Documente Academic
Documente Profesional
Documente Cultură
Banking Business
Busines of Banking
&
Types & Constitution of Banks
Contents
3
Definition of Banking Business
Acceptance of deposits of money from the public for the purpose of lending or investment.
Involves two basic functions (a) acceptance of deposits (b) lending or investments of such
deposits.
The deposits are repayable on demand or at an agreed time frame.
Banks can accept ‘deposits of money’ and not anything else for lending & investments.
4
Permitted Business under Banking
5
Prohibited business under Banking
Holding property beyond seven years except as is required for its own use.
6
Types of Banks & constitution of Banks
7
Reserve Bank of India Act, 1934
RBI Act, 1934 Does not directly deal with the regulation of Banking system but plays the
role of a regulator.
8
Banking Regulation Act, 1949
Issues guidelines regarding loans & advances, interest rates, maintenance of assets,
selective credit control.
Issues guidelines regarding audit, inspection and submission of Balance Sheet & other
financials.
9
Session - 2
2. Branch Licensing
3. Capital Requirements
6. Board of Directors
11
Licensing Requirements
12
Branch Licensing
• Specific RBI permission is required for providing foreign exchange services from any Branch.
• Registration with SEBI is required for undertaking capital market activities.
• Bank branches are required to obtain license under the Shops & Establishment Act also
before commencing Branch operations.
13
Capital Requirements
• Multi State Bank with place of business in Mumbai and/or Calcutta INR 1,000,000
• Bank with operations in one state only but no place of business in INR 100,000
Mumbai or Calcutta
• Bank with operations in one state only but place of business in INR 500,000
Mumbai or Calcutta
• For Banking Companies Incorporated outside India
• No Place of business in Mumbai or Calcutta INR 1,500,000
• Place of business in Mumbai or Calcutta INR 2,000,000
• New Banks
• New Private Sector Banks INR 200 Crores
• Foreign Bank USD 50 Mn
• The authorised capital of each public sector Bank cannot be less than INR 1500 Crores
14
Tier I & Tier II Capital
• The present Capital Adequacy ratio is 8% comprising of Tier I & Tier II Capital
• Tier I Capital
15
Shareholding & Voting Rights
• Shareholding in Banks
• Banks are allowed to issue there shares to the Indian public without any ceiling.
• Foreign investors are allowed to hold only upto 10% of Paid–up capital in Indian
Commercial Banks.
• Shareholding by Banks
• Allowed to form subsidiaries with 100% holding, but only for
- Carrying on Banking Business
- Carrying on banking business exclusively outside India
• Allowed to hold shares in other companies subject to a maximum of
- 30% of paid up capital of the ‘other’ company
- 30% of its own paid up capital
• Holding of shares in any company where the Managing Director or Manger is
interested is prohibited.
• Voting Rights
• One vote for every share subject to maximum of 10% of total voting rights.
• One vote for every share holder in case of Co-operative Banks.
• No restriction applicable on voting rights of the Govt. of India in Public Sector Banks.
16
Board of Directors
1. Reserve Funds
19
Reserve Funds
• Reserve Funds are a means of regulating lending activity of Banks to ensure safety and
timely return of depositors money.
Foreign Banks
• Every year 20% of the profits is to be deposited with RBI.
• Exemption can be given by Central Govt. on RBI recommendation to Banks which have
adequate paid-up capital & reserves in relation to its deposit liabilities.
20
Maintenance of Cash Reserves
• Every Scheduled Bank has to Maintain an average daily Cash Reserve with RBI.
• Also known as the Cash Reserve Ratio or CRR.
• At present the CRR to be maintained is 7.5% of the aggregate demand & time liabilities.
• The CRR can be increase by RBI upto 20% of the total demand & time liabilities.
• Liabilities for calculating CRR would not include borrowings from NABARD, RRB, RBI, EXIM
Bank & other banks except state co-op banks
• The Banks receive interest at the rate of 6% from RBI.
• Non Scheduled Banks need not maintain CRR at 30% of demand & time liabilities.
• The CRR need not be maintained with RBI, it can be with the Bank itself.
