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SYLLABUS-B.Com - Banking and Insurance Semester IV Module 4.

1 Universal Banking

Evolution of Universal Banking, Commercial Banking Vs. Development Banking Sources and Uses of finds Universal Banking as a Mix of Commercial and Development Banking Asset-Liability Mismatch Possibilities Risks in Project Lending Short term nature of funding resources Universal Banking in the open economy context Off Balance sheet items and services that the development wing of the universal banks provides The entry of commercial banks into the securities business Consumer finance, Retail Banking, Principles of Retail Lending, Case studies Merchant Banking, Non banking investments and activities of banks Universal banking and the future of small business lending Case studies-Universal Banking abroad-applicability of universal banking in open market-oriented emerging economies-advantages and disadvantages; supervisory issues and regulatory concerns The debate over universal banking in India; Recent trends in universal banking in India. Challenges of Universal banking in the Indian context International Banking Mergers & Acquisitions Syndication of Loans Prudential lending Norms Non-Banking Finance Companies-RBI guidelines Venture Capital, Money Laundering RBI Act 1934 Bibliography

S.No. 1. Universal Banking i. ii. 2. i. ii. iii. iv. v. 3. 4. 5. 6. Evolution


Page 3 3 3 5 7 9 9 11 12 14 18 24 25 32 33 34 35 36 43 45 45 47 48 51 51 52 52 52 56 56 56 59

Universal BANKING V/S Narrow Banking Basel Committee The New Growth Avenue Consolidation Future Outlook Corporate Governance

Challenges in Banking Sector

Indian Financial System Commercial Banking Vs Development Banking Development Banks Development Financial Institutions Asset Liability Management (ALM) i. ii. iii. iv. v. What is ALM Scope of ALM and Role of ALCO Risk Management Tools of ALM and their mechanisms Relevance of ALM to printing of Currency Notes Credit Policy and Bank Lending Bankers Credit Report, Specimen of a CR Credit Control Consumer Finance Need of Emphasis for Retail Banking


Risks in Project Lending i. ii. iii.


Short Term Nature of Funding i. ii.


Universal Banking: The Road Ahead The Challenges of Universal Banking in the Indian context and Universal Banking abroad


The Debate over Universal Banking in India i. ii. iii. Thoughts on Universal Banking Advantages and Disadvantages ICICI-ICICI Bank Merger

11. 12.

The Entry of Commercial Banks into the Securities Market Money Laundering i. ii. iii. Essential Elements and Legal Setup Role of Banks With Regard To Money Laundering Know Your Customer (KYC) Banking Services through Information Technology Bank Automation



Computers and Banking i. ii.


Customer Relationship Management(CRM) Full Service Banking Relationship Managers are a New Breed of Banker Loan Syndication Domestic Loan Syndication External


Loan Syndication i. ii.

16. 17. 18. 19. 20. 21. 22. 23.

Mergers, Amalgamations and Takeovers Merchant Banking International Banking International Financial Market Major Financial Instruments Multilateral Financial Institutions International Equity Markets Universal Banking Abroad i. ii. iii. Islamic Banking US Banking European Banking

24. 25. 26. 27.

Non-Banking Financial Companies (NBFCs) Financial and banking Sector Reforms Money and Government Securities Markets Venture Capital Banking Reforms of Narasimham Committee i. ii. Income Recognition Asset Classification

28. 29. 30.

The Reserve Bank of India (RBI) Act, 1934 Conclusion Bibliography

UNIVERSAL BANKING A shift from brick and mortar banking to click and mouse banking, a banking company turning into a financial departmental stores, rendering services comparable to that of a cafeteria according to the tastes and needs of a customer

- c.m.lakshmanan EVOLUTION: The fabric of financial institutions is closely linked to the economic stature of a country. For many years, banks have been concentrating on their traditional functions of acceptance of deposits from the public and investing them in selected number of restricted securities. Lack of infrastructure, economic, financial and the mindset of the financial system were the deterrent factors in developing economies like India, not to switch over to broad based activities. It requires better knowledge management, globally acceptable standards banking practices, sound credit appraisal mechanisms, development of customer centric skills. Unlike the erstwhile banking fraternity, with more and more players entering into banking activities competition is becoming severe. Customers expectation for innovative products, rationalization of service charges, competitive pricing and simplified procedures for documentation are having a telling impact on the earning spread. Banks no longer offer plain vanilla products. It has become imperative for them to explore new innovative products to retain, if not increase their market share. The banks should shed their thoughts, that they no longer are financiers of working capital finance; they are expected to extend term loan facilities also. This rationale for undertaking the activities of development financial institutions has been a long felt need. This would facilitate the concept of single window, serving like a cafeteria, paving way for the birth of Universal Banking. UNIVERSAL BANKING V/S NARROW BANKING The concept of narrow banking was widely discussed in the late 1980s and early 1990s in the United States following the failure of large number of insured institutions in the savings and loan crisis. In India it came to discussion after the submission of the report by the Committee on capital Account Convertibility (Tarapore Committee). The concept has been suggested as a solution to the problem of high Non Performing Assets and related matters. The Committee proposed that incremental resources of these narrow banks should be restricted only to investments in government securities.

The Narrow Bank in its narrow sense, may be defined as the one which places its funds only in short-term, risk free assets or alternatively it is one whose demand deposits are matched by safe and liquid assets. failure and the consequent risk and loss to depositors. Due to this pattern of However, this system deployment of funds, these banks are expected to remove the problems of bank restrains Banks from going into more risky business or advances, which may increase their profitability as these Banks do have enough potential to withstand any short term crisis also. To overcome this problem, it was suggested that the Banks should go in for Universal Banking. As against narrow banking, Universal Banking means the removal of distinction between the activities which the financial institutions (like IDBI, IFCI in India) and Banks undertake and allowing these financial institutions to undertake any activity of banking or development financing or activity associated with that, subject to compliance of statutory and other requirements as prescribed by the Central Bank (i.e. Reserve Bank of India). This will help bring harmony in the role of Financial Institutions/Banks, offer world class efficient services under one roof, compete with international banks due to size and reap cost benefits arising from economies of scale.


After the nationalization of Banks, increasing adoption of technology, continuous mergers in the banking, modernizing backroom operation in the banks and competition pave the path of growth of Indian banking. By the mid-1990, the near monopoly of public sector banks faced the competition by the more customer-

focused private sector entrants. This competition forced older and nationalized banks to revitalize their operations.

Year 1992 was the golden period of Indian Banking system due to the scam-tainted stock market. Large proportion of household saving moved into the banking system, which recorded an annual growth of 20 percent in deposit.

But along with the continuous growth and modernization, there are several challenges confronting the banking sector. The main challenges facing the banking sector is the deployment of funds in quality assets and the management of revenues and costs. The problem of NPA (non- performing assets), overall credit recovery system still exist. There is a continuous reforms and modernization is in process. A number of recommendations of two Narasimham committees have been implemented.

Foreign Banks are focusing on corporate and on the middle class consumer and providing them better service. Nationalized Banks are also attempting to get on the path of automation. Strong Banks will acquire the weaker banks. The member of foreign banks operating in India has increased significantly and their share of total assets has also increased. In the year 2001 estimated foreign bank account for 14.7 percent of the total net profit of commercial banking sector in India. The Reserve Bank of Indias recently released report on Trend and Progress of Banking (2003-04) once again highlights the major issues in Indian banking in the light of increasing global competition. The financial sector reforms have to go hand in hand with the overall economic reform process. To achieve this, a number of suggestions have been put forward from time to time. Since the banks have been exposed to competition at home and also at global level, Indian banks are taking steps under the overall regulatory and supervisory framework of the RBI. Due to new practices, greater accountability and market discipline among the participants, the Indian financial system is now moving closer to global standards. Accordingly, an elaborate roadmap has been drawn to move the

Indian banks closer to Basel II norms. No doubt, there are some problems in this respect. Indian banks have smaller asset bases and volume of operations in comparison with international standards. No bank is big enough to rank among the top 100 banks of the world. The operations of the Indian banks are mostly in the domestic sector. Some of them have a few foreign branches but they are not exposed to significant lending or investments in the overseas market. Indian banks are not major banks of world class stature. There is also huge cost involved for putting in place proper automation system needed to switch over to the Basel II model. Public sector banks in the past have adapted themselves to international practices such as computerization, asset liability management and Basel I norms. Under the circumstances it should not be difficult for banks to adopt the Basel II norms as it provides opportunity to Indian banks to raise their standard of banking practices as per international standards. The Basel Accord is something that has to be adopted if Indian Banks are interested in becoming global players. Initially RBI had taken a view that the standards will apply only to a few select banks depending on the strength of the institutions. But now the RBI has taken a view that the standards will apply to all the banks. Accordingly, a taskforce has been formed to examine the related issues. The report has pointed out that as much as two-thirds of the recent growth in credit has been on account of retail loans. That means corporate borrowing is yet to pick up significantly in spite of rise in investment demand. Another important aspect of the report is its analysis of the cooperative banks. They are facing a deep crisis with the rising NPAs and the financial position of one third of these banks is not satisfactory. Cooperative banks need restructuring if they are to survive in the competitive environment. They have to turn to modern technologies for better performance. The new private and foreign banks have thrown open many challenges for the Urban Cooperative Banks (UCBs). They have to strategically alter their business models in terms of marketing and dealing with customers at the lowest cost. They should not be slow in providing round the clock service to the customers.

The major challenge before the cooperative banks is technology. Some cooperative banks are facing challenges created by a few badly managed banks. These banks have to use technology for value addition and cost reduction, for easing the work of the bank staff and to attract customers. Finally, for maintaining orderly growth, UCBs have to be more professional in their approach in order to face new realities. The Changing Landscape of Banking Sector Under Universal Banking, banks would handle (a) Working Capital (b) Long term Capital (Term Loans) meant for industrial development. The ongoing reforms process, growing use of technology, increased competition and product innovation has all put the banking sector on a high growth trajectory. However significant challenge lie ahead for the banks in the country as they gear unto embrace international standards and best practices in line with BASEL II norms.

A Word about Basel Committee Founded in 1974, the Basel Committee is made up of central banking officials from leading industrial nations including the U.S., Canada, France, Germany, Italy, Japan and the U.K. The committee does not have enforcement powers, instead, it recommends broad standards, guidelines and best practices that central bank in member nations can use the foundation for their own policies or statutes. Basel committee addresses the need for better risk management practices, transparency, audit, and secrecy as third party contractors are used to support e-banking services, but has also increased banks exposure to financial and legal risks. The banking sector in India has undergone remarkable changes since the economic reforms were initiated in 1991-92. The period has been marked by a slew of reforms in the sector, which provided the much-needed impetus for the growth of the sector as a whole. Some of the major initiatives during this period deregulation of interest rates, adoption of prudential norms in terms of capital adequacy, asset classification and provisioning, lowering of reserve requirements in terms of Statutory Liquidity

Ratio (SLR) and Cash reserve ratio (CRR), dilution of government equity holding in Public Sector Banks (PSBs), opening of the sector to private participation, permission to foreign banks to expand their operations through subsidiaries, introduction of Universal Banking, greater emphasis on risk management by allowing banks to participate in instruments such as interest rate swaps, cross country forward contracts, liquidity adjustment facility, liberalization of FDI norms in banks, and the introduction of Real Time Gross Settlement (RTGS), among others. These measures along with Reserve Bank of India (RBI) efforts to adopt international Banking standards and best practices as prescribed in the Basel Accords have no doubt helped the domestic banking industry enter a new era. Further it has pushed banks to put greater emphasis on risk management and corporate governance areas that were until now ignored. Growing Competition The opening of the banking sector to private as well as foreign banks has been a major milestone in the history of the industry in the country. As a result of the deregulation of the sector, a host of new generation private banks have entered the scene. This along with the permission to foreign banks to expand their operations in the country through subsidiaries has galvanized the domestic banking sector, dominated so far by the hitherto slow and lethargic public sector banks. Increased competitive pressure is forcing public sector banks to wake up from their deep slumber and adapt to the changing business environment so as to remain competitive. On the positive side, PSBs have begun responding to the challenge well; although many of them are yet to gear up to meet the challenges of the deregulatory era. The entry of new generation private sector and foreign banks is rewriting the rules of banking in the country. Today, there is a greater emphasis on customer convenience, which is the key to success. Technology has emerged as a key enabler to achieve this objective, and is now an integral component of any bank strategy. It is helping new generation banks overcome the disadvantage of late entry by allowing them to achieve greater market penetration without having a brick-and-mortar structure, which is time consuming and expensive. The proliferation of ATMs of both private and foreign banks in the towns and cities of India prove that. A majority of these banks are now widening and running their operations almost branchless, using


technology platforms like ATMs, Internet banking, etc. Also, technology is helping banks in bringing down their operational costs, which is allowing them to stay competitive even as competition is heating up.

Universal Banking The New Growth Avenue Another notable change that has taken place in the banking environment of the country is the introduction of Universal Banking, which refers to cross-selling of financial products and enables a bank to act as a one-stop financial supermarket. It is also helping transform the financial institutions in the country that were facing bleak prospects as their traditional sources of lending dried up and became virtually non-existent. Further, it is attracting existing banks. Today, many banks have begun to migrate to the universal Banking model, which has opened up new avenues of growth for them. Several banks are now foraying into areas such as credit cards, insurance, DEMAT services, mortgage financing, investment banking, securitization, mutual funds, insurance, etc. , thereby offering different services to their customers under one roof. This is also fueling the growth of these banks.

Consolidation The Inevitable As the competition increases, it will make consolidation in the sector inevitable. With the highly fragmented nature of the sector, it is not unlikely that many banks especially PSBs will find some of their branches unproductive and unsustainable. The greater cost competitiveness of private banks will also force PSBs with inefficient operations and high costs to either close those branches of merge with other banks to bring down the costs. Signs of consolidation have already begun to emerge. The high profile merger of Times Bank with HDFC Bank five years ago marked the arrival of Mergers and Acquisitions (M&A) in the banking sector in the country. A couple recent mergers clearly send a signal that consolidation is inevitable. The merger between ICICI Bank and Bank of Madura, Nedungadi Banks merger with Punjab National Bank, and more recently, the merger of the beleaguered Global Trust Bank with the government-owned Oriental Bank of Commerce vindicate the argument. Industry experts opine that there may be many more mergers on the cards. The of


Union Finance Minister has also hinted that he is favourable to mergers between banks, especially government-owned ones. He was recently quoted saying, Consolidation alone will give banks the muscle, size and scale to act local and seek new markets, new classes of borrowers. This gives enough indication as to what lies in store for the banks, particularly the PSBs, as far as consolidation is concerned. Further as banks in India look forward to expanding their presence outside the country and have a global reach they will be competing with global behemoths like the Citigroup, HSBC Bank, etc. in terms of strong balance sheet, and economies of scale and size. To acquire these capabilities Indian banks will have to look beyond organic growth. State-owned banks like State Bank of India and Bank of Baroda, and private sector players like ICICI Bank have already made their intentions of going global clear. Improved financial health The ongoing reforms process has seen several major positive changes for the Indian banking sector. Deregulation has enabled banks in India to improve their financial health in terms of capital adequacy, asset quality, profitability, and provisioning (read: Non Performing Assets). Many of the PSU Banks have shown improved Capital Adequacy Ratio (CAR) for the fiscal 2002-03 as against the previous fiscal. Further, the progress made on the NPA front too is encouraging, though it needs to be further improved. For instance, only eight PSBs have shown NPAs of more than 5% for the fiscal 2003, as compared to 15% in the previous fiscal. According to Standard & Poors, key structural reforms have improved the asset quality, profitability and capital adequacy ratio of banks, besides increasing transparency and efficiency in the system. This is an encouraging sign as the Indian banking industry has for long been suffering the chronic problem of NPAs. However, the Securitization Act that came into vogue two years ago is helping banks clean their balance sheets. However, as the banks have pointed out the Act suffers from certain loopholes and, therefore, needs fine-tuning. Basel II challenges As the process of integration of the Indian economy with the global economy gains momentum it will pose significant challenges to the banking sector in India as a whole. A major challenge it faces is the implementation of Basel II norms. The Basel


II norms relate to the new comprehensive framework for global capital standards laid down by the Basel Committee on banking supervision. RBI has asked Indian banks to gear up to migrate to the new guidelines by the end of December 2004. RBI announced that India should examine the options available under Basel II and draw a road map by the end of 2004 so that they are ready for the migration to Basel II, and review the progress made thereof at quarterly intervals. The Basel II norms will be implemented from 2006. However, banks are concerned that unless some loopholes are plugged it will be difficult to implement the norms in their entirety. According to a survey finding by Federation of Indian Chambers of Commerce and Industry (FICCI), the low level of computerization, the absence of robust internal credit rating mechanism and a strong Management Information System (MIS) and lack of training and education among employees are the prime reasons why Indian Banks are reluctant to shift to the Basel II norms by 2006. A total of 87% respondents felt that the provision for capital changes to address operational risks will put pressure on capital adequacy requirements and will also adversely affect the credit flow to the industry, as banks will become more averse to risk. However, overall, as the survey finding reveal, banks feel that internal rating-based Basel II norms will make Indian banks more resilient to risk and help them face competition better. Future Outlook While moving ahead the banks in India face challenges on the following fronts: Financial Performance: Banks in the recent past have enjoyed strong earnings growth from treasury operations. As their exposure to capital market is limited, and spreads are shrinking with the competition heating up, this will have a significant impact on their profitability. Also as more and more banks get listed on the stock exchanges, their performances will be closely watched by the markets, and they could be exposed to severe punishment in terms of stock price if their financial performance does not meet market expectations. Technology: As technology emerges as the key enabler in terms of customer convenience, retention and services, banks with strong IT capabilities will have an edge over competition. Technology will also facilitate better capability in terms of


managing large volume of transactions and improving and maintaining cost competitiveness. Risk Management: With increasing pace of globalization and easy flow of money across the globe, banks in the country will be exposed to several new kinds of risk, prominently country risk, besides the traditions risks like credit risk, and operational risk. In this backdrop, banks will be required to strengthen their risk management and surveillance systems and improve their credit assessment and risk management skills. International Best Practices: If the banks in the country have to compete with international banks, they will have to gear up to embrace international best practices and standards in terms of operating, reporting and disclosure norms.

Corporate Governance: With growing emphasis on the part of listed companies worldwide on creating shareholder wealth; domestic banks, which are seeing a dilution in government ownership, will come under intense pressure to be more transparent in their operations, and improve disclosure and reporting practices. Hence these banks will have to gear up to meet the stock market demands, and improve their corporate governance practices. Increased integration with the global economy and the fast changing banking environment in the country along with the reform process will be an overwhelming challenge for the banking sector. Factors such as cost competitiveness, giving emphasis on acquiring and leveraging technology capabilities to deliver services, strong balance sheet, better risk management skills, and, perhaps a global presence will hold key to the success of banks in the future. Questions: 1. What is meant by Universal Banking? 2. Comment on the evolution of Universal Banking?


3. Make a comparative study of Universal banking Vs Narrow Banking? 4. What is current scenario on consolidation of banking? 5. What are the recommendations of Basel II reforms, and Indias status in this regard? 6. What is risk management? 7. How important is corporate governance from the point of view of financial institution and the shareholders?

INDIAN FINANCIAL SYSTEM Indian Financial System is broadly classified into two groups: 1. Organized sector 2. Unorganized sector


The financial system is also divided into users of financial services and providers. Financial institutions sell their services to households, business and government who are the users of financial services. The providers of financial services are: 1. Central bank 2. Banks 3. Financial institutions 4. Money and Capital markets 5. Informal financial enterprises The organized financial system comprises the following subsystems: 1. The banking system 2. The co-operative system 3. Development banking system a. Public sector b. Private sector 1. Money markets 2. Financial companies/institutions The unorganized financial system comprises of moneylenders, indigenous bankers, lending pawn brokers, landlords, traders, etc. There are also a host of financial companies, investment companies, chit funds, etc. in the unorganized sector. These are not regulated by the Central Bank or the government in a systematic manner.

CO-OPERATIVE SECTOR The co-operative banking sector has been developed in the country to the supplement the village moneylender. The co-operative banking sector in India is divided into 4 components 1. State Co-operative Banks


2. Central Co-operative Banks 3. Primary Agriculture Credit Societies 4. Land Development Banks 5. Urban Co-operative Banks 6. Primary Agricultural Development Banks 7. Primary Land Development Banks 8. State Land Development banks DEVELOPMENT BANKS Development Banks are those financial institutions that provide long-term capital for industries and agriculture namely : 1. Industrial Finance Corporation of India (IFCI) 2. Industrial Development Bank of India (IDBI) 3. Industrial Credit and Investment Corporation of India (ICICI) 4. Industrial Investment Bank of India (IIBI) 5. Small Industries Development Bank of India (SIDBI) 6. SCICI Ltd. 7. National Bank for Agriculture and Rural Development (NABARD) 8. Export Import Bank of India 9. National Housing Bank MONEY MARKET

The money market is the market in which short-term funds are borrowed and lend. The leading money market institutions are : 1. Discount and Finance House of India Limited (DFHI) 2. Securities Trading Corporation of India (STCI) FINANCIAL COMPANIES Financial companies are those companies who mobilize and channel savings into investment. They are only partly controlled by the Reserve Bank and partly by the Registrar of Companies under the Companies Act.


Over the years, the structure of financial institutions in India has developed and become broad based. Today, there are more than 4,58,782 institutions channelizing credit into the various areas of the economy. INDIAN BANKING SYSTEM Banking in India has its origin as early as the Vedic period. It is believed that the transition from money lending to banking must have occurred even before Manu, the great Hindu Jurist, who has devoted a section of his work to deposits and advances and laid down rules relating to rates of interest. During the Mogul period, the indigenous bankers played a very important role in lending money and financing foreign trade and commerce. During the days of the East India Company, it was the turn of the agency houses to carry on the banking business. The General Bank of India was the first Joint Stock Bank to be established in the year 1786. The others that followed were the Bank of Hindustan and the Bengal Bank. The Bank of Hindustan is reported to have continued till 1906 while the other two failed in the meantime. In the first half of the 19th century the East India Company established three banks; the Bank of Bengal in 1809, the Bank of Bombay in 1840 and the Bank of Madras in 1843. These three banks also known as Presidency Banks, were independent units and functioned well. These three banks were amalgamated in 1920 and a new bank, the Imperial Bank of India was established on 27th January 1921. With the passing of the State Bank of India Act in 1955 the undertaking of the Imperial Bank of India was taken over by the newly constituted State Bank of India. The Reserve Bank which is the Central Bank was created in 1935 by passing Reserve Bank of India Act 1934. In the wake of the Swadeshi Movement, a number of banks with Indian management were established in the country namely, Punjab National Bank Ltd, Bank of India Ltd, Canara Bank Ltd, Indian Bank Ltd, the Bank of Baroda Ltd, the Central Bank of India Ltd. On July 19, 1969, 14 major banks of the country were nationalized and in 15th April 1980 six more commercial private sector banks were also taken over by the government. Today the commercial banking system in India may be distinguished into: 1. Public Sector Banks a. State Bank of India and its associate banks called the State Bank group b. 20 nationalized banks


c. Regional Rural Banks mainly sponsored by Public Sector Banks 2. Private Sector Banks a. Old generation private banks b. New generation private banks c. Foreign banks in India d. Scheduled Co-operative Banks e. Non-scheduled Banks

COMMERCIAL BANKING VS DEVELOPMENT BANKING Commercial Banks Commercial banks are profit making institutions. A commercial bank accepts money from those who have to save and disburse loans to those who need them. Out of


such transactions the commercial bank makes profit. Examples of commercial banks are, Allahabad Bank, Bank of Baroda, Bank of India, Canara Bank. Dena Bank, Indian Bank, Indian Overseas Bank, Oriental Bank of Commerce, Punjab National Bank, State Bank of India and its subsidiaries, Union Bank of India, United Bank, United Commercial Bank, Vijaya Bank etc. Functions of Commercial Banks (CB) There are three types of functions of CB. 1. Primary Functions These functions includes accepting of different deposits (current deposits, savings deposits, fixed deposits etc), giving loans (short term loans and medium term loans). 2. Secondary and Subsidiary Functions These functions include (i) Agency services rendered by the commercial banks such as making payment of insurance, payment, rent, school fees, salary collection, pension, dividend etc. (ii) Saving and purchasing of security and shares, collection of bills, cheques, demand draft etc. (iii) Undertaking and executing the trust, agreements and wills etc. (iv) Carrying transactions as an agent to government to local authority. 3. General Utility Services : Providing safe deposit vaults or locker to the customer for keeping their valuable and maintaining in the safe custody of bank, documents, security papers, shares, wills and sealed packets on behalf of customers Securing of travelers confidential status report about the customers on the basis of balance in their accounts, the mode and frequency of repayments.


Some banks maintain foreign exchange department dealing with foreign exchange. (Banks carry on and transact every kind of guarantee in connection with business on behalf of its constituents). The commercial bank also serves as correspondence and underwriters for the issue of shares and debentures of public limited company. Thus, commercial banks play an important role in the conduct of trade industry and commerce. The description of above functions is as follows: Commercial banks act as intermediaries between those who have surplus money and those who need it. To receive deposits and advance loans are thus the two main functions of all commercial banks. In short, they borrow to lend. They borrow in the form of deposits and lend in the form of advances. Besides, there are other incidental functions which have developed according to the needs of society. We discuss all of them below:1. Accepting Deposits Banks attract the idle savings of people in the form of deposits. These deposits may be of any of the following types: Demand Deposits, also known as current accounts. These are repayable on demand without any notice. Usually no interest is paid on them because the banks cannot utilize short-term deposits and must keep almost cent per cent reserve against them. On the other hand, a little commission is charged for the service rendered. Occasionally, a small interest is paid to the people who keep large balances.

Fixed Deposits or Time deposits These deposits can be withdrawn only after the expiry of the period for which these deposits are made. Higher interests are paid on them, the rate rising with the length of the period. Savings Bank Deposits


These deposits stand midway between current and fixed deposit accounts. The rate of interest is less than that on fixed deposits. 2. Granting Loans After collecting money, a bank invests it or lends it out. Money is lent to businessmen and traders usually for short periods only. This is so because the bank must keep itself ready to meet the demand of the depositors who have deposited money for short periods. Money is advanced by the banks in any one of the following ways: By allowing overdraft: Customers are given the right to over-draw their accounts. In other words they can get more than they have deposited, but they have to pay interest on the extra amount which has to be repaid within a short period. The amount of permissible overdraft varies with the financial position of the borrowers. By creating a Deposit Cash credit is another way of lending by the banks. When a person is in need of a loan from a bank, he has to satisfy the banker about his ability to repay, the soundness of his venture and his honesty of purpose. After that the banker may require a tangible security, or it may be satisfied with the borrowers personal security. Usually such security is accepted as can be easily disposed of in the market, e.g. government securities or shares of approved concerns. Then details about time, rate of interest are settled and the loan is advanced. After the period for which the money has been borrowed is over, the borrower returns the amount with interest to the bank. Banks make their profits thus by giving loans. Discounting Bills


The discounting of bills is another way of lending money. The banks purchase these bills through bill brokers and discount companies or discount them directly for the merchants. These bills provide a very liquid asset (i.e. an asset which can be easily converted into cash). The banks immediately disburse funds for the bill after discounting discount and wait for the bill to mature when they get back their full value. 3. Remitting funds: Banks remit funds for their customers through bank drafts to anywhere they have branches or agencies. This is the cheapest means of remitting funds. Funds can also be remitted to foreign countries. 4. Miscellaneous Functions: Besides these main functions, the banks perform several other functions as given under:

Safe Custody: Ornaments and valuable documents can be kept in safe deposit with a bank, in its strong room fitted with lockers, on payment of a small sum per year. Thus, risk of theft is avoided. Agency Functions: The bank works as an agent of their constituents. They receive payments on their behalf. They collect rents, dividends on shares, etc. They pay insurance premium and make other payments as instructed by their depositors. They accept bills of exchange on behalf of their customers. They pass bill of lading or railway receipts to the purchases of goods when they pay for them. This amount is passed on the suppliers of goods.

References: They give references about the financial position of their customers. When required they supply this information confidentially. This is done when their customers want to establish business connections with some new firms within or outside the country. Letters of credit:


In order to help the travelers the banks issue letters of credit. A man who is going abroad takes with him a letter of credit from his bank. It is mentioned there that he can be paid sums up to a certain limit. He shows this letter to banks in other countries which make the payment to him and debit the bank which has issued the letter of credit. UTILITY OF BANKS An efficient banking system is absolutely necessary for a country. If it is to prosper economically, the services that an efficient banking system can render a country cannot be exaggerated. Undeveloped banking system is not only an index of economic backwardness of a country, it is also an important cause of it. The banking system can be useful in the following ways in addition to what has been mentioned above in the functions of banks: 1. The banks create instruments of credit which serve very convenient substitutes for money. This means a great saving. 2. The banks increase the mobility of capital. They bring the borrowers and the lenders together. They collect money from those who cannot use it and give it to those who can. They thus help the movement of funds from place to place and from person to person in a very convenient and inexpensive manner. 3. They encourage the habit of thrift. One of the requisite conditions of saving is that there should be channels of investment. So long as money is kept in ones pocket, the chances are that it will be spent and not saved. But if it is put in the bank, it is out of sight and to be out of sight is to be out of mind. The chances are that it will remain in the bank. 4. By encouraging savings, the banks bring about accumulation of large amounts of capital in the country from small individual savings. In this way, they add to the productivity of the resources of the country and contribute to the general prosperity and welfare. Questions 1. What is a commercial Bank and what are their functions? 2. What are the general utility functions of commercial banks? 3. What role does commercial bank play in the development of an economy? 4. What is meant by funding and non-funding facility of commercial banks?


