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Banks usually offer a number of loans to borrowers, especially those who have a good history
of repaying their bills and a stable job. Most loans require proof of income and identity, and some
may require collateral (such as a car or home equity loan). Small local banks and large national bank
chains are among those offering loans

Types of Loans Offered by Banks

By Stephanie Mojica, eHow Contributor

Banks usually offer a number of loans to borrowers, especially those who have a good history
of repaying their bills and a stable job. Most loans require proof of income and identity, and some
may require collateral (such as a car or home equity loan). Small local banks and large national bank
chains are among those offering loans.

1 Unsecured Personal Loans

An unsecured personal loan allows a borrower to get a check or cash and pay it back in set
installments over a fixed period of time. No collateral or specific loan purpose is required.

2 Secured Personal Loans

A secured personal loan issues cash or a check to the borrower. However, the borrower must
provide the bank with interest in collateral such as a savings account or a home in case the loan is
not repaid.

3 Computer Loans

Most banks offer loans for people to buy new computers from major companies. The loan check
is given to the computer company, and the borrower chooses goods as approved and then makes

4 Auto Loans

Virtually every bank provides auto loans for new and used vehicles. This allows the consumer to
drive a car while paying for it each month. The car is repossessed if the payments are not made.

5 Mortgage Loans

Many banks offer mortgage loans, which permit borrowers to live in a home while paying it off
over time. A cash down payment of 5 percent to 20 percent is usually required, and the house is
seized in foreclosure if payments are not made.

A security is a fungible, negotiable instrument representing financial value. Securities are

broadly categorized into debt securities (such as banknotes, bonds and debentures) and equity
securities, e.g., common stocks; and derivative contracts, such as forwards, futures, options and
swaps. The company or other entity issuing the security is called the issuer. A country's regulatory
structure determines what qualifies as a security. For example, private investment pools may have
some features of securities, but they may not be registered or regulated as such if they meet various

Securities may be represented by a certificate or, more typically, "non-certificated", that is in

electronic or "book entry" only form. Certificates may be bearer, meaning they entitle the holder to
rights under the security merely by holding the security, or registered, meaning they entitle the
holder to rights only if he or she appears on a security register maintained by the issuer or an
intermediary. They include shares of corporate stock or mutual funds, bonds issued by corporations
or governmental agencies, stock options or other options, limited partnership units, and various other
formal investment instruments that are negotiable and fungible.


• 1 Classification
o 1.1 New capital
o 1.2 Repackaging
o 1.3 By type of holder
 1.3.1 Investment
 1.3.2 Collateral
• 2 Debt and equity
o 2.1 Debt
o 2.2 Equity
o 2.3 Hybrid
• 3 The securities markets
o 3.1 Primary and secondary market
o 3.2 Public offer and private placement
o 3.3 Listing and OTC dealing
o 3.4 Market
• 4 Physical nature of securities
o 4.1 Certificated securities
 4.1.1 Bearer securities
 4.1.2 Registered securities
o 4.2 Non-certificated securities and global certificates
 4.2.1 Non-certificated securities
 4.2.2 Global certificates, book entry interests, depositories
 4.2.3 Other depositories: Euroclear and Clearstream
o 4.3 Divided and undivided security
o 4.4 Fungible and non-fungible security
• 5 Regulation

1 Classification
Securities may be classified according to many categories or classification systems:

• Currency of denomination
• Ownership rights
• Term to maturity
• Degree of liquidity
• Income payments
• Tax treatment
• Credit rating
• Industrial sector or "industry". ("Sector" often refers to a higher level or
broader category, such as Consumer Discretionary, whereas "industry"
often refers to a lower level classification, such as Consumer Appliances.
See Industry for a discussion of some classification systems.)
• Region or country (such as country of incorporation, country of principal
sales/market of its products or services, or country in which the principal
securities exchange where it trades is located)
• Market capitalization
• State (typically for municipal or "tax-free" bonds in the U.S.)

1.1 New capital

Commercial enterprises have traditionally used securities as a means of raising new capital.
Securities may be an attractive option relative to bank loans depending on their pricing and market
demand for particular characteristics. Another disadvantage of bank loans as a source of financing is
that the bank may seek a measure of protection against default by the borrower via extensive
financial covenants. Through securities, capital is provided by investors who purchase the securities
upon their initial issuance. In a similar way, the governments may raise capital through the issuance
of securities (see government debt).

1.2 Repackaging

securities have been issued to repackage existing assets. In a traditional securitization, a

financial institution may wish to remove assets from its balance sheet to achieve regulatory capital
efficiencies or to accelerate its receipt of cash flow from the original assets. Alternatively, an
intermediary may wish to make a profit by acquiring financial assets and repackaging them in a way
more attractive to investors. In other words, a basket of assets is typically contributed or placed into a
separate legal entity such as a trust or SPV, which subsequently issues shares of equity interest to
investors. This allows the sponsor entity to more easily raise capital for these assets as opposed to
finding buyers to purchase directly such assets.

1.3 By type of holder

1.3.1 Investment

The traditional economic function of the purchase of securities is investment, with the view
to receiving income and/or achieving capital gain. Debt securities generally offer a higher rate of
interest than bank deposits, and equities may offer the prospect of capital growth. Equity investment
may also offer control of the business of the issuer. Debt holdings may also offer some measure of
control to the investor if the company is a fledgling start-up or an old giant undergoing
'restructuring'. In these cases, if interest payments are missed, the creditors may take control of the
company and liquidate it to recover some of their investment.
1.3.2 Collateral (something promised to someone if one cannot repay a

The last decade has seen an enormous growth in the use of securities as collateral. Purchasing
securities with borrowed money secured by other securities or cash itself is called "buying on
margin". Where A is owed a debt or other obligation by B, A may require B to deliver property
rights in securities to A, either at inception (transfer of title) or only in default (non-transfer-of-title
institutional). For institutional loans property rights are not transferred but nevertheless enable A to
satisfy its claims in the event that B fails to make good on its obligations to A or otherwise becomes
insolvent. Collateral arrangements are divided into two broad categories, namely security interests
and outright collateral transfers. Commonly, commercial banks, investment banks, government
agencies and other institutional investors such as mutual funds are significant collateral takers as well
as providers. In addition, private parties may utilize stocks or other securities as collateral for
portfolio loans in securities lending scenarios.

On the consumer level, loans against securities have grown into three distinct groups over
the last decade: 1) Standard Institutional Loans, generally offering low loan-to-value with very
strict call and coverage regimens; 2) Transfer-of-Title (ToT) Loans, typically provided by private
parties where borrower ownership is completely extinguished save for the rights provided in the loan
contract; and 3) Enhanced Institutional Loan Facilities - a marriage of public and private entities in
the form of fully regulated, institutionally managed brokerage financing supplemented ("enhanced")
by private capital where the securities remain in the client's title and account unless there is an event
of default. Of the three, transfer-of-title loans typically allow the lender to sell or sell short at least
some portion of the shares (if not all) to fund the transaction, and many operate outside the regulated
financial universe as a private loan program. Institutionally managed loans, on the other hand, draw
loan funds from credit lines or other institutional funding sources and do not involve any loss of
borrower ownership or control thereby making them more transparent.

2 Debt and equity

Securities are traditionally divided into debt securities and equities (see also derivatives).

2.1 Debt

Debt securities may be called debentures, bonds, deposits, notes or commercial paper
depending on their maturity and certain other characteristics. The holder of a debt security is
typically entitled to the payment of principal and interest, together with other contractual rights under
the terms of the issue, such as the right to receive certain information. Debt securities are generally
issued for a fixed term and redeemable by the issuer at the end of that term. Debt securities may be
protected by collateral or may be unsecured, and, if they are unsecured, may be contractually
"senior" to other unsecured debt meaning their holders would have a priority in a bankruptcy of the
issuer. Debt that is not senior is "subordinated".

Corporate bonds represent the debt of commercial or industrial entities. Debentures have a long
maturity, typically at least ten years, whereas notes have a shorter maturity. Commercial paper is a
simple form of debt security that essentially represents a post-dated check with a maturity of not
more than 270 days.

Money market instruments are short term debt instruments that may have characteristics of deposit
accounts, such as certificates of deposit, and certain bills of exchange. They are highly liquid and are
sometimes referred to as "near cash". Commercial paper is also often highly liquid.

Euro debt securities are securities issued internationally outside their domestic market in a
denomination different from that of the issuer's domicile. They include eurobonds and euronotes.
Eurobonds are characteristically underwritten, and not secured, and interest is paid gross. A euronote
may take the form of euro-commercial paper (ECP) or euro-certificates of deposit.

