Risk Peoject

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CONTENTS PAGE NO

INTRODUCTION 02

LITERATURE REVIEW 07

y Off Balance Sheet Activities

And Its Types. 08y Regulation issues. 21

y Trading Activities 24

ANALYSIS AND INTERPRETATION 28


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INTRODUCTION:

Deregulation, technology and financial innovation aretransforming banking. Indeed, banking is no longer the businessit was a few decades ago. The way banking services areprovided has changed dramatically, and in many countries theyare even offered by institutions that are quite different fromtraditional banks. As the old institutional demarcations becomeincreasingly irrelevant, increased competition from other intermediaries has led to a decline in traditional banking in whichbanks took deposits and made loans that stayed on their booksto maturity. Banks thus have been moving rapidly into new areasof business.

In this evolving financial environment, the international bankingcommunity and the BASEL community on banking supervision of the Bank for international settlement (BIS) are currently wrestling

to form an appropriate regulatory framework. The regulatoryresponse to these changes has been a move away from theincreasingly ineffective command and control regulations togreater reliance on assessing the internal risk managementsystems, the supervision of banks and more effective marketdiscipline.

Inadequate resolution of these challenges will create the wrong

incentives and lead to banking fragility. On the other hand over regulation carries a danger that it will retard the development of national financial systems, hinder the best use of availabledomestic savings, prevent countries from assessing internationalcapital, and ultimately lead to slower growth. Finding the rightbalance between regulations, supervision, and reliance on


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market discipline is likely to be even more difficult in developingand transition countries.

As is well known, banks and the other financial intermediariesPerform three key functions: channeling funds from savers toinvestors, providing a payment system for transactions, anddistributing risk across space and time to those best able to bear them. While the first two continue to remain pivotal for thefunctioning of real economy, the risk distribution function hasbecome increasingly important as the financial instruments havebecome more complex.

For the development of the financial system, markets andintermediaries have to function jointly and effectively. Banks andfinancial intermediaries are seen as crucial to the functioning of markets, since they add value by reducing costs of participationin markets for individuals and firms. Indeed, this risk trading andmanagement is becoming a central function for financialintermediaries who, in addition, are becoming more adept atbundling and unbundling risks into instruments that other marketparticipants find more convenient to hold and manage.

In developing and emerging market economies banks are thedominant financial institutions. Many of these economies arecharacterized by low per capita income and asset levels,inadequate legal systems, a corporate sector dominated by smallfamily owned businesses, and inadequate accounting policiesand standards. In such an environment, individuals and firmshave a limited ability to contend with market volatility and there isa preference for risk sharing and risk smoothing contracts; agreater desire for stability, even at the expense of competitiveefficiency; and a corporate structure that favors bank financeover the use of capital markets. Banks provide a way to deal withthe deficiencies in the infrastructure needed for equity and bondmarkets to flourish. Banks take advantage of scale economies


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and a concentration of expertise to reduce the costs associatedwith financial transactions. Besides providing a return, theyprovide safekeeping, diversification and liquidity. Hence theregulatory framework for banks and the way it evolves are of fundamental importance to developing countries.

Technology has been a phenomenally important engine in thebanking system and bankers now take this as a fact of their life.Technology has made markets more open and contestable.

Advances in the computer technology and the credit scoringmethods are diminishing the asymmetries of information andreducing the value of possessing local knowledge. Besides

providing considerable flexibility in designing products, themarketing, advertising and delivery channels have become moreconvenient with the coming of the internet and e-banking. Seeingtheir franchises being eroded, traditional financial intermediarieshave reacted in many ways by:

y Making traditional banking products as attractive aspossible (efficient, speedy, convenient and useful) to

maintain traditional lines of business, and by moving intonew and riskier lending, for example, real estate loans.y Increasing fee based income by pursuing new (off

balance sheet) activities.y Becoming loan originators that use their capital to

generate loan bundles that are eventually securitized andsold in the debt markets.

y Extending their activities into new lines of business suchas insurance, investment banking and assetmanagement and also entering into joint ventures withthe corporate firms that have begun competing with themin retail banking.


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OBJECTIVE OF THE PROJECT:

The project aims at understanding off-balance

sheet activities, its types, rules and regulations

guiding them, the trading mechanism and evaluates

their growth trend in different types of banks in India

and their effect on non interest income of banks.


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OFF BALANCE SHEET ACTIVITIES AND ITSTYPES:

By the term off balance sheet activity, one refers to the variousfee/ commission based activities of banks which do not have anydirect reflection on the banks balance-sheet either on the assetor on the liability side.