5. Write notes on: 6. (a) Letter of credit 7. (b) Bill discounting business 8. (c) Types of advances

DEVELOPMENT BANKS After the independence of India from the yoke of British rule, one of the primary visions of the then Prime Minister Pt. Jawaharlal Nehru was to industrialize the nation and also to make India a self-reliant one. The policies pursued by him, were to encourage state participation in infusing funds into the economy. The


investment by the private entrepreneurs had no place and infact, totally discouraged. Consequent result is bureaucratic regime, mired in the rigmarole of unimaginable rules. Growth as envisioned was a distant dream. The birth of International bank for Reconstruction and Development to reconstruct the liberated underdeveloped economies was the first phase of development. Protectionism coupled with excessive control over foreign interference had resulted in lop-sided development all around.

Origin and Nature Development Financial Institutions (DFIs) or development banks provide long term credit for projects. The rapid industrialization of continental Europe in the 19th century has been facilitated with the emergence of DFIs. Many of these institutions were sponsored by national governments and international organizations. The Netherlands set up an institution in 1822; and in France institutions such as Credit Froncier and Credit Mobiliser were created during 1848-1852. In Asia, the Industrial Bank of Japan founded in 1902 assisted not only in the development of the domestic capital markets, but also obtained equity for the industrial firms in Japan. To resolve the dearth of long term funds and the perceived socially unjustified risk aversion of creditors specialized financial institutions were set up in India: Industrial Finance Corporation in 1948 followed by the setting up of State Financial Corporations (SFCs) at the state level under the State Finance Corporation Act, 1951; Industrial Credit and Investment Corporation (ICICI) in 1955; and Industrial Development Bank of India (IDBI) as the apex bank 1964. There are investment institutions which mobilize resources and provide medium to long term investment. These are Unit Trust of India (1964) and LIC and GIC and its subsidiaries; and specialized institutions like the Technology and Information Company of India Ltd (TDICI) and Tourism Finance Corporation of India (TFCI) and Small Industries Development Bank of India (SIDBI) to serve in their specified areas. These institutions played an important role in acquiring and


disseminating skills necessary to assess investment projects and borrowers creditworthiness.

Sources of Term Loans The sources of funds of financial institutions were Reserve Bank of India, multilateral and bilateral agencies and issue bonds. Reserve bank made available funds at concessional rates for long-term financing from its Long Term Operations (LTO) funds. The funds from multilateral and bilateral agencies to FIs were guaranteed by the Government and carried low coupon rates. Finally the bonds issued by FIs qualified for SLR investment by banks thus ensuring a captive market. Financial institutions also raise term money borrowings, CDs, term deposits and inter-corporate deposits. An umbrella limit for the financial institutions has been prescribed by RBI. FIs make available term loans of 5 to 7 years and even exceeding 10 years. They also make available foreign exchange loans out of funds made available by foreign agencies to meet the foreign exchange component of project.

DEVELOPMENT FINANCIAL INSTITUTIONS Industrial Development Bank of India (IDBI) The Industrial Development Bank of India (IDBI) which was established in 1964 under an Act of Parliament is the principal financial institution for providing credit and other facilities for development of industry, coordinating working of institutions engaged in financing, promoting or developing industrial units and assisting development of such institutions. IDBI has been providing financial assistance to large and medium industrial units. Industrial Credit and Investment Corporation of India (ICICI)


ICICI was established in 1955 as a public limited company to encourage and assist industrial units in the country. It provides term loans in Indian and foreign currencies, underwrites issues of shares and debentures, makes direct subscription to the issues and guarantees payment for credit made by others. Industrial Finance Corporation of India (IFCI) IFCI was set up under a statute in 1948 but has been converted into public limited company to give flexibility to its operations. IFCI provides to industrial units project finance, financial services and promotional services. Under its project finance, financial assistance is available to units in the corporate and cooperative sectors for new units, expansion, diversification and modernization programme in the form of rupee loans and foreign currency loans, underwriting and direct subscription to shares, debentures, guarantees for deferred payments and foreign currency loans. State Financial Corporations (SFCs) At the state level, State Financial Corporations have been set up under State Finance Corporations Act 1951. Along with the all India financial institutions they form an integral part of the development financing institutions in the country. There are 18 IFCs in the country. They provide financial assistance to small and medium enterprises by term loans, direct subscription to equity/debentures, discounting of bill of exchange and guarantees. SFCs also provide equity type assistance under the special capital and seed capital schemes to entrepreneurs having viable projects but lacking adequate funds of their own.

Small Industries Development Bank of India (SIDBI) SIDBI has been established in 1989 to function as an apex bank for tiny and small scale industries. It functions as the principal financial institution for promotion, financing and development of industrial concerns in small scale sector and will also coordinate functions of institutions engaged in promotion, financing


and developing industrial concerns in this sector. From 1993 SIDBI is extending direct assistance to small scale units on a selective basis. SIDBI will also participate with selected commercial banks financing small scale projects so that working capital will be fully tied up in the case of jointly financed projects. Equipment Finance targeted at well run existing units will be extended to take up modernization and technology up gradation. Procedures have been simplified in the matted of refinancing limit. Shipping Credit and Investment Company of India (SCICI) The SCICI was set up in 1987 by ICICI for the development of shipping, fishing and related industries and financing projects on the strength of their financial viability after careful elaboration of the project t. The primary function of SCICI is to act as a channel for providing development finance to shipping, deep sea fishing and related industries which inter alia include road and air transportation, agriculture, feed mill, hatchery, fish processing, on-shore and off-shore oil survey, exploration and production, food processing and associated infrastructure facilities. SCICI provides financial assistance to enterprises in rupee loans, foreign currency loans, guarantees and underwriting of public and private issues and offer for sale of securities. There was a significant overlap in the business activities of SCICI with ICICI. SCICI was mainly promoted by ICICI and it is its largest shareholder. With a view to consolidate their activities as size is a significant factor in both lending and resource raising SCICI was merged with ICICI effective April 1, 1996. The merger of the two entities was based on economic logic of strong capital base and optimization of operational efficiencies. The merger of both the institutions will result in an increase in market share and reap the benefits of economies of scale. The merger is also expected to provide synergy in operations and resource mobilization and improve asset quality. Industrial Investment Bank of India


IIBI was formed on 27.3.1997 under the Companies Act as a development financial institution by reconstructing the erstwhile Industrial Reconstruction Bank of India with adequate operational flexibility and functional autonomy. The entire assets and liabilities of IRBI were transferred to IIBI. Tourist Financial Corporation of India Ltd. (TFCI) TFCI was sponsored by IFCI which commenced operations in 1989 to sanction project loans, lease assistance and direct subscription to shares. Apart from the conventional tourism projects in the accommodation and hospitality segments, assistance sanctioned by TFCI has enabled non-conventional tourism projects like amusement parks, car rental services and air taxi passenger facilities. National Bank for Agriculture & Rural Development (NABARD) NABARD is a apex credit institution set up on July 12, 1982 under the National Bank for Agricultural and Rural Development Act 1981 (Act 61 of 1981). It was established by merging the Agricultural Credit Department and the Rural Planning and Credit Cell of the RBI and Agricultural Refinance & Development Corporation (ARDC.) Objectives: Supporting and promoting agriculture and rural development Providing credit for the promotion of agriculture, small scale industries, handicrafts and other rural areas Promoting integrated rural development and securing prosperity of rural areas

Functions: 1. Credit Functions:


NABARD provides all kinds of productive and investment credit through the banking system to agriculture, small scale industries, village and cottage industries, handicrafts and other economic activities. It provides short term, medium term and long term finance to eligible institutions namely state co-operative banks, regional rural banks state land development banks (excluding short term), commercial banks (only long term) and other financial institutions approved by the RBI. NABARD has prescribed lower rates of interest on the refinance provided by it and the rates payable by the ultimate borrowers. 2. Development Functions: NABARD co-ordinates the operations of rural agencies, develops expertise to deal with agricultural and rural problems, assist the RBI and other institutions in rural development efforts and acts as an agent to the government and the RBI in relevant areas. It provides facilities for training and research and assists governments to enable them to contribute to the share capital of eligible institutions. Development and dissemination of technology, employment oriented production technology, area planning for rural industrialization. 3. Regulatory Functions: The Banking Regulations Act 1949 empowers NABARD to undertake inspection of regional rural banks, and co-operative banks (other than primary co-operative banks). If any such bank seeks permission of the RBI for opening of branches, etc., it will have to get recommendations from NABARD. Resources of NABARD The resources are contributed by the government of India and the RBI. Besides getting funds from the National Rural Credit (Long term operations) Fund and National Rural Credit (Stabilization) Fund, and Rural Infrastructure Development Fund, NABARD is authorized to raise funds by issue of bonds and debentures guaranteed by the central government and borrowings from other sources. Participation in thrust areas:


Integrated Rural Development Programme (IRDP) IRDP is a scheme devised by Government of India for generating self-employment opportunities in the rural sector and for development of rural areas. Extending cheap credit facilities to selected group, poverty alleviation programme and steps taken in this regard. It includes Service area plan, backward and forward linkage and infrastructural support. Bridging income gap and lifting family above poverty line Optimum utilization of available resources, facilitating provision for infrastructural project, diversifying the IRDP by encouraging secondary and tertiary sectors. Other schemes are, (a) Swaranjayanthi Gram Swarozgar Yojana (SGSY) Scheme focusing to help rural poor, women and disabled children. (b) Development of Women and children in Rural areas by promoting group activities (c) Training cum production centre for women by providing vocational/entrepreneurship training centers (d) Self-help group by organizing voluntary agencies for poor people in rural areas (e)providing refinance for project taken under National Watershed Development Programme and National Mission of Wasteland development. Other activities are briefly given below: Schemes for Monitoring Evaluation and Research activities -aimed at getting feedback on performance and initiate proper remedial steps Vikas Volunteer Vahini Programme-organizing farmers club, creating awareness among weaker sections of the technology External Aid Project-implementing projects aided by World Bank, OPEC Fund and monitoring performance and submitting report to aid agencies


Human Resources Development providing training to staff of other credit institutions in credit disbursal through training institutions attached to NABARD, organizing seminars/programmes on Non-farm Centre Business Development, inspection of banks etc., National Housing Bank (NHB) NHB was set up in July 1988 as an apex level housing finance institution in India. It is a wholly owned subsidiary of RBI. The primary objectives are to promote housing and arrange for refinance housing loans under its refinance schemes of scheduled commercial banks, housing finance companies, and co-operative housing finance societies. Questions: 1. Trace the origin of development of banks? 2. What were the objectives of Development Banks? 3. How do you differentiate the functions of a commercial bank and a development bank? 4. What are the different types of Development financial institutions? 5. Write a note on NABARD? 6. What are sources of funds for NABARD? 7. What are IRDP and other activities of NABARD?

ASSET LIABILITY MANAGEMENT Paul S. Nadler said If there is any area of banking that has undergone drastic change, it is the whole subject of asset/liability management.


ALM management is an integral part of the planning process of commercial banks. Asset Liability Management focuses on the maturity balance sheet of asset and liability transactions on a daily basis. Proper infrastructure and management Information System is in place for achieving the objectives of ALM. The main focus is to ascertain the net profit derived from every transaction that has been put through in banks. Income is a very sensitive issue and leakage is not tolerated. Mismatches between assets and liabilities of banks expose them to various types of risks. The experience of the South-East-Asian Crises showed the dangers posed by compromising asset-liability management principles and allowing the disproportionate accumulation of mismatches both on and off the balance sheets, leading to illiquidity and even insolvency. Risk management is a continuous process of planning, organizing and controlling the assets and liabilities, volumes, maturities, rates and yields. With the growing complexity of operations in financial markets, banks would have to rapidly equip themselves with a variety of knowledge-intensive skills and appropriate technology. To help manage this fragile transitional phase, the Reserve Bank has provided assetliability managers with guidelines that serve as benchmarks for an integrated risk management system. Asset-Liability Management (ALM) guidelines were issued to banks in April 1999 for managing liquidity and market risks. In October 1999, the ALM guidelines were included in a broad framework of guidelines for risk management systems in banks to cover the management of credit, market and operational risks. These guidelines would help to prepare the bank management to meet the challenges posed by the changing context of regulation and supervision. Banks are encouraged to evolve risk rating systems and internal control mechanisms based on value-at-risk and duration measures. The primary responsibilities of prescribing risk parameters and establishing effective control systems are vested directly in the boards of directors of the banks. For example the balance sheet of any bank contains asset and liability transactions of differing maturities. Deposits of any kind are liability for a bank and loans and advances constitute assets of a bank. These deposits and assets are classified currency-wise and maturity-wise, so as to ensure that short term deposits are not used for long term advances and long term deposits are not used for short term


purposes. Lest it would result in mismatch of asset and liability. There should not as far as possible gap between the maturity period of asset and liability. If any exists at any point of time remedial measures must be initiated then and there before problem strikes. ASSETS-LIABILITY MANAGEMENT IN BANKS (ALM) In India, the assets- liability- management is of recent origin. The Reserve Bank of India issued guidelines on February 10, 1999, for implementation of ALM. It has been implemented with effect from April 01, 1999. What is ALM? Assets liability management is a comprehensive and dynamic framework for measuring, monitoring and managing the market risk of a bank. It is the management of structure of balance sheet (liability and assets) in such a way that the net earning from interest is minimized within the risk-preference (present and future) of the institutions. Traditionally, banks and insurance companies used accrual accounting for essentially all their assets and liabilities. They would take on liabilities, such as deposits, life insurance policies or annuities. They would invest the proceeds from these liabilities in assets such as loans, bonds or real estate. All assets and liabilities were held at book value. Doing so disguised possible risks arising from how the assets and liabilities were structured. Increasingly, managers of financial firms focused on asset-liability risk. The problem was not that the value of assets might fall or that the value of liabilities might rise. It was that capital might be depleted by narrowing of the difference between assets and liabilitiesthat the values of assets and liabilities might fail to move in tandem. Asset-liability risk is a leveraged form of risk. The capital of most financial institutions is small relative to the firm's assets or liabilities, so small percentage changes in assets or liabilities can translate into large percentage changes in capital. Scope of ALM:











management, management of market risk, trading risk management, funding and capital planning and growth projection. Residual maturity: Residual maturity is the time period which a particular asset or liability will still take to mature i.e. become due for payment (once at a time, say in case of a term deposit or in installments, say in case of term loan). Maturity buckets: Maturity buckets are different time intervals (8 for the time being, 1-14 days, 15-28 days, 29-90 days, 91-180 days, 181-365 days, 1-3 years, 3-5 years and above 5 years), in which the value of a particular asset or liability is placed depending upon its residual maturity. Mismatch position: When in a particular maturity bucket, the amount of maturing liabilities or assets does not match, such position is called o mismatch position, which creates liquidity surplus or liquidity crunch position and depending upon the interest rate movement, such situation may turn out to be risky for the bank. The mismatches for cash flows for 1-14 days and 15-28 days buckets are to be kept to the minimum (not to exceed 20% each of cash outflows for those buckets). Role of ALCO: Asset Liability Committee is the topmost committee to oversee the implementation of ALM systems to be headed by CMD or ED. ALCO would consider product pricing for deposits and advances, the desired maturity profile of the incremental assets and liability, in addition to monitoring the risk level of the Bank. It will have to articulate the current interest rates view of the Bank and base its decisions for future business strategy on this view.


Benefits of ALM: It is a tool that enables Banks managements to take business decisions in a more informed framework with an eye on the risks that Banks are exposed to. It is an integrated approach to financial management, requiring simultaneous decisions about the types of amounts of financial assets and liabilities both mix and volume with the complexities of the financial markets in which the institution operates. RISK MANAGEMENT Reserve Bank of India issued guidelines on risk management in banks on October 20th 1999 which broadly cover management of credit, market and operational risk in the banking sector. Banks are also to adopt proper systems to measure, monitor and control operational risk that is emerging in the wake of phenomenal increase in the volume of financial transactions. The highlights are: 1. Banks to set up a comprehensive risk rating system for counter parties. 2. Banks are to fix a definite time frame for moving over to value-at-risk (VaR). 3. From March 2001 banks with international presents have to develop methodologies for estimating and maintaining economic capital. 4. Banks should evaluate portfolio quality on an ongoing basis instead of near balance sheet. 5. Investment proposals to be subjected to same credit risk analysis as in case of loan proposals. 6. Investment proposals to be included in the total risk evaluation. 7. For off-balance sheet exposure, the current and potential credit exposure to be measured by daily measure. 8. Activities of ALCO (Assets- Liability Committee) and Credit Policy Committee should be integrated. 9. For managing liquidity risk, Banks should place limits on inter bank borrowings which include call-funding, purchased-funds, core deposits to core assets, off Balance Sheet commitments, Swapped funds etc. 10. Banks have to provide a contingency plan to meet adverse swings in the liquidity conditions.


Tools of Asset Liability Management (ALM) and their Mechanisms SWAPS Swap literally means exchange and thus simply stated swap is nothing but exchange of liabilities between two parties. A swap is a financial transaction in which two counterparties agree to exchange streams of payment over time. Swaps are a common and popular product in derivative markets. An interest rate swaps does not involve exchange of principal either at the beginning or at the end of the agreed period, but does involve periodic exchange of streams of interest payments, of differing character in accordance with predetermined terms, on a notional agreed principal. A Currency Swap is a financial transaction whereby two counterparties agree to exchange specific amounts of two different currencies at the outset and periodic repayments overtime in accordance with predetermined terms. Swap as a derivative product, is a significant development in the financial markets of the world. This helps the borrowers in capital market to fund their requirements in a variety of ways. They can thereafter, as and when required under the circumstances, change the interest rate or currency exposure from the basic terms of the initial funding. Thus this product helps in not only raising money at a competitive price but also allows them to change their asset/liability profile as per their needs which might change in future.

Uses of Swaps: They can raise finance at a cheaper cost They can obtain high yield assets The swaps are used by them to hedge against interest rate exposure


They use it as a tool for ALM (Asset-Liability Management), particularly in short term Swaps have been used to raise resources abroad, which may otherwise be not allowed by the authorities Swaps are used for arbitraging in different markets More venturesome trade (speculate) in swaps.

OPTIONS Options are derivative products used for hedging the risks arising on account of wither interest rates or exchange rates. These products are generally, in the form of agreements and both the counterparties to the contract have certain rights as well as obligations under the said contracts. It is always good to have a right but no obligation. Illustration: Let us consider an exchange forward contract entered into by an exporter @ USD 1= Rs.49.9000, value date July 31. The possibility of exchange rates on July 31 could be as under: I) 49.9000 Or II) USD 1= 49.9800 USD 1=Rs.49.9000 The exporter neither gains nor loses by booking a forward contract @ USD 1=

Had the exporter not booked a forward contract @ USD1=49.9000, he would be better off by selling on spot rate getting 8 paise per USD higher. But by booking a forward contract he surrenders the upside gain. Or III) USD 1= Rs.49.8000

Had the exporter not booked the forward contract @ USD 1=49.9000, he would be worse off by selling USD on spot rate and getting 10 paise per USD less. But by booking a forward contract he ensures that the downside risk has been covered.


Options are contracts which give the buyers right but no obligation to buy or sell the underlying at the agreed rate, on or before an agreed rate. If we continue with the illustration and the exporter had instead of entering into a forward contract, bought an option, he would have a right to sell USD 1=Rs.49.9000 but no obligation. If spot exchange rate on July 31, were USD 1= Rs. 49.8000 he will exercise his right to sell USD @ USD 1= 49.9000 under the option contract but if the spot exchange rate on July 31 were USD 1=49.9800, he will not exercise his right to sell USD @ USD 1= 49.9000 under the option contract, rather forego his right and sell USD @ USD 1 = 49.9800 in the spot market and take advantage of the movement of exchange rate in his favour. In the light of the above, we can define an Option Contract a contract under which the buyer has a right but not an obligation, to buy or sell a specific quantity of a given asset at a specified price at or before a particular date in future. To acquire this right, the buyer pays a premium to the seller (as also called the option writer). If the buyer chooses to exercise his right to buy or sell an asset the seller has the obligation to deliver or take delivery of the underlying asset. The potential loss to an option seller is unlimited and to the buyer it is limited to the premium amount. Currency Option Terminology Call Option: The right to buy specified amount of one currency against another currency is known as call option. Put Option: The right to sell specified amount of one currency against another currency is known as put option. Buyer: The person who buys the right to buy or sell specified amount of one currency against another currency. Seller (Writer): The person who sells the right to buy or sell specified amount of one currency against another currency. Premium: The amount paid by the buyer of an option to the seller (writer of the option), is called premium. Strike Price: This represents predetermined price at which the option can be exercised.


Exercise Date: For delivery of foreign exchange the buyer of the option must notify the seller about his decision for taking or giving delivery and this is known as exercising the option. The date on which the option can be exercised is called exercise date. Expiration Date: The last up to which the option can be exercised. American Style: An option which can be exercised at any time between the initial deal date and the expiry date. European Style: An option which can be exercised only on the expiry date. ITM: If by exercising option, the buyer has an advantage, the option is called In the Money. If the option has intrinsic value, it is called In the Money. ATM: If by exercising option, the buyer has neither advantage nor disadvantage, the option is called At the Money. If the option has no intrinsic value i.e., the strike price is equal to the underlying spot or future rate, it is called At the Money. OTM: If by exercising option, the buyer has a disadvantage, the option is called Out of the Money. If the option has extrinsic value it is called Out of the Money. Intrinsic Value: The difference between current exchange rate and the strike price is called Intrinsic Value. Extrinsic Value: The total premium amount less intrinsic value is called Extrinsic Value or time value or volatility value. What are Futures? A currency futures contract is an agreement to buy or sell at future exchange a standard quantity of a foreign currency at a future date at the price agreed to between the parties to the contract. Although the contracts are traded between two parties, however, for clearing purposes clearing house of future exchange is the counterparty to each contract. This system thus eliminates credit risk on the counterparty to a large extent. The future exchange also looks after the work relating to margin accounts, reconciliation of payments and supervision of delivery process. Deals are effected through Future Commission Merchant who is regulated by the relevant law in the country. Like in USA, they are governed by Commodity Exchange Act and are governed by Commodity Futures Trading Commission.


Exchanges The order of the customer, to either buy or sell a futures contract, is executed by Future Commission Merchant on an exchange or Commodity Market. The main functions of the exchange are: 1. Provide and maintain a physical market place (called floor) where future contracts can be bought and sold by members of exchange. 2. Supervise and enforce, ethical and financial standards applicable to the future trading conducted on the exchange, 3. Promote the business interest of the members. Exchangers are generally membership organizations. Clearing House Every future exchange has a clearing house attached to it. The job of clearing house is to: 1. Receive daily report from the members of the exchange containing details of all future trades, 2. Matching the shorts against longs and reconcile the same, 3. Computing and collecting/paying daily margin calls to the members. Financial futures are liquid and transparent tools for hedging currency and interest rate exposure. Foreign exchange futures are very popular although they are not as flexible as forward contracts in respect of amount of contract and value date (maturity date). Financial Futures A futures contract is firm obligation to give or take delivery of a commodity of specific quantity or quality at a specified date at an agreed price. The seller is called the short and the buyer, the long. Further the law requires that all the futures contracts be bought and sold on designated contract markets.


There are basically two types of futures in the market and these are differentiated on the basis of underlying. If the underlying is a commodity, these are known as commodity futures and if the underlying is a financial instrument these are known as financial futures. Most actively traded futures are the following: Treasury Bills, euro dollars, crude oil, S&P 500, Corn, Soyabeans, Gold, Copper, Wheat, Currencies (DEM,YEN,CHF) are some of the most actively traded futures on various future exchanges. In financial futures, interest rates and exchange rates are being increasingly used as hedging techniques. The futures trading were first started in 1972 and it soon caught the fancy of the operators in the market. International Monetary market (IMM) in United States was the first market to trade financial futures. However, since then similar markets have been established in almost all the important financial centers like London, New York, Tokyo, Paris, Frankfurt, Singapore etc. Some of the major exchanges where various types of futures are traded are as follows: London International Financial Futures exchange (LIFFE) Chicago Board of Trade (CBOT) Chicago Mercantile Exchange (CME) Commodity Exchange (COMEX) New York Mercantile Exchange (NYMEX) Le March a Terme des Instruments Financiers, France (MATIF) Tokyo Securities Exchange (TSE) Osaka Securities Exchange (OSE) Singapore Monetary Exchange (SIMEX) Kuala Lumpur Commodity Exchange, Malaysia Deutsche Terminborse, Germany

The main reason for such a phenomenal growth of financial futures market is the volatility of exchange rates and interest rates. In financial futures market, unlike


cash markets, physical delivery is not required and thus there are pricing markets only. A future exchange is an independent body like stock exchange, which provides a place with infrastructural facilities where members can meet and trade among themselves. The same body also frames rules and regulations which govern the transactions in the futures market. To benefit in these uncertain times, read between the lines *********** Questions: 1. What is meant by asset liability management? 2. How does mismatch of asset-liability occur and what are the consequences? 3. Critically analyze the possibilities of mismatch of ALM in Universal Banking? 4. What is short term, medium term, and long term lending? 5. What are the various purposes of the above three types of loans? 6. Why was it considered necessary that commercial banks must switch over to universal banking? 7. What would be the consequences for development banks if commercial banks take over to universal banking? 8. Give examples of the merger of development bank and commercial banks? 9. What measures must be in place to prevent ALM mismatch that may be possible when banks function as a universal bank?

Relevance of ALM to printing of Currency notes


How does the Reserve Bank of India decide about the requirement of currency notes? Under Section 22 of the Reserve Bank of India Act, the Reserve Bank of India has got the sole right of printing currency notes. It can print and issue currency notes of different denominations from the rupee notes ten-thousand rupee notes. The Reserve Bank maintains a separate issue department to look after currency issue. This department maintains reserve against currency notes. At present the assets of the issue department consists of a minimum of gold and foreign securities to the extent of Rs 200 crores (of which gold should be of value of Rs 115 crores and the balance in rupee securities). The present system is known as the minimum reserve system of note issue. Although issue of currency notes is the monopoly of the Reserve Bank of India, it becomes a must when the government meets its surplus expenditure (so-called deficit financing) by resorting to issue of currency notes. DEVALUATION By devaluation of a countrys currency unit is meant the decrease in the external value of a unit of that currency expressed in terms of gold, SDR or foreign currency by government edict. A fall in the gold, SDR or foreign currency value of the currency unit amounts to an increase in the number of units of that currency per ounce of gold, per SDR or per unit of foreign currency. A country may reduce the foreign exchange value of her currency unit for more than one reason, e.g., to create surplus in her international balance of payments. In short, devaluation means an act of officially reducing the external value of the currency unit of the country in whose relationship the country has devalued her currency. For example, when the poundsterling was devalued on September 20, 1949 in terms of the US dollar, the old sterling-dollar exchange rate of 1 = US $ 4.03 was altered to the new exchange parity of 1 = US $ 2.80. Consequently, the dollar price of the pound-sterling had depreciated by about 30%. Generally, a country devalues her currency in order to correct the persisting deficit in her international balance of payments. When a country is faced with the chronic deficit in her balance of payments which cannot be removed through other methods at the pre-devaluation foreign exchange rate, e.g., through deflation or export


subsidies, she devalues her currency. The desired effects of devaluation follow from the fact that while the external value of currency is reduced there is no change immediately in the internal value of currency. In other words, the purchasing power of the currency in terms of domestic goods and services remain unaltered, i.e., the prices of goods and services in the country do not rise following the devaluation of the currency. Devaluation restores the balance of payments equilibrium primarily through an improvement in the domestic versus the international cost-price ratio. MEANING OF DEFICIT AND SURPLUS IN THE BALANCE OF PAYMENTS If the BOP is a double-entry accounting record, then apart from errors and omissions, it must always balance. Obviously, the terms deficit or surplus cannot then refer to the entire BOP but must indicate imbalance on a subset of accounts included in the BOP. The imbalance must be interpreted in some sense as an economic disequilibrium.