Government bonds are medium or long term debt securities issued by sovereign governments or
their agencies. Typically they carry a lower rate of interest than corporate bonds, and serve as a
source of finance for governments. U.S. federal government bonds are called treasuries. Because of
their liquidity and perceived low risk, treasuries are used to manage the money supply in the open
market operations of non-US central banks.

Sub-sovereign government bonds, known in the U.S. as municipal bonds, represent the debt of
state, provincial, territorial, municipal or other governmental units other than sovereign governments.

Supranational bonds represent the debt of international organizations such as the World Bank, the
International Monetary Fund, regional multilateral development banks and others.

2.2 Equity

An equity security is a share of equity interest in an entity such as the capital stock of a
company, trust or partnership. The most common form of equity interest is common stock, although
preferred equity is also a form of capital stock. The holder of an equity is a shareholder, owning a
share, or fractional part of the issuer. Unlike debt securities, which typically require regular
payments (interest) to the holder, equity securities are not entitled to any payment. In bankruptcy,
they share only in the residual interest of the issuer after all obligations have been paid out to
creditors. However, equity generally entitles the holder to a pro rata portion of control of the
company, meaning that a holder of a majority of the equity is usually entitled to control the issuer.
Equity also enjoys the right to profits and capital gain, whereas holders of debt securities receive
only interest and repayment of principal regardless of how well the issuer performs financially.
Furthermore, debt securities do not have voting rights outside of bankruptcy. In other words, equity
holders are entitled to the "upside" of the business and to control the business.

2.3 Hybrid

Hybrid securities combine some of the characteristics of both debt and equity securities.

Preference shares form an intermediate class of security between equities and debt. If the issuer is
liquidated, they carry the right to receive interest and/or a return of capital in priority to ordinary
shareholders. However, from a legal perspective, they are capital stock and therefore may entitle
holders to some degree of control depending on whether they contain voting rights.

Convertibles are bonds or preferred stock that can be converted, at the election of the holder of the
convertibles, into the common stock of the issuing company. The convertibility, however, may be
forced if the convertible is a callable bond, and the issuer calls the bond. The bondholder has about 1
month to convert it, or the company will call the bond by giving the holder the call price, which may
be less than the value of the converted stock. This is referred to as a forced conversion.

Equity warrants are options issued by the company that allow the holder of the warrant to purchase
a specific number of shares at a specified price within a specified time. They are often issued
together with bonds or existing equities, and are, sometimes, detachable from them and separately
tradable. When the holder of the warrant exercises it, he pays the money directly to the company, and
the company issues new shares to the holder.

Warrants, like other convertible securities, increases the number of shares outstanding, and are
always accounted for in financial reports as fully diluted earnings per share, which assumes that all
warrants and convertibles will be exercised.
3 The securities markets

3.1 Primary and secondary market

In the U.S., the public securities markets can be divided into primary and secondary markets.
The distinguishing difference between the two markets is that in the primary market, the money for
the securities is received by the issuer of those securities from investors, typically in an initial public
offering transaction, whereas in the secondary market, the securities are simply assets held by one
investor selling them to another investor (money goes from one investor to the other). An initial
public offering is when a company issues public stock newly to investors, called an "IPO" for short.
A company can later issue more new shares, or issue shares that have been previously registered in a
shelf registration. These later new issues are also sold in the primary market, but they are not
considered to be an IPO but are often called a "secondary offering". Issuers usually retain investment
banks to assist them in administering the IPO, obtaining SEC (or other regulatory body) approval of
the offering filing, and selling the new issue. When the investment bank buys the entire new issue
from the issuer at a discount to resell it at a markup, it is called a firm commitment underwriting.
However, if the investment bank considers the risk too great for an underwriting, it may only assent
to a best effort agreement, where the investment bank will simply do its best to sell the new issue.

For the primary market to thrive, there must be a secondary market, or aftermarket that
provides liquidity for the investment security—where holders of securities can sell them to other
investors for cash. Otherwise, few people would purchase primary issues, and, thus, companies and
governments would be restricted in raising equity capital (money) for their operations. Organized
exchanges constitute the main secondary markets. Many smaller issues and most debt securities trade
in the decentralized, dealer-based over-the-counter markets.

In Europe, the principal trade organization for securities dealers is the International Capital
Market Association. In the U.S., the principal trade organization for securities dealers is the
Securities Industry and Financial Markets Association, which is the result of the merger of the
Securities Industry Association and the Bond Market Association. The Financial Information
Services Division of the Software and Information Industry Association (FISD/SIIA) represents a
round-table of market data industry firms, referring to them as Consumers, Exchanges, and Vendors.

3.2 Public offer and private placement

In the primary markets, securities may be offered to the public in a public offer.
Alternatively, they may be offered privately to a limited number of qualified persons in a private
placement. Sometimes a combination of the two is used. The distinction between the two is
important to securities regulation and company law. Privately placed securities are not publicly
tradable and may only be bought and sold by sophisticated qualified investors. As a result, the
secondary market is not nearly as liquid as it is for public (registered) securities.

3.3 Listing and OTC dealing

Securities are often listed in a stock exchange, an organized and officially recognized market on
which securities can be bought and sold. Issuers may seek listings for their securities to attract
investors, by ensuring there is a liquid and regulated market that investors can buy and sell securities
Growth in informal electronic trading systems has challenged the traditional business of stock
exchanges. Large volumes of securities are also bought and sold "over the counter" (OTC). OTC
dealing involves buyers and sellers dealing with each other by telephone or electronically on the
basis of prices that are displayed electronically, usually by commercial information vendors such as
Reuters and Bloomberg.

There are also eurosecurities, which are securities that are issued outside their domestic market into
more than one jurisdiction. They are generally listed on the Luxembourg Stock Exchange or
admitted to listing in London. The reasons for listing eurobonds include regulatory and tax
considerations, as well as the investment restrictions.

3.4 Market

London is the centre of the eurosecurities markets. There was a huge rise in the eurosecurities market
in London in the early 1980s. Settlement of trades in eurosecurities is currently effected through two
European computerized clearing/depositories called Euroclear (in Belgium) and Clearstream
(formerly Cedelbank) in Luxembourg.

The main market for Eurobonds is the EuroMTS, owned by Borsa Italiana and Euronext. There are
ramp up market in Emergent countries, but it is growing slowly.

4 Physical nature of securities

4.1 Certificated securities

Securities that are represented in paper (physical) form are called certificated securities. They may be
bearer or registered.

4.1.1 Bearer securities

Bearer securities are completely negotiable and entitle the holder to the rights under the security (e.g.
to payment if it is a debt security, and voting if it is an equity security). They are transferred by
delivering the instrument from person to person. In some cases, transfer is by endorsement, or
signing the back of the instrument, and delivery.

Regulatory and fiscal authorities sometimes regard bearer securities negatively, as they may be used
to facilitate the evasion of regulatory restrictions and tax. In the United Kingdom, for example, the
issue of bearer securities was heavily restricted firstly by the Exchange Control Act 1947 until 1953.
Bearer securities are very rare in the United States because of the negative tax implications they may
have to the issuer and holder.

4.1.2 Registered securities

In the case of registered securities, certificates bearing the name of the holder are issued, but these
merely represent the securities. A person does not automatically acquire legal ownership by having
possession of the certificate. Instead, the issuer (or its appointed agent) maintains a register in which
details of the holder of the securities are entered and updated as appropriate. A transfer of registered
securities is effected by amending the register.

4.2 Non-certificated securities and global certificates

Modern practice has developed to eliminate both the need for certificates and maintenance of a
complete security register by the issuer. There are two general ways this has been accomplished.
4.2.1 Non-certificated securities

In some jurisdictions, such as France, it is possible for issuers of that jurisdiction to maintain a legal
record of their securities electronically.

In the United States, the current "official" version of Article 8 of the Uniform Commercial Code
permits non-certificated securities. However, the "official" UCC is a mere draft that must be enacted
individually by each of the U.S. states. Though all 50 states (as well as the District of Columbia and
the U.S. Virgin Islands) have enacted some form of Article 8, many of them still appear to use older
versions of Article 8, including some that did not permit non-certificated securities.[2]

In the U.S. today, most mutual funds issue only non-certificated shares to shareholders, though some
may issue certificates only upon request and may charge a fee. Shareholders typically don't need
certificates except for perhaps pledging such shares as collateral for a loan.

4.2.2 Global certificates, book entry interests, depositories

To facilitate the electronic transfer of interests in securities without dealing with inconsistent
versions of Article 8, a system has developed whereby issuers deposit a single global certificate
representing all the outstanding securities of a class or series with a universal depository. This
depository is called The Depository Trust Company, or DTC. DTC's parent, Depository Trust &
Clearing Corporation (DTCC), is a non-profit cooperative owned by approximately thirty of the
largest Wall Street players that typically act as brokers or dealers in securities. These thirty banks are
called the DTC participants. DTC, through a legal nominee, owns each of the global securities on
behalf of all the DTC participants.

