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Reserve Bank of India, Volume 3, 1967-81 gives very valuable account of the evolution of
Central Banking in India. This third volume describes vividly the background against which the
Reserve Bank of India came into being on April 1, 1935. Before the establishment of the Reserve
Bank, the Central Banking functions were handled by the Imperial Bank of India. The Royal
Commission on Indian Currency and Finance (Hilton Young Commission) 1926 recommended
that there is conflict of interest in the Imperial Bank of India functioning as the controller of
currency while also functioning as a Commercial Bank. After detailed analysis on the ownership,
constitution and composition of the ownership, RBI was established by a Bill in the Legislative
Assembly. It was in 1948 that the Reserve Bank of India was nationalised under the RBI
(Transfer to Public Ownership) Act, 1948. The earlier volumes viz., Volume I and Volume II
covered the developments in Central Banking up to 1967 and Volume III was covered under the
period 1967 to 1981. This was the most dynamic period of Commercial Banking in the history.
The Government was very critical for the attitudes of the Private Banks for their failure to be
socially responsible, which led the Government to impose social control on Banks. Mrs. Indira
Gandhi nationalised 14 Banks during July 1969. Reserve Bank was given newer responsibilities
in terms of the Developmental role.

The RBI was assigned not only the role of maintaining monetary and fiscal stability but also the
developmental role of establishing institutional framework to complement commercial banking
to help agriculture, Export Sectors, etc.

Securitization and Reconstruction of Financial Assets Enactment of Security Interest Act
2002 (SARFAESI Act) Government of India has taken the initiative of making the legislation to
help Banks to provide better Risk Management for their asset portfolio. Risk Management of the
Loan book has been posing a challenge to the Banks and Financial Institutions which are
helpless in view of the protracted legal processes. The act enables Banks to realise their dues
without intervention of Courts and Tribunals. As a part of the Risk Management strategies, banks
can set up Asset Management Companies (AMC) to acquire Non Performing Assets of Banks
and Financial agencies by paying the consideration in the form of Debentures, Bonds etc. This
relieves the Bank transferring the asset to concentrate on their loan book to secure that the
quality of the portfolio does not deteriorate. The act contains severe penalties on the debtors. The
AMC is vested with the power to issue notices to borrowers who ask for the repayment within 60
days. If the borrower fails to meet the commitment, the AMC can take possession of the secured
assets and appoint any Agency to manage the secured assets. Borrowers are given the option of
appealing to the Debt Tribunal, but only after paying 75% of the amount claimed by the AMC.
There are strict provisions of penalties for offences or default by the securitisation or
reconstruction company.

Dr. Y. V. Reddy, Governor, Reserve Bank of India observed that the Indian financial system in
the pre-reform period (i.e., prior to Gulf Crisis on 1991) was preoccupied with fulfilling the
financial needs of the Planning process to the neglect of the health of the Banks. Due to
Governments dominance of ownership of Banks, large scale pre-emptions in terms of Statutory
Liquidity Ratio and Cash Reserve Ratio were resorted to and the Banks Managements fell short
of their professional attitude with the result they functioned at the behest of the Finance Ministry.

The Reform process has created a favourable environment for Banks to overcome the constraints
that they faced. For example deregulation of interest rates for bringing down the pre-emptions
which includes Statutory Liquidity Ratio and Cash Reserve ratio to workable levels in a phased
manner, dispensing with the system of directed lending have helped Banks in restoring their
financial health. The changes brought about in terms of ownership of Banks also had a salutary
effect on the working of the Banks. The share of the public sector banks in the aggregate assets
of the Banking Sector which was 90 per cent in 1991 has gradually come down and by 2004 the
same was around 75 per cent. The capital adequacy of Indian Banks now is comparable to those
at international levels. The asset quality of the Banks has registered marked improvement. The
Non-Performing Assets to Gross advances for the Banking system in 1998 have reduced from
14.4 per cent to 7.2 per cent in 2004. The return on assets (ROA) was at a low of 0.4 per cent in
the year 1991-92. By 2003-04 it has improved to 1.2 per cent. He expressed that consolidation,
competition and Risk Management are critical to the future of the Banking system.

