MBN F658 - BANKING MANAGEMENT

SEMESTER III

MBN F658 - BANKING MANAGEMENT

SEMESTER III

Introduction to Banking
Banking means the 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. Banking Company means any company which transacts the business of banking. A bank is a financial institution that serves as a financial intermediary. Banking Management provides a comprehensive knowledge about the managerial skills required for effectively managing the banking sector and the related industries.

Types of Banks
Banking institutions of a country can be classified in to the following types on the basis of their functions:
1) 2) 3) 4) 5) 6) 7) 8) Central Bank Commercial Banks Industrial Banks Exchange Banks Co-operative Banks Agriculture Land Mortgage Banks Indigenous Banks Regional Rural Banks

Role of Banks
Banks play a vital role in modern economy - by accepting deposits the banks promote the habit of saving among the people. - the banks encourage industrial innovations and business expansion through funds provided to entrepreneurs - the banks exercise considerable influence on the level of economic activity through their ability to create or manufacture money in the economy. - through their lending policy the banks can influence the course and direction of economic activity. - the various utility functions performed by the banks are of great economic significance for the economy.

Role of Banks for a Developing Country

Capital Formation Monetisation Innovations Finance for priority sector Provision for Long-Term Finance Cheap Money Policy Need for a Sound Banking System

Functions of Banks
The fundamental functions of a bank are :
 Acceptance of deposits
- Savings Bank Account - Current Account - Fixed Deposit Account

 Advancing of Loans
- Making Ordinary Loans - Cash Credit - Overdraft, Discount of BOE

 Promote the use of Cheques  Agency functions of the Bank

- Transfer of funds - Collecting Customer s funds - Purchase and Sale of Shares and Securities - Collecting Dividends on the Shares of the Customers - Payment of Premium - The bank acts as a Trustee and the Executor - Income Tax Consultant - Act as Correspondent

Functions of Banks
 Purchase and Sale of Foreign Exchange  Financing Internal and Foreign Trade  Other Functions of the Bank
- Safe Custody of Valuable Goods

- Issuing Traveller s Cheque - Giving Information about its Customers - Collection of Statistics - Underwriting of Company Debentures - Accepting Bills of Exchange on behalf of Customers - Giving advice on Financial Matters

 Creation of Credit

Banking Structure
The different types of Banking Structure are :     Branch Banking Unit Banking Group Banking Chain Banking

Banking Structure
Branch Banking
Advantages
- Economies of large scale operation - Economy of Reserves - Remittance Facilities - Spreading of Risks - Increasing Mobility of Capital - Clearing of Cheques made easy - Service of Powerful and affluent banks - Good Social relation with Customers a typical commercial bank in most countries having a network of branches scattered all over the country.

Disadvantages
- Need to consult the Head Office - Transfer of Managers - Lack of Effective Control - Economic Repurcussions of Failure - Lack of Initiative and Personal touch

Banking Structure
Unit Banking
Advantages:
- Catering of Local needs

system of banking in which the bank s operations are in general confined to a single office.

- Knowledge of local Industries and Conditions - Effective Management and Supervision - Elimination of Bad Debts

Disadvantages:
- Limited Financial Resources and Vulnerability to Failure - Limited scope for offering Customer services - Difficulty in assessing Loan Applications

Banking Structure
Group Banking is a legal form of bank organisation in which two or
more independently incorporated banks are controlled by a Holding Company.

A holding company is a corporate body which owns stock in other corporation. There are no restrictions as regards the types of banks which may belong to the group these may be either unit banks or branch banks.

Advantages:
- Centralised management and control of group units by a holding company. - Chief merit of this banking system lies in economising in the maintenance of large cash reserves. - all members of the group can pool their resources to finance large burrowers. - advantages of economies of scale - better and extensive customer services

Banking Structure
Disadvantages:
- it is difficult to exercise a direct control over the member units - the failure of one member of the group affects all others. - it is difficult to supervise all units simultaneouly and the holding company may utilise the surplus reserves of the group for furthering its own economic interests. - the group banking system lends to monopoly thereby restricting efficiency which grows as a consequence of healthy competition among banks.

Banking Structure
Chain Banking
is a variant of Group Banking System. This system of banking is similar or group banking except that the holding company technique is not used. - the main feature of the chain banking is the control of two or more banking companies by a single person, by members of the same family, by the same group of persons through ownership of stock, through common membership on the board of directors of the banks. - chain banking system are small confined to two or three banks, although some chains involve substantially large number of banks. - the extent of centralisation shows wide variations. - the chain banking has also developed as a substitute for branch banking and has more or less the same advantages and disadvantages of group banking system.

RBI act, 1934

The objective of The Reserve Bank of India Act, 1934 is to regulate the issue of bank notes and keeping of reserve with a view to secure monetary stability in India and generally to operate the currency and credit system of the country to its advantage. In 1935, the Reserve Bank of India was established under the Reserve Bank of India Act as the central bank of India. the Reserve Bank of India was nationalized in 1949 and given wide powers in the area of bank supervision through the Banking Companies Act As a central Bank, the main function of RBI is to regulate the monetary mechanism comprising of the currency, banking and credit systems of the country.

Functions of the RBI

Monopoly of Note issue Monetary policy Bank rate, Open Market operations, Variable reserve ratio method Banker s Bank Lender of the Last Resort Banker to the Government Exchange Control Development Role

RBI
Legal Requirements
Cash Reserve Ratio (CRR) - Banks in India are required statutorily to hold cash reserves, called cash reserve ratio (CRR), with the RBI. Increase/decrease in CRR is used by the RBI as an instrument of monetary control. Statutory Liquidity Ratio (SLR) - Banks are required under law to invest prescribed minimum proportions of their total assets/liabilities in government securities and other approved securities. Prime Lending Rate (PLR) - The interest rate charged by banks to their largest, most secure, and most creditworthy customers on short-term loans.

