Bank Management Quick Guide

1/9/2017 BankManagementQuickGuide
BankManagementQuickGuide
https://www.tutorialspoint.com/bank_management/bank_management_quick_guide.htm
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BankManagementIntroduction
Abankisafinancialinstitutionwhichacceptsdeposits,paysinterestonpredefinedrates,clearschecks,makes
loans,andoftenactsasanintermediaryinfinancialtransactions.Italsoprovidesotherfinancialservicestoits
customers.
Bankmanagementgovernsvariousconcernsassociatedwithbankinordertomaximizeprofits.Theconcerns
broadlyincludeliquiditymanagement,assetmanagement,liabilitymanagementandcapitalmanagement.We
willdiscusstheseareasinlaterchapters.
OriginofBanks
TheoriginofbankorbankingactivitiescanbetracedtotheRomanempireduringtheBabylonianperiod.Itwas
beingpracticedonaverysmallscaleascomparedtomoderndaybankingandframeworkwasnotsystematic.
Modernbanksdealwithbankingactivitiesonalargerscaleandabidebytherulesmadebythegovernment.The
governmentplaysacrucialrolewithitscontroloverthebankingsystem.Thiscallsforbankmanagement,which
furtherensuresqualityservicetocustomersandawinwinsituationbetweenthecustomer,thebanksandthe
government.
Scheduled&NonScheduledBanks
Scheduledandnonscheduledbanksarecategorizedbythecriteriaoreligibilitysetupbythegoverningauthority
ofaparticularregion.Thefollowingarethebasicdifferencesbetweenscheduledandnonscheduledbanksinthe
Indianbankingperspective.
Scheduledbanksarethosethathavepaidupcapitalanddepositsofanaggregatevalueofnotlessthanrupees
fivelakhsintheReserveBankofIndia.AlltheirbankingbusinessesarecarriedoutinIndia.Mostofthebanks
inIndiafallinthescheduledbankcategory.
Nonscheduledbanksarethebankswithreservecapitaloflessthanfivelakhrupees.Thereareveryfewbanks
thatfallinthiscategory.
EvolutionofBanks
Bankingsystemhasevolvedfrombarbaricbankingwherecommoditieswereloanedtomoderndaybanking
system,whichcaterstoarangeoffinancialservices.Theevolutionofbankingsystemwasgradualwithgrowth
ineachandeveryaspectofbanking.Someofthemajorchangeswhichtookplaceareasfollows
Bartersystemreplacedbymoneywhichmadetransactionuniform
Uniformlawsweresetuptoincreasepublictrust
Centralizedbanksweresetuptogovernotherbanks
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Bookkeepingwasevolvedfrompaperstodigitalformatwiththeintroductionofcomputers
ATMsweresetupforeasierwithdrawaloffunds
Internetbankingcameintoexistencewithdevelopmentofinternet
Bankingsystemhaswitnessedunprecedentedgrowthandwillbeundergoingitinfuturetoowiththe
advancementintechnology.
GrowthofBankingSysteminIndia
ThejourneyofbankingsysteminIndiacanbeputintothreedifferentphasesbasedontheservicesprovidedby
them.Theentireevolutionofbankingcanbedescribedinthesedistinctphases
Phase1
ThiswastheearlyphaseofbankingsysteminIndiafrom1786to1969.Thisperiodmarkedtheestablishmentof
Indianbankswithmorebanksbeingsetup.Thegrowthwasveryslowinthisphaseandbankingindustryalso
experiencedfailuresbetween1913to1948.
TheGovernmentofIndiacameupwiththebankingCompaniesActin1949.Thishelpedtostreamlinethe
functionsandactivitiesofbanks.Duringthisphase,publichadlesserconfidenceinbanksandpostofficeswere
consideredmoresafetodepositfunds.
Phase2
Thisphaseofbankingwasbetween1969to1991,therewereseveralmajordecisionsbeingmadeinthisphase.
In1969,fourteenmajorbankswerenationalized.CreditGuaranteeCorporationwascreatedin1971.This
helpedpeopleavailloanstosetupbusinesses.
In1975,regionalruralbankswerecreatedforthedevelopmentofruralareas.Thesebanksprovidedloansat
lowerrates.Peoplestartedhavingenoughfaithandconfidenceonthebankingsystem,andtherewasaplungein
thedepositsandadvancesbeingmade.
Phase3
Thisphasecameintoexistencefrom1991.Theyear1991markedthebeginningofliberalization,andvarious
strategieswereimplementedtoensurequalityserviceandimprovecustomersatisfaction.
TheongoingphasewitnessedthelaunchofATMswhichmadecashwithdrawalseasier.Thisphasealsobrought
inInternetbankingforeasierfinancialtransactionsfromanypartofworld.Bankshavebeenmakingattemptsto
providebetterservicesandmakefinancialtransactionsfasterandefficient.
BankManagementCommercialBanking
Acommercialbankisatypeoffinancialinstitutionthatprovidesserviceslikeacceptingdeposits,making
businessloans,andofferingbasicinvestmentproducts.Thetermcommercialbankcanalsorefertoabank,ora
divisionofalargebank,whichpreciselydealswithdepositsandloanservicesprovidedtocorporationsorlarge
ormiddlesizedenterprisesasopposedtoindividualmembersofthepublicorsmallenterprises.Forexample,
Retailbanking,orMerchantbanks.
Acommercialbankcanalsobedefinedasafinancialinstitutionthatislicensedbylawtoacceptmoneyfrom
differententerprisesaswellasindividualsandlendmoneytothem.Thesebanksareopentothemassandassist
individuals,institutions,andenterprises.
Basically,acommercialbankisthetypeofbankpeopletendtouseregularly.Theyareformulatedbyfederal
andstatelawsonthebasisofthecoordinationandtheservicestheyprovide.
ThesebanksarecontrolledbytheFederalReserveSystem.Acommercialbankislicensedtoassistthe
followingfunctions
AcceptdepositsReceivingmoneyfromindividualsandenterprisesknownasdepositors.
DispensepaymentsMakingpaymentsaccordingtotheconvenienceofthedepositors.Forexample,
honoringacheck.
CollectionsBankplaysasanagenttocollectfundsfromanotherbanksreceivabletothedepositor.For
example,whensomeonepaysthroughcheckdrawnonanaccountfromadifferentbank.
InvestfundsContributingorspendingmoneyinsecuritiesformakingmoremoney.Forexample,
mutualfunds.
SafeguardmoneyAbankisregardedasasafeplacetostorewealthincludingjewelryandotherassets.
MaintainsavingsThemoneyofthedepositorsismaintained,andtheaccountsarecheckedandona
regularbasis.
MaintaincustodialaccountsTheseaccountsaremaintainedunderthesupervisionofonepersonbut
areactuallyforthebenefitofanotherperson.
LendmoneyLendingmoneytocompanies,depositorsincaseofsomeemergency.
Commercialbanksareapparentlythelargestsourceoffinancingforprivatecapitalinvestmentinanation,
especially,likeIndia.Acapitalinvestmentcanbedefinedasthepurchaseofapropertywiththepurposeof
eitherproducingincomefromtheproperty,increasingthevalueofthepropertyovertime,orboth.Similar
capitalpurchasesmadebyenterprisesmayinvolvethingslikeplants,toolsandequipment.
PresentStructure
ThecurrentbankingframeworkinIndiacanbebroadlyclassifiedintotwo.Thefirstclassificationdividesbanks
intothreesubcategoriestheReserveBankofIndia,commercialbanksandcooperativebanks.
Theseconddividesthebanksintotwosubcategoriesscheduledbanksandnonscheduledbanks.Inbothof
thesesystemsofcategorization,theRBI,istheheadofthebankingstructure.Itmonitorsandholdsallthe
reservecapitalofallthecommercialorscheduledbanksacrossthenation.
Commercialbanksarethefoundationsthatreceivedepositsfromindividualsandenterprisesandlendloansto
them.Theygeneratecredit.CommercialbanksinIndiaareregulateundertheBankingRegulationActof1949.
Thesebanksarefurthercategorizedas
Scheduledbanks
Nonscheduledbanks
Scheduledbanksarebankswhicharelistedinthe2ndscheduleoftheReserveBankofIndiaAct,1934.Non
scheduledbanksarethosebankswhicharenotlistedinthesecondscheduleoftheReserveBankofIndia
Act,1934.
ScheduledBanks
InIndia,forabanktoqualifyasascheduledbank,itneedstomeetthecriteriaasunderplayedbytheReserve
BankofIndia.Thefollowingisalistofthecriterions
ThebanksshouldcarryalltheirbusinesstransactionsinIndia.
AllschedulebanksareboundtoholdacapitalofnotlessthanrupeesfivelakhsintheReserveBankof
India.
Intheyear2011,fivelakhsrupeescalculatedintermsofdollarsamountedto$11,156.
Thus,anycommercial,cooperative,nationalized,foreignbankandanyotherbankingfoundationthataccepts
andsatisfiesthesesetconditionsaretermedasscheduledbanksbutnotallschedulebanksarecommercial
banks.
ThescheduledcommercialbanksarethosebankswhichareincludedinthesecondscheduleofRBIAct,1934.
Thesebanksacceptdeposits,lendloansandalsoofferotherbankingservices.Themajordifferencebetween
scheduledcommercialbanksandscheduledcooperativebanksistheirholdingpattern.Cooperativebanksare
registeredascooperativecreditinstitutionsundertheCooperativeSocietiesActof1912.
Scheduledbanksarefurthercategorizedas
Privatesectorbanks
Publicsectorbanks
Foreignsectorbanks
PrivateSectorBanks
Thesebanksacquirelargerpartsofstakeorcongruityismaintainedbytheprivateshareholdersandnotby
government.Thus,bankswheremaximumamountofcapitalisinprivatehandsareconsideredasprivatesector
banks.InIndia,wehavetwotypesofprivatesectorbanks
OldPrivateSectorBanks
NewPrivateSectorBanks
OldPrivatesectorBanks
Theoldprivatesectorbanksweresetupbeforenationalizationin1969.Theyhadtheirownindependence.
Thesebankswereeithertoosmallorspecialisttobeincorporatedinnationalization.Thefollowingisalistof
oldprivatesectorbanksinIndia
CatholicSyrianBank
CityUnionBank
DhanlaxmiBank
FederalBankING
VysyaBank
JammuandKashmirBank
KarnatakaBank
KarurVysyaBank
LakshmiVilasBank
NainitalBank
RatnakarBank
SouthIndianBank
TamilnaduMercantileBank
Fromtheabovementionedbanks,theNainitalBankisanauxiliaryorbranchoftheBankofBaroda,whichhas
98.57%stakeinit.Afewoldgenerationprivatesectorbanksmergedwithotherbanks.Forexample,intheyear
2007,LordKrishnaBankmergedwithCenturionBankofPunjab.SangliBankmergedwithICICIBankin
2006.Yetagain,CenturionBankofPunjabmergedwithHDFCin2008.
NewPrivatesectorBanks
Bankswhichstartedtheiroperationsafterliberalizationinthe1990sarethenewprivatesectorbanks.These
bankswerepermittedentryintotheIndianbankingsectoraftertheamendmentoftheBankingRegulationActin
1993.
Atpresent,thefollowingnewprivatesectorbanksareoperationalinIndia
AxisBankDevelopment
CreditBank[MathProcessingError]
HDFCBank
ICICIBank
IndusIndBank
KotakMahindraBank
YesBank
Inadditiontothesesevenbanks,therearetwomorebankswhichareyettocommenceoperation.Theygotthe
inprinciplelicensesfromRBI.ThesetwobanksareIDFCandBandhanBankofBandhanFinancialServices.
CommercialBankingFunctions
Commercialbankingisbasicallytheparentofalltypesofbankingavailableinthepresentbankingstructure.In
ordertounderstandtheroleofcommercialbanking,letusdiscusssomeofitsmajorfunctions.Thefollowing
arethemajorfunctionsofcommercialbanks
AcceptanceofDeposits
Themostimportanttaskofcommercialbanksistoacceptdepositsfromthepublic.Banksmaintainandkeep
recordsofallthedemanddepositaccountsoftheircustomersandtransformthedepositmoneyintocash,vice
versaisalsopossibleaspertherequirementsofthecustomers.Technically,demanddepositsareacceptedin
currentaccounts.Thedepositorcanwithdrawdepositedmoneyanytimebymeansofchecks.