The word project has wider meaning. It refers to investment in several areas of economic development, including agriculture, education, transport and industry. An entrepreneur conceives the idea of setting up an industrial project after proper assessment which indicates that there is demand for the products/services and the profit margin will be attractive. After identification of the project, the entrepreneur does some preparatory work, such as arranging for some foreign collaboration, if necessary, and preparation of project report by engaging a consultant. The stage is now ripe for approaching commercial banks/financial institutions for support. Banks/financial institutions go for detailed appraisal of the project studying the following aspects of the project: (a)Market (a) Management (b) Technical (c) Financial (d) Economic (e) Political Banks and financial institutions must remember that a project is one whole and it has to be appraised as such. A few deficiencies in one area may be more than made up by stronger points in other areas. Projects brought up by new entrepreneurs, who are inexperienced, are bound to have some drawback/deficiencies. The object of a good appraisal is to improve and revamp the project with the co-operation of the promoters till it passes all tests. CREDIT POLICY AND BANK LENDING Safety of a loan is directly related to the basis on which The decision to lend is taken, The type and amount of credit Terms and conditions on which advance will be made available. Pre-sanction appraisal to determine the bank ability of each loan proposal

Therefore a banker adopts a two-pronged approach to ensure safety. They are


Post-sanction control to ensure proper documentation, follow-up and supervision

Tailoring a credit appraisal exercise to suit a pre-conceived decision on a credit demand is fraught with risks. A pre-sanction appraisal need not justify the credit demand of a customer. It has to be an objective exercise no matter how well known the customer is. Pre-sanction appraisal is concerned with the measurement of the risks of a loan proposal. The yardsticks used are Collection of financial data relating to the past and future working results Detailed credit report is compiled on the borrower and the surety, if any, Based on information collected from the party(ies) themselves, market reports, Final/audited accounts and Income-tax wealth tax returns/assessment orders and Confidential information called for from other banks with which the party has dealings. CREDIT INVESTIGATION REPORT (CR) It is a personal profile of the borrower It should be updated periodically It should reveal the personal details of the proprietor, partners or directors of the business, their assets and liabilities including indebtedness to other banks and financial institutions The CR in brief should reveal whether a loan proposal is a fair banking risk. Post-sanction Control

Depends upon the findings of the pre-sanction appraisal Involves proper documentation facility After care or follow up Supervision through monitoring of transactions


Scrutiny of periodical statements submitted by borrower Physical examination of securities and books of accounts of the borrower Periodical reviews and renewals etc.

Successful lending thus depends upon careful selection of the customer, proper appraisal of his credit needs and adequate control to ensure that his dealings with the bank are above-board and that he is complying with the terms and conditions on which credit has been sanctioned to him. Bankers Credit Reports (CRs) Furnishing of information to third parties including other banks about a customers account and his creditworthiness is a usual practice. Such reports should contain a disclaimer clause stating that the information in the report is given in strict confidence and without any responsibility on the part of the bank, or any of its officials and on the condition that our name will not be disclosed to anyone. Specimen of a CR:

Name of client Limit proposed


Expiry date

ORR (Obligors Risk Rate)

Limit approved

Nature of facility * Maximum Cap

Conditions:1. Security (Inventory/receivables/Cash collateral etc) 2.Consortium or otherwise 3.Share in the consortium 4.Frequency of submission of stock statements 5.Insurance Policy covering security 6. Tenor 7. Bank charges (bear in mind RBI/FEDAI rules in this regard) 8. ECGC where applicable Special conditions: 1. If client may be allowed exposure against uncleared funds. 2.If yes state the limit of such amount .3.If in excess, whose approval is to be taken 4.Others

Nature of Facility(Funding & Non-funding)


Funding 1. Overdraft 2. Demand Loan (IRS & FCY) 3. Export Finance (i) Preshipment (ii) Post shipment 4. Short term Trade Bills discounting 5. Commercial Paper 6. Non-Convertible Debentures (NCD)

Non-Funding 1. Letter of Credit 2. Bank Guarantees (i) Bid-bond guarantee (ii)

Financial Guarantee (iii) Performance Guarantee & others 3. Foreign Exchange Contract Spot & Forward

Recommended Sign/Date Date

Approved by

Approved by

Approved by Sign/

Sign/ Date



The function of currency regulation is the function of credit control. This function assumed importance with the growing popularity of bank credit. Thus the total amount of money in circulation has a relationship with the creation of credit. Of course, commercial bankers are not the only persons having the power. Besides, there are other forms of credit. Businessmen and industrial enterprises can acquire goods and services without paying for them immediately. Such factors, no doubt, loosen the control of the central bank over credit money. However, a modern central bank does not refrain from its attempts to create orderly monetary creations. These attempts can further be reinforced by appropriate fiscal policies on the part of the State, and control of investment. In addition, exchange controls can add their contribution towards the goal of establishing equilibrium in the realm of money activities. As to the main objective of credit control, there are differing opinions. Some economists are of the opinion that credit control should mainly aim at exchange


stability while some others are of the opinion that credit control should mainly aim at internal price stability. There are certain others who consider the elimination of business cycle as the primary objective of credit control. The most recent tendency is, as observed by De Kock, to combine the objective of international exchange stability with that of promoting and maintaining high levels of employment and real income. Methods of Credit Control


Bank Rate Policy, involving the alteration of discount rate so as to influence the market rate of interest, which pays a crucial role in the creation of credit.

2. Open Market Operations, involving the purchase and sale of securities in the open market so as to influence the total amount of money circulation. 3. Variable Reserve System, involving the variation of the minimum reserves, which the commercial banks are required to keep with the central bank, so as to influence the power of the commercial banks to create credit. 4. Selective Credit Controls, involving directional control so as to influence the flow of credit in particular channels. 5. Credit Rationing, involving the shortening of the currency of bills eligible for rediscount and the limiting of the amounts made available to individual banks so as to allocate funds among financially sound credit aspirants in accordance with a definite plan. 6. Moral suasion, involving friendly persuasion and advice so as to influence the lending policy of commercial banks. 7. Direct Action, involving coercive measures against particular banks so as to penalize recalcitrant units of the banking system. The aforesaid weapons of credit control are used in conjunction . That is to say that a central bank does not implement each method independent of others.

Questions: 1. What is project lending?


2. What are the risks of project lending? 3. What steps are taken by an entrepreneur before venturing into a project? 4. Give examples of projects and appraisals done before financing of a project at international level? 5. What is consortium financing?



Banks in their normal course of business activity deal in short term as well as long term funding and non-funding facilities. There are items that appear in the balance sheet of a bank and certain of the transactions that does appear outside the scope of the balance sheet known as off balance sheet items which are given below. Advances are granted by banks to their customers in different forms. When banks part with funds, the advances are called fund-based advances, as it involves direct lending of funds. There are some advances which are also called non-fund based advances. In these types of advances banks only make a commitment that in case the borrower defaults, the banks will make good the loss as per terms of the contract. If the borrower default in non-fund based advances, they also become fund-based advances. Fund based facilities: Cash Credit Overdraft Bills Purchased and discounted Export packing credit Non-fund based facilities: (Off Balance Sheet items) Letters of credit Guarantees Bills co-acceptance facility Foreign Exchange Contracts CONSUMER FINANCE The emergence of middle class with substantial purchasing power in India during last one decade or so and its desire to spend according to the changing lifestyle has offered the Indian Banking system a ready market for mobilization and deployment of their funds. Given the rising purchasing power of this class, there is huge untapped potential for business.


Objectives: Retail banking means providing services to individuals, focusing on individual needs for different kinds of financial services, in an integrated manner. The objective of retail banking is to increase penetration by providing increasing level of services and increased access by offering value added services to customers by packing them with retail banking products and services. The retail banking offers considerably better spread of 3-4 percent compared to very thin spread available to banks in case of Corporate clients. Retail banking is different from wholesale banking where focus is on industry and institutional clients. Need of Emphasis for Retail Banking: With large corporate borrowers having diversified their sources to fund their financial requirements, frequent reduction in Cash Reserve Ratio, resulting in pumping in of liquidity, declining Bank rate leading to decline in spreads, unattractive yields on Govt. securities etc. have all forced banks to be in search of alternative opportunity to deploy their funds. In fact retail banking is not a new concept. Rather it has come into focus only in recent times. Various Segments in Retail Banking: Basically there are 2 important segments in retail banking which include: 1. Deposit products (convenient deposit schemes like flexi deposits) 2. Loan products such as Housing Loans, Education Loans, Conveyance Loans, Personal Loans for diverse purposes such as medical expenses, travel abroad Besides there are number of value added services such as free collection of outstation cheque, concession in service fee in case of remittances, issue of free ATM cards, waiver of fee on credit cards and utility services such as payment of water, electricity and phone bills. Various Delivery Channel of Retail Banking:


The delivery of the above products and services can be through branch banking, Internet Banking or Automated Teller Machines. These can be called Home Banking, Internet Banking or Mobile banking, Credit Cards etc. Advantages of Retail Banking: Banks have excellent opportunity to cross sell various retail products like Credit Cards, Insurance Policies, Funds Investment services (including mutual funds) ancillary services like dematerialization, portfolio management, safe custody etc. ELIGIBILITY An adult, select customer of a bank who has a steady source of income. 1. Type of Advance: (a) For consumer durables (b) Two Wheeler vehicles Demand Loan -Demand Loan

(c) For four wheeler vehicles -Demand or term loan 2. Quantum of advance: (a) For consumer durables As per bank rules

(b) For four wheeler vehicles- As per bank rules Purpose: 1. Indigenous consumer durables, like TV, VCR, VCP, refrigerator, air conditioner, washing machines, personal computers etc. 2. Two wheeler vehicles, like scooter, motor cycles, mopeds (bicycles are not allowed) 3. Four wheeler vehicles Important:


1. No advance for purchase of vacuum cleaners or furniture 2. Loans for accessories for vehicles not to be considered 3. In exceptional cases, loans for second hand vehicles can also be considered, where comprehensive insurance cover is available. Margin: Minimum 25 percent, but low margin can be considered by a bank in case of group loans to employees of corporate borrowers/bodies where repayment is through deduction from salary. Rate of Interest: Commercial rate of interest as decided by the bank. Repayment: Generally, Demand loan-maximum 30 months Term Loan- 36 to 60 months Security: 1. Hypothecation of the assets purchased 2. Irrevocable letter of authority for recovery of installment and interest 3. Third party guarantee 4. Insurance for vehicles-for other goods, insurance may not be insisted upon. 5. Letter from employer to deduct the monthly installment from salary (wherever available)

Other terms: 1. Payment to be made direct to suppliers.


2. A bank has the right to inspect the assets purchased as and when required 3. Borrower to be induced to open recurring accounts 4. As and when asset is sold, the account should be closed immediately and any fresh request from the same proponent should be considered after a minimum period of six months. Housing Finance HOUSING FINANCE POLICY, ALLOCATION AND ACHIEVEMENT OF TARGET National Housing Policy The Central Government has adopted a comprehensive National Housing Policy which envisages (i) Development of a viable and accessible institutional system for the provision of housing finance; (ii) Establishing a system where housing boards and development authorities would concentrate on acquisition and development of land and infrastructure; and (iii) Creation of conditions in which access to institutional finance is made easier and affordable for individuals for construction/buying of houses/flats. The banks should gear up to deliver the requisite housing finance.

Housing Finance Allocation Every year, banks will need to achieve the prescribed target of housing finance fixed on the basis of their growth of deposits recorded during the previous year. For the financial year April 2001 to March 2002, each bank is required to compute its share of the housing finance allocation at 3 per cent of its incremental deposits as on the last reporting Friday of March 2001 over the corresponding figure of the last reporting Friday of March 2000.

Target Achievement by Banks


Banks may deploy their funds under the housing finance allocation in any of the three categories - (i) direct finance, (ii) indirect finance, or (iii) investment in bonds of NHB/HUDCO, or combination thereof. CONSTRUCTION ACTIVITIES Classification The Working Group appointed by RBI to examine the role of banking system in providing finance for housing schemes, classified construction activities in the following three categories: (i) Categories of construction activities eligible for bank credit as housing

finance and inclusion in the yearly allocation. (ii) Categories of construction activities eligible for bank credit but not to be included in the housing finance allocation. (iii) Categories of construction activities not eligible for bank credit. Bank credit eligible for inclusion in the Housing Finance Target under Annual Housing Finance Allocation The following types of bank credit will be eligible for being treated as housing finance under the Annual Housing Finance Allocation: Direct housing finance up to Rs. 5 lakhs provided per dwelling in semiurban/rural areas and up to Rs. 10 lakhs provided in urban/ metropolitan areas. Finance provided for construction of residential houses to be constructed by public housing agencies like HUDCO, Housing Boards, local bodies, individuals, co-operative societies, employers, etc Finance for construction of educational, health, social, cultural or other institutions/ centers, which are part of a housing project Finance for shopping complexes, markets and such other centers catering to the day to day needs of the residents of the housing colonies Finance for construction meant for improving the conditions in slum areas


Bank credit given for slum improvement schemes to be implemented by Slum Clearance Boards and other public agencies

Finance provided to (a) The bodies constituted for undertaking repairs to houses, and (b) The owners of building/house/flat, whether occupied by themselves or by tenants, to meet the need-based requirements for their repairs/additions Housing finance provided by banks for which refinance is availed of from National Housing Bank (NHB); Investment in the guaranteed/non-guaranteed bonds and debentures of NHB/HUDCO in the primary market, provided investment in non-guaranteed bonds is made only if guaranteed bonds are not available.

Bank credit not eligible for inclusion in the Housing Finance Allocation The following types of bank credit for construction will not be reckoned for the purpose of achievement of housing finance allocation: (i) Housing finance granted by banks to their own employees. (ii) Housing finance granted to non-resident Indians (NRIs) direct or through Housing Finance Institutions. (iii) Direct housing loans in excess of Rs. 5 lakhs and Rs. 10 lakhs provided in semiurban/rural areas and Urban/Metropolitan centers, respectively. (iv) Housing loans taken over by banks from other banks. (v) Industries manufacturing building material for construction. (vi) Construction of warehouses, including those to be constructed for Food Corporation of India, godowns and cold storages. (vii) Buildings which do not form a part of housing project like hospitals, clinics, schools, colleges, markets, shopping centers and cinema houses. (viii) Construction of hotels and accommodation for tourist and commercial offices.


(ix) Construction of hostels.

Construction activities not eligible for bank credit Banks should not grant finance for construction of buildings meant purely for Government/Semi-Government offices. Projects undertaken by public sector entities which are not corporate bodies. DIRECT HOUSING FINANCE Ceiling on Housing Loans per Dwelling (i) Semi-urban/ Rural areas - Rs. 5 lakhs (ii) Urban/Metropolitan centers - Rs. 10 lakhs (v) Supplementary finance (a) Banks may consider requests for additional finance within the overall ceiling for carrying out alterations/ additions/repairs to the house/flat already financed by them. INDIRECT HOUSING FINANCE General Banks should ensure that their indirect housing finance is channeled by way of term loans to housing finance institutions, housing boards, and other public housing agencies.

Lending to Housing Intermediary Agencies


Lending to Housing Finance Institutions

Banks may grant term loans to housing finance institutions. In respect of housing finance companies, the quantum of term loan to be sanctioned to them will not be linked to net owned fun

Lending to Housing Boards and Other Agencies Banks may extend term loans to state level housing boards and other public agencies. Financing of Land Acquisition Banks may extend finance to public agencies for acquisition and development of land,

Terms and Conditions for Lending to Housing Intermediary Agencies Term loans may be granted by banks to housing intermediary agencies Banks can grant term loans to housing intermediary agencies against the direct loans sanctioned/proposed to be sanctioned by them to NonResident Indians also. Banks have freedom to charge interest rates to housing intermediary agencies without reference to Prime Lending Rate (PLR).

Term Loans to Private Builders Commercial banks may extend credit to private builders on commercial terms by way of loans linked to each specific project.


The following housing finance limits will be considered as Priority Sector Advances:


Direct Finance (i) Loans up to Rs. 5 lakhs in rural/semi-urban areas and up to Rs. 10 lakhs in

urban/ metropolitan centers for construction of houses by individuals. (ii) Loans up to Rs. 50,000/- for repairs to damaged houses by individuals.

Indirect Finance (i) Assistance given to any governmental agency for construction of houses, or for slum clearance and rehabilitation of slum dwellers, (ii) Assistance given to a non-governmental agency approved by the National Housing Bank for the purpose of refinance for construction of houses or for slum clearance and rehabilitation of slum dwellers


Investments in Bonds


RBI REFINANCE Finance provided by the banks would not be eligible for refinance from Reserve Bank.


OPENING OF SPECIALISED HOUSING FINANCE BRANCHES A housing finance branch should be established in each district. branches may be restricted to semi-urban/urban areas bank Specialized


HOME LOAN ACCOUNT SCHEME (HLAS) FOR NHB Foreclosure of Loans Obtained from Other Sources Under the HLAS, a member of HLAS is eligible for a loan after subscription to the scheme for a minimum period of 5 years.

There is no objection to bank loans under HLAS being utilized for foreclosing loans secured earlier from other sources, as a special case.


Classification of Deposits/Loans under HLAS Under HLAS, the participating bank is required to accept deposits on behalf of NHB and make use of these deposits by way of refinance under any scheme approved by NHB from time to time.

Universal Banking: The Road Ahead The Challenges of Universal Banking in the Indian context and Universal Banking Abroad Economic historians have long emphasized the importance of financial institutions in industrialization. More recently, economists have begun more intensive investigation of the links between financial system structure and real economic outcomes. In theory, the organization of financial institutions partly determines the extent of competition among financial intermediaries, the quantity of financial capital drawn into the financial system, and the distribution of that capital to ultimate uses. The choice between universal and specialized banking may affect interest rates, underwriting costs, and the efficiency of secondary markets in securities. Furthermore, the presence or absence of formal bank relationships may affect the quality of investments undertaken, strategic decision-making, and even the competitiveness of industry. Particularly since World War II, many economists and historians have argued that German-style universal banks offer advantages for industrial development and economic growth. Universal banking efficiency combined with close relationships between banks and industrial firms, they hypothesize, spurred Germanys rapid development at the end of the nineteenth century and again in the post-World War II reconstruction. A corollary to this view holds that countries that failed to adopt the universal-relationship system suffered as a consequence. Adherents suggest that British industry has declined over the past hundred years or more, and that the


American economy has failed to reach its full potential, due to short-comings of the financial system that lead to relatively high costs of capital. Indian context In Indian context, the phenomenon of universal bankingas different from narrow bankinghas been in the news in the recently. With the last Narasimham Committee and the Khan Committee reports recommending consolidation of the banking industry through mergers and integration of financial activities, the stage seems to be set for a debate on the entire issue. A universal bank is a one-stop supplier for all financial products and activities, like deposits, short-term and long-term loans, insurance, investment banking etc. Global experience with universal banking has been varied. Universal banking has been prevalent in different forms in many European countries, such as Germany, Switzerland, France, Italy etc. For example, in these countries, commercial banks have been selling insurance products, which have been referred to as Banc assurance or Allfinanz. After the stock market crash of 1929 and banking crisis of the 1930s, the US banned all forms of universal banking through what is known as the Glass- Steagall Act of 1933. This prohibited commercial banks from investment banking activities, taking equity positions in borrowing firms, selling insurance products etc. The idea was to mitigate risky behaviour by restricting commercial banks to their traditional activity of accepting deposits and lending. Research on the effects of universal banking has been inconclusive as there is no clear-cut evidence in favour of or against it anywhere. Nevertheless, the United States has once again started moving cautiously towards universal banking through the Gramm-Leach-Bliley Act of 1999 which rolled back many of the earlier restrictions. Some recent phenomenon, like the merger between Citicorp (banking group) and Travelers (insurance group) confirmed the fact that universal banking is here to stay. Hence it becomes all the more imperative to know whether we need universal banks in India. And whether it is a more efficient concept than the traditional narrow banking. What are the benefits to banks from universal banking? The standard argument given everywherealso by the various Reserve Bank


committees and reportsin favour of universal banking is that it enables banks to exploit economies of scale and scope. What it means is that a bank can reduce average costs and thereby improve spreads if it expands its scale of operations and diversifies its activities. By diversifying, the bank can use its existing expertise in one type of financial service in providing the other types. So, it entails less cost in performing all the functions by one entity instead of separate specialized bodies. A bank possesses information on the risk characteristics of its clients, which it can use to pursue other activities with the same clients. This again saves cost compared to the case of different entities catering to the different needs of the same clients. A bank has an existing network of branches, which can act as shops for selling products like insurance. This way a big bank can reach the remotest client without having to take recourse to an agent. Many financial services are inter-linked activities, e.g. insurance and lending. A bank can use its instruments in one activity to exploit the other, e.g., in the case of project lending to the same firm which has purchased insurance from the bank. Now, let us turn to the benefits accruing to the customers. The idea of one-stopshopping saves a lot of transaction costs and increases the speed of economic activity. Another manifestation of universal banking is a bank holding stakes in a firm. A banks equity holding in a borrower firm acts as a signal for other investors on the health of the firm, since the lending bank is in a better position to monitor the firms activities. This is useful from the investors point of view. Of course, all these benefits have to be weighed out against the problems. The obvious drawback is that universal banking leads to a loss in economies of specialization. Then there is the problem of the bank indulging in too many risky activities. To account for this, appropriate regulation can be devised, which will ultimately benefit all the participants in the market, including the banks themselves. In spite of the associated problems, there seems to be a lot of interest expressed by banks and financial institutions in universal banking. In India, too, a lot of opportunities are there to be exploited. Banks, especially the financial institutions, are aware of it. And most of the groups have plans to diversify in a big way.


Even though there might not be profits forthcoming in the short run due to the switching costs incurred in moving to a new business. The long-run prospects, however, are very encouraging. At present, only an armslength relationship between a bank and an insurance entity has been allowed by the regulatory authority, i.e. the Insurance Regulatory and Development Authority (IRDA). This means that commercial banks can enter insurance business either by acting as agents or by setting up joint ventures with insurance companies. And the RBI allows banks to only marginally invest in equity (5 per cent of their outstanding credit). Development financial institutions (DFIs) can turn themselves into banks, but have to adhere to the statutory liquidity ratio and cash reserve requirements meant for banks. Even then, some groups like the HDFC (commercial banking and insurance joint venture with Standard Assurance), ICICI (commercial banking), SBI (investment banking) etc., have already started diversifying from their traditional activities through setting up subsidiaries and joint ventures. In a recent move, the Life Insurance Corporation increased its stakes in Corporation Bank and is planning to sell insurance to the customers of the Bank. Corporation Bank itself has been planning to set up an insurance subsidiary since a long time. Even a specialized DFI, like IIBI, is now talking of turning into a universal bank. All these can be seen as steps towards an ultimate culmination of financial intermediation in India into universal banking.


THE DEBATE OVER UNIVERSAL BANKING IN INDIA Thoughts on Universal Banking: FIs and banks Recent trends in universal banking in open market and emerging economies- Advantages and disadvantages Some of the troubling issues of universal banking. One key question: the financial institutions, with subsidized funds, tax incentives and other concessions have been unable to add to their resources (capital formation) over decades. In the early Nineties the forces of globalization were unleashed on the hitherto protected Indian environment. The financial sector was crying out for reform. Public sector banks which had a useful role to play earlier on now faced deteriorating performance. For these and certain other reasons private banking was sought to be encouraged in line with the Narasimham Committee's recommendations. It would be pertinent to recapitulate the prevailing conditions in the banking industry in the early Nineties: the nationalized sector had outlived its utility; in fact they became burdened with unwelcome legacies; customer service had become a casualty; need for computerization, including networking among the vast branch network was felt. Private banking in that context was viewed a brand new approach, to bypass the structural and other shortcomings of the public sector. A few of the new ones that were promoted by the institutions such as the IDBI and ICICI did establish themselves, though in varying degrees, surviving the market upheavals of the 1990.That was possible apart from other factors due to the highly professional approach some of them adopted: it helped them stay clear of the pitfalls of


nationalized banking. Yet in less than a decade after the advent of these new generation banks, some of the successful ones, are being forced to change organizationally and in every other way. Who benefits after this restructuring is something that has to be asked. It is essential to assimilate history of banking as well as the role of the financial institutions till recently. The branch banking concept with which we are familiar and practised since inception is basically on certain `protected' fundamentals. The insulated economy till the Nineties provided comforts to public sector banks, in areas of liquidity management while in an administered interest regime, discretion of managements was limited and consequently, the risk parameters in these spheres were hazy and not quantifiable. The share of private sector banks which is distinctly known as old private sector banks' established before 1994 was thus not substantial while operations of foreign banks were also restricted. Staff orientation especially at the branch level is a key ingredient for success and neither the older private banks nor the nationalized banks were successful in that respect. The woes of the public sector banks till date relate to handling volumes, be it in the area of transactions or staff complement or branch offices. Post nationalization, mass banking sans commercial or professional goals, indiscreet branch expansion, lack of networking, wide gaps/inefficiency at the levels of control apart from environmental impacts, contributed to their present status. Turning to recent merger announcement between the ICICI and its more recently promoted banking subsidiary the following become relevant. One of the main motivations has been the need to access a low cost retail deposit base. Public sector banks, by way of contrast never had to face such a constraint. Today, in a market driven economy, to face the competition, one factor is the size and hence, mergers are advocated. Talking of the PSBs it is relevant to note that except for a build up of savings accounts (as low cost deposits), the advantage of vast branch network is yet to be exploited by them while on the other hand, most of the complaints, irregularities, and mounting arrears in reconciliation are attributable to such branch expansion. At the same time, this has enabled a few of the smart foreign/new private sector banks to enrich themselves by offering cash management products, utilizing the


same branch network! All these pose a question to the recent merger of Bank of Madura - will the ICICI Bank decide to shed unwanted, unremunerative branches? Pertinently for all banks the RBI has already provided an exit route but there have been no takers among the public sector banks, for obvious reasons. Pertinent again is to note that another set of banks, namely, foreign banks prospered during all these difficult days. Even today, these banks do not have branch network to speak of but in terms of volume, profitability they are far ahead of the public sector banks. Only a couple of new private sector banks have posed any challenge to them in the recent years. Converting into Commercial Banks Hitherto the business of the financial institutions has been confined to only `credit' with attendant Forex business (with limitations). Apart from the proportion of existing NPAs in their balance sheets the FIs have to reckon with other important variables while moving towards commercial banking. Looking at the existing size of the financial institutions as compared to the bank with which merger is intended, the relatively short gestation period available to the bank to establish itself amidst the turbulent market/competition, the scenario is quite challenging. One might well ask the input from a financial institution, in a merger to a relatively less asset based bank. FIs have had a crucial role in the years following Independence: in the then prevalent conditions, financial institutions built up infrastructure contributed to a better industrial climate. The expertise in these fields may be sub served or enlarged appropriately. However is such expertise relevant for say small, retail loans-which are promising avenues for the banks of today? Are we looking at another type of mismatch?. Further, it is a matter of introspection in general: in what may be termed as `conventional' or `prudent' banking, (RBI itself had raised it in one of its circulars to banks way back in 1974) in the context of variation in profits (for whatever reasons), the net profit is to be determined within prudent levels, that is, in years where large increase in profits accrue, it was considered prudent to allocate larger amounts to `inner reserves' which were consciously not disclosed in those years. Accordingly, dividend payouts were also contained to take care of a lean period. The RBI is empowered even now by legislation on this aspect. However, in the recent past


corporates/ banks vie with each other to declare higher dividend payouts. What is worse ``creative accounting'' carries this process further. For instance, a prudent banker may opt for `written down value' method for depreciating fixed assets while some banks (including some of the new private sector banks) opt for the straight line method whereby, profits are more with less depreciation charged to the profit and loss account. Ironically they have been preaching to their borrowers those salutary goals.

The long and short of it Looked from another perspective, the financial institutions till yesterday are only for `long term' both on the assets and liabilities sides while commercial banks cater to `short term' businesses. There was a marked demarcation, though not a `Chinese wall' between these two. With the advent of market economy, the gap is getting closed through `universal banking'. The subject is in the air for sometime but currently, rising NPAs and dearth of avenues for resources for the financial institutions in the wake of falling market sentiments in the recent period, have accelerated the process. For a few of the FIs, survival itself might be at stake. On the risk parameters, the long term liabilities (at higher rates of interest, in the context of declining trends) will remain as they. A relook on the assets side strongly suggests that after netting the NPAs, the existing `mismatch' might well go up. Barring one or two of the new generation banks and foreign banks of course, the concept of ALM (asset-liability management) remains an academic subject. As far as the ICICI Bank is concerned, having only recently completed the takeover of Bank of Madura, it probably needs some more time to prepare for another drastic organizational upheaval. ICICI-ICICI Bank merger yet another dimension: the intended reverse merger of ICICI with ICICI Bank is unique in other ways too: the top management of ICICI `enbloc' will form the top corporate management of the ICICI Bank; among banks ICICI Bank may be the first to be headed by a non-executive Chairman and except for him, all others in the top management, after the merger might be non-bankers.