All securities traded through DTC are in fact held, in electronic form, on the books of various
intermediaries between the ultimate owner, e.g. a retail investor, and the DTC participants. For
example, Mr. Smith may hold 100 shares of Coca Cola, Inc. in his brokerage account at local broker
Jones & Co. brokers. In turn, Jones & Co. may hold 1000 shares of Coca Cola on behalf of Mr.
Smith and nine other customers. These 1000 shares are held by Jones & Co. in an account with
Goldman Sachs, a DTC participant, or in an account at another DTC participant. Goldman Sachs in
turn may hold millions of Coca Cola shares on its books on behalf of hundreds of brokers similar to
Jones & Co. Each day, the DTC participants settle their accounts with the other DTC participants and
adjust the number of shares held on their books for the benefit of customers like Jones & Co.
Ownership of securities in this fashion is called beneficial ownership. Each intermediary holds on
behalf of someone beneath him in the chain. The ultimate owner is called the beneficial owner. This
is also referred to as owning in "Street name".

Among brokerages and mutual fund companies, a large amount of mutual fund share transactions
take place among intermediaries as opposed to shares being sold and redeemed directly with the
transfer agent of the fund. Most of these intermediaries such as brokerage firms clear the shares
electronically through the National Securities Clearing Corp. or "NSCC", a subsidiary of DTCC.

4.2.3 Other depositories: Euroclear and Clearstream

Besides DTC, two other large securities depositories exist, both in Europe: Euroclear and

4.3 Divided and undivided security

The terms "divided" and "undivided" relate to the proprietary nature of a security.
Each a separate asset, which is legally distinct from each other security in the same issue. Pre-
electronic bearer securities were divided. Each instrument constitutes the separate covenant of the
issuer and is a separate debt.

With undivided securities, the entire issue makes up one single asset, with each of the securities
being a fractional part of this undivided whole. Shares in the secondary markets are always
undivided. The issuer owes only one set of obligations to shareholders under its memorandum,
articles of association and company law. A share represents an undivided fractional part of the
issuing company. Registered debt securities also have this undivided nature.

4.4 Fungible and non-fungible security

The terms "fungible" and "non-fungible" are a feature of assets.

If an asset is fungible, this means that if such an asset is lent, or placed with a custodian, it is
customary for the borrower or custodian to be obliged at the end of the loan or custody arrangement
to return assets equivalent to the original asset, rather than the specific identical asset. In other words,
the redelivery of fungibles is equivalent and not in specie[disambiguation needed]. In other words, if an owner
of 100 shares of IBM transfers custody of those shares to another party to hold for a purpose, at the
end of the arrangement, the holder need simply provide the owner with 100 shares of IBM identical
to those received. Cash is also an example of a fungible asset. The exact currency notes received
need not be segregated and returned to the owner.

Undivided securities are always fungible by logical necessity. Divided securities may or may not be
fungible, depending on market practice. The clear trend is towards fungible arrangements.

4.5 Regulation

In the United States, the public offer and sale of securities must be either registered pursuant to a
registration statement that is filed with the U.S. Securities and Exchange Commission (SEC) or are
offered and sold pursuant to an exemption there from. Dealing in securities is regulated by both
federal authorities (SEC) and state securities departments. In addition, the brokerage industry is
supposedly self policed by Self Regulatory Organizations (SROs), such as the Financial Industry
Regulatory Authority (FINRA), formerly the National Association of Securities Dealers (or NASD)
or the MSRB.

With respect to investment schemes that do not fall within the traditional categories of securities
listed in the definition of a security (Sec. 2(a)(1) of the 33 act and Sec. 3(a)(10) of the 34 act) the US
Courts have developed a broad definition for securities that must then be registered with the SEC.
When determining if there a is an "investment contract" that must be registered the courts look for an
investment of money, a common enterprise and expectation of profits to come primarily from the
efforts of others. See SEC v. W.J. Howey Co. and SEC v. Glenn W. Turner Enterprises, Inc.

What is project Finance?

Project financing is an innovative and timely financing technique that has been used on many high-
profile corporate projects, including Euro Disneyland and the Eurotunnel. Employing a carefully
engineered financing mix, it has long been used to fund large-scale natural resource projects, from
pipelines and refineries to electric-generating facilities and hydro-electric projects. Increasingly,
project financing is emerging as the preferred alternative to conventional methods of financing
infrastructure and other large-scale projects worldwide.

Project Financing discipline includes understanding the rationale for project financing, how to
prepare the financial plan, assess the risks, design the financing mix, and raise the funds. In addition,
one must understand the cogent analyses of why some project financing plans have succeeded while
others have failed. A knowledge-base is required regarding the design of contractual arrangements to
support project financing; issues for the host government legislative provisions, public/private
infrastructure partnerships, public/private financing structures; credit requirements of lenders, and
how to determine the project's borrowing capacity; how to prepare cash flow projections and use
them to measure expected rates of return; tax and accounting considerations; and analytical
techniques to validate the project's feasibility

Project finance is finance for a particular project, such as a mine, toll road, railway, pipeline, power
station, ship, hospital or prison, which is repaid from the cash-flow of that project. Project finance is
different from traditional forms of finance because the financier principally looks to the assets and
revenue of the project in order to secure and service the loan. In contrast to an ordinary borrowing
situation, in a project financing the financier usually has little or no recourse to the non-project assets
of the borrower or the sponsors of the project. In this situation, the credit risk associated with the
borrower is not as important as in an ordinary loan transaction; what is most important is the
identification, analysis, allocation and management of every risk associated with the project.

The purpose of this paper is to explain, in a brief and general way, the manner in which risks are
approached by financiers in a project finance transaction. Such risk minimisation lies at the heart of
project finance.

In a no recourse or limited recourse project financing, the risks for a financier are great. Since the
loan can only be repaid when the project is operational, if a major part of the project fails, the
financiers are likely to lose a substantial amount of money. The assets that remain are usually highly
specialised and possibly in a remote location. If saleable, they may have little value outside the
project. Therefore, it is not surprising that financiers, and their advisers, go to substantial efforts to
ensure that the risks associated with the project are reduced or eliminated as far as possible. It is also
not surprising that because of the risks involved, the cost of such finance is generally higher and it is
more time consuming for such finance to be provided.

2] Risk minimisation process

Financiers are concerned with minimising the dangers of any events which could have a negative
impact on the financial performance of the project, in particular, events which could result in: (1) the
project not being completed on time, on budget, or at all; (2) the project not operating at its full
capacity; (3) the project failing to generate sufficient revenue to service the debt; or (4) the project
prematurely coming to an end.

The minimisation of such risks involves a three step process. The first step requires the identification
and analysis of all the risks that may bear upon the project. The second step is the allocation of those
risks among the parties. The last step involves the creation of mechanisms to manage the risks.

STEP 1 - Risk identification and analysis

The project sponsors will usually prepare a feasibility study, e.g. as to the construction and operation
of a mine or pipeline. The financiers will carefully review the study and may engage independent
expert consultants to supplement it. The matters of particular focus will be whether the costs of the
project have been properly assessed and whether the cash-flow streams from the project are properly
calculated. Some risks are analysed using financial models to determine the project's cash-flow and
hence the ability of the project to meet repayment schedules. Different scenarios will be examined by
adjusting economic variables such as inflation, interest rates, exchange rates and prices for the inputs
and output of the project. Various classes of risk that may be identified in a project financing will be
discussed below.

STEP 2 - Risk allocation

Once the risks are identified and analysed, they are allocated by the parties through negotiation of the
contractual framework. Ideally a risk should be allocated to the party who is the most appropriate to
bear it (i.e. who is in the best position to manage, control and insure against it) and who has the
financial capacity to bear it. It has been observed that financiers attempt to allocate uncontrollable
risks widely and to ensure that each party has an interest in fixing such risks. Generally, commercial
risks are sought to be allocated to the private sector and political risks to the state sector.

STEP 3 - Risk management

Risks must be also managed in order to minimise the possibility of the risk event occurring and to
minimise its consequences if it does occur. Financiers need to ensure that the greater the risks that
they bear, the more informed they are and the greater their control over the project. Since they take
security over the entire project and must be prepared to step in and take it over if the borrower
defaults. This requires the financiers to be involved in and monitor the project closely. Such risk
management is facilitated by imposing reporting obligations on the borrower and controls over
project accounts. Such measures may lead to tension between the flexibility desired by borrower and
risk management mechanisms required by the financier.

