_A_to_Z_Banking

7/30/2019 _A_to_Z_Banking

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A to Z of Banking

BANKING:

Banking is accepting for the purpose of lending or investment, of deposits or money

from the public, repayable on demand or otherwise, withdraw able by cheque, draft,order or otherwise (Section 5(b), Banking regulations Acts, 1949)

Primary Functions:i) Acceptance of depositsii) Lending of money on investment of funds.

Secondary

i) Collection of cheques and bill of exchange.

ii) Remittance facility issue of Demand Draft Telegraphic Transfer, Real TimeGovt. settlement (RTGS) electronic fund Transfer(EFT)

iii) Safe custody of articles securities and other documents.

iv) Safe demerit locker to keeper valuables in a safe place.

v) Non-fund facilities letter of credit, Banker Guarantee

vi) Crafts selling of third party products e.g. Insurance mutual fund products,Govt. securities

Retail Banking

Retail Banking is banking catering to requirements of individuals relating to deposits,advances and functions. It is almost banking of the ---by the banking of the peopleand for the doge.

Advantages:

i) High yield

ii) Diversified risk

iii) Low level of NPA

iv) Helping large under of customers to increase their standard of living.

v) Opportunity for cross-selling.

Disadvantages:i) Larger tenure of loan for 5 to 20 years.ii) High cost of securing money customers in different locations.

Opportunity:i) Tremendous opportunity for anytime, anywhere banking.


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Threat:i) Concurrent borrowing of retail customers from different bankers and financial

institutions.ii) Reduced proportion of no cost funds (current account), inscrolling the cost of

funds for banks.

Wholesale banking:

Wholesale banking is banking of corporate customers and institutional finance .

SWOT analysis

Strength:i) High quality of service to limited number of customer

ii) Low cost of maintenance (of services)

iii) Monitoring and follow up of wholesale advances is cashes.

Weakness:

i) High risk

ii) Low yield of loan as the customers are highly demanding.

iii) Cost of fund is high as the corporate customers donot keep idle no cost fund.

iv) From the viewpoint of economy, increases inequality of income and wealth.

Threat:A few corporate and institutions and large number of banks files competing for theirbusiness.

Opportunity:Growth of corporate and institution with the advent of liberalization and globalistion.Strategy for success:- Retail.

1. Customer Relationship management.2. Universal banking/financial supplement.

3. Advanced technology like:- ATM, core banking, EFT, RTGS making anytime,anywhere banking possible

4. More delivery channels

5. Service quality with a human touch.


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6. Market research for innovative products and services

Wholesale

1. Advanced technology

2. Strategic cast managerial

3. Risk management strategy.

New retail products

1. Certificate of deposit (C.O)

Minimum deposit Rs. 1 lakh

Period 15 days to 1 year

Higher rate of interest.

2. Smart money (HSBC) fixed deposit linked to current/savings account.

3. Business varitage- HSB current account with e-banking, phone banking,diversity banking service, special ATM withdrawal submit of Rs.10 lakhs peerday and no bounce cheque protection.

4. Business select: Business select customers with ATM withdrawal of Rs. 2lakh per day, Hon living of cheques with Rs 2 lakhs irrespective of balancebusiness centre facilities at all and managerial forces exchange rates order.

5. Classical credit card: Classical credit card offers o/o-balance transfer from

other credit cards, internets banking, and comprehensive insurance exclusivetravel benefits from interactive travel house, global calling card etc.

6. Gold card: Gold card holder gets all these privileges plus rebate oninternational/domestic leisure packages, discount at hotel, high amountpersonal accident insurance.

7. Flexi-finance: This facility draws money against assets such as balancesheets salary steps shares fixed deposits etc.

8. Gen next account-Exclusive account to secure a childrens future throughsystematic investment plan.

9. Orange saving Account- ING Vysyas account with added convenience to thecustomer.

10. Prashanti: ING Vysyas senior citizens.

11. Mediplus Scheme-SBIS scheme to cover medical expenses.

12. Cyber plus, Courier plus, Doctor plus, Paryatan plus


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Social Plus

Plans Scheme of SBI to help the targeted sector with selectively low interest rate and

additional facilities for targeted customer groups.

13. Now corgs Jeevan Griha Raksha-Corporation banks low cost single premises group insurance scheme envisagingforeclosure of the on expanding loan amount by the proceeds of claim amount receivedfrom LIC on the death of the borrower.

14. Corp e-cheque: Corporation Banks Scheme of remittance of funds to pre-approvedbeneficiaries with 48 hours.

ASSET-LIABILITY RISKS

This includes interest rate risk for the banking book, foreign exchange and liquidity risks.These risks are named asset-liability risks because they arise from the dissimilarcharacteristics of assets and liabilities.

Interest Rate Risk

Interest rate risk is the volatility in the earnings or the value of a financial institutionowing to unexpected changes in interest rates. It is due to the mismatched re-pricing of

a financial intermediarys assets and liabilities.

Liquidity Risk

Liquidity risk is the risk of economic losses resulting from the fact that the sum of allinflows and the cash reserves of a financial intermediary on a day are not sufficient tomeet its outflows on that day.

Foreign Exchange Risk

Foreign exchange risk is defined as the volatility in earnings or value of a financialintermediary caused by unexpected changes in exchange rates.

Operational Risk

Operational risk is the risk of loss resulting from inadequate or failed internal processes,people and systems or from external events. The changes in the markets, products, andtechnologies of financial intermediaries caused operational risk.


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Solvency Risk

The risk of insolvency, is a situation wherein losses are large enough to wipe out thecapital of a financial intermediary, is called solvency risk. It is impossible to reduce thepossibility of insolvency to zero.

MARKET RISK

VALUE-AT-RISK

Value-at-risk (VAR) is the potential loss in value of a position over a certain period oftime with a specific probability. The time horizon used most often for VaR is a day. AVaR of Rs. 1 million at a 90% confidence level means that the loss in value of theportfolio over a day is likely to exceed Rs.1 million 10% only of the time.

Historical Simulation

Historical simulation uses the distribution of historical prices to calculate VaR. The dailyprices for the last t days are used to revalue the anchored portfolio with a compositionas on the anchor date. The historical daily returns are applied to the prices of theportfolio of the form, V1, V2,.V1. This series of values is then used to generate a series odaily changes in values, V1V2, etc. The series of value changes is then used tocalculate the VaR.

Monte Carlo Simulation

Monte Carlo simulation is like the historical simulation approach except that the pricesare simulated randomly from a pre-specified stochastic process. These prices are thenused to revalue the portfolio and calculate VaR in the same manner as in historicalsimulation.

STRESS TESTING

Stress testing tells banks about the large losses that might occur owing to changes inmarket prices that are placed in the extreme tails of the market return distributions,beyond the VaR. While these events may not have a high probability of occurrence,their severity merits them an analysis.

There are three types of stress. The first involves analyzing the largest loss incurredduring the reporting period and comparing that to the VaR.

The second involves subjecting bank portfolios to a series of simulated stress scenarioswhich are historical.


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The third stress test involves the bank using its own internally generated (as againsthistorical) Stress scenarios to stress the risk calculations reported by its VaRmeasurement model.

INTEREST RATE RISK

Sources of Interest Rate Risk

i) Mismatched Re-pricing: The timing difference in maturity of fixed rate assetsand liabilities and in re-pricing of floating rate assets and liabilities.

ii) Basis Risk: Interest rates on each asset/liability type might be linked todifferent indices causing them to change in an unsynchronized fashion.

iii) Embedded Options: A number of bank assets and liabilities provideembedded options for customers e.g. each withdrawal option on deposits and

prepayment option on advances.iv) Yield Curve Composition: Non-parallel shifts in the yield curve contribute to

interest rate risk. For example, if a bank has long-term assets financed withshort-term liabilities, its spread will widen when the yield curves slopeincreases.

Exposure Measurement:

i) Earnings Perspective: The GAP analysis measures volatility in net interest

income attributable to unexpected interest rate changes, over a period of oneyear.

The steps in carrying out GAP analysis are:

a) Selection of a time frame for analysis

b) Construction of time buckets or bands within the time frame.

c) Apportioning assets and liabilities to the time band corresponding to theirmaturity or re-pricing date

d) Grouping the assets and liabilities in each band into homogeneousgroups.

e) Calculating the periodic and cumulative GAPs for each time band

Economic Value Perspective:Duration GAP calculation: The duration of an instrument measures the sensitivity ofthe market value of the instrument of interest rate changes. Duration is additive


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across securities, enabling the calculation of the sensitivity of the entire portfolio.Thus aggregate risk to the net worth of a bank can be calculated using the durationof its assets and liabilities.