As a regular part of their operation, some branches are involvedin originating financial contracts that may result in the acquisitionof certain assets and liabilities at some future date, under certain

conditions. Generally accepted accounting principles do notconsider these contracts in themselves to be assets or liabilitiesand, thus, do not recognize them on the face of the balancesheet. These off-balance-sheet items are quite diverse in natureand purpose and may include such instruments as firm loancommitments, standby letters of credit, foreign exchange,financial futures, forward contracts, options, interest rate swapcontracts, and other derivative products. Greater competition,marketing innovations, and government deregulation havechanged the focus of attention from contingent liabilities. Inaddition to assessing the risk in on-balance sheet instruments,examiners must also assess the risk of off-balance-sheetactivities. Branches are now involved in a wide spectrum of banking activities designed to generate fee income, such assecurities clearance and brokerage activities, data processingservices, and investment and management advisory services. Asthe branches find more avenues of non-traditional banking.

Activities available to them, they may expand the scope of services offered to customers. These new activities may involverisks which are difficult to quantify, such as legal risk, or reputational risk. In recent years, there has been significantgrowth in the volume of contingent liabilities related to variousderivative products. At the same time, growth in standby lettersof credit enhancements has moderated due to global risk based


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C apital considerations. There are many types of risks which theexaminer should be aware of: principal (position), credit, andsettlement risk (i.e., loss of principal due to default by acontractual party); interest rate (basis), market, and foreignexchange risk (i.e., depreciation of principal amount or loss of income due to rate, market or currency fluctuations); daylightoverdraft risk (i.e., exposure due to transactions originating andsettling during the same day); liquidity risk (i.e., lack of funds tohonor commitments leading to higher borrowing costs); countryrisk; and litigation risk. Of these, the major risk to consider wouldbe credit risk, interest rate risk, and market risk.It is essential that a system of controls be in place to limit off-

balance-sheet risk. These controls, including policies,procedures, recordkeeping systems, and audit coverage, shouldbe sufficiently detailed to ensure proper performance evaluationby branch and head office management, auditors, and regulatoryauthorities. Formal written policies, stating goals and strategiesand setting limitations at various levels, are necessary to preventabuses and to act as benchmarks against which, performancemay be gauged. A limit should be placed on an activitys totalvolume. In addition, limits should be established for individualcustomers, and parameters set for traders. Procedures shouldbe in place to ensure that operations are consistent with writtenpolicies. C omprehensive recordkeeping and reporting areneeded for adequate audit coverage and managementinformation. Most importantly, branch management should beaware of all off-balance-sheet activity and ensure that controlsand procedures are in place to identify and monitor attendantrisk.


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COMMITMENTS TO MAKE OR PURCHASE LOANS OR TO EXTEND CREDIT IN THE FORM OF LEASE FINANCING

ARRANGEMENTS:These transactions include the portion of commitments thatobligate the branch to extend credit in the form of loans(including credit card lines), participations in loans, leasefinancing receivables, or similar transactions. This categorywould include commitments for which the branch has charged acommitment fee or other consideration or otherwise has a legallybinding commitment.

STANDBY LETTERS OF CREDIT: A standby letter of credit provides for payment to the beneficiaryby the issuing bank in the event of default or nonperformance bythe account party (the issuing banks customer) upon thepresentation of a draft or documentation required in the letter of credit. A standby letter of credit, typically, is unsecured and isPayable against a simple statement of default or nonperformance.Letters of credit are the most widely used instrument to financeinternational trade transactions. The two major types of letters of credit used are the commercial documentary letter of credit andthe standby letter of credit.

1 . Commercial Documentary Letters Of Credit: A commercial documentary letter of credit is an instrument inwhich a bank (issuing bank) undertakes to pay a party(beneficiary) named in the instrument a sum of money on behalf of the banks customer (account party). This type of letter of credit is used most commonly to provide a banks credit andpossible financing to a commercial contract for the shipment of goods from seller to buyer. The beneficiary will be paid when the


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terms of the letter of credit are met and the required supportingdocuments are submitted to the paying or negotiating bank.