3] Types of risks
Of course, every project is different and it is not possible to compile an exhaustive list of risks or to
rank them in order of priority. What is a major risk for one project may be quite minor for another. In
a vacuum, one can just discuss the risks that are common to most projects and possible avenues for
minimising them. However, it is helpful to categorise the risks according to the phases of the project
within which they may arise: (1) the design and construction phase; (2) the operation phase; or (3)
either phase. It is useful to divide the project in this way when looking at risks because the nature and
the allocation of risks usually change between the construction phase and the operation phase.

1. Construction phase risk - Completion risk

Completion risk allocation is a vital part of the risk allocation of any project. This phase carries the
greatest risk for the financier. Construction carries the danger that the project will not be completed
on time, on budget or at all because of technical, labour, and other construction difficulties. Such
delays or cost increases may delay loan repayments and cause interest and debt to accumulate. They
may also jeopardise contracts for the sale of the project's output and supply contacts for raw

Commonly employed mechanisms for minimising completion risk before lending takes place
include: (a) obtaining completion guarantees requiring the sponsors to pay all debts and liquidated
damages if completion does not occur by the required date; (b) ensuring that sponsors have a
significant financial interest in the success of the project so that they remain committed to it by
insisting that sponsors inject equity into the project; (c) requiring the project to be developed under
fixed-price, fixed-time turnkey contracts by reputable and financially sound contractors whose
performance is secured by performance bonds or guaranteed by third parties; and (d) obtaining
independent experts' reports on the design and construction of the project. Completion risk is
managed during the loan period by methods such as making pre-completion phase drawdowns of
further funds conditional on certificates being issued by independent experts to confirm that the
construction is progressing as planned.

2. Operation phase risk - Resource / reserve risk

This is the risk that for a mining project, rail project, power station or toll road there are inadequate
inputs that can be processed or serviced to produce an adequate return. For example, this is the risk
that there are insufficient reserves for a mine, passengers for a railway, fuel for a power station or
vehicles for a toll road.

Such resource risks are usually minimised by: (a) experts' reports as to the existence of the inputs
(e.g. detailed reservoir and engineering reports which classify and quantify the reserves for a mining
project) or estimates of public users of the project based on surveys and other empirical evidence
(e.g. the number of passengers who will use a railway); (b) requiring long term supply contracts for
inputs to be entered into as protection against shortages or price fluctuations (e.g. fuel supply
agreements for a power station); (c) obtaining guarantees that there will be a minimum level of
inputs (e.g. from a government that a certain number of vehicles will use a toll road); and (d) "take or
pay" off-take contacts which require the purchaser to make minimum payments even if the product
cannot be delivered.

Operating risk
These are general risks that may affect the cash-flow of the project by increasing the operating costs
or affecting the project's capacity to continue to generate the quantity and quality of the planned
output over the life of the project. Operating risks include, for example, the level of experience and
resources of the operator, inefficiencies in operations or shortages in the supply of skilled labour.
The usual way for minimising operating risks before lending takes place is to require the project to
be operated by a reputable and financially sound operator whose performance is secured by
performance bonds. Operating risks are managed during the loan period by requiring the provision of
detailed reports on the operations of the project and by controlling cash-flows by requiring the
proceeds of the sale of product to be paid into a tightly regulated proceeds account to ensure that
funds are used for approved operating costs only.

Market / off-take risk

Obviously, the loan can only be repaid if the product that is generated can be turned into cash.
Market risk is the risk that a buyer cannot be found for the product at a price sufficient to provide
adequate cash-flow to service the debt. The best mechanism for minimising market risk before
lending takes place is an acceptable forward sales contact entered into with a financially sound

4] Risks common to both construction and operational phases

Participant / credit risk
These are the risks associated with the sponsors or the borrowers themselves. The question is
whether they have sufficient resources to manage the construction and operation of the project and to
efficiently resolve any problems which may arise. Of course, credit risk is also important for the
sponsors' completion guarantees. To minimise these risks, the financiers need to satisfy themselves
that the participants in the project have the necessary human resources, experience in past projects of
this nature and are financially strong (e.g. so that they can inject funds into an ailing project to save
Technical risk
This is the risk of technical difficulties in the construction and operation of the project's plant and
equipment, including latent defects. Financiers usually minimise this risk by preferring tried and
tested technologies to new unproven technologies. Technical risk is also minimised before lending
takes place by obtaining experts reports as to the proposed technology. Technical risks are managed
during the loan period by requiring a maintenance retention account to be maintained to receive a
proportion of cash-flows to cover future maintenance expenditure.

Currency risk
Currency risks include the risks that: (a) a depreciation in loan currencies may increase the costs of
construction where significant construction items are sourced offshore; or (b) a depreciation in the
revenue currencies may cause a cash-flow problem in the operating phase. Mechanisms for
minimising resource include: (a) matching the currencies of the sales contracts with the currencies of
supply contracts as far as possible; (b) denominating the loan in the most relevant foreign currency;
and (c) requiring suitable foreign currency hedging contracts to be entered into.

Regulatory / approvals risk

These are risks that government licenses and approvals required to construct or operate the project
will not be issued (or will only be issued subject to onerous conditions), or that the project will be
subject to excessive taxation, royalty payments, or rigid requirements as to local supply or
distribution. Such risks may be reduced by obtaining legal opinions confirming compliance with
applicable laws and ensuring that any necessary approvals are a condition precedent to the drawdown
of funds.

Political risk
This is the danger of political or financial instability in the host country caused by events such as
insurrections, strikes, suspension of foreign exchange, creeping expropriation and outright
nationalisation. It also includes the risk that a government may be able to avoid its contractual
obligations through sovereign immunity doctrines. Common mechanisms for minimising political
risk include: (a) requiring host country agreements and assurances that project will not be interfered
with; (b) obtaining legal opinions as to the applicable laws and the enforceability of contracts with
government entities; (c) requiring political risk insurance to be obtained from bodies which provide
such insurance (traditionally government agencies); (d) involving financiers from a number of
different countries, national export credit agencies and multilateral lending institutions such as a
development bank; and (e) establishing accounts in stable countries for the receipt of sale proceeds
from purchasers.

Force majeure risk

This is the risk of events which render the construction or operation of the project impossible, either
temporarily (e.g. minor floods) or permanently (e.g. complete destruction by fire). Mechanisms for
minimising such risks include: (a) conducting due diligence as to the possibility of the relevant risks;
(b) allocating such risks to other parties as far as possible (e.g. to the builder under the construction
contract); and (c) requiring adequate insurances which note the financiers' interests to be put in place.
The Evolution of Banking Regulation in India – A Retrospect on Some Aspects*
It is my pleasure to be here with you this afternoon on the occasion of the Bankers’ Conference,
which has become a landmark annual event in the Indian banking industry. I am indeed grateful to
the organisers for their kind invitation, which provided me an opportunity to share my thoughts on
the evolutionary path of the banking regulation in India over the past several decades. The topic, to
my mind, appears particularly relevant today when India has completed 60 years of its Independence
this year. While during the last six decades, the Indian banking system has indeed come a long way
traversing an arduous and tortuous path, it would perhaps be appropriate to assess in retrospect and
take stock of how far we have come from where we started and what more remains to be achieved. I
would, therefore, like to briefly present a bird’s eye view of the salient milestones crossed in the long
journey of our banking system and to take stock of the current status of the industry. I would also
like to take this opportunity to briefly touch upon certain doubts, which somehow seem to have crept
in, about certain aspects of the current regulatory dispensation for the Indian banking sector.