Infixeddepositaccounts,thedepositorcanwithdrawthemoneydepositedonlyafteracertainperiod.Wecan
say,fixeddepositsaretimeliabilitiesofthebanks.Depositsinthesavingbankaccountsaresubjectedtocertain
limitationsregardingtheamountonecanreceiveandwithdraw.Inthisway,bankscollectsavingsfrompeople
andmaintainareserveofthesesavings.
GivingLoansandAdvances
Oneofthemostimportantfunctionsofcommercialbanksistoextendloansandadvancesoutofthemoney
throughdepositsofbusinessmenandentrepreneursagainstpermittedsecuritiesandsafetylikegoldorsilver
bullion,governmentsecurities,easilysaleablestocksandsharesandmarketablegoods.
Banksgiveadvancestocustomersordepositorsthroughoverdrafts,discountingbills,moneyatcallandshort
notice,loansandadvances,differentformsofdirectloanstotradersandproducers.
UsingCheckSystem
Banksfacilitateservicesthroughsomemediumofexchangelikechecks.Usingchecksforsettlingdebtsin
businesstransactionisalwayspreferredovercash.Checkisalsoreferredasthemostdevelopedcredit
instrument.
Therearesomeothermajorfunctionsofcommercialbanking.Theyperformamultitudeofothernonbanking
operations.Thesenonbankingoperationsarefurtherclassifiedasagencyservicesandgeneralutilityservices.
AgencyServices
Theservicesbanksensureforandonbehalfoftheircustomersareagencyservices.Thebanksplaytherole
ofanexecutor,trusteeandattorneyforthecustomerswill.Theyaccumulateaswellasmakepaymentsforbills,
checks,promissorynotes,interests,dividends,rents,subscriptions,insurancepremium,policyetc.
Asmentionedabove,theyprovideservicesforandonbehalfofcustomersandalsoissuedrafts,mail,
telegraphictransfersonbehalfofclientstoremitfunds.Theyalsohelptheircustomersbyarrangingincometax
professionalstofacilitatetheprocessofincometaxreturns.Basicallythebankersworkascorrespondents,
agentsorrepresentativesoftheirclients.
GeneralUtilityServices
Theservicesensuredfortheentiresocietyareknownasgeneralutilityservices.Thebankersissuebankdrafts
andtravelerscheckstofacilitatetransferoffundsfromonepartofthecountrytoanother.Theygivethe
customerslettersofcreditwhichhelpthemwhentheygoabroad.
Theyhandleforeignexchangeorfinanceforeigntradebyacceptingorassemblingforeignbillsofexchange.
Banksarrangeforsafedepositvaultswherethecustomerscansecuretheirvaluables.Banksalsoassemble
statisticsandbusinessinformationrelevanttotrade,commerceandindustry.
CommercialBankingReforms
TheIndiangovernmentdecidedtoamendneweconomicreforms.Earlier,thebankingindustrywashighly
dominatedbythepublicsector.Thisleadtoprofitabilityandpoorassetquality.Thecountrywasundergoing
deepeconomiccrisis.Themainaimofthebankingsectorreformswastobuildadiversified,efficientand
competitivefinancialsystem.Theultimategoalofthissystemwastoproperlyallocateresourcesthrough
functionalflexibility,improvedfinancialviabilityandinstitutionalstrengthening.
Thereformsaremainlyfocusedtowardseradicatingfinancialrepressionthroughminimizationsinstatutory
preemptions,whileconcurrentlysteppingupprudentialregulations.Inadditiontothis,interestratesondeposits
andtheloanslentbybankshadbeenprogressivelydenationalized.
Bytheyear1991,Indiahadnationalizedbanksintwophasesin1969and1980.Thepublicsectorbanks[Math
ProcessingError]controlledthecreditsupply.Thepost1991periodsawthreedifferentchronologicalphases.
Thefirstphasewasroughlybetween1991to1998.Thesecondphasestartedin1998andcontinueduntilthe
beginningofglobalfinancialcrisis.Thethirdphaseistheongoingone.
Phase1
Asweknowpost1991wasaperiodofstructuralreformsinthefinancialsector.Therewasunprecedented
developmentinvariousareassuchasbankingandcapitalmarkets.Thesereformswerebasedonthe
recommendationsputforwardbytheNarasimhamCommitteeintheirreportinNovember1991.
AfterthefirstphaseofbankingsectorreformsundertheguidanceofNarasimhamCommitteethefollowing
measureswereundertakenbygovernment
LoweringSLRandCRR
ThehighSLRandCRRminimizedtheprofitsofthebanks.TheSLRwasminimizedfrom38.5%in1991to
25%in1997.Asaresult,bankswereleftwithmorefundsthatcouldbeallocatedtoagriculture,industry,trade
etc.
TheCashReserveRatio[MathProcessingError]isabankscashratiooftotaldepositstobemaintainedwith
RBI.TheCRRhasbeenloweredfrom15%in1991to4.1%inJune2003.Theaimistoreleasethefundslocked
upwithRBI.
PrudentialNorms
ThesenormswereinitiatedbyRBIinordertobringinprofessionalismincommercialbanks.Themain
objectiveofthesenormswereproperdisclosureofincome,classificationofassetsandprovisionforbaddebts
soastoassurethatthebooksofcommercialbanksmirroredtheaccurateandcorrectpictureoffinancial
position.
Prudentialnormsensuredthebanksmade100%provisionforallnonperformingassets[MathProcessing
Error].Forthispurpose,sponsoringwasplacedatRs.10,000croresphasedover2years.
CapitalAdequacyNorms[MathProcessingError]
Itistheratioofminimumcapitaltoriskassetratio.InApril1992,RBIfixedCANat8%.ByMarch1996,all
publicsectorbankshadattainedtheratioof8%.
DeregulationofInterestRates
TheNarasimhamCommitteerecommendedthatinterestratesshouldbedeterminedbymarketforces.From
1992,determininginterestrateshasbecomemoresimpleandeasy.
RecoveryofDebts
ThegovernmentofIndiaissuedtheRecoveryofdebtsduetoBanksandFinancialInstitutionsAct1993in
ordertosupportandspeeduptherecoveryoftheduesofbanksandfinancialinstitutions.SixSpecialRecovery
Tribunalshavebeenestablishedtoworkonthesame.AnAppellateTribunalwasalsoestablishedinMumbai.
CompetitionfromNewPrivateSectorBanks
Todaybankingisopentoprivatesector.Newprivatesectorbankshavealreadystartedfunctioningwellinthe
bankingindustry.Thesenewprivatesectorbanksarepermittedtohikecapitalcontributionfromforeign
institutionalinvestorsupto20%andfromNRIsupto40%.Asaresult,thereisanincreaseincompetition.
PhasingOutofDirectedCredit
Thecommitteerecommendedphasingoutofthedirectedcreditplans.Arecommendationwasmadetolowerthe
credittargetfortheprioritysectorfrom40%to10%.Itwouldbeverydifficultforthegovernmentasfarmers,
smallindustrialistsandtransportershavepowerfullobbies.
AccesstoCapitalMarket
TheBankingCompanies[MathProcessingError]wasenhancedtoallowthebankstoincreasecapitalthrough
publicissues.Thisissubjecttoaprovisionthattheholdingofcentralgovernmentwouldnotdecreasebelow
51%ofpaidupcapital.TheStateBankofIndiahasalreadyincreasedsubstantialamountoffundsthrough
equityandbonds.
FreedomofOperation
Scheduledcommercialbanksaregivenfreedomtoopennewbranchesandupgradeextensioncounters,after
attainingcapitaladequacyratioandprudentialaccountingnorms.Thebanksarealsopermittedtoclosenon
viablebranchesotherthaninruralareas.
LocalAreabanks[MathProcessingError]
In1996,RBIissuedguidelinesforestablishingLocalAreaBanksanditapprovedtobuild7LABsinprivate
sector.LABsprovidesupportinmobilizingruralsavingsandinconvertingthemtoinvestmentinlocalareas.
SupervisionofCommercialBanks
TheRBIformedaBoardoffinancialSupervisionwithanadvisoryCounciltoempowerthesupervisionofbanks
andfinancialinstitutions.In1993,RBIestablishedanewdepartment,theDepartmentofSupervision,asan
independentunitforsupervisionofcommercialbanks.
MeasuresweretakentoempowercapitalinfusionbythegovernmenttoapproximatelyRs.20,000Crore.Along
withthis,publicsectorbankswerepermittedtoaccessthecapitalmarketsforinfusionofequitycapitalsubject
totheconditionthatgovernmentownershipwouldremainatleastat51percent.
Also,necessarymeasuresweretakentodevelopthefragilehealthandlowprofitability.Thiscalledfor
adherencetointernationallyacceptableprudentialnorms,assetclassificationandprovisioningandcapital
adequacy.Manymeasureswerealsostarted,theprominentonebeingtheenactmentofTheRecoveryofDebts
DuetoBanksandFinancialInstitutionsActin1993.Followingthis,29debtrecoverytribunals[Math
ProcessingError]andfivedebtrecoveryappellatetribunals[MathProcessingError]wereestablishedata
numberofplacesinthecountry.
AllthesemeasuresminimizedthepercentageofNPAstogrossadvancesfrom23.2percentinMarch1993to16
percentinMarch1998.Laterrationalizationandderegulationofinterestrateswasalsoundertaken.
Concurrently,inordertobuildcompetitionwithinthebankingsphere,differentmeasureswereundertaken.
Thesecomprisedofopeningprivatesectorbanks,greaterfreedomtoopenbranchesandinstallationofATMs,
andfullfunctionalfreedomtobankstoevaluateworkingcapitalrequirements.
Phase2
ThesecondphaseofreformsbegunwithanotherNarasimhamCommitteereportinApril1998,whichsucceeded
theEastAsianCrisis.Post1998,aneedwasfelttorestructuredebtastheDRTsprocesswasveryslowbecause
ofmanylegalandotherhurdles.
Animportantfeatureinthisphasewasthegrowingcompetitionbetweenbanks.Though21newbanksincluding
fourprivatesectorbanks,onepublicsectorbankand16foreignentitiesenrolled,theoverallscheduled
commercialbanks[MathProcessingError]decreasedapproximatelyfourfifthsto82by2007.Inadditionto
this,FDIinthebankingsectorwasbroughtundertheautomaticroute,andthelimitinprivatesectorbankswas
increasedfrom49percentto74percentin2004.
Inordertomakebankingsectorstronger,thegovernmentdelegatedaCommitteeonbankingsectorreforms
undertheChairmanshipofM.Narasimham.ItendureditsreportinApril1998.TheCommitteefocusedmainly
onstructuralmeasuresanddevelopmentinstandardsofdisclosureandlevelsoftransparency.
Thefollowingreformswereundertakenontherecommendationsmadebythecommittee
NewAreasNewareasforbankfinancinghavebeenunclosedlikeInsurance,creditcards,asset
management,leasing,goldbanking,investmentbankingetc.
NewInstrumentsFormoreflexibilityandbetterriskmanagementnewtoolsandtechnologieshave
beenintroduced.Theseinstrumentsincludeinterestrateswaps,crosscurrencyforwardcontracts,forward
rateagreements,liquidityadjustmentfacilityformeetingdaytodayliquiditymismatch.
RiskManagementBankshaveinitializedspecializedcommitteestoassessvariousrisks.TheirSkills
andsystemsareupgradedonaregularbasis.
StrengtheningTechnologyTechnologyinfrastructurehasbeenreinforcedforpaymentandsettlement
withservicessuchaselectronicfundstransfer,centralizedfundmanagementsystem,etc.
IncreaseInflowofCreditMeasuresaretakentoboostuptheflowofcredittoprioritysectorby
focusingonMicroCreditandSelfHelpGroups.
IncreaseinFDILimitThelimitforFDIhasbeenincreasedinprivatesectorbanksfrom49%to74%.
UniversalbankingItreferstothemergingofcommercialbankingandinvestmentbanking.Therearea
fewguidelinesfortheexpansionofuniversalbanking.
AdoptionofGlobalStandardsTheRBIrecentlyintroducedriskbasedsupervisionofbanks.Best
internationalexercisesinaccountingsystems,corporategovernance,paymentandsettlementsystemsetc.
arebeingendorsed.
InformationTechnologyBankshaveproposedonlinebanking,Ebanking,Internetbanking,telephone
bankingetc.Measureshavebeentakentosupportdeliveryofbankingservicesviaelectronicchannels.
ManagementofNPAsMeasuresweretakenbyRBIandcentralgovernmentformanagementofnon
performingassets[MathProcessingError],likecorporateDebtRestructuring[MathProcessingError],
DebtRecoveryTribunals[MathProcessingError]andLokAdalats.