• A return needs to be filed with RBI before 20th of every month showing amount so held every
alternate Friday.
21
Maintenance of Liquid Assets
• Every Banking company has to maintain in India, 20% of daily demand & time liabilities
in liquid assets.
• Every Banking company has to maintain in India, 25% of daily demand & time liabilities
in India in liquid assets. This can be raised to 40% by RBI.
22
Maintenance of Assets in India
• Every Banking company has to maintain in India, assets worth 75% of demand & time
liabilities in India at the end of each quarter. .
• This is to ensure resources mobilised in India are largely invested in India.
• A return within 30 days of the end of the quarter is submitted to RBI showing amount so held.
23
Priority Sector Lending
• Those sectors which should receive priority in lending over other sectors as they are
important for development of the basic needs of the country.
Priority sector includes
• Primary Sector – agriculture & allied activities.
• Secondary Sector – SSI’s, Cottage industries, tiny industries, Small scale service &
business enterprises.
• Tertiary Sector - small road & water supply operators, self employed & professionals,
education, housing, retail traders.
Banks incorporated in India
• 40% of all advances have to be made to the Priority Sector.
• 18% of all advances to priority sector should go to the agricultural sector.
• 12% of all advances to priority sector should go towards export finance.
• 10% of all advances to priority sector should go to weaker sections.
Foreign Banks
• 40% of all advances have to be made to the Priority Sector.
• 12% of all advances to priority sector should go towards SSI’s & export finance.
• Any shortfall towards lending to SSI’s can be invested in bonds issued by SIDBI.
24
Session – 4
26
Major Generic Client Groups & Products
• Banking Services
• Investment advisory Transaction Banking
• Discretionary portfolio mgt
• Estate planning Private Equity
•Trust
Asset Management
27
Fundamental Principles of Lending
• Since lending is one of the major activities of banks its fundamental principles are of utmost
importance.
• Safety - Since banks deal with money borrowed from depositors it has to be satisfied
that the advance is safe and will be recoverable in future.
• Liquidity - 70% of banks deposits are payable within a year. Hence lending should
ensure that money is not locked for a long period of time. It should be in line
with the repayment schedule.
• Risk Diversification - Advances should be diversified across locations, industry, business houses
and borrowers.
28
Credit Facilities
29
Bill Finance
• Bill Finance involves discounting or purchase of bills arising out of sale of goods.
• Bill Finance entitles the bank to the ownership of the instrument / bill.
• Bills can be clean or documentary. Clean Bills are not supported by documents of title to the
goods whereas Documentary Bills contain title to the goods.
• Bills Discounting - Bills payable after a period of time that is not on demand.
• Adv against Bills for Collection - Advance payment extended by banks against bills after keeping a
prescribed margin.
• Drawee Bills Acceptance - Bank makes payment against the bills to the drawer and is
reimbursed by the borrower with interest.
• Bills Co-acceptance facility - Bank accepts the bill along with the borrower thus undertaking
joint
liability for the payment to the drawer of the bill.
30
Bank Guarantees
• It’s a guarantee given by a bank to a third party to pay him a certain amount on behalf of a
customer on the failure of the customer to fulfill any contractual obligation.
. Types of Bank Guarantees
- Financial Guarantee - issued as a proxy to Earnest Money Deposit requirements in
contractual works.
- Performance Guarantee - issued as a guarantee that the customer will perform as per the
conditions stipulated in in the contract.
- Deferred Payment Guarantee - issued as a guarantee towards payment of instalments over a
period of time
- Statutory Guarantees - issued to courts & other statutory bodies guaranteeing that the
customer will honour his commitments imposed under law
• Bank Guarantees are independent contract between the Bank & the Third Party and Bank’s
obligation to pay Primary i.e. not dependent any any dispute between the beneficiary & the
customer.
• Every Bank Guarantees has a stipulated financial liability and a fixed period of validity & claim period.
• Under the Law of limitation a beneficiary can enforce the claim against the Bank within 30 years if it
is a Govt. Dept or within 3 years in other cases.
31
Letter of Credits
• Used mostly in foreign trade for effecting payment by bankers on behalf of its customer to
suppliers of goods & services on production of documents as stipulated in the LC.