Banking Regulation Act, 1949

The Banking Regulation Act was passed as the Banking Companies Act 1949 and came into force wef 16.3.49. Subsequently it was changed to Banking Regulations Act 1949 wef 01.03.66. Objectives of the Banking Regulation Act broadly are: to safeguard the interest of depositors; to develop banking institutions on sound lines; and to attune the monetary and credit system to the larger interests and priorities of the nation.

Modern Banking in India

As a rule, banking systems are adopted to the structure and needs of the particular economy they exist in. The concept of banking has undergone a dynamic change in keeping with the need to achieve rapid socio-economic progress. In such way Indian Banking System has several outstanding achievements to its credits,  its reach
   its network in terms of no. of branches close association of banks with the country s development efforts

Breakthroughs in Indian Banking Industry

From Security Orientation to Purpose Orientation Correction of Regional Imbalances Development of Banking habit Attitudinal change in the part of Banks Emergence of Retail Banking Breakthru in Virtual Banking Move towards Universal banking From Money Lending to Development Banking Establishment of Specialised branches Customer Focus

E- Banking
Internet banking (or E-banking) means any user with a personal computer and a browser can get connected to his bank -s website to perform any of the virtual banking functions.

Internet banking in india

The Reserve Bank of India constituted a working group on Internet Banking. The group divided the internet banking products in India into 3 types based on the levels of access granted. They are: i) Information Only System: General purpose information like interest rates, branch location, bank products and their features, loan and deposit calculations are provided in the banks website.

E - Banking
ii) Electronic Information Transfer System: The system
provides customer- specific information in the form of account balances, transaction details, and statement of accounts.

iii) Fully Electronic Transactional System: This system

allows bi-directional capabilities.
Automated Teller Machine (ATM) Credit Cards/Debit Cards Smart Card Bill payment service Fund transfer Credit card customers Investing through Internet banking Recharging your prepaid phone Shopping

Core Banking
Core banking is a general term used to describe the services provided by a group of networked bank branches. Bank customers may access their funds and other simple transactions from any of the member branch offices. Core Banking is normally defined as the business conducted by a banking institution with its retail and small business customers. Banks treat the retail customers as their core banking customers. Larger businesses are managed via the corporate banking division of the institution.

Core Banking
Most banks use core banking applications to support their operations where CORE stands for "centralized online real-time exchange". The bank's branches access applications from centralized datacenters. Normal core banking functions will include deposit accounts, loans, mortgages and payments. Banks make these services available across multiple channels like ATMs, Internet banking, and branches.

Reforms in Banking Systems

Various reform measures introduced in India have indeed strengthened the Indian banking system in preparation for the fresh global challenges ahead. The Narasimham Committee had proposed wide-ranging reforms for: 1. Improving the financial viability of the banks; 2. Improving the macroeconomic policy framework for banks; 3. Increasing their autonomy from government directions; 4. Allowing a greater entry to the private sector in banking; 5. Liberalizing the capital markets; 6. Improvement in the financial health and competitive position of the banks; 7. Furthering operational flexibility and competition among the financial institutions.

Reforms in Banking Systems

A number of reforms initiatives have been taken to remove or minimize the distortions impinging upon the efficient and profitable functioning of banks. These include the followings: 1. Reduction in SLR & CRR 2. Transparent guidelines or norms for entry and exit of private sector banks 3. Public sector banks have been allowed for direct access to capital markets 4. The regulated interest rates have been rationalized and simplified. 5. Branch licensing policy has been liberalized 6. A board for Financial Bank Supervision has been established to strengthen the supervisory system of the RBI.

Reforms in Banking Systems

The second report was submitted on 23rd April, 1998, which sets the pace for the second generation of banking sector reforms. These include: 1. Merge strong banks, close weak banks unviable ones 2. Two or three banks with international orientation, 8 to 10 national banks and a large number of local banks 3. Increase Capital Adequacy to match enhanced banking risk 4. Rationalize branches and staff, review recruitment 5. De-politicize Bank Boards under RBI supervision 6. Integrate NBFCs activities with banks.

Best Practiced Code

RBI with other 11 banks in India set up the Banking codes and Standards Board in Feb 2006 to monitor and ensure that banking codes and standards voluntarily adopted by banks are adhered to, while providing service to customers. Code of Bank s commitment to Customers came in to existence in July 2006. The individual customer has been provided with a charter of rights which he can enforce against his bank. The code sets minimum standards of banking practices for banks to follow and emphasize transparency in bank dealings with its customers.

Best Practiced Code

Some features of Code:
Documentation of Bank s fees and service charges in form of a tariff schedule. Banks to set a cheque collection policy, compensation policy and a security repossession policy. To provide full information to the customer before a product or service is sold to him. Banks should not rely on implicit consent from customers. Provisions of code are applicable to third party products sold thru bank branches.

Corporate governance in Banks

The Corporate Governance refers to conducting the affairs of a banking organisation in such a manner that gives a fair deal to all the stake holders i.e. shareholders, bank customers, regulatory authority, society at large, employees etc. The system of corporate governance is important for banks in India because, majority of the banks are in public sector, where they are not only competing with one another but with other players in the banking system as well as in financial services system including Financial Institutions, Mutual Funds and other intermediaries, in a new environment of liberalization and globalization.

Corporate governance in Banks

The concept of corporate governance, which emerged as a response to corporate failures and widespread dissatisfaction with the way many corporates function, has become one of the wide and deep discussions across the globe recently. It is about the value orientation of the organisation, ethical norms for its performance, the direction of development and social accomplishment of the organisation and the visibility of its performance and practices. Corporate Governance is different from day to day management of a bank, which is the basic responsibility of the operating management.

Corporate governance in Banks

Corporate governance covers a variety of aspects such as protection of shareholders' rights, enhancing the shareholders' value, issues concerning the composition and role of the Board of directors, deciding the disclosure requirements, prescribing the accounting systems, putting in place effective monitoring mechanism etc. There are a number of parameters on the basis of which the level of corporate governance can be judged for a banking organisation. It includes the suggested model code for best practices, preferred internal system, recommended disclosure requirements including the level of transparency, role of Board of directors and committees, reporting system to the Board of directors, policies formulated by the Board and monitoring of performance.