Also the proposed merger is the first of its kind that a non-bank of a larger balance sheet size (Rs. 74,371 crores as on March 31, 2001) is proposed with a commercial bank (Rs. 203,809 crores); post-merger again, the larger complement of ICICI staff will be non-bankers again, having exposure to `credit' only and would probably require a refresher course on diverse banking activities, the several enactments as well as the peculiar banking practices. Staff Incompatibility It is pertinent to mention that amalgamation between banks in the past, from a personnel angle has not been at all compatible - the striking example of the New Bank of India with the Punjab National Bank is a case in point. But here, larger strength of non-bankers need to be groomed and accepted for banking counters! Dealings in financial institutions are structured in an easier convenient `one to one basis unlike in commercial banks where the personnel are rotated among different functions. There are sharp variations even in lending practices. For instance, in the FIs loan disbursals are structured over a period as compared to running accounts of borrowers in banks where they need to respond on the spot to the situations. In the context of RBI's dictates, in conformity with Basle Committee prescriptions at the international level, to banks on `risk management', apparent risks in all spheres may call for special dispensations to the merged entity and thus one more class of banks (apart from public sector, old/new private sector, foreign banks) will emerge for the central bank to deal with. Lest unhealthy precedents are permitted, the central bank may have to envision a long term strategy to respond to emerging situations. In fact, RBI's policy to have permitted private banks to be established in the early Nineties has already been reviewed and yet another phase is now seen in regard to few banks which were then established. In fact, ever since RBI talked of `risk management' since 1998, except for some sporadic responses, it is yet to percolate at the top levels of management. So far it has been yet another jugglery with figures. One has to see the kind of disclosures in annual report of banks abroad on the risk parameters. The time is not far off for such compulsions from the international arenas (as the attraction for GAAP registration increases) to take hold. Failure or inaccuracies in disclosures may do greater harm at the national levels. For example, recently the regulatory authorities in the U.S. demanded policy documents on certain aspects of banking business: here, practices exist sans any documents,


notwithstanding the infamous securities scam of the 1990's; such permissiveness need to be contained. The RBI has on its record, such prescriptions, but these need to be enforced with rigour to match the U.S. practices. It is time that a long term approach, which should be sustained, sans pressures from any quarters is the need of the hour.

THE ENTRY OF COMMERCIAL BANKS INTO THE SECURITIES MARKET Government Securities Market New auction based instruments were introduced with varying maturities such as 364 day, 182 day, 91 day and 14 day treasury bills and the zero coupon bond. The auction system was also introduced for Government of India dated securities. An innovative feature of part payment was added to the auction of Government of India dated securities. In the long term segment, Floating rate Bonds (FRBs) benchmarked to the 364 day treasury bills yields and a 10 year loan with embedded call and put options exercisable on or after 5 years from the date pf issue were introduced. A system of Primary Dealers (PDs) was made operational in March 1996. Foreign Institutional Investors (FIIs) were allowed to set up 100 percent debt funds to invest in Government (Central and State) dated securities in both primary and secondary markets. The system of automatic monetization of budget deficit through adhoc treasury bills which hampered the development of the market was phased out over a


period of three years from 1993-94 to 1996-97 and was replaced by the system of Ways and Means Advances (WMA) with effect from April 1, 1997. The Delivery Vs Payment system was introduced in 1995 for the settlement of transactions in Government securities. A screen-based trade reporting system with the use of VAT communication network complemented by a centralized Subsidiary General Ledger (SGL) accounting system was put in place. The Negotiated Dealing System (NDS) (Phase I) was operationalized in February 2002 to enable on-line electronic bidding facility in the primary auctions of Central/State Government securities, OMO/LAF auctions, screen-based electronic dealing and reporting of transactions in money market instruments, including repo and to facilitate information on trades with minimum time lag. Since timely flow of information is a critical factor in evolving the efficient price discovery mechanism, improvements were brought in transparency of operations and data dissemination. A practice of pre-announcing a calendar of treasury bills and government securities auctions to the market was introduced. Retail trading in government securities at select stock exchanges commenced in January 2003.


MONEY LAUNDERING What Is Money Laundering? Money laundering means acquiring, owning, possessing or transferring any proceeds (of money) of crime or knowingly entering into any transaction that is related to the proceeds of the crime either directly or indirectly or concealing or aiding in the concealment of the proceeds or gains of crime, within or outside India. Money laundering is a process for conversion of money obtained illegally to appear to have originated from legitimate sources. Essential Elements of Money Laundering The essential elements are that a crime is committed, there are gains from the crime, proceeds have been received from crime and there is some transaction in respect of these proceeds or the gains. Legal Setup in India Indian parliament passed The Prevention of Money Laundering Act, 2002 during December 2002, for prevention of money laundering. The Act also provides for confiscation of property derived from or involved in money laundering. Role of Banks With Regard To Money Laundering: In India all banking companies including co-operative banks are covered under the Act. The money launderers may open deposit accounts with banks in fake names and banks will be required to be vigilant for not becoming a party to such transactions. Similarly they have to observe the norms regarding record keeping, reporting, account opening and monitoring transactions. Banks may also have to train their staff appropriately to check such activities. The Act has made various provisions regarding money laundering transactions which include maintenance of record of all transactions relating to money laundering.


Records relating to such transactions shall be preserved for 10 years from the date of cessation of the transaction between the clients and the banking company. Offences and Punishments: Offences would be cognizable and non-bailable. Punishment would be rigorous imprisonment for not less than 3 years but up to 7 years and fine up to Rs. 5 lakhs. For unlawful detention, searches or arrests without recording the reasons, the authority under the Act would be also liable to convicted for imprisonment up to 2 years and fine up to Rs. 50,000.

Know Your Customer Concept (KYC) As part of Know Your Customer principle, the Reserve Bank of India has issued several guidelines relating to identification of depositors and advised the Banks to put in place the systems and procedures to help control financial frauds, identify money laundering and suspicious activities and for scrutiny or monitoring of large value cash transactions. The guidelines are applicable to all accounts including Foreign Currency accounts or transactions. New accounts: KYC procedure should be the key principle for identification of an individual or corporate while opening an account. The customer identification or verification should be through an introductory reference from an existing account holder or a person known to the Bank or on the basis of documents provided by the customer. Banks should also take into account IBA Working Group recommendations for strengthening KYC norms with anti-money laundering focus and make use of formats for customer profile, account opening procedure, establishing relationship with specific categories of customers as well as an illustrative list of suspicious activities.


Existing Customers: Where the Banks have not adopted appropriate KYC norms at the time of opening accounts, the requisite KYC procedure for customer identification should be completed at the earliest. Cash Transactions: Banks are required to issue Travelers Cheques, Demand Drafts, Mail Transfer and Telegraphic Transfer for Rs.50000 and above only by debit to customers accounts or against cheques and not against cash. Further, the applications (whether customer or not) for the above transactions for amount exceeding Rs.10000 should affix PAN (Permanent Account Number) on the applications. Since KYC is now expected to establish the identity of the customer and as the issue of Demand Draft etc. for Rs.50000 and above is by debit to account, the requirement for furnishing PAN stands increased uniformly to Rs.50000. Large sized transactions: The Banks are required to keep a close watch of cash withdrawals and deposits for Rs.10 lakhs and above in deposit, cash-credit or overdraft accounts and keep record of details of these large cash transactions in a separate register. Reporting of large sized transactions: The branches of Banks are required to report all cash deposits and withdrawals of Rs.10 lakhs and above as well as transactions of suspicious nature with full details in fortnightly statement to their controlling offices. Besides controlling offices are also required to apprise their Head Office regarding transactions of suspicious nature.


COMPUTERS AND BANKING Banking through Computers A combination of computers and communication technologies is at present enabling international banks and financial institutions to expand their reach and offer technology based products to a wide spectrum of clientele which was unthinkable in olden days. Banks being essentially the processors of information in large quantities use the information technology (IT) to achieve the: Ability to handle large volumes of business with the desired level of efficiency; Maximizing profitability of operations and Exercising a strict vigil on costs

International banks have achieved the above objectives while Indian banks have started entering recently in the areas such as: Collection, storage and processing of information in administrative offices Toning up book-keeping efficiency at branches by computerizing back office operations Full branch computerization Setting up automated teller machines (ATM)

New private sector banks adopted the IT in a big way in order to capture corporate business. They use IT as a tool for designing and marketing aggressively a wide variety of retail banking products to capture the business of well-to-d- customers in urban/metro centers. The customers in these centers expect faster remittance facilities, automated teller machines and anywhere banking facilities, telephone banking, home banking, credit card facility, personal loans including for car, houses, consumption purpose, cash management for corporate etc. The banks have started meeting these requirements of the customers.


Banking Services through Information Technology Faster remittances services:

Electronic funds transfer (EFT) has accelerated the movement of funds across the globe. E-cash or Cyber-cash place a predominant role in world commerce. Such electronic funds movements amounting to a few trillion dollars are settled on a daily basis at major international financial centers. Society for World Wide Inter Bank Financial Tele-communication (SWIFT) is a classic example of EFT among banks with its own standard for messages, which ensure speed, reliability, security and accuracy. If large Banks in India create such infrastructure for their branches in India, this will lead for more efficient use of funds and contribute to excellence in customer service in remittances and collections. Anywhere Banking and ATM

It empowers the customers to operate their account at any of the branches of a Bank at one city and with the help of inter-city communication linkage it can be used across different cities. ATMs have made it more convenient for the customers to transact business from nearest ATM. The commencement of shared payment network (SPN) system by IBA in Mumbai is a step in this direction. Further a smart card provides in-built intelligence enabling the storage of a number of other details concerning the customers account including available balances. Tele Banking

It has started attracting the fancy of urban customers for convenience of facility which takes care of transport bottle-neck, traffic jams, non availability of time for visiting bank branches etc. Any branch of a commercial bank which has computerized operations can offer this facility with the help of a suitable software for this purpose. Digitalization of voice has enabled the introducing of this technological marvel. Facilities offered through telephone banking include a range of services such as Balance enquiries, enquiries of collection or specific credits and debits, transfer of funds, request for statements of account, account opening forms etc. Banks are also offering services such as account opening and ordering for demand drafts.


Home Banking

It is an extended version of tele-banking whereby the customer is able to access is branch account from his home for availing a variety of services which is made available through the customers personal computer attached to a telephone line and a modem. On-line banking facilities including normal transactions can be handled Corporate clients can benefit considerably by having a The application software for such through this arrangement.

remote PC terminal for this purpose in the Corporate Office itself and can handle their documentary credit related transactions. facility should incorporate suitable security features such as encryption to protect the transmission of sensitive data over telephone lines. Cash Management

Some banks including SBI, Corporation Bank introduce cash management products for Corporates to improve their quality of services. CMP (Cash Management Products) Technology involves pooling of the collection details of cheques deposited by the Corporates at upcountry centers to a central place and offering credit in their account either on the same day or next day. The details of cheques deposited are relayed from upcountry branches either through dial-up lines or through Leased lines or through V-Sats (Very small aperture terminals). A versatile CMP application software is used at a Central place in the Bank for consolidating the details of cheques. The arrangement is gaining popularity as it provides the much needed value addition in the range of services offered to Corporate customers. BANK AUTOMATION As a result in the increase of volume of business in the Banks, the quality of customer services had a set-back and in order to improve this quality, reduce the expenditure to attain profits and to handle volume of transactions, the need for Bank computerization was severely felt. This objective has now been achieved through networking system such as LAN and WAN.


At a very low level the machines such as ALPM (Automated or Advanced Ledger Posting Machines) are being used to perform the functions relating to various sections of branch banking such as current accounts, saving accounts, cash credit, salary etc. An ALPM contains records of the customers and during transactions; the details of his account are available on the screen of VDU. system is used with the help of password of the user. The Automated Teller Machines (ATMs) on the other hand are made use of through WAN. ATMs are electronic machines which are operated by the customer himself to deposit or withdraw. For using an ATM, a customer requires an ATM card which is a plastic card magnetically coated and read by the machine. To use an ATM the customer has to insert the card in the machine. After establishing the authentication of the customer, the ATM permits the customer to make entries and after processing the transactions, the machine performs the desired function. On completion of the transaction, the customers card is ejected. ATMs provide round the clock service, with ease and privacy of operations. It reduces pressure on banks staff and avoids congestion in the branch premises. To ensure security the


CUSTOMER RELATIONSHIP MANAGEMENT (CRM) CRM stands for Customer Relationship Management. It is a process or methodology used to learn more about customers' needs and behaviors in order to develop stronger relationships with them. There are many technological components to CRM, but thinking about CRM in primarily technological terms is a mistake. The more useful way to think about CRM is as a process that will help bring together lots of pieces of information about customers, sales, marketing effectiveness, responsiveness and market trends. CRM helps businesses use technology and human resources to gain insight into the behavior of customers and the value of those customers. Advantages of CRM Using CRM, a business can: Provide better customer service Increase customer revenues Discover new customers Cross sell/Up Sell products more effectively Help sales staff close deals faster Make call centers more efficient Simplify marketing and sales processes

The types of data CRM project collects: Responses to campaigns Shipping and fulfillment dates Sales and purchase data Account information Web registration data Service and support records Demographic data Web sales data

Today's organizations are racing to develop the analytical and technological tools that will help them identify, attract, and build relationships with precisely those


customers they want. They realize that they must evolve their marketing strategies, operating structures, and systems to confront the sophisticated, information-driven marketing models wielded by non-traditional competitors, such as retailers and Webenabled financial services firms. Banks that want to capture and keep the lead will use what is learned about individuals - not just segments, or even micro segments to determine the product configurations, promotion tactics, pricing, service levels, and channel mix that make sense for each customer. A joint research project by PricewaterhouseCoopers and the Economist Intelligence Unit identified three stages of change in the area of Customer Acquisition and Management. Stage One: Broad Customer Segments Identified Profitability-based segmentation and house holding for current customers are the primary weapons Unrefined customer analyses have some influence on the product, channel, pricing, retention, cross-selling, and service mix offered Generally speaking, the organization is internally focused

Stage One banks are striving to obtain more value from high-value customers with targeted cross-selling. At the same time, they are actively migrating from low-value customers to lower-cost (self-service) channels and providing them with lower-cost service offerings.

Stage Two: Customer Needs, Behaviours, and Values Clarified Banks achieve better prospect and customer management by combining profitability, behavioural segmentation, and analysis Banks deliver information to customer touch points (e.g., branches or call centers) to influence customer activity and workflow management Stage Two banks manage and influence the workflow of their branches and call centers, and generate more effective customer acquisition and management activities.


Stage Three: Virtual Intimacy You can achieve virtual intimacy with your clients through a major transformation of strategies, processes, systems, and structures. The traditional organization design is redrawn and IT infrastructure redesigned Advanced predictive capability enhances customer acquisition and crossselling You will gain influence over your competitors' strategies

Stage Three banks completely transform many elements of their customer acquisition and management strategies thereby creating an entirely new marketing approach. Moving beyond the previous stages, the Stage Three bank constantly designs and tests product offerings tailored for specific micro-segmentsas small as one. The basis of business success in today's corporate banking market is related to a bank's ability to design and deliver unique value creating solutions for its clients. The desired role of the relationship manager is that of a problem-solving professional and company champion. Full service banks that best master this more sophisticated way of doing business will theoretically have the competitive edge. Corporate financial executives acknowledge both advantages and disadvantages associated with full service banking. Some of the advantages include 'the simplicity of a one-stop-shop', 'a deeper understanding of the company's needs' and 'the ability to save time'. Some of the disadvantages include 'their knowledge is generally less specialized', 'they tend to be less competitive / hungry for business' and 'there is a potential for conflict between the investment and commercial bankers'. Several relationship specific disadvantages were recognized as well. For instance, many clients are experiencing considerable pressure from their banks to provide fee based advisory business as a quid pro quo for loans, to the point of destroying the relationship. Also, bankers who leverage the overall relationship to push products that the company does not need or want are considered to be wasting valuable time.


Surprisingly, it was also reported that some bankers were 'whining and moaning' when they lost business to competitors, to the point of destroying the relationship. Too many banks appear driven by short-term deal making practices. Full service banks need to take a long term view of the client relationship. They should not expect to win all the business in the short term. Each business opportunity presents a chance to learn and develop intellectual capital. This knowledge when disseminated to other bankers faced with similar circumstances becomes a valuable corporate asset. Personal reward programmes should recognize the value of knowledge generated associated with failures. Full Service Banking Relationship Managers are a New Breed of Banker Corporate financial executives expect their banks to provide a single-point of contact for investment and commercial banking relationship purposes. They want their relationship manager to be a senior decision-maker with clout who can get things done for them. The relationship manager is expected to be knowledgeable of the company, its management, its financial needs and the range of capabilities the bank offers. They are also expected to manage the relationship proactively as a problemsolving professional using their knowledge to tailor unique and innovative financial solutions that will create company value. There is a clear need for banks to invest in the continuous development of this new type of banking professional. A large proportion of the financial executives interviewed in the Survey felt that it was 'important' or 'very important' for their relationship managers to improve their knowledge of and interactions with the company. The need for a well-defined career path and development programme is especially critical given that the clients are also complaining about the lack of relationship manager continuity. The Organization of People and Information must be Client Centric The organization of people and information must support the need to manage contacts, knowledge and information on a local and global basis. Many corporate financial executives complain about the difficulties in identifying and contacting the appropriate person for a particular question or problem. Also, they complain about the inability of some of their banks to provide a complete picture of business dealings with the company.


The corporate client prefers that a bank be organized on a sector basis. Major corporate clients should have a dedicated individual or team for each service area. They want the relationship manager to be the focal point between themselves and the other resources of the bank. They also want direct access to product and service specialists who know them and the business they have transacted. Sector specialization should permeate the entire structure of the corporate banking operation. Corporate banking is a knowledge business. The bank's information technology must support the communication and networking of people, the accessibility and presentation of information, the tailoring of innovative solutions and the efficiency of decision making processes. Information must be comprehensive, accurate and accessible providing a comprehensive picture of the company, the sector, the bank's capabilities, the business conducted with the bank and the business environment. The need for banks to improve their relationship management capabilities is becoming significant. Most corporate financial executives feel that there is a need for banks in general to improve their relationship management capabilities . Relationship management is evolving, becoming more professional in its approach to creating client value. Long gone are the days when a financial organization could rely mainly on a 'social' or 'historical' relationship to sustain an acceptable share of profitable business.


LOAN SYNDICATION LOAN SYNDICATION [DOMESTIC] Introduction Loan syndication refers to assistance rendered by merchant banks to get mainly term loans for projects. Such loans may be obtained from a single development finance institution or a syndicate or consortium as in the case of large term loans. Merchant banks can also help corporate clients to raise syndicated loans from commercial banks. Term Loans Following institutions extend term loans for the promotion and financing of fixed assets. They cover small and medium industrial units in the corporate and cooperative sectors. Development Financial Institutions (DFIs) or development banks like, Industrial Finance Corporation of India State Finance Corporations IDBI, ICICI, Industrial Reconstruction Bank of India, Small Industries Development Bank of India, State Industrial Development Corporations, UTI, LIC, GIC and its subsidiaries

Activities Term loans in Indian and foreign currencies Underwrites issues of shares and debentures Makes direct subscription to the issues Issuance of deferred guarantees for advance made by others Discounting of bills of exchange

Shipping Credit and Investment Company of India [SCICI] - They finance shipping, deep sea fishing, road and rail transportation, aquaculture, feed mill, hatchery, fish processing, on-shore and off-shore oil survey, exploration and production, food processing and associated infrastructure facilities.


Tourism Finance Corporation of India Ltd [TFCI] They cover hospitality segments, tourism projects like amusement parks, car rental services and taxi passenger services, project loans, lease assistance and direct subscription to shares. Priority Sectors- Financing Projects contributing to infrastructural facilities in centrally declared backward areas, agriculture, and rural development, export units, import substitution, commercially proven indigenous technology, modernization, energy conservation, nonconventional sources of energy and projects promoted by new entrepreneurs, technocrats and non-residents. The projects should not fall under negative list which includes, cigarettes, beer, alcohol, toilet, cosmetics, LP Gas cylinders, HDPE woven socks, bright bars, tin and metal containers, drums and barrels, plywood, commercial and decorative veneers, black boards and flush doors, calcium carbide, Hamilton poles, tubular poles, hand operated sewing machines, conveyor belting, fan and V belts etc. Foreign Currency Loans The interest rates are linked to LIBOR plus 1.5% and negotiable for prime clients. All Indian financial institutions (IDBI, IFCI, & ICICI) operate Exchange Rate Administration Scheme (ERAS) to cover exchange rate fluctuations. In short Loan syndication is an alternative to Consortium Lending. LOAN SYNDICATION [EXTERNAL] Guidelines A cap is put on the External Commercial Borrowing [ECB] to ensure that it remains within manageable limits. ECB is defined to include suppliers credit and credits from sponsored agencies. Applicants are Free to raise commercial loans from any internationally recognized source including commercial banks, export credit agencies,


Free to negotiate choice of currency, interest rates, fees, security, repayment schedule etc but consistent with the current available market terms.

However, where the security is in the form of a guarantee from an Indian financial institution, there should be no counter guarantee by any institution abroad. The Govt while approving, would ensure meeting such conditions inter alia applicability of withholding tax. Approvals Department of Economic Affairs, Govt of India, and Reserve Bank of Indias approval is pre condition before drawing loan. Govts and Govt related borrowers resorted to Euro-credit market for industries, and infra structure projects and even to finance balance of payment deficits. There is no shortage of funds in euro market and further the lender would be satisfied, if end use is for the intended purpose. Loan Syndication Sovereign risks do arise in international lending. Lead banks assemble a management group of other banks to underwrite the loan and to market shares in it to other participating banks. In a syndicate there are three levels of banks, lead banks, managing banks and participating banks. The mandate to organize the loan is awarded by the borrower to one or two major banks after competitive bidding procedure. Common type of syndicated loan is a term loan with a grace period before repayment of principal commences. Grace period is one of the factors that determine the cost of the loan. The loans are normally denominated in US$, CHF, JY, EURO and other currencies are also granted. Pricing Interest on syndicated loans is altered every three or six months bearing fixed relationship to the LIBOR. The roll over euro dollars bear a rate tied directly to money market and interbank cost of funds. Beyond LIBOR is the


Spread, premium, commitment fees, front-end fees and sometimes an annual agents fee. Loan Agreement Provisions Euro loan agreements are simple and contain fewer restrictive covenants. Loan document clauses cover pricing, interest payment dates, amortization dates. In the case of loans to multinational companies, affiliates are regarded as obligators of the parent company. The other aspect in the loan document reflects the international character of the loan. The borrower may be in one country, the booking of loan in another country and the funding another country. First relates to jurisdiction. New York is often chosen because of the extensive case law on banking matters even in cases involving lenders and borrowers not residents of the U.S.A. Judgement currency clauses are necessary because courts in several countries render judgement in domestic currency only. Place & Method of Payment Payment of principal and interest on loan is normally affected means of transfer of funds from one bank account to another in the country of the currency in which the loan is denominated. Borrowers normally receive funds in the place of their choice. Guarantee Clause The syndicated loans have no collateral. A bank guarantee is required and the bank should satisfy capital adequacy norms. Reserve Requirement Clause [RRC] The lending banks in the Eurodollar markets are free of any reserve regulations imposed by central bank. The RRC stipulates that the borrower has to absorb any additional cost the lender incurs when interest free reserve requirements are imposed. Free and Clear of Taxes Lending banks insist on payments, of principal and interest free of taxes. Euro Dollar Availability clause permits the bank to call for prepayment if sufficient dollar funds are not available.


Euro-Bonds- are usually for duration of 10 to 15 year period. These bonds are issued by a borrower who is of a nationality different from the country of the capital market. Loans are cheaper, flexible than bonds and allow for switching of currencies and early payment. Companies and Governments prefer to raise a bank loan or a syndicated loan rather than tap the international debt market. Besides larger amounts can be raised. Priority Sectors- Financing Projects contributing to infrastructural facilities in centrally declared backward areas, agriculture, and rural development, export units, import substitution, commercially proven indigenous technology, modernization, energy conservation, nonconventional sources of energy and projects promoted by new entrepreneurs, technocrats and non-residents. The projects should not fall under negative list which includes, cigarettes, beer, alcohol, toilet, cosmetics, LP Gas cylinders, HDPE woven socks, bright bars, tin and metal containers, drums and barrels, plywood, commercial and decorative veneers, black boards and flush doors, calcium carbide, Hamilton poles, tubular poles, hand operated sewing machines, conveyor belting, fan and V belts etc. Foreign Currency Loans The interest rates are linked to LIBOR plus 1.5% and negotiable for prime clients. All Indian financial institutions (IDBI, IFCI, & ICICI) operate Exchange Rate Administration Scheme (ERAS) to cover exchange rate fluctuations. In short Loan syndication is an alternative to Consortium Lending.


MERGERS, AMALGAMATIONS AND TAKE OVERS Introduction Mergers and amalgamations are generic terms referring to different types of business combinations wherein two or more firms combine to form one legal entity. A merger is an investment in a future growth opportunity. In merger proposals plant is ready and market acceptance, clear and well established. In this connection, three other terms are also used, acquisition, leveraged buyout and takeover. Abroad the terms mergers and acquisitions [M&A] are commonly used. Takeover is another term used especially in our country under the sick industries rehabilitation. Mergers, amalgamations, acquisitions and takeovers, whatever the name used are likely to become a common feature of the emerging industrial scene in India, which we are witnessing today. The experience of United States in 1980s shows that mergers were prevalent in industries experiencing rapid technological change, deregulation price stocks or increased foreign competition. The largest ever merger in Indian corporate history is of Reliance Petro Chemicals with Reliance Industries in 1992. Merger, Acquisition, Amalgamation and Takeover Merger is a broad term and it denotes the combination of two or more companies in such a way only one survives while the other is dissolved. When two companies differ significantly in size, they usually merge. Acquisition refers to a situation where one firm acquires another and the latter ceases to exist. Sometime only a part of the other firm is acquired in which the company survives. The assets of the dissolved firm would be owned by the acquiring firm. The shareholders of the dissolved firm are paid either cash or given shares in acquiring company. Amalgamation is an arrangement whereby the assets of the two companies are vested in one which has as its shareholders all or substantially all shareholders of the two companies. Amalgamations are governed by Sections 390 to 394 and 396 of the Companies Act requiring consent of shareholders and creditors.


Takeover is normally an unfriendly acquisition by tender offer. This happens when two companies are about the same size. Sometime acquisition of control is preferred to full acquisition and act as a holding company. Holding company is a firm that owns sufficient shares in one or more companies. Funds required would be much less than in the case of a merger to have effective control over them. Takeover is regulated by clauses 40A and 40B of the Listing Agreement of Stock Exchange and Guidelines of SEBI with sanctions to be obtained from SEBI in respect of offer document and from Government under Sections 108A and 372 of the Companies Act. Nature of Mergers Mergers can be classified into horizontal and vertical mergers. In the case of horizontal mergers, the units are in the same business and the resulting increase in market share could lead to a monopoly situation. Examples of merger in similar product line, are Tata Finance Ltd with Tata Industrial Finance Ltd, GEC with EEC and TOMCO with Hindustan Lever Ltd. An example of merger which has the effect of backward and forward product integration is Reliance Petro Chemicals Ltd with RIL. The advantages of mergers are a lower transaction cost, assured supplies, improved coordination and higher barriers to entry. The disadvantages are large capital requirements, reduced flexibility and less of specialization. The objective of merger is value creation and maximization of shareholder wealth. The factors responsible for value creation are economies of scale, financial advantage, and synergy and tax advantage. Synergism

The whole is larger than the sum of parts. This is called synergism. That is 2+2=22. With it follows operating economies, accounting, purchasing and other operations. Besides if the merging companies were in the same line of business, there would be reduction in cost with increase in volume.

More effective management also gives rise to synergy. It would be a positive signal for profitability. Tax factors too motivate a merger often. Diversification or acquiring a different line of business is sometimes a motive for mergers. It can achieve control of large aggregation of assets with small investment. Sometimes the shareholders of


closely held company by merging with a publicly held company may obtain an improvement in liquidity of their investment. Merger is effected through either purchase of assets or shares. For merger, shareholders representing 75 percent of the value of shares of the Target Company must approve. Hostile Takeover A tender offer to purchase shares of another company at a fixed price from shareholders who tender them may be made by the acquiring company. The tender offer allows the acquiring company to bypass the management of the company. Purchase of shares from the market or through tender is likely to be expensive if the targets board is not receptive. A hostile takeover through a proxy is resorted. Takeovers in India

Apart from phrases such as mergers, amalgamations and acquisitions, the phrase takeover has gained wide currency. Takeover, of course, represents acquisition of substantial shares for the purpose of seeking management control of the company. The first step is takeover by merger of a good acquirer with a sick company to avail of the benefits of tax shield. Secondly takeover is by acquisition of shares through direct negotiations with one who owns controlling interest or through open offer or market purchase of an adequate level of voting capital to change the management of the company. SEBI Guidelines on Corporate Takeover

The listing agreement between the company and the stock exchange are based on (I) Creating a greater transparency in takeover deals, (ii) insisting upon a greater amount of disclosure through detailed public announcement and offer documents. (iii) Safeguarding the interest of minority shareholders as the acquiring company has to compulsorily make an offer to small shareholders, and (iv) opportunity to small shareholders to decide whether to continue as a shareholder in the company under the new management.


The offer document should include detailed terms of offer, identity of the acquisition, long term commercial justification and the intention of the acquirer about introducing any major changes in the business of the company. Valuation methods, Tax aspects of M&A, Amortization of Capital Expenses, and Exemption in respect of Capital Gains, Allowances and rebate, legal procedures have all to be considered in this regard.