Institutional Evolution of the Indian Banking

As most of you would, no doubt, be aware, the indigenous system of banking had existed in India
for many centuries, and catered to the credit needs of the economy of that time. The famous Kautilya
Arthashastra, which is ascribed to be dating back to the 4th century BC, contains references to
creditors and lending. For instance, it says “If anyone became bankrupt, debts owed to the state had
priority over other creditors”. Similarly, there is also a reference to “Interest on commodities
loaned” (PRAYOG PRATYADANAM) to be accounted as revenue of the state. Thus, it appears that
lending activities were not entirely unknown in the medieval India and the concepts such as ‘priority
of claims of creditors’ and ‘commodity lending’ were established business practices.
During the period of modern history, however, the roots of commercial banking in India can be
traced back to the early eighteenth century when the Bank of Calcutta was established in June 1806 –
which was renamed as Bank of Bengal in January 1809 – mainly to fund General Wellesley’s wars.
This was followed by the establishment of the Bank of Madras in July 1843, as a joint stock
company, through the reorganisation and amalgamation of four banks viz., Madras Bank, Carnatic
Bank, Bank of Madras and the Asiatic Bank. This bank brought about major innovations in banking
such as use of joint stock system, conferring of limited liability on shareholders, acceptance of
deposits from the general public, etc. The Bank of Bombay, the last bank to be set up under the
British Raj pursuant to the Charter of the then British East India Company, was established in 1868,
about a decade after the India’s first war of independence. The three Presidency Banks, as these were
then known, were amalgamated in January 1921 to form the Imperial Bank of India, which acquired
the three-fold role: of a commercial bank, of a banker’s bank and of a banker to the government. It is
interesting to note here that merger of banks and consolidation in the banking system in India, is not
as recent a phenomenon as is often thought to be, and dates back to at least 1843 – and the process,
of course, still continues. With the formation of the Reserve Bank of India in 1935, some of the
central banking functions of the Imperial Bank were taken over by the RBI and subsequently,
* The Special Address delivered by Shri V Leeladhar, Deputy Governor, Reserve Bank of India at
theBankers’ Conference (BANCON) 2007 on November 26, 2007 at Hotel Taj Lands End, Mumbai.

Evolution of Legislative Regulation of Banking in India

In the very early phase of commercial banking in India, the regulatory framework was somewhat
diffused and the Presidency Banks were regulated and governed by their Royal Charter, the East
India Company and the Government of India of that time. Though the Company law was introduced
in India way back in 1850, it did not apply to the banking companies. The banking crisis of 1913,
however, had revealed several weaknesses in the Indian banking system, such as the low proportion
of liquid assets of the banks and connected lending practices, resulting in large-scale bank failures.
The recommendations of the Indian Central Banking Enquiry Committee (1929-31), which looked
into the issue of bank failures, paved the way for a legislation for banking regulation in the country.
Though the RBI, as part of its monetary management mandate, had, from the very beginning, been
vested with the powers, under the RBI Act, 1934, to regulate the volume and cost of bank credit in
the economy through the instruments of general credit control, it was not until 1949 that a
comprehensive enactment, applicable only to the banking sector, came into existence. Prior to 1949,
the banking companies, in common with other companies, were governed by the Indian Companies
Act, 1913, which itself was a comprehensive re-enactment of the earlier company law of 1850. This
Act, however, contained a few provisions specially applicable to banks. There were also a few ad
hoc enactments, such as the Banking Companies (Inspection) Ordinance, 1946, and the Banking
Companies (Restriction of Branches) Act, 1946, covering specific regulatory aspects. In this
backdrop, in March 1949, a special legislation, called the Banking Companies Act, 1949, applicable
exclusively to the banking companies, was passed; this Act was renamed as the Banking Regulation
Act from March 1966. The Act vested in the Reserve Bank the responsibility relating to licensing of
banks, branch expansion, liquidity of their assets, management and methods of working,
amalgamation, reconstruction and liquidation. Important changes in several provisions of the Act
were made from time to time, designed to enlarge or amplify the responsibilities of the RBI or to
impart flexibility to the relative provisions, commensurate with the imperatives of the banking sector
developments. It is interesting to note that till March 1966, the Reserve Bank had practically no role
in relation to the functioning of the urban co-operative banks. However, by the enactment of the
Banking Laws (Application to Co-operative Societies) Act, 1965, certain provisions of the Banking
Regulation Act, regarding the matters relating to banking business, were extended to the urban co-
operative banks also. Thus, for the first time in 1966, the urban co-operative banks too came within
the regulatory purview of the RBI.

Prudential Policy Framework for Banking Regulation and Supervision

The basic rationale for exercising fairly close regulation and supervision of banking institutions, all
over the world, is premised on the fact that the banks are “special” – for several reasons. The banks
accept uncollateralised public deposits, are part of the payment and settlement system, enjoy the
safety net of deposit insurance funded by the public money, and are an important channel for
monetary policy transmission. Thus, the banks become a keystone in the edifice of financial stability
of the system – which is a ‘public good’ that the public authorities are committed to provide.
Preventing the spread of contagion through the banking system, therefore, becomes an obvious
corollary of regulating the banks to pre-empt any systemic crisis, which can entail enormous costs
for the economy as a whole. This is particularly so on account of the inevitable linkages that the
banks have by virtue of the nature of their role in the financial system. Ensuring safety and
soundness of the banking system, therefore, becomes a predominant objective of the financial
regulators. While the modalities of exercising regulation and supervision over banks have evolved
over the decades, in tandem with the market and technological developments, the fundamental
objective underlying the exercise has hardly changed. Of course, a well-regulated and efficient
banking sector also enhances the allocative efficiency of the financial system, thereby facilitating
In this backdrop, as the functions of the RBI evolved over the years, the focus of its role as a
regulator and supervisor of the banking system has shifted gradually from micro regulation to macro
prudential supervision. A journey through the major landmarks in the evolution of the RBI’s role vis-
à-vis the commercial banks provide interesting insights. Allow me to very briefly dwell on the salient
aspects of this evolutionary process.
As regard the prudential regulatory framework for the banking system, we have come a long way
from the administered interest rate regime to deregulated interest rates, from the system of Health
Codes for an eight-fold judgmental loan classification to the prudential asset classification based on
objective criteria, from the concept of simple statutory minimum capital and capital-deposit ratio to
the risk-sensitive capital adequacy norms – initially under Basel I framework and now under the
Basel II regime. There is much greater focus now on improving the corporate governance set up
through “fit and proper” criteria, on encouraging integrated risk management systems in the banks
and on promoting market discipline through more transparent disclosure standards. The policy
endeavor has all along been to benchmark our regulatory norms with the international best practices,
of course, keeping in view the domestic imperatives and the country context. The consultative
approach of the RBI in formulating the prudential regulations has been the hallmark of the current
regulatory regime which enables taking account of a wide diversity of views on the issues at hand.
On the supervisory side, we have traversed vast territory in progressively refining our supervisory
focus to ensure a safe and sound banking system, comparable with the best in the world. Thus, we
have continually graduated from the system of on-site Annual Appraisal of the banks by the RBI
followed in the 1970s to the system of Annual Financial Review during the 1980s, then on to the
Annual Financial Inspection of stand-alone banks during the 1990s and further on to the consolidated
supervision of financial conglomerates so as to address the supervisory concerns on a group-wide
basis. The off-site monitoring of the banking system was also introduced in 1995 as a part of the
supervisory strategy of ongoing supervision of the banks, so as to supplement the periodical full-
scope on-site bank examinations. The supervisory rating models (CAMELS and CACS), based on
crucial prudential parameters, were also developed by the RBI to provide a summary view of the
overall health of the banks. The Prompt Corrective Action (PCA) Framework was put in place to
enable timely intervention in case of any incipient stress in a bank. The latest supervisory initiative
has been the introduction of risk-based supervision of the banks so as to move away from transaction
audit and to enable the modulation of the supervisory efforts in tune with the risk profile of the banks
and to achieve optimal deployment of the scarce supervisory resources. Last but not the least, the
Board for Financial Supervision, constituted in 1994 under the Chairmanship of the Governor, RBI
has been the guiding force in securing the transformation in the regulatory and supervisory apparatus
of the banking system.
While the multi-dimensional regulatory and supervisory measures are justifiably reflected in the
significantly improved prudential parameters of the Indian banking system, be it the level of NPAs or
the capital adequacy ratios, there is hardly any room for complacence. In the era of ever-increasing
financial globalisation and in the face of rapid financial innovations, all of us will continually need to
remain on a steep learning curve and upgrade our skills and knowledge to be able to meet the
emerging challenges in the financial world.

Some Elucidation Regarding the Regulatory Environment

Let me now digress a little to address a somewhat different aspect of our regulatory environment.
The Reserve Bank of India has earned, in the service of our country, a proven track record of
professionalism, which has lent it considerable credibility – both domestically and globally. This
credibility enables the RBI to confidently carry on with the reform process to be able to maintain
price and financial stability, while enabling a self-accelerating equitable growth at elevated levels.
However, as I mentioned earlier, in certain quarters, there seem to be some misunderstandings,
regarding certain dimensions of the extant prudential regulatory framework of the RBI. I would like
to briefly address some of the salient ones and explain as to how the perceptions and the reality may
not often converge.