• Also known as documentary credit and is governed by Uniform Customs & Practice for Documentary
Credits (UCPDC-500) released by the International Chamber of Commerce.
32
Letter of Credits …. Contd.
• Types of LC’s
Acceptance Credit - Immediate Payment on LC Usance Bills - Payment over a agreed period of
time.
Revocable - Can be cancelled without notice Irrevocable - No cancellation without sellers consent
With Recourse - Seller remains liable to its bank Without Recourse – No Liability of the seller to its bank
for payment by the buyer/ bank. for payment by buyer / bank.
Anticipatory LC – Preshipment advance allowed Revolving LC – Continual LC for regular trade.
33
Fixed Income
• Fixed income refers to any type of investment that yields a regular or fixed return.
• Refers largely to Bonds, Debentures & Preferred Stocks.
Bonds
• A Bond is a debt security, in which the issuer owes the holders a debt and is obliged to repay the
principal and interest (coupon) on maturity .
Types of Bonds by issuer
• Sovereign/Government Bonds
• Agency Bonds / Municipal Bonds
• Corporate Bonds - Senior Debt & Subordinated Debt
Types of Bonds by payout
• Fixed Rate Bonds - have a coupon that remains constant throughout the life of the bond
• Floating Rate Bonds - have a coupon that is linked to a money market index
• Zero Coupon Bond - do not pay any interest but trade at a substantial discount from par value
• Inflation Index Bond - in which the principal amount is indexed to inflation
• Accrual Bond – fixed interest bond issued at face value and repaid at maturity with accrued interest
• Convertible Bond - can be converted into shares of issuing company at some pre-announced ratio
• High Yield Debt Bond - are bonds that are rated below investment grade but come with a high coupon
34
Contd….
Fixed Income …,. Contd
Preferred Stock
• Preferred stocks are preference shares issued by companies.
• There is a preference over dividend payouts to these shareholders as compared to
Ordinary share holders.
• Often dividends not paid in any year is accumulated and paid when surplus is available.
• These may not always be referred as Fixed Income
Debentures
• A Debenture is a long-term debt instrument used by governments and large companies to obtain funds .
• It is similar to a Bond except that a debenture is usually unsecured in the sense that there are no
pledges on specific assets
• It is however secured by all properties not otherwise pledged
• In the case of bankruptcy debenture holders are considered as general creditors.
35
Money Market Instruments
• Money market is the global financial market for short-term borrowing and lending typically upto 13
months.
• The money market consists of banks, financial institutions, trading companies, dealers in money or credit
• Is affected by liquidity / money supply in the market.
• The need to borrow money from the call money market arises due to short-term mismatches of funds.
• As a part of their operations, banks borrow money from their depositors and lend money to their
borrowers. In this process, banks’ assets and liabilities get locked into different maturity brackets.
Common Money Market Instruments
• Certificate of Deposits - A time deposit at a bank with a specific maturity date. It is generally insured
hence risk free.
• Commercial Paper - An unsecured promissory notes issued by corporates with a fixed maturity of
one to 270 days issued ; usually sold at a discount from face value.
• Inter-corporate Deposits - Unsecured loan issued by one corporate to another.
• Treasury Bills - Short-term debt obligations of a national government that are issued with
maturity of 3 to 12 months.
• Call Money - This market deals with overnight borrowing and lending among the banks.
36
Session – 5
1. Derivatives
2. Foreign Exchange
3. Securitisation
4. Transaction Banking
5. Asset Management
38
Derivatives
• A product that is derived from the value of an underlying assets such as currency, commodities,
shares, bonds or any of the indices.
• These are contracts which aim to hedge against uncertain movements in prices of the underlying
assets.
• Derivatives could be Over the Counter (OTC) - i.e. made to order on specific requirements.
Exchanged Traded (ETC) - i.e. standardized products traded on exchanges
Types of Derivatives
• Forward Contracts - Is an OTC derivative involving fixation of rates in advance for deliveries in future.
- The seller agrees to deliver goods to the buyer on a future date at a fixed rate.
- The rate specified is known as forward rate and is at a premium or discount to
the spot rate.