An investment banker is total solutions provider as far as any corporate, desirous of mobilizing capital, is concerned. The services range from investment research to investor service on the one side and from preparation of offer documents to legal compliances and post issue monitoring on the other. There exists a long lasting relationship between the Issuer company and the Investment banker. A Merchant Banker could be defined as An organization that acts as an intermediary between the issuers and the ultimate purchasers of securities in the primary security market. Merchant Banker has been defined under the Securities and Exchange Board of India (Merchant Bankers) Rules, 1992 as any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities as manager, consultant, advisor or rendering corporate advisory service in relation to such issue management. Merchant Banking, as a commercial activity, took shape in India through the management of Public Issues of capital and Loan Syndication. It was originated in 1969 with the setting up of the Merchant Banking Division of ANZ Grindlays Bank. The main service offered at that time to the corporate enterprises by the merchant banks included the management of public issues and some aspects of financial consultancy. The early and mid-seventies witnessed a boom in the growth of merchant banking organizations in the country with various commercial banks, financial institutions, brokers firms entering into the field of merchant banking.



Organization Historically banking industry has been more multilateral in character. Today the giant international banks have their presence in more countries than giant corporations in other industries such as Sony, IBM, and Philips etc. Physical presence enables, first hand on the spot, up-tothe minute study of the financial centers, despite advances in telecommunication. Evaluation done by the banks own staff is more reliable than that obtained through correspondents/agencies for expediting disbursal of loans. As clients business becomes more multinational, it can serve its domestic clients better-making international payments, advising home clients on local regulations by being on the spot. How do they establish their presence? Correspondent Banking: (a) a substitute for branches, maintenance of accounts (b) facilitate payments and collections (c) electronic funds transfer through SWIFT, CHIPS Resident Representative: (a) Business offices for providing information on creditworthiness (b) No regular banking Bank Agencies: Is almost like a full fledged bank except it does not deal with local deposits. Functions are operating in the local money market, foreign exchange markets, clearing drafts, arranging loans etc. Foreign Branches: Like a local bank, subject to local and their head office regulations, compliance requirements of the country of origin of the bank are more professional. Foreign subsidiaries: A bank that is locally incorporated but partially or wholly owned by a foreign parent bank is a subsidiary bank. Consortium Banks: Joint venture of large international banks. They deal in investments, corporate and sovereign loans, involve in merger and acquisitions. Egg. Recently BAYER A.G. acquired AVENTIS CROP SCIENCE an agrochemical giant of India for Rs. 750cr Bridge loan granted by Banc of America Securities Ltd, Deutsche Bank, J.P. Morgan P.l.c. as a back up for issuance of Commercial Paper (CP). Bayer will become the largest company


in the Rs.2700 cr Agrochem Sector and will see the emergence of an Agrochem powerhouse in India. (Dec 27, 2001) A number of foreign banks have been allowed to open branches in India and carry on various types of banking business. Indian banks too have their branches and representative offices. International Regulation of Commercial Banks: Subject to (a) stringent prudential control to ensure integrity and soundness of the entire financial systems. (b) Local guidelines of Central Banking authority as well as regulations of the respective foreign banks (i) in deploying customers funds (ii) maintaining levels of liquidity (iii) character of assets (iv) exercising of provisions against doubtful loans. They call it the CAMEL Approach. i.e. C apital Adequacy A sset Quality M anagement Aspects E arnings L iquidity Talking about International Banking, under the present scenario, with LPG, EU and the cascading effects sweeping across the world, the influence it exercises on banking cannot be ignored. For banks the process of integration brings a bit of bad news with the good. The 'Home Currency Bias', domestic companies preferred to issue bonds denominated in domestic currencies for which they preferred domestic banks. A simple example of our own country where we Have several banks spread over the whole length and breadth of the country. People of each state prefer their own banks belonging to their states for their


banking needs. Even when they migrate to another city, they would still prefer the bank belonging to their state. The reasons could be anything, sentimental, language, accepted practices and customs etc. This paves way for consolidation of the banks. Marrying of Societe Generale with Banque Paribas is a point in context. A single currency means a single central bank. There lies the rub. Central banks of the member countries ceded monetary control to the Frankfurt based European Central Bank (ECB). The German Bundes Bank heavily influences ECB's monetary Management, with inflation control as the main objective. 'Loss of Sovereignty ' Abdication of monetary control is a touchy issue for most countries. Fiscal discipline measures have to be as per MASSTRICHT criteria. "One Coat for All" Ireland had sensitive issues on the 'Loss of Sovereignty'; the measures of European Central Bank were not tenable to the conditions prevailing in their economy. It may apply to other members at any time. UK is not a member for the time being for such obvious reason. Ultimately they have got to join EU, as there is already a categorical demand from the trading community. In tune with the Economic Union, there has to be a centralized pool of taxes, in which case a portion of it could be transferred to the needy nations to tide over temporary disequilibrium.

The issue is


Is a politically unified Europe palatable to member nations? Only time to use that terrible clich will tell. "It is co-existence or no existence" said Bertrand Russell. Talking about International Banking, under the present scenario, with LPG, EU and the cascading effects sweeping across the world, the influence it exercises on banking cannot be ignored. For banks the process of integration brings a bit of bad news with the good. The 'Home Currency Bias', domestic companies preferred to issue bonds denominated in domestic currencies for which they preferred domestic banks. A simple example of our own country where we have several banks spread over the whole length and breadth of the country. People of each state prefer their own banks belonging to their states for their banking needs. Even when they migrate to another city, they would still prefer the bank belonging to their state. The reasons could be anything, sentimental, language, accepted practices and customs etc. This paves way for consolidation of the banks. Marrying of Societe Generale with Banque Paribas is a point in context. A single currency means a single central bank. There lies the rub. Central banks of the member countries ceded monetary control to the Frankfurt based European Central Bank (ECB). The German Bundes Bank heavily influences ECB's monetary Management, with inflation control as the main objective. 'Loss of Sovereignty ' Abdication of monetary control is a touchy issue for most countries.


Fiscal discipline measures have to be as per MASSTRICHT criteria. "One Coat for All" Ireland had sensitive issues on the 'Loss of Sovereignty'; the measures of European Central Bank were not tenable to the conditions prevailing in their economy. It may apply to other members at any time.

Risk Management After liquidity risk, re-investment risk, systemic risk, there is new kind of market risk, according to the Clearing Corporation of India (CCIL) chairman R H Patil. It is 'reputation risk'. He feels that Reputation matters more to players in the bond market than in equities. However the reputation risk is higher in the equity market, than in bonds. He said. Better risk management will lead to lower capital requirement. But banks will have to invest heavily in technology and focus on training specialist staff. (Brinda Jagirdar, AGM, SBI) UK is not a member for the time being for such obvious reason. Ultimately they have got to join EU, as there is already a categorical demand from the trading community. In tune with the Economic Union, there has to be a centralized pool of taxes, in which case a portion of it could be transferred to the needy nations to tide over temporary disequilibrium. The issue is - Is a politically unified Europe palatable to member nations? Only time to use that terrible clich will tell. "Money speaks sense in a language all nations understand" -Alphra Behn (1682) Our Bilateral Trade with India was equal to that of Vietnam, a mere $3bn. We need to explore each other's market and raise it to $ 10bn. (Chine PM ZHUI RONGJI)


MMTC, CHINA IRON STEEL GROUP TRADE CORPORATION signed MOU for export of 1-1.2 million tones of Iron ore to China. (TOI DT 18.1.02) The term '15 minutes of fame' has become old hat, it's the 'famous 15 minutes' that have electrified the Indian Chatterati. That is the length of time it took Chinese premier ZHU RONGJI to clear an application by software major Infosys Technologies to open a facility in Shanghai. China is opposed to dumping. We are not in favour of trade protectionism in the name of anti-dumping. (Chinese PM on Indian anti-dumping duties on Chinese goods) INDIA IS FAR AWAY FROM HAVING A CURRENCY LIKE EURO!!! How far the Euro will affect the demand of US$ in the world market? Euro will definitely affect USD since they had virtual monopoly. Over a period of time countries will shift their positions or may like to have their position in Euro as well. Why can't we have a world currency like Euro? We are far away from that situation. Also with whom would we be sharing this concept? Further, in order to have such transition, your economy needs to be disciplined and much more incorporated in world trade. Still a long time to go. Is a common currency possible only in an economy like Europe? No. They have definitely set up the trend. Middle East is also following soon. They are going to have common customs by next two years and then they are planning to have one common currency by 2010. In case of Europe there was commitment from all countries to discipline their economies in order to have one currency. How will Euro help Indian exports?


Euro will give us one single position in 12 different countries, thus giving us a good deal if we have consolidated positions with banks. Also at the time of launch of Euro, it was estimated that people would be saving up to 13 billion USD in transaction costs in trade alone leaving tourism conversion as additional savings.



Offshore Financial Markets A major development on the international financial scene of the post-war years The establishment and explosive growth of offshore market What is offshore market? E.g. Dollar deposits and loans outside the US The traditional name for such markets is Euromarkets Euromarkets are called as Offshore markets to avoid confusion since the single European currency has been named Euro Environment of Offshore market is free from rules and regulations This led to explosive growth of the financial market

Eurocurrency Markets & Euro Credit A deposit or borrowing domiciled outside the home country of the currency Euro dollar is a dollar deposit at a bank outside the USA. Euro Currency deposit is similarly a deposit at a bank in one country, but denominated in the currency of another. There is no virtual difference between the two. While the market originally started with Dollar, other currencies e.g., GBP, DEM, CHF etc., got added and it came to be known as Eurocurrency market instead of simply as Eurodollar market, dollar being still its major component. Market initially confined to London got extended to a world-wide network. Originally a short term market, developed into a longer term source of finance in course of time. Lenders in this market (source of finance with longer maturities) require adjusting their rates at regular intervals, keeping in view their funding procedure. LIBOR for short term market plus agreed margin, or spread based on assessment of the risk, overhead costs and profit. Spreads often vary rather widely depending on the reliability and integrity of the borrower and the guarantee, if any it is, however, the borrower, who has to bear the impact of market fluctuations, if any in the interest rates. Remarkable Innovation in the Eurocurrency market


Development of syndicate lending in which the participating banks agree to shoulder the risk under one loan agreement. Borrower need to complete only one set of documentation and pricing negotiations and to make one schedule of interest and principal payment, mainly to the agent bank acting on behalf of all the participating banks. In a major loan agreement, provision is normally made for drawdown in agreed number of installments (say 3,6,12 months) at the beginning, and subsequently at the borrowers choice. The end of each term is known as roll-over date. It is the lending banks funding of the loan, rather than the loan itself, that is thus rolled over.

Eurodollar Origin Eurodollars are the creation of the book keepers pen, involving transfer of US dollar to a foreign bank, accomplishing many deposits and loan operations while lying offshore, although the original dollar remains as a deposit with an American bank in the USA. This offshore book-value swings round the world unaffected by most national regulations, creating an influence (malign or benign) on the world trade and money. Problem of plenty The origin of Eurodollar and its market are accidental. It is said that the Banque Commerciale pour I Europe du Nord, Paris (cable address: EUROBANK), a Soviet owned bank in Paris, together with its London sister unit, the Moscow Narodowy Bank, was used by the communist countries to finance east-west trade. They held substantial dollar balances, but the cold war tensions made them feel uneasy in holding such balances in dollars and the troubles of sterling also made them feel no better. Attempt to move into Swiss Francs was also discouraged by the Swiss Monetary Authority.

Accidental coincidence- A Panacea


In the circumstances, they wanted some trustworthy non-American banks willing to borrow their dollar holdings and undertaking repayment in dollars on demand. It was a coincidence that some London bankers almost around the same time, looked for deposits in foreign currencies (particularly US dollar for use in transactions with Latin America and Europe and they found dollars looking for borrowers. Factors encouraging emergence of Eurodollar market Interest differential between the USA and other countries US policy limiting foreign access to the New York market Restrictions on certain types of foreign trade financing and credit squeeze Exchange control relaxation as regards acceptance of foreign currency deposits by the British/Swiss banks encouraged Euro-dollar transactions in London and Switzerland and contributed to the emergence of Eurodollar market Operation Whereas in dollar-foreign exchange transactions (buying & selling) the margin is the exchange difference, in Eurodollar dealings there is no such rate of exchange. Eurodollar rates relate to the interest rates at which deposits are accepted and lending and borrowing takes place. Both the lender and the borrower are domiciled outside the USA. Worlds leading banks are now-a-days active participants in the deposit and re-deposit of Eurodollar with one another for adjustment of their liquidity position, entirely without security and at rates of interest which are affected by the margins between the official New York and London money market rates. Ownership of dollar balances in the USA changes hands in between parties (mainly banks) outside the USA at rates of interest higher than those permitted in the USA. In fact, interest rate differential is the prime motivating factor in Eurodollar lending and borrowing. Euro market in Euro Currencies. Future- one of optimism


Although the market came into existence owing to an accidental set of circumstances, Eurodollar may be regarded as playing the role of an international currency to a limited extent. In its absence, there would probably have been far more problems concerning redeployment of petro-dollar flows which have had an easy outlet through this market. May be the future of Eurodollar is uncertain, but the market has, in fact flourished so effectively that a thorough-going re-ordering of the worlds monetary sister might dent its influence and usefulness Euro Bond Markets A bond is a debt security issued by the borrower, purchased by the investor, usually through the intermediation of a group of underwriters. A bond issue for a foreign borrower, offered in the domestic capital market of a particular country and denominated in the currency of that country. Dollars were both borrowed and lent for short periods but gradually the deposits started being used for slightly longer and even medium term lending. Despite some occasional losses at times with unexpected rise in the interest rates, such transactions became a highly remunerative business over the years. When the New York capital market was virtually closed to foreign borrowers, European Bond Market in dollars (and later in DM) also developed. This too was mostly initiated by the London banks. Banks engaged in Eurodollar transactions have to maintain a high degree of liquidity in as much as they do not have access to central bank assistance. It is evident, however, that the growing Central Bank non-interference and in some cases, cooperation have provided indirect support to the growth of this market. Even closed economies (Eastern Europe) operate extensively in the Eurodollar market with the Moscow Narody Bank, London and Banque Commercial pour IEurope du Nord, Paris. Initially they started as lenders, and once they gained the European Banks confidence, they turned also as borrowers. Major Financial Instruments


Introduction In the 1970s, commercial bank loans were by far the most important source of finance for developing countries. In 1981, the year before the third world debt crisis became front page news, as much as 46% of the USD 157 bn capital flow (gross) to the developing world, was in the form of bank loans. Since then, their access to capital markets (bond, equities), has been growing. The important reasons for the relatively lower bank credit are: The losses sustained by the international banks on third world debt in the 1980s The imposition of capital adequacy norms which has made it difficult, and costly, for the banks to take on additional assets. Therefore, capital markets have become more important to the developing world. International investors can be broadly classified under two categories: a) Institutional Investor b) Individual Investor

Individual investor makes decisions more by perception than by analysis. His perceptions are derived more from what flashes on his TV screen, or his newspaper headlines. These more often consist of sensational news about assassinations, natural (or man made) disasters, correction and so on. This makes it difficult to persuade him to invest in thirds world paper. Whereas a professionally managed institutional investor has got the wherewithal and options to diversify in different markets, currencies part or in full. Foreign & Offshore bonds The issue of international bonds to finance capital flows has a history of more than 150 years. In the 19th century foreign issuers of bonds, mainly governments and railway companies used the London market to raise funds. New Instruments and innovations


Floating rates: Traditionally, bonds are fixed rate instruments. The issue of medium term securities carrying a floating rate of interest, which is reset at regular intervals, typically quarterly or half-yearly, in relation to some predetermined reference rate usually LIBOR. Floating rate mechanism allows the interest rate risk to be passed from the investor to the issuer of bonds. Such bonds are called floating rate notes (FRNs) or bonds (also variable rate bonds). The distinction between the term notes and bonds, both debt securities, is really the time to maturity. For long term instruments, the preferred term is bond, for shorter term ones, note. But there is no rigid definition uniformly used. Collared/Inverse Floaters: Not as popular as these FRNs had a cap on the interest. Convertible Bonds: Straight bonds allowing the investor to convert bonds into equity at pre-determined price Perpetual Bonds: Perpetual floating rate bonds had no maturity, as the name signifies. This too proved short lived. Dual Currency Bonds: The bond is issued in one currency; the issuer retains the option to repay the principal in another currency, the conversion rate being fixed at the time of issue. Since the investor carries the exchange risk, he is compensated by a higher rate of interest. Callable Bonds: Call Option in favour of the issuer to prepay the bond if interest rates have fallen. To compensate the investor for the risk, of early redemption, the bonds carry a higher rate of interest. Equity Index-linked notes: The principal amount repayable on maturity is linked to an equity index. If the index is higher compared to a base level, the holder will get a correspondingly larger principal repayment. Within this various combinations are possible like, a) principal amount protected, b) principal amount unprotected and c) participative-where only a part amount is linked to the index. This is most popular in US domestic market.


Strips: A typical government bond, say 20 interest or coupon on a ten year bond and one principal payment on maturity. High Yield of Junk Bonds: These bonds are rate below investment grade. They have to offer higher returns to attract investors-hence the name high yield. Huge amounts of such bonds have been issued in the U.S. often for financing risky take over bids. Zero-Coupon Bonds: Such bonds carry no coupon or periodic interest payments and are issued at well below the face value. The difference between the issue price and face value represents the return to the investor. Medium Term Notes(MTNs)-Maturity 1 year to 5 years Commercial Paper- (Certificate of Deposit) - Maturity 270 days. Both the above instruments are more flexible and easy of operation. Low issue costs, speed and flexibility have made them popular funding device. Precautions: While innovations have the ostensible and laudable, objective of creating instruments to suit investor preferences and thereby reduce the cost of borrowing for the issuer


Introduction Apart from public deposits, finance for working capital can also be availed through issue of commercial paper. Corporate borrowers especially the large and financially sound ones can diversify their short term borrowing by the issue of commercial paper. While deposits from public are regulated by Section 58A of the Companies Act raising funds through commercial paper is exempt. They are however regulated by the RBI.


Issue of CP Commercial Paper can be issued by the company, whose, Tangible net worth (paid up capital plus free reserve) is not less than Rs. 5 crores (ii) Fund based working capital limits are not less than Rs. 5crores (iii) Shares are listed on a stock exchange (iv) Specified credit rating of P2 is obtained from Credit Rating Information Services of India LTD (CRISIL) and A2 in the case of Investment Information and Credit Rating Agency of India LTD (ICRA). (v) Borrowal account is classified under health code no 1 and (vi) current ratio is 1.33:1 Usance: Three months to Six months. No grace period is allowed for payment and if the maturity date falls on a holiday it should be paid on the previous working day. Every issue of CP is treated as a fresh issue. Denomination

Issued in the denomination of Rs. 5 lakhs, minimum lot or investment is Rs. 25 lakhs per investor. Total amount proposed to be issued should be raised within 2 weeks from the date on which the bank takes the proposal on record. The paper may be issued in a single day or in parts on different dates in which case each paper should have the same maturity date. Ceiling

The aggregate amount that can be raised by CP should not exceed 75 percent of the companys fund based working capital limits. Mode of Issue and Discount Rate

CP should be in the form of usance promissory note negotiable by endorsement and delivery. It can be issued at such discount to face value as may be decided by the issuing company.


Issue Expenses

Issue expenses consisting of dealers fees, rating agency fee and other relevant expenses as well as charges levied by the bank for providing stand-by facilities should be borne by the company.


CP may be issued to any person, banks, companies and other registered (in India) corporate bodies and unincorporated bodies. Issue to NRI can only be on a nonrepatriable basis and is not transferable. The paper issued to NRI should state that it is non-repatriable and non-endorsable. Procedure

CP issued only through the bankers who have sanctioned working capital limits to the company. It is counted as a part of the working capital. There is no increase in the overall short term borrowing facilities. The bank would on satisfaction of the eligibility criteria as stated in the prescribed form of RBI along with credit rating takes the proposal. The bank disburses discounted value; simultaneously reduce the working capital limit. The company has to inform RBI within 3 days of the amount of CP disbursal. Stand-by Facility

The company can fall back on the working capital limit with the bank, especially in cases where there is no room over of commercial paper. The stand-by arrangement is basically meant to be an assurance to the borrower that its working capital limit will be restored on the due date of the commercial paper. No underwriting of co-acceptance can be done in the case of commercial paper. On maturity the holder of the commercial paper should present the instrument for payment to the issuing company.


The more complicated a structure, the more vary an investor needs to be a theme to be at the back of your mind. - Bond Issue Drill Appointment of a group of managers/lead managers of the issue Appointment of underwriters Completion of regulatory requirements, as may be necessary for the kind of issue proposed Fixing of management and underwriting fees Drafting of the offer document, road shows to market the issue, book building and pricing of the bond The actual issue A tombstone, i.e., an advertisement recording the issue of the bonds

For without advertisement issuance and marketing of bond would be likened looking at a damsel in darkness Be it in a developed economy, be it a developing economy or be an economy at take off stage.



The Bretton Woods conference gave birth to the International Bank for Reconstruction and Development (IBRD), more particularly known as the World Bank.

Functions Give loans to member countries initially for the reconstruction of their warravaged economies Development of the economies of the poorer member countries By far the bulk of the loans have been for financing specific projects Recent years witness that the bank has bee engaged in giving structural adjustment loans to the heavily indebted countries Constituents The World Bank itself International Development Association (IDA) International Finance Corporation (IFC) Multilateral Investment Guarantee Agency (MIGA)



International Centre for settlement of Investment Disputes

IBRD & IDA IBRD & IDA engaged in helping its borrowers to reduce poverty Strengthening economies and expanding markets To improve the quality of life for people everywhere, especially the poorest Make loans to borrower Governments for projects and programs that promote economic and social projects, ensuring better life Provide advice and technical assistance IFC & MIGA Work closely with private investors and invests in commercial enterprises in developing countries MIGA encourages direct foreign investment in developing countries by offering insurance against noncommercial risk ICSID Share the World Banks objective of promoting increased flows of international investment Providing facilities for settling disputes between foreign investors and their host countries Collectively, these five institutions are known as the World Bank Group. Analysis of the institutions IBRD- Established in 1945, owned by the governments of 181 countries. To join the IBRD, countries must first be members of the IMF. Upon joining the IBRD members subscribe to its capital stock. The amount of shares each member is allocated reflects its quota in the IMF, which in turn reflects the countrys relative economic Both share the same overall goals


strength in the world economy. Members may pay in a small portion of the value of their shares; the remainder is callable capital and would only be paid should the IBRD be unable to meet its obligations-a situation that has never arisen. IBRD lends only to creditworthy borrowers and only for projects that promise high real rates of economic return to the country. As a matter of policy, the IBRD does not re-schedule payments, and it has suffered no losses on the loans it has made. While it does not aim to maximize profits, but rather to intermediate development funds at the lowest cost, the IBRD has earned a net income every year since 1948. IBRD borrows most of the money it lends through medium and long term borrowings in capital markets across the globe. It also borrows funds at Market-based rates from central banks and other government institutions. Conservative lending policies, strong financial backing from members and prudent financial management give the IBRD strong standing in the markets. As well as borrowings, the IBRD is funded by the capital its members have paid in; its retained earnings and repayment on its loans. IDA Established in 1960 to provide assistance to poorer developing countries that cannot meet the IBRDs near-commercial terms. IDA provides credits to the poorest countries-mainly those with an annual per capita gross national product of about USD 1000 or less. By this criterion, about seventy countries are eligible. All members of the IBRD are eligible to join IDA, and 160 have done so. Unlike the IBRD. Most of IDAs funds are contributed by its richer members, although some developing countries contribute to IDA as well. In addition IDA receives transfers from the net earnings of the IBRD and repayments on its credits. IDA credits are made only to governments. The repayment period is thirty-five to forty years. Credits carry no interest, but there is a small service charge, currently 0.75%. There is also a commitment charge, which is set annually, within a range of 0-0.5% of the undisbursed balance; the commitment charge is currently set at zero percent. Although IDA is legally and financially distinct from the IBRD, it shares the same staff and the projects it supports have to meet the same criteria as do projects supported by the IBRD.


Under its Articles of Agreement, the World Bank cannot allow itself to be influenced by the political character of a member country. Only economic considerations are relevant. To ensure that its borrowers get the best value for the money they borrow, Bank assistance is untied and may be used to purchase goods and services from any member country. IFC Established in 1956, helps promote private sector growth in developing countries and helps mobilize domestic and foreign capital for this purpose. It has 174 members. Legally and financially the IFC and the World Bank are separate entities, and the IFC has its own operating and legal staff. It draws upon the World Bank for administrative and other services, however. The IFC provides loans and makes equity investments in support of projects. Unlike most multilateral institutions, the IFC does not accept government guarantees for its financing. Like a private financial institution, the IFC seeks profitable returns and prices its finance and service, to the extent possible, in line with the market while taking into account the cost of its funds. The IFC shares full project risks with its private sector partners. The IFC issues its own annual report. ICSID established in 1966 to help promote international investment. It does this by providing facilities for the settlement, by conciliation and arbitration, of disputes between foreign investors and their host countries. Provisions referring to arbitration under the auspices of ICSID are a common feature of international investment contracts, investment laws, and bilateral and multilateral treaties. ICSID has 129 members. In addition to its dispute-settling activities, ICSID undertakes research, advisory services and publishing in the fields of arbitration and investment law. Its publication includes multivolume collections of Investment Laws of the World and Investment Treaties and the semi-annual ICSID Review-Foreign Investment Law Journal. ICSID issues its own annual report. MIGA Established in 1988 to promote the flow of foreign direct investment in member countries. It does this by providing guarantees to private investors against major political risks and offering investment and marketing services to host governments to help them attract foreign investment.


MIGA is an independent self-supporting agency of the World Bank Group. Like the IFC, it has its own capital base and country membership, but it shares the World Banks development mandate to promote the economic growth of its developing countries. MIGA has 145 members. MIGA issues its own annual report.. Besides the World Bank Group, there are also multilateral regional development banks (like the Manila-based ADB) for Latin America, Africa and Asia. While technically these are independent of the World Bank Group, their functioning is similar to that of the World Bank itself. An unwritten, code of conduct and compliance, is in place, whereby, resources are made available to the smaller ADB members INTERNATIONAL EQUITY MARKETS Introduction International new equity markets with globally syndicated offerings emerged during the 1980s. The initial impetus was provided by the desire on the part of institutional investors To diversify their portfolios globally as foreign exchange regulations were relaxed in the advanced western economies. Institutional investors in UK, USA, and Japan transferred huge amounts of money into foreign equities Share of their aggregate portfolios accounted for < 10% October 1987 crash in the major stock markets resulted in slow rate of growth globally Cross-border equity investment was confined to stock markets of developed countries initially The emerging stock markets of South East Asian countries have also attracted large investments Indian context Till 1992, no Indian firm had approached the world capital markets to raise equity financing. India Growth Fund, a closed ended mutual fund had been listed on the New York stock exchange earlier


In June 1992, Reliance Industries made a small issue of Global Depository Receipts. Unfortunately the prices plunged, as rumours of serious trouble on the Indian Stock markets had become rampant. A partial recovery was made, but this experience forced other Indian companies to postpone their plans of making their offerings in the international markets.

Things changed radically during 1993. As a result of improvement in foreign investors perception of India, a number of Indian corporate was able to raise substantial amount of funds through GDR issues. It is estimated that around 3 billion dollars of funding was mobilized via the GDR and convertible Eurobond issues during 1993. UNIVERSAL BANKING ABROAD While making a study of banking or universal banking it is pertinent to know the banking operations of different economies. It closely resembles with the cultures, code of ethics and religious beliefs. Will universal banking in those economies succeed would again depend on the policies of the individual banks and the credit off take. Banks after all are financial facilitators and policies are framed according to circumstances bearing in mind, customer convenience, uncompromising quality of service, integrity, and above all a good citizen to the society at large. Recently Standard Chartered Bank, Mumbai hosted a marathon race in January 2005 for the cause of tsunami victims. This has nothing to do with the definition of a banking function which implies that the bank serves as a universal friend inviting participants from all over the world. There is no banker customer relationship here, the relationship extends much beyond what we have studied about a customer and the obligations of a bank. This is a social responsibility that promotes universal brotherhood. In the light of such activities, no one definition of a banker is conclusive as the field of their activities have assumed immeasurable proposition. We examine below banking practices followed by a few nations: Islamic Banking:


As the name itself suggests , Islamic Banking is a system of banking which is consistent with Islamic law and guided by Islamic economics. Islamic economics respects its associated ethical codes, and has been developed in such a way that it integrates the religious beliefs of Muslims with external economic realities of the nations they live in. The issue of interest free banking attracted the attention of Muslim intellectuals in the 1940s and 1950s when a number of local and national banks were set up on the lines of foreign banks and the banking system and services were brought to the local population. By this time few of the Muslim countries that gained political independence, felt the need for a banking system to meet their requirement related to international financial transactions. Though these countries recognized the necessity of commercial banking, they wanted to have a system that would not only take care of their requirement but also conform to the rules of shariah. Thus the concept of Islamic Banking based on the concept of profit and loss sharing (Mudarabah) was derived. The first modern experiment with Islamic Banking was led by Ahmad El Najjar in the Egyptian town of Mit Ghamr when in 1963, a savings bank based on profit sharing was set up. This experiment lasted until 1967 by which time there were nine such banks in the country. These banks neither charged nor paid interest, ;but invested the funds collected in trade and industry, either directly or in partnership with others and shared the gains made with their depositors. In the 1970s, a number of Islamic banks came into existence in the Middle East, e.g. The Dubai Islamic Bank (1975), The Faisal Islamic Bank of Sudan (1977), The Faisal Islamic Bank of Egypt (1977) and the Bahrain Islamic Bank, to mention a few. An example of a US Bank: A woman walks into a bank in New York City and asks for the loan officer. She says she is going to Europe on business for two weeks and needs to borrow $5000. The bank officer tells her that the bank will need some kind of security for such a loan, so the woman hands over the keys to a new Rolls Royce that is parked on the street in front of the bank. Everything checks out, and the bank agrees to accept the car a


collateral for the loan. An employee drives the Rolls Royce into the banks underground garage and parks it there. Two weeks later, the woman returns, repays the $5000 and the interest, which comes to $15.41. The loan officer approaches her and says: We are very happy to have had your business, and this transaction has worked out very nicely, but were a little puzzled. While you were away, we checked out your accounts and found that you were a multimillionaire. What puzzles us is why would you bother to borrow $5000? Well, where else in Manhattan can I part my car for two weeks for fifteen bucks? Its another innovative universal banking service availed of by a customer indeed!