Corporate governance in Banks

Need for Corporate Governance in Banks:
o Since banks are important players in the Indian financial system, special focus on the Corporate Governance in the banking sector becomes critical. o The Reserve Bank of India, as a regulator, has the responsibility on the nature of Corporate Governance in the banking sector. o To the extent that banks have systemic implications, Corporate Governance in the banks is of critical importance. o Given the dominance of public ownership in the banking system in India, corporate practices in the banking sector would also set the standards for Corporate Governance in the private sector. o With a view to reducing the possible fiscal burden of recapitalising the PSBs

Prerequisites for Good Governance

There are some pre-requisites for good corporate governance. They are:
o A proper system consisting of clearly defined and adequate structure of roles, authority and responsibility. o Vision, principles and norms which indicate development path, normative considerations and guidelines and norms for performance. o A proper system for guiding, monitoring, reporting and control. The success of corporate governance lies in minimising the regulatory norms and adoption of voluntary codes.

Universal Banking
Universal banking' refers to those banks that offer a wide range of financial services, beyond the commercial banking functions like Mutual Funds, Merchant Banking, Factoring, Credit Cards, Retail loans, Housing Finance, Auto loans, Investment banking, Insurance etc. A Universal Banking is a superstore for financial products under one roof.

Narrow Banking
Narrow banking is a proposed type of bank called a narrow bank also called a safe bank. System of banking under which a bank places its funds in riskfree assets with maturity period matching its liability maturity profile, so that there is no problem relating to asset liability mismatch and the quality of assets remains intact without leading to emergence of sub-standard assets. The concept is practically being implemented by the Indian banking system partly, as a large part of the deposits mobilised (i.e. more than 46%) by the banks, has been deployed in Govt. securities (against a prescription of 25% in the form of SLR) as it provides a safe avenue of investment but at a very low return.

Narrow Banking
Key attributes of narrow banks include 1. no lending of deposits (reducing a key risk materially but constraining return on investment for depositors and shareholders alike) 2. extremely high liquidity (typically short-term assets e.g. bonds) 3. extremely high asset security (typically government bonds) 4. lower interest rates paid to depositors (as a function of the no lending and other constraints) 5. possibly specific regulatory framework with higher level of scrutiny and operational/investing restrictions

Investment Banking
An investment bank is a financial institution that assists individuals, corporations and governments in raising capital by underwriting and/or acting as the client's agent in the issuance of securities. An investment bank may also assist companies involved in mergers and acquisitions, and provide ancillary services such as market making, trading of derivatives, fixed income instruments, foreign exchange, commodities, and equity securities. Unlike commercial banks and retail banks, investment banks do not take deposits.

Investment Banking
There are two main lines of business in investment banking, Trading securities for cash or for other securities or the promotion of securities is the "sell side . Dealing with pension funds, mutual funds, hedge funds, and the investing public constitutes the "buy side". Main activities Investment banks offer services to both corporations issuing securities and investors buying securities. For corporations, investment bankers offer information on when and how to place their to an investment bank's reputation, and hence loss of business.

Private Banking
Private banking is a term for banking, investment and other financial services provided by banks to private individuals investing sizable assets. The term "private" refers to the customer service being rendered on a more personal basis than in mass-market retail banking, usually via dedicated bank advisers. The word "private" also alludes to bank secrecy and minimizing taxes through careful allocation of assets or by hiding assets from the taxing authorities. A high-level form of private banking (for the especially affluent) is often referred to as wealth management.

Private Banking
For wealth management purposes, HNWIs have accrued far more wealth than the average person, and therefore have the means to access a larger variety of conventional and alternative investments. For private banking services clients pay either based on the number of transactions, the annual portfolio performance or a "flat-fee", usually calculated as a yearly percentage of the total investment amount. Services include: protecting and growing assets in the present, providing specialized financing solutions, planning retirement and passing wealth on to future generations.

Private Sector Bank Guidelines

Private Sector Banks gained dominance after the economic reforms in 1991. It is general principle that greater financial depth, stability and soundness contribute to economic growth. But broadening and deepening the reach of banking is the important factor for growth to be truly inclusive. In spite of crossing such long steps in resource mobilization, geographical and functional reach, financial viability, profitability and competitiveness, vast segments of population, especially the underprivileged sections of society have still no access to formal banking services.

Private Sector Bank Guidelines

RBI is therefore taking into account granting licenses to a limited number of new banks. A large number of banks would foster greater competition and thereby reduce costs, and improve quality of service. The objective of guidelines issued in january 1993 and subsequently revised in January 2001 was to instill greater competition in banking system to increase productivity and efficiency. Formation of Banks Capital Operations Opening of Branches

Know Your Customer

Know Your Customer (KYC) is the due diligence and bank regulation that financial institutions and other regulated companies must perform to identify their clients and ascertain relevant information pertinent to doing financial business with them. Know your customer policies are becoming increasingly important globally to prevent identity theft fraud, money laundering and terrorist financing. A key aspect of KYC controls is to monitor transactions of a customer against their recorded profile, history on the customers account(s) and with peers.

Know Your Customer

The objective of KYC guidelines is to prevent banks from being used, intentionally or unintentionally, by criminal elements for money laundering activities. Banks should frame their KYC policies incorporating the following four key elements:  Customer Acceptance Policy  Customer Identification Procedures  Monitoring of Transactions  Risk management Know Your Customer processes are also employed by regular companies of all sizes, for the purpose of ensuring their proposed agents', consultants' or distributors' anti-bribery compliance.

Anti Money Laundering

Money laundering is the practice of disguising the origins of illegally-obtained money. Money laundering often occurs in three steps:
cash is introduced into the financial system by some means ( placement ) the second involves carrying out complex financial transactions in order to camouflage the illegal source ( layering ) the final step entails acquiring wealth generated from the transactions of the illicit funds ( integration ).

Anti Money Laundering

Anti money laundering (AML) is a term mainly used in the financial and legal industries to describe the legal controls that require financial institutions and other regulated entities to prevent or report money laundering activities. Today, most financial institutions globally, and many nonfinancial institutions, are required to identify and report transactions of a suspicious nature to the financial intelligence unit in the respective country. A bank must perform due diligence by verifying a customer's identity and monitor transactions for suspicious activity.

