of their aggregate deposit liabilities.
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Functions of Reserve Bank of India Controller of Credit-The Reserve Bank of India is the controller of credit i.e. it has the power to influence the volume of credit created by banks in India. It can do so through changing the Bank rate or through open market operations. Controller of money market -The Reserve Bank of India is armed with many more powers to control the Indian money market Custodian of foreign exchange reserves Besides maintaining the rate of exchange of the rupee, the Reserve Bank has to act as the custodian of India.
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Custodian of foreign exchange reserves- Besides maintaining the rate of exchange of the rupee, the Reserve Bank has to act as the custodian of India's reserve of international currencies.
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What is monetary policy? A macroeconomic policy tool used to influence interest rates, inflation, and credit availability through changes in the supply of money available in the economy. In India it is also called the Reserve Bank of India‘s ‘Credit Policy’ as the stress is primarily on directing credit.
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There are two kinds of tools:
Quantitative tools –control the volume of
credit and inflation, indirectly.
Qualitative tools –they control the supply
of money in selective sectors of the economy.
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Bank Rate-Bank Rate is the rate at which RBI allows
finance to commercial banks. Bank Rate is a tool, which RBI uses for short-term purposes. It is the rate at which RBI rediscounts certain defined bills. It has been defined as the varying of the terms and of the conditions, in the broadest sense ,under which the market may have temporary access to the central bank through secured advances. Thus by varying the bank rate upwards or downwards , the central bank can maintain equilibrium in the balance of payments. CRR All scheduled commercial banks are required to maintain a fortnightly minimum average daily cash reserve equivalent with RBI .
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The apex bank is empowered to vary this ratio between 3 and 15 per cent. RBI uses CRR either to impound the excess liquidity or to release funds needed for the economy from time to time.RBI uses CRR to freeze a part of the lendable resources of the banks in order to neutralize the expansionary impact of large fiscal deficits and consequent generation of inflationary pressures. SLR : Every bank is required to maintain at the close of business every day, a minimum proportion of their Net Demand and Time Liabilities as liquid assets in the form of cash, gold and un-encumbered approved securities.
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The ratio of liquid assets to demand and time liabilities is known as Statutory Liquidity Ratio (SLR). RBI is empowered to increase this ratio up to 40%. An increase in SLR also restrict the bank‘s leverage position to pump more money into the economy. SLR stands for Statutory Liquidity Ratio. This term is used by bankers and indicates the minimum percentage of deposits that the bank has to maintain in form of gold, cash or other approved securities. Thus, we can say that it is ratio of cash and some other approved securities to liabilities (deposits) It regulates the credit growth in India.
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An instrument of monetary policy. It involves buying and selling of govt. securities by the RBI to influence the volume of cash reserves with commercial banks and thus influence their loans and advances .To contract the flow of credit ,RBI starts selling govt securities. To increase the credit flow RBI starts purchasing the govt securities. It implies the purchases and sales of Govt. Securities. In addition they are employed for creating and maintaining cheap money conditions on grounds of public policy, as a means of absorbing excess liquid cash or for raising the necessary funds to finance the developmental activities of the state .
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Suppose RBI purchases securities through open market operation this will have effect of injecting more money into circulation. Sellers of the securities will deposit the sale proceeds in their banks thereby increasing the cash reserves of the banks. Conversely sales of securities will be followed by absorption of excess of money in circulation.
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Specifies minimum margins for lending against specific securities Ceiling on amt of credit for certain purposes to stem the flow of credit to speculative and non productive sectors Charges discriminatory rate of interest on certain types of advances
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Credit Rationing
It is employed by central banks as a temporary expedient or an abnormal pressure dictated by special circumstances ,or as a part of comprehensive scheme of national economic planning. Under this method , the central bank rations credit by limiting the amount available to each applicant and restricting rediscounts. The setting of credit quotas is the only decisive method which the central bank has in order to prevent excessive credit demands on the part of business.
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• Direct Action : implies the coercive measures taken by the central bank against individual units of the banking system . it involves direct dealing with individual banks. • Moral Suasion: It implies the friendly persuasion by the central bank . And advice so as to influence the lending policy of banks.
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Risk Management in Banks
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The potential loss an asset or a portfolio is likely to suffer due to a variety of reasons. A condition in which there is a possibility of an adverse deviation from a desired outcome that is expected or hoped for.
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Importance of Risk Management
The importance of risk management can be discussed as follows: 1.For developing appropriate business policies and strategies 2.For effective management of resources. 3.For evaluating and appraising events that can have a bearing on the operation of the business. 4.For qualitative and quantitative assessment of such risks with a view to assist top management make effective decisions concerning innovation.