OPERATIONAL RISK

Caused (2001) an increase in the importance of operational risk to five Drivers ofChanging Operations. Changing markets; changing products and services; changingtechnologies, changing techniques; and unexpected events are responsible foroperational loss.

OperationalLoss event categories

Event type

Category

Definition Sub-categories

Internal fraud Losses due to acts of a type intended todefraud, misappropriate property orcircumvent regulations, the law or

company policy which involves atleast one internal party. Excludes diversity/discrimination events

UnauthorizedactivityTheft and fraud

External fraud Losses due to acts of a type intended todefraud, misappropriate property orcircumvent the law, by a third party

Theft and fraudSystems security

EmployeePractices andWorkplaceSafety

Losses arising from acts inconsistent withemployment, health or safety laws oragreements, from payment of personal injuryclaims, or from diversity/ Discriminationevents

Employee relationssafe environmentDiversity anddiscrimination

Clients, ProductsandBusinessPractices

Losses arising from an unintentional ornegligent failure to meet a professionalobligation to specific clients (includingfiduciary and suitability requirements), Orfrom the nature and design of products.

Suitability,disclosure andfiduciaryImproper businessor market practices

Product flawsSelection,sponsorshipand exposure

Advisory activities

Damage to Losses arising from loss or damage to


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physical assets physical assets from natural disaster or otherevents.

Businessdisruption andsystems failure

Losses arising from disruption of business orsystem failures.

Execution,delivery processmanagement

Losses from failed transaction processing orprocess management, from relations withtrade counterparties and vendors

Transactioncapture, executionand maintenanceMonitoring andreportingCustomer intakeand documentation.Customer accountmanagementTradecounterparties.

Vendors andsuppliers

Key Risk indicators

Employee sick days

Staff turnover

Aggregate grading of employee reviews

Failed background checks on employees.

Above market returns

Transaction volumes

Amount of overtime worked

Investments in technology

System downtime

Age of hardware

Capacity to usage ratio

Margin on a product

Level of training required by internal staff.


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MEASUREMENT

Top-Down Approaches.

The first and the least sophisticated method is the basic indicator approach. The

standardized approach is the next and the advanced measurement approach is themost sophisticated.

The basic indicator approach allows a bank to calculate the operational risk capitalcharge as 15% of its average annual gross income* over the previous three years.

The choice of 15% has been made on the basis of an observed industry widerelationship between the required capital and annual gross income.

The standardized approach due to banks activities into eight business lines, namelycorporate finance, trading and sales, retail banking, commercial banking, payment and

settlement, agency services, asset management, and retail brokerage. The operationalrisk capital charge for each business line is calculated by multiplying the gross incomeof that business line by a factor ranging from 12 to 18%.

Bottom-Up Approache

It allows banks to use an internal operational risk measurement system provided somequalitative and quantitative criteria are met.

The difficulties are: lack of position equivalence; incompleteness of portfolio; contextdependence and irrelevance of past data; and validation difficulties. Unlike credit and

market risks, operational risk does not have a measurable exposure amount or positionequivalence.

Managing Bank Capital

The term bank capital can have different meanings. Capital can be either book value ofcapital, market value of capital. The focus in this chapter is on economic capital.

Difference between the assets and liabilities of bank. Book capital paid-up share capitalof the financial intermediary of the premium received at the time of capital issuance toretained earnings and free reserves.

The market value of equity the number of shares outstanding times the current marketprice of the financial intermediarys stock. Market value of capital reflects not only thecurrent and past performance expectations of investors.

Regulator capital is the minimum capital a bank is required to maintain as per regulatorystandards. This calculated as a specified percentage of a banks assets weightedaccording to their level of risk.


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Economic Capital

Economic capital is the aggregate amount of equity capital required as a cushion for acompanys unexpected losses due to all its credit, market and operational risks.

Frequency

Provisions

Expected

level of

loss

Economic

Capital

Unexpecte

d level of

loss

Catastrophic loss

Loss

Potential loss distribution.

Measuring Economic Capital1. The confidence

2. The time horizon

3. Measures of banking risks.

The Confidence Level

The choice of confidence interval is a managerial decision made at the highest level.This decision is made using the historical default probabilities of peer banks and theirassociated ratings. The first step for the bank is to identify a target rating for itself.

The Time Horizon

The time horizon typically selected is a one-year horizon. The choice of horizon involvesa trade off between the horizons for credit risk which tend to be longer than a year andthe horizons for market risk that are shorter than a year.


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Measuring Risks:

The risk of loss owing to borrower defaults, i.e. credit risk is measured at the level ofindividual loans in the case of commercial credits and portfolios in the case of retailcredits.

Market risk, the risk of losses owing to changes in market prices, can be measured byusing VaR. While evaluating market risk for the purpose of economic capital it isimportant to ensure that the confidence level selected is the same as that for measuringcapital-at-risk and also the horizon. If the horizon used to measure VaR is different, itcan be up-sealed or down-sealed in line with the horizon for the capital-at-risk.

Operational risk can be quantified using either top-down or bottom-up approaches.Again the confidence level and time horizon should be selected to match that chosen forcapital risk. The critical estimates required for operational risk measurement are resultsof self-assessments, key risk indicator and loss frequency and loss severity data.

Aggregating Risks.

After quantifying risks that a financial institution faces, these can be aggregated to yieldeconomic capital either through simple addition (assuming perfect correlation), orassuming independence between the risks, or after taking diversification benefitsbetween the risks into account.

Risk Adjusted Return on Capital

The calculation of economic capital is used in performance evaluation of the firm as a

whole and of individual business units. This is achieved through the calculation of a riskadjusted performance measure.Return on risk adjusted capital is defined as,

Expected annual net incomeRORAC =---------------------------------------

Economic capital

Where,

Expected annual net income = Expected annual net interest income-expected annualoperating costsexpected annual losses (or loan loss provisions) - expected annualtaxes.

RORAC Hurdle Rate

The hurdle rate is nothing but the cost of equity for the bank as a whole. The cost ofequity or the required rate of return from an equity investment in the bank by


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shareholders is calculated by using the capital asset pricing model, which expresses therequired rate of return on a security as the risk free rate plus a premium based on theextent to which the securitys returns move with the market returns. Following is theequation for calculating cost of equity.

Ri = Rf + (Rm-Rf)

Where, Ri are the returns on the banks equity,

Rm are the returns on the market portfolio

Rf is the risk free rate of return and

is the covariance (Ri, Rm) / m2

m2 is the volatility of market returns.

Shareholder Value Added (SVA)Economic profit defined as earnings net of interest payments (funding cost),taxes, and provisions for specific loan losses, less a charge for cost of equitycapital. The cost of equity capital or capital charge is calculated by multiplyingthe economic capital by the firm wide hurdle rate.The shareholder value added (SVA) is defined as follows:

SVA = Expected net interest income-Expected operating costs-Expected losses(or loan loss provisions)-Expected taxes-Capital charges.

Where,

Capital charges = Economic capital utilized by an activity times banks hurdlerate.

Liquidity Risk

Liquidity risk as the risk to a banks earnings and capital arising from its inability totimely meet obligations when they come due without incurring unacceptable losses.

SORUCES

Intrinsic mismatches: identifying a large mismatch in the contractual cash flows arising

from existing business.

Uncertain account activity

The nature of demand liabilities and advances in the form of cash credit and overdraftaccounts is the second source of risk.


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Portfolio dynamism

The growth dynamics of the banks portfolio both in terms of existing and new deals isthe third major source of liquidity risk. This involves alteration of existing deals that have

otherwise contractually bound cash flows and garnering of new deals.

Credit and interest rate risk.

The default of a counter party lends further uncertainty to cash flows and is anothersource of liquidity risk. A problem loan will demonstrate irregular payments of principaland interest causing inference in cash flows.

Inadequate funding capability

A bank might also experience liquidity risk owing unavailability of liquid assets,

Systemic failures

A system failure refers to a liquidity crisis that engulfs a large part of the bankingsystem. This can happen because of the interconnected transitions of banks and thelarge size of the inter-bank market.

Portfolio characteristics

Some bank specific characteristics that can amplify liquidity risk are the presence of afew large contract holders (depositors or borrowers), and portfolios concentrated in a

few sectors or clients.

Central BankDefinition:

H.A Shaw (1918) defines a Central Bank as the bank whose main function is control ofcredit. In the words of Hawtrey, A Central Bank is that which the lender of the lastresort is. According to P.A. Samuelson (1966-86), A Central Bank is a bank ofbankers. Its duty is to control the monetary base and through control of high-poweredmoney to control the communitys supply of money.

1. The Central Bank is the apex institution of the monetary and bankingsystem of the country. A commercial bank is only a constituent unit of thebanking system and a subordinate to the Central Bank.