Role of Bank as Financial Intermediary and Constituent of Payment System

A financial intermediary is a financial institution that connects surplus and deficit agents. Financial intermediaries provide 3 major functions:  Maturity transformation  Risk transformation  Convenience denomination There are 2 essential advantages from using financial intermediaries: 1. Cost advantage 2. Market failure protection

Role of Bank as Financial Intermediary and Constituent of Payment System

Banks enjoy the benefit of being the only institutions through which the money can be transferred from one person to another and from one place to another. Therefore, banks become the constituent of the payment system of the economy. Banks, because of their reach, trust of the people, and other roles that they play, have enabled them to emerge as the largest financial intermediaries of the world. Banks are able to lend a major portion of their deposits, and play the role of a financial intermediary and constitute the payment system because of the understanding that banks will honor the commitments that they have made to the people.

Bank as Financial Service Provider

Financial services refer to services provided by the finance industry. The finance industry encompasses a broad range of organizations that deal with the management of money. Financial Service providers are those who provide financial services to customers. Among these organizations are credit unions, banks, credit card companies, insurance companies, consumer finance companies, stock brokerages, investment funds and some government sponsored enterprises.

Banking of Business Mathematics

Business mathematics is mathematics used by commercial enterprises to record and manage business operations. Commercial organizations use mathematics in accounting, inventory management, marketing, sales forecasting, and financial analysis. The practical applications typically include checking accounts, price discounts, markups and markdowns, payroll calculations, simple and compound interest, consumer and business credit, and mortgages.

Banking of Business Mathematics

WHY MATHEMATICS REQUIRED IN BANKING
 To calculate interest on deposits and advances  To calculated yield on bonds in which banks have to invest substantial amount.  To calculate depreciation  To decide on buying/selling rates of foreign currencies  To calculate minimum capital required by the bank  To appraise loan proposals

Money Market Operations

Money market is a place where short term surplus investible funds at the disposal of many financial institutions and individuals are borrowed by various commercial institutions and also the government inself who are in need. Money Market is a market for lending and borrowing of short term loans. Not dealing in money but in trade bills, promissory notes and treasury bills which are drawn for short periods. Funds can be borrowed for a day, week, month or 3 to 6 months against different types of securities such as BOE, Bonds, etc.

Money Market Operations

Dealers in Money Market Consists of the government, commercial and industrial concerns, stock exchange brokers, dealer in govt. securities, merchants, commercial banks and central bank, financial and insurance companies. Borrowers Traders, brokers, speculators, manufacturers, govt. who need funds to meet their current requirement. Institutions Central Bank, Commercial Banks, Institutional investors, private individuals

Money Market Operations

Composition of Money Market
Call Money Market Collateral Loan Market Acceptance Market Bill Market Discount Market

Functions of Money Market

Outlets to commercial banks, non-bank finance concerns, investors Short term funds to businessmen, industrialist, traders to meet day to day requirements Short term funds to govt. and govt. agencies Medium which have control on the creation of credit

Money Market Operations

Characteristics of a developed Money Market:
Highly organised commercial banking system Presence of a central bank Availability of proper credit instruments Mobility of funds Existence of sub markets No. of dealers in sub market Availability of ample resources, frequent transactions Habits of commercial practices in the community Industrial development and corporate organization Development of related markets Monetary policy of the govt.

Other conditioning factors:

Profitability of Banks
How does a bank make profit? Bank profits are derived from the spread between the rate they pay for funds and the rate they receive from borrowers. Basically, when the interest that a bank earns from loans is greater than the interest it must pay on deposits, it generates a positive interest spread or net interest income. The size of this spread is a major determinant of the profit generated by a bank. Banks face expenses (salaries, rent, etc.) other sources of income are fees and services.

Negotiable Instrument Act

A negotiable instrument is one which represents contractual rights that are generally accepted as money. It is written contract evidencing a right to receive money and it may be transferred by negotiation. Accr. To NI Act, 1881 A Negotiable Instrument means a promissory note, BOE, Cheque payable either to order or to bearer . Negotiable Instruments share warrants, dividends, demand draft, treasury bills, etc. Non Negotiable Instruments bill of lading, LC, deposit receipts, share or stock certificates, etc.

Negotiable Instrument Act

Essential features of Negotiable Instruments:
Can be transferred from one person to another like cash A bonafide transferee for value of NI gets complete, independent title Certain presumptions apply to all NIs. (Example Consideration) These instruments are in writing and signed by the parties, they are used as evidence of the fact of indebtedness because they have special rules of evidence. These instruments relate to payment of certain money in legal tender. These instruments can be transferred in infinitum till they are at maturity.

Collection of Cheques
A cheque is a document/instrument (usually a piece of paper) that orders a payment of money from a bank account. Cheques are a type of bill of exchange and were developed as a way to make payments without the need to carry around large amounts of gold and silver. Technically, a cheque is a negotiable instrument instructing a financial institution to pay a specific amount of a specific currency from a specified transactional account held in the drawer's name with that institution. Any cheque crossed with two parallel lines means that the cheque can only be deposited directly into an account with a bank and cannot be immediately cashed by a bank over the counter.

Collection of Cheques
Cheques can be of two types:1. Open or an uncrossed cheque - An open cheque is a cheque which is payable at the counter of the drawee bank. 2. Crossed cheque - A crossed cheque is a cheque which is payable only through a collecting banker. Types of Crossing General Crossing Special Crossing Account Payee or Restrictive Crossing 'Not Negotiable' Crossing -A bank's failure to comply with the crossings amounts to a breach of contract with its customer. The bank may not be able to debit the drawer's account and may be liable to the true owner for his loss.

Collection of Cheques
Cheque collection policy of the Bank is a reflection of ongoing efforts to provide better service to customers and set higher standards for performance.