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Necessity of Risk Management in banks
1.Authority to banks 2.Increased competition 3.Globalization 4.Automation 5.Market disclosure /Tranparency
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RISKS
FINANCIAL RISK NON FINANCIAL RISK
OPERATING RISK
CREDIT RISK
MARKET RISK
SYSTEMATIC RISK POLITICAL RISK
TRANSACTION RISK
INTEREST RATE RISK
HUMAN RISK
PORTFOLIO RISK LIQUIDITY RISK
TECHNOLOGY RISK
FOREX RISK
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Risks Faced by Banks
Credit Risk Market Risk Liquidity Risk Interest Rate Risk Foreign Exchange Risk Operational Risk Solvency Risk
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College of Agricultural Banking, RBI,
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CREDIT RISK Risk that the counterparty will fail to perform or meet the obligation on the agreed terms . It refers to the possibility of the issuer of a debt instrument being unable to honour his interest payments and/or principal repayment obligations . The primary cause of credit risk is poor credit management.
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TYPES OF CREDIT RISKS
Transaction Risk
Risk relating to specific trade transactions, sectors or groups.
Portfolio Risk
Risk arising from lending to sectors non related to the core competencies of the Bank / concentrated credits to a particular sector / lending to a few big borrowers.
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MARKET RISK
Market risk is the risk to a bank’s financial condition that could result from adverse movements in market price. The risk that an un-expected happening ,which is extreme sudden or dramatic will cause an all-round fall in market prices. It signifies the the adverse movement in the market value of trading portfolio during period required to liquidate the transaction
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TYPES OF MARKET RISK Interest Rate Risk
Risk felt, when changes in the interest rate structure put pressure on the net interest margin of the Bank. This risk is
the possibility that assets or liabilities have to be repriced on account of changes in the market rates and its impact on the income of the bank.
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Liquidity Risk: Risk arising due to the potential for
liabilities to drain from the Bank at a faster rate than assets. Liquidity risk is when the bank is unable to meet a financial commitment arising out of a variety of situations. However, there are times when an FI can face a liquidity crisis. When all or many FIs are facing similar abnormally large cash demands, the cost of additional funds rises as their supply becomes restricted or unavailable. Such serious liquidity problems may eventually result in a run in which all liability claimholders seek to withdraw their funds simultaneously from the FI. This turns the FI‘s liquidity problem into a solvency problem and could cause it to fail.
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Forex Risk: To the extent that the returns on domestic and foreign investments are imperfectly correlated, there are potential gains for an FI that expands its asset holdings and liability funding beyond the domestic frontier. One potential benefit from an FI becoming increasingly global in its outlook is the ability to expand abroad directly or to expand a financial asset portfolio to include foreign securities as well as domestic securities. Even so, undiversified foreign expansion exposes an FI to foreign exchange risk in addition to interest rate risk and default risk.
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It offers enormous scope for making profits the other side of the coin is the risk of big losses from unexpected swings in exchange rates.
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NON-FINANCIAL RISKS
Operational Risk :arises as a result of failure of operating system in the bank due to certain reasons like fraudulent activities, natural disaster, human error, omission etc. Systemic Risk: is seen when the failure of one financial institution spreads as chain reaction to threaten the financial stability of the financial system as a whole. Political Risk arises due to introduction of Service tax or increase in income tax, freezing the assets of the bank by the legal authority etc. Human Risk: Labour unrest, lack of motivation, inadequate skills, problems faced by the bank after implementation of VRS lead to Human Risk. Technology Risk: Obsolescence, mismatches, breakdowns, adoption of latest technology by competitors, etc, come under technology risk
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Technology risk: occurs when technological investments do not produce the anticipated cost savings in economies of scale or scope. Diseconomies of scope arise when an FI fails to generate perceived synergies or cost savings through major new technology investments. Operational Risk: Operational risk is partly related to technology risk and can arise whenever existing technology malfunctions or back-office support systems break down. Even though such computer glitches are rare, their occurrence can cause major dislocations in the FIs involved and potentially disrupt the financial system in general.
