0506 banking operations 1

Banking Operations

Session Objectives

• Banking Scenario in India• Challenges the banking sector is facing• Basics of banking• Banking activities

April 11, 2023 Session - Banking 2

Definition of Banks• Banking Regulation Act, (BR Act), 1949 Section

5(c) defines a bank as 'a banking company is a company which transacts the business of banking in India.'

• Section 5(b) of the BR Act defines banking as, 'accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable, by cheque, draft, order or otherwise.’


Distinguishing features of Commercial Banks from other financial Institutions • maintaining deposit accounts including

current accounts, • issue and pay cheques, and • collect cheques for the bank customers



Maximise share holders wealth

GOALAmount of cash flows

Timing of cash flow

Risk of cash flow

• Credit risk• Interest rate risk• Liquidity risk• Operational risk• Capital risk• Fraud risk etc.

Constraints

• Market competition• Social constraints• Legal constraints

Source: Gup and Kolari (2005), Commercial Banking – Management of Risk, Wiley, 3 rd Ed.

Bank Goals and Constraints

Bank Risks• credit risk• interest rate risk• foreign exchange risk• equity/commodity price risk• liquidity risk • operational risks• compliance risk• strategic risk• reputation risk



Table: Indicators of financial soundness, 2012

Sr. No. Country Gross NPAs as % of gross advances CRAR (%)

Select advanced countries

1 Germany 3.0* 17.9

2 Japan 2.4 14.2

3 UK 4.0 15.7

4 USA 3.9 15.3

BRICS

5 Brazil 3.5 16.7

6 Russia 6.0 13.7

7 India 3.6 13.6

8 China 1.0 12.9

9 South Africa 4.0 15.8

EMEs

10 Indonesia 1.8 17.3

11 Korea 1.6 14.1

12 Mexico 2.4 16.0

13 Turkey 2.7 17.9CRAR: Capital to risk-weighted assets ratio.*: Data pertains to 2011.Source: IMF, Financial Soundness Indicators.


Table : Indicators of banking access

Item 2001 2011 2012

Households availing banking services (in per cent) 35.2 58.7 -

Population per bank branch (‘000) 15.6 13.3 12.5

No. of accounts per 1000 Population (credit) 51 100 106

No. of accounts per 1000 population (all deposits) 416 669 734

No. of accounts per 1000 population (savings deposits)

272 516 571

Per capita credit outstanding (` ‘000) 5.2 33.7 39.1

Per capita total deposits (` ‘000) 9.2 44.5 49.4

Source:RBI (for number of deposits accounts, credit accounts, credit outstanding, and deposits outstanding); Office of the Registrar General and Census Commissioner of India for population and households’ data.


Table : Select parameters of banking sector efficiency

Year-ended March

Return on assets (%)

Net Interest Margin (%)

Cost-income ratio (%)

Business per employee

(` lakh)*

Business per branch (` lakh)*

2001 0.54 3.1 25.9 2.1 34.7

2002 0.82 2.8 22.3 2.5 39.5

2003 1.05 2.9 22.1 2.8 43.0

2004 1.21 3.1 23.7 3.1 47.7

2005 0.97 3.1 26.1 3.5 53.6

2006 0.96 3.0 26.8 4.1 62.6

2007 1.00 2.9 24.0 4.6 68.6

2008 1.10 2.6 21.0 5.6 79.8

2009 1.10 2.6 19.2 6.5 90.1

2010 1.01 2.5 20.2 7.1 92.1

2011 1.06 2.9 21.6 7.7 99.5

2012 1.05 2.9 18.5 8.3 99.3

* At 2004-05 pricesNote: NIM refers to net interest income as per cent of average total assets.

RoA refers to net profits as per cent of average total assets.

Cost to income ratio is worked out as operating costs as per cent of total income.Source: Statistical Tables relating to Banks in India, various issues; Basic Statistical Returns of Scheduled Commercial Banks in India, RBI.

CAMEL for assessing banks• C – Capital Adequacy• A – Assets• M – Management Capability• E – Earnings• L – Liquidity also called asset liability

management• S – Sensitivity to market risk, especially interest

rate risk.