MergersandAmalgamationInMay2005,RBIissuedguidelinesformergerandAmalgamationof
privatesectorbanks.
GuidelinesforAntiMoneyLaunderingRecently,preventionofmoneylaunderingwasgiven
importanceininternationalfinancialrelationships.In2004,RBIupdatedtheguidelinesonknowyour
customer[MathProcessingError]principles.
ManagerialAutonomyInFebruary2005,theGovernmentofIndiacirculatedamanagerialautonomy
packageforpublicsectorbankstosupplythemalevelplayingfieldwithprivatesectorbanksinIndia.
CustomerServicePastyearswitnessedimprovementincustomerservice.TheRBIadvancedits
serviceswithcreditcardfacilities,bankingombudsman,settlementofclaimsofdeceaseddepositorsetc.
BaseRateSystemofInterestRatesThesystemofBenchmarkPrimeLendingRate[MathProcessing
Error]wasintroducedin2003toensuretruereflectionoftheactualcosts.TheRBIproposedthesystem
ofBaseRateon1stJuly,2010.Thebaseratecanbedefinedastheminimumrateforallloans.Ifwetake
bankingsystemasawhole,thebaserateswereintherangeof5.50%9.00%ason13thOctober,2010.
TheBankingSectorReformCommitteefurtherrecommendedthatpresenceofahealthycompetitionbetween
publicsectorbanksandprivatesectorbankswasimportant.Thereportshowedflowofcapitaltomeethigher
andunspecifiedlevelsofcapitaladequacyandminimizationoftargetedcredit.
Thegovernmentfocusedwiththehelpofreformprocessonimprovingtheroleofmarketforcesbymaking
sharpreductioninpreemptionthroughreserverequirement,marketdeterminedpricingforgovernment
securities,disbandingofadministeredinterestrateswithafewexceptionsandimprovedtransparencyand
disclosurenormstosupportmarketdiscipline.
BankManagementLiquidity
Liquidityinbankingreferstotheabilityofabanktomeetitsfinancialobligationsastheycomedue.Itcan
comefromdirectcashholdingsincurrencyoronaccountattheFederalReserveorothercentralbank.More
frequently,itcomesfromacquiringsecuritiesthatcanbesoldquicklywithminimalloss.Thisbasicallystates
highlycreditworthysecurities,comprisingofgovernmentbills,whichhaveshorttermmaturities.
Iftheirmaturityisshortenoughthebankmaysimplywaitforthemtoreturntheprincipleatmaturity.Forshort
term,verysafesecuritiesfavortotradeinliquidmarkets,statingthatlargevolumescanbesoldwithoutmoving
pricestoomuchandwithlowtransactioncosts.
Nevertheless,abanksliquiditycondition,particularlyinacrisis,willbeaffectedbymuchmorethanjustthis
reserveofcashandhighlyliquidsecurities.Thematurityofitslessliquidassetswillalsomatter.Assomeof
themmaymaturebeforethecashcrunchpasses,therebyprovidinganadditionalsourceoffunds.
NeedforLiquidity
Weareconcernedaboutbankliquiditylevelsasbanksareimportanttothefinancialsystem.Theyareinherently
sensitiveiftheydonothaveenoughsafetymargins.Wehavewitnessedinthepasttheextremeformofdamage
thataneconomycanundergowhencreditdriesupinacrisis.Capitalisarguablythemostessentialsafetybuffer.
Thisisbecauseitsupportstheresourcestoreclaimfromsubstantiallossesofanynature.
Theclosestcauseofabanksdemiseismostlyaliquidityissuethatmakesitimpossibletosurviveaclassic
bankrunor,nowadays,amodernequivalent,likeaninabilitytoapproachthedebtmarketsfornewfunding.It
iscompletelypossiblefortheeconomicvalueofabanksassetstobemorethanenoughtowrapupallofits
demandsandyetforthatbanktogobustasitsassetsareilliquidanditsliabilitieshaveshorttermmaturities.
Bankshavealwaysbeenrecliningtorunsasoneoftheirprinciplesocialintentionsaretoperformmaturity
transformation,alsoknownastimeintermediation.Insimplewords,theyyielddemanddepositsandothershort
termfundsandlendthembackoutatlongermaturities.
Maturityconversionisusefulashouseholdsandenterprisesoftenhaveastrongchoiceforasubstantialdegree
ofliquidity,yetmuchoftheusefulactivityintheeconomyneedsconfirmedfundingformultipleyears.Banks
squarethiscyclebydependingonthefactthathouseholdsandenterprisesseldomtakeadvantageoftheliquidity
theyhaveacquired.
Depositsareconsideredsticky.Theoretically,itispossibletowithdrawalldemanddepositsinasingleday,yet
theiraveragebalancesshowremarkablestabilityinnormaltimes.Thus,bankscanaccommodatethefundsfor
longerdurationswithafairdegreeofassurancethatthedepositswillbereadilyavailableorthatequivalent
depositscanbeacquiredfromothersasperrequirement,witharaiseindepositrates.
HowCanaBankAchieveLiquidity
Largebankinggroupsengagethemselvesinsubstantialcapitalmarketsbusinessesandtheyhaveconsiderable
addedcomplexityintheirliquidityrequirements.Thisisdonetosupportrepobusinesses,derivatives
transactions,primebrokerage,andotheractivities.
Bankscanachieveliquidityinmultipleways.Eachofthesemethodsordinarilyhasacost,comprisingof
Shortenassetmaturities
Improvetheaverageliquidityofassets
Lengthen
Liabilitymaturities
Issuemoreequity
Reducecontingentcommitments
Obtainliquidityprotection
Shortenassetmaturities
Thiscanassistintwofundamentalways.Thefirstwaystatesthat,ifthematurityofsomeassetsisshortenedto
anextentthattheymatureduringthedurationofacashcrunch,thenthereisadirectbenefit.Thesecondway
statesthat,shortermaturityassetsarebasicallymoreliquid.
Improvetheaverageliquidityofassets
Assetsthatwillmatureoverthetimehorizonofanactualorpossiblecashcrunchcanstillbecrucialproviders
ofliquidity,iftheycanbesoldinatimelymannerwithoutanyredundantloss.Bankscanraiseassetliquidityin
manyways.
Typically,securitiesaremoreliquidthanloansandotherassets,eventhoughsomelargeloansarenowframedto
becomparativelyeasytosellonthewholesalemarkets.Thus,itisanelementofdegreeandnotanabsolute
statement.Mostlyshortermaturityassetsaremoreliquidthanlongerones.Securitiesissuedinlargevolumeand
bylargeenterpriseshavegreaterliquidity,becausetheydomorecreditworthysecurities.
Lengthenliabilitymaturities
Thelongerdurationofaliability,thelessitisexpectedthatitwillmaturewhileabankisstillinacashcrunch.
Issuemoreequity
Commonstocksarebarelyequivalenttoanagreementwithaperpetualmaturity,withthecombinedbenefitthat
nointerestorsimilarperiodicpaymentshavetobemade.
Reducecontingentcommitments
Cuttingbacktheamountoflinesofcreditandothercontingentcommitmentstopayoutcashinthefuture.It
limitsthepotentialoutflowthusreconstructingthebalanceofsourcesandusesofcash.
Obtainliquidityprotection
Abankcanscaleanotherbankoraninsurer,orinsomecasesacentralbank,toguaranteetheconnectionofcash
inthefuture,ifrequired.Forexample,abankmaypayforalineofcreditfromanotherbank.Insomecountries,
bankshaveassetsprepositionedwiththeircentralbankthatcanfurtherbepasseddownascollateraltohirecash
inacrisis.
Alltheabovementionedtechniquesusedtoachieveliquidityhaveanetcostinnormaltimes.Basically,
financialmarketshaveanupwardslopingyieldcurve,statingthatinterestratesarehigherforlongterm
securitiesthantheyareforshorttermones.
Thisissomostlythecasethatsuchacurveisreferredasnormalyieldcurveandtheexceptionalperiodsare
knownasinverseyieldcurves.Whentheyieldcurvehasatoporientedslope,contractingassetmaturities
decreasesinvestmentincomewhileextendingliabilitymaturitiesraisesinterestexpense.Inthesameway,more
liquidinstrumentshaveloweryields,elseequal,minimizinginvestmentincome.
BankMngmtLiquidityManagementTheory
Thereareprobablecontradictionsbetweentheobjectivesofliquidity,safetyandprofitabilitywhenlinkedtoa
commercialbank.Effortshavebeenmadebyeconomiststoresolvethesecontradictionsbylayingdownsome
theoriesfromtimetotime.
Infact,thesetheoriesmonitorthedistributionofassetsconsideringtheseobjectives.Thesetheoriesarereferred
toasthetheoriesofliquiditymanagementwhichwillbediscussedfurtherinthischapter.
CommercialLoanTheory
Thecommercialloanortherealbillsdoctrinetheorystatesthatacommercialbankshouldforwardonlyshort
termselfliquidatingproductiveloanstobusinessorganizations.Loansmeanttofinancetheproduction,and
evolutionofgoodsthroughthesuccessivephasesofproduction,storage,transportation,anddistributionare
consideredasselfliquidatingloans.
Thistheoryalsostatesthatwhenevercommercialbanksmakeshorttermselfliquidatingproductiveloans,the
centralbankshouldlendtothebanksonthesecurityofsuchshorttermloans.Thisprincipleassuresthatthe
appropriatedegreeofliquidityforeachbankandappropriatemoneysupplyforthewholeeconomy.
Thecentralbankwasexpectedtoincreaseorerasebankreservesbyrediscountingapprovedloans.When
businessstartedgrowingandtherequirementsoftradeincreased,bankswereabletocaptureadditionalreserves
byrediscountingbillswiththecentralbanks.Whenbusinesswentdownandtherequirementsoftradedeclined,
thevolumeofrediscountingofbillswouldfall,thesupplyofbankreservesandtheamountofbankcreditand
moneywouldalsocontract.
Advantages
Theseshorttermselfliquidatingproductiveloansacquirethreeadvantages.First,theyacquireliquiditysothey
automaticallyliquidatethemselves.Second,astheymatureintheshortrunandareforproductiveambitions,
thereisnoriskoftheirrunningtobaddebts.Third,suchloansarehighonproductivityandearnincomeforthe
banks.
Disadvantages
Despitetheadvantages,thecommercialloantheoryhascertaindefects.First,ifabankdeclinestograntloan
untiltheoldloanisrepaid,thedisheartenedborrowerwillhavetominimizeproductionwhichwillultimately
affectbusinessactivity.Ifallthebankspursuethesamerule,thismayresultinreductioninthemoneysupply
andcostinthecommunity.Asaresult,itmakesitimpossibleforexistingdebtorstorepaytheirloansintime.
Second,thistheorybelievesthatloansareselfliquidatingundernormaleconomiccircumstances.Ifthereis
depression,productionandtradedeteriorateandthedebtorfailstorepaythedebtatmaturity.
Third,thistheorydisregardsthefactthattheliquidityofabankreliesonthesalabilityofitsliquidassetsandnot
onrealtradebills.Itassuressafety,liquidityandprofitability.Thebankneednotdependonmaturitiesintimeof
trouble.
Fourth,thegeneraldemeritofthistheoryisthatnoloanisselfliquidating.Aloangiventoaretailerisnotself
liquidatingiftheitemspurchasedarenotsoldtoconsumersandstaywiththeretailer.Insimplewordsaloanto
besuccessfulengagesathirdparty.Inthiscasetheconsumersarethethirdparty,besidesthelenderandthe
borrower.
ShiftabilityTheory
ThistheorywasproposedbyH.G.Moultonwhoinsistedthatifthecommercialbankscontinueasubstantial
amountofassetsthatcanbemovedtootherbanksforcashwithoutanylossofmaterial.Incaseofrequirement,
thereisnoneedtodependonmaturities.
Thistheorystatesthat,foranassettobeperfectlyshiftable,itmustbedirectlytransferablewithoutanylossof
capitallosswhenthereisaneedforliquidity.Thisisspecificallyusedforshorttermmarketinvestments,like
treasurybillsandbillsofexchangewhichcanbedirectlysoldwheneverthereisaneedtoraisefundsbybanks.
Butingeneralcircumstanceswhenallbanksrequireliquidity,theshiftabilitytheoryneedallbankstoacquire
suchassetswhichcanbeshiftedontothecentralbankwhichisthelenderofthelastresort.