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Sources Of Risk There are variety of situation that give rise to risk.They are: 1.Decision/Indecision 2.Business Cycles/Seasonality 3.Economic /Fiscal Changes 4.Market preferences 5.Political compulsions 6.Regulations 7.Competition
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8. Technology 9.Non availability of information
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Risk Management Process
The process involves the following steps: 1.Identify risk by each functional area and /corporate policy: to properly identify the risks, the bank must recognize and understand existing risks or risks that may arise from new business initiatives. It should be identified at each transaction and portfolio levels. 2.Categorize risk by Risk profile 3.Anticipate the direction the risk is expected to take within the next twelve months: Direction of risk is the probable change in the aggregate level of risk over the next twelve months and is characterized as decreasing ,stable or increasing.
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If the risk is decreasing , aggregate risk should decline over the next twelve months. If the risk is stable the aggregate risk should remain unchanged. If the risk is increasing , aggregate risk should be expected to be higher in the next twelve months. 4.Elaborate on systems established to monitor risk and the frequency of monitoring: Banks should monitor risk levels to ensure timely review of risk positions and exceptions. Monitoring reports should be timely accurate, and informative and should be distributed to appropriate individuals , to ensure action, when needed .
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5.State policy and /or procedure to control the risk identified: Banks should establish and communicate risk limits through policies ,standards, and procedures that define responsibility and authority.
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Measures to Control Risks
• Market risk- this risk includes the interest rate risk measure Which can be measured by • Gap analysis- it indicates the gap between repricing assets and liabilities and hence indicates the interest rate sensitivity of the entire balance sheet. A typical gap statement would divide the time into buckets of different time periods. These buckets represent the values of maturing and repricing of assets and liabilities.
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Liquidity risk : it is the most difficult risk to measure it can be measured if the risk manager plan for the known demands on the bank regarding scheduled deposit repayments ,tax payments and known loan repayments by different ratios i.e. the ratio of liquid assets of a bank to its total assets ,the ratio of liquid assets to demand deposits and short term borrowings, the ratio of net loans to total deposits which measures the quantum of deposits,etc, ratios must be derived to control liquidity risk. Credit Risk : the risk of counter party defaults has a number of measures:
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Exposures as a percentage to total outstanding, credit ratings also serve as an indicator of the credit risk,& the ratio of impaired loans to total loans serves as an indicator of the credit risk. • Operational Risk: It is harder to quantify and model than market and credit risks, over the past few years improvements in Management information systems and computing technology have opened the way for improved operational risk measurement.
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ASSET LIABILITY MANAGEMENT
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ASSET & LIABILITY MANAGEMENT (ALM) DEFINITION
ALM is continuously arranging and rearranging the assets and liabilities of the bank without infringing the liquidity and safety of the bank and with the purpose of maximizing the bank‘s profits.
ALM [email protected]
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Assets Liability Management
It is a dynamic process of Planning, Organizing & Controlling of Assets & Liabilitiestheir volumes, mixes, maturities, yields and costs in order to maintain liquidity and NII.
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Scope of ALM
Liquidity Risk: Risk arising out of unexpected fluctuation in cash flows from the assets and liabilities – both in banking and trading books. Interest Rate Risk: Risk arising out of fluctuations in the interest rates on assets and liabilities in the banking book. Market Risk: Risk of price fluctuations due to market factors causing changes in the value of the trading portfolio.
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ALM PILLARS
ALM process rests on three pillars: • ALM information systems 1.Management information systems 2.Information availability, accuracy, adequacy and expediency • ALM organization 1.Structure and responsibilities 2.level of top management involvement
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• ALM process 1.Risk parameters 2.Risk identification 3.Risk measurement 4.Risk management 5.Risk policies and tolerance level
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ALM Information Systems ALM has to be supported by a management philosophy which clearly specifies the risk policies and tolerance limits. The central element for the entire ALM exercise is the availability of adequate and accurate information with expedience. It involves analyzing the behavior of asset and liability products in the sample branches accounting for significant business and then making rational assumptions about the way in which assets and liabilities would behave in other branches.
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Yesterday
Tomorrow
Arena
Services Organizatio n & Reporting Data
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ALM [email protected]
ALM Organization
Three-tier organizational set-up for ALM Implementation : 1. Management Committee of the Board (MC) Oversees the ALM implementation by ALCO Reviews the ALM implementation periodically Funding strategies for correcting the mismatches in ALM Statements.
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ALM Organization
2. ASSET-LIABILITY MANAGEMENT COMMITTEE (ALCO): Headed by Executive director. GM ( Nodal officer). GMs : Central Accounts, R&D, Credit, Risk Management, International Banking Division are the members. GM (IT) & AGM (Economist) are the invitees for ALCO meetings.