Bank Operations Performance • Effective planning to allocate personnel and

equipment for better utilization of limited resources

• Tighter control procedures to evaluate where improvements are possible – eg. Reduction in errors and rework

• Redesign of service/processes systems configuration to improve operations by reducing tasks/operations in providing financial services


Challenges for the Banking Sector• Asset quality – improve asset quality

• Efficiency parameters – reduce NPAs, enhance productivity, reduce

intermediation cost

• Additional capital requirements to comply with Basel III– To maintain a minimum leverage of 4.5 per cent of

Tier I capital

• New entrants and increased competition


Structure of Banking in India

• Regulator – RBI• Scheduled Banks – those included in the

second schedule of the RBI Act, 1934.• Non-scheduled Banks

http://www.allbankingsolutions.com/Links/List-of-Bank-in-India.shtml


Functions of RBI

• Acts as the currency authority• Controls money supply and credit• Manages foreign exchange• Serves as a banker to the government• Builds up and strengthens the country's financial

infrastructure• Acts as the banker of banks• Supervises banks



Break-up of Bank Branches

Source: Economic Survey 2010-2011, Government of IndiaApril 11, 2023 Session - Banking 16

Functions of Commercial Banks

• Payment System • Financial Intermediation• Financial Services


Payment System

A payment refers to the means by which financial transactions are settled. • issuing and paying cheques issued on behalf of customers. • Modern banking, also involves electronic banking, wire transfers, settlement of credit card transactions


Financial Intermediation

Banks take different types of deposits from customers and then lend these funds to borrowers•bank deposits represent the banks' liabilities•loans disbursed, and investments made by banks are their assets


Financial Services

Banks provide•investment banking,•insurance-related services, •government-related business,•foreign exchange businesses,•wealth management services etc.


Banking Processes• Account opening – Deposit and Loan• Income Services– Travellers Cheques and Forex– Mutual Funds– Bancassurance

• Payments• Service– Tellers– Customer service – lobby management

• Complaints and requests• Phone banking, internet banking, mobile banking• Monitoring and reporting• Back-office reconciliationsApril 11, 2023 Insurance - Session 3 21

Front office operations• Sales • Operations

– Cash • Receipt and Payment• Cash sorting (soiled and fit)• ATM handling

– Clearing • Collection of cheques• Entries made• Sent to service branch• Sent to clearing house• Sent to the concerned branch• Accounts debited or credited

– Fund transfer (NEFT, RTGS)• RTGS – Settlements of Rs. 2 lakhs and above – Settled in 2-3 hours• NEFT – Settlement of less than 2 lakhs – Settled in 48 hours


Basic Relationship between Banker and Customer

• The general relationship between the banker and the customer is that of a debtor and a creditor, i.e., borrower and lender.

• The respective positions being determined by the existing state of account.– On opening the account a banker assumes the position of a

debtor. – A depositor remains a creditor as long as his account carries a

credit balance. He does not get any charge over the assets of his debtor (bank) and remains an unsecured creditor of the bank.

• Banker’s relation with the customer is reversed as soon as the customer’s account is overdrawn.– Bankers are secured creditor of his customers.

April 11, 2023 Session - Banking23

Legal relationships of banker and customer• Agent and Principal – “Agent” a person employed to do any act for another

or to represent another in dealings with third persons “Principal”.

– Collection of cheques, Bills of Exchange, promisory notes, payment of insurance premiums, bills etc.

• Trustee and beneficiary– trustee is one to whom property is entrusted to be

administered for the benefit of another called the beneficiary.

– When a customer deposits securities or other valuables with the banker for safe custody


Legal relationships of banker and customer• Pawnee and Pawner: – pawn is a sort of bailment in which the goods are

delivered to another as a pawn, to be a security for money borrowed.

– The banker can retain the goods pledged till the debt is paid.

• Mortgagee and Mortgagor – Home loans, loans on other immovable property

• Lessee and Lessor– Safe deposit locker

• Guarantor and guarantee – – Letter of creditApril 11, 2023 Session - Banking 25

Bank Deposits• Demand deposits are defined as deposits payable

on demand through cheque or otherwise. Demand deposits serve as a medium of exchange, for their ownership can be transferred from one person to another through cheques and clearing arrangements provided by banks. They have no fixed term to maturity.