- Since price is fixed today it eliminates risk of any adverse price movements.
- Delivery under forward contracts is essential.
- Margins are not necessary and are not marked to market every day.
39
Derivatives ……Contd.
• Options - Is an ETC derivative conveying the rights to buy or sell an agreed quantity, at an
agreed price without any obligation to do so.
- Involves a right to the option buyer to allow the option contract to lapse without
any obligation to buy or sell.
- The option buyer exercises this option on payment of a premium which is levied
upfront.
- The Option seller usually a bank or FI is under obligation to deliver the contract.
- Options conferring a right to buy at a fixed rate on or before a fixed date are
called Call Options.
- Options conferring a right to sell at a fixed rate on or before a fixed date are
called Put Options.
• Swaps - It is an OTC derivative involving Currency Swaps or Interest Rate Swaps only.
- Involves simultaneous sale and purchase of one currency or interest stream for
another.
- Currency Swaps involve exchange of pre-determined streams of payments in
different currencies on pre-determined dates, at pre-determined exchange
rates.
- Interest Rate Swaps involves exchange of different streams of interest structures
• The foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another.
• Forex rate is the price of one currency expressed in terms of another currency
• It is by far the largest financial market in the world, and includes trading between large banks, central
banks, currency speculators, multinational companies, governments.
• It is a 24 hour OTC market and is currently is over USD 3 trillion in size.
• There is a high fluctuation in currency rates (every 4 seconds)
• Settlements are affected by time zone factors
Contd…..
41
Foreign Exchange ……Contd
• Securitisation is the process of conversion of existing assets or future cash flows into marketable
securities.
• It deals with conversion of assets which are not marketable into marketable ones.
• The conversion of existing assets into marketable securities is known as asset-backed securitisation
• The conversion of future cash flows into marketable securities is known as future-flows securitisation.
• Some of the assets that can be securitised are loans like car loans, housing loans
• Some of the future cash flows that can be securitised are credit card payments, car rentals or any other
form of future receivables.
• Banks have a pool of assets where funds are locked.
• To free these blocked funds the assets are transferred by the originator to a Special Purpose Vehicle
(SPV)
•The SPV will act as an intermediary which divides the assets of the originator into marketable securities
• Only one type of asset (eg: auto loans) of similar maturity (eg: 20 to 24 months) will be bundled together for
creating the securitised instrument .
• These securities are issued by the SPV to investors and are known as pass-through-certificates (PTCs).
• The difference between rate of interest payable by the obligor and return promised to the investor investing
in PTCs is the servicing fee for the SPV
43
Transaction Banking
44
Asset Management
• Asset Management is the management of the financial assets in order to maximize return
• Major objective of Asset Management is Long Term Returns and Risk Diversification.
• Forms of Asset Management
• A mutual fund is a professionally-managed firm of collective investments that collects money from
many investors and invests it in stocks, bonds, money market instruments, and/or other securities.
• Investment Managers conduct an assessment of each client's individual needs and risk profile
before recommending appropriate investments.
45
Session – 6
Contd…..
47
New Age Banking Technology ….Contd.
• SWIFT
- Stands for Society for Worldwide Inter Bank Financial Telecommunications
- SIWFT is a message transmission system wholly owned by its 200+ member banks
- All message formats standardised ; 400+ standardised formats are available
- SWIFT assumes financial liability for accuracy & timely delivery of all messages
• CHIPS
- Stands for Clearing House Inter Bank Payment System
- Is run by New York Clearing House for transfer of payments internationally
- Most international fund transfers happen through CHIPS as most international trade happens in USDs
- Settlement of payments carried through CHIPS is through Federal Reserve Bank
- Has direct interface with SWIFT system
• CHAPS
- Stands for Clearing House Automated Payment Systems
- Set up in the UK
• CHATS
- Stands for Clearing House Automated Transfer Systems
- Set up in Hong Kong
48
Session – 7
Risk Management
Risk Management
• Risk Management is a structured approach to managing uncertainty through risk assessment, developing
strategies to manage it, and mitigation of risk.
50
Risk Management …. Contd
51