Branch Authorisation Policy :- as you are aware, the RBI announced a new Branch Authorisation
Policy in September 2005 under which certain changes were brought about in the authorisation
process adopted by the RBI for the bank branches in the country. As against the earlier system,
where the banks approached the RBI, piece meal, through out the year for branch authorisation, the
revised system provides for a holistic and streamlined approach for the purpose, by granting a bank-
wise, annual aggregated authorisation, in consultation and interaction with each applicant bank.
The objective is to ensure that the banks take an integrated view of their branch- network needs,
including branch relocations, mergers, conversions and closures as well as setting up of the ATMs,
over a one-year time horizon, in tune with their own business strategy, and then approach the RBI for
consolidated annual authorisations accordingly.
There seems to be some misunderstanding in some quarters that, under the new policy, the banks
have to wait for the annual authorisation exercise and are constrained in approaching the RBI for
any emergent authorisation in between. Since the branch expansion planning of the banks is expected
to be a well thought out, Board-approved annual process, normally, there should be no need for any
emergent or urgent authorisation being required by the banks, in the interim. However, I would like
to emphasise that the new policy does not preclude the possibility of any urgent proposals for
opening bank branches being considered by the RBI even outside the annual plan, specially in the
rural / under-banked areas, anytimeduring the year. This flexibility has been clearly articulated in our
policy guidelines as contained in theMaster Circular of July 2007 but somehow, it seems to have got
overlooked. There also seems to be a feeling among some banks that under the new authorisation
policy, the process adopted is more cumbersome and, as a result, there have been delays in issuing
Since the banks are required to approach the RBI only after obtaining the approval of their respective
Boards for their annual branch expansion plan, it is possible that the preparatory time required for
filing their annual plan with the RBI might be a little longer. The processing time at the end of the
RBI, however, has been generally in the range of one to two months – which I consider to be
reasonable, given the element of consultation with the banks built into the process. However, the
actual number of authorisations issued by the RBI under the new policy has been much higher than
before. For instance, as against the a total of 881,
1125 and 1259 authorisations given by the RBI under the old policy regime during 2003-04, 2004-05
and 2005-06, respectively, the number of authorisations issued under the new policy during 2006-07
was 2028.
Thus, as against the general perception that the new policy has been more restrictive in granting
authorisations, the fact is that there has been a sharp increase of about 61 per cent in the total number
of authorisations granted last year.
I am afraid, however, that similar improvements can not be said about the performance of the banks
in utilising the authorisations received. Even though the banks were granted authorisations to the
extent of 97 per cent and 62 per cent of the authorisations sought by them for the years 2004-05
(April- March) and 2005-06, respectively, as at end-March 2007, as much as 30 per cent and 38 per
cent of the authorisations granted for those years had still not been utilised, even after more than a
year or two of grant of the authorisations. As on that date, the extent of non-utilisation for the year
2006-07 was much higher at 61 per cent when only 69 per cent of the authorisations sought had been
granted. Though I presume that many more licences would have been utilised since March 2007, I
would, nonetheless, like to urge the
banks present here to ensure expeditious and fullest utilisation of the authorisations granted.
You would recall that under the old authorisation policy, the banks were free to install off-site
ATMs, at the places of their choice, without the prior approval of the RBI but only needed a licence
from the concerned Regional Office of the RBI before operationalising the ATM, so as to ensure
compliance with the provisions of Section 23 of the B R Act. Under the revised authorisation policy,
however, the banks are required to obtain prior approval of the RBI even for the off-site ATMs.
Some, therefore, expressed a view that the requirement of prior authorisation of the ATMs in the new
policy is not quite justified, as an ATM is not a full-fledged place of business for the banks. Let me
hasten to mention here the RBI has been liberal in authorising setting up of the ATMs and all the
requests received by the RBI for establishing as many as 7443 ATMs were fully acceded to for the
year 2006-07.
As we know, the ATMs, in the format they are used today in India, already provide for deposit and
withdrawal of cash, balance enquiry, account statements, etc. However, as seen in some of the
advanced countries, the technology permits and can be leveraged to deploy the ATMs for delivering
a much wider variety of banking services to the banks’ customers and thus, have the potential of
becoming a much fuller place of banking business. In any case, since the ATMs constitute an
important channel for delivery of banking services, it is only logical that the network planning of the
banks also captures the plan for setting up their ATMs and reflects it in their annual plan furnished to
the RBI for authorisation. Besides, in India’s WTO commitments in regard to banking services, the
Market Access limitations provide for specific licensing of the ATMs of the foreign banks, though
the ATM licences are not counted within the ceiling of 12 licences per year, as committed by India.
In the emerging global context, therefore, it is only appropriate that the ATMs continue to be kept
within the purview of regulatory authorisation policy.

Operations of Foreign Banks in India :- At present, there are 29 foreign banks operating in India
with a network of 273 branches and 871 offsite ATMs. Among some circles, a doubt is sometimes
expressed as to whether the regulatory environment in India is liberal in regard to the functioning of
the foreign banks and whether the regulatory approach towards foreign participation in the Indian
banking system is consistent with liberalized environment.
Undoubtedly, the facts indicate that regulatory regime followed by the Reserve Bank in respect of
foreign banks is non-discriminatory, and is, in fact, very liberal by global standards. Here are a few
facts which bear out the contention;

 India issues a single class of banking licence to foreign banks and does not require them to
graduate from a lower to a higher category of banking licence over a number of years, as is the
practice followed in certain other jurisdictions.
 This single class of licence places them virtually on the same footing as an Indian bank and does
not place any restrictions on the scope of their operations. Thus, a foreign bank can undertake, from
the very first day of its operations, any or all of the activities permitted to an Indian bank and all
foreign banks can carry on both retail as well as wholesale banking business. This is in contrast with
practices in many other countries.
 No restrictions have been placed on establishment of non-banking financial subsidiaries in India
by the foreign banks or of their group companies.
 Deposit insurance cover is uniformly available to all foreign banks at a non-discriminatory rate of
premium. In many other countries there is a discriminatory regime.
 The prudential norms applicable to the foreign banks for capital adequacy, income recognition
and asset classification, etc., are, by and large, the same as for the Indian banks. Other prudential
norms such as those for the exposure limits, investment valuation, etc., are the same as those
applicable to the Indian banks.
 Unlike some of the countries where overall exposure limits have been placed on the foreign-
country related business, India has not placed any restriction on the kind of business that can be
routed through the branches of foreign banks. This has been advantageous to the foreign bank
branches as the entire home-country business is generally routed through these branches. Substantial
FII business is also handled exclusively by the foreign banks.
 In fact, some Indian banks contend that certain amount of positive discrimination exists in favour
of foreign banks by way of lower Priority Sector lending requirement at 32 per cent of the adjusted
net bank credit as against a level of 40 per cent required for the Indian banks. Unlike in the case of
Indian banks, the sub-ceiling in respect of agricultural advances is also not applicable to foreign
banks whereas export credit granted by the foreign banks can be reckoned towards priority sector
lending obligation, which is not permitted for the Indian banks.
 Notably, in terms of our WTO commitment, licences for new foreign banks may be denied when
the share of foreign banks’ assets in India, including both on- as well as off-balance-sheet items, in
the total assets (including both on- and off-balance-sheet items) of the banking system exceeds 15
per cent. However, we have autonomously not invoked this limitation so far to deny licences to the
new foreign banks even though the actual share of foreign banks in the total assets of the banking
system, including both on- and off-balance-sheet items (on Notional Principal basis), has been far
above the limit. This share of foreign banks stood at 49 per cent, as at end-January 2007, as
mentioned in the India’s Trade Policy Review, 2007.
It is thus very obvious that the Indian regulatory regime is essentially non-discriminatory as between
branches of foreign banks and domestic banks, in regard to their authorisation or the scope of their
operations, though some hold that there is some positive discrimination in favour of the foreign
banks. As explained, Indian regulatory regime is in fact much more equitable and provides a far
more level playing field to the foreign banks, than in many other jurisdictions both developed and
emerging economies.