2. While the Central Bank possesses the monopoly of note issue,commercial banks do not have this right.


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3. The Central Bank is not a profit-making institution. Its aim is to promotethe general economic policy of the government. But, the primary objective ofthe commercial banks is to earn profit for their shareholders.

4. The Central Bank maintains the foreign exchange reserves of the country.The commercial banks only deal in foreign exchange under the directions of

the Central Bank.

5. The Central Bank is an organ of the government and acts as its bankerand the financial advisor, whereas the commercial banks act as advisors andbankers to the general public only.

FUNCTIONS:

Implementation of Monetary Policy.

Note Issue

The Reserve Bank of India is required to keep Rs. 115 crore in gold and Rs.85

crore in foreign securities, but there is no limit to the issue of notes.

Banker to the Government.

Bankers Bank

Custodian of Foreign Exchange Reserves

Lender of the Last Resort

Clearing Function

Credit Control

Quantitative Methods

1. Bank rate policy

2. Open market operations

3. Variations in reserve ratios of commercial banks.

Bank rate (or) discount rate policy:- The rate of interest of every Central Bank isknown as bank rate. It is also known as discount rate.At this rate, the Central Bankrediscounts bill of exchange and government securities held by he commercial banks.


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Open market operations: Direct buying and selling of securities, bill, and bonds ofgovernment and private financial institutions by the Central Bank on its own initiative iscalled Open market operations.

Variable reserve ratio: Every commercial bank is required by law to maintain a

minimum percentage of its time and demand deposits with the Central Bank.

Qualitative or Selective Credit Control.

Margin requirements:

Regulation of Consumer Credit:

Rationing of Credit:

Direct Action:

Moral Suasion.

Publicity.

INDIAN MONEY MARKET AND FINANCIAL SERVICES

INDIAN MONEY MARKET: The Money market performs three broad functions:

1. Providing an equilibrating mechanism for demand and supply of short-termfunds.

2. Enabling borrowers and lenders of short-term funds to fulfill their borrowing andinvestment requirements at an efficient market-clearing price.

3. Providing an avenue for the Central Bank intervention in influencing bothquantum and cost liquidity in the financial system thereby transmitting monetarypolicy impulses to the real economy.

INSTRUMENTS OF MONEY MARKET:

CALL/NOTICE MONEY MARKET: Borrowed or lent for a day, it is known as call(overnight) money. When money is borrowed or lend for more than a day and up to 14

days, it is called notice money.

Inter-bank Term Money: Inter-bank market for deposits of maturity beyond 14 days isreferred to as the term money market. The Discount and Finance House of India (DEHI)is a major player in the market.

Treasury Bills:At present, there are the 91 days and 364 days treasury bills.


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The benefits of investment in treasury bills include:

1. No tax deducted at source

2. Zero default risk being sovereign paper

3. Highly liquid money market instrument

4. Better returns especially in the short term

5. Transparency

6. simplified settlement

7. High degree of tradability and active secondary market facilitate meetingunplanned fund requirements.

Features:Minimum amount of bids: Rs.25, 000/-only and in multiples thereof.

Yield calculation:(100-P*) 365* 100

Y = -----------------------P*D

Y = discounted yieldP = PriceD = days to maturity

There are two types of auction for treasury bills:

1. Multiple price based or French auction: Under this type, all bids equal to or abovethe cut-off price are accepted. However, the bidder has to obtain the treasurybills at the price quoted by him.

2. Uniform price based on Dutch auction: Under this system, all the bids equal to orabove the cut-off price are accepted at the cut-off level.

Participation Certificates (PCs) and Commercial Bills

PCs were utilized mostly by financial institutions to park their funds for longer maturitiesand could not be developed for meeting liquidity mismatches between financial

institutions and/or banks.

1. PCs with risk sharing. The instrument provides flexibility in the credit portfolio ofbanks. These PCs are issued for 91-180 days in respect of certain types of loanadvances. Interest is to be determined between the issuing and the participatingbank freely.


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2. PCs without risk sharing. This instrument is a money market instrument withtenure not exceeding 90 days. The two contracting banks determine the interestson such PCs.

Certificates of Deposit (CD):

Certificates of Deposit (CDs0 is a negotiable money market instrument, issued indematerialized from or as a Since Promissory Note for funds deposited at a bank orother eligible financial institution for a specified time period. Guidelines for issue of CDsare presently governed by various directives issued by the Reserve Bank of India, asamended from time to time.

1. CDs can be issued to individuals, corporations, companies, trusts, funds,associates, etc.

2. NRIs can subscribe to CDs on non-repairable basis.

3. CDs attract stamp duty as applicable to negotiable instruments.

4. Banks have to maintain SLR and CRR on the issue price of CDs. No ceiling onthe amount to be issued.

5. The minimum issue size of CDs is RS. 5 lakh and multiples thereof.

6. CDs are transferable by endorsement and delivery.

7. The minimum lock-in-period for CDs is 15 days.

Commercial Papers: Commercial papers (CP) refer to short-term unsecuredpromissory notes normally issued by corporate companies with a high credit rating. It

is a note in evidence of the debt obligation of the issuer.

1. CPs is issued by companies in the form of usance promissory note, redeemableat par to the holder on maturity.

2. The tangible net worth of the issuing company should be not less than Rs.4crore.

3. Working capital (fund-based) limit of the company should not less than Rs. 4crore.

4. Credit rating should be at least equivalent of P2/A2/PP2/Ind.D.2 or higher from

any approved rating agencies and should be more than two months old on thedate of issue of CP.

5. Corporate are allowed to issue CP is up to 100 per cent of their fund-basedworking capital limits.

6. Issued at a discount to face value

7. Attract stamp duty.


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8. Can be issued for maturities between 15 days and less than one year from thedate of issue.

9. May be issued in the multiples of Rs. 5 lakh.

10.No prior approval of RBI is needed to issue CP, and underwriting the issue is not

mandatory.11.All expenses (such as dealers fees, rating agency fee and charges for provision

of stand by facilities) for the issue of a CP are to be borne by the issuingcompany.

Derivative Usance Promissory Notes (DUPN):RBI has restricted rediscounting for a minimum period of 15days. The maturity date ofthe bill should not be more than 90 days from the date of rediscounting. RBI haswidened the entry regulation for Bill Market by selectively allowing cooperative banks,mutual funds and financial institutions, besides banks and Primary dealers (PDs).

Ready Forward Contracts (REPOS)

Ready forward or repo orBuyback deal is a transaction in which two parties agree tosell and repurchase the same security. Under such an arrangement, the seller sellsspecified securities with an agreement to repurchase the same at a mutually decidedfuture date and a price. Similarly, the buyer purchases the securities with an agreementto resell the same to the seller on an agreed date in future at a pre-fixed price. Underready forward deal, the seller of the security is the borrower and the buyer is the lenderof funds. Such a transaction offers benefits both to the seller and the buyer. The sellergets the funds at a specified interest rate and, thus, hedges himself against volatilerates without parting with his security permanently, and the buyer gets the security tomeet his SLR requirements.

Scheme of Liquidity Adjustment Facility

Pursuant to the recommendations of the Narsimham Committee Report on BankingReforms (Narasimham Committee II), it has been decided in principle to introduce aLiquidity Adjustment Facility (LAF) operated through repo and reverse repo since June5, 2000. Under this scheme, (i) repo auctions (for absorption of liquidity), and (ii) reverserepo auctions (for injection of liquidity) will be conducted on a daily basis (exceptSaturdays).

Dated Government Securities:

Since the date of maturity is specified in the securities, these are known as datedgovernment securities. Its market in India has two segments:

1. Primary market2. Secondary market.

The primary market consists of the issuers of the securities, viz. Central and StateGovernments. The secondary market includes commercial banks, financial institutions,


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insurance companies, provident funds, trusts, individuals, primary dealers and theReserve Bank of India.

Gilt-edged Market:

Government securities do not suffer from the risk of default, and are highly liquid.

Regulatory Framework

The Securities and Exchange Board of India (SEBI) is the regulatory authorityestablished under the SEBI Act, 1992 in order to protect the interests of the investors insecurities as well as promote the development of the capital market. It involvesregulating the business in stock exchanges and supervising the working of stockbrokers, share transfer agents, merchant bankers, underwriters, and etc. as well asprohibiting unfair trade practices in the securities market.

Capital Market Instruments.

Debentures: A debenture is usually a loan repayable at a fixed date.

Bonds: A bond is a debt investment with which the investor loans money to an entity(company or government) that borrows the funds for a defined period of time at aspecified interest rate.

Preference Shares:Preferential shareholders enjoy a preferential right over equity shareholders with

regards to: (i) receipt of dividend and (ii) receipt of residual funds after liquidation.

Equity Shares: Equity shares represent proportionate ownership in a company.Investors who own equity shares in a company are entitled to ownership rights.