This type of letter of credit is used most commonly to provide abanks credit and possible financing to a commercial contract for the shipment of goods from seller to buyer. A commercialdocumentary letter of credit is a letter issued by a bank (issuingbank) on behalf of its customer (account party), a buyer of merchandise, to a seller (beneficiary), authorizing the seller todraw drafts up to a stipulated amount, under specified terms andundertaking to provide eventual payment for drafts drawn. Thebeneficiary will be paid when the terms of the letter of credit are

met and the required supporting documents are submitted to thepaying or negotiating bank. The issuance and negotiation bybanks of letters of credit are governed by Article 5 of the UniformC ommercial C ode and the Uniform C ustoms and Practice for Documentary C redits published by the International C hamber of C ommerce.

All letters of credit must be issued In favor of a definite beneficiary. For a specific amount of money. In a form clearly stating how payment to the beneficiary is to bemade and under what conditions. With a definite expiration date.C ommercial letters of credit are issued in either irrevocable or revocable form. An irrevocable letter of credit cannot be changedwithout the agreement of all parties. C onversely, a revocableletter of credit can be canceled or amended by the issuing bankat any time, without notice to or the agreement of the beneficiary.

An irrevocable letter of credit constitutes a definite commitmentby the issuing bank to pay, provided the beneficiary complieswith the letters terms and conditions. In contrast, the revocablecredit is not truly a bank credit but serves as a device thatprovides the buyer and seller a means of settling payments.


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Because a revocable credit can be canceled or changed withoutnotice, the beneficiary should not rely on the credit, but rather onthe willingness and ability of the buyer to meet the terms of theunderlying contract.The letter of credit may be sent to the beneficiary directly by theissuing bank or through the beneficiarys bank or through theissuing banks correspondent located in the same place as thebeneficiary. The correspondent may act as an advising bankthat is, it may act as an agent of the issuing bank in forwardingthe letter on to the beneficiary without any commitment to pay onits part. Advised letters of credit will bear a notation by theadvising bank that it makes no engagement or words to that

effect. An irrevocable advised letter of credit is, therefore, anundertaking to pay by the issuing bank but not by the advisingbank.Some beneficiaries (sellers), particularly those not familiar withthe issuing bank, request that the buyer have the issuing bankask the advising bank to add its confirmation to the issuingbanks irrevocable letter of credit. C onfirmed letters of credit areevidenced by the confirming banks notation: We undertakethat all drafts drawn . . . will be honored by us or similar words.The beneficiary of a confirmed credit has a definite commitmentto pay from a bank in his or her country and does not need to beconcerned with the willingness or ability of the issuing bank topay. One bank may play more than one role. For example, anadvising bank may add its confirmation and be designated inthe letter as the paying bank.Payment terms of a letter of credit usually vary from sight to 180days, although other terms sometimes are used. The letter willspecify on which bank drafts are to be drawn. If the draft isdrawn at sight, the bank will effect payment upon presentation of the draft provided the terms of the credit have been met. If thedraft is a time draft, the drawee bank can accept the draft (bystamping Accepted on the face of the draft), which then can beheld by either the seller or the sellers bank or the accepting


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shipment of the goods. However, this type of credit does notrequire a time draft to be presented for payment. Themerchandise is released without payment. Instead, the issuingbank undertakes to reimburse the paying bank at some futuredate as stipulated in the credit. Deferred payment credits arediscouraged by banks since no debt instrument exists todiscount. The obligation represents a direct liability of the bankand is booked in a manner similar to the liability booked for anacceptance.

A revolving letter of credit allows for the amount of the credit tobe renewed or automatically reinstated without specific

amendments to the credit. Such credits allow for flexibility incommercial dealings between exporters and importers; however,credits of this type usually specify a maximum overall amountwhich can be drawn for control purposes. C redits of this type canrevolve in relation to time or value, and be cumulative or noncumulative. In practice, the vast majority of letters of credit arenon revolving.Since the maximum exposure under an irrevocable revolvingcredit can be large, most revolving credits are issued inrevocable form.

Originally the clause in the letter of credit was written in red ink todraw attention to the special nature of the credit. Hence, thename Red Clause Credits. The use of this clause permits thebeneficiary to obtain an advance or pre shipment advances fromthe advising or confirming bank. Its purpose is to provide theseller credit. Any advances are the responsibility of the issuingbank. Interest is normally charged by the bank making theadvance until documents are presented and the bank isreimbursed by the issuing bank.Documentation is of paramount importance in all letter of credittransactions. The branch is required to examine all documentswith care to determine that they conform to all of the terms andconditions of the letter of credit. Ultimate repayment often


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depends upon the eventual sale of the goods involved. Thus, theproper handling and accuracy of the documents required under the letter of credit is of primary concern.

