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Alok Rustagi Kaushik Sadhu Paresh Nemade Swapnil Deshapnde

Old scenario
Why do we have banks ?
To answer this question imagine a situation without

banks existing in society.

What will I do with my surplus units? Where to go in case I need finance ? All other intermediaries do not provide

liquidity(checking deposits) and surety .

Can we write off banks ?

the theory suggests

liquidity creation, credit origination, & financial innovation, without banks issuing claims susceptible to runs and thus being financially fragile. In breaking up banks into finance companies and money market funds (the so-called "narrow" bank proposals),

But in doing so we risk throwing the baby out with the bath water. Thus part of the Faustian bargain

that we have to live with is that periodic banking disasters will occur and public money will be used. Innovations in regulation and supervision can attempt to reduce the magnitude of the problem, but we should recognize that the alternative of doing away with the banks, at least in the foreseeable future, could be much worse.

A bank can achieve economies of scale Lower fixed costs relative to its assets . It will have less need for liquidity. It will be able to lower its equity ratio without increasing

the danger of insolvency.

Economies of Scope
While economies of scale result from doing more of the

same thing, economies of scope result from doing different, but related, things.(Story of 3 M)(Regulations often stand in the way)

Evolution of Banking
15th Century -------Money changer banks.
13th -17th centuryMerchant banks. 17th Century -----Bank of Deposits - suspension of


Type of banking

Bank Rate- @ central bank lends fund to commercial

banks Repo rate -@ RBI lends short term debt to banks against securities. Reverse repo- @ banks kept their short term excess liquidity with RBI. CRR- Reserve Bank of India(Amendment)Bill,2006 SLR- Minimum proportion of Net Demand and Time Liabilities.

Bank Rate

Reverse Repo

24% 6% 7% 8% 6%

Bank Rate

Reverse Repo

24% 6% 7% 8% 6%

Mobilisation of funds across Time & Space

Flow of funds

Surplus Units
Surplus of funds

Deficit Units

Users of funds

Sources of funds
Demand deposit (Current account and savings account

deposit) Time deposit & term deposit Short term borrowings from other banks and RBI Equity capital

Investment of funds
Lending short term loan

Loan providing to other banks Funded to RBI

Lending long term loan

Households- auto loan, home loan, personal loan, Education loan, Corporate loan

Q: By eliminating the middle man the saver could get a higher return.Why, then ,do so many people use Bank as a financial intermediary?

Cost advantage

Time advantage

How banks earn profits?

Bid/Ask Spread measured in terms of net interest income(NII) and net interest margin(NIM).

Risk management
Risk involved in banking structure is broadly classified

as Credit risk. Market risk. Operational Risk. Regulatory Risk.

Credit Risk
Exposure Ceilings Review/Renewal

Risk Rating Model

Risk based scientific pricing Portfolio Management Loan Review Mechanism

Market Risk may be defined as the possibility of loss to bank caused by the changes in the market variables. Types of market risk: Liquidity Risk Interest Rate Risk Forex Risk Country Risk

Operational risk
Banks always live with the risks arising out of human

error, financial fraud and natural disasters. E.g., WTC tragedy Barings debacle

Other functions performed by banks as Financial Intermediaries

Maturity Transformation
Risk Transformation Convenience denomination

Growth Hurdle-NPA
A NPA is a loan or an advance where Interest and/ or installment of principal remain overdue for a period of more than 90 days in respect of a term loan In 2009 Gross NPA of commercial bank was about 70k crore Increasing NPA implies moral hazard problem in bank.


Poor Credit discipline Inadequate Credit & Risk Management Diversion of funds by promoters Funding of non-viable projects Banks has little freedom to price products and invest in their best interest


Drain on Profitability
Impact on capital adequacy Adverse effect on credit growth

Excessive focus on Credit Risk Management


Sale of NPA to ARC/ SC under Securitization and

Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SRFAESI) Willful defaulter reported to RBI A NPA is eligible for sale to other banks(Transfer of risk)`

Payments System
Realization of transaction
Inseparable part of trades and goods. The primary goal of any national payment system is to

enable the circulation of money in its economy. Payment system is part of business model Substantial source of income.

Payment characteristics
It is expected safe, secure, sound and efficient

payment and settlement systems for the country Commonly known as Triple-S + E.

Efficiency of payments
Minimum transaction cost
Competitive Pricing Integration

Minimizing systemic risk in inter bank payment


Types of payment
Electronic payment-RTGS,NEFT
Cash payment-Bank branch,ATM Paper payment- Cheque, Pay order, Demand Draft

Money Laundering
Money laundering is disguising illegal sources of

money so that it looks like it came from legal sources. The objective of KYC/AML RBI guidelines is to prevent banks from being used, intentionally or unintentionally, by criminal elements for money laundering or terrorist financing activities.

Know Your Customer (KYC)

a) Customer Acceptance Policy; b) Customer Identification Procedures; c) Monitoring of Transactions; d) Risk Management.

Formed by Indian government to lend long term debt

to development work in. In 1992 Narsimhan committee report suggested to convert into banks. Example:HDFC,IDBI,ICICI

Informational Role of Asset Prices

What are assets?
Asset prices appear to contain some information

regarding future realizations of inflation and output.

What happens to prices in case of scams bubbles?

Informational role of asset prices

Banks provide many secured loans
They may be backed by different assets such as shares,

land etc. To take loan decision banks need real time data on asset prices. If asset price is less than loan amount then it will create problem for banks.

As per banking regulation act 1949
Assets of banking company should not be less than

75% of its demand and time liabilities.

Liabilities above should not include paid up capital. Banking company has to report this status at the end

of every quarter to RBI

Managerial Incentives
Working for self interest creates incentive problem Measures to avoid this problem

-Employee stock options -concentrated ownership In India RBI put some guidelines to avoid incentive problem such as he should not be director partner in any other trading commercial firm

he should not have substantial interest in any other firm or be engaged in any other company.
RBI holds right to change the director if it feels it is in public interest.

Basel II Norms
These norms based on three pillars Minimal capital requirement Supervisory review process Market discipline Banks need to maintain 9% CRAR and PSB 12% CRAR Tier I capital norm is at 6%

Banks require to hold 2% common equity.

Basel III Norms

New Banking Regulation

Eligibility norms

-promoter holding at least 40% for 5 years. -minimum paid-up capital should be 500 cr. FDI is capped to 49 % for first five years after that 74% is upper limit. Min CAR of 12% should be maintained.

Regarding directors 50% of directors should be totally

25% of branches should be in rural sector.
Priority lending as applicable to other domestic banks

Banking penetration is 45% in middle and high

income group 5% in lower income group Increased use of technology in rural parts provides new medium to increase penetration Continuous GDP growth demand more funding from banks for development

To raise the bar of service and speedy redresser of

customer grievances How to increase rural penetration Swabhiman yojna Increase use of technology Demographical Diversifications

Fulfill growing demand for finance from infrastructure

and real estate sector More transparency in banking system Consolidation of KYC Norms. Increase financial depth.

Thank You