Functions of Capital Market

1. It provides for the investors a safe and productive channel for investment ofsavings and secures the recurring benefit of return thereon as long as thesavings are retained.

2. It provides liquidity to the savings of the investors by developing a secondarycapital market and, thus, makes even short-term savings consistently availablefor long-term users.

3. It mobilizes savings of a large number of individuals, families and associationsand makes the same available for meeting the large capital needs of organizedindustry, trade and business and for progress and development of the country asa whole and its economy.


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Over the Counter Exchange of India (OTCEI)

The traditional trading mechanism prevailed in the Indian stock markets gave way tomany functional inefficiencies, such as absence of liquidity, lack of transparency, undulylong settlement periods and benami transactions, which affected the small investors to a

great extent. To provide improved services to investors, the countrys first ring less,scrip-less electronic stock exchange, called OTCEL, was created in 1992 by thecountrys premier financial institutions-Unit Trust of India, Industrial Credit andInvestment Corporation of India, Industrial Development Bank of India, SBI Capitalmarkets, Industrial finance Corporation of India, General Insurance Corporation and itssubsidiaries and CanBank Financial services.

National Stock Exchange (NSE)

Non-Banking Financial Companies (NBFCs)

An NBFC is a company registered under the Companies Act, 1956 and is engaged inthe business of loans and advances, acquisition of shares/stock/ bonds/debentures/securities issued by the government or local authority or other securities ofmarketable nature, leasing, hire purchase, insurance business, chit business, but doesnot include any institution whose principal business is that of agricultural activity,industrial activity, or sale/purchase/construction of immovable property.

Registration: Minimum net owned fund (NOF) should be Rs.2 Crore for new NBFCsseeking grant of Certificate of Registration.

Supervision:

1. On-site inspection

2. Off-site monitoring supported by state-of-the art technology

3. Market intelligence

4. Exception reports of statutory auditors of NBFCs.

The system of on-site examination put in the place during 1997 is structured on thebasis of assessment and evaluation of CAMELS (Capital, Assets, Management,

Earnings, Liquidity, and Systems and Procedures) approach.

Ceiling of interest rates:For RNBCs, the minimum interest rate is 4 per cent daily deposits and 6 per cent onother than daily deposits.


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Period of deposits:All NBFCs cannot accept demand deposits. For other deposits, thedeposits periods are (i) NBFC: 12-60 months, (ii) RNBCs: 12-84 months, and (iii)MNBCs (chit funds): 6-36 months.

Payment of brokerage. The permissible brokerage, commission, incentives or any

other benefit on deposits with all NBFCs is 2 per cent of the deposit. The expenses byway of reimbursement on the basis of related vouchers/bills produced up to 0.5 per centof the deposits are also permitted.

New Financial Products and Services:

1. Merchant banking: A merchant banker is a financial intermediary who helpstransfer capital from those who possess it to those who need it. Merchantbanking includes a wide range of activities such as management of customersecurities, portfolio management, project counseling and appraisal, underwritingof shares and debentures, loan syndication, acting as banker for the refundorders, and handling interest and dividend warrants.

2. Loan syndication. This is more or less similar to consortium financing. But thiswork is taken up by the merchant banker as a lead manager.

3. Leasing: A lease is an agreement under which a company or a firm acquires aright to make use of a capital asset like machinery, on payment of a prescribedfee called rental charges.

4. Mutual funds: A mutual fund refers to a fund raised by a financial servicescompany by pooling the savings of the public.

5. Factoring:

6. Forfeiting: It is a technique by which a forfeiter (financing agency) discounts an

export bill and pays ready cash to the exporter who can concentrate on theexport front without bothering about collection of export bills.

7. Custodial services: Under this, a financial intermediary mainly providesservices for a prescribed fee to clients such as safe keeping of financialsecurities and collection of interest and dividends.

8. Corporate advisory services: Financial intermediaries, particularly banks, haveset up specialized branches for this. As new avenues of finance such as Euroloans, and GDRs are available to corporate customers, this service is ofimmense help to the customers.

9. Securitisation: It is a technique whereby a financial company converts its ill-liquid, on-negotiable and high value financial assets into securities of small valuewhich are made tradable and transferable.

10.New products in forex markets:

Forward contract. A forward transaction is one where the delivery offoreign currency takes place at a specified future date for a specified price.It may have a fixed or flexible maturity date.


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Options. As the very name implies, it is a contract wherein the buyer ofoptions has a right to buy or sell a fixed amount of currency againstanother currency at a fixed rate on a future date according to his options.

Futures: It is a contract wherein there is an agreement to buy or sell astated quantity of foreign currency at a future date at a price agreed

between the parties on the stated exchange.

Swaps: A swap refers to a transaction wherein a financial intermediarybuys and sells a specified foreign currency simultaneously for differentmaturity dates.

Lines of credit (LoC): It is an innovative funding mechanism for theimport of goods and services on deferred payments terms. LoC is anarrangement of a financing institution of one country with another tosupport the export of goods and services so as to enable the importer toimport on deferred payment terms.

MODERN TRENDS IN INDIAN BANKING

Revised Guidelines on Priority Sector Lending

1. In order to overcome the crowding-out effect against small loans particularly toagriculture, big-ticket loans/ advances have been kept out of the direct agriculturesegment (loans/advances in excess of Rs.1 crore granted to corporate, will getonly one-third weight -age for being counted under direct agriculture)

2. With a view to encouraging direct and retail lending by banks, intermediation hasbeen generally discouraged by keeping loans for on-lending barring a fewcategories out of the priority sector fold and by phasing out investment in bondsof financial institutions from the priority sector.

3. Some of the banks had a nil or negligible net bank credit (NBC) and wereengaging mostly in non-funded business (derivatives). This distortion has beensought to be corrected by linking their targets to the credit equivalent of their offbalance-sheet business.

4. The overall priority sector lending targets at 40 per cent and 32 per cent for thedomestic and foreign banks, respectively, as also other sub-targets, have been

retained unchanged. However, these are now calculated as a percentage ofadjusted net bank credit (ANBC) or credit equivalent amount of off-balance-sheetexposures (OBC), whichever is higher, instead of NBC. ANBC includes NBC plusinvestments made by banks in non-SLR bonds held in HTM category. In order toaddress the problem faced by banks in pursuing a moving target, the reference

ANBC or credit equivalent of OBE for the purpose of the targets has beenstipulated as ANBC or credit equivalent of OBE as on March 31 of the precedingyear.


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5. Certain concessions granted earlier for the purpose of priority sector (i.e.exclusion of FCNR (B)/NRNR deposits from NBC) have lost their relevance in anenvironment of substantially large foreign exchange reserves. Such concessionshave, therefore, been withdrawn. The outstanding FCNR (B)/ and NRNR depositbalances would no longer be deducted for computation of ANBC for priority

sector lending purposes.6. The revised guidelines also take into account the revised definition of small and

micro enterprises as included in the Micro. Small and Medium EnterprisesDevelopment (MSMED) Act, 2006.

Technical group for review of legislations on money lending: The All-India Debt andInvestment Survey (NSS fifty-ninth round) had revealed that the share of moneylendersin total dues of rural households had increased from 17.5 per cent in 1991 to 29.6 percent in 2002. Considering that high indebtedness to moneylenders could be animportant reason for distress of farmers, a Technical Group for Review of Legislations of

money-lending (Chairman: Shri S.C. Gupta) as announced in the Annual PolicyStatement for the year 2006-07, was set up to review the efficacy of the existinglegislative framework governing money lending and its enforcement machinery indifferent States.

1. Money-lenders should be registered compulsorily with the State Governments.Unregistered moneylenders will be penalized. The procedure for registration andrenewal should be made simple and hassle free.

2. In order to focus the legislation on the regulation of money-lending transactions,banks, statutory corporations, corporative, financial institutions, NBFCs and RBI

need to be kept out of the purview of the legislation.3. To provide with the flexibility of adjusting the rates of interest in accordance with

the market realities, the maximum rates of interest to be charged bymoneylenders should be notified by the State Governments from time to time.

4. Alternate dispute resolution mechanisms such as Lok Adalat and NyayaPanchayat for speedy and economical dispensation of justice have beenrecommended. Alternatively.

Financial Inclusion

Financial inclusion refers to delivery of banking services at an affordable cost to the vastsections of disadvantaged and low-income groups who tend to be excluded from theformal banking channel. RBIs broad approach to financial inclusion aims at connectingpeople with the banking system and not just credit dispensation; giving people accessto the payments system; and portraying financial inclusion as a viable business modeland opportunity.


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Services to depositors and small borrowers in rural and semi-urban areas:NCAER initiated the study in January 2006 and submitted the report in October 2007.The study covered 930 bank branches across the country from 30 States/ UnionTerritories, and included 9300 depositors and 13,950 borrowers. Prompt servicesdelivery at the counter and professional attitude of the bank staff in reaching out to the

customers emerged as the key determinants for customer satisfaction in rural and semi-urban areas.