Another story of a US Bank: The story of American Express is a fascinating one, filled with interesting and sometimes quirky characters who through a combination of brains, perseverance and luck shaped the companys development during the past century and half. Their vision of what American Express should become has changed over time, resulting in a company that has had many faces during its long history. The express company that forwarded freight and valuables evolved into a company that created and sold financial products like money orders and travelers cheques. Following an era of international expansion and an emphasis on the travel business, the company became an entity perhaps best known for its charge card. Today, American Express is a global travel, financial and card services provider. The attributes that today are the hallmarks of the American Express brand trust, integrity, security, quality, customer service all have their roots in this compelling and sometimes amusing story. In this history, as well, are the genesis and development of the companys aspiration to become the worlds most respected service brand. American Express is by no means alone among the list of venerable American companies that have become household names around the world, but is unique. The Coca-Cola company still bottles the same product that was perfected and sold in an Atlanta drugstore in 1886. Levi Strauss & Co. founded in 1853, still manufactures


the denim jeans that became its trademark following the California Gold Rush. Procter & Gamble was founded as a soap maker in Cincinnati in 1837, roots that are still reflected in its current product mix. By contrast, the rough and tumble freight forwarding businesses that launched the American Express story in 1850 are long gone. Other activities that were once the mainstays of the company are no longer its primary lines of business. Changing times and changing customer needs forced American Express to reinvent itself continually, and that capacity for reinvention makes American Express unique. It has demonstrated a remarkable ability to survive and even thrive despite significant setbacks and changing external forces-mergers and takeovers; recessions and depressions; government interventions; industry turmoil and consolidations; scandals and even wars. European Banking Giant adopts Agile Development Methodology: European banking and financial group, BNP Paribas is adopting new software development projects with a methodology aimed at improving quality and project delivery. Traditionally, software development projects use the waterfall system for producing code, where testing and end user acceptance are conducted only once the analysis, design and development phases of a project have been completed. The agile approach, part of a wider programming methodology known as extreme programming, is iterative, so testing and user acceptance occurs continually throughout development of the project. The idea is for a project to be split into small chunks which are presented to users on a regular basis as completed pieces of functionality. The approach is based on delivering what is known as a minimal marketable feature set of an application to business users every two weeks. This approach is able to provide continual feedback. This can reduce the development effort if certain functions are no longer needed by the business. There is, however, one characteristic of American Express that has remained constant throughout the companys history: its commitment to providing extraordinary service to its customers, no matter who or where those customers may be. It was just as true in 1914, when American Express was helping stranded tourists in Europe at the outbreak of World War I, as it was in 1998, when employees were assisting customers during the national crisis in Indonesia.


This book is about how one company has spent the past 150 years Becoming American Express, and its stories of its continual reinvention and constant commitment to customer service reveal a rich and interesting past. Those essential qualities which have made American Express one of the most widely recognized brands in the world not only will help ensure its place among the great companies of the past; they will also help ensure that American Express continues to be one of the most dynamic companies of the future.

UNIVERSAL BANKING: NO PANACEA FOR OPERATIONAL PROBLEMS Executives of several banks have different views on the adoption of Universal Banking. It is the latest event happening on the sub-continent. It would be interesting to look into the world scenario before putting down the thoughts on the subject. Universal Banking is not a new concept and there is nothing universal about it. Many countries of the Europe, Latin America, Far East and the West are having banking regulations, which allow banks to undertake banking and allied activities under the same roof or through subsidiary route. The cardinal principle of banking, however, remains the same i.e., accepting deposits or savings from the public and facilitating its deployment into productive assets. The saver either get simple interest and are satisfied with the safety, security and liquidity offered by bank deposit products or satisfy certain other needs like insurance, credit cards, securities or bonds etc. However, for the financial intermediary, it can prove to be a winning strategy. As and when the economy progresses on the reforms path, there are tendencies towards integration of the financial markets. Administrative and regulatory barriers melt down and the society achieves what is called the optimization of scarce resources. Thus, Universal Banking is only a logical step in the journey towards globalization, liberalization and deregulation.

The Supermarket Concept


Universal Banking basically refers to the practice of offering a variety of financial services by the same intermediary. As the Reserve Bank of India Discussion Paper has nicely summarized, one can classify Universal Banking into two broad heads viz., (a) Narrow Universal Banking and (b) Broad Universal Banking. While the former covers commercial banking and investment banking., issuing, underwriting, investing and trading in securities, the latter class of Broad Universal Banking extends beyond investment banking into other areas like insurance, factoring, leasing, gold banking, credit cards, credit rating, merger and acquisition etc. Under Universal Banking, it is possible to respond effectively to the market demand for broader product range through a more flexible and efficient distribution network. A large number of countries are practicing narrow Universal Banking, which include Germany, France, Australia, Poland, Sweden and Switzerland. Here all the activities are performed in-house. On the other hand, in countries like Canada, U.K., Japan and China such related activities are performed through the subsidiaries. In US, banks are permitted to deal in Government securities and stock broking. However, there are restrictions on dealing in corporate securities and it can be done only through subsidiaries. As far as broad Universal Banking is concerned, only in Poland and Sweden banks are permitted to offer insurance products in-house. In quite a few other countries, including the U.K., France, Germany etc. , it is not permitted. Looking at it from this perspective, we can say that in India, banks are practicing Narrow Universal Banking. The Glass-Steagall Act Whether to permit Universal Banking or not has been one of the oldest controversies in American banking. The regulators felt that when commercial banks combine lending and securities underwriting, there could be potential conflict of interest. The main concern has been that banks could use the private balance sheet information on bad accounts, underwrite the equities of those companies and get the loan repaid through equity proceeds. It was these fears that prompted the Glass-Steagall Banking Act which separated the commercial and investment banking activities in 1933. Even after almost 7 decades, the Act is not repealed though some concessions are available under Section 20 to the American Banks to deal in


corporate securities in a limited manner. It is little strange to note that even in the most developed country of the world, the regulators act in a knee-jerk fashion and based upon a few isolated cases of abuse, stringent laws like the Glass-Steagall Act are brought into being. Research on American banking has in fact shown and proved that the regulatory fears were quite unfounded about the conflict of interest. For example, one of the arguments against wider Universal Banking powers was that it will shun smaller firms from raising equity resources. A study of bank underwritings in the 1990s shows that banks brought a larger proposition of small firms to the market than the investment houses. When, in 1995-96, the Federal Reserve decided to permit banks to trade in corporate securities through subsidiaries, the Bankers Trust Co. of New York was the first one to take advantage of it. Surmounting several problems faced during the midnineties, the Bankers Trust Co. was riding the wave of Universal Banking before it merged with Deutsche Bank in 1999. It is interesting to note that the Indian banks are passing through a similar phase as the American banks underwent in the 70s. During 70s, in America, the securities market offered the corporates much better options for financing, whether it was a short term Commercial Paper or long-term Debt Issue. The credit lines granted by banks were mostly under-utilized or utilized only as back-up lines for commercial papers. Banks were not able to lend to A rated clients and were forced to lend to second grade clients who did not have market access. This resulted in higher credit risks on banking books. Some banks looked out for real estate loans or loans to cross-border sovereigns. What happened during the recession following the oil shocks, we all know very well. The Bankers Trust Co. claimed that, with Universal Banking permitted in whatever small measure, it will help small companies grow well. A note of caution before accepting and appreciating what the BTC has been preaching and doing is to acknowledge that it was operating in a country which has a very effective regulatory regime. The financial institutions out there are quite transparent to the regulators in most comprehensive fashion. Secondly, the American banking and financial systems have gone through a great deal of adjustment with deregulation and restructuring process, which is a challenge still ahead for banks in many countries around the world including India. While U.S. has now begun to embrace Universal Banking, U.K. has a ling history of this practice, thanks to the emergence and development of bank assurance


movement since the late 60s to mid 80s. Banks in U.K. started with selling simple insurance products through their branches as agents. Soon, they captured the fullfledged insurance markets and they could leverage their vast customer base for selling the insurance products. The banks, brand name, reputation and high productivity levels of the branch staff proved to be unique advantages for the commercial banks to undertake insurance business. The improved customer retention and overall customer satisfaction associated with successful cross-selling led to higher profit for the banks practicing Universal Banking. By 1985, the banc assurance movement was firmly established in U.K. The banks embracing Universal Banking model had realized the fact that savings sector would be eventually dominated not by short-term deposit products but by ling term investment products, insurance, pension products and mutual funds. The wave of Universal Banking soon spread over to the European Continent where banks were not satisfied merely with insurance products but expanded their net to include asset management and private banking products through independent agents and brokers. The success of Universal Banking in U.K. and the Europe largely hinged upon the availability of a large captive customer base and comprehensive customer information. This opened opportunities for improved customer retention and crossselling of products. Though banks in Europe and U.K. have experienced Universal Banking, quite a few barriers remain to be surmounted. If market developments are any indication, there is a need for in-market consolidation in many of the developing European markets. Besides, Universal Banking would require well developed high net-worth segment of customers. Similarly, more robust asset management market must emerge. Universal Banking has a vast potential and large appetite for business. Hence, it is felt that once the in-market consolidation is over, there will be trend towards cross-border universal institutions with banking, insurance and asset management capabilities. While those being the experiences of other countries in Universal Banking, which were triggered by changing customer preferences and necessity on the part of the players to consolidate the gains out of technology investments, the Indian experience on Universal Banking seems to be little different. With the initiation of financial sector reforms and the interest rate regulation, commercial banks have been entering into various new ancillary services like housing finance, credit cards,


mutual funds, factoring, leasing, cash management, internet banking, depository services, merchant banking, custodial services etc. In a way, therefore, Indian banks have been casting their net wider and wider. What prevented the commercial banks from going all out into realm of Universal Banking is the barriers for undertaking insurance business and restrictions on investments in equities. Similarly, restrictions on accepting short term deposits imposed upon the large Development Finance Institutions kept them out of the reach of banking and related activities. Thus though the Indian banks were into universal banking as a narrow sense of the term, we did not have any universal banks as such in existence. After the opening up of insurance sector, we find that a few banks, like State Bank of India and ICICI Bank are offering a wide range of products to the customers. As the experience in India and other countries show, Universal Banking is not something for which one would need a regulatory intervention or any special administrative structure. It must flow very naturally out of the existing business of the banking institutions purely guided by the customer needs on one hand and risk-return consideration on the other. If it pays for a bank to expand its umbrella of products, it should be allowed to do so. Secondly technology should support such myriad and complex operations undertaken by any bank. And most importantly, the bank or financial institution should have adequate skills and expertise to offer such services and make profit out of it. Unfortunately, the discussion on Universal Banking in India is today veering round the issue of allowing development finance institutions to conduct banking activities by merging or converting themselves into commercial banks. If a development finance institution decides to convert or merge into a commercial bank, it should be allowed to do so provided it is prepared to amply with all the regulatory and prudential requirements. If you are in Rome, live like Romans do. The question of concession in reserve requirements or directed lending does not arise. Merger of development finance institutions with banks or for that matter any merger must be based on pure business and profit considerations. The Reserve Bank of India Governor has rightly pointed out that the movement towards Universal Banking is expected to foster stability and efficiency of the financial system. I would like to stress that the efficiency and stability of the financial system will pave the way for Universal Banking as a natural growth process.


The question, therefore, that arises now is : -Whether the Indian financial system and the players have achieved the level of stability and maturity? -Whether it is the scale of operations or the quality of the financials, Indian banks and Financial institutions have to cover quite a distance before they can achieve the global benchmarks of asset quality and profitability. Without passing through the rigours of reforms should Indian banks jump into universal banking? This is a point worth deliberating. But one cannot disagree with Dr.Bimal Jalan the then governor of RBI when he says that Universal Banking is not the panacea for the operational problems of banks and financial institutions. Change management is the biggest challenge posed by the process of liberalization before the Indian banks. One can see that we are to-day caught in the dichotomy of the changing paradigm. Change has two facets. One which is external, which can be seen, felt, imitated or copied. The second aspect is the internal one which is more subtle and deals with the institutional philosophy and the way people think about competition. This cannot be imitated. It has to be imbibed and the latter must precede the former. Only when you are mentally convinced about the need for change, should you venture into structural changes. Merely changing the logo, signboards, structure, number of tiers, technology platforms will not give the desired results. Unfortunately, there are no short cuts to enduring process. Universal Banking would not simply mean offering too many products from the bank branches. This would also call for new delivery channels, customer segmentation and sound risk management techniques. Technology is central to modern day banking. We have to look at it from two angles. One is the infrastructure and processing platform i.e., the hardware point of it. The other angle is the use of technology for developing new markets, new products and new tools. In the absence of a sound and dependable database, the risk management models can be great hazard. Too much of dependence on the Central Processing Unit (CPU) of the computer can lead to loss of memory and wisdom which the Indian banker has achieved so assiduously over the years.


Thus the issue of Universal Banking need to be seen from a broader and deeper perspective of financial sector reforms. Universal Banking is not the issue of merger of a DFI into bank or one bank merging with another bank. It is also not confined to the size and depth of the product basket offered to the customer. It is the issue of integration of various segments of the financial markets, removal of rigidities and arbitrage opportunities between them and fostering stability of the total financial system which is so central to the health of the economy. Equally important is the efficiency of the regulatory system to monitor the affairs of such large conglomerates. Transparency and disclosure norms coupled with good corporate governance must go hand-in-hand with any new steps towards liberalization and Universalisation of Indian banking industry



1. General All Non-Banking Financial Companies have to be mandatorily registered with the Reserve Bank of India. 2. BANK FINANCE TO REGISTERED NBFCS

The ceiling on bank credit linked to net owned fund (NOF) of such companies has been withdrawn in respect of all NBFCs which are statutorily registered with RBI and are engaged in principal business of equipment leasing (EL), hire-purchase (HP), loan and investment activities.


In respect of NBFCs which do not require to be registered with RBI, banks may take their credit decisions on the basis of usual factors.


Residuary Non-Banking Companies (RNBCs) are also required to be mandatorily registered with Reserve Bank of India. Bank finance would be restricted to the extent of their Net Owned Fund (NOF).



Banks may assess and provide need-based finance to NBFCs referred to above, (as part of the overall working capital credit limit) within the prudential guidelines and exposure norms prescribed by the Reserve Bank Activities Not Eligible for Bank Credit The activities undertaken by NBFCs, which are NOT ELIGIBLE for bank credit, have been listed in the Circular. Leased and Sub-Leased Assets Banks should not enter into lease agreements departmentally with equipment leasing companies as well as other NonBanking Financial Companies engaged in equipment leasing.


Bridge Loans/Interim Finance Banks should not grant bridge loans of any nature, or interim finance against capital/debenture issues and/or in the form of loans of a bridging nature pending raising of long-term funds from the market by way of capital, deposits, etc. to all categories of Non-Banking Financial Companies.,

Prudential Norms on Income Recognition, Asset Classification and Provisioning Pertaining to Advances DBOD No. BP.BC/ 20 /21.04.048 /2001-2002 dated September 1, 2001 GENERAL Provisioning should be made on the basis of the classification of assets based on the period for which the asset has remained non-performing and the availability of security and the realizable value thereof.



Non-performing assets

An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank. A Non-performing Asset (NPA) shall be an advance where

i) ii) iii) iv)

Interest and/or installment of principal remain overdue for a period of more than 180 days in respect of a Term Loan, The account remains out of order for a period of more than 180 days, in respect of an Overdraft/Cash Credit (OD/CC), The bill remains overdue for a period of more than 180 days in the case of bills purchased and discounted, Interest and/or installment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purposes, and


Any amount to be received remains overdue for a period of more than 180 days in respect of other accounts.

The 90 days overdue norm is to be adopted for identification of NPAs, from the year ending March 31, 2004. Out of Order' status An account should be treated as 'out of order' if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power. In cases where the outstanding balance in the principal operating account is less than the sanctioned limit/drawing power, but there are no credits continuously for six months as on the date of Balance Sheet or credits are not enough to cover the interest debited during the same period, these accounts should be treated as 'out of order'.


Overdue Any amount due to the bank under any credit facility is overdue if it is not paid on the due date fixed by the bank.


FINANCIAL & BANKING SECTOR REFORMS - MONEY AND GOVERNMENT SECURITIES MARKET In an earlier chapter we studied about the initiation of the Economic & Structural Reforms in our country in mid-1991, which heralded a new era in the economic history of our country. We will now consider the measures undertaken by the Government of India and RBI by way of Financial and Banking Sector reforms. Certain reforms in the financial sector were put through even before the onset of economic reforms in 1991. These measures were taken in 1985 based on the report of an expert committee constituted by RBI. This is the Report of Sukhmoy Chakravarthi Committee (1985), which in fact initiated the process of financial sector reforms in our country. This was followed by the report of the working group headed by Mr.N.Vaghul (1987). This is in the form of a follow-up report of the earlier Sukhmoy Chakravarthi Committee Report. In 1991 after the advent of the Economic Reforms, the recommendations of the Committee on Financial System (popularly called the Narasimhan Committee) provided the impetus for further initiatives. A second report was submitted by Mr.Narasimhan in the year 1987 signaled the need for the 2nd phase of Financial & Banking Sector Reforms. Coverage of Financial Sector Reforms What constituents of the Financial Sector were covered by reforms? The components of the financial markets that were chosen for effecting measures under the reforms are: 1. Money Market 2. The Securities market (also called the debt market or Government securities market). Objective of Financial Sector Reforms by Government of India & RBI To widen, deepen and integrate the different segments of financial sector, namely, the money market, debt market (particularly Government securities) and foreign exchange market.


Condition of Money Market in the pre-reform period (before 1991) Financial system functioned in an environment of constriction, driven primarily by fiscal compulsions. It was geared to provide significant support for Government expenditure. The monetary and debt management policy was underlined by excessive monetization of Central Government's fiscal deficit. Money and Govt. Securities market did not display any vibrancy and had limited significance in the indirect conduct of monetary policy. Money Market instruments were few Market had a narrow base and limited to a few participants - commercial banks and six all India Financial Institutions Rate of interest on money market instruments was regulated. Money market instruments consisted of Treasury Bills (91-days T-Bills) and term securities of different maturities issued by the Central and State Governments. The average maturity of securities remained fairly long, that is above 20years, reflecting the preference of more the Issuers than those of the Investors. Government borrowings were done at rates, which were far below the market rates. For example, for 30-year securities the interest rate was low at 6.5 per cent in 1977-78. The Policy led to distortions in the Banking System with high lending rates on certain segments combined with relatively low interest rates on deposits.


The Report of the Committee to Review the Working of the Monetary System - 1985 (Sukhmoy Chakravarthi Committee) The committee made several recommendations for the development of money and government securities markets. As a follow up, the RBI set up the working group on money market (Chairman Mr.N.Vaghul), which submitted its report in 1987 The working group recommended a four pronged strategy to activate the money market. 1. Attempt to be made to widen and deepen the market by selective increase in the number of participants. 2. An endeavour to be made to activate existing instruments so as to have a well-diversified mix of instruments suited to the different requirements of borrowers and lenders. 3. A gradual shift from administered interest rates to market determined rates. 4. To create an active secondary market for money and Securities, through a process of establishing new sets of institutions, which would impart sufficient liquidity to the system. Follow up Measures initiated by R.B.I based on Chakravarthi Committee and Vaghul Committee Reports during the period 1985-91 Measures taken to encouraging a secondary market in securities: 1. Maximum coupon rate, which was as low as 6.5 per cent in 1977-78, was raised in stages to 11.5 per cent in 1985-86. Along with this the maximum maturity period was reduced from 30 years to 20 years. 2. 182 days Treasury bills were introduced in November 1986 for the first time


3. The Discount and Finance House of India Ltd. was set up in April 1988 as a money market institution jointly by RBI, Public sector banks and all India financial institutions, to develop a secondary market for money market instruments and to provide liquidity to these instruments.

Steps taken to strengthen Money Market 1. Interest rate ceiling was completely withdrawn for all operations in the call/notice money market and also on rediscounting of commercial bills in May 1989. 2. In May 1990 THE GIC, IDBI and NABARD were allowed to enter the Call Money Market as lenders. Also 13 financial institutions, which were already operating in the Bills Rediscounting Scheme, were granted entry in the call money market as lenders in October 1990. 3. Certain other non-banking institutions were permitted in October 1991 to enter the call money market as lender through the DFHI (Discounting and Finance of India Ltd. 4. New money market instruments viz. Certificate of Deposit (CD), Commercial Paper (CP) and inter-bank participation certificates entered the market in 1989-90. RBI framed guidelines for the issuance of these instruments. Recommendations of the Committee on Financial System (The Narasimhan Committee) A comprehensive package of stabilization and structural reform measures was initiated by the Government in mid-1991, in the financial sector based on the recommendations of the Narasimhan Committee. A second Report was submitted by Narasimhan in 1987 called as the Report of Narasimhan Committee II Reforms with regards to Call, Notice, Term Money Market


In pursuance of the recommendations of the Narasimhan Committee II, the RBI has a taken a decision to restrict the call, notice, term money market as a pure interbank market with additional access only to PDs. Steps have been taken to phase out non-bank participants from the market by granting them permission to operate in the repo market. Reasons for the step Since the withdrawal of the ceiling on the call rate, the call money rate has shown a tendency to fluctuate significantly on occasions. The sharp imbalances that arise in the demand and supply of money due to combination of several factors have led to such volatile behaviour. The most important of these has been bunching of banks' needs for short-term funds in order to meet the CRR compliance. Earlier steps by RBI to reduce instability in the Call Money Market In December 1992, RBI injected liquidity through the DFHI and the Securities Trading Corporation of India. In subsequent years, RBI has been moderating liquidity and volatilities through continuous use of repos and refinances operations and changes in the procedure for maintenance of CRR requirements. Government Securities- Reform Process in Debt Management As part of the reform process, debt management underwent significant changes. The principal objectives of Debt Management were defined as under: to smoothen the maturity structure of debt to enable debt to be raised at close to market rates To improve the liquidity of government securities by developing an active secondary market. To make the government securities market vibrant, broad-based and efficient in view of its role in setting a bench mark for the development of the financial market as a whole and bringing about an effective and reliable channel for the use of indirect instrument of monetary control. Reforms in Primary market


Auction system of issuing securities has been introduced for both treasury bills and term securities since 1992-93, in order to pave the way for market related rates of interest for government paper. The base for treasury bills market was widened with auctioning of different types, introduction of 364-day TB in April 1992 and 91-day TB in January 1993, and reintroduction of 182-day TBs in May, 1999.

Funding of auctioned TBs into term securities at the option of holder as part of debt management.

New instruments such as Zero coupon bonds, tap stock, partly paid tap and floating rate bonds were introduced.

Bringing down the maximum maturity rate government securities from 30 to 20 years.

Developments of instruments for repurchase o agreements (repos) between RBI and commercial banks beginning from December 1997.

Since April 1997, a new approach was followed by the RBI in its open market operations that is, sale/purchase operations in government securities. In setting its price, the RBI responded to market expectations. It was also prepared to purchase certain securities in cash.

The effect of the above reform measures resulted in expanding the investor base gradually to non-traditional investors. The auction system contributed to a new treasury culture and progressive development of bidding and portfolio management skills. Reforms in Secondary market in Government Securities A phased reduction in SLR requirements from an effective 37.4 per cent in March 1992 to a little over 28 per cent in March 1996.It has since been reduced to the statutory benchmark level of 25%. The DFHI was authorized to deal in government securities in 1992-93


The Securities Trading Corporation of India (STCI) was set up in 1994 by the RBI jointly with public sector banks and all India financial institutions with the main objective of fostering the development of the government securities market (It commenced operations in September 1994)

Market transparency was achieved through regular publication of details of SGL transactions in Government securities put though Mumbai PDO since September 1994.

After its establishment and becoming operational in June 1994, the National Stock Exchange provided secondary market treading facilities through its wholesale debt market segment.

A system of Delivery Versus Payment (DVP) in Government securities was introduced in Mumbai in June 1995 to ensure that the transactions in government securities were fully secured.

The Repo market has been activated by allowing repos/reverse repos transactions in all government securities besides treasury bills of all maturities.

Non-bank entities which are holders of account with the RBI have been allowed to enter reverse repo (but not direct) transactions with banks/PDs

With a view to encouraging Mutual Funds to set up gilt funds in government securities either by way of outright purchase or reverse repos to the extent of 20 per cent of the outstanding investments.

Guidelines for satellite dealers in government securities market were announced in December 1996 And in April 1997 and the RBI granted approval to 17 entities for registration as satellite dealers in government securities, to promote/activate retailing in Government securities

Primary Dealers in Government Securities Two institutions - DFHI and STCI were accredited as PDs in March 1996 and subsequently four more PDs were allowed to come into operation - SBI Gilts, PNB


Gilts, Gilts Securities Trading Corporation, and ICICI Securities. A scheme for payment of underwriting commission was introduced in May 1997 replacing earlier scheme for paying nominal commission. In March 1995 the RBI announced guidelines for setting up of primary dealers (PD) with the objectives of a. Strengthening the infrastructure of the government securities market in order to make it vibrant, liquid and broad based. b. Ensuring development of underwriting and market capabilities of government securities outside the RBI. c. Improving the secondary market trading system, which could contribute to price discovery, enhanced liquidity and to turn over and encourage voluntary holdings of government securities outside the RBI. d. Making PDs an effective conduit for conducting open market operations. The full extent of notified amount of the dated government securities were offered for underwriting and the underwriting fees and amounts to be allowed to each PD prior to auction of each security. In respect of TBs, the PDs are required to give minimum holding commitments and fixed underwriting fees are paid for successful bids. The RBI granted liquidity support for PDs against their holding in SGL. Account. Market transparency was established through regular publication of details of SGL transactions in government securities put through at Mumbai PDO since September 1994. The NSC which became operational in June 1994 also provided secondary market trading facilities through its wholesale debt market segment since 1994-95. Guidelines for satellite dealers in the government securities market were announced in December 1996 and in April 1997. Satellite dealers in government securities are expected to activate retailing of government securities.


VENTURE CAPITAL Nature & Scope Venture Capital is an important source of funds for technology based industries. Venture capital represents funds invested in new enterprises which are risky but promise high returns. A pathetic example of the risk of Venture Capital Funds (VCFs) is pre and post 9/11, when hard times have ripped through Silicon Valley like a wild fire, incinerating scores of companies and tens of thousands of jobs. The raw numbers across the US are staggering: Almost 700,000 people working at high-tech companies were laid off last year, sent packing in an industry that once seemed to be the growth engine of the economy.


A Comeback The venture capitalists may have lost money, but the rest of the economy will use these people to do extraordinary things. The best engineers, managers and sales representatives are regrouping and reemerging, like shoots poking up through still smoldering ashes. Silicon Valley was a magnet for people. Now they are spreading out again taking the knowledge they gained here with them. The seeds of innovation are starting to germinate in Silicon Valley again. The VCFs would come back to provide technical, financial and managerial services and help the company to set up a track record. Characteristics The characteristics of venture capital are substantial control over managementSome protection against downside risks and a share in capital appreciations. Investors of venture capital have no liquidity for a period of time. Venture capitalists hope the company they are backing would thrive. Reward is there for illiquidity and waiting. New venture proposals in high technology are attractive because of the perceived possibility of substantial growth and capital gains. In USA, the VCFs got a boost under the Small Business Investment Act in 1958. There are a number of venture capital firms in Great Boston, San Francisco, New York, Chicago and Dallas. Sources of funds Individuals or partnership of individuals make venture capital investments. Venture capitalist appraises the proposal and presents evaluation to investors. Venture capitalist develops venture situations in which to invest. They get 20 to 25% of ultimate profits of the partnerships, besides an annual fee of 2 %. Investors include institutions like pension funds, trusts, insurance companies and even universities. VCFs in India Govt. of India created a VCF to be administered by IDBI. Research and Development [R&D] levy on import of technology formed the source of funding VCF. In 1988 a scheme was formulated to enable VCFs to invest in new companies. Concessional treatment of capital gains made available to non-corporate entities.