Local Cheques
All cheques and other Negotiable Instruments payable locally would be presented through the clearing system prevailing at the centre. Bank branches situated at centres where no clearing house exists, would present local cheques on drawee banks across the counter and it would be the bank s endeavour to credit the proceeds at the earliest. For local cheques presented in clearing credit will be afforded as on the date of settlement of funds in clearing and the account holder will be allowed to withdraw funds as per return clearing norms in vogue.

Collection of Cheques
Outstation Cheques
Cheques drawn on other banks at outstation centres will normally be collected through bank s branches at those centres. Where the bank does not have a branch of its own, the instrument would be directly sent for collection to the drawee bank or collected through a correspondent bank. Cheques presented at any of the four major Metro Centres (New Delhi, Mumbai, Kolkata and Chennai) and payable at any of the other three centres : Maximum period of 7 days. Metro Centres and State Capitals (other than those of North Eastern States and Sikkim): Maximum period of 10 days. In all other Centres : Maximum period of 14 days.

Collection of Cheques
Cheques payable in Foreign Countries
Cheques payable at foreign centres where the bank has branch operations (or banking operations through a subsidiary, etc.) will be collected through that office. Cheques drawn on foreign banks at centres where the bank or its correspondents do not have direct presence will be sent direct to the drawee bank with instructions to credit proceeds to the respective Nostro Account of the bank maintained with one of the correspondent banks. Such instruments are accepted for collection on the best of efforts basis. Bank would give credit to the party on credit of proceeds to the bank s Nostro Account with the correspondent bank after taking into account cooling periods as applicable to the countries concerned.

Dishonour of Cheques
A dishonoured cheque cannot be redeemed for its value and is worthless The NI Act makes the drawer of cheque liable for penalties in case of dishonour of cheques due to insufficiency of funds or for the reason that it exceeds the arrangements made by the drawer. The NI Act also contains sufficient safe guards to protect the drawer of cheques by giving him an opportunity to make good the payment of dishonoured Cheque when a demand is made by the payee. In case of dishonour, the main thrust of the amendment of NI Act is to provide for a speedy and time bound trial, punishment of 2 years and double the amount of the cheque as fine.

Dishonour of Cheques
Offence under the NI Act:
Offence under Section 138 of the N I Act shall be deemed to have been committed, if the following conditions are satisfied: a) Cheque must have been drawn by a person(the drawer) in favour of a payee on his bank account for making payment b) Such payment must be either in whole or partial discharge of a legally enforceable debt c) Cheque must have been returned by the Banker to the payee or holder in due course due to insufficient balance in the account of the drawer or it exceeds the arrangement he had with the bank

Dishonour of Cheques
Proviso requires fulfillment following additional conditions: a) Cheque must be presented within a period of 6 months from the date of cheque or its validity period which ever is earlier. b) The payee or holder in due course must demand payment of the cheque amount by written notice within 15 days of receipt of notice c) Such notice must be issued within 30 days from the date of receipt of intimation of dishonour from bank and d) The drawer of cheque fails to pay demanded sum within 15 days from the date of receipt of the notice

Bank Customer Relationship

Banker customer relationship,is just a special contract where a person entrusts valuable items with another person with an intention that such items shall be retrieved on demand from the keeper by the person who so entrust. It begins as soon as the acceptance of cash or a cheque for collection on an understanding that relations will continue if references are found to be satisfactory. The relationship can be suspended or rescinded by (1) mutual assent, (2) giving notice by one party to the other and (3) operation of law in as in the case of death, insanity, insolvency, war, liquidation of the bank itself, etc.

Bank Customer Relationship

The legal relationship between a banker and a customer is of two kinds, 1) The General or Primary relationship - The general relationship between a banker and a customer is that of a debtor and creditor. - Thus the customer is the creditor who has the right of demand on the money from the banker.As long as the banker is keeping the customer items,the banker is indebted to the customer. - The terms and conditons governing the relationship should not be leaked to a third party,particularly by the banker.Also the items kept should not be released to a third party without due authorisation by the customer.

Bank Customer Relationship

2) Special or Subsidiary relationship - The first special relationship between the banker and the customer is that of an Agent and Principal, where the banker performs a number of agency services for his customer by charging a very nominal commission. - The next is that of Trustee and Beneficiary relationship that arises when the banker accepts valuables or securities from the customer for safe custody. - This relationship gives the customer a right to claim any dues from his banker or recovering the debt due to him from the bank when goes into liquidation.

Banker s Obligation
Acceptance of deposit Honouring of cheques Maintenance of secrecy of the accounts Notice to be given in case of closure of accounts Payment of interest Furnishing statement Providing services

Right of Appropriation
Lien is the right of the creditor to retain goods belonging to the debtor until the amount due to the former is completely discharged. Bank can transfer money from the customer s personal account into a joint account, to cover a debt on an account held jointly by the customer, without the permission of the customer. If the account is overdrawn, the customer can choose how any further money paid into the account is used (for example to pay mortgage or rent). This is called Right of appropriation. The customer need to write to the bank with new instructions each time he makes a deposit. Under common law customer have a right of appropriation over his own money and money he pays to another.

Different types of Customers

- Lunatics - Drunkards - Undischarged Bankrupts - Minors - Married Woman - Agents - Partnership - Joint Stock Companies - Local Authorities - Trust Accounts - Unincorporated Bodies - Joint Accounts - Joint Hindu Families

Chore Committee Reports

Financing of working capital had always been an exclusive domain of commercial banks. Projects promoted by technically qualified entrepreneurs with no tangible security to offer found it difficult to raise finance for the working capital required by them from banks. Small sector and other segments of priority sector were to be the major beneficiary of nationalisation and were preferred claimants of credit. The factor which called for reforms was the inbuilt weakness in the cash credit system linked with emphasis on security. A major part of credit limits sanctioned by the bank remained unutilised and there was a strong tendency within the banks to oversell the credit.