Credit counseling: setting up of centers on a pilot basis: The Working Group underthe Chairmanship of: Prof. S. S. Johl had recommended that financial and livelihoodcounseling is important for increasing the viability of credit. Further, the Working Groupunder the chairmanship of Shri C.P. Swarnkar also had recommended that banksshould actively consider opening counseling with a view to giving special thrust to creditdelivery in the relatively underdeveloped regions.

Micro-Credit Disbursement Indicators

1. An intermediate model that works on banking principles with focus on bothsavings and credit activities and where banking services are provided to theclients either directly or through SHGs.

2. There is a wholesale banking model where the clients comprise NGOs, MFIsand SHG federations. This model involves a unique package of providing bothloans and capacity building support to its partners.

3. Further, there is an individual banking-based model that has its clients asindividuals or joint liability groups. While programme management and client

appraisal in this model may be a challenge, it is best suited to lending toenterprises.

Micro-FinanceRecognizing the potential of micro-finance to positively influence the upliftment of thepoor, RBI has been making efforts to create an environment for its orderly development.It conducted a joint fact-finding study in May 2006 with a few major banks. The studyrevealed that some of the micro-finance institutions (MFIs) financed by banks or actingas their intermediaries/partners appeared to be focusing on relatively better bankedarea. They were also operating in the same area trying to reach out to the same set ofpoor resulting in multiple lending. Further, many MFIs, supported by banks were not

engaging themselves in capacity building and empowerment of the groups to thedesired extent. Also, some banks, as principal financiers of MFIs, did not appear to beengaging them for improving their systems, practices and lending policies. An advisorywas, therefore, issued to banks in November 2006 communicating these findings andadvising them to take corrective action at their end.

Board for Financial Supervision (BFS)


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An independent Board for financial Supervision (BFS) under the aegis of the RBI hasbeen established as the apex supervisory authority for commercial banks, financialinstitutions, urban banks and NBFCs. Consistent with international practice, the Boardsfocus is on offsite and onsite inspections and on banks internal control systems. Offsitesurveillance has been strengthened through control returns.

A scheme of Prompt Corrective Action (PCA) is in place for attending to banks showingsteady deterioration in financial health. Three financial indicators, viz. (i) capital-to-risk-weighted-assets ratio (CRAR), (ii) net non-performing assets(net NPA), AND (iii) Returnon Assets (RoA) have been identified with specific threshold limits. When the indicatorsfall below the threshold level (CRAR, RoA) or go above it (net NPAs), the PCA schemeenvisages certain structured/discretionary actions to be taken by the regulator.

Deposit Insurance Reforms

The issue of the limit of deposit insurance cover in India, now Rs. 1 lakh, is to be seen.

In India, there have been demands to raise the insurance cover limit. The ShereCommittee (1997) and the Vasudev the non-banks on the grounds of moral hazard,among others. In fact, the Committee on Banking Sector Reforms (1998) also endorsedthis view.

The increase in premium is required to enable the Deposit Insurance and CreditGuarantee Corporation (DICGC) to build up a deposit insurance fund of 2% of insureddeposits over the next four years.

For the deposit insurance fund to account for 2% of insured bank deposits, the total sizeof the fund would need to be Rs 94 billion. At the same time, to ensure that there is no

moral hazard arising out of the security of deposit insurance, RBI has proposed tointroduce a risk-based pricing of the premium. The report on Reforms in DepositInsurance in India has stated that DIC will have the right to reject insuring a banksdeposit if the banks rating is below investment grade for three consecutive years. Asper the Central Banks recommendation, the liquidity in the event or a bank failure willhave to be provided by the corporation. Thus, there is a need for DIC to have a largerdeposit insurance fund to inspire depositors confidence in the system.

SECURITISATION

Securitisation is the process of conversion of existing assets or future cash flows intomarketable securities. In other words, it deals with the conversion of assets, which arenot marketable, into marketable ones. For the purpose of distinction, the conversion ofexisting assets into marketable securities is known as asset-backed securitization andthe conversion of future cash flows into marketable securities is known as future-flowssecuritization.


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Some of the assets that can be securitized are loans such as car loans, housing loans,and future cash flows viz. ticket sales, credit card payments, car rentals or any otherform of future receivables.

CAPITAL ADEQUACY NORMS

The framework suggested a minimum of 8 per cent capital to risk-weighted assets ratiowhich includes both on-and off-balance sheet items.

REVERSE MORTGAGE

In the Union Budget 2007-08, the Finance Minister announced the introduction of anovel product for senior citizens-the reverse mortgage. This product enables a seniorcitizen, who is the owner of a house, to avail of a monthly stream of income against themortgage of his/her house while remaining the owner and occupying the housethroughout his/her lifetime without repayment or servicing of the loan. Conceptually,

reverse mortgage seeks to monetize the house as an asset and specifically the ownersand equity in the house. It is just opposite of a forward mortgage which requires thepayment of the principal loan amount along with interest on a monthly basis. This helpsa borrower in retaining his home equity and hence increasing the home value. But withreverse mortgages, there are no such monthly repayments and so the debts go onincreasing. The home equity, therefore, reduces to an extremely low value unless theproperty value keeps increasing. Reverse mortgages are therefore often known asrising debt and falling equity.

Principal benefits of the scheme are that it enables senior / elderly citizens owning ahouse but having inadequate income to meet unexpected lump-sum expenditure needs

such as renovation/repairs to house, hospitalization etc. Even after the demise of theborrower, the spouse can continue to stay in the house. If the spouse is co-borrower,he/she will continue to receive payment (up to 15 years from grant of the loan).Payment received from a reverse mortgage is considered as loan and not incomefrom tax angle. Such a scheme can be a partial substitute for a social security schemefor home owning senior citizens and it will be particularly useful to those withno/unwilling family to support them. However, the scheme involves revaluation of theproperty mortgaged to the lender at intervals that may be fixed by the lender dependingupon the location of the property and its physical state.

AGRICULTURAL DEBT WAIVER AND DEBT RELIEF SCHEME (ADWRS),2008

In the waiver scheme, a farmer, who had obtained investment credit for allied activitieswhere the principal loan amount did not exceed Rs. 50,000, was classified as small andmarginal farmer and where the principal amount exceeded Rs. 50,000, was to beclassified as other farmer, irrespective in both cases of the size of the size of the landholding, if any. In the case of a short-term production loan, the amount of such loan(together with applicable interest) and, in the case of an investment loan, theinstallments of such loan that are overdue (together with applicable interest on such


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installments), were eligible for debt waiver or debt relief, as the case may be, if the loanwas (a) disbursed up to March 31, 2007 and overdue as on December 31, 2007 andremained unpaid until February 29, 2008; (b) restructured and rescheduled by banks in2004 and 2006 through the special packages announced by the Central Government,whether overdue or not. Applicable Reserve Banks guidelines on account of natural

calamities, whether overdue or not.

The Committee on Agricultural Indebtedness (under the chairmanship of Dr. R.Radhakrishna) constituted by the Government of India submitted its report, which interalia, addressed issues relating to creation of credit absorption capacities, need for risk-mitigation practices, introduction of cyclical credit system, dispute resolutionmechanisms and setting up of a debt-redemption fund. Consequent upon theannouncement made in the Mid-Term Review of the Annual Policy Statement for theyear-2007-08, an internal working group was constituted (under the chairmanship ofShri V.S.Das) to examine the recommendations of the Radhakrishna Committee thatwere relevant to the banking system in general and the Reserve Bank in particular. The

internal group submitted its report in April 2008. Based on their recommendations, itwas bank, including RRBs, would be asked to select one district for introduction, on apilot basis, of a simplified cyclical credit product for farmers to enable them tocontinuously utilize a core component of 20% of the credit limit. This arrangementshould ensure minimum year-round liquidity as long as the interest is serviced. It wasalso announced to introduce a simplified procedure for crop loans to landless laborers,share croppers, tenant farmers and oral lessees whereby banks could accept anaffidavit giving details of land tilled/crops grown by such persons for loans up toRs.50,000 without any need for independent certification. Banks could also encouragethe Joint Liability Group (JLG) SHG mode of lending for such persons. The modalitiesfor implementation of the announcement are being finalized.

BANKING ON INNOVATION

Area like revenue growth market share increased customer satisfaction, are concern forinnovation. The sources of innovation are customers, employees, consultants, businesspartner, and competitors.

Examples

1) Securitization and venture capital funds. Securitization helps them to avoidcredit risk and additional regulatory capital, but in the process retains the

customer loyalty and connectivity. Venture capitalists perform the role of thecatalysts in transforming innovative ideas into useful products or services, bytheir propensity to take higher risk and ability to identity a new idea.