Establishment VCFs have to be approved by Ministry of Finance. SEBI is presumed to regulate this segment. All India public sector financial institutions, commercial banks are eligible to start VCFs. Management The VCFs/companies [VCC] are required to be run by professionals. They have code of conduct and keep an arms length distance with their sponsors. Technology Development and Information Company of India Ltd [TDICI] and Risk Capital and Technology Finance Corporation Ltd [RCTFC] - set up to foster technological development. Venture Capital Fund of SIDBI- set up to exclusively support entrepreneurs in the small scale sector. Special mention may be made of Credit Capital Venture Capital Fund (India) Ltd. IMF subscribed to the capital. The company made project and lease investments and other short term investments. Depending upon requirements, the fund would be augmented in future. BANKING REFORMS OF NARASIMHAM COMMITTEE - Prudential lending norms and income recognition With globalization, liberalization and privatization sweeping the world across, India cannot lag behind, if the rating of the economy is to be at competitive level in order to promote international transactions. The balance of payment position of the economy was at a gloomy stage during the nineties and one of the measures undertaken at the behest of International Monetary fund (IMF) was to reform the banking system. When financial institutions the world over are shifting their gear towards advanced broad banking, measures were initiated through the reforms to identify the weakness of the system in India. Before embarking on the Universal Banking which necessarily has to be in line with international banking standards as per Bank for International Settlements (BIS) and Basel II Committee risk management norms, Prudential lending Norms were introduced as one of the measures to bring back the economy on track and to reverse the trend of balance of payment situation. Therefore a study of these norms finds a place, and an


understanding of these norms is necessary while introducing Universal banking in India. Income Recognition Income recognition Policy Banks should not charge and take to income account interest on any NPA. Reversal of income If any advance, , becomes NPA as at the close of any year, interest accrued and credited to income account in the corresponding previous year, should be reversed or provided for if the same is not realized. This will apply to Government guaranteed accounts also. In respect of NPAs, fees, commission and similar income that have accrued should cease to accrue in the current period and should be reversed or provided for with respect to past periods, if uncollected.

Appropriation of recovery in NPAs Interest realized on NPAs may be taken to income account provided the credits in the accounts towards interest are not out of fresh/ additional credit facilities sanctioned to the borrower concerned. In the absence of a clear agreement between the bank and the borrower for the purpose of appropriation of recoveries in NPAs (i.e. towards principal or interest due), banks should adopt an accounting principle and exercise the right of appropriation of recoveries in a uniform and consistent manner. Interest Application There is no objection to the banks using their own discretion in debiting interest to an NPA account taking the same to Interest Suspense Account or maintaining only a record of such interest in pro forma accounts.



Categories of NPAs Banks are required to classify non-performing assets further into the following three categories based on the period for which the asset has remained nonperforming and the reliability of the dues: a) Sub-standard Assets b) Doubtful Assets c) Loss Assets

Sub-standard Assets A sub-standard asset was one, which was classified as NPA for a period not exceeding two years. With effect from 31 March 2001, a sub-standard asset is one, which has remained NPA for a period less than or equal to 18 months

Doubtful Assets A doubtful asset was one, which remained NPA for a period exceeding two years. With effect from 31 March 2001, an asset is to be classified as doubtful, if it has remained NPA for a period exceeding 18 months Loss Assets A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly.


Accounts with temporary deficiencies The classification of an asset as NPA should be based on the record of recovery.

Asset Classification to be borrower-wise and not facility-wise Accounts where there is erosion in the value of security A NPA need not go through the various stages of classification in cases of serious credit impairment and such assets should be straightaway classified as doubtful or loss asset as appropriate.

Advances to PACS/FSS ceded to Commercial Banks In respect of agricultural advances as well as advances for other purposes granted by banks to ceded PACS/ FSS under the on-lending system, only that particular credit facility granted to PACS/ FSS which is in default for a period of two harvest seasons (not exceeding two half years)/two quarters, as the case may be, after it has become due will be classified as NPA.

Advances against Term Deposits, NSCs, KVP/IVP, etc Advances against term deposits, NSCs eligible for surrender, IVPs, KVPs and life policies need not be treated as NPAs. Loans with moratorium for payment of interest In the case of bank finance given for industrial projects or for agricultural plantations etc. where moratorium is available for payment of interest, payment of interest becomes 'due' only after the moratorium or gestation period is over.


Agricultural advances In respect of advances granted for agricultural purpose where interest and/or installment of principal remains unpaid after it has become past due for two harvest seasons but for a period not exceeding two half-years, such an advance should be treated as NPA.

Government guaranteed advances The credit facilities backed by guarantee of the Central Government though overdue may be treated as NPA only when the Government repudiates its guarantee when invoked.

Restructuring/ Rescheduling of Loans A standard asset where the terms of the loan agreement regarding interest and principal have been renegotiated or rescheduled after commencement of production should be classified as sub-standard and should remain in such category for at least one year of satisfactory performance. Availability of security/ net worth of

borrower/guarantor The availability of security or net worth of borrower/ guarantor should not be taken into account for the propose of treating an advance as NPA Advances under rehabilitation approved by BIFR/ TLI Banks are not permitted to upgrade the classification of any advance in respect of which the terms have been re-negotiated unless the package of re-negotiated terms has worked satisfactorily for a period of one year.


5. Provisioning norms

General The primary responsibility for making adequate provisions for any diminution in the value of loan assets, investment or other assets is that of the bank managements and the statutory auditors. In conformity with the prudential norms, provisions should be made on the non-performing assets on the basis of classification of assets into prescribed categories

Loss assets The entire asset should be written off. If the assets are permitted to remain in the books 100 percent of the outstanding should be provided for.

Doubtful assets i) 100 percent of the extent to which the advance is not covered by the realisable value of the security to which the bank has a valid recourse and the realisable value is estimated on a realistic basis. ii) In regard to the secured portion, provision may be made, at the rates ranging from 20 percent to 50 percent of the secured portion depending upon the period for which the asset has remained doubtful: iii) Additional provisioning consequent upon the change in the definition of doubtful assets) effective from March 31, 2001 has to be made in phases as under: As on 31.03.2001, 50 percent of the

additional provisioning requirement on the assets which became


doubtful on account of new norm of 18 months for transition from substandard asset to doubtful category. As on 31.03.2002, balance of the provisions

not made during the previous year, in addition to the provisions needed, as on 31.03.2002. Sub-standard assets A general provision of 10 percent on total

outstanding should be made without making any allowance for DICGC/ECGC guarantee cover and securities available.

Standard assets From the year ending 31.03.2000, the banks should make a general provision of a minimum of 0.25 percent on standard assets on global loan portfolio basis.

Floating provisions The floating provisions, wherever available, could be set-off against provisions required to be made as per above stated provisioning guidelines.

Provisions on Leased Assets i) (a) Sub-standard assets

10 percent of the 'net book value'. ii) Doubtful assets

100 percent of the extent to which the finance is not secured by the realisable value of the leased asset: iii) Loss assets The entire asset should be written-off








Treatment of interest suspense account Amounts held in Interest Suspense Account should not be reckoned as part of provisions.

Advances covered by ECGC/DICGC guarantee In the case of advances guaranteed by

DICGC/ECGC, provision should be made only for the balance in excess of the amount guaranteed by these Corporations. Advance covered by CGTSI guarantee No provision need be made towards the guaranteed portion. The amount outstanding in excess of the guaranteed portion should be provided for. Take-out finance The lending institution should make provisions against a 'take-out finance' turning into NPA pending its take-over by the taking-over institution.

Reserve for Exchange Rate Fluctuations Account (RERFA) In case Foreign Currency Denominated Loan assets need to be revalued as per requirement of accounting practices or for any other requirement, the following procedure may be adopted: The loss on revaluation of assets has to be booked in the bank's Profit & Loss Account.









Classification, banks should treat the full amount of the Revaluation Gain relating to the corresponding assets, if any, on account of Foreign Exchange Fluctuation as provision against the particular assets.

Writing-off of NPAs The banks should either make full provision as per the guidelines or write-off such advances and claim such tax benefits as are applicable

Write-off at Head Office Level Banks may write-off advances at Head Office level, even though the relative advances are still outstanding in the branch books.

GENERAL Whatever be the type of banking, be it Universal, Innovative, Retail, Investment etc, it is of paramount importance to have a general idea of the Reserve bank of India Act, as activities of a bank are to be strictly carried out as per their directives. Violation of any kind would lead to cancellation of licence to operate banking function. Hence this chapter is essential for students pursuing banking as their career.


THE RESERVE BANK OF INDIA ACT, 1934 BUSINESS WHICH THE BANK MAY TRANSACT The bank shall be authorized to carry on and transact the several kinds of business hereinafter specified namely:(1) The accepting of money on deposits without interest from, and the collection of money for the Central Government, the State Government, local authorities, banks and any other persons. (2) (a) the purchase, sale and rediscount of bills of exchange and promissory notes, drawn on and payable in India and arising out of bona fide commercial or trade transaction bearing two or more good signatures, one of which shall be that of a scheduled bank or a State co-operative bank or any financial institutions , which is predominantly engaged in the acceptance or discounting of bills exchange and promissory notes and which is approved by the Bank in the behalf and maturing (i) in the case of bills of exchange and promissory notes arising out of any such transaction relating to the export of goods from India, within on e hundred and eighty days, and (ii) in any other case , within ninety days, from the date of such purchase or rediscount exclusive of days of grace; (b) the purchase, sale and rediscount of bills of exchange and promissory notes, drawn and payable in India and bearing two or more good signatures, one of


which shall be that of a scheduled bank or a State co-operative bank or any financial institutions, which is predominantly engaged in the acceptance or discounting of bills of exchange and promissory notes and which is approved by the bank in this behalf and drawn or issued for the purpose of financing agricultural operations or the marketing of crops , and maturing within fifteen months from the date of such purchase or rediscount, exclusive days of grace; (i) the purchase, sale and rediscount of bills of exchange and promissory notes drawn and payable in India and bearing two or more good signatures, one of which shall be that of a State co-operative bank or a State co-operative bank or any financial institutions, which is predominantly engaged in the acceptance or discounting of bills of exchange and promissory notes and which is approved by the bank in this behalf and drawn or issued for the purpose of financing the production or marketing activities of cottage and small scale industries approved by the bank and maturing within twelve months from the date of such purchase or rediscount, exclusive of days of grace, provided that the payment of the principal and interest of such bills of exchange or promissory notes is fully guaranteed by the State Government;

(c) the purchase, sale and rediscount of bills of exchange and promissory notes drawn and payable in India and bearing the signature of a scheduled bank and issued or drawn for the purpose of holding or trading in securities of the Central Government or a State Government and maturing within ninety days from the date of such purchase or rediscount, exclusive of days of grace; (3) (a) the purchase from and sale to scheduled banks (b) The purchase, sale and rediscount of bills of exchange (including treasury bills) drawn in or on any place in any country outside India which is a member of the International Monetary Fund and maturing,(i) in the case of bills of exchange arising out of any bona fide transactions relating to the export of goods from India, within one hundred and eighty days, and



in any other case, within ninety days, from the date of such purchase or rediscount:

Provided that no such purchase, sale or rediscount shall be made in India except with a scheduled bank or a State co-operative bank; the making to any scheduled bank or a State co-operative bank, or loans and advance, against promissory notes or such bank, repayable on demand or on the expiry of fixed periods not exceeding one hundred and eighty days: Provided that the borrowings bank furnishes a declaration in writing, to the effect that


it holds bills of exchange arising out of any transaction relating to the export of goods from India of a value not less than the amount of such loans or advances (a) drawn in India and no any place in any country outside India which is a member of the International Monetary Fund or in any other country notified in this behalf by the bank in the Gazette of India, and (b) maturing not later than one hundred and eighty days from the date of the loan or advance, and it will, so long as any part of such loans and advances remains unpaid, continue to hold such bills of exchange of a value not less than the amount of such loans or advances outstanding for the time being; or


It has granted a pre-shipment loan or advance to an exporter or any other person in India in order to enable him to export goods from India, the amount of the loan or advance drawn and outstanding at any time being not less than the outstanding amount of the loan or advance obtained by the borrowing bank from the bank.

The making to any scheduled bank or a State co-operative bank or loans and advances repayable on demand or on the expiry of fixed periods not exceeding one hundred and eighty days against promissory notes of such bank:


Provided that the borrowing bank furnished a declaration in writing to the effect that it has made loans and advances for bone fide commercial or trade transactions for financing agricultural operations or the marketing of crops or for other agricultural purposes as set out in the declaration includes such other particulars as may be required by the bank:

(4) The making to local authorities, scheduled banks, State co-operative banks and State Financial Corporations or loans and advances, repayable on demand or on the expiry of fixed periods not exceeding ninety days, against the security of-

(a) Stocks, funds and securities ( other than immovable property ) in which a trustee is authorized to invest trust money by any Act of Parliament of the United Kingdom or by any law for the time being in force in India


Gold or silver or documents of title to the same;

(c) Such bills of exchange and promissory notes as are eligible for purchase or rediscount by the bank or as are fully guaranteed as to the repayment of the principal and payment of interest by a State Government;


Promissory notes of any scheduled bank or State co-operative bank

supported by documents of title to goods such documents having been transferred, assigned, or pledged to any such bank as security for a loan or advance made for bona fide commercial or trade transactions , or for the purpose of financing agricultural operations or the marketing of crops:

Provided that loans and advances made against the security of bills of exchange and promissory notes arising out of any transaction relating to the export of goods from India shall be repayable on demand or on the expiry of fixed period not exceeding one hundred and eighty days;


4A the making to any State Financial Corporation of loans and advances repayable on the expiry of fixed periods not exceeding eighteen months from the date of such loan or advance, against securities of the Central Government or of any State Government of any maturity, or against bonds and debentures issued by that Corporation and guaranteed by the State Government concerned and maturing within a period not exceeding eighteen months from the date of such loan or advance:

Provided that the previous approval of the State Government shall be obtained for the borrowing by the State Financial Corporation and the amount of loans and advances granted to that Corporation under this clause shall not, at any time, exceed in the aggregate twice in the paid up share capital thereof.

4AA. The making of annual contribution to the National Rural Credit (Long Term Operations) Fund and the National Rural Credit (Stabilization) Fund established under sections 42 and 43, respectively, of the National Bank for Agriculture and Rural Development Act, 1981.

4B. The making to the Industrial Finance Corporation of India of loans and advances,(a) Repayable on demand or on the expiry of fixed periods not

exceeding ninety days from the date of such loans or advance, against the securities of the Central Government or of any State Government, or


Repayable on the expiry of fixed periods not exceeding

eighteen months from the date of such loan or advance, against securities of the Central Government of any maturity or against bonds and debentures issued by the Corporation guaranteed by the Central Government and maturity within a period not exceeding eighteen months from the date of such loan or advance:


4BB. The making to any financial institution notified by the Central Government in this behalf, of loans and advances,(a) Repayable on demand or on the expiry of fixed periods not exceeding ninety days from the date of such loan or advance, against the securities of the Central Government or of any State Government, or

(b) repayable on the expiry of fixed periods not exceeding eighteen months from the date of such loan or advance, against securities of the Central Government or of any State Government, of any maturity, or against bonds and debentures issued by that financial institution and guaranteed by the Central Government or any State Government, and maturing within a period not exceeding eighteen months from the date of such loan or advance: Provided that the amount of loan and advances granted to financial institution under sub-clause (b) shall, not at nay time, exceed in the aggregate sixty per cent of the paid up share capital thereof; 4BBB. The making to the Unit Trust of loans and advances(i) repayable on demand or on expiry of a fixed period not exceeding ninety days from the date of such loans or advance against the security of stocks, funds and securities ( other than immovable security ) in which a trustee is authorized to invest trust money by any law for the time being in force in India; (ii) repayable on demand or within a period of eighteen months from the date of such loan or advance against the security of the bonds of the Unit Trust issued with the approval of and guaranteed by the Central Government; (iii) for the purpose of any scheme other than the first unit scheme under the Unit Trust if India Act, 1963 ( 52 of 1963 ) on such terms and conditions and against the security of such other security of the Unit Trust as may be specified in this behalf by the Bank; 4C. the making to a warehousing corporation established under the Agricultural Produce (Development) Corporations Act, 1956 (28 of 1956) of loans and advances,-



repayable on demand or on expiry of fixed periods not exceeding ninety

days, from the date of such loan or advance, against securities of the Central Government or of any State Government, or (b) of repayable on the expiry of fixed periods not exceeding eighteen months from any State Government, of any maturity, or against bonds and debentures the date of such loan or advance, against securities of the Central Government or issued by the corporation to which the loan or advance is made, and guaranteed by the Central or a State Government, and maturing within a period nor exceeding eighteen months from the date of such loan or advance: Provided that the amount of loans and advances granted under clause (b) shall not at nay time exceed, in the aggregate, three crores of rupees in the case of the Central Warehousing Corporation and fifty lakhs of rupees in the case of a State Warehousing Corporation; 4D. the making to the Deposit Insurance Corporation of loans and advances; and generally assisting the Corporation in such manner and on such terms as may be determined by the Central Board; 4DD, the making to the National Housing Corporation of loans and advances; and generally assisting the National Housing Bank, in such manner and on such terms as may be determined by the Central Bank; 4E. the making to the National Bank of loans and advances repayable on demand or on the expiry of fixed period not exceeding eighteen months from the date of making of the loan or advance, either(i) against the security of stocks, funds and securities ( other than immovable security ) in which a trustee is authorized to invest trust money by any law for the time being in force in India; or (ii) on such term and conditions as the bank may specify;

4F. contributing to the initial Capital of the Unit Trust;


4G. the making of loans and advances to, and the purchasing of bonds and debentures of, the Development Bank or the Exim Bank or the Reconstruction Bank or the Small Industries Bank out of the National Industries Credit (Long Term Operations) Fund established under section 46C. 4GG. the making of loans and advances to, and the purchasing of bonds and debentures of, the National Housing Bank out of the National Housing Credit (Long Term Operations) Fund established under section 46D. 4H. the making the Development Bank or the Small Industries Bank of loans and advances(a) repayable on demand or on the expiry of fixed periods not exceeding ninety

days from the date of such loans or advance against the security of stocks, funds and securities ( other than immovable security ) in which a trustee is authorized to invest trust money by any law for the time being in force in India or, (b) against the security of bills of exchange or promissory notes , arising out of bona fide commercial transactions bearing two or more good signatures and maturing within five years from the date of such loan or advance; 4I. The making to scheduled banks, the Development Bank, the Exim Bank, the Reconstruction Bank or the Small Industries Bank , the Industrial Finance Corporation and any other financial institution as may , on the recommendation of the bank , be approved in this behalf by the Central Government of loans and advances repayable on demand or otherwise and against such security and on such other terms and conditions as may be approved in this behalf by the Central Board for the purpose of enabling such banks , or financial institutions, as may be, to purchase foreign exchange from the bank for the purpose of financing the import of capital goods or such other purposes as may be approved by the Central Government; 4J. the making to the Exim Bank of loans and advances-



repayable on demand or on the expiry of a fixed periods not exceeding

ninety days, from the date of such loan or advance against the security of stocks, funds and securities ( other than immovable security ) in which a trustee is authorized to invest trust money by any law for the time being in force in India; or (b) against the security of bills of exchange or promissory notes , arising out of bona fide commercial or trade transactions bearing two or more good signatures and maturing within five years from the date of such loan or advance; 4K. the making to the Reconstruction Bank of loans and advances (a) repayable on demand or on the expiry of a fixed periods not exceeding ninety

days, from the date of such loan or advance against the security of stocks, funds and securities ( other than immovable security ) in which a trustee is authorized to invest trust money by any law for the time being in force in India; or (b) against the security of bills of exchange or promissory notes , arising out of bona fide commercial or trade transactions bearing two or more good signatures and maturing within five years from the date of such loan or advance; 5. the making to the Central Government and State Government of advances repayable in each case not later than three months from the date of the making of the advance; 6. the issue of demand drafts, telegraphic transfers and other kinds of remittances made payable at its own offices or offices or agencies, the purchase of telegraphic transfers, and the making, issue and circulation of bank post bills; 8. the purchase and the sale of securities of the Central Government or s State Government of any maturity or of such securities of a local authority as may be specified in this behalf by the Central Government on the recommendation of the Central Board; Provided that securities fully guaranteed as to principal and interest by any such Government or authority shall be deemed for the purposes of this clause to be securities of such Government or authority.


8A. the purchase and sale of shares in, or the capital of the National Bank Deposit Insurance Corporation , the Development Bank, the State Bank or any other bank or financial institutions notified by the Central Government in this behalf; 8AA. The promoting, establishing, supporting or adding in the promotion,

establishment and support of any financial institution, whether as its subsidiary or otherwise; 9. the custody of monies, securities and other articles of value, and the collection of the proceeds, whether principal, interest or dividends, or of any such securities; 10. the sale realization of all property, whether movable or immovable, which may in any way come into the possession of the bank in satisfaction, or in part satisfaction, of any of its clause; 11. the acting as agent for the Central Government or any State Government or any local authority or the Industrial Finance Corporation of India or any other body corporate which is established or constituted by or under any other law or the Government of any such country outside India or any such person or authority is may be approved in this behalf by the Central Government in the transaction of nay of the following kinds of business, namely:(a) (b) the purchase and sale of gold or silver or foreign exchange. The purchase, sale, transfer and custody of bills of exchange, securities or

shares in any company; (c)The collection of the proceeds, whether principal, interest or dividends, of any securities or shares; (d) (e) The remittance of such proceeds, at the risk of the principal, by bills of The management of public debt; exchange payable either in India or elsewhere; (f) The issue and management of bonds and debentures; 11A. the acting as agent for the Central Government,-



In guaranteeing the due performance by any small-scale industrial concern ,

approved by the Central Government, of its obligations to any bank or other financial institutions in respect of loans and advances made, or other credit facilities provided, to it by such bank or other financial institutions and the making as such agent of payments in connection with such guarantee, and (b) in administering any scheme for subsiding the rate of interest or other charge in relation to any loans or advances made, or other credit facilities provided , by banks or other financial institutions any export from India and the making as such agent of payments on behalf of the Central Government. 12. the purchase and sale of gold or silver coins and gold ad silver bullion and foreign exchange and the opening of a gold account with the principal currency authority of any foreign country or the Bank for International Settlements or any international or regional bank or financial institution formed by such principal currency authority or authorities or by the Government of any foreign country; 12A. the purchase and sale of securities issued by the Government of any country outside India or by any institution or body corporate established outside India and expressed to be payable in a foreign currency or any international or composite currency unit, being in the case of purchase by the bank securities maturing within a period of ten years from the date of purchase: Provided that in the case of securities of an institution or body corporate, the repayment of principal and payment of interest in respect of such securities shall be guaranteed by the Government of the country concerned. 12B. the making of loans and advances in foreign currencies to scheduled banks, the Development bank, the Exim Bank or the Reconstruction Bank or the Small Industries Bank ,the Industrial Finance Corporation , any State Financial Corporation and any other financial institution as may, on the recommendation of the bank , be approved by the Central Government and on such terms and conditions as may be specified by the Central Board in this behalf , against promissory notes of such bank or financial institution, as the case may be:


Provided that the borrowing bank or financial institution, as the case may be, furnishes a declaration in writing t the effect that(a) it has loans and advances in foreign currencies for financing

international trade or for the import of capital goods or for such purposes as may be approved by the Central Government ;and (b) that the amount of loans or advances so made and outstanding at nay time will not be less than the outstanding amount of loans or advances obtained by it from the bank; 13. the opening of an account with an office outside India of any bank, including a bank incorporated in India or the making of an agency agreement with, and the acting as an agent or correspondent of, any bank incorporated outside India, or the principal currency authority of any country under any law for the time being in force in that country or any international or regional bank or financial institutions formed by such principal currency authorities or foreign governments, and the investing of the funds of the bank in the shares and securities of any such international or regional bank or financial institutions or of any other foreign institution as may be approved by the Central Board in this behalf; 13A. Participation in any arrangement for the clearing and settlement of any amount due from, or to, any person or authority on account of external trade of India with any other country or group of countries or of any remittances, to from, that country or group of countries or of any remittances to, or from, that country or group of countries. Including the advancing, or receiving , of any amount in any currency in connection therewith , and, for that purpose , becoming, with the approval of the Central Government , a member of any international or regional clearing union of central banks monetary or other authorities , or being associated with any clearing arrangements or becoming a member of any body or association formed by central banks , monetary banks, monetary or other similar authorities, or being associated with the same in any manner; 14. the borrowings of money for a period not exceeding one month for the purposes of the business of the bank, and the giving of security for money so borrowed:


Provided that no money shall be borrowed under this clause from any person in India other than a scheduled bank or from any person outside India other than a bank which is the principal currency authority of any country under the law for the time being in force in that country. Provided that the total amount of such borrowings from persons in India shall not at nay time exceed the amount of the capital of the bank. 15. the making and issue of bank notes subject to the provisions of this Act 15A. The exercise of powers and functions and the performance of duties entrusted to the bank under this Act or under any law for the time being in force; 15B. the providing of facilities for training in banking and for the promotion of research, where, in the opinion of the bank, such provision may facilitate the exercise by the Bank of its powers and functions, or the discharge of its duties; 16. Generally, the doing of all such matters and things as may be incidental to or consequential upon the exercise of its powers or the discharge of its duties under this Act. 18. POWER OF DIRECT DISCOUNT When , in the opinion of the bank a special occasion has arisen making it necessary or expedient that action should be taken under this section for the purpose of regulating credit in the interests of Indian, trade, commerce , industry and agricultural, the Bank may, notwithstanding any limitation contained in section 17 1) purchase, sell or discount any bill of exchange or promissory note through such bill or promissory note is not eligible for purchase or discount by the bank under that section; or 2) make loans or advances to(a) a State co-operative bank , or



on the recommendation of a state co-operative society registered within the

area in which the State co-operative bank operates, or (c) any other person repayable on demand or on the expiry of the fixed periods ,nor exceeding ninety days , on such terms and conditions as the bank may consider to be sufficient. 18A. VALIDITY OF LOAN OR ADVANCE NOT TO BE QUESTIONEDNotwithstanding anything to the contrary contained in any other law for the time being in force,(a) the validity of any loan or advance granted by the bank in pursuance of the provisions of this Act shall not be called in question merely on the ground of non-compliance with the requirements of such other law as aforesaid or of any resolution , contract , memorandum , articles of association or other instrument: Provided that nothing contained in this clause shall render valid any loan or advance obtained by nay company or co-operative society is not empowered by its memorandum to obtain loans or advances; (b) where a loan or advance has been granted under clause (3A) or under clause

(3B) or section 17 or a loan or advance granted under clause (3) of section 18 by the bank to any person has been applied by such person, wholly or in part, in making a loan or advance to any borrower , any sum received(i) by the borrowing bank on account of bills of exchange in respect of which the declaration under clause (i) of the proviso to clause (3A) of section 17 has been furnished or in repayment or realization of the outstanding loans or advances referred to in clause (ii) of the said proviso or in the proviso to clause (3B) of the said section or (ii) by the borrowing bank or any other person in repayment or realization of loans and advances granted to a borrower out of funds obtained by it or by him from the Bank under section 18,


shall be utilized only for the repayment by the borrowing bank or other person, as the case may be, of the amounts due to repaid by it or by him to the bank, and shall be held by it or by him in trust for the bank, until such time as the amounts are so repaid. 19. BUSINESS WHICH MAY NOT TRANSACTSave as otherwise provided in sections 17, 18, 42 and 45, the bank may not, 1) engage in trade or otherwise have a direct interest in any commercial, industrial or other undertaking except such interest as it may in any way acquire in the course of the satisfaction of nay of its claims: provided that all such interests shall be disposed of at the earliest possible moment; 2) purchase the shares of any banking company or of any other company, or grant loans upon the security of any such shares; 3) advance money on mortgage of, or otherwise on the security of, immovable property or documents of title relating thereto, or become the owner of immovable property, except so far as it necessary for its own business premises and residence foe its officers and servants 4) make loans or advances; 5) draw or accept bills payable otherwise than on demand; 6) allow interest on deposits or current accounts. COLLECTION AND FURNISHING OF CREDIT INFORMATION

45A. Definitions (a) banking company means a banking company as defined in section 5 of the

Banking Regulation Act, 1949 ( 10 of 1949 ) and includes the State Bank of India, any subsidiary bank as defined in the State Bank of India ( Subsidiary Banks ) Act, 1959 ( 38 of 1959 ) , any corresponding new bank constituted by section 3 of the Banking Companies ( Acquisition and transfer of Undertakings ) Act, 1970 ( 5cof 1970 ) , and any other financial institution notified by the Central Government in this behalf.



borrower means any person to whom any credit limit has been sanctioned

by any banking company .whether availed of or not , and includes(i) (ii) (iii) (iv) in the case of a company or corporation , its subsidiaries in the case of a Hindu Undivided Family , any member thereof or any firm in which such member is a partner in the case of a firm, any partner thereof or any firm in which such partner is a partner; and in the case of an individual , any firm in which such individual is a partner; (c) credit information means any information relating to(i) the amounts and the nature of loans or advances and other credit facilities granted by a banking company to any borrower or class of borrowers; (ii) the nature of security taken from any borrower ( or class of borrowers ) for credit facilities granted to him or to such class; (iii) the guarantee furnished by a banking company for any of its customers or any class of customers (iv) the means , antecedents , history of financial statements and the creditworthiness of any borrower or class of borrowers (v) any other information which the bank may consider to be relevant for the more orderly regulation of credit or credit policy. 45B. Power of Bank to collect credit informationThe Bank may (a) (b) collect , in such manner as it may think fit, credit information from banking furnish such information to any banking company in accordance with the

companies and provisions of section 45D.

