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Financial guarantees
• Standby letters of credit:
• In a traditional letter of credit, the beneficiary obtains
payment against documents evidencing
performance. In a standby credit, the beneficiary
usually obtains payment from a bank when the
applicant for the credit has failed to perform as per
contract
• Financial SLCs: Backup lines of credit on bonds, notes,
and commercial paper serve as guarantee.
• Performance SLCs: Completion of construction
contracts guaranteed.
• SLCs are considered loans. They may be
collateralized.
• Bank loan commitments:
• Promise by a bank to a customer to make a future
loan under certain conditions. Most commercial and
industrial loans are made under some form of
guarantee (informal or formal).
Financial guarantees
• Note issuance facilities
A syndicate of commercial banks that have
agreed to purchase any short to medium-term
notes that a borrower is unable to sell in the
eurocurrency market
The bank acts as an underwriter. Should the
borrower be unable to sell all notes, the syndicate
is obligated to purchase all the remaining notes
from the borrower, essentially providing credit.
Note issuance facilities are useful in reducing risk
and costs for both the borrower and the lender.
Derivatives
• Forward Rate Agreement (FRA) –
It is a forward contract in which one party pays a fixed
interest rate, and receives a floating interest rate equal to
a reference rate (the underlying rate)
• Interest Rate Swap (IRS)
An agreement between two parties (known as
counterparties) where one stream of future interest
payments is exchanged for another based on a specified
principal amount. Interest rate swaps often exchange a
fixed payment for a floating payment that is linked to an
interest rate (most often the LIBOR).
• Interest Rate Futures (IRF)
An interest rate future is a financial derivative (a futures
contract) with an interest-bearing instrument as the
underlying asset.
• Interest Rate Caps and Floors
An interest rate cap is an interest rate option in which
payments are made when the reference rate exceeds the
strike rate. Analogously, an interest rate floor is an interest
Derivatives
• Foreign Exchange Forward
A foreign exchange forward is an over-the-
counter contract under which a purchaser agrees
to buy from the seller, and the seller agrees to sell
to the purchaser, a specified amount of a
specified currency on a specified date in the
future - beyond the spot settlement date - at a
known price denominated in 26 another currency
(known as the forward price) that is specified at
the time the contract is entered into.
• Currency Options
Investors can hedge against foreign currency
risk by purchasing a currency option put or call.
• Currency Swaps
It is an interest rate swap where the two legs to
the swap are denominated in different currencies.
Non-Interest Income.
• Non-interest income is earned by providing a
variety of services, such as trading of
securities, assisting companies to issue new
equity financing, securities commissions and
wealth management, sale of land, building,
profit and loss on revaluation of assets.
•
Components of non interest income
The major components of non interest income
in India banking sector are as follows:
• Commission/ exchange and brokerage
• Profit or loss on Sale of investments
• Profit or loss Sale of land& buildings
• Profit/loss on revaluation of investments
• Profit or loss on Exchange transaction etc.
• Miscellaneous income source which includes
advisory, trading.
•
Leasing
•
Importance of Non
Interest Income
• Loan yields have fallen on a relative basis due to
credit scoring and increased competition
among lenders
• NIM is being squeezed, so banks must
concentrate more on non-interest income to
grow profits.
• Banks must rely less on net interest income and
more on non-interest income to be more
successful.
• The highest earning banks will be those that
generate an increasing share of operating
revenue from non-interest sources, like fee
income
• Largest contributors are deposit service charges
and other non-interest income
SBI Off Balance
Sheet Items
PNB Off Balance
Sheet Items
ICICI Off Balance
Sheet Items
DBOI Off Balance Sheet
Items
SBI Non Interest Income
Components
PNB Non Interest Income
Components
ICICI Non Interest Income
Components
DBOI Non Interest Income
Components
OBS/Total Assets
General Banking Trends with
regard to OBS
•
•
• Lower is better
• Operating Risk Ratio
•
•
•
•
•
• Lower is better because proportionally more
income comes from fees
SBI’s operating risk increase
in FY10
• Year-on-year, fee income was up 26.57%.
Lo w e fficie n cy ra tio s d o n o t a lw a ys le a d to h ig h e r R O E s
BASEL II Norms :
Provisioning for Off-balance sheet
items.
CREDIT CONVERSION FACTORS :
NON-MARKET OFF-BALANCE SHEET
ITEMS
CREDIT CONVERSION
FACTORS (contd)
CREDIT CONVERSION FACTORS FOR
MARKET RELATED OFF-BALANCE SHEET
ITEMS
M a rk to N o tio n a l
M a rke t Prin cip a l
Risks of OBS exposures
• Off balance sheets obligations in the Indian
banking system have grown exponentially- from
56% of balance sheet in 2004-05 to 106% in
2007-08. In new private banks, the growth has
been larger- from 173% to 301%.
• In the sub-prime crisis, contingent obligations are
at the root of banks' problems. There, the
exposures were mostly towards securitisation
vehicles and credit default swaps.
• In India, these obligations seem to be more in the
nature of forex derivatives. Banks abroad face
losses as a result of their exposures; Indian
banks are seeing an 'involuntary' expansion in
loans.
• From the banks disclosures, it appears that the
range of losses and/or provisions for private
banks is from 0.02 to 0.05 percent of total
contingent liabilities. However for the PSU State
Bank of India its only about 0.004 percent of
total contingent liabilities.
•
•
After effects of RBI’s
Measures
• Scheduled commercial banks reduced their off-
balance sheet exposure by 26.4 per cent during
2008-09, partly due to strengthening of
prudential norms by RBI.
• While foreign banks recorded 32 per cent
reduction in the off-balance sheet exposure,
public sector banks recorded 2.3 per cent
increase in the exposure
•
Conclusion