2) A nationalized bank has proposed to utilize the services of dabbawallabsof Mumbai as delivery channels for its products and services.

3) The RBI, engaged in the task of financial inclusion, has designed twodelivery models, namely, business correspondents model and business


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facilitators model to enhance the outreach of the banks in extending bankingservices to the poor. It also proposes to engage the services of the wide networkof post offices.

4) The development of payment and settlement systems by the RBI,consisting of Real Time Gross Settlement System (RTGSS), National

5) Electronic Funds Transfer, Centralized Funds

6) Management System, besides Cheque Truncation System, have to eviewed as the process innovations of great value for the banking system.

Rural Credit and Microfinance What the RBI Internal Group Report Says.

H.R. Khan Group (2005) recommended the following:

Persons are unbankable in the evaluation / perception of bankers. He loan amount is too small to invite attention of the bankers.

No the person is bankable on a credit appraisal approach but distances are toolong for servicing and supporting the accounts and expanding branch network isnot feasible and viable.

High transaction costs particularly in dealing with a large number of smallaccounts.

Lack of collateral security.

Inability to evaluate and monitor cash flow cycles and repayment capacities dueto information asymmetry, lack of data base and absence of credit history ofpeople with small means.

Human resources-related constraints both in terms of inadequacy of manpowerand lack of proper orientation /expertise.

Adverse security situation prevailing in some parts of rural India.

Lack of banking habits and credit culture.

Information-shadow geographical area.

Extension services which are crucial to improve the production efficiency of thefarmers are inadequate.

The report records the following reasons from the demand side:

High transaction costs at the client level due to expenses such as travel

costs, wage losses, incidental expenses, etc. Documentation.

Lack of awareness.

Lack of social capital

Non-availability of ideal products.

Very small volumes/size of transactions which are not encouraged by formalbanking institutions.


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Hassles related to documentation and procedures in the formal system.

Flow Chart

Model ABusiness Facilitator

Model BBusiness Correspondent

Non-financialServices

Scope of ActivitiesBorrower identificationCollection, processing andsubmission of applications.Preliminary appraisal.Marketing of the financialproducts.Post-sanction monitoring.Promotion and nurturing SHGs/LGs.Follow-up of recovery.

Financialservices as

Pass-throughagents

Scope of ActivitiesDisbursal of small value loan.Recovery ofprincipal/collection of interest.Sale of insurance, mutualfund, etc.Collection of small deposits indue course of time.

Eligible Entities

NGOs, Farmers Clubs, FunctionalCooperatives, IT-enable rural outlets ofcorporates, Postal Agents, InsuranceAgents, Well-functioning Panchayats,Rural Multipurpose Kiosks/villageKnowledge Centers, Agri Clinics/AgriBusiness Centers, KVIC/KVIB units,KVKs Local youth, Retired bankemployees, etc.

Eligible Entities

Registered NBFCs, Section 25companies, NGOs-MFIs set up underSocieties /Trust Act, Societies underMACS, PACs, government/corporatessupported IT-enabled outlets,Organizations/trusts set up by banks(e.g., RUDSET), etc.


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Banc Assurance

In terms of insurance penetration ratio (defined as ratio of insurance premium to GDP),

a key indicator of the spread of insurance coverage and insurance culture, Indiacompares poorly by international standards.

Insurance Penetration-International Comparison-2006(Select European and Asian Countries)

Countries Insurance Penetration # (Per cent)Life Non-life Total

1 2 3 4European CountriesUK

SwitzerlandFranceIrelandThe NetherlandsBelgiumPortugalGermany

13.1

6.27.97.95.16.56.13.1

3.4

4.93.12.54.32.72.93.6

16.5

11.111.010.49.49.29.06.7

Asian CountriesTaiwanSouth KoreaJapan

Hong KongSingaporeMalaysiaPR ChinaIndia

11.67.98.3

9.25.43.21.74.1

2.93.22.2

1.21.11.71.00.7

14.511.110.5

10.46.54.92.74.8

World 4.5 3.0 7.5USACanada

4.03.1

4.83.9

8.87.0


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#: insurance penetration is measured by the ratio of insurance premium to GDP (in per cent)

Source: Swiss Re.

Banc assurance as Distribution Channel for life Insurance

Products in Select European Countries. In per centCountries # Proportion of insurance products

distributed by banks1 2

FrancePortugalSpainBelgiumIrelandSweden

The NetherlandsUK

706963423022

1812

Select Indicators of Insurance Business in IndiaYear Insurance Density * (Rs.) Insurance Penetration** (%)

Life Non-life Total Life Non-life Total1 2 3 4 5 6 72005-06 956.42 183.91 1140.00 4.10 $ 0.70$ 4.80$

Bancassurance Models

Banks intending not to take risk could adopt referral model wherein they merely partwith their client data base for business lead for commission. The actual transaction withthe prospective client in referral model is done by the staff of the insurance companyeither at the premise of the bank or elsewhere.


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Corporate AgencyThe other form of non-risk participatory distribution channel is that of corporate agency,wherein the bank staff is trained to appraise and sell the products to the customers.Here the bank as an institution acts as corporate agent for the insurance products for a

fee /commission.A developed country like US. banks stated to have preferred to focus on the distributionchannel akin to corporate agency rather than underwriting business. Several major USbanks including Wells Fargo, Wachovia and BB &T build a large distribution network byacquiring insurance brokerage business. This model of banc assurance worked well inthe US, because consumers generally prefer to purchase policies through broker banksthat offer a wide range of products from competing insurers.

Insurance as Fully Integrated Financial Service /Joint Ventures

State Bank of India in the public sector, have already taken a lead in resorting to thistype of banc assurance model and have acquired sizeable share in the insurancemarket, also made a big stride within a short span of time.

Some Issues:The difference in working style and culture of the banks and insurance sector needsgreater appreciation. Insurance is a business of solicitation unlike a typical bankingservice, it requires great drive to sell/ market the insurance products. Conflict depositsand other products which are mainly aimed at long term savings/investments can bevery similar to that of the insurance products.

In case the Banc assurance is fully integrated with that of the banking institution, it issuitable only for larger banks.

All efforts that a bank staff spends in explaining to a customer would clinch the deal dueto the very nature of the insurance products.

Bankers in India are extremely nave in insurance products as there were no occasionsin the past for the bankers to deal in insurance products; therefore they require strongmotivation of both monetary and non monetary incentives.

The problem of conflict of interest would also arise in a different form; as banks areprivy to a lot of information about the customer, especially in the context of Know YourCustomer (KYC) system being in place, these information could be used by the insurersfor their unfair advantage.

With more integration between and among various constituents of financial sector, thereis greater possibility for contagion effect


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The regulation and supervision needs to address the institution as a financialconglomerate rather than each institution individually.

Differences in the risk characteristics in banking and insurance will persist, relating, inparticular, to the time pattern and degree of uncertainty in the cash flows and that has to

be recognized and appropriately handled.

Conflicts of interest between different regulators also could not be ruled out.

Ensuring transparency and disclosure on activity-wise may be difficult task for theregulators, albeit it is essential.

Possibility of abuse of consumers by bankers from being coerced to buy insuranceproducts against their will need to be guarded, which RBI has been alreadyemphasizing in its circular.

Possibility of banks using the long term insurance funds to meet their short term liquidityand the problem of asset-liability management also could not be ruled out.

CUSTOMER MANAGEMENT IN RETAIL BANKING: AN OVERVIEW

RETAIL BANKING: Modern retail banking sector has been distinguished three basiccharacteristics:

1) Multiple products: Different financial products like the savings and currentdeposits, credit/debit cards, personal loans, investments and securities are

offered by these banks.2) Multiple channels of distribution: Retail Banks approach their customersthrough multi-channels like call centre, branch, Internet and kiosk.

3) Multiple customer groups: Retail banks segment their consumers intogroups like consumers, small business and corporate. They have differentstrategies for each customer segment.

Rules:

1) Customers redefine the rules of the game:

2) Universal banks and ultra-focused niche players thrive:

3) Changing workforce composition dictates new approaches:

4) Regulatory burdens intensify: With increasing security concerns and privacy,banks will have to make proactive approach for managing compliance issues.

5) Technology improves inexorably to enable breakaway value:


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Strategy:

1) Strategies are developed differently for different segments. Retail banksimplement segment specific channel strategies to develop high-performance by

migrating clients to cost-effective direct channels.2) Development of contact centers services and processes for high and low-end

customers.

3) Retail Banks are increasing their cross-selling and up-scaling activities forincreasing their customer base and improve their customer relation.

4) Product innovation is another strategy applied by retail banks. The different clientsegments are offered other services like insurance or leasing services.