2 . Standby Letters Of Credit: A standby letter of credit provides for payment to the beneficiaryby the issuing bank in the event of default or nonperformance bythe account party (the issuing banks customer) upon thepresentation of a draft or the documentation, as required in theletter of credit. Although a standby letter of credit may arise froma commercial transaction, it usually is not linked directly to theshipment of goods from seller to buyer. It may cover

performance of a construction contract, serve as an assurance toa bank that the seller will honor his or her obligations under warranties, or relate to the payment of a purely monetaryobligation, for example, when the credit is used in backingpayment of commercial paper.Under all letters of credit, the banker expects the account partyto be financially able to meet his or her commitments. A bankerspayment under a commercial letter of credit for the customersaccount is usually reimbursed immediately by the customer anddoes not become a loan. However, payment under a standbyletter of credit generally occurs because the account party hasdefaulted on its primary obligation. That default can be a result of the customer being unable to pay or of a dispute between thebeneficiary and the account party.

A standby letter of credit transaction involves greater potentialrisk for the issuing bank than does a commercial documentaryletter of credit.Unless the transaction is fully secured, the issuer of a standbyletter of credit retains nothing of value to protect against loss,whereas a commercial documentary letter of credit may providethe bank with title to the goods being shipped. To reduce the riskof a standby letter of credit, the issuing banks credit analysis of the account party should be equivalent to that applicable to aborrower in an ordinary loan situation. For reporting purposes,


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standby letters of credit are shown as contingent liabilities in thebranchs Report of Assets and Liabilities. Depending on anyapplicable state and federal laws and regulations, standby lettersof credit may be subject to prudential limitations.

GUARANTEES ISSUED: A common example of a guarantee is a steamship letter of guarantee. Frequently, in an international sale of goods, themerchandise arrives at the importers (buyers) port and thecomplete negotiable bills of lading are either lost or delayed intransit. In such instances, it is customary for the importer (buyer)to obtain immediate possession of the goods by providing

the shipping company with a bank guarantee, often called asteamship guarantee, which relieves the shipping company of liability resulting from release of the goods without proper or complete negotiable title documents. Usually, the guaranteerelies on a counter-guarantee issued to the branch by theimporter.

All types of guarantees issued are to be recorded as contingentliabilities by the branch. Usually, the party for whom theguarantee was issued will reimburse the branch should it berequired to pay under the guarantee; however, in certainsituations, some other designated party may reimburse thebranch. That other party may be designated in the guaranteeagreement with the branch or in the guarantee instrument itself.The branch may also be reimbursed from segregated depositsheld, pledged collateral, or by a counter-guarantor.

Effective from July 1997, Branches do not have the authority toissue guarantees or sureties, except as may be incidental or usual in carrying on their banking business. Such an instancemay occur when a branch has a substantial interest in theperformance of the transaction involved or has a segregateddeposit sufficient to cover its total potential liability.

A branch may also guarantee or endorse notes or other obligations sold by the branch for its own account. The amount


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of the obligations covered by such guarantee or endorsement isto be recorded as a contingent liability on the records of thebranch. Furthermore, such liabilities are included in computingthe aggregate indebtedness of the branch, which may be subjectto limitations imposed by any applicable law or regulation.

ACCEPTANCES:

A bankers acceptance is a time draft or bill of exchangethat has been drawn on and accepted by a banking institution for payment by that institution at some future date. Participationsin acceptances conveyed to others by the accepting bank

include such transactions that provide for the other party to theparticipation to pay the amount of its participated share to theaccepting bank at the maturity of the acceptance, whether or not the account party defaults.

PARTICIPATIONS IN ACCEPTANCES ACQUIRED BYTHE SUBJECT BRANCH: Participations in acceptances of other banks acquired by thebranch (non accepting bank) include such transactions thatprovide for the non accepting bank to pay the amount of itsParticipated share to the accepting bank at the maturity of theacceptance, whether or not the account party defaults.