Advantage
Theshiftabilitytheoryhaspositiveelementsoftruth.Nowbanksobtainsoundassetswhichcanbeshiftedonto
otherbanks.Sharesanddebenturesoflargeenterprisesarewelcomedasliquidassetsaccompaniedbytreasury
billsandbillsofexchange.Thishasmotivatedtermlendingbybanks.
Disadvantage
Shiftabilitytheoryhasitsowndemerits.Firstly,onlyshiftabilityofassetsdoesnotprovideliquiditytothe
bankingsystem.Itcompletelyreliesontheeconomicconditions.Secondly,thistheoryneglectsacute
depression,thesharesanddebenturescannotbeshiftedtoothersbythebanks.Insuchasituation,thereareno
buyersandallwhopossessthemwanttosellthem.Third,asinglebankmayhaveshiftableassetsinsufficient
quantitiesbutifittriestosellthemwhenthereisarunonthebank,itmayadverselyaffecttheentirebanking
system.Fourth,ifallthebankssimultaneouslystartshiftingtheirassets,itwouldhavedisastrouseffectsonboth
thelendersandtheborrowers.
AnticipatedIncomeTheory
ThistheorywasproposedbyH.V.Prochanowin1944onthebasisofthepracticeofextendingtermloansbythe
UScommercialbanks.Thistheorystatesthatirrespectiveofthenatureandfeatureofaborrowersbusiness,the
bankplanstheliquidationofthetermloanfromtheexpectedincomeoftheborrower.Atermloanisfora
periodexceedingoneyearandextendingtoaperiodlessthanfiveyears.
Itisadmittedagainstthehypothecation[MathProcessingError]ofmachinery,stockandevenimmovable
property.Thebankputslimitationsonthefinancialactivitiesoftheborrowerwhilelendingthisloan.While
lendingaloan,thebankconsiderssecurityalongwiththeanticipatedearningsoftheborrower.Soaloanbythe
bankgetsrepaidbythefutureearningsoftheborrowerininstallments,rathergivingalumpsumatthematurity
oftheloan.
Advantages
Thistheorydominatesthecommercialloantheoryandtheshiftabilitytheoryasitsatisfiesthethreemajor
objectivesofliquidity,safetyandprofitability.Liquidityissettledtothebankwhentheborrowersavesand
repaystheloanregularlyaftercertainperiodoftimeininstallments.Itfulfillsthesafetyprincipleasthebank
permitsarelyingongoodsecurityaswellastheabilityoftheborrowertorepaytheloan.Thebankcanuseits
excessreservesinlendingtermloanandisconvincedofaregularincome.Lastly,thetermloanishighly
profitableforthebusinesscommunitywhichcollectsfundsformediumterms.
Disadvantages
Thetheoryofanticipatedincomeisnotfreefromdemerits.Thistheoryisamethodtoexamineaborrowers
creditworthiness.Itgivesthebankconditionsforexaminingthepotentialofaborrowertofavorablyrepaya
loanontime.Italsofailstomeetemergencycashrequirements.
LiabilitiesManagementTheory
Thistheorywasdevelopedfurtherinthe1960s.Thistheorystatesthat,thereisnoneedforbankstolendself
liquidatingloansandmaintainliquidassetsastheycanborrowreservemoneyinthemoneymarketwhenever
necessary.Abankcanholdreservesbybuildingadditionalliabilitiesagainstitselfviadifferentsources.
Thesesourcescompriseofissuingtimecertificatesofdeposit,borrowingfromothercommercialbanks,
borrowingfromthecentralbanks,raisingofcapitalfundsthroughissuingshares,andbyploughingbackof
profits.Wewilllookintothesesourcesofbankfundsinthischapter.
TimeCertificatesofDeposits
Thesedepositshavedifferentmaturitiesrangingfrom90daystolessthan12months.Theyaretransferablein
themoneymarket.Thus,abankcanhaveconnectiontoliquiditybysellingtheminthemoneymarket.Butthis
sourcehastwodemerits.
First,ifduringacrisis,theinterestratelayoutinthemoneymarketishigherthantheceilingratesetbythe
centralbank,timedepositcertificatescannotbesoldinthemarket.Second,theyarenotreliablesourceoffunds
forthecommercialbanks.Biggercommercialbankshaveabenefitinsellingthesecertificatesastheyhavelarge
certificateswhichtheycanaffordtosellatevenlowinterestrates.Sothesmallerbanksfacetroubleinthis
respect.
BorrowingfromotherCommercialBanks
Abankmaybuildadditionalliabilitiesbyborrowingfromthosebanksthathaveexcessreserves.Butthese
borrowsareonlyforaveryshorttime,thatisforadayoratthemostforaweek.
Theinterestrateofthesetypesofborrowingsreliesonthecontrollingpriceinthemoneymarket.But
borrowingsfromotherbanksareonlypossiblewhentheeconomicconditionsarenormaleconomic.Inabnormal
times,nobankcanaffordtogranttoothers.
BorrowingfromtheCentralBank
Banksalsobuildliabilitiesonthemselvesbyborrowingfromthecentralbankofthecountry.Theyborrowto
satisfytheirliquidityrequirementsforshorttermandbydiscountingbillsfromthecentralbank.Butthesetypes
ofborrowingsarecomparativelycostlierthanborrowingsfromothersources.
RaisingCapitalFunds
Commercialbanksholdfundsbydistributingfreshsharesordebentures.Buttheavailabilityoffundsthrough
thesesourcesreliesonthevolumeofdividendorinterestratewhichthebankispreparedtopay.Basicallybanks
arenotpreparedtopayratesmorethanpaidbymanufacturingandtradingenterprises.Thustheyfailtoget
enoughfundsfromthesesources.
PloughingBackProfits
Theploughingbackofitsprofitsisconsideredasanalternativesourceofliquidfundsforacommercialbank.
Buthowmuchitcanobtainfromthissourcereliesonitsrateofprofitanditsdividendpolicy.Largerbankscan
dependonthesesourcesratherthanthesmallerbanks.
FunctionsofCapitalFunds
Generally,bankcapitalcomprisesofownsourcesofassetfinances.Thevolumeofcapitalisequivalenttothe
netassetsworth,markingthemarginbywhichassetsoutweighliabilities.
Capitalisexpectedtosecureabankfromallsortsofuninsuredandunsecuredriskssuitabletotransforminto
losses.Here,weobtaintwoprinciplefunctionsofcapital.Thefirstfunctionistocapturelossesandthesecondis
toestablishandmaintainconfidenceinabank.
Thedifferentfunctionsofcapitalfundsarebrieflydescribedinthischapter.
TheLossAbsorbingFunction
Capitalisrequiredtopermitabanktocoveranylosseswithitsownfunds.Abankcankeepitsliabilities
completelyenclosedbyassetsaslongasitssumlossesdonotdepleteitscapital.
Anylossessustainedminimizeabankscapital,setoffacrossitsequityproductslikesharecapital,capitalfunds,
profitgeneratedfunds,retainedearnings,relyingonhowitsgeneralassemblydecides.
Bankstakegoodcaretofixtheirinterestmarginsandotherspreadsbetweentheincomederivedfromandthe
priceofborrowedfundstoenclosetheirordinaryexpenses.Thatiswhyoperatinglossesareunlikelytosubside
capitalonalongtermbasis.Wecanalsosaythatbankswithalongandsoundtrackrecordowingtotheirpast
efficiency,havemanagedtoproduceenoughamountofownfundstoeasilycopewithanyoperatinglosses.
Foranewbankwithoutmuchofasuccesshistory,operatinglossesmayconcludedrivingcapitalbelowthe
minimumlevelfixedbylaw.Banksrunaprobableandgreaterriskoflossescomingfromborrowerdefaults,
renderingsomeoftheirassetspartlyorcompletelyirrecoverable.
TheConfidenceFunction
Abankmayhavesufficientassetstobackitsliabilities,andalsoadequatecapitalpowerwhichbalancesdeposits
andotherliabilitiesbyassets.Thisgeneratesafinancialflowintheordinarycourseofbankingbusiness.Here,it
isanimportantnecessitythatabankscapitalcoversitsfixedinvestmentslikefixedassets,involvinginterestsin
subsidiaries.Theseareusedinitsbusinessoperation,whichbasicallygeneratenofinancialflow.
Ifthecashflowgeneratedbyassetsfallsshortofmeetingdepositcallsorotherdueliabilities,itisnotdifficult
forabankwithsufficientcapitalbackingandcredibilitytogetitsmissingliquidityontheinterbankmarket.
Otherbankswillnotfeeluncomfortablelendingtoit,astheyareawareofthecapacitytoconcludeitsliabilities
withitsassets.
Thistypeofbankcanwithstandamajordepositflightandrefinanceitwithinterbankmarketborrowings.In
bankswithasufficientcapitalbase,anyhow,thereisnoreasontofearamassscaledepositorexodus.Thelogic
isthattheissueswhichmaytriggerabankcaptureinthefirstplacedonotcomeinthelimelight.Analternating
patternofliquiditywithlowsandhighsisexpected,withthelatteroccurringattimesofassetfinancialinflow
outstrippingoutflow,wherethebankislikelytolenditsexcessliquidity.
Banksarerestrictednottocountontheinterbankmarkettoclarifyalltheirissues.Intheirowninterestandas
expectedbybankregulators,theyexpecttomatchtheirassetsandliabilitymaturities,somethingthatpermits
themtosailthroughstressfulmarketsituations.
MarketratescouldbeaffectedduetotheinterventionofCentralBank.Therecanbemanyfactorscontributing
toitlikethechangeinmonetarypolicyorotherfactors.Thiscouldleadtoanincreaseinmarketratesorthe
marketmaycollapse.Dependinguponthemarketproblemthebanksmayhavetocutdowntheclientlines.
TheFinancingFunction
Asdepositsareunfitforthepurpose,itisuptocapitaltoprovidefundstofinancefixedinvestments[Math
ProcessingError].Thisparticularfunctionisapparentwhenabankstartsup,whenmoneyraisedfrom
subscribingshareholdersisusedtobuybuildings,landandequipment.Itisdesirabletohavepermanentcapital
coverageforfixedassets.Thatmeansanyadditionalinvestmentsinfixedassetsshouldcoincidewithacapital
rise.
Duringabankslife,itgeneratesnewcapitalfromitsprofits.Profitsnotdistributedtoshareholdersareallocated
toothercomponentsofshareholdersequity,resultinginapermanentincrease.Capitalgrowthisasourceof
additionalfundsusedtofinancenewassets.Itcanbuynewfixedassets,loansorothertransactions.Itisgood
forabanktoplacesomeofitscapitalinproductiveassets,asanyincomeearnedonselffinancedassetsisfree
fromthecostofborrowedfunds.Ifabankhappenstoneedmorenewcapitalthanitcanproduceitself,itcan
eitherissuenewsharesortakeasubordinateddebt,bothanoutsidesourceofcapital.
TheRestrictiveFunction
Capitalisawidelyusedreferenceforlimitsonvarioustypesofassetsandbankingtransactions.Theobjectiveis
topreventbanksfromtakingtoomanychances.Thecapitaladequacyratio,asthemainlimit,measurescapital
againstriskweightedassets.
Dependingontheirrespectiverelativerisks,thevalueofassetsismultipliedbyweightsrangingfrom0to20,50
and100%.Weusethenetbookvaluehere,reflectinganyadjustments,reservesandprovisions.Asaresult,the
totalofassetsisadjustedforanydevaluationcausedbyloandefaults,fixedassetdepreciationandmarketprice
declines,astheamountofcapitalhasalreadyfallenduetoexpensesincurredinprovidingforidentifiedrisks.
Thatexposescapitaltopotentialrisks,whichcanleadtofuturelossesifabankfailstorecoveritsassets.
Theminimumrequiredratioofcapitaltoriskweightedassetsis8percent.Undertheapplicablecapital
adequacydecree,capitalisadjustedforuncoveredlossesandexcessreserves,lessspecificdeductibleitems.To
alimitedextent,subordinateddebtisalsoincludedincapital.Thedecreealsoreflectstheriskscontainedinoff
balancesheetliabilities.
Intherestrictivefunctioncontext,itisthekeyimportanceofcapitalandtheprecisedeterminationofitsamount
incapitaladequacycalculationsthatmakeitagoodbaseforlimitationsoncreditexposureandunsecured
foreignexchangepositionsinbanks.Themostimportantcreditexposurelimitsrestrictabanksnetcredit
exposure[MathProcessingError]againstasinglecustomeroragroupofrelatedcustomersat25%ofthe
reportingbankscapital,orat125%ifagainstabankbasedinSlovakiaoranOECDcountry.Thisshouldensure
anappropriateloanportfoliodiversification.