Chore Committee Reports

In 1973 when a sudden demand on bank credit was made due to unprecedented rate of inflation and the banks had to arbitrarily freeze the credit limits of their borrowers. In view of such a situation obtaining at that time, Reserve Bank of India constituted a 'Study Group' with Shri Prakash Tandon as Chairman in July, 1974 to frame necessary guidelines on bank credit with the following terms of reference : To suggest guidelines for commercial banks to follow up and supervise credit from the point of view of ensuring proper end-use of funds and keeping a watch on the safety of the advances and to suggest the type of operational data and other information that may be obtained by banks periodically from such borrowers and by the, Reserve Bank of India from the lending banks,

Chore Committee Reports

To make recommendations for obtaining periodical forecasts from borrowers of (a) business/production plans, and (b) credit needs, To make suggestions for prescribing inventory norms for different industries both in the private and public sectors and indicate the broad criteria for deviating from these norms, To suggest criteria regarding satisfactory capital structure and sound financial basis in relation to borrowings, To make recommendations regarding the sources for financing the minimum working capital requirements, To make recommendations as to whether the existing pattern of financing working capital requirements of cash credit/overdraft system etc., requires to be modified, if so, to suggest suitable modifications, and

Chore Committee Reports

To make recommendations on any other related matter as the Group may consider relevant to the subject of enquiry or any other allied matter which may be specifically referred to it by the Reserve Bank of India. Based upon these terms of reference the Group attempted to identify the various constituents of working capital that could be financed by the banks and suggested norms for build up of inventory. Far reaching recommendations on the style of lending and improvement in the present system of Cash Credit were also made. These recommendations were mostly accepted by Reserve Bank and were referred to banks for implementation in late 1975. Many modifications have since been suggested by 'Chore Committee'.

Chore Committee Reports

The quality of lending improved considerably but the cash credit system continued to pose few difficulties. Bifurcation of working capital limit in two parts as demand loan and a fluctuating cash credit component, as suggested by Tandon Group, was not done by many banks. Reserve Bank to review the system of cash credit in all its aspects and for this purpose a 'Working Group' headed by Sh. K. B. Chore was appointed in 1979.

Chore Committee Reports

The terms of reference to the 'Group' were as follows: To review the operation of cash credit system in recent years, particularly with reference to the gap between sanctioned credit limits and the extent of their utilisation; In the light of the review, to suggest: (a) modifications in the system with a view to making the system more amenable to rational management of funds by commercial banks, and/or (b) alternative types of credit facilities, which would ensure greater credit discipline and also enable banks to relate credit limits to increases in output or other productive activities, and To make recommendations on any other related matter as the 'Group' may consider germane to the subject. The 'Group' gave its recommendations in 1979.

Chore Committee Reports

Important recommendations which are accepted by Reserve Bank and have a direct bearing on credit limits of the borrowers are
No Structural Change-Continuation of Cash Credit, Loan and Bills Facilities Review of Borrowal Accounts Bifurcation of Cash Credit Limit Application of 2nd Method of Lending Working Capital Term Loan 'Peak Level' and 'Normal Non-Peak Level' Limits
(Contd..)

Chore Committee Reports

Adhoc or Temporary Limits Fixation of Operative Limits Cash Credit Limits against Book Debts Drawee Bill Scheme - Acceptance system, Bill discounting system Non Submission of QIS statements Slip Back in Current Ratio Diversion of working capital finance

Credit Risk Management

Due to regulated environment, banks could not afford to take risks. But of late, banks are exposed to same competition and hence are compeled to encounter various types of financial and nonfinancial risks. Risk is associated with uncertainty and reflected by way of charge on the fundamental/ basic i.e. in the case of business it is the Capital, which is the cushion that protects the liability holders of an institution. Risk Management system is the pro-active action in the present for the future. As per the Reserve Bank of India guidelines issued in Oct. 1999, there are three major types of risks encountered by the banks and these are Credit Risk, Market Risk & Operational Risk.

Credit Risk Management

Credit Risk is the potential that a bank borrower/counter party fails to meet the obligations on agreed terms. Credit risk is inherent to the business of lending funds to the operations linked closely to market risk variables. The objective of credit risk management is to minimize the risk and maximize bank s risk adjusted rate of return by assuming and maintaining credit exposure within the acceptable parameters. The process of credit risk management needs analysis of uncertainty and analysis of the risks inherent in a credit proposal. Credit risk consists of primarily two components, viz Quantity of risk and the quality of risk.

Credit Risk Management

The management of credit risk includes a) measurement through credit rating/ scoring, b) quantification through estimate of expected loan losses, c) Pricing on a scientific basis and d) Controlling through effective Loan Review Mechanism and Portfolio Management. Tools of Credit Risk Management  Exposure Ceilings  Review/Renewal  Risk Rating Model  Risk based scientific pricing  Portfolio Management  Loan Review Mechanism

Corporate Debt Restructuring

Inspite of their best efforts and intentions, sometimes corporates find themselves in financial difficulty because of factors beyond their control and also due to certain internal reasons. For the revival of the corporates as well as for the safety of the money lent by the banks and FIs, timely support through restructuring in genuine cases a Corporate Debt Restructuring System was evolved, and detailed guidelines were issued vide circular DBOD No. BP.BC. 15/21.04.114/2000-01 dated August 23, 2001 for implementation by banks. The objective of the Corporate Debt Restructuring (CDR) framework is to ensure timely and transparent mechanism for restructuring the corporate debts of viable entities facing problems, outside the purview of BIFR, DRT and other legal proceedings, for the benefit of all concerned.

Principles of Lending
There are certain precautions and principles the banker needs to follow while granting advances in relation to specific securities. Liquidity Profitability Safety and Security Purpose Social Responsibility Industrial and Geographical Diversification

Recommendations of the Talwar Committee

It was observed that the problems peculiar for borrowers arise due to difficulties in attitudinal adjustment of bank staff to the new client and new environments and inadequate job knowledge coupled with inexperience. The committee made some recommendations with a view to bringing about a measure of improvement. Each bank should immediately undertake a sample study of the information and data sought for examination of small loan proposals from clients in the priority sector. The task of simplification and consolidation of documentsand bringing them out in regional languages. Banks must enjoin on their operating staff to call for information data, etc., for examination of loan applicatons

Recommendations of the Talwar Committee

In considering loan applications for small amounts in priority sectors, especially from small agriculturists, artisans, etc., loan officers should be encouraged to adopt flexible approach. Repayment installments in regards to small loans should be in relation to applicant s paying capacity. Controlling offices of banks should advice their branches detailed reasons for rejection of loan proposals. Customers should be advised of the reasons for rejection of their loan applications backed by counseling in appropriate cases. At every office of each bank, a separate record, in appropriate form, should be maintained of all loan applications received, their disposal and full reasons for delay in sanctions and for rejections.