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C ontingent liabilities containing interest, market, and credit riskinclude the following categories:

FUTURES AND FORWARD CONTRACTS:

Futures and forward contracts are tools for use in asset andliability management, and can be used by branches to effectivelyhedge portions of their portfolios against interest rate risk.Branches that engage in futures and forward contract activitiesshould only do so in accordance with safe and sound bankingpractices, with levels of activity reasonably related to thebranchs business needs and capacity to fulfill its obligations

under the contracts. In managing their assets and liabilities,branches should evaluate the interest rate risk exposureresulting from their overall activities to ensure that the positionsthey take in futures and forward contract markets will reducetheir risk exposure. Policy objectives should be formulated inlight of the branchs entire asset and liability mix. Definitionsof futures and forward contracts are as follows:

Futures contracts :These are standardized contracts traded on organizedexchanges to purchase or sell a specified security, moneymarket instrument, or other financial undertaking on a future dateat a specified price. Accordingly, the credit exposure is to theexchange and is generally considered to be negligible. However,this may not be the case for exchanges in less developedcountries.


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Forward contracts:

These are over-the-counter contracts for forward placement or delayed delivery of securities in which one party agrees topurchase and another to sell a specified security at a specifiedprice for future delivery. C ontracts specifying settlement inexcess of 30 days following trade date are considered to beforward contracts. Forward contracts are not traded on organizedexchanges, generally have no required margin payments, andcan only be terminated by agreement of both parties to thetransaction.

STANDBY CONTRACTS AND OTHER OPTION ARRANGEMENTS:

Standby contracts and other option arrangements are also toolsfor asset and liability management which, when properly used,can reduce the risks of interest rate fluctuations. Standbycontracts are optional delivery forward contracts on U.S.government and agency securities, arranged between securitiesdealers and customers. The buyer of a standby contract (put -option) acquires, upon paying a fee, the right to sell securities tothe other party at a stated price at a future time. The seller of thestandby (the issuer) receives the fee and must stand ready tobuy the securities at the other partys option. Exchange trading isconducted in options specifying delivery of debt securities,money market instruments, or futures contracts specifyingdelivery of debt securities.

FOREIGN EXCHANGE CONTRACTS:

These are contracts to exchange one currency for another as of a specified date and time at a specified rate of exchange (price).Delivery of the currency may be spot (two or less business days)or forward (more than two business days).


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INTEREST RATE SWAP CONTRACTS:Interest rate swap contacts are private, over-the counter contracts between counterparties for exchanging interestpayments for a specified period based on a notional principalamount. Entities generally enter into interest rate swaps for interest rate risk management; namely, to manage the interestrate exposures arising from asset and liability positions.


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REGULATION ISSUES:

As banking system is changing and is becoming multi faceted,

the major concern is to regulate all those banks properly that inthe face of increasing competition may be tempted to takeimprudent risks in existing or new lines of business. Regulatorshave to impose heavy handed regulations to prevent marketsfrom creating synthetic instruments that mimic the pay-offs frominstruments not allowed by law. And for the design of regulationthere are four key challenges:

y There is the need to redefine risk based capitalstandard to more accurately reflect the risks that areactually being borne, particularly when operating withsome new financial instruments.

y The complexity and rapidity with which the balancesheet of financial intermediaries can change has madethe traditional capital standard less appropriate as aregulatory tool.

y The blurring distinction across instruments and acrossinstitutions has created a greater need for defining alevel playing field to prevent regulatory arbitrage. Thisis not easy because from an efficiency perspective theconcern is with making sure that financial functions areperformed, whereas from a stability perspective thefocus is on the solvency and health of institutions.

y C onsolidation is creating more institutions that may betoo big to fail. It is therefore imperative that theregulatory framework and supervision be designed to

prevent moral hazard on the part of largeintermediaries, and regulators explore new ways toprovide a safety net for financial institutions.


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Banking Regulation And Its Evolution:

C hanges in bank regulation in 1970s and 1980s came about asa response to three factors. First, the deregulation of interest andexchange rates occurred at the time when macroeconomicenvironment changed. High and variable inflation generated ademand for new hedging products, made savers seek higher yields and generally intensified banking competition. Second,advances in IT revolutionized the financial industry. Thirdly, theglobalization of banking made domestic banks compete withforeign ones, and initiated a global debate on comparing theefficacy of regulatory frameworks. It was because of all thesereasons Basel committee of the Bank for internationalsettlements (BIS) formulated the first Basel accord.The original accord or Basel 1st, was signed in 1988emphasized the importance of adequate capital. And this accordmainly dealt with credit risk.Banks reacted to Basel 1st by finding ways to economize on

capital. Like banks took more interest rate risk, market andoperational risk. Further by using the bank capital to originateloans, they also found it profitable to securitize part of their balance sheet and generate fee income. This resulted in bankskeeping their low quality assets on their balance sheet becausethrough securitization it was easier to off-load their higher quality(less risky) assets.The deficiencies of Basel 1st sent the Basel committee back tothe drawing board to improve on the earlier rules by making therisk assessment more accurate and comprehensive. In 1999, itformalized Basel 2 nd in a consultative paper and put forward athree pillar approach to regulating banks. The first pillar is,Regulations which covers the rules imposed by the officialregulators. The second pillar is Supervision, which covers themonitoring and enforcement of regulations and the third pillar is


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Market discipline that stresses on the enforcement of goodbehavior by financial markets and institutions.