Thedecreeonunsecuredforeignexchangepositionsseekstolimittheriskscausedbyexchangeratefluctuations
intransactionsinvolvingforeigncurrencies,cappingunsecuredforeignexchangepositions[MathProcessing
Error]inEURat15%ofabankscapital,or10%ifinanyothercurrency.Thetotalunsecuredforeignexchange
position[MathProcessingError]mustnotexceed25%ofabankscapital.
Thedecreedealingwithliquidityrulesincorporatesthealreadydiscussedprinciplethatassets,whichareusually
notpaidinbankingactivities,needtobecoveredbycapital.Itrequiresthattheratioofthesumoffixed
investments[MathProcessingError]andilliquidassets[MathProcessingError]toabanksownfundsand
reservesnotexceed1.
Owingtoitsimportance,capitalhasbecomeacentralpointintheworldofbanking.Inleadingworldbanks,its
shareintotalassets/liabilitiesmovesbetween2.5and8%.Thisseeminglylowlevelisgenerallyconsidered
sufficientforasoundbankingoperation.Abletooperateatthelowerendoftherangearelargebankswitha
qualityandwelldiversifiedassetportfolio.
Capitaladequacydeservesconstantattention.Assetgrowthneedstorespecttheamountofcapital.Eventually,
anyproblemsabankmaybefacingwillshowonitscapital.Incommercialbanking,capitalistheking.
BankManagementBasleNorms
ThefoundationoftheBaselbankingnormsisattributedtotheincorporationoftheBaselCommitteeonBanking
Supervision[MathProcessingError],establishedbythecentralbankoftheG10countriesin1974.Thiswas
underthesponsorshipofBankforInternationalSettlements[MathProcessingError],Basel,Switzerland.
TheCommitteeformsguidelinesandprovidesrecommendationsonbankingregulationonthebasisofcapital
risk,marketriskandoperationalrisk.TheCommitteewasestablishedinresponsetothechaoticliquidationof
HerstattBank,basedinCologne,Germanyin1974.Theincidentdemonstratedtheexistenceofsettlementrisk
ininternationalfinance.
Later,thiscommitteewasrenamedasBaselCommitteeonBankingSupervision.TheCommitteeactsasaforum
whereregularcollaborationconcerningbankingregulationsandsupervisorypracticesbetweenthemember
countriestakesplace.TheCommitteetargetsatdevelopingsupervisoryknowhowandthequalityofbanking
supervisionqualityworldwide.
Presently,thereare27membercountriesintheCommitteesince2009.Thesemembercountriesarebeing
representedintheCommitteebythecentralbankandtheauthorityfortheprudentialsupervisionofbanking
business.Apartfrombankingregulationsandsupervisorypractices,theCommitteealsostressesonclosingthe
differencesininternationalsupervisorycoverage.
BasleI
In1988,theBaselCommitteeonBankingSupervision[MathProcessingError]inBasel,Switzerland,
announcedthefirstsetofminimumcapitalrequirementsforbanksBaselI.Itcompletelyaimedoncreditrisk
orthedefaultrisk.Thatistheriskofcounterpartyfailure.Itstatedcapitalneedandstructureofriskweightsfor
banks.
Underthesenormsassetsofbankswerecategorizedandgroupedintofivecategoriesaccordingtocreditrisk,
carryingriskweightsof0%likeCash,Bullion,HomeCountryDebtLikeTreasuries,10,20,50and100%and
norating.Bankswithaninternationalpresencewereexpectedtoholdcapitalequalto8%oftheirriskweighted
assets[MathProcessingError].Thesebanksmusthaveatleast4%inTierICapitalthatisEquityCapital+
retainedearningsandmorethan8%inTierIandTierIICapital.Thetargetwassettobeachievedby1992.
OneofthemajorfunctionsofBaselnormsistostandardizethebankingpracticeacrossallcountries.Anyhow,
therearemajorproblemswithdefinitionofCapitalandDifferentialRiskWeightstoAssetsacrosscountries,like
Baselstandardsarecomputedonthebasisofbookvalueaccountingmeasuresofcapital,notmarketvalues.
AccountingpracticesvaryextremelyacrosstheG10countriesandmostlyyieldoutcomesthatdiffermarkedly
frommarketassessments.
Anothermajorissuewasthattheriskweightsdonotattempttotakeaccountofrisksotherthancreditrisks,like
marketrisks,liquidityrisksandoperationalrisksthatmaybecriticalsourcesofinsolvencyexposureforbanks.
BasleII
BaselIIwasintroducedin2004.Itspeculatedguidelinesforcapitaladequacythatiswithmorerefined
definitions,riskmanagementlikeMarketRiskandOperationalRiskandexposureneeds.Italsoexpressedthe
useofexternalratingsagenciestofixtheriskweightsforcorporate,bankandsovereignclaims.
Operationalriskisdefinedastheriskofdirectandindirectlossesresultingfrominadequateorfailedinternal
processes,peopleandsystemsorfromexternalevents.Thiscomprisesoflegalrisk,butprohibitsstrategicand
reputationrisk.Thereby,legalriskinvolvesexposurestofines,penalties,orpunitivedamagesasaresultof
supervisoryactionsinadditiontoprivateagreements.Therearecomplexmethodstoappraisethisrisk.
Theexposureneedspermitparticipantsofmarkettoevaluatethecapitaladequacyofthefoundationonthebasis
ofinformationonthescopeofapplication,capital,riskexposures,riskassessmentprocesses,etc.
BasleIII
ItisbelievedthattheshortcomingsoftheBaselIInormsresultedintheglobalfinancialcrisisof2008.Thatis
duetothefactthatBaselIInormsdidnothaveanyexplicitregulationonthedebtthatbankscouldtakeontheir
books,andstressedmoreonindividualfinancialinstitutions,whileneglectingsystemicrisks.
Toassurethatbanksdonttakeonexcessivedebt,andthattheydontdependtoomuchonshorttermfunds,
BaselIIInormswereintroducedin2010.Themainobjectivebehindtheseguidelinesweretopromoteamore
resilientbankingsystembystressingonfourvitalbankingparameterscapital,leverage,fundingand
liquidity.
NeedsformutualequityandTier1capitalwillbe4.5%and6%,respectively.Theliquiditycoverageratio
[MathProcessingError]requiresthebankstoacquireabufferofhighqualityliquidassetsenoughtocopewith
thecashoutflowsencounteredinanacuteshorttermstressscenarioasspecifiedbythesupervisors.The
minimumLCRneedwillbetomeet100%on1January2019.ThisistosecuresituationslikeBankRun.The
termleverageRatio>3%denotesthattheleverageratiowascalculatedbydividingTier1capitalbythebank's
averagetotalcombinedassets.
BankManagementCredit
Creditmanagementistheprocessofmonitoringandcollectingpaymentsfromcustomers.Agoodcredit
managementsystemminimizestheamountofcapitaltiedupwithdebtors.
Itisveryimportanttohavegoodcreditmanagementforefficientcashflow.Thereareinstanceswhenaplan
seemstobeprofitablewhenassumedtheoreticallybutpracticalexecutionisnotpossibleduetoinsufficient
funds.Inordertoavoidsuchsituations,thebestalternativeistolimitthelikelihoodofbaddebts.Thiscanonly
beachievedthroughgoodcreditmanagementpractices.
Forrunningaprofitablebusinessinanenterprisetheentrepreneurneedstoprepareanddesignnewpoliciesand
proceduresforcreditmanagement.Forexample,thetermsandconditions,invoicingpromptlyandthe
controllingdebts.
PrinciplesofCreditManagement
Creditmanagementplaysavitalroleinthebankingsector.Asweallknowbankisoneofthemajorsourceof
lendingcapital.So,Banksfollowthefollowingprinciplesforlendingcapital
Liquidity
Liquidityplaysamajorrolewhenabankisintolendingmoney.Usually,banksgivemoneyforshortdurationof
time.Thisisbecausethemoneytheylendispublicmoney.Thismoneycanbewithdrawnbythedepositorat
anypointoftime.
So,toavoidthischaos,bankslendloansaftertheloanseekerproducesenoughsecurityofassetswhichcanbe
easilymarketableandtransformabletocashinashortperiodoftime.Abankisinpossessiontotakeoverthese
producedassetsiftheborrowerfailstorepaytheloanamountaftersomeintervaloftimeasdecided
Abankhasitsownselectioncriteriaforchoosingsecurity.Onlythosesecuritieswhichacquiresenoughliquidity
areaddedinthebanksinvestmentportfolio.Thisisimportantasthebankrequiresfundstomeettheurgent
needsofitscustomersordepositors.Thebankshouldbeinaconditiontosellsomeofthesecuritiesatavery
shortnoticewithoutcreatinganimpactontheirmarketratesmuch.Thereareparticularsecuritiessuchasthe
central,stateandlocalgovernmentagreementswhichareeasilysaleablewithouthavinganyimpactontheir
marketrates.
Sharesanddebenturesoflargeindustriesarealsoaddressedunderthiscategory.Butthesharesanddebentures
ofordinaryindustriesarenoteasilymarketablewithouthavingafallintheirmarketrates.Therefore,banks
shouldalwaysmakeinvestmentsingovernmentsecuritiesandsharesanddebenturesofreputedindustrial
houses.
Safety
Thesecondmostimportantfunctionoflendingissafety,safetyoffundslent.Safetymeansthattheborrower
shouldbeinapositiontorepaytheloanandinterestatregulardurationsoftimewithoutanyfail.Therepayment
oftheloanreliesonthenatureofsecurityandthepotentialoftheborrowertorepaytheloan.
Unlikeallotherinvestments,bankinvestmentsareriskprone.Theintensityofriskdiffersaccordingtothetype
ofsecurity.Securitiesofthecentralgovernmentaresaferwhencomparedtothesecuritiesofthestate
governmentsandlocalbodies.Similarly,thesecuritiesofstategovernmentandlocalbodiesaremuchsafer
whencomparedtothesecuritiesofindustrialconcerns.
Thisvariationisduetothefactthattheresourcesacquiredbythecentralgovernmentaremuchhigheras
comparedtoresourcedheldbythestateandlocalgovernments.Itisalsohigherthantheindustrialconcerns.
Also,theshareanddebenturesofindustrialconcernsareboundtotheirearnings.Incomevariesaccordingtothe
businessactivitiesheldinacountry.Thebankshouldalsoconsidertheabilityofthedebtortorepaythedebtof
thegovernmentswhileinvestingintheirsecurities.Theprerequisitesforthisarepoliticalstabilityandpeaceand
securitywithinthecountry.
Securitiesofagovernmentacquiringlargetaxrevenueandhighborrowingcapacityareconsideredassafe
investments.Thesamegoeswiththesecuritiesofarichmunicipalityorlocalbodyandstategovernmentofa
flourishingarea.Thus,whilemakinganysortofinvestments,banksshoulddecidesecurities,sharesand
debenturesofsuchgovernments,localbodiesandindustrialconcernswhichmeetstheprincipleofsafety.
Therefore,fromthebankswayofperceiving,thenatureofsecurityisveryessentialwhilelendingaloan.Even
afterconsideringthesecurities,thebankneedstocheckthecreditworthinessoftheborrowerwhichismonitored
byhischaracter,capacitytorepay,andhisfinancialstanding.Aboveall,thesafetyofbankfundsreliesonthe
technicalfeasibilityandeconomicviabilityoftheprojectforwhichtheloanistobegiven.
Diversity
Whileselectinganinvestmentportfolio,acommercialbankshouldabidebytheprincipleofdiversity.Itshould
neverinvestitstotalfundsinaspecifictypeofsecurities,itshouldpreferinvestingindifferenttypesof
securities.
Itshouldselectthesharesanddebenturesofvariousindustrieslocatedindifferentpartsofthecountry.Incaseof
stategovernmentsandlocalgoverningbodies,sameprincipleshouldbeabidedto.Diversificationbasically
targetsatreducingriskoftheinvestmentportfolioofabank.
Theprincipleofdiversityisapplicabletotheadvancingofloanstodifferenttypesoffirms,industries,factories,
businessesandmarkets.AbankshouldabidebythemaximthatisDonotkeepalleggsinonebasket.It
shoulddistributeitsrisksbylendingloanstodifferenttradesandcompaniesindifferentpartsofthecountry.
Stability
Anotheressentialprincipleofabanksinvestmentpolicyisstability.Abankshouldpreferinvestinginthose
stocksandsecuritieswhichholdahighdegreeofstabilityintheircosts.Anybankcannotincuranylossonthe
rateofitssecurities.Soitshouldalwaysinvestfundsinthesharesofbrandedcompanieswheretheprobability
ofdeclineintheirrateisless.