5) The latest strategy is in the use of debit/ATM cards in a all processing platformsirrespective of the retail banks. In other words a single credit/debit/ATM card canbe used in any of the ATM machine without any processing or transaction fee.

6) For the high net-worth and techno-savvy individuals retail banks offer e-bankingfacilities which will enable them to do the banking transaction form anywhere inthe world without physically going down to the branch.

7) Increasing their product penetration to the existing clients in the traditional marketwhile for the urban or metro markets, increasing the distribution and selling ofspecialized business products to commercial customers is focused more.

Factors Affecting Customers Choice

1) Safety of Deposits,2) Size and Strength,

3) Accuracy,

4) General Service Quality

5) Speed of Delivery,

6) Proximity

7) Security of Environment,

8) Cordiality of staff,

9) Price and Service Charges,

10) Product Packaging

11) General Public impression,

12) Peer Group impression,

13) Face Lift (structural),


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14) Friendship with Staff, and

15) Advertisement and Publicity.

According to the findings based on the empirical study, the first six factors exert thegreatest influence, next four have moderate importance, and the remaining five have

relatively lower influence.

Customer Relationship Management

KEY DRIVERS OF CRM

Internal Factors

1. Improving customer satisfaction and cross-selling:

2. Increasing share of customer spend:

3. Operational performance:

4. Competitive pressure:

5. Understanding customer lifetime value:

6. Integration of all delivery channels:

7. Introduction of multi-channel management:

8. Automated Business Processes:

External Factors

1. Reduced competitive barriers:

2. Reduced scope for differentiation:

3. Customer demand:

4. Relationship banking:

5. Advances in technology:

6. Affordable data storage for the retention :7. Calculate customer profitability:

HIGH NET WORTHCUSTOMERS

CUSTOMEROUTSOURCINGMANAGEMENT


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Unlocking Client Advocacy

Unlocking Client Advocacy: The IBM Customer Focused Insight Quotient (CFiq)

TM

Customer Focused Insight Quotient (CFiq), this measure captitures and integratesthese attributes by asking clients to state their level of agreement with three simplestatements:

I would recommend my bank to friends and family.

I would go to my bank first for future financial services needs.

I would stick with my bank if offered a competitively priced product.

The CFiq results are eye-opening-according to this measure; only 27 percent ofretail banking clients are advocates of their bank

Whats more telling is that the smaller players, such as credit unions and non-traditional banks, have a higher proportion of advocates than the national bankswhen segmented by CFiq scores.

How Can Banks Capture the Opportunity?

1. Adopt a transformative mindset.

2. Apply an outside in perspective.

3. Break traditional design approaches and constraints.

Shift Mindset

A mindset shift is required, beginning with executive management; it must become away of life for the organization and central of the culture. This implies it is a top-downled strategy.

SMALLEST

REVENUESFROM

COST TO

Rs. 1UNIT

CUSTOMER RELATIONSHIPMANAGEMENT


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Donald Bell of Wesjlet Airlines. Bell has set the tempo for his customer focusedenterprise. He is known as the spiritual leader and culture guru of his organization.Bell leads his customer focused mission by experiencing his business and customerbase first-hands: he pilots a plane once a week to discuss experiences with front-lineemployees and customers.

Apply an Outside-in Perspective

The understand and effectively manage client attitude, banks need to identify specificmoments of truth by advocacy segment and design competitively superior targetexperiences, while prioritizing resources and investments.

Human Performance:

Customer Experience Management (CEM) has emerged to focus on the fundamentalsof understand customers-not simply from an analytical perspective but from arelationship point of view, and not as an alternative to having a competitive product orreasonable price, but as a differentiator.

Leadership roles are assigned with in each channel to create a framework for customer-facing employees to collaborate and design targeted client experiences.

Solution experience:Some banks focused on interactions with the client, as opposed to more typicalgeneralized communications and product promotions.

Customer focused organization and operating model innovation: Banks need toasses what customer relationship attributes make them different or especially valuablefrom the clients perspective. Then they must deliver consistently on these attributes atthe point of interaction.

Customer Advocacy:

At a high level, the Customer Experience Management:

1. Perform a baseline advocacy measurement analysis, such as the CFiq, byselecting an appropriate client sample set from a banks database that draws

from the banks collective lines of business and channels.2. Apply customer experience principles to customer events, aligning thecompanys brand promise with the customers expectations.

3. Identify key experiences and events for each customer segment, creatinga comprehensive catalog of moments of truth in a Customer Event Map.

4. Understand customer expectations, needs and wants in order to developan outside-in view and distinguish which actions will change client attitude


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toward advocacy. To quickly focus on the key experiences among thethousands of customer interactions, we recommend both an internal andexternal data overlay on the Customer event Map.

5. Blueprint the customers target experience, or in other words, describethe type of interaction that will build advocacy in the future client-facing

operation.

6. Perform a gap analysis to determine the operational shortcomings andrequirements needed to fulfill the target interaction.

7. Develop the operational blueprint that will allow the organization to deliverthe target client interactions with the desired attributes. The operationalblueprint includes business rules, process and organization, data, applicationand infrastructure decisions.

8. Develop a value case and refine the target to determine the interactionsthat will deliver the most for the client and company and, ultimately, prioritizethe areas the company should focus on first, those they should implement later,and those not worth doing. A value case should be developed to show theeconomic returns on customer experience investments.

9. Implement the capabilities, deliver and measure these intentional clientexperiences. Begin rolling out the new interaction capabilities and measuretheir results on advocacy and client attitude.

BANKERS AUTOMATED CLEARING SYSTEM.

1. Regular automated payments.

2. Reduces time and cost of administering bulk payments.

3. Helps manage cash flow and improve financial control.

4. Reduces risk of loss, late payment and theft for customers.

Electronic Credit Clearing Service:

Electronic Credit Clearing is a method of payment whereby the institutions having to

make a large number of payments (such as interest and dividend) can directly credit theamount electronically into the bank accounts of the share holders/depositors/investorswithout having to issue paper instruments.

1. It requires expensive administrative machinery for printing, dispatch andreconciliation.


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2. Bunching of a large number of instruments in clearing results in operationalbottlenecks and pressures on the cheque processing system.

3. Chances of loss of instruments in transit and their fraudulent encashment.

4. The customer has also to keep track of the receipt/non-receipt of the instrument

and take efforts in depositing the instrument to the bank on receipt of the same.5. Banks find processing of such a large volume of instruments not only error prone

and monotonous, but also a strain on the cheque clearing system.

ECS helps save the administrative cost presently being incurred for printing of paperinstruments in MICR format and dispatching them by registered post. By the time theECS cycle is completed, the user institution gets an electronic data file from its bankwith the date of payment and bankers confirmation thereon.

At present, the ECS scheme is in operation at 15 RBI centres (where clearing housesare managed by RBI) and other centres managed by various public sector banksmanaging the clearing houses. ECS is highly beneficial to corporate bodies/institutionswho have periodic, large volume payments to a fixed group of investors /beneficiaries.

Electronic Debt Clearing

The Reserve Bank of India has introduced the Electronic Clearing Service (Debit)scheme to provide faster, periodic and repetitive payments by direct debt tocustomers accounts (duly authorised), thereby minimising paper transactions andincreasing customer satisfaction. Thos scheme envisages. a large number of debitsand one credit in the case of collection of electricity bills, telephone bills, loaninstallments, insurance premia, club fees etc. by the utility service providers.

The benefits are:

1. Faster collection of bills by the companies and better cash management by them.

2. Eliminates the need to go to the collection centres / banks by the customers andno need to stand in long queues for payment.

3. Automatic debiting to the accounts once the mandates are given by thecustomers, to that effect cuts down the procedural delay.

SOCEITY FOR WORLDWIDE INTERBANK FINANCIAL TELECOMMUNICATION(SWIFT)

The Society for Worldwide Inter-bank Financial Telecommunication (SWIFT) operates aworldwide financial messaging network. The swift network exchanges messagesecurely and reliably between banks and other financial institutions, much of it for useon the SWIFT Net network and the ISO 9362 bank identifier codes which are popularlyknown as SWIFT codes.


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SWIFT provides turn-key solutions for members consisting of linkage clients to facilitateconnectivity to the SWIFT-Net and computer-based terminals (CBTs) which membersuse to manage the delivery and receipt of their messages. Some of the more well-known CBTs are:

1. SWIFTNet Link (SNL)2. SWIFT Net Alliance Access/ Entry ( SAA/SAE)

3. SWIFT Alliance Workstation (SAW)

4. SWIFT Alliance Gateway(SAG)

5. SWIFT Alliance Starter Set (SAS)

6. SWIFT Alliance Web station (SAB)

7. SWIFT Alliance Messenger(SAM)

Currently, 90 per cent of all banks worldwide us the SWIFT network to carry out

international bank transfers. Some banks in developing countries are not affiliated withnetwork and they transmit this kind of information by telex, thus resulting in delay.