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3. ALM Support Group:
Consisting of operating staff. Responsible for analyzing. monitoring and reporting the risk profiles to ALCO, prepare forecasts/ simulations on possible changes in market conditions and recommend action on banks limits.
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ALM Process The scope of ALM function can be described as follows: • Liquidity risk management • Management of market risks • Trading risk management • Funding and capital planning • Profit planning and growth projection
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Functions of ALCO:
Monitor the risk levels of the Bank. Articulate the Interest Rate Position & fix interest rate on Deposits & Advances. Fix differential rate of interest rate on Bulk Deposits. Facilitating and coordinating to put in place the ALM System in the Bank.
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I manage
Assets!
% rates, due dates...
RISKS
Liabilities
% rates, due dates...
ALM [email protected]
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Internet
Personal Training Office Automation Computerization
Management Reorganization GAAP
SC of Accounts Deregulations
ALM [email protected]
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Tools of Asset-Liability Management: • • • • Gap Analysis. Duration Gap Analysis. Value at Risk (VaR). Simulation.
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Gap analysis
• The Gap Analysis addresses the problem of impact on net interest income and as such is carried out for the Planning Horizon(one quarter, half year or one year) and confines itself to possible changes in the interest rates occurring during such time horizons. • The starting point for Gap Analysis is to decide on time buckets and identification of interest rate-sensitive assets and liabilities.
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Duration Gap Analysis
Matching the duration of assets and liabilities ,instead of matching the maturity of repricing dates is the most effective way to protect the economic values of the banks Model focuses on managing economic value of banks by recognizing the change in the market value of assets ,liabilities .
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Value at Risk Estimation of maximum potential loss on a given position for a given holding period. Value-at-Risk is a measure of Market Risk, which measures the maximum loss in the market value of a portfolio with a given confidence
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Simulation
Many of the international banks are now using balance sheet simulation models to gauge the effect of market interest rate variations on reported earnings /economic values over different time zones. The simulation involves detailed assessment of the potential effects of changes in interest rate on earnings and economic value.
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TREASURY & FUNDS MANAGEMENT
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Introduction
Traditionally ,the role of the treasury in Indian banks was limited to ensuring the maintenance of the RBI-stipulated norms for cash Reserve ratio (CRR) –which mandates that a minimum proportion of defined liabilities be kept as deposit with the central bank and Statutory liquidity ratio(SLR) –which obliges banks to invest a specified percentages of their liabilities in notified securities issued by the govt. of India and state govt or guaranteed by them .
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An active treasury can arbitrage /earn profit without risk by borrowing cheap and investing high in money,forex and bond markets. Another key function of the treasury is asset –liability management and hedging/insulating the banks balance sheet from interest and exchange rate fluctuations. The sources of profits of treasury are:
1.Investments- where a bank earns a higher yield than its cost of funds. 2.Spreads- Between yields on money market assets and money market funding For eg. The bank may borrow short term for 5% and deploy in commercial paper with returns of 6%
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3.Arbitrage- is a buy / sell swap in the forex market, where the bank converts its rupee funds in to a dollar deposit. 4. Trading – In this the focus is entirely on short term , as opposed to investment which is long term. The aim is to earn trading profits from movements in security and forex prices during a day or a few days of trading 5. Customer services- bank treasuries offer their products and services to customers/non- banking customers
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Bank Treasuries may have the following departments: A Fixed Income or Money Market desk that is devoted to buying and selling interest bearing securities A Foreign exchange or "FX" desk that buys and sells currencies A Capital Markets or Equities desk that deals in shares listed on the stock market.
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Objectives of Treasury
Treasury of a commercial bank undertakes various operations in fulfillment of the following objectives: To take advantage of the attractive trading and arbitrage opportunities in the bond and forex markets. To deploy and invest the deposit liabilities, internal generation and cash flows from maturing assets for maximum return on a current and forward basis To fund the balance sheet on current and forward basis as cheaply as possible taking into account the marginal impact of these actions.
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To effectively mange the forex assets and
liabilities of the bank To manage and contain the treasury risks of the bank within the approved and prudential norms To assess , advise and manage the financial risks associated with assets and liabilities of the bank. To adopt best practices in dealing ,clearing, settlement and risk management in treasury operations .
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To maintain statutory reserves-CRR and SLR as mandated by the RBI on current and forward planning basis. To offer comprehensive value- added treasury and related services to the banks customers To act as profit centre for the bank.