Committee on Banking Sector Reforms (1998) Chairman Shri M.Narasimham (popularly
known as Narasimham Committee II) Report discusses the steps required for further
strengthening the Banking system by concentrating on prudential management, introduction of
technology etc. The main recommendations of the committee are:
Further Capital Adequacy norms also tightened market risk in addition to credit risk

Capital requirement for open position of foreign exchange.
Capital adequacy to be increased to 10 per cent in a phased manner.
Asset/Liability Management: Risk Management
Internal Systems
Human Resources Management
Technology Up gradation

The Report laid emphasis on the strengthening of regulatory measures and implement Risk
Management strategies to secure the soundness of Banks.

S.K.Bagchi observed that in the world of finance more specifically in Banking, Credit Risk is
the most predominant risk in Banking and occupies roughly 90-95 per cent of risk segment. The
remaining fraction is on account of Market Risk, Operations Risk etc. He feels that so much of
concern on operational risk is misplaced. As per him, it may be just one to two per cent of
Banks risk. For this small fraction, instituting an elaborate mechanism may be unwarranted. A
well laid out Risk Management System should give its best attention to Credit Risk and Market
Risk. In instituting the Risk Management apparatus, Banks seem to be giving equal priority to
these three Risks viz., Credit Risk, Operational Risk and Market Risk. This may prove counter-

Rekha Arunkumar and Koteshwar feels that the Credit Risk is the oldest and biggest risk that
Banks, by virtue of their very nature of business inherit. The pre-dominance of credit risk is the
main component in the capital allocation. As per their estimate credit risk takes the major part of
the Risk Management apparatus accounting for over 70 per cent of all Risks. As per them the

Market Risk and Operational Risk are important, but more attention needs to be paid to the
Credit Risk Management in Banks.
Mrudul Gokhale elaborately dealt with the subject of capital adequacy in Banks. According to
her Banks mostly give adequate focus for the credit risk aspect. There is a shift from the
qualitative risk assessment to the quantitative management of risk. In tune with the regulatory
insistence on capturing risks for the purpose of capital charge, sophisticated risk models are
being developed. These models help Banks to near accurately quantify the potential losses
arising from different risks viz., credit risk, market risk and operations risk. This will enable the
Regulator to ascertain whether individual Bank has accurately compiled the risk profile of assets.

Jorg Hashagen, Nigel Harman, Michael Conover, Jitendra Sharma (2009) volume 15, page
92-103 wrote about Risk Management in Banking Sector: Beyond the credit crisis. The credit
crisis has forced banks to take a critical look at how to manage risk and has exposed some
weaknesses in risk management across the financial services industry. In a first analysis, the
current situation appears to be due to the pursuit of revenue growth in a world of easy credit. The
reality, of course, is more complex, and a number of themes emerge from a recent survey
conducted by KPMG and the Intelligence Unit of The Economist: weaknesses in the culture of
risk management, gap in a risk expertise at a non-executive board level, the lack of influence of
the risk function, the lack of responsibility and accountability on the part of the front line, a
compensation culture too oriented to increase profits year after year, and business models that
were too dependent on ample liquidity in the market.

Anthony M. Santomer (1997) dealt with the risk management of commercial banks. He
describes that throughout the past year, on-site visits to financial service firms were conducted to
review and evaluate the system of financial risk management. The commercial banking analysis
covered a number of North American super-regionals and quasi-money centre institutions as well
as several firms outside the U.S. The information collected covers both the philosophy and
practice of financial risk management. It reports the status of risk management techniques in the
industry, standards of practice and evaluates how and why it is conducted in the particular way
chosen. The problems which the industry finds most difficult to address, shortcomings of the
current methodology used to analyze risk, and the elements that are missing in the current
procedures of risk management were also discussed.