Governmentcontractsanddebenturesofindustriescarryfixedcostsofinterest.Theircostvarieswithvariation
inthemarketrateofinterest.Butthebankisboundtoliquidateapartofthemtosatisfyitsneedsofcash
wheneverstuckbyafinancialcrisis.
Else,theyfollowtheirfulltermof10yearsormoreandvariationsinthemarketrateofinterestdonotdisturb
them.So,bankinvestmentsindebenturesandcontractsaremorestablewhencomparedtothesharesof
industries.
Profitability
Thisshouldbethechiefprincipleofinvestment.Abankshouldonlyinvestifitearnssufficientprofitsfromit.
Thus,itshould,investinsecuritiesthathaveafairandstablereturnonthefundsinvested.Theprocuring
capacityofsecuritiesandsharesreliesontheinterestrateandthedividendrateandthetaxbenefitstheyhold.
Broadly,itisthesecuritiesofgovernmentbrancheslikethegovernmentatthecenter,stateandlocalbodiesthat
hugelycarrytheexceptionoftheirinterestfromtaxes.Abankshouldpreferinvestinginthesetypeofsecurities
insteadofinvestinginthesharesofnewcompanieswhichalsocarrytaxexception.Thisisduetothefactthat
sharesofnewcompaniesarenotconsideredassafeinvestments.
Nowlendingmoneytosomeoneisaccompaniedbysomerisksmainly.Asweknowthatbanklendsthemoney
ofitsdepositorsasloans.Toputitsimplythemainjobofabankistorentmoneyfromdepositorsandgive
moneytotheborrowers.Astheprimarysourceoffundsforabankisthemoneydepositedbyitscustomers
whicharerepayableasandwhenrequiredbythedepositors,thebankneedstobeverycarefulwhilelending
moneytocustomers.
Banksmakemoneybylendingmoneytoborrowersandchargingsomeinterestrates.So,itisveryessential
fromthebanksparttofollowthecardinalprinciplesoflending.Whentheseprinciplesareabided,theyassure
thesafetyofbanksfundsandinresponsetothattheyassureitsdepositorsandshareholders.Inthiswhole
process,banksearngoodprofitsandgrowasfinancialinstitutions.Soundlendingprinciplesbybanksalsohelp
theeconomyofanationtoprosperandalsoadvertiseexpansionofbanksinruralareas.
BankManagementFormulatingLoanPolicy
Basically,loanportfolioshavethelargesteffectonthetotalriskprofileandearningsperformance.Thisearning
performancecomprisesofvariousfactorslikeinterestincome,fees,provisions,andotherfactorsofcommercial
banks.
Themediocreloanportfoliomarksapproximately62.5percentoftotalcentralizedassetsforbanking
organizationswithlessthan[MathProcessingError]10billionintotalassets.
Inordertolimitcreditrisk,itiscompulsorythatsuitableandeffectivepolicies,procedures,andpracticesare
developedandexecuted.Loanpoliciesshouldcoordinatewiththetargetandobjectivesofthebank,inaddition
tosupportingsafeandsoundlendingactivity.
Policiesandproceduresshouldbepresentedasalayoutforallmajorcreditdecisionsandactions,enclosingall
materialaspectsofcreditrisk,andmirroringthecomplexityoftheactivitiesinwhichabankisengaged.
PolicyDevelopment
Asweknowrisksareinevitable,bankscanlightencreditriskbydevelopmentofandcohesiontoefficientand
effectiveloanpoliciesandprocedures.Awelldocumentedanddescriptiveloanpolicyprovestobethe
milestoneofanysoundlendingfunction.
Ultimately,abanksboardofdirectorsisaccountableforflayingoutthestructureoftheloanpoliciestoaddress
theinherentandresidualrisks.Residualrisksarethoserisksthatremainevenaftersoundinternalcontrolshave
beenexecutedinthelendingbusinesslines.
Afterformulatingthepolicy,seniormanagementisheldaccountableforitsexecutionandongoingmonitoring,
accompaniedbythemaintenanceofprocedurestoassuretheyareuptodateandcompatibletothecurrentrisk
profile.
PolicyObjectives
Theloanpolicyshouldclearlycommunicatethestrategicgoalsandobjectivesofthebank,aswellasdefinethe
typesofloanexposuresacceptabletotheinstitution,loanapprovalauthority,loanlimits,loanunderwriting
criteria,andseveralotherguidelines.
Itisimportanttonotethatapolicydiffersfromproceduresinwhichitsetsforththeplan,guidingprinciples,and
frameworkfordecisions.Procedures,ontheotherhand,establishmethodsandstepstoperformtasks.Banks
thatofferawidervarietyofloanproductsand/ormorecomplexproductsshouldconsiderdevelopingseparate
policyandproceduremanualsforloanproducts.
PolicyElements
Theregulatoryagenciesexaminationmanualsandpolicystatementscanbeconsideredasthebestplaceto
beginwhendecidingthekeyelementstobeincorporatedintotheloanpolicy.
Inordertooutlineloanpolicyelements,thebankshouldhaveaconsistentlendingstrategy,identifyingthetypes
ofloansthatarepermissibleandthosethatareimpermissible.Alongwithidentifyingthetypesofloans,the
bankwillandwillnotunderwriteregardlessofpermissibility.Thepolicyelementsshouldalsooutlineother
commonloantypesfoundincommercialbanks.
Themajorpolicyelementsforabankare
Astatementhighlightingthefeaturesofagoodloanportfoliointermsoftypes,maturities,sizes,and
qualityofloans.Inshort,agoalstatementforentireloanportfolio.
Stipulationoflendingauthorityprescribedtoeachloanofficerandloancommittee.Themaintaskofloan
officersandloancommitteeistomeasurethemaximumamountandtypesofloanapprovedbyeach
employeeandcommitteeandwhatsignaturesofapprovalareneeded.
Boundariesofdutyinmakingassignmentsandreportinginformation.
Functioningproceduresforsoliciting,examining,accessingandmakingdecisionsoncustomerloan
applications.
Thedocumentsrequiredforeachloanapplicationandallthenecessarypapersandrecordstobekeptin
thelendersfileslikefinancialstatements,passbookdetails,securityagreements,etc.
Linesofauthorityandaccountabilityformaintaining,monitoring,updatingandreviewingtheinstitutions
creditfiles.
Loanpoliciesvarysignificantlyfromonebanktoanother.Itiscompletelybasedonthecomplexityofthe
activitiestheyareengagedin.Thepolicyelementsofaprivatebankmayslightlydifferfromthegovernment
bank.Anyhow,ageneralloanpolicyincorporatesspecificbasiclendingtenets.
BankMngmtAssetLiability
Assetliabilitymanagementistheprocessthroughwhichanassociationhandlesitsfinancialrisksthatmaycome
withchangesininterestrateandwhichinturnwouldaffecttheliquidityscenario.
Banksandotherfinancialassociationssupplyserviceswhichpresentthemtodifferentkindsofrisks.Wehave
threetypesofriskscreditrisk,interestrisk,andliquidityrisk.So,assetliabilitymanagementisanapproach
orastepthatassuresbanksandotherfinancialinstitutionswithprotectionthathelpsthemmanagetheserisks
efficiently.
Themodelofassetliabilitymanagementhelpstomeasure,examineandmonitorrisks.Itensuresappropriate
strategiesfortheirmanagement.Thus,itissuitableforinstitutionslikebanks,financecompanies,leasing
companies,insurancecompanies,andotherfinancingbodies.
Assetliabilitymanagementisaninitialsteptobetakentowardsthelongtermstrategicplanning.Thiscanalso
beconsideredasanoutliningfunctionforanintermediateterm.
Inparticular,liabilitymanagementalsoreferstotheactivitiesofpurchasingmoneythroughcumulativedeposits,
federalfundsandcommercialpaperssothatthefundsleadtoprofitableloanopportunities.Butwhenthereisan
increaseofvolatilityininterestrates,thereismajorrecessiondamagingmultipleeconomies.Banksbeginto
focusmoreonthemanagementofbothsidesofthebalancesheetthatisassetsaswellasliabilities.
ALMConcepts
Assetliabilitymanagement[MathProcessingError]canbestatedasthecomprehensiveanddynamiclayoutfor
measuring,examining,analyzing,monitoringandmanagingthefinancialriskslinkedwithvaryinginterestrates,
foreignexchangeratesandotherelementsthatcanhaveanimpactontheorganizationsliquidity.
Assetliabilitymanagementisastrategicapproachofmanagingthebalancesheetinsuchawaythatthetotal
earningsfrominterestaremaximizedwithintheoverallriskpreference[MathProcessingError]ofthe
institutions.
Thus,theALMfunctionsincludethetoolsadoptedtomitigateliquidlyrisk,managementofinterestraterisk/
marketriskandtradingriskmanagement.Inshort,ALMisthesumofthefinancialriskmanagementofany
financialinstitution.
Inotherwords,ALMhandlesthefollowingthreecentralrisks
InterestRateRisk
LiquidityRisk
Foreigncurrencyrisk
Bankswhichfacilitateforexfunctionsalsohandlesonemorecentralriskcurrencyrisk.Withthesupportof
ALM,bankstrytomeettheassetsandliabilitiesintermsofmaturitiesandinterestratesandreducetheinterest
rateriskandliquidityrisk.
AssetliabilitymismatchesThebalancesheetofabanksassetsandliabilitiesarethefuturecashinflows&
outflows.Underassetliabilitymanagement,thecashinflows&outflowsaregroupedintodifferenttime
buckets.Further,eachbucketofassetsisbalancedwiththematchingbucketofliability.Thedifferences
obtainedineachbucketareknownasmismatches.
BankManagementEvolutionOfALM
Therewasnosignificantinterestrateriskduringthe1970stoearly1990speriod.Thisisbecausetheinterest
rateswereformulatedandrecommendedbytheRBI.Thespreadsbetweendepositsandlendingrateswerevery
wide.
Inthosedays,banksdidnthandlethebalancesheetsbythemselves.Themainreasonbehindthiswas,the
balancesheetsweremanagedthroughprescriptionsoftheregulatoryauthorityandthegovernment.Bankswere
givenalotofspaceandfreedomtohandletheirbalancesheetswiththederegulationofinterestrates.So,itwas
importanttolaunchALMguidelinessothatbankscanremainsafefrombiglossesduetowideALM
mismatches.
TheReserveBankofIndiaannounceditsfirstsetofALMGuidelinesinFebruary1999.Theseguidelineswere
effectivefrom1stApril,1999.Theseguidelinesenclosed,interalia,interestrateriskandliquidityrisk
measurement,broadcastinglayoutandprudentiallimits.Gapstatementswerenecessarytobemadeby
schedulingallassetsandliabilitiesaccordingtothestatedoranticipatedrepricingdateormaturitydate.
Atthisstagetheassetsandliabilitieswereenforcedtobedividedintothefollowing8maturitybuckets
114days
1528days
2990days
91180days
181365days
13years
35years
andabove5years
Onthebasisoftheremainingintervalstotheirmaturitywhicharealsoreferredasresidualmaturity,allthe
liabilityrecordsweretobestudiedasoutflowswhiletheassetrecordsweretobestudiedasinflows.
Asameasureofliquiditymanagement,bankswereenforcedtocontroltheircumulativemismatchesbeyondall
timebucketsintheirstatementofstructuralliquiditybybuildinginternalprudentiallimitswiththeconsentof
theirboards/managementcommittees.
Accordingtotheprescribedguidelines,inthenormalcourse,themismatchesalsoknownasthenegativegapin
thetimebucketsof114daysand1528dayswerenottocross20percentofthecashoutflowswithrespectto
thetimebuckets.
Later,theRBImadeitcompulsoryforbankstoformALCO,thatis,theAssetLiabilityCommitteeasa
CommitteeoftheBoardofDirectorstotrack,control,monitorandreportALM.
ThiswasinSeptember2007,inresponsetotheinternationalexercisesandtosatisfytherequirementfora
sharperevaluationoftheefficacyofliquiditymanagementandwithaviewtosupplyingastimulusfor
improvementofthetermmoneymarket.
TheRBIfinetunedtheseregulationsanditwasensuredthatthebanksshallacceptamoregranularstrategyfor
themeasurementofliquidityriskbydividingthefirsttimebucketthatisof114dayscurrentlyintheStatement
ofStructuralLiquidityintothreetimebuckets.Theyare1dayaddressednextday,27daysand814days.