Clearing House Automated Payment System.

The Clearing House Automated Payment System (CHAPS) was established in Londonin 1984. Today, it offers same-day sterling and euro fund transfers. CHAPS is amember of the trader organization APACS.

1. for business-to-business payments;

2. by solicitors/licensed conveyances to transfer the purchase price of a house

between the bank accounts of those involved; and

3. by individuals buying or selling a high-value item, such as a car, who need a

secure, urgent, same-day guaranteed payment.

EFT transactions may be accompanied by methods to authenticate the card and thecardholder. The merchant may manually verify the cardholders signature, or his PINmay be sent online in an encrypted form for validation by the card issuer. Someinformation included in the transaction may not be visible to the cardholder (for instance,the cardholders address or the CVV2 value printed on the card)

ELECTRONIC FUNDS TRANSFER POINT OF SALE:

Electronic Funds Transfer Point of Sale (EFTPOS) technology allows a retailer todirectly debit a customers bank account by using debit card. The debit card, generallythe same as an ATM card, is swiped through a reading device just like a credit card.


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The customer must enter his/ her PIN number, generally requested once the amount ofthe sale has been entered into the EFTPOS device.

There are many advantages to using an EFTPOS for the retailer and the customeralike. The retailer is paid instantly without having to accept actual cash. Though cash

is certainly preferable over credit cards with surcharges, or personal cheques that canbounce, there are many security liabilities surrounding the handling of large amounts ofcash. Cash must be manually counted by the cashier at the POS, counted again whenthe register is balanced out, and finally collected by an armed service or personallydeposited. With EFTPOS, the money is wired directly into the retailers bank account,bypassing those liabilities while saving manual resources.

1. Never tell anyone, not even your bank, what your EFTPOS security PIN numberis.

2. Choose an EFFTPOS security PIN that is difficult to guess (NOT your birthday orthe same number as other cards)

3. Do not write down your EFTPOS security PIN, but memorise it.

4. Call your bank immediately if you lose your EFTPOS card.

5. Be aware of anyone nearby when using your EFTPOS security PIN. Cover theEFTPOS keypad with your hand in such cases.

6. Do not leave your EFTPOS card in your car.

7. Never give your EFTPOS card in your car.

8. Carry handbags strapped around your body with openings towards you.

9. Sign your new EFTPOS card as soon as it arrives and destroy the old one.

10. If you must write down any security PIN number, keep the record separate fromyour EFTPOS card and code it securely (for example, write what looks like aphone number in your address book, but has a PIN written backwards as the last4 digit)

11. Be sure that you know where your EFTPOS card is at all times. Develop aroutine when you change clothes.

DIGITAL PAYMENT SYSTEM:

The digital payment system represents just a part of the world payment system, butit is certainly the part which has undergone a major change as a result of evolvingtechnological, social and economic conditions. Like the global payment systemuniverse, the digital payment system also can be represented as an expandinguniverse as there is a continuous marked growth in the number and value oftransactions. However, the growing number of electronic transactions, more andmore of which are international, and the rise in their total value are capturingincreased attention and interest by operators and newcomers who were previously


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outside the field. The evolution of such global networks calls for new technologiesoffering increasing efficiency security, convenience and value creation, consumerempowerment and greater transparency in fees application, and it also alls forstandardization and regulation.

E-BANKING

E-banking is about using the infrastructure of the digital age to create opportunities,both local and global. It enables the dramatic lowering of transaction costs, and thecreation of new types of banking opportunities that address the barriers of time anddistance. Banking opportunities are local, global and immediate in e-banking.

1. Electronic mail (e-mail) improves communication between individuals and thebank, within the bank, with the bank and external parties, and between banks.

2. The availability of online information and services online, which customers canpay for and receive.

3. Banks can provide information and services online, which customers can pay forand vehicle for research.

4. Banking processes are made more efficient and cost-effective by integratingother aspects of banking operations such as treasury management and financialcontrol.

5. If a banking function does not require physical interaction, it may derive thebenefits of electronic banking.

VIRTUAL PAYMENT SYSTEMS

A virtual credit card is a way for people to make purchase online without riskingthemselves with frauds. The card enables the cardholder to avoid giving details of anactive credit card online (credit card number, billing address, shipping address etc).Its main advantages are: the cardholder can buy anywhere online, there is nomonthly fee to the credit card company, it can be used to pay online tuition foracademic institutes, it is good for purchases worldwide, and the cardholder doesnthave to have a bank account.

PAYPAL

Paypal is an e-commerce business allowing payments and money transfers to bemade through the Internet. It performs payment processing for online vendors,auction sites, and other corporate users, for which it charges a fee.

WebMoney


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Web Money Transfer Online Payment System is an electronic money and onlinepayment system owned and administered by WM Transfer Ltd. it was founded in1998 and is a legal corporate entity of Belize. Originally targeted at Russian clients,it is now used worldwide. The company more than 2 million users.Clients can use the system through the downloaded software called WM Keeper or

through a limited web client called WM Keeper light. Signing up and receivingWebMoney (known as WM units) from other users is free; sending WM units toother accounts incurs a fee of 0.8 per cent.

Web Money transactions are safe because they do not require a credit card or bankaccount, and are immune against certain scams because they are final and cannotbe retracted. This is similar to e-gold and cash, and unlike credit card transactionsand PayPal.

INTERNET BANKING

Internet banking offers the following features:

1. Bank statements, with the possibility to import data in a personal financeprogramme such as Quicken or Microsoft Money.

2. Electronic bill presentment and payment (EBPP)

3. Funds transfer between a customers own checking and savings accounts, or toanother customers account.

4. Investment purchase or sale.

5. Loan applications and transactions, such as repayments.

6. Account aggregation to allow the customers to monitor all their accounts in oneplace, whether they are with their main bank or with other institutions.

Drivers

1. Improve customer access

2. Facilitate more services

3. Increase customer loyalty

4. Attract new customers

5. Provide services offered by competitors

6. Reduce customer attrition.

Long-term success, a bank may follow:

1. Adopting a webs mindset.

2. Catching on the first movers advantage.

3. Recognising the core competencies.


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4. Ability to deal multiplicity with simplicity.

5. Senior management initiative to transform the organization from inward tooutward looking.

6. Aligning roles and value propositions with the customer segments.

7. Redesigning optimal channel portfolio.

8. Acquiring new capabilities through strategic alliances.

The above can be implemented in four steps:

1. First, familiarizing the customer to new environment by demo version of softwareon the banks website. This should contain tour through the features which are tobe included. It will enable users to give suggestions for improvements, which canbe incorporated in later versions wherever feasible.

2. The second phase provides services such as account information and balances,statement of account, transaction tracking, mailbox, cheque book issue, stoppayment, and financial and customized information.

3. The third phase may include additional services such as fund transfers, DDissue, standing instructions, opening fixed deposits, and intimation of loss of ATMcards.

4. The forth step should include advanced corporate banking services such as thirdparty payments, utility bill payments, establishment of L/Cs, and cashmanagement services. Enhanced plan for the customers in future can includerequests for demand drafts and pay orders and many more to bring in theultimate in banking convenience.

MOBILE BANKING:

Mobile banking can be said to consist of three interrelated concepts:

1. Mobile accounting.

2. Mobile brokerage

3. Mobile financial information services.

CHALLENGES:

Interoperability:


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There is a lack of common technology standards for m-banking. The many protocolsbeing used for it include HTML, WAP, SOAP and XML. It would be a wise idea for thevendor to develop a mobile banking application that can connect multiple banks.

SECURITY

Security of financial transaction from some remote location and transmission of financialinformation over the air are the most complicated challenges that need to be addressed

jointly by mobile application developers, wireless network service providers and thebanks IT department.

Scalability and Reliability

Another challenge for the CIOs and CTOs of the banks is to scale-up the m-bankinginfrastructure to handle exponential growth of the customer base. With m-banking, thecustomer may be sitting in any part of the world (a true anytime, anywhere banking),hence banks need to ensure that the systems are up and running in a true 24 x 7fashion. As customers will find m-banking more and more useful, their expectationsfrom the solution will increase.

HOME BANKING

Self-service banking for consumers and small business owners enabling users to

perform many routine functions at home by telephone or cable modem connection.Home banking, also called online banking or PC banking, give consumers an array ofconvenient services: they can move money between accounts, pay bills, checkbalances, and buy and sell mutual funds and securities. They can also look up loanrates and see if they qualify for a credit card or mortgage.

Some of the home banking services currently the most popular are:

1. Vision of the credit.

2. Bank transfers

3. Oper

Documents

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