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Organizational Structure Organizational structure of a commercial bank treasury should facilitate the handling of all market operations , from dealing to settlement ,custody and accounting in both domestic and foreign exchange markets. Front Office – Risk taking Mid office : risk management and management information Back –Office : Confirmations,settlements,accounting and reconciliation
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Front Office Front office of a treasury has a responsibility to manage investment and market risks in accordance with instructions received from the banks ALCO. This is undertaken through the dealing room which acts as the banks interface to international and domestic financial markets . It is the clearing house for risk and has the responsibility to manage the treasury risks taken in all areas of the bank , on behalf of customers and on behalf of the bank ,within the policies and limits prescribed by the board and risk management committee.
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MID OFFICE Mid –office is responsible for onsite risk measurement ,monitoring and management reporting. The other functions of Mid-office are: 1.Limit setting and monitoring exposures in relation to limits. 2.Assessing likely market movements based on internal assessments and external/internal research. 3.Evolving hedging strategies for assets and liabilities
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4.Interacting with banks risk management department on liquidity and market risk. 5.Risk –return analysis 6.Stress testing and back testing of investment and trading portfolios.
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Back Office Functions The key functions of back office are: 1.Deal slip verification 2.Generation and dispatch of interbank confirmations 3.Monitoring receipt of confirmations from counterparty banks 4.Effecting/receiving payments 5.Accounting 6.Monitoring receipt of funds in interbank contracts.
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Functions of a Treasurer
Treasury operations of a commercial bank consist mainly of two vital functions: Ensuring strict compliance with the statutory requirements of maintaining the stipulated cash reserve ratio and SLR. Liquidity management by 1.Ensuring the optimum utilization of the residual resources through investments 2.Raising additional resources required for meeting credit demands at optimal cost. 3. Managing market and liquidity risks in the transactions.
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Domestic Operations
1.Maintenance of statutory reserves 2.Managing Liquidity
Forex Operations
1.Extending cover to foreign
2.Funding and managing forex assets and liabilities 3.Providing hedge to forex risks proprietary and for its constituents 4.Trading and arbitrage
3. Profitability deployment reserves
4. Trading and arbitrate
5.Hedge and cover operations 5.Mid/Back office functions
6.Mid/Back- office function
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Responsibilities of a Treasurer In today's highly competitive environment , the treasury plays a vital role in the viability and success of a bank and calls for effective internal and external interface. Balance sheet management Liquidity management Reserves management Funds management Investments management Technology and operations , risk management , Trading activities and offering hedge products.
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Major Reforms /Special issues in the Indian Banking Sector
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NARSIMHAM COMMITTEE I & II
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About the committee • 1991 -RBI proposed the committee chaired by M. Narasimham, former RBI Governor to review the Financial System •‡ Review- aspects relating to the Structure, Organization, Procedures and Functioning of the financial system • Constituted in 1991, the Committee submitted two reports, in 1992 and 1998, which laid significant thrust on enhancing the efficiency and viability of the banking sector • The Narasimham Committee laid the foundation for the reformation of the Indian banking sector
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The main recommendations of the Committee were: • Reduction of Statutory Liquidity Ratio (SLR) to 25 per cent over a
period of five years • Progressive reduction in Cash Reserve Ratio (CRR) to 3-5% • Phasing out of directed credit programme and redefinition of the priority sector • Stipulation of minimum capital adequacy ratio of 8 per cent by March 1996. (Capital adequacy ratios ("CAR") are a measure of the amount of a bank's capital expressed as a percentage of its risk weighted credit exposures.)
• Adoption of uniform accounting practices in regard to income
recognition, asset classification and provisioning against bad and doubtful debts
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CONTD
• Setting up of special tribunals to speed up the recovery process of
loans • Setting up of Asset Reconstruction Funds (ARFs) to take over from banks a portion of their bad and doubtful advances at a discount • Abolition of branch licensing • Liberalizing the policy with regard to allowing foreign banks to open offices in India • Giving freedom to individual banks to recruit officers • Revised procedure for selection of Chief Executives and Directors of Boards of public sector banks • Speedy liberalization of capital market • Enactment of a separate legislation providing appropriate legal framework for mutual funds and laying down prudential norms for such institutions, etc.
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Committee On Banking Sector Reforms 1998
• 1998- Finance minister appointed Mr. Narasimham as
chairman of one more committee. • This committee was asked to ―review the progress of banking sector reforms to date and a programme on financial sector reforms to strengthen India's financial system and make it internationally competitive‖. • The committee submitted its report to the government in April 1998. • The report covered issues like- capital adequacy, bank mergers, recasting bank board, and creation of global sized banks.
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