As regards the market share of the foreign banks in the Indian commercial banking system,
theshare, as at end-June 2007, in the deposits and advances stood at 6.11 and 6.83 per cent,
However, the foreign banks were far more dominant in the off-balance sheet business with a market
share of as high as 72.66 per cent. Besides the foreign banks, there are also two large Indian private
sector banks in which the non-resident ownership is very close to 74 per cent permitted, which could,
therefore, be considered as incorporated in India but predominantly foreign owned banks. These
banks together with the foreign banks, have a combined market share in the country in the deposits,
advances and off-balancesheet business of 17.46, 18.65 and 76.63 per cent, respectively, which, by
no means, are insignificant levels. Moreover, there are also about 10 large listed public sector banks
in which the non-resident / FII shareholding was close to the permitted ceiling of 20 per cent, as at
March-end 2007. In these public sector banks, resident private shareholding would thus be close to
thirty per cent only.
Furthermore, the share of the foreign banks in the foreign exchange market in India was also
significant and had registered a rising trend. For instance, as against their share of 41 per cent in the
total foreign exchange turnover during 2005-06, their share during the first half of 2007-08 stood at
52 per cent. Thus, viewed in totality, it would be extremely difficult to justify the notion that the
foreign and nonresident participation in the Indian banking markets is insignificant or restricted and
that the policy or regulatory environment is not conducive to it.
Another dimension of the foreign banks’ functioning in India is the returns generated from their
Indian operations. Let me mention a few interesting facts here. The net profit per branch for the
foreign banks in India for the year 2005-06 was Rs. 11.99 crore as against the corresponding figure
of Rs. 0.33 crore for the public sector banks (PSBs). Further, for the year 2006-07, the Return on
Assets (ROA) of the foreign banks was 1.65 per cent while the Return on Equity (ROE) was 14.02
per cent, as against the corresponding figures of 0.82 per cent and 13.62 per cent for the PSBs. These
returns need to be viewed in the context of the international benchmarks for these parameters, which
are generally considerably lower. Thus, the Indian operations of the foreign banks are very
remunerative and the returns are notably higher than that of their domestic counterparts as also the
customary international levels. While this could be attributed, to an extent, to the level of domestic
market development and lack of contestability in the Indian markets, this is also, in no small
measure, on account their business mix and a dominant share in the offbalance business, which is
more regulatory-capital efficient, and the pattern of their branch presence, which is so far largely
confined to the major cities of the country.
Yet another aspect of the foreign banks’ operations is the authorisation of their branches in India.
As you might be aware, as per India’s existing WTO commitments, which came into effect from
1997-98, our obligation is to permit to foreign banks only 12 licences per year, including both – the
new entrants and the existing banks. As per the commitment made by India, this obligation of 12
licences does not include the ATMs that might be permitted by the RBI. RBI has, however,
consistently been granting authorisations at levels higher than our obligation, not counting the
numbers of ATMs set up by the foreign banks. Thus, during the period 2003 to October 2007, RBI
had authorised as many as 75 branches of the foreign banks in India, excluding the off-site ATMs set
up by them. Thus, branch authorisation policy for the foreign banks in India may even be described
as quite generous, and not merely liberal.
Notwithstanding the WTO obligations, permitting foreign banks’ presence in a country is in some
senses also guided by the extent of reciprocity amongst the nations – which simply means that there
should be some defensible proportionality in the authorisations granted for the banks of each other’s
countries. In this context, an illustration would be revealing of the ground realities. During the period
2003 to October 2007, India had granted 19 authorisations to the USA-based banks, most of which
also stand utilised. However, during the same period of five years, USA did not authorise any office
of the Indian banks in the US territory, vis-à-vis the requests from the Indian banks for setting up
three branches, two subsidiaries and nine representative offices. Some of the requests have been
pending with the US authorities for more than five years.
Yet another aspect of the foreign participation in the Indian financial sector is the foreign ownership
of the non-banking finance companies (NBFCs) operating in India, quite a few of which are the
subsidiaries of the foreign banks. It is interesting to note that, as of August 2007, in the category
nondeposit- taking systemically important (ND-SI) NBFCs, the NBFCs with some element of
foreign ownership had an asset base of Rs. 87,542 crore and accounted for more than 26 per cent of
the total assets of this class of NBFCs. Of these, the NBFCs with majority foreign ownership had an
asset base of Rs.34,095 crore accounting for 9.2 per cent of the total assets of this class of companies
– a level which could not be considered to be insignificant. The ND-SI NBFCs, which are not closely
regulated by the RBI, therefore, provide, in certain ways, a means of expanding the reach of the
foreign banks in India. Thus, the current policy environment enables a fair level of foreign
participation even in the non-banking financial sector of the country.

Securitisation Guidelines of the RBI :- As you are well aware, the RBI had first issued the draft
guidelines for securitisation of standard assets in April 2005, for public comments and after an
extensive consultative process, the final guidelines were issued in February 2006, in order to
facilitate an orderly development of this market. In certain quarters, however, a view has been
expressed that these guidelines, tend to negate the benefits envisaged in the very concept of
securitisation, and thus, are hindering the growth of securitisation market in the country. Let me
attempt to briefly present today the international perspective vis-à-vis RBI guidelines and the
thinking and rationale underlying our formulation.
RBI’s guidelines are broadly in tune with the stipulations of several regulators in other jurisdictions.
For instance, concept of “true sale” and the independence of the Special Purpose Vehicle (SPV) from
the originator of the assets, prescribed in our guidelines is also embedded, in one form or the other,
in the regulatory guidelines obtaining in Australia, Malaysia, Singapore, the UK and the USA.
Similarly, the prudential treatment of the credit enhancement provided to the SPVs and the
requirement of capital charge thereagainst, as prescribed in our guidelines, is also echoed in the
regulatory framework in Australia, the United Kingdom and Singapore. Likewise, the provisions
relating to the ‘Clean up Calls”, or repurchase of the residual performing assets from the SPV by the
originator, also figure in the regulations in Australia, the United Kingdom and Singapore. The
restrictions placed by us on purchase of securities issued by the SPV by the originator are also found
in other jurisdictions such as Australia, Singapore and the UK. Similarly, the restrictions in regard to
the provision of liquidity facility to the SPV, underwriting of the securities issued by the SPV and
the servicing of the securitised assets are also found in several other jurisdictions, with variations in
details and in the degree of stringency. I am citing all this at some length to point out that RBI’s
guidelines on securitisation are broadly in line with the practices obtaining in several other
jurisdictions, though they have some unique features.
The accounting treatment prescribed in our guidelines provides for upfront recognition of any loss
incurred on sale of assets to the SPV but the profit arising from such sale is required to be amortised
over the life of the securities issued / to be issued by the SPV. Thus, we have not permitted the banks
to recognise the profit upfront, on sale of assets to the SPVs. As you are aware, the main
considerations for the originator in undertaking a securitisation transaction are obtaining the
regulatory-capital relief and generating liquidity from an otherwise illiquid loan book, and not the
profit, per se. In this background, RBI’s guidelines have justifiably adopted such an approach in
order to ensure that profit-booking does not become the primary motive for undertaking
securitisation transactions – which could perhaps lead to profit smoothening, possibly through
inappropriate valuations, and the consequent window dressing of the financial statements – none of
which is prudentially desirable. In brief, the restrictions in our guidelines on upfront recognition of
profit on sale of assets by the banks seek to create the right incentive framework for the banks so that
the basic objective underlying the concept of securitisation does not get negated.
In the aftermath of the recent sub-prime episode in some of the developed countries, caused also by
wide dispersal of credit risk throughout the system through complex structured transactions, I am
sure, you would appreciate the merit of adopting an appropriate incentive-compatible prudential
approach towards securitisation. We need to squarely recognise that securitisation, after all, is also a
credit-risktransfer instrument and has the potential of dispersing the risks from the originating banks
to those parts of the system which might not necessarily be best equipped to manage that risk. Hence,
RBI’s stand in creating the right incentive framework through prudential restrictions would seem to
be an approach which has much to commend itself.

Migration to Principles-Based Regulation (PBR)

A view has been expressed in certain quarters that the Indian regulatory framework should migrate
to principles-based regulation from the current rules-based approach. The merits of a principles-
based approach are that in a dynamic market context, where the product innovation is the order of the
day, the principles-based approach to regulation provides a more enduring regulatory option since
the underlying principles would not need to change with every new product whereas the detailed
rules may have to be constantly modified to address the unique features of market and product
developments. However, despite the stated superiority of the principles-based approach, so far very
few countries have adopted this model in a big-bang or comprehensive manner. The FSA of the UK
which is one of the forerunners in adoption of principles-based regulation has a rule book which has
over 8000 pages. So, the PBR is not as simple to operationalise as it is to advocate.
Thus, in any regulatory regime, complete reliance on a principles-based approach would rarely be a
feasible option since the high-level principles would need to be underpinned by the detailed rules at
the operational level, to achieve the regulatory objectives. To illustrate, it might be easy to enunciate
the principle that “Treat your customer fairly” but ensuring it at the ground level would invariably
require specific rules and prescriptions to achieve the objective underlying the principle. Besides, a
PBR approach also pre-supposes greater reliance on the discretion and judgment of the supervisors
and regulators in interpreting the broad principles – an aspect with which the market players might
not be very comfortable.
On the other hand, the regulated entities too, in the absence of detailed regulatory prescriptions,
would need to develop a certain level of maturity of outlook to correctly understand the spirit of the
principles while implementing them at the operational level. This approach would, therefore, also
require a good deal of skill up gradation on the part of the regulator as well as the regulated entities.
Moreover, in any jurisdiction, there could be certain areas of regulation which would be more
amenable to a PBR approach while certain other areas might inevitably require detailed prescriptive
rules. Thus, the rules-based and principles-based approaches to regulation are not mutually exclusive
options but could very well co-exist and complement each other. To illustrate, the Pillar 1 of the
Basel II framework is essentially rule-based prescription while the Pillar 2 is more oriented towards
principles-based regime.
Within the RBI, we too are in the process of exploring the feasibility of adopting a principles-based
approach to banking regulation but it may be quite some time before we could be ready for adoption
of the PBR approach on a significant scale in the Indian context.