Types of Capital
Fixed capital
This is money which is used to purchase assets that will remain permanently in the business and help it to make a profit. Factors determining fixed capital requirements Nature of business Size of business Stage of development Capital invested by the owners location of that area

Types of Capital
Working capital
Working capital is that part of capital invested which is used for running the business such like money which is used to buy stock, pay expenses and finance credit. Factors determining working capital requirements
Size of business Stage of development Time of production Rate of stock turnover ratio Buying and selling terms Seasonal consumption Seasonal product profit level growth and expansion production cycle general nature of business business cycle

Non fund based facilities

The credit facilities given by the banks where actual bank funds are not involved are termed as 'non-fund based facilities'. Letter of Credit Guarantee Pledge Mortgage Hypothecation

Letter of Credit
Article 2 of UCPDC defines a letter of credit as under: The expressions "documentary credit(s) and standby letter(s) of credit used herein (hereinafter referred to as "credit(s)" means any arrangement, however, named or described whereby a bank (the issuing bank), acting at the request and on the instructions of a customer (the applicant of the credit) or on its own behalf. Letter of credit is a written undertaking by a bank (issuing bank) given to the seller (beneficiary) at the request and in accordance with the instructions of buyer (applicant) to effect payment of a stated amount within a prescribed time limit and against stipulated documents provided all the terms and conditions of the credit are complied with". Letters of credit thus offers both parties to a trade transaction a degree of security.

Letter of Credit
Parties to a Letter of Credit
       The buyer The beneficiary The issuing bank The notifying bank The negotiating bank The confirming bank The paying bank

Letter of Credit Mechanism

1. Issuing of Credit 2. 2. Negotiation of Documents by beneficiary 3. Settlement of Bills Drawn under Letter of Credit by the opener.

Guarantee
A contract of guarantee can be defined as a contract to perform the promise, or discharge the liability of a third person in case of his default. Bank provides guarantee facilities to its customers who may require these facilities for various purpose. The guarantees may broadly be divided in two categories as under : Financial guarantees - Guarantees to discharge financial obligations to the customers. Performance guarantees - Guarantees for due performance of a contract by customers. The banker has to assess the character, capacity and capital of the guarantor

Pledge
Transfer or assignment of assets to secure payment of an obligation. The borrower assigns an interest in the property to the lender, which becomes a lien on the collateral. If the borrower offers stocks, bonds, or other securities as collateral, the lender generally takes possession or is assigned ownership of the collateral until the loan is paid. Essential features of pledge  There must be a bailment of goods  The bailment must be by way of security  The security must be for payment of debt or performance of a promise

Mortgage
A mortgage is the transfer of an interest in a specific immovable property for the purpose of securing the payment of money advanced or to be advanced by way of loan, an existing or future debt or the performance of an engagement which may give rise to pecuniary liability The essentials of a mortgage are 1) There must be a transfer of interest in an immovable property 2) The immovable property must be a specific one 3) The consideration of a mortgage may be either money advanced or to be advanced by way of loan, or the performance of a contract.

Hypothecation
A mortgage of movables where no possession is given. A document known as letter of Hypothecation is executed. The main contents of the letter of hypothecation are 1) Affirmation by the borrower that the goods are free from encumbrances, that further encumbrances will not be created on them and he is the absolute owner of the goods. 2) Undertaking by the borrower that proceeds arising from the sale of the hypothecated goods will be utilised for the repayment of the advance 3) Undertaking by the borrower to meet all expenses relating to the safe custody of the hypothecated goods 4) Provision to the effect that the banker has the right to take possession of the hypothecated goods and realize them in the event of the borrower making default in the repayment of the advance.

Predential Norms
As per recommendations by the Narasimham committee, the RBI introduced in a phased manner, prudential norms for Income Recognition, Asset Classification and Provisioning for the advances portfolio of the banks so as to move towards greater consistency and transparency in the published accounts. Income Recognition  The policy of income recognition has to be objective and based on the record of recovery.  Income from NPAs is not recognised on accrual basis but is booked as income only when it is actually received.  The banks should not charge and take to income account interest on any NPA.

Predential Norms
Asset Classification  Banks are required to classify NPA s based on the period for which the asset has remained non performing and the realisability of the dues 1) Sub standard assets 2) Doubtful Assets 3) Loss Assets  Classification of assets into above categories should be done taking into account the degree of well defined credit weaknesses and the extent of dependence on collateral security for realization of dues.

Predential Norms
Asset classification Accounts with Temporary Deficiencies Accounts regularised near the Balance sheet date Asset classification to be Borrower-wise and not Facility-wise Advances under Consortium Arrangements Accounts with Erosion in the Value of Security Advances to PACS/ FSS Ceded to Commercial Banks Advances against Term Deposits, NSCs, KVP, etc Loans with Moratorium for Payment of Interest Agricultural Advances Government Guaranteed Advances

Predential Norms
Provisioning  In conformity with the prudential norms, provisions should be made on the NPAs on the basis of classification of assets.  Taking in to account the time lag between an account becoming doubtful of recovery, its recognition as such, the realisation of the security and the erosion overtime in the value of security charged to the bank, the banks should make provision against sub-standard assets, doubtful assets and loss assets.  Loss assets - the entire asset should be written-off - If the assets are permitted to remain in the books for any reason, 100% of the outstanding should be provided for.