Given the changes in the way banks operate, the weight of regulation has shifted from the first pillar to the second and thirdpillars. Direct regulation of risks is seen as increasingly difficultand regulators are indirectly relating them by approving thebanks risk management processes. This shift in emphasis is inpart due to the recognition that financial engineering can be usedby banks and other intermediaries to escape regulation. It alsoreflects the realization that given the complexity and rapidity of balance sheet changes, and the limited availability of regulatory

resources, continuous surveillance of banks is a formidableundertaking.Bank regulation is necessary because of financial externalities.

The system by design is leveraged; banks are intimately involvedwith the payment system on whose integrity the functioning of amarket economy rests; dangers from the failure of any bank isever present; and there is need to protect the deposit insurancefund and in extreme circumstances limit the losses to the taxpayer. Basel 2 nd is an attempt to design bank regulations for thenews banking environment. Now increased focus will not be onaccounting rules, but instead on assessing the methodologiesand models used for estimating risks and the stress testsconducted to judge the adequacy of capital cushions. This willrequire considerable expertise in banks and regulatory agencies.Further, the development of markets and their help in providingdiscipline on banks is going to require an ingredient that is notemphasized enough namely, political discipline. Only with astrong measure of political discipline will countries be able tohandle banking problems and contain devastation they can bringwhen regulatory frameworks, which perpetually play catch upwith market and institutional changes, fall too far behind.


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Authorization for every trader to conduct trades; Reporting lines for trading and back office staff; Guidelines for the frequency of preparing management reports; Guidelines for calculating open positions; Procedures for estimating the risk inherent in open positions; Position limits and stop-loss limits for each product and eachtrader; and, Procedures for obtaining approval to trade a new product.If traders have exceeded the limits established in the policies, itis determined whether traders and management took appropriateaction, and whether details of the instance(s)were documented

and communicated to senior management. Traders prior experience and the level of ongoing training is reviewed for adequacy. The traders journals should be reviewed to determinewhether profit and loss and open positions agree with officialinternal records, activities conducted are consistent with thestrategy and objectives stated by management, transactions areaccurately reported, and authorized transactions are beingconducted.

MANAGEMENT INFORMATION REPORTS:- Management reports should contain sufficient information toprovide management with an adequate level of understanding of the branchs trading activities. Reports should detail trader positions, daily revaluation of open positions, interest sensitivegaps, and profit and loss. The accuracy of management reportsshould be tested using subsidiary records to recalculate figures.Reported figures for open positions should also be compared tolimits established in the policies.Generally, reports for open positions and interest sensitivityshould be prepared daily, and those for profit and loss andrevaluations should be prepared at least weekly. At a minimum,the frequency of reports should be consistent with limits. For example, if the policy establishes an intra-day open position limit,


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the profit and loss should be calculated several times during theday.

OPERATIONAL CONTROLS:- Examiners must evaluate the effectiveness of establishedoperational controls within the trading function. These controlsshould cover segregation of duties, systems for reconcilingtrading positions, profits and losses, and value at risk; andshould establish a system for settling trade transactions. Inaddition, internal audits of the offices trading activities should beconducted regularly.Segregation of duties will ensure that instances of fraud or

embezzlement, or violations of regulations are minimized. Thereis a clear need to separate trading personnel from control of receipts, disbursements and custody functions. Personsexecuting transactions should not confirm, reconcile, revalue, or clear transactions or control the disbursement of funds,securities or other payments. Persons initiating transactionsshould not confirm trades, revalue positions, approve or makegeneral ledger entries, or resolve disputed trades.Reconciliations should be performed on a timely basis. Personsperforming reconciliations should be independent of the personresponsible for the input of transaction data. In addition,segregation must occur between persons reconciling andpersons confirming transactions. Any discrepancies should bebrought immediately to the attention of the appropriateoperations manager.Examiners should review the various methods of settlement or the range of products traded, and any exceptions to commonlyaccepted practices should be noted. Unsettled items should bemonitored closely by the branch. Settlement risk should becontrolled through the continuous monitoring of movement of thebranchs money and securities and by the establishment of counterparty limits. Internal audits of the branchs tradingactivities should be conducted regularly. The frequency of internal audits will depend upon the complexity and level of