45C. Power to call for returns containing credit information


1) For the purpose of enabling the Bank to discharge its functions under this Chapter, it may at any time direct any banking company to submit to it such statements relating to such credit information and in such form as may be specified by the bank from time to time. 2) A banking company shall, notwithstanding anything to the contrary contained in any law for the time being in force on in any instrument regulating the constitution thereof or in any agreement executed by it, relating to the secrecy of its dealings with its constituents, be bound to comply with any direction issued under sub-section (1).

45D. Procedure for furnishing credit information to banking companies

1) A banking company may, in connection with any financial arrangement entered into or proposed to be entered into by it, with any person, make an application to the bank in such form as the bank may specify requesting it to furnish the applicant with such credit information as may be specified in the application. 2) On receipt of an application under sub-section (1), the bank shall , as soon as may be furnish the applicant with such credit information relating to the matters specified in the application, as may be in its possession: Provided that the information so furnished shall not disclose the names of the banking companies which have submitted such information to the bank.

3) The bank may in respect of each application levy such fees, not exceeding twenty-five rupees, as it may deem fit for furnishing credit information. 45E. Disclosure of information prohibited

1) Any credit information contained in any statement submitted by a banking company under section 45C or furnished by the bank to any banking company


under section 45D , shall be treated as confidential and shall, not, except for the purposes of this chapter , be published or otherwise disclosed 2) Nothing in this section shall apply to(a) (b) The disclosure by any banking company , with the previous permission of the the publication by the bank if it considers necessary in the public interest so

bank, of any information furnished to the bank under section 45C; to do of any information collected by it under section 45C, in such consolidated form as it may think fit without disclosing the name of any banking company or its borrowers; (c) the disclosure or publication by the banking company or by the bank of any credit information to any other banking company or in accordance with the practice and usage customary among bankers or as permitted or required under any other law. Provided that any credit information received by banking company under this clause shall not be published except in accordance with the practice and usage customary among bankers or as permitted or required under any other law. 3) Notwithstanding anything contained in any law for the time being in force, no court, tribunal or other authority shall compel the Bank or any banking company to produce or to give inspection of any statement submitted by that banking company under section 45C or to disclose any credit information furnished by the Bank to that banking company under section 45D. 45F. Certain claims for compensation barred.- No person shall have any right , whether in contract or otherwise , to any compensation for any loss incurred by reason of the operation of any of the provisions of this chapter. 45G, Penalties- [Rep. By the Reserve Bank of India (Amendment) Act, 1974 (51 of 1974), Sec. 15]



45H. Chapter III B not to apply in certain cases.- The provisions of this chapter shall not apply to the State Bank or a banking company as defined in section 5 of the Banking Regulation Act, 1949 ( 10 of 1949 ) or a corresponding new bank as defined in clause (da) of section 5 of the Act or a subsidiary bank as defined in State Bank of India ( Subsidiary Banks ) Act, 1959 ( 38 of 1959 ) or a subsidiary bank as defined in State Bank of India ( Subsidiary Banks ) Act, 1959 ( 38 of 1959 ) or a Regional Rural Bank or a co-operative bank or a primary agricultural credit society or a primary credit society: Provided that for the purposes of this chapter, the Tamil Nadu Industrial Investment Corporation Limited shall not be deemed to be a banking company. 45I. Definitions- In this chapter, unless the context otherwise requires,(a) business of a non-banking financial institutions means carrying on the

business of a financial institution referred to in clause (c) and includes business of a non-banking financial company referred to in clause (f): (aa) company means a company as defined in section 3 of the Companies Act, 1956 9 1 of 1956), and includes a foreign company within the meaning of section 591 of that Act; (b) Corporation means a corporation incorporated by an act of any legislature; (bb) deposit includes and shall be deemed always to have include any receipt of money by way of deposit or loan or in any other form, but doe not include,i. ii. iii. amounts raised by way of share capital; amounts contributed as capital by partners of a firm amounts received from a scheduled bank or a co-operative bank or any other banking company as defined in clause ( c ) of section 5 of a Banking Regulation Act, 1949 ( 10 of 1949 ); iv. any amount received from,a) the Development Bank


b) a State Financial Corporation c) any Financial Institution specified in or under section 6A of the Industrial Development Bank of India Act, 1964 9 18 of 1964 ), or d) v. any other institution that may be specified by the bank in this behalf; amounts received in the ordinary course of business, by way of a) security deposit b) dealership deposit c) earnest money, or d) advance against orders for goods , properties or services; vi. any amount received from an individual or a firm or an association of individuals not being a body corporate , registered under any enactment relating to money lending which is for the time being in force in any State; and vii. any amount received by way of subscription in respect of a chit.

Explanation I- Chit has the meaning assigned to it in clause (b) of section 2 of the Chit Funds Act, 1982 (40 of 1982). Explanation II Any credit given by a seller to a buyer on the sale of any property (whether movable or immovable) shall not be deemed to be deposit for the purposes of this clause (c) financial institution means nay non-banking institution which carries on as its business or part of its business any of the following activities, namely:i. ii. iii. iv. the financing , whether by way of making loans or advances or otherwise, of nay activity other than its own; the acquisition of shares, stock, bonds, debentures or securities issued by as Government or local authority or other marketable securities of a like nature; letting or delivering of any goods to a hirer under a hire-purchase agreement as defined in clause ( c ) of section 2 of the Hire- Purchase Act, 1972 (26 of 1972 ) the carrying on any class of insurance business;



managing, conducting or supervising , as foreman, agent or in nay other capacity, of units or kuries as defined in any law which is for the time being in force in ant statue, or any business, which is similar thereto;


collecting, for any purpose or under any scheme or arrangement by whatever name called, monies in lump sum or otherwise, by way of subscriptions or by sale of units, or other instruments or in any other manner and awarding prizes or gifts, whether in cash or kind, or disbursing monies in any other way, to persons from whom monies are collected or to any other person. [But does not include any institution, which carries on as its principal business, a) agricultural operations; or b) industrial activity; or c) the purchase, construction or sale of immovable property, so however , that no portion of the income of the institution is derived from the financing of purchases, constructions or sales of immovable property by other persons; [ Explanation For the purposes of this clause, industrial activity means and

activity specified in sub-clauses (i) to (xviii) of clause ( c ) of section 2 of the Industrial Development Bank of India Act, 1964 ( 18 of 1964 ) d) firm means a firm as defined in the Indian Partnership Act, 1932(9 of 1932) e) non banking institution means a company, corporation, or co-operative society f) non-banking financial company meansi. ii. a financial institution which is a company a non-banking institution which is a company and which has its principal business the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner; iii. such other non-banking institution or class of such institution, as the bank may, with the previous approval of the Central Government and by notification in the Official Gazette, specify.




In order to be a deposit within the meaning of the term as defined, a receipt of money must carry with it the corresponding obligation to repay the same; Peerless General Finance and Investment Co. Ltd. v. Reserve Bank of India [ 1996 ] 85 Comp Cas 808.


All non-banking institution which carry on the activities mentioned in the various clauses of section 45I ( c ) whether they are on the said activities on their main business or part of their business come within the purview of being the financial institutions; Peerless General Finance and Investment Co. Ltd. v. Reserve Bank of India [ 1996 ] 85 Comp Cas 808.

45IA. Requirements of registration and net owned fund, (1) Notwithstanding anything contained in this Chapter or in any other law for the time being in force, no non-banking financial company shall commence or carry on the business of a non-banking financial institution withouta) Obtaining a certificate of registration issued under this Chapter; and b) Having the net owned fund of twenty-five lakhs rupees or such other amount, not exceeding two hundred lakhs rupees, as the bank may, by notification in the official Gazette, specify. (2) Every non/ banking financial company shall make an application for registration to the bank in such form as the bank may, specify: Provided that a non-banking financial company in existence on the

commencement of the Reserve Bank of India (Amendment) Act, 1997 shall make an application for registration to the bank before the expiry of six months from such commencement and notwithstanding anything contained is sub-section (1) may continue to carry on the business of a non-banking financial institution until a certificate of registration is issued to it or rejection of application for registration is communicated to it.


(3) Notwithstanding anything contained in sub-section (1), a non-banking financial company in existence on the commencement of the Reserve bank of India ( Amendment ) Act, 1997 and having a net owned fund of less than twenty-five lakhs rupees may, for the purpose of enabling such company to fulfill the requirement of the net owned fund, continue to carry on the business of a nonbanking financial institutioni. For a period of three years from such commencement; or ii. For such further period as the bank may, after recording the reasons in writing for so doing, extend, Subject to the condition that such company shall, within three months of fulfilling the requirement of the net owned fund, inform the Bank about such fulfillment:

Provided that the period allowed continuing business under this sub-section shall in no case exceed six years in the aggregate. (4) The Bank, for the purpose of considering the application for registration ,may require to be satisfied by an inspection of the books of the non-banking financial company or otherwise that the following conditions are fulfilled:a) That the non-banking financial company is or shall be in a position to pay its present or future depositors in full as and when their claims accrue; b) That the affairs of the non-banking financial company are not being or are not likely to be conducted in manner detrimental to the interest of its present or future depositors; c) That the general character of the management or the proposed management of the non-banking financial company shall not be prejudicial to the public interest or the interests of its depositors; d) That the non/ banking financial company has adequate capital structure and earning prospects; e) That the public interest shall be served by the grant of certificate of registration to the non-banking financial company to commence or carry on the business of India f) That the grant of certificate of registration shall not be prejudicial to the operation and consolidation of the financial sector consistent with monetary


stability and economic growth considering such other relevant factors which the bank may, by notification in the Official Gazette, specify; and g) Any other condition, fulfillment of which in the opinion of the bank, shall be necessary to ensure that the commencement of or carrying on of the business in India by a non-banking financial company shall not be prejudicial to the public interest or in the interest of the depositors. (5) The bank, after being satisfied that the conditions specified in sub-section (4) are fulfilled, grant a certificate of registration subject to such conditions which it may consider fit to impose. (6) The Bank cancel certificate of registration granted to a non banking financial company under this section if such companyi. Ceases to carry on the business of a non-banking financial institution in India; or ii. Has failed to comply with any condition subject to which the certificate of registration had been issued to it; or iii. At nay time fails to fulfill any of the conditions referred to in clauses (d) to (g) of sub-section (4); or iv. Failsa) To comply with any direction issued by the Bank under the provisions of this Chapter b) To maintain accounts in accordance with the requirements of any law or any direction or order issued by the Bank under the provisions of this Chapter; or c) To submit or offer for inspection its books of account and other relevant documents when so demanded by an inspecting authority of the bank; or v. Has been prohibited from accepting deposit by an order made by the bank under the provisions of this chapter and such order has been in period of not less than three months: Provided that before canceling a certificate of registration on the ground that the non banking financial company has failed to comply with the provisions of clause (ii) or has failed to fulfill any of the conditions referred to in clause (iii) the Bank, unless it is of the opinion that the delay in canceling the certificate of registration shall be force for a


prejudicial to public interest or the interest of the depositors or the non-banking financial company , shall give an opportunity to such company on such term as the bank may specify for taking necessary steps to comply with such provision or fulfillment of such condition; Provided that before making may order of cancellation of certificate of registration, such company shall be given a reasonable opportunity of being heard. (7) A company aggrieved by the order of rejection of application for registration or cancellation of certificate of registration may prefer an appeal, within a period of thirty days from the date on which such order of rejection or cancellation is communicated to it, to the Central Government and the decision of the Central Government where an appeal has been preferred to it, or of the bank where no appeal has been preferred , shall be final Provided that before making any order of rejection of appeal, such company shall be given a reasonable opportunity of being heard. Explanations For the purposes of this section.(I) net owned fund meansa) The aggregate of the paid up equity capital and free reserves as disclosed in the latest balance sheet of the company after deducting there fromi. ii. iii. Accumulated balance of loss; Deferred revenue expenditure; and Other intangible assets; and

b) Further reduced by the amounts representing1) Investments of such company in shares of i. ii. Its subsidiaries Companies in the same group



All other non-banking financial companies; and

2) The book value of debentures , bonds, outstanding loans and advances ( including hire-purchases and lease finance) made to, and deposits with,i. ii. Subsidiaries of such company; and Companies in the same group,

To the extent such book value exceeds ten percent, of (a) above. (II) Subsidiaries and companies in the same group shall have the same meanings assigned to them in the Companies Act, 1956 (1 of 1956). 45IB. Maintenance of percentage of assets. 1) Every non-banking financial company shall invest and continue to invest in India in unencumbered approved securities, valued at a price not exceeding the current market price of such securities, an amount which, at the close of business on any day, shall, not be less than five per cent , or such higher percentage not exceeding twenty-five percent as the Bank may, from time to time and by notification in the Official Gazette, specify , of the deposits outstanding at the close of business on the last working day of the second preceding quarter: Provided that the bank may specify different percentages of investment in respect of different classes of non-banking financial companies. 2) For the purpose of ensuring compliance with the provisions of this section, the bank may require every non-banking financial company to furnish to it in such form, in such manner and for such period as may be specified by the bank. 3) If the amount invested by a non-banking financial company at the close of business on any day falls below the rate specified under sub-section (1), such company shall be liable to pay to the bank, in respect of such shortfall, a penal interest at a rate of three per cent annum above the bank on such amount by which the amount actually invested falls short of the specified percentage, and where the shortfall continues in the subsequent quarters, the rate of penal


interest shall be five per cent per annum above the bank rate on such shortfall for each subsequent quarter. 4) (a) The penal interest payable under sub-section (3) shall be payable within a period of fourteen days from the date on which a notice issued by the bank demanding payment of the same is served on the non-banking financial company and, in the event of a failure of the non-banking financial company to pay the same within such period, penalty may be levied by a direction of the principal civil court having jurisdiction in the area where an office of the defaulting nonbanking financial company is situated and such be made only upon an application made in this behalf to the court by the bank; and (b) when the court makes a direction under clause ( a), it shall issue a certificate specifying the sum payable by the non-banking financial company and every such certificate shall be enforceable in the same manner as if it were a decree made by the court in a suit, 5) Notwithstanding anything contained in this section, if the Bank is satisfied that the defaulting non-banking financial company had sufficient cause for its failure to comply with the provisions of sub-section (1), it may not deemed the payment of the penal interest. Explanation For the purpose of this section, i. approved securities means securities of any State Government or of the Central Government and such bonds , both the p[principal whereof and the interest whereon shall have been fully and unconditionally guaranteed by any such Government; ii. unencumbered approved securities includes the approved securities lodged by the non-banking financial company with another institution for an advance or any other arrangement to the extent to which such securities have not been drawn against or availed of or encumbered in any manner; iii. quarter means the period of three months ending on the last day of March, June, September, and December.


45IC. Reserve Fund. 1) Every non-banking financial company shall create a reserve fund the transfer therein a sum not less than twenty per cent of its net profit every year as disclosed in the profit and loss account and before any dividend is declared. 2) No appropriation of any sum from the reserve fund shall be made by the nonbanking financial company except for the purpose as may be specified by the Bank from time to time and every such appropriation shall be reported to the bank within twenty-one days from the date of such withdrawal: Provided that the Bank may, in particular case and for sufficient cause being shown extend the period of twenty-one days by such further period as it thinks fit or condone any delay in making such report. 3) Notwithstanding anything contained in sub-section (1), the Central Government may, on the recommendation of the bank and having regard to the adequacy of the paid-up capital and reserves of a non-banking company in relation to its deposit liabilities, declare by order in writing that the provisions of sub-section (1) shall not be applicable to the non-banking financial company for such period as may be specified in the order. Provided that no such order shall be made unless the amount in the reserved fund under sub-section (1) together with the amount in the share premium account is not less than the paid-up capital of the non-banking financial company. 45J. Bank to regulate or prohibit issue of provisions or advertisement soliciting deposits money.- The bank may , if it consider necessary in the public interest so to do, by general or special order.a) Regulate or prohibit the issue by any non-banking institution of nay prospectus or advertisement soliciting deposits of money from the public, and b) Specify the conditions subject to which any such prospectus or advertisement, if not prohibited, may be issued. COMMENTS


This section merely empowers the Reserve Bank of India to regulate or prohibit the issuance by any non-banking institution of any prospectus or advertisement soliciting deposits of money and specifying conditions subject to which any such prospectus or advertisement may be issued; Peerless General Finance and Investment Co. Ltd. v. Reserve Bank of India, [1996] 85 Comp Cas 808.

45JA. Power of Bank to determine policy and issue direction.1) If the bank is satisfied that, in the public interest or to regulate the financial system of the country to its advantage or to prevent the affairs of any nonbanking financial company being conducted in manner detrimental to the interest of the depositors or in a manner prejudicial to the interest of the non-banking financial company, it is necessary or expedient so to do it may determine the policy and give directions to all or any of the non-banking financial companies relating to the income recognition, accounting standards, making of proper provision for bad and doubtful debts, capital adequacy based on risk weights for assets and credit conversion factors for off balance-sheet items and also relating to deployment of funds by a non-banking financial company or a class of nonbanking financial companies or non-banking financial companies generally, as the case may be, and such non-banking financial companies shall be bound to follow the policy so determined and the direction so issued. 2) Without prejudice to the generality of the powers vested under sub-section (1), the Bank may give directions to the non-banking financial companies generally or to a class of non-banking financial companies or to any non-banking financial company in particular as to a) The purpose for which advances or other fund based or non-fund based accommodation may not be made; and b) The maximum amount of advances of other financial accommodation or investment in shares and other securities which, having regard to the paid-up capital, reserves and deposits of the non-banking financial company and other relevant considerations, may be made by that non-banking financial company to nay person or a company or to a group of companies.


45K. Power of Bank to collect information from non-banking institutions as to deposits and to give directions.1) The Bank may at nay time direct that every non-banking institution shall furnish to the Bank, in such form, at such intervals and within such time, such statements information or particulars relating to or connected with deposits received by the non-banking institution, as may be specified by the Bank by general or special order. 2) Without prejudice to the generality of the power vested in the Bank, under subsection (1), the statements information or particulars to be furnished under subsection (1), may relate to all or any of the following matters, namely, the amount of the deposits, the purposes and periods for which, and the rates of interest and other terms and conditions on which, they are received. 3) The Bank may, if it considers necessary in the public interest so to do, give directions to non banking institutions or group of non-banking institutions in particular, in respect of nay matters relating to or connected with the receipt of deposits, including the rates of interest payable on such deposits, and the periods for which deposits may be received. 4) If any non-banking institution fails to comply with any direction given by the Bank under sub-section (3), the Bank may prohibit the acceptance of deposits by that non-banking institution. 5) Omitted 6) Every non-banking institution receiving deposits shall, if so required by the Bank and within such time as the Bank may specify, cause to be sent at the cost of the non-banking institution a copy of its annual accounts to every person from whom the non-banking institution holds, as on the day of the year to which the accounts relate, deposits higher than such sum as may be specified by the Bank. COMMENTS i. Reserve Bank is competent under section 45K (3) to deal with or take appropriate action as it nay deem fit and proper in public interest with regard to deposit or receipt relating to deposits if it so desires; Peerless General Finance and Investment Co. Ltd. v. Reserve Bank of India [ 1996 ] 85 Comp Cas 808.



The words any matters relating to or connected with receipts or deposits occurring in section 45K (3) have to be considered in light of the words which follow the same namely, including the rates of interest payable on such deposits and the profits for which such deposits may be received; Peerless General Finance and Investment Co. Ltd. v. Reserve Bank of India, [1996] 85 Comp Cas 808.


If Reserve Bank issue directions, which provides the procedure for investing deposits received by Residuary Non-banking companies and also provides the way it is to be disclosed in account books, the said directions are covered under sections 45K (3) and are reasonable and are not invalid; Peerless General Finance and Investment Co. Ltd. v. Reserve Bank of India, CLR 1992 (2) SC 60.

45L. Power of Bank to call for information from financial institutions and to give directions.1) If the Bank is satisfied for the purpose of enabling it to regulate the credit system of the country to its advantage it is necessary so to do, if anya) Require financial institutions either generally or any group of financial institutions or financial institution in particular, to furnish to the Bank in such form, at such intervals and within such time, such statements, information or particulars relating to the business of such financial institutions or institution, as may be specified by the Bank by general or special order. b) Give to such institutions either generally or to any such institution in particular directions relating to the conduct of business by them or by it as financial institutions or institution. 2) Without prejudice to the generality either generality of the power vested in the bank under clause (a) of sub-section (1), the statements, information or particulars to be furnished by a financial institution may relate to all or any of the following matters, namely, the paid-up capital, reserves or other liabilities, the investments whether in Government securities or otherwise, the persons to


whom, and periods for which, finance is provided and the terms and conditions, including the rates of interest , on which it is provided.

COMMENTS i. It appears from the true construction of section 45L that the section only empowers the Reserve Bank to give directions to financial institutions defined in the Act; Peerless General Finance and Investment Co. Ltd. v. Reserve Bank of India [1996] 85 Comp Cas 808 ii. Under this section the Reserve Bank must be satisfied that it is necessary to issue directions to regulate the credit system of the country to its advantage; Peerless General Finance and Investment Co. Ltd. v. Reserve Bank of India [1996] 85 Comp Cas 808

45M. Duty of non-banking institutions to furnish statements etc. required by Bank.It shall be the duty of every non-banking institution to furnish the statements information or particulars called for, and to comply with any direction given to it, under the provisions of this chapter.

45MA. Powers and Charts of auditors.1. It shall be the duty of an auditor of a non-banking institution to inquire whether or not non-banking institution has furnished to the bank such statements, information or particulars relating to or connected with deposits received by it, as are required to be furnished such statements, information or particulars, make a report to the Bank giving the aggregate amount of such deposits held by the non-banking institution. 1A. The Bank may, on being satisfied that it is necessary so to do, in the public interest or in the interest of the depositors or for the purpose of proper assessment of the books of accounts, issue directions to any non-banking


financial company or any class of non-banking financial institutions or nonbanking financial company generally or to the auditors of such non-banking financial company or companies relating to balance-sheet, profit and loss account, disclosure of liabilities in the books of accounts or any matters relating thereto. 2. Where, in the case of a non-banking financial company, the auditor has made, or intends to make, a report to the bank under sub-section (1), he shall include in his report under sub-section (2) of section 227 of the Companies Act, 1956 (1 of 1956), the contents of the report which he has made or intends to make, to the bank. 3. Where the bank is of the opinion that it is necessary so to do in the public interest or in the interest of the non-banking financial company or in the interest of depositors of such company it may at any time by order direct that a special audit of the accounts of the non-banking financial company in relation to any such transaction or class of transactions or for such period or periods, as may be specified in the order, shall be conducted and the bank may appoint an auditor to conduct such special audit and direct the auditor or the auditors to submit the report to it. 4. The remuneration of the auditors as may be fixed by the Bank , having regard to the nature and volume of work involved in the audit and the expenses of or incidental to the audit shall be borne by the non-banking financial company so audited

45MB. Powers OF Banks to prohibit acceptance of deposit and alienation of assets.1. If any non-banking financial company violates the provisions of any section or fails to comply with any direction or order given by the bank under any of the provisions of this chapter , the bank may prohibit the non-banking financial company from accepting any deposit 2. Notwithstanding anything to the contrary contained in any agreement or instruments or any law for the time being in force, the Bank, on being satisfied that it is necessary so to do in the public interest or in the interest of the


depositors, may direct, the non-banking financial company against which an order prohibiting from accepting deposit has been issued, not to sell, transfer, create charge or mortgage or deal in any manner with its property and assets without prior written permission of the bank for such period not exceeding six months from the date of the order.

THE FIRST SCHEDULE (See Section 9) 1. The Western Area shall consist of the State of Goa, Gujarat, Madhya Pradesh and Maharashtra and the Union Territories of Dadra and Nagar Haveli, and Daman and Diu. 2. The Eastern Area shall consist of the States of Arunachal Pradesh, Assam, Bihar, Manipur, Meghalaya, Mizoram, Nagaland, Orissa, Sikkim, Tripura and West Bengal and the Union Territories of Andaman and Nicobar Islands. 3. The Northern Area shall consist of the States of Jammu and Kashmir, Punjab, Haryana, Himachal Pradesh, and Uttar Pradesh and the Union Territories of Chandigarh and Delhi. 4. The Southern area shall consist of the states of Andhra Pradesh, Karnataka, Tamil Nadu and Kerala and the Union territories of Pondicherry and Lakshadweep

THE SECOND SCHEDULE (See section 42 and section 2 (e)) SCHEDULED BANKS Abyudaya Co-operative Bank Ltd., Bombay Adhiyanam Grama Bank, Dharmapuri (Tamil Nadu) Ahmadnagar Sahakari Bank Ltd., Mumbai (1998) Ajodhia Bank, Fyzabad


Conclusion The Indian economy is emerging as a reckoning force and it is a foregone conclusion that privatization is the panacea for overall efficient growth of the economy and to push up the GDP as pronounced in the current budget of February 2005. The doors are opened for Foreign Direct Investment (FDI) and Foreign Institutional Investment (FII) and dilution of Government participation in all sectors of the economy in general and banks in particular are on the cards. The world is now operating without barriers, and if we as a nation has to be successful in our race for competition, financial sector especially the banking system must switch over from narrow banking to broad banking which is why Universal Banking has to be adopted as a choice and not as a chance. Teething trouble is unavoidable as is applicable to any venture or initiative during the transition stage. Protagonists may have their say, in view of the fact that as a bank taking divorce from traditional banking to the innovative path of Universal banking handling short term, long term loan portfolios, besides a host of other retail products, scope for mismatch of ALM is not something impossible. But as a professional banking outfit,with the latest infrastructure and technological support system in place, the Indian banking system can catch up with the banks in the developed world strictly adhering to the Basel II norms relating to risk management, reduction of NPAs and concentrate on innovative ideas. As Napoleon said Imagination gives rise to innovation and in tune with that Universal Banking would soon be a reality in India.


About the author C.M. Lakshmanan is currently a visiting management faculty in the areas of Banking, Insurance, Exim Management, and Indias Foreign trade, CRM, Co-operative Management, Rural Marketing, HR Management, International Banking and Finance. He was earlier Manager - Asset Services, American Express Bank Limited, a member of the Certified Associate of the Indian Institute of Bankers. Has undergone training in General Banking, Foreign Exchange Orientation and Advanced Programme, Export Finance, Legal aspects of documentation and procedure conducted by The Bankers Training College of Reserve bank of India. He was also an active participant in seminars hosted by International Chamber of Commerce, Paris. He had a short stint of service at American express Bank Ltd, Poole, London when the bank was centralizing their international trade transactions on a global scale. He is presently teaching in several management institutions and degree colleges at graduate, post-graduate and PGDBA levels. To name a few the institutions are: NMIMS, Vile Parle Indian Institute of Planning & Management (IIPM), Mumbai K.C. Institute of Management Indian Merchants Chamber Alkesh Dinesh Mody Institute of Management Services And several degree colleges teaching BMS and B.Com (Banking & Insurance) students. C.M. Lakshmanan is an empanelled member in the University of Mumbai for assessment of papers at graduate and post graduate levels and for conducting Viva Voce relating to BMS courses. He is a prolific essay writer, having a practical bent and an excellent flair for teaching.


Preface During the last 12 years, The Indian Financial Services has witnessed sea changes. The challenge of the new millennium is the increasing use of technology and the near elimination of national borders in trade. What measures would enable the banking and finance industry in India to meet them and emerge successful is a million dollar question. The diversification of the financial sector, mergers and acquisitions, e-commerce and the reforms of the nineties to bring down the non-performing assets of banks, ever changing demands of the customers, wafer thin spread, are the compelling reasons that CHANGE has become the order of the day. The introduction of the subject Banking and Insurance at graduate level by the Mumbai University, and the enthusiasm of the students fraternity inspired me make an earnest attempt to pen this book based on my practical knowledge as a professional banker in a multi-national bank of repute. This book is meant for students, academicians, professionals and the like. I would with pleasure, welcome any constructive criticisms on any missing links that would give me an opportunity to enhance the knowledge of myself and that of the students to arrive at a wholesome study on this subject. It would not be out of place to mention my gratitude to my beloved sons, wife an exbanker herself, for the valuable suggestions, publishers and many well wishers who enthused me to write a book on Universal banking without whose guiding spirit, I could not have ventured in this discipline.

Bibliography -The Journal of The Institute of Banking & Finance and Indian Banks Association


-Various magazines and publications of ICFAI -Banking Theory & Practice