Hence,banksweredemandedtoputtheirmaturingassetandliabilitiesin10timebuckets.
AccordingtotheRBIguidelinesannouncedinOctober2007,bankswererecommendedthatthetotal
cumulativenegativemismatchesduringthenextday,27days,814daysand1528daysshouldnotcross5%,
10%,15%and20%ofthecumulativeoutflows,respectively,inordertoaddressthecumulativeeffecton
liquidity.
Bankswerealsorecommendedtoattemptdynamicliquiditymanagementanddesignthestatementofstructural
liquidityonaregularbasis.Intheabsenceofafullynetworkedenvironment,bankswerepermittedtoassemble
thestatementonbestpresentdatacoverageoriginallybutwereadvisedtomakecarefulattemptstoattain100
percentdatacoverageinatimelymanner.
Inthesamemanner,thestatementofstructuralliquiditywastobepresentedtotheRBIatregularintervalsof
onemonth,asonthethirdWednesdayofeverymonth.Thefrequencyofsupervisoryreportingonthestructural
liquiditystatuswaschangedtofortnightly,witheffectfromApril1,2008.Thebanksareexpectedto
acknowledgethestatementofstructuralliquidityasonthefirstandthirdWednesdayofeverymonthtothe
ReserveBank.
BoardsoftheBankswereallocatedwiththecompletedutyofthemanagementofrisksandwereneededto
concludetheriskmanagementpolicyandsetlimitsforliquidity,interestrates,foreignexchangeandequity
pricerisks.
TheAssetLiabilityCommittee[MathProcessingError]isoneofthetopmostcommitteestooverlookthe
executionofALMsystem.ThiscommitteeisledbytheCMD/ED.ALCOalsoacknowledgesproductpricing
forthedepositsaswellastheadvances.Theexpectedmaturityprofileoftheincrementalassetsandliabilities
alongwithcontrolling,monitoringtherisklevelsofthebank.Itneedstomandatethecurrentinterestratesview
ofthebankandbaseitsdecisionsforfuturebusinessstrategyonthisview.
TheALMProcess
TheALMprocessrestsonthefollowingthreepillars
ALMinformationsystems
ManagementInformationSystem
Informationavailability,accuracy,adequacyandexpediency
Itcomprisesoffunctionslikeidentifyingtheriskparameters,identifyingtherisk,riskmeasurementandRisk
managementandlayingoutofRiskpoliciesandtolerancelevels.
ALMinformationsystems
ThekeytotheALMprocessisinformation.Thelargenetworkofbranchesandtheunavailabilityanadequate
systemtocollectinformationnecessaryforALM,whichexaminesinformationonthebasisofresidualmaturity
andbehavioralpatternmakesittimeconsumingforthebanksinthecurrentstatetoprocurethenecessary
information.
Measuringandhandlingliquidityrequirementsareimportantpracticesofcommercialbanks.Bypersuadinga
banksabilitytosatisfyitsliabilitiesastheybecomedue,theliquiditymanagementcanminimizetheprobability
ofanadversesituationdeveloping.
TheImportanceofLiquidity
Liquiditygobeyondindividualfoundations,asliquidityshortfallinonefoundationcanhavebacklashonthe
completesystem.Bankmanagementshouldnotonlyportiontheliquiditydesignationsofbanksonanongoing
basisbutalsoanalyzehowliquiditydemandsarelikelytoevolveundercrisisscenarios.
PastexperiencedisplaysthatassetscommonlyassumedasliquidlikeGovernmentsecuritiesandothermoney
markettoolscouldalsobecomeilliquidwhenthemarketandplayersareUnidirectional.Thusliquidityhastobe
chasedthroughmaturityorcashflowmismatches.
BankManagementRisksWithAssets
Riskshaveanegativeeffectonabanksfutureearnings,savingsandonthemarketvalueofitsfairnessbecause
ofthechangesininterestrates.Handlingassetsinvitesdifferenttypesofrisks.Riskscannotbeavoidedor
neglectedinbankmanagement.Thebankhastoanalyzethetypeofriskandnecessarystepsneedtobetaken.
Withrespecttoassets,riskscanfurtherbecategorizedintothefollowing
CurrencyRisk
Floatingexchangeratearrangementhasbroughtinitswakepronouncedvolatilityaddinganewdimensionto
theriskprofileofbanksbalancesheets.Theincreasedcapitalflowsacrossfreeeconomiesfollowing
deregulationhavecontributedtoanincreaseinthevolumeoftransactions.
Largecrossborderflowstogetherwiththevolatilityhasrenderedthebanksbalancesheetsvulnerableto
exchangeratemovements.
DealinginDifferentCurrencies
Itbringsopportunitiesasalsorisks.Iftheliabilitiesinonecurrencyexceedthelevelofassetsinthesame
currency,thenthecurrencymismatchcanaddvalueorerodevaluedependinguponthecurrencymovements.
Thesimplestwaytoavoidcurrencyriskistoensurethatmismatches,ifany,arereducedtozeroornearzero.
Banksundertakeoperationsinforeignexchangelikeacceptingdeposits,makingloansandadvancesandquoting
pricesforforeignexchangetransactions.Irrespectiveofthestrategiesadopted,itmaynotbepossibleto
eliminatecurrencymismatchesaltogether.Besides,someoftheinstitutionsmaytakeproprietarytrading
positionsasaconsciousbusinessstrategy.ManagingCurrencyRiskisonemoredimensionofAssetLiability
Management.
Mismatchedcurrencypositionbesidesexposingthebalancesheettomovementsinexchangeratealsoexposesit
tocountryriskandsettlementrisk.EversincetheRBI[MathProcessingError]introducedtheconceptofend
ofthedaynearsquarepositionin1978,bankshavebeensettingupovernightlimitsandselectivelyundertaking
activedaytimetrading.
InterestRateRisk[MathProcessingError]
Thephasedderegulationofinterestratesandtheoperationalflexibilitygiventobanksinpricingmostofthe
assetsandliabilitieshaveexposedthebankingsystemtoInterestRateRisk.
Interestrateriskistheriskwherechangesinmarketinterestratesmightadverselyaffectabanksfinancial
condition.Changesininterestratesaffectboththecurrentearnings[MathProcessingError]asalsothenet
worthofthebank[MathProcessingError].Theriskfromtheearningsperspectivecanbemeasuredaschanges
intheNetInterestIncome[MathProcessingError]orNetInterestMargin[MathProcessingError].
Therefore,ALMisaregularprocessandaneverydayaffair.Thisneedstobehandledcarefullyandpreventive
stepsneedtobetakentolightentheissuesrelatedtoit.Itmayleadtoirreparableharmtothebanksonregards
ofliquidity,profitabilityandsolvency,ifnotcontrolledproperly.
RiskMeasurementTechniques
Inordertodealwiththedifferenttypesofrisksinvolvedinthemanagementofassetsandliabilities,weneedto
managetherisksforefficientbankmanagement.Therearevarioustechniquesusedformeasuringdisclosureof
bankstointerestraterisks
GapAnalysisModel
Thegapanalysismodelportionstheflowandlevelofassetliabilitymismatchthrougheitherfundingormaturity
gap.Itiscalculatedforassetsandliabilitiesofvaryingmaturitiesandisderivedforasettimehorizon.This
modelchecksontherepricinggapthatispresentinthemiddleoftheinterestrevenueearnedonthebank's
assetsandtheinterestpaidonitsliabilitieswithinamentionedintervaloftime.
GapAnalysis
Thismodelrepresentsthetotalinterestincomedisclosureofthebank,tovariationsoccurringintheinterestrates
indifferentmaturitybuckets.Repricinggapsareestimatedforassetsandliabilitiesofvaryingmaturities.
Apositivegapreflectsthatassetsarerepricedbeforeliabilities.Meanwhile,anegativegapreflectsthat
liabilitiesneedtoberepricedbeforeassets.Thebankmonitorstheratesensitivitythatisthetimethebank
managerwillhavetowaitsothatthereisavariationinthepostedratesonanyassetorliabilityofeveryasset
andliabilityonthebalancesheet.
Thegeneralformulathatisusedisasfollows
NII=RiGAPi
Intheaboveformula
NIIisthetotalinterestincome.
Ristheinterestratesinfluencingassetsandliabilitiesintherelevantmaturitybucket.
GAPisthedifferencebetweenthebookvalueoftheratesensitiveassetsandtheratesensitiveliabilities.
Hence,whenthereisavariationintheinterestrate,wecaneasilyanalyzetheinfluenceofthevariationonthe
totalinterestincomeofthebank.Achangeininterestratehasdirectimpactontheirmarketvalue.
Themaindrawbackofthismodelisthatthismethodconsidersonlythebookvalueofassetsandliabilitiesand
thusneglectstheirmarketvalue.So,thismethodisanincompletemeasureofthetrueinterestrateexposureofa
bank.
DurationModel
Durationorintervalisacriticalmeasurefortheinterestratesensitivityofassetsandliabilities.Thisisduetothe
factthatitconsidersthetimeofarrivalofcashflowsandthematurityofassetsandliabilities.Itisthemeasured
averagetimetomaturityofallthepresetvaluesofcashflows.Thismodelstatestheaveragelifeoftheassetor
theliability.Itisdenotedbythefollowingformula
DPp=D[MathProcessingError]
Theaboveequationbriefsthepercentagefallinpriceoftheagreementforagivenincreaseinthenecessary
interestratesoryields.Thelargerthevalueoftheinterval,themoresensitiveisthecostofthatassetorliability
tovariationsininterestrates.
Accordingtotheaboveequation,thebankwillbeprotectedfrominterestrateriskifthedurationgapbetween
assetsandtheliabilitiesiszero.Themajoradvantageofthismodelisthatitusesthemarketvalueofassetsand
liabilities.
SimulationModel
Thismodelassistsinintroducingadynamicelementintheexaminationofinterestraterisk.Theprevious
modelstheGapanalysisandthedurationanalysisforassetliabilitymanagementendurefromtheir
inefficiencytomoveacrossthestaticanalysisofcurrentinterestrateriskexposures.Inshort,thesimulation
modelsusecomputerpowertosupportwhatifscenarios.Forexample,
Whatif
thetotallevelofinterestratesswitches
marketingplansareunderachievedoroverachieved
balancesheetsshrinkorexpand
Thisdevelopstheinformationavailableformanagementintermsofpreciseassessmentofcurrentexposuresof
assetandliability,portfoliostointerestraterisk,variationsindistributivetargetvariableslikethetotalinterest
incomecapitaladequacy,andliquidityaswellasthefuturegaps.
Therearepossibilitiesthatthissimulationmodelpreventstheusetoseeallthecomplexpaperworkbecauseof
thenatureofmassivepaperresults.Inthistypeofcondition,itisveryimportanttomergethetechnicalexpertise
withproperawarenessofissuesintheenterprise.
Thereareparticulardemandsforasimulationmodeltogrow.Theserefertoaccuracyofdataandreliabilityof
theassumptionsorhypothesismade.Insimplewords,oneshouldbeinastatustolookatsubstitutesreferringto
interestrates,growthratedistributions,reinvestments,etc.,underdifferentinterestratescenes.Thismaybe
difficultandsometimescontentious.
Animportantpointtonotehereisthatthebankmanagersmaynotwishtodocumenttheirassumptionsanddata
isreadilyavailablefordifferentialcollisionofinterestratesonmultiplevariables.Thus,thismodelneedstobe
appliedcarefully,especiallyintheIndianbankingsystem.
Theapplicationofsimulationmodelsaddressesthecommitmentofsubstantialamountoftimeandresources.If
incase,onecantaffordthecostor,moreimportantlythetimeengagedinsimulationmodeling,itmakesperfect
sensetosticktosimplertypesofanalysis.
BankManagementMarketing
Bankmarketingisknownforitsnatureofdevelopingauniquebrandimage,whichistreatedasthecapital
reputationofthefinancialacademy.Itisveryimportantforabanktodevelopgoodrelationshipwithvalued
customersaccompaniedbyinnovativeideaswhichcanbeusedasmeasurestomeettheirrequirements.
Customersexpectqualityservicesandreturns.Therearegoodchancesthatthequalityfactorwillbethesole
determinantofsuccessfulbankingcorporations.Therefore,Indianbanksneedtoacknowledgetheimperativeof
proactiveBankMarketingandCustomerRelationshipManagementandalsotakesystematicstepsinthis
direction.