• Time deposits are defined as those deposits which are not payable on demand and on which cheques cannot be drawn. They have a fixed term to maturity


Categories of Accounts

• Current Account• Savings Bank Account• Term Deposit Account


Current Deposits• A current account is a form of demand-deposit, as the banker

is obliged to repay these liabilities on demand from the customer.

• Withdrawals from current accounts are allowed any number of times depending upon the balance in the account or up to a particular agreed amount.

• Current deposits are non-interest bearing.• A current account is a running and actively operated account

with very little restriction on the number and amount of drawings.

• Major objective of the a/c is to provide convenient operation facility via continuous liquidity.April 11, 2023 Session - Banking 28

Savings Bank Deposits• A form of demand deposits, which is subject to

restrictions on the number of withdrawals as well as on the amounts of withdrawals during any specified period.

• Minimum balances may be prescribed in order to offset the cost of maintaining and servicing such deposits.


Current a/c and Savings a/c (CASA) Deposits• CASA are low cost savings deposits compared to

other deposits. CA is non-interest bearing while SA is low interest bearing.

• Banks mobilise CASA by offering – Salary accounts, encouraging companies to open CA,

use cash management facilities etc.

• CASA deposits to total deposits is showing a gradual decline across all banks.


Term Deposits• A deposit received by the Bank for a fixed period,

after which it can be withdrawn.• Deposits include– Fixed Deposits – Reinvestment deposits– Recurring Deposits


Guidelines for opening and operating Deposit Account

• Due Diligence Process - KYC guidelines• Minimum Balance• Transparency• Eligibility• Requirement of PAN• Operation of joint account• Power of attorney• Closure/renewal of deposits• Nomination


Deposit related services• Customer Information• Interest Payments– Savings Bank Accounts– Term deposits– Tax deducted at source (TDS)

• Premature withdrawal of term deposit• Premature renewal of term deposit• Advances against deposits• Stop payment facility• Safe deposit lockers


Definition of NRI• As per the Foreign Exchange Management Act

(FEMA), 1999, an NRI means:• Non-Resident Indian National (i.e. Non-

resident Indian holding Indian passport), and• Persons of Indian Origin (i.e., Non-residents

holding foreign passports)


Services offered to Non-resident Indians • Non-resident Ordinary Accounts (NRO)• Non-resident (External) Rupee Accounts• Foreign Currency Non-resident Account

(Banks) FCNR(B)


Comparison of Deposit Schemes available to NRIsApril 11, 2023 Session - Banking 36

Deposit Insurance • Bank deposits are covered under the insurance

scheme offered by Deposit Insurance and Credit Guarantee Corporation of India (DICGC).

• DICGC is a subsidiary of RBI and is funded by RBI• All banks, including branches of foreign banks

functioning in India are insured by DICGC.• DICGC is liable if – A bank goes into liquidation– A bank is amalgamated/merged with another bank


Methods of Protecting Depositor Interest

There are two methods of protection when an insured bank fails

• By transferring business of the failed bank to another sound bank

• DICGC pays insurance proceeds to depositors.


Principles of Lending and Loan Policy• Principles of Lending– Safety– Liquidity– Profitability – Risk Diversification

• Loan Policy – lays down guidelines in these areas– Level of Credit-deposit ratio – Targeted portfolio mix– Hurdle ratings– Loan pricing– Collateral security


Loan PolicyCredit Policy Committee (CPC) approved by the Board of Directors of the

Bank• Loan policy outlines the lending guidelines and establishes operating

procedures for – credit management – standards for presentation of credit proposals, financial covenants,– rating standards and benchmarks, – delegation of credit approving powers, – prudential limits on large credit exposures, – asset concentrations, – portfolio management, – loan review mechanism, – risk monitoring and evaluation, – pricing of loans, – provisioning for bad debts, – regulatory/ legal compliance etc.


Credit Deposit Ratio: Quantum of credit that can be granted by the bank as a percentage of deposits available.

Targeted Portfolio Mix: Portfolio mix of different sectors based on the forecasts for growth and profitability for each sector.