Oldfield and Santomero (1997), it has been argued that risks facing all financial institutions can
be segmented into three separable types, from a management perspective. These are:
(i) Risks that can be eliminated or avoided by simple business practices, (ii) risks that can be
transferred to other participants, and (iii) risks that must be actively managed at the firm level. In
the first of these cases, the practice of risk avoidance involves actions to reduce the chances of
idiosyncratic losses from standard banking activity by eliminating risks that are superfluous to
the institution's business purpose. Common risk avoidance practices here include at least three
types of actions. The standardization of process, contracts and procedures to prevent inefficient
or incorrect financial decisions is the first of these. The construction of portfolios that benefit
from diversification across borrowers and that reduce the effects of any one loss experience is
another. Finally, the implementation of incentive-compatible contracts with the institution's
management to require that employees be held accountable is the third.

Sah Bittu and Amit Kumar Dwivedi (2012) in his journal credit risk in Indian banking sector
describes the empirically analyses fundamental factors affecting periodic addition to non-
performing assets (NPAs or fresh slippage), taken as proxy for measuring credit risk, in Indian
scenario. Panel regression on definitionally uniform data for five-year period, 2005-2009, on
fresh slippage rate is performed for 70 banks to investigate variations on ownership dimension,
aggressiveness, risk taking behaviour and performance of banks. Credit risk for foreign sector
banks is higher than new generation banks for the given time period.
Dr. Ratna singh (2013) said that the banking sector is having the highest growth opportunity in
the near future, since banking plays an important role in the economic development. Indian
economy is growing at a constant growth of 9% so it is expected that in coming years banks will
be highest performer. Banks performs various roles in the economy; they ameliorate the
information problems between investors and borrowers by monitoring the borrowers and
ensuring a proper use of the depositors funds.
Froot and Stein (1998) found credit risk management through active loan purchase and sales
activity affects banks investments in risky loans. Banks which purchase and sell loans hold
more risky loans that is Credit Risk and Loss loans and commercial real estate loans as a
percentage of the balance sheet than other banks. Again, these results are especially striking
because banks that manage their credit risk hold more risky loans than banks that merely sell
loans or banks that merely buy loans.

Treacy and Carey (1998) observed the credit risk rating mechanism at US Banks. The paper
highlighted the architecture of Bank Internal Rating System and Operating Design of rating
system and made a comparison of bank system relative to the rating agency system. The
conclusion was that banks internal rating system helps in management of credit risk, profitability
analysis and product pricing.

Bagchi (2003) examined the credit risk management in banks. He came up with risk
identification, risk measurement, risk monitoring, risks control and risk audit as basic
considerations for credit risk management. The conclusion was that proper credit risk
architecture, policies and framework of credit risk management, credit rating system, monitoring
and control contributes in success of credit risk management system which in turn attract
investors for investment.

Bandyopadhyay (2006) aims at developing an early warning signal model for predicting
corporate default in emerging market economy like India. The method for directly estimating
probability of default using financial and non-financial variable was presented by him. For
predicting corporate bond default multiple discriminant analysis is used and logistic regressions
model is employed for estimating Probability of Default (PD). The conclusion was that by using
Z score model, banks and investors in emerging markets like India can get early warning
signals about the firms solvency status. The PD estimate from logistic analysis would help
banks to estimate credit risk capital and set corporate pricing on a risk adjusted return basis.


Carbedo and Tirados (2004) describes that globalization and technical improvements is a new
management approaches for risks and making it difficult for investors and other stakeholders for
forecasting the companies behaviour. The internal and external factor creates both challenges
and threats which can lead to exposure to risks. The types of risks which banks must handle are:
Credit risk, Liquidity risk, market risk, operational risk. He classified that how to categorize risk.
According to him financial risk are of most interest and specific interest which focuses on are
credit risk, market risk and liquidity risk. These 3 risk are of high interest due to fact that they
affect the chosen proxies for uncertainty as presented in Article name Proxies for uncertainty in
banking sector.