MarketingApproach
Thebankingindustryprovidesdifferenttypesofbankingandalliedservicestoitsclients.Bankcustomersare
mostlypeopleandenterprisesthathavesurplusorlackoffundsandthosewhorequirevarioustypesoffinancial
andrelatedservices.Thesecustomersarefromdifferentstrataoftheeconomy,theybelongtodifferent
geographicalregions,areasandareintodifferentprofessionsandbusinesses.
Itisquitenaturalfortherequirementofeachindividualgroupofcustomerstobeuniquefromtherequirements
ofothergroups.Thus,itisimportanttoacknowledgedistincthomogenousgroupsandevensubgroupsof
customers,andthenwithmaximumprecisionconcludetheirrequirements,designschemestosuittheir
particularrequirements,anddeliverthemmostefficiently.
Basically,banksengageintransactionofproductsandservicesthroughtheirretailoutletsknownasbranchesto
differentcustomersatthegrassrootslevel.Thisisreferredasthetoptobottomapproach.
Itshouldbebottomtotopapproachwithcustomersatthegrassrootslevelasthetargetpointtoworkoutwith
differentproductsorschemestomatchtherequirementsofvarioushomogenousgroupsofcustomers.Hence,
bankmarketingapproach,isconsideredasagrouporcollectiveapproach.
Bankmanagementasacollectiveapproachoraselectiveapproachisafundamentalidentificationofthefact
thatbanksneedcustomerorientedapproach.Insimplewords,bankmarketingisthedesignstructure,layoutand
deliveryofcustomerneededservicesworkedoutbycheckingoutthecorporateobjectivesofthebankand
environmentalconstraints.
BankManagementRelationshipBanking
Relationshipbankingcanbedefinedasaprocessthatincludesproactivelypredictingthedemandsofindividual
bankcustomersandtakingstepstomeetthesedemandsbeforetheclientshowsthem.Thebasicconceptofthis
approachistodevelopandbuildamorecomprehensiveworkingrelationshipwitheachandeveryclient,
examininghisorherindividualsituation,andmakingrecommendationsfordifferentservicesofferedbythe
banktohelpdevelopthefinancialwellbeingofthecustomer.
Thisapproachismostlylinkedwithsmallerbanksthatuseamorepersonalapproachwithcustomers,even
thoughanincreasingnumberoflargebankcorporationsarebeginningtomotivatesimilarstrategiesintheir
localbranches.
RelationshipBanking
Atthebaseofrelationshipbankingisthethoughtthatthefoundationsandtheindividualcustomerarepartners
withagoalofdevelopingthefinancialsecurityofthecustomer.Duetothisreason,theclientsupport
representativeswithinthebankarefrequentlypursuingtoacknowledgewhatcustomerslikeanddontlikeabout
theservicesofferedbythebank,howtheyarepresented,andhowtoidentifytheservicesthatarelikelytobe
beneficialtoeachcustomer.
Thistypeofproactiveapproachiscompletelydifferentfromthereactiveapproachusedbymanybanksoverthe
years,inwhichthebankcriticallybuildsitssuiteofservicesandthequalificationsforacquiringthem.After
whichitwaitspassivelyforcustomerstoapproachthem.Withrelationshipbanking,therepresentativesofthe
foundationsdontwaitforcustomerstocometotheminstead,theygotothecustomerswithaplanofaction.
ImprovingCustomerRelationships
Wecannotexpectactiveparticipationfromthecustomerssideinaday,weekoramonth.Itisthebaselevelof
buildingarelationshipthatneedstrust,dialogue,asteadygrowthinserviceownershipandagrowthinshareof
walletifdonecorrectly.Thesubstitutetoconcentratingonestablishingcustomerengagementisarelationship
thatdoesnotsatisfyitsfullpotentialorcustomerattrition.
CustomerRelationships
Researchsuggeststhattheconcreteadvantagesofacompletelyengagedcustomer,whoisattitudinallyloyalas
wellasemotionallyattachedtothebankisveryimportant.Thefollowingmeasurescanbefollowedtobuild
andenhancerelationshipwithcustomers
IncreasedRevenues,WalletShareandProductPenetration
Customerswhoarecompletelyinvolvedbring$402inadditionalrevenueperyeartotheirprimarybankas
measuredwiththosewhoareactivelynotinvolved,10%greaterwalletshareindepositbalancesand14%
greaterwalletshareininvestments.Completelyinvolvedcustomersalsoaverage1.14additionalproduct
categorieswiththeirprimarybankthandocustomerswhoareactivelynotinvolved.
HigherPurchaseIntentandConsideration
Activelyinvolvedcustomersnotonlyacquiremoreaccountsattheirprimarybank,butalsolooktothatsame
bankwhenthinkingoffuturerequirements.Nowadays,whenalmosteverythingisdoneonlinedeveloping
bankschancesofbeinginthecustomersconsiderationsetisessential.
BecomingaFinancialPartner
Lessconcrete,butnolessimportant.Anactivelyengagedcustomerestablishesasettlementwiththeirbankor
creditunionthateveryfinancialfoundationwouldcovet.
Wehaveseenhowtoimprovecustomerbond.Anothermajoraspectistounderstandtheguidelinesonhowthe
bondingwiththecustomercanbemadestronger.Thiscanbedoneinthefollowingways
ImproveAcquisitionTargeting
Customerengagementbeginsevenbeforeanewcustomeropensanaccount.Theadvancedtechnologytoday
makesitpossibletofindnewprospectsthatareidenticaltothebestcustomerswhohavetheiraccountsata
financialfoundation.
Thecreationofanacquisitionmodelmonitorstheproductusage,financialbehaviorandrelationship
profitability,openingaccountswithlimitedpotentialforinvolvementorgrowthisminimized.
ChangetheConversation
Letussaybreakingtheiceorstartingacommunicationorinteractingwithcustomersisoneofthekeyelements
tobuildinganengagedcustomerrelationship.Thisrelationshipbondingstartswiththeconversationduringthe
processofaccountopening.Todeveloptrust,theconversationmuststressonconfirmingthatthecustomer
believesthatyouaregenuinelyinterestedinknowingthem,arewillingtolookoutforthemandafterduecourse
oftime,theywillberewardedfortheirbusinessorloyalty.
Thisinitialinteractionrequiresconcentratingmoreoncapturinginsightfromthecustomerandfiguringoutthe
valuedifferentproductsandserviceswillhavefromthecustomerpointofviewasopposedtosimply
consideringfeatures.
Theaimistodemonstratetothecustomerthattheproductsandservicesbeingsoldmustsatisfytheirunique
financialandnonfinancialrequirements.
Unfortunately,researchshowsthatmostofthebranchpersonnelhaveproblemsindealingwithcustomers
aroundrequirementsandthevalueofservicesprovidedbyanenterprise.Insimplewords,havinganenterprise
graspofproductknowledgeisnotsufficient.Initially,theenterpriseshouldconcentrateonsalesqualityas
opposedtosalesquantity.
SomefinancialfoundationshavestartedusingiPadstocollectinsightdirectlyfromthecustomer.Whileseeming
lesspersonal,aniPadnewaccountquestionnairesetsastandardcollectionprocessandbasicallyisableto
collectfarmorepersonalinformationthanthebankorcreditunionemployeearecomfortableincollecting.
CommunicateEarlyandOften
Itisquitealluringhowbanksandcreditunionssetgoalsandobjectivesforbroadeningacustomerrelationship
andinvolvementandthenbuildarbitraryrulesaroundinteractionfrequencyandcadence.
Itisnotuncommonforabanktominimizethenumberofinteractionstooneamonthorlessinspiteofthefact
thatanewcustomerisexpressingthedesireformoreinteractionaspartoftheirnewrelationship.
Researchsuggeststhattheoptimumnumberofinteractionmessageswithinthefirst90dayperiodfrombotha
customersatisfactionandrelationshipgrowthpointofviewisseventimesbeyonddifferentcommunication
channels.
PersonalizetheMessage
Studiesshowthatmorethan50percentofactivelyinvolvedcustomersgetmistargetedinteraction.
Basically,thisinvolvestalkingaboutaproductoraservicethecustomeralreadypossessesorregardinga
servicethatisnotinsightingwiththeinsightthatthecustomerhasinmutualwiththefoundation.
Presently,customersexpectwelltargetedandpersonalizedinteractingsessions.Anythinglessthanthismakes
themlosetheirtrustonthebanks.Thisismostlytruewithfinancialservices,wherethecustomerhasprovided
verypersonalinformationandexpectsthisinsighttobeusedonlyfortheirbenefits.
Toestablishproperengagement,itisbesttoinvolveservicesalesgridthatreflectswhatservicesshouldbe
underlinedininteraction,givenpresentproductownership.Involvementcommunicationisnotafreesizethat
fitsalldialogue.Itshouldshowtherelationshipinrealtime.
BuildTrustbeforeSelling
Toestablishproperengagement,itisbesttoinvolveservicesalesgridthatreflectswhatservicesshouldbe
underlinedininteraction,givenpresentproductownership.Involvementcommunicationisnotafreesizethat
fitsalldialogue.Itshouldshowtherelationshipinrealtime.
Ifacustomeropensanewcheckingaccount,thentheservicesthatshouldbediscussedareasfollows
DirectDeposit
OnlineBillPay
OnlineBanking
MobileBanking
PrivacyProtection/SecurityServices
Benefits
Acknowledgingcustomersbeyondadditionalenhancementstoacheckingaccountthatcanfurtherhelpin
constructinganengagingrelationshipinvolve
MobileDepositCapture
RewardsProgram
AccounttoAccountTransfers
P2PTransfers
ElectronicStatements
NotificationAlerts
Allalongthisrelationshipgrowthprocess,supplementaryinsightintothecustomersrequirementsshouldbe
assembledwheneverpossiblewithpersonalizedcommunicationexpressingthisnewinsight.
RewardEngagement
Unfortunately,inbankingtheconceptofifyouconstructit,theywillcomedoesntwork.Whilewemay
constructgreatproductsandsupplynew,innovativeservices,mostlycustomersneedsupplementarymotivation
toutilizeaproductoptimallyandforengagementtogrowthewaywewoulddesire.
Theoutcomeis,mostlyproposalsarerequiredtoprovokethedesiredbehavior.Inthedevelopmentofproposals,
banksandcreditunionsshouldmakesurethattheproposalshouldbeestablishedontheproductsalreadyheldas
opposedtotheproductorservicebeingsold.
Exclusivelyinfinancialservices,acustomerdoesntcompletelyunderstandtheadvantagesofthenewservice.
Thus,ifthenewaccountisacheckingaccount,theproposalshouldbeonethatlimitsthecostofthechecking,
suppliesanextrabenefittothecheckingorstrengthensthecheckingrelationship.
Potentialproposalsmayinvolvewaivedfeesoroptimallyimprovedstagesofrewardsforapreciseactionor
limitedduration.Theadvantageofusingrewardswouldbethatarewardprogramisastrongengagementtool
itself.
GeartotheMobileCustomer
Weknowdirectmailandphonearehighlyeffectivemethodsusedforconstructinganengagingrelationship.
TheuseofemailandSMStextinghasledtoprogressiveoutcomesduetomobilecommunication
consumptionpatterns.
MobileCustomer
Recentlythereadingofemailonmobiledevicesexceededdesktopconsumptionhighlightingthatmost
messagesshouldbegearedtoaconsumerwhoiseitheronthegoormultitaskingorboth.
Tointeractwiththemobilecustomer,emailandSMStextingmustbeapointtopointthatisoneonone
conversation.Thecustomerdoesnotwishtoknoweverythingabouttheaccount,allthathewantstoknowis
whatisinitforthemandhowdotheyreact.Aslinksshouldbeusedtosupportsupplementaryproduct
informationifitisrequiredasingleclickoptionshouldbeavailabletosayyes.
Withrespecttotheselinks,manyfinancialfoundationshavefoundthatusingshortformvideosisthebestway
toproduceunderstandingandresponse.Brilliantvideosaroundonlinebillpay,mobiledepositcaptureand
A2A/P2Ptransfersnotonlyeducatepeoplebutimmediatelylinktotheyesbuttontoclosethesale.
Itisverynecessarytorememberthatthevideoshouldbeshortlikeunder30secondsandconstructedformobile
consumptionfirstwhenusingeducationalsalesvideos.Asavideoconstructedformobilewillalwaysplaywell
onlargerdevices,theoppositeisbasicallynottrue.Mobilescreenneedstobefocusedmoreasnowadays
everythingisdoneonphonesitselfanditsnotpossibletocarryadesktopeverywhere.Alsothecustomerwill
notalwaysbothertocheckthelinksandvideosintheirdesktop.

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