Hurdle Rating: Risk rating system for the borrowers is prepared by the banks. For new borrowers, a bank lays down guidelines regarding the minimum rating to be achieved by the borrower to be eligible for loan. This is known as the ‘hurdle rating’ criterion for the borrower.


Pricing of loans• Pricing of a loan is dependent on the following– Credit risk of the borrower– cost of raising resources,– cost of administration and overheads,– cost of reserve assets like CRR and SLR, – cost of maintaining capital,– percentage of bad debt, etc. – Competition

Collateral Security – Working capital loans - physical and financial assets– Clear loans – personal guarantee of the borrower


Activities of Commercial Banks• Other basic banking activities– Foreign Exchange services– Provision of remittance facilities including issuance

of drafts, mail transfers and telegraphic transfers,– issuance of travellers cheques & gift cheques,– locker facility etc.

• Para-banking activities– Investment banking– selling mutual funds, insurance products – depository services, – wealth management services, brokerage, etc.April 11, 2023 Session - Banking 43

Other Basic Banking Activities• Foreign Exchange Services• Services to Government• Payment and Settlement Systems– Paper based clearing system - cheque, clearing

house, clearing operations– Electronic Payment System• RTGS, EFT, NEFT, Electronic Clearing Service (ECS),


Prevention of Money Laundering Act (PMLA), 2002The act requires the maintenance and reporting of the following

transactionsa) all cash transactions of the value of more than Rs 10 lakh or its

equivalent in foreign currency;b) all series of cash transactions integrally connected to each other

which have been valued below Rs 10 Lakh or its equivalent in foreign currency where such series of transactions have taken place within a month and the aggregate value of such transactions exceeds Rs 10 Lakh;

c) all cash transactions where forged or counterfeit currency notes or bank notes have been used as genuine and where any forgery of a valuable security or a document has taken place facilitating the transaction; and

d) all suspicious transactions whether or not made in cash April 11, 2023 Session - Banking 45

Asset Liability Management

Asset Liability Management is defined as the process of adjusting bank liabilities to meet loan demands, liquidity needs and safety requirements.


Reasons for growing significance of ALM -Volatility -Product Innovation -Regulatory Framework -Management Recognition An effective Asset Liability Management technique aims to manage the volume mix, maturity, rate sensitivity, quality and liquidity of assets and liabilities as a whole so as to attain a predetermined acceptable risk/reward ratio.

Liabilities of Bank

Sources of funds for lending and investing for the bank – Capital – Reserves and Surplus– Deposits– Borrowings– Other liabilities and provisions


Assets of Bank • Cash and bank balances with RBI• Balances with banks and money at call and

short notice• Investments• Advances• Fixed assets• Other assets


Pillars for ALM process • ALM information systems

– Management Information System– Information availability, accuracy, adequacy and expediency

• ALM organisation– Structure and responsibilities– Level of top management involvement

· ALM process– Risk parameters– Risk identification– Risk measurement– Risk management– Risk policies and tolerance levels.


ALM Information System

• Information system which provides accurate and adequate information

• Extensive computerisation


ALM Organisation• The Board of Directors would have the overall

responsibility for the ALM & risk management and should lay down the tolerance limits for liquidity and interest rate risk in line with the organization’s philosophy

• Asset Liability Committee (ALCO) is responsible for deciding on the business strategies consistent with the laid down policies and for operatinalising them. – Typically, ALCO consists of the senior management,

including the Chief Executive.


ALM Process

• Focuses on – liquidity and interest rate risk• Guidelines specify the use of a maturity ladder

upto 8 time buckets and calculation of cumulative surplus or deficit of funds at selected maturity dates


Gap Analysis

• Gap is the difference between the rate sensitive assets and the rate sensitive liabilities

• Time buckets


Trends in Modern Banking• Technology

– Internet Banking– Point of Sale (POS) Terminals

• Outsourcing of Services – Managing data centres,– Managing ATM networks– Call support services– Help desk support– Credit card processing– Cheque processing

• Financial Inclusion– No-frills account– Adoption of technonology


Thank you

Documents

0506 banking operations 1