To sum up, I would only say that the Indian regulatory regime for the banking sector has come a long
way over the past six decades. The current regulatory dispensation is ownership neutral,
nondiscriminatory and provides a level playing field for the market participants. In my presentation
today, I have also tried to present some facts, with a view to dispel certain ill informed apprehensions
about the regulatory environment for the Indian banking system. Let me assure you that there is
considerable scope for improvements in the regulatory systems in India and we have been pursuing a
policy of constant improvements through a participative and consultative approach with market
participants. The policy outcomes so far, in terms of contribution to growth, price stability, financial
stability, efficiency and robustness of banking sector have been significant by all standards of
measurements, but the search of excellence, in the RBI’s mission, is an unending journey. I would
urge banking community to join us in this great adventure of serving a billion people, with passion as
well as positive and broader set of values.

The Banking Regulation Act was passed as the Banking Companies Act 1949 and
came into force wef 16.3.49. Subsequently it was changed to Banking Regulations
Act 1949 wef 01.03.66. Summary of some important sections is provided
hereunder. The section no. is given at the end of each item. For details, kindly
refer the bare Act.

• Banking means accepting for the purpose of lending or investment of deposits of money from
public repayable on demand or otherwise and with drawable by cheque, drafts order or
otherwise (5 (i) (b)).
• Banking company means any company which transacts the business of banking (5(i)(c)
• Transact banking business in India (5 (i) (e).
• Demand liabilities are the liabilities which must be met on demand and time liabilities means
liabilities which are not demand liabilities (5(i)(f)
• Secured loan or advances means a loan or advance made on the security of asset the market
value of which is not at any time less than the amount of such loan or advances and unsecured
loan or advances means a loan or advance not secured (5(i)(h).
• Defines business a banking company may be engaged in like borrowing, lockers, letter of
credit, traveller cheques, mortgages etc (6(1).
• States that no company shall engage in any form of business other than those referred in
Section 6(1) (6(2).
• For banking companies carrying on banking business in India to use at least one word bank,
banking, banking company in its name (7).
• Restrictions on business of certain kinds such as trading of goods etc. (8)
• Prohibits banks from holding any immovable property howsoever acquired except as acquired
for its own use for a period exceeding 7 years from acquisition of the property. RBI may
extend this period by five years (9)
• Prohibitions on employments like Chairman, Directors etc (10)
• Paid up capital, reserves and rules relating to these (11 & 12)
• Banks not to pay any commission, brokerage, discount etc. more than 2.5% of paid up value
of one share (13)
• Prohibits a banking company from creating a charge upon any unpaid capital of the company.
(14) Section 14(A) prohibits a banking company from creating a floating charge on the
undertaking or any property of the company without the RBI permission.
• Prohibits payment of dividend by any bank until all of its capitalised expenses have been
completely written off (15)
• To create reserve fund and 20% of the profits should be transferred to this fund before any
dividend is declared (17 (1))
• Cash reserve - Non-scheduled banks to maintain 3% of the demand and time liabilities by
way of cash reserves with itself or by way of balance in a current account with RBI (18)
• Permits banks to form subsidiary company for certain purposes (19)
• No banking company shall hold shares in any company, whether as pledgee, mortgagee or
absolute owners of any amount exceeding 30% of its own paid up share capital + reserves or
30% of the paid up share capital of that company whichever is less. (19(2).
• Restrictions on banks to grant loan to person interested in management of the bank (20)
• Power to Reserve Bank to issue directive to banks to determine policy for advances (21)
• Every bank to maintain a percentage of its demand and time liabilities by way of cash, gold,
unencumbered securities 25%-40% as on last Friday of 2nd preceding fortnight (24).
• Return of unclaimed deposits (10 years and above) (26)
• Every bank has to publish its balance sheet as on March 31st (29).
• Balance sheet is to be got audited from qualified auditors (30 (i))
• Publish balance sheet and auditors report within 3 months from the end of period to which
they refer. RBI may extend the period by further three month (31)
• Prevents banks from producing any confidential information to any authority under Indl
Disputes Act. (34A)
• RBI authorised to undertake inspection of banks (35).
• Amendment carried in the Act during 1983 empowers Central Govt to frame rules specifying
the period for which a bank shall preserve its books (45-y), nomination facilities (45ZA to
ZF) and return a paid instrument to a customer by keeping a true copy (45Z).

• Certain returns are also required to be sent to RBI by banks such as monthly return of liquid
assets and liabilities (24-3), quarterly return of assets and liabilities in India (25), return of
unclaimed deposits i.e. 10 years and above (26) and monthly return of assets and liabilities



The reduction of overhead expenses is one of the few areas of corporate cost control that receives
little or no attention from management. Yet, the resulting savings and profit improvement can be

The "pain" from the control of these expenses is mild and, in certain instances, nonexistent. This
article will explore the overhead expense areas that are easy targets for expense control, and present
the methodology commonly used to extract hard dollar savings. Finally, this article will review the
results of an actual overhead expense reduction campaign in a financial institution.

It appears surprising tat overhead expense reduction is not a popular management tool. Business
owners and/or executive managers are involved in the day-to-day operation of their businesses and
are much more familiar with the cost of printing, stationery, insurance, office supplies, and telephone
expenses than they are, perhaps, of derivatives or financial instruments with Off Balance-sheet risk.
Yet, the pressures of doing business in today's economy demand that executives review and
constantly challenge overhead expenses. Good business practice dictates that managers focus on this
sensitive area that can so dramatically affect profit. However, expanded responsibilities and the
constant demands on management's time severely limit the ability of senior executives to remain
current on products, services, and creative pricing plans available in today's economy.

Management-must make every available effort to achieve every dollar of profitability. Unfortunately,
management has in many cases failed to communicate this concern to those individuals directly
responsible for the control of overhead expenses. Many of these individuals are also guilty of
complacency and suffer from fear of change. In some cases, bruised egos prevent some individuals
from being creative and proactive in exercising their responsibilities. It is this productivity that is the
key to success.


A serious overhead expense reduction audit or review has several components. They include the

* Study the current procedures that have been established to reduce expenses and then assess the
effectiveness of these procedures.
* Establish either a permanent or ad hoc committee with the primary responsibility for overhead
expense control.

Develop an employee awareness program that emphasizes expense control and its benefits to the
economic welfare of the organization.


The following is one methodology that can assist a committee in the responsible quest for control of
overhead expense:

* Meet with the CEO and/or CFO to select those areas with the greatest potential savings.

* Set a specific time table for the analysis to be completed.

* Research the cost of specific overhead expenses. Detail is extremely important and the accounts
payable department should be the best starting point of the research.

* Review purchasing policies and inventory controls.

* Review contracts and other agreements which affect purchasing decision.

* Interview appropriate personnel.

* Test expenses in the market place to determine their value and competitiveness. A major goal
should be to either identify more productive sources or to negotiate greater value from present

* Present the results of efforts in a written plan. Include recommendations in the plan. Discuss these
recommendations in detail with both executives and staff personnel responsible for purchasing
decisions. Obviously, these solutions should be technically sound and cost effective.

* Meet your agreed-upon deadlines. This will lend creditability and resolve to the analysis.

* Review the implemented recommendations quarterly to insure the program is running according to
the original plan. Experience dictates that follow up is critical to the program's success.

* Advertise successes. Review failures (if any). Make any appropriate adjustments.


Typically, management operates under the false assumption that all of its officers and employees
share a common goal: maximum efficiency and profitability. Unfortunately, the reality of the
organization's deficiencies will become readily evident. As you proceed with your cost reduction
efforts, be prepared for excuses, "questionable reasoning," failed logic, etc. The following are but a
few examples:

* Our people do a good job...let's not upset anyone. Ask the obvious question, "Isn't there room for
improvement?" If the answer is yes (which is usually the case), then ask, "Where can and do we
start?" As far as upsetting someone, this comment should be met with both skepticism and concern.

* We have things under control. This should be an indication there are opportunities which will
reveal themselves as your efforts intensify.
* Our ratios are in line with our competitors They're good. Great] Show me an organization who
doesn't want to improve its ratios and I'll show you one who is in decline.