Predential Norms
 Doubtful Assets - 100% to the extent to which the advance is not covered by the realisable value of the security - In regard to the secured portion, provision may be made on the following basis
upto one year 20% One to three years 30% More than three years 50%

- Banks are permitted to phase the additional provisioning consequent upon the reduction in the transition perion from substandard to doubtful asset from 18 to 12 months  Sub-standard Assets - A general provisioning of 10% on total outstanding should be made without making any allowance for DICGC/ ECGC guarantee cover and securities available.

Asset Liability Management

Asset and liability management is the practice of managing risks that arise due to mismatches between the assets and liabilities (debts and assets) of the bank. It is the management of structure of balance sheet (liabilities and assets) in such a way that the net earning from interest is maximised within the overall risk-preference (present and future) of the institutions. The ALM functions extend to liquidly risk management, management of market risk, trading risk management, funding and capital planning and profit planning and growth projection.

Asset Liability Management

The ALM process rests on three pillars: ALM Information Systems
Management Information Systems Information availability, accuracy, adequacy and expediency

ALM Organisation
Structure and responsibilities Level of top management involvement

ALM Process
Risk parameters Risk identification Risk measurement Risk management Risk policies and tolerance levels.

Capital Adequacy in Banks

The capital requirement is a bank regulation, which sets a framework on how banks and depository institutions must handle their capital. Regulators try to ensure that banks and other financial institutions have sufficient capital to keep them out of difficulty. Capital adequacy requirements have existed for a long time, but the two most important are those specified by the Basel committee of the Bank for International Settlements.

Capital Adequacy in Banks

Basel 1 The Basel 1 accord defined capital adequacy as a single number that was the ratio of a banks capital to its assets. There are two types of capital, tier one and tier two. The first is primarily share capital, the second other types such as preference shares and subordinated debt. The key requirement was that tier one capital was at least 8% of assets.

Capital Adequacy in Banks

Basel 2 The Basel 1 accord has largely been replaced by new rules. Basel 2 is based on three pillars : minimum capital requirements, supervisory review process and market forces. The first "pillar" is similar to the Basel 1 requirement, the second is the use of sophisticated risk models to ascertain whether additional capital (i.e. more than required by pillar 1) is necessary. The third pillar requires more disclosure of risks, capital and risk management policies. This encourages the markets to react to the taking of high risks.

CAMELS Rating of Banks

The CAMELS rating is a United States supervisory rating of the bank's overall condition and to identify its strengths and weaknesses: Financial, Operational, Managerial This rating is based on financial statements of the bank and on-site examination by regulators. The scale is from 1 to 5 with 1 being strongest and 5 being weakest. The components of a bank's condition that are assessed:
      (C) Capital adequacy (A) Asset quality (M) Management (E) Earnings (L) Liquidity and (S) Sensitivity to market risk

CAMELS Rating of Banks

Capital Adequacy - The capital requirement is a bank regulation, which sets a framework on how banks and depository institutions must handle their capital. Asset Quality - Asset represents all the assets of the bank, current and fixed, loan portfolio, investments and real estate owned as well as off balance sheet transactions. Management - Management includes all key managers and the Board of Directors. Earnings - All income from operations, non-traditional sources, extraordinary items. Liquidity - The ability to generate cash or turn quickly short term assets into cash. Sensitivity to market risks is not taken into consideration at present.

 Credit risk is an investor's risk of loss arising from a borrower who does not make payments as promised. Such an event is called a default. Another term for credit risk is default risk. Market risk is the risk that the value of a portfolio, either an investment portfolio or a trading portfolio, will decrease due to the change in value of the market risk factors. The four standard market risk factors are stock prices, interest rates, foreign exchange rates, and commodity prices. Operational Risk is a risk arising from execution of a company's business functions. It is a very broad concept which focuses on the risks arising from the people, systems and processes through which a company operates. It also includes other categories such as fraud risks, legal risks, physical or environmental risks.

Credit Risk, Market Risk & Operational Risk

Banking Ombudsman Scheme

Banking Ombudsman is a quasi judicial authority functioning under India s Banking Ombudsman Scheme 2006, and the authority was created pursuant to the a decision by the Government of India to enable resolution of complaints of customers of banks relating to certain services rendered by the banks. The Banking Ombudsman Scheme was first introduced in India1 in 1995, and was revised in 2002. The current scheme became operative from 1st January 2006, and replaced and superseded the banking Ombudsman Scheme 2002. From 2002 until 2006, around 36,000 complaints have been dealt by the Banking Ombudsmen.

Banking Ombudsman Scheme

The Banking Ombudsman Scheme consists of several chapters : CHAPTER I - PRELIMINARY 1. Short Title, Commencement, Extent and Application 2. Suspension of the Scheme 3. Definitions CHAPTER II - ESTABLISHMENT OF OFFICE OF BANKING OMBUDSMAN 4. Appointment & Tenure 5. Location of Office and Temporary Headquarters 6. Secretariat CHAPTER III - JURISDICTION, POWERS AND DUTIES OF BANKING OMBUDSMAN 7. Powers and Jurisdiction

Banking Ombudsman Scheme

CHAPTER IV - PROCEDURE FOR REDRESSAL OF GRIEVANCE 8. Grounds of Complaint 9. Procedure for Filing Complaint 10. Power to Call for Information 11. Settlement of Complaint by Agreement 12. Award by the Banking Ombudsman 13. Rejection of the Complaint 14. Appeal Before the Appellate Authority 15. Banks to Display Salient Features of the Scheme for Common Knowledge of Public CHAPTER V - MISCELLANEOUS 16. Removal of Difficulties 17. Application of the Banking Ombudsman Schemes, 1995 and 2002

SARFAESI Act, 2002

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, allows banks and financial institutions to auction properties when borrowers fail to repay their loans. It enables banks to reduce their nonperforming assets (NPAs) by adopting measures for recovery or reconstruction. If a borrower defaults on repayment of his/her home loan for six months at stretch, banks give him/her a 60-day period to regularise the repayment, that is, start repaying. On failure to do so, banks declare the loan an NPA and auction it to recover the debt. Auction price depends on the market value of the property. If the price fetched exceeds the bank s dues, the excess amount is given to the borrower.