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activity of the branchs trading operations. The scope of theaudits should include a review of trading risk management.Procedures for following up on audit exceptions should beadequate. The examiner should review the internal audit reportsto determine the severity of deficiencies identified, and shoulddetermine whether management implemented corrective actionin a timely manner. Generally, the head trader has regular meetings with senior management. If minutes of these meetingsare maintained, the minutes should be reviewed to determine thefollowing: Management was adequately informed of the risks taken;

C ircumstances when traders exceeded limits were reported to

management; Management was informed when market conditions wereunfavorable to existing positions; Any improper activities or defalcation were disclosed; andinformation in the minutes is accurate.If minutes are not maintained, or meetings are not held, theexaminer should recommend the branch do so if the amount of activity warrants such a practice.


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OFF BALANCE SHEET ACTIVITIES OF BANKSIN INDIA:

For banks operating in India, off balance sheet activities havebecome important in the reform years because of the followingreasons:

(i) The deregulation of the banking sector entry and relaxation of branch licensing policy resulted in substantial decline in bankingsector spread ( in terms of total assets) compelling thecommercial banks to look for some other source of income.

(ii) The introduction of asset classification, income recognitionand capital adequacy norms made lending a relatively riskyproposition.

(iii) Financial sector policies in the reform period provided greater room for the banks to engage in off balance sheet activities ascompared to the pre-reform period.

For the foreign commercial banks operating in India, off balancesheet activities generated a significant proportion of their incomes even during the pre-reform period. However, for theIndian commercial banks, these activities were relativelyunimportant as the banks depended mainly on their fund basedactivities for the generation of income. The scenario however changed considerably during the reform period.

Tables given on next page provides a sketchy view of the off balance sheet exposure profile of the Indian banks from 2004-05to 2008-09.


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Off Balance Sheet Exposure of Foreign Banks

(200 4-05 to 200 8-09) (Figures in Rupees lakhs )

ItemsYEARS

2004-05 2005-06 2006-07 2007-08 2008-09

Liability on account of outstanding future contracts 116190323 2184 02025 422 152754 857929748 58587 1308

Guaran tees

1. i n Ind ia 1338341 1814802 2357357 3333054 4178306

2. o u tsi d e Ind ia 581165 666457 970570 1225341 1545744

Acceptances, endorsements

and other obligations1385625 2101 610 307824 0 4034 043 40468 15

othe r s39568148 32433279 76475464 154552262

10 6424542

Tot al 159063602 255418173 505034385 1021074448 702066715


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0

20000000

40000000

60000000

80000000

1E+09

1. 2E+09

200 4-05 200 5-06 200 6-07 200 7-08 200 8-09

Off Balanc e Sheet Expos ur e o f Fo r eig n Bank s

200 4-05

200 5-06

200 6-07

200 7-08

200 8-09


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Off Balance Sheet Exposure of State Bank of India and its Associates(200 4-05 to 200 8-09) (Figures in Rupees lacs )

ItemsYEARS

2004-05 2005-06 2006-07 2007-08 2008-09

Liability on account of outstanding future contracts 12535104 187 04879 25876623 41511 584 39 101 76 1

Guaran tees

1. i n Ind ia 1757305 2634739 32 09787 464 0922 618576 0

2. o u tsi d e Ind ia 560480 628397 1456294 1503067 27 1210 3

Acceptances, endorsementsand other obligations 3424991 0 0 0 0

othe r s2247827

0 0 0 0

Tot al 20525707 21968015 30542704 47655573 47999624


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0

5000000

10000000

15000000

20000000

25 000000

30000000

35 000000

40000000

45 000000

50000000

200 4-05 200 5-06 200 6-07 200 7-08 200 8-09

Off Balanc e Sheet Expos ur e o f Sta te B ank o f Ind ia and its Asso c ia tes

200 4-05

200 5-06

200 6-07

200 7-08

200 8-09


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Off Balance Sheet Exposure of Nationalized Banks


ItemsYEARS

2004-05 2005-06 2006-07 2007-08 2008-09

Liability on account of outstanding future contracts 28980713 3182665 1 354 1695 0 11 292 047 141348 12

Guaran tees

1. i n Ind ia 4963768 6410406 8124372 11648288 9227242

2. o u tsi d e Ind ia 611507 687912 981067 92203490 104968048


othe r s6962276

0 0 0 0

Tot al 47856156 38924969 44522389 115143825 128330102


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0

20000000

40000000

60000000

80000000

10000000

12000000

14000000

200 4-05 200 5-06 200 6-07 200 7-08 200 8-09

Off Balanc e Sheet Expos ur e o f Na tio nal ize d Bank s

200 4-05

200 5-06

200 6-07

200 7-08

200 8-09


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Off Balance Sheet Exposure of Scheduled Commercial Banks


ItemsYEARS

2004-05 2005-06 2006-07 2007-08 2008-09

Liability on account of outstanding future contracts 21705543 46995495 75079283 130282139 101635932

Guaran tees

1. i n Ind ia 2325351 3059886 4351409 6716090 9031884

2. o u tsi d e Ind ia 176451 220274 510866 768266 1358718


othe r s27100202 31598547 48648415 97513894 55023075

Tot al 54047035 85317281 133009276 242101813 174187114


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0

50000000

10000000

15000000

20000000

25 000000

30000000

200 4-05 200 5-06 200 6-07 200 7-08 200 8-09

YEARS

o ff b alanc e sheet expos ur e o f sc he dul e d c omme rc ial b ank s:


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The table given below gives the information about the position of non-interest income earned by different groups of banksoperating in India from 2004-05 to 2008-09:


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The charts given below depict the growth trend in the noninterest income earned by different groups of banks from 2004 -2005 to 2008-09:

Graphical presentation of non interest income earned bystate bank of India and its associates:

0

200000

400000

600000

800000

1000000

1200000

1400000

1600000

1800000

200 4-05 200 5-06 200 6-07 200 7-08 200 8-09

years (amount in lacs )

State Bank Of India And ItsAssociates


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Graphical presentation of non interest income earned byNationalized banks from 2004-05 to 2008-09:

Graphical presentation of non interest income earned byOther scheduled commercial banks :

0

500000

1000000

1500000

2000000

25 00000

3000000

1 2 3 4 5

Nationalized Banks

0200000400000600000800000

100000012000001400000160000018000002000000

200 4-05 200 5-06 200 6-07 200 7-08 200 8-09

years (amount in lacs )

Other Scheduled CommercialBanks


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INTERPRETATION:

For the purpose of comparison, we have excluded foreign banks

as they used to deal in off balance sheet activities before thereforms. While making a comparison between state bank of India

and its associates, nationalized banks and scheduled

commercial banks we can conclude that all the three

classifications show an upward trend i.e. they have increased

their off balance sheet exposure.

As far as SBI and its associates are concerned they have

increased their off balance sheet exposure from 2,05,25,707 lacs

in 2004-05 to 4,79.99,624 lacs in 2008-09. The percentage

change in their off balance sheet exposure is about 133%. From

the graph we can see that they have not increased much from

2007-08 to 2008-09 and the reason for this can be attributed tothe global recession.

The nationalized banks have moved from 4,78,56,156 lacs to

12,83,30,102 lacs in 2008-09 with the percentage increase of

168% approximately.

The scheduled commercial banks have moved from 5,40,47,035

lacs to 17,41,87,114 lacs. Recession have affected the

scheduled commercial banks to a great extend as their off

balance sheet activities have decreased from 24,21,01,813 lacs

in 2007-08 to 17,41,87,114 lacs in 2008-09. But still the

percentage change from 2004-05 to 2008-09 is 222%


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approximately, thus depicting that the scheduled commercial

banks are doing much better than nationalized banks and SBI

and its associates. SBI and its associates and nationalized

banks seem to have a conservative approach towards off

balance sheet activities. It is because these banks are managed

by government and thus do not expose themselves to much risk.

Now, while comparing their non interest incomes, one can see

that SBI and its associates have earned 16,07,002 lacs in 2008-09 as compared to 9,46,800 lacs in 2004-05. The percentage

increase being 69% approximately.

The nationalized banks have earned 26,10,800 lacs in 2008-09

as compared to 14,52,900 lacs in 2004-05 with the percentage

increase of 80% approximately.

The scheduled commercial banks have earned 17,94,800 lacs in

2008-09 as compared to 6,33,400 lacs in 2004-05 with the

percentage increase of 183.35% approximately.

Hence, it can be said that the scheduled commercial banks have

been more efficient in tapping the growing market of off